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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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AMENDMENT NO. 1
TO
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 27, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NO. 0-21203
DIEDRICH COFFEE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 33-0086628
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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2144 MICHELSON DRIVE
IRVINE, CALIFORNIA 92612
(949) 260-1600
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE
AND TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the registrant's common stock held by
non-affiliates, based upon the closing sale price of the registrant's common
stock on April 7, 1999, as reported on the Nasdaq National Market, was
$15,874,826.
The number of shares of the registrant's common stock outstanding, as of
April 7, 1999, was 6,173,538.
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TABLE OF CONTENTS
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PAGE
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A Warning About Forward-Looking Statements.................. 1
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17
Item 7A. Quantitative and Qualitative Disclosures About Market
Price....................................................... 23
Item 8. Financial Statements and Supplementary Data................. 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 23
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 24
Item 11. Executive Compensation...................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 35
Item 13. Certain Relationships and Related Transactions.............. 37
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 38
Signatures.................................................. 41
Financial Statements........................................ F-1
Index to Exhibits........................................... S-1
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A WARNING ABOUT FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this document that are subject to
risks and uncertainties. These forward-looking statements include information
about possible or assumed future results of the company's financial condition,
operations, plans, objectives and performance. Additionally, when we use the
words "believe," "expect," "anticipate," "estimate" or similar expressions, we
are making forward-looking statements. Many possible events or factors could
affect our future financial results and performance. This could cause our
results or performance to differ materially from those expressed in our
forward-looking statements. You should consider these risks when you review this
document, along with the following possible events or factors:
- our growth strategy may not be as successful as we expect if we are
unable to attract franchise area developers or single store
franchisees;
- 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.
PART I
ITEM 1. BUSINESS.
OVERVIEW
Diedrich Coffee is a specialty coffee retailer that sells specialty brewed
coffee and espresso-based beverages such as cappuccinos, lattes, mochas and
espressos and various blended drinks through its 39 company-operated and 2
franchised retail locations in Southern California, Colorado and Texas. To
complement beverage sales, we also sell light food items, specialty whole bean
coffee and accessories at our retail locations. In addition to our retail
locations, we operate a coffee roasting facility located in Southern California
that provides 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.
Diedrich Coffee believes that as the specialty coffee market has matured,
distinct segments have emerged: espresso/coffee bars, coffeehouses and mall
coffee stores. Espresso/coffee bars offer limited seating to facilitate quick
customer turnover, are generally less than 1,200 square feet in size and are
usually located in densely populated urban areas. Coffeehouses are generally
greater than 1,200 square feet in size, located in suburban areas, and encourage
customers to linger and enjoy a more relaxed, comfortable atmosphere. Mall
coffee stores cater to mall consumers and place a heavier emphasis on the sale
of flavored whole bean coffee and coffee-related merchandise. Based on the
number of domestic retail coffee locations, Starbucks is the leader in the
espresso/coffee bar segment, Gloria Jean's is the leader in the mall coffee
store segment and there is presently no leader in the coffeehouse segment. Our
business objective is to 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.
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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.
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, 45% 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).
Diedrich Coffee believes that several factors have contributed to the
increase in demand for gourmet coffee including:
- greater consumer awareness of gourmet coffee as a result of its
increasing availability;
- increased quality differentiation over commercial grade coffees by
consumers;
- increased demand for all premium food products, including gourmet coffee,
where the differential in price from the commercial brands is small
compared to the perceived improvement in product quality and taste;
- ease of preparation of gourmet coffees resulting from the increased use
of automatic drip coffee makers and home espresso machines; and
- the decline in alcoholic beverage consumption.
The Specialty Coffee Association of America projects the number of
specialty coffee beverage outlets in the United States to increase to over
10,000 by the end of 1999. Diedrich Coffee believes that, despite the increase
in the number of specialty coffee stores, the market is highly fragmented and,
with the exception of Starbucks with less than 20% of the total retail
locations, remains relatively unbranded.
THE DIEDRICH COFFEEHOUSE CONCEPT
Diedrich Coffee's business objective is to be the leading specialty coffee
retailer in the coffeehouse segment. 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.
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A Diedrich coffeehouse experience is strongly influenced by three
components: ambiance, hospitality and coffee knowledge. Each component is made
up of the following elements that are unique to Diedrich Coffee:
Ambiance. Diedrich Coffee guest comments indicate taste superiority of
our products versus the competition. Moreover, surveys also indicate that
customers are not only loyal to a better, specialty cup of coffee, but also
to the ambiance provided by the comfortable surroundings designed into
every Diedrich coffeehouse. Our coffeehouses are specifically designed to
encourage guests to linger with friends and business associates, or to
relax alone in comfort. The architectural design of the Diedrich Coffee
prototype is a contemporary American interpretation of the European
colonial plantation style of the 1800's. Ample seating is augmented with
cozy sofas and comfortable chairs to create intimate nooks for meeting and
relaxing. A weekly entertainment schedule is provided to encourage patrons
to revisit on weekend evenings.
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.
GROWTH STRATEGY
In order to achieve Diedrich Coffee's objective to be the leading specialty
coffee company in the coffeehouse segment, Diedrich Coffee's 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
Diedrich Coffee's strategic plan emphasizes franchise area development in
markets outside of the core Orange County, California market. Our objective is
to expand our operations 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 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
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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.
Developing Company-Operated Retail Locations
Diedrich Coffee 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. Both the
Orange County and Phoenix markets have significant capacity for the addition of
more coffeehouses.
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
Diedrich Coffee has taken significant steps to build its 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
Diedrich Coffee evaluates potential acquisitions that may accelerate our
critical mass in existing or new markets. In particular, we look for acquisition
targets that may provide:
- improved stability of financial and business operations due to increased
cash flow and earnings;
- greater access to capital, distribution channels and coffee roasting
infrastructures; and
- decreased supply and distribution costs.
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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.
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 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.
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.
RETAIL LOCATIONS
Set forth below is a list of each of the retail locations of Diedrich
Coffee as of June 1, 1999, separated by the states in which they are located.
COFFEEHOUSES AND CARTS
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COMPANY-
LOCATION FRANCHISED OPERATED
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California...................................... 2 28
Colorado........................................ -- 7
Texas........................................... -- 4
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Total...................................... 2 39
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We currently operate through two 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 34 neighborhood
coffeehouses.
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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 7 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 Diedrich
Coffee company-operated coffeehouses:
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Beverages................................................... 73%
Coffee beans................................................ 6%
Food items.................................................. 19%
Accessories and clothing.................................... 2%
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Total............................................. 100%
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Franchise Operations
Diedrich Coffee's current franchise agreements require franchisees to
purchase all of their coffee from us. 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.
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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
Our marketing strategy is to differentiate Diedrich Coffee and to build a
strong brand identity primarily utilizing the coffeehouse model. The wholesale
division and the office coffee service help ensure the visibility of the brand,
but the core of this business is the coffeehouse. We implement this strategy at
the coffeehouse level by promoting the distinctive qualities of the various
Diedrich Coffee products, educating customers about the origins of coffee,
including the private estate coffees and roasts and delivering excellent
customer service in a cozy, comfortable atmosphere. Our marketing efforts are
based upon the belief that the proprietary roast recipes and our commitment to
quality and freshness deliver a distinctive advantage in the coffee product. A
steady introduction of new coffee and coffee-related drinks is an intrinsic
aspect of our marketing strategy.
To date, we have relied primarily upon the high visibility of our real
estate locations, word-of-mouth, public relations, local store marketing and the
inviting atmosphere of our coffeehouses to drive growth. 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.
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 characteris-
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tics and flavor of the varieties available from each region of the world. The
background and experience of our personnel allows Diedrich Coffee to maintain
its commitment to serve and sell only the highest quality coffee.
During the buying season, we may enter into forward commitments for the
purchase of more than a dozen different types of coffee, plus specially featured
coffees, that may only be available in small quantities. Rotating our coffee
selection enables us to provide our customers with a wider variety of coffees,
as well as certain coffees that are available only on a seasonal basis. We
contract for future delivery of green coffee to help ensure adequacy of supply
and typically maintain a minimum six-week supply of each variety of whole beans
then available.
Roasting
Diedrich Coffee employs a roasting process that varies based upon the
variety, quality, origin and physical characteristics of the coffee beans being
roasted. We utilize recipes and techniques that have been developed over three
generations to bring out the best characteristics of the coffee during the
roasting process and to develop the optimal flavor conditions that a coffee has
to offer. This approach differentiates Diedrich Coffee from commercial coffee
producers and other specialty producers employing uniform roasting processes
that do not differentiate between the types of coffee being roasted.
Diedrich Coffee's master roasters, 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.
Freshness
Diedrich Coffee is committed to serving its 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.
The systems used in Diedrich Coffee's corporate offices provide financial
reporting that includes performance comparisons of actual, budget and prior year
results by period and year-to-date, statistical recaps and 12 month reports.
This information allows management to measure store performance based on sales,
cost of sales, labor and store expenses on a timely basis.
COMPETITION
The specialty coffee market is intensely competitive and highly fragmented.
With low barriers to entry, competition in the industry is expected to increase
from national and regional chains, franchise operators and local specialty
coffee stores. Diedrich Coffee competes directly against all other premium
coffee roasters,
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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 may also be affected by factors
such as traffic patterns and the type, number and proximity of competing
coffeehouses. 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 in particular.
INTELLECTUAL PROPERTY
Diedrich Coffee owns 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.
EMPLOYEES
As of June 1, 1999, Diedrich Coffee employed a work force of 800 persons,
117 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.
GOVERNMENT REGULATION
In addition to the laws and regulations relating to the food service
industry, Diedrich Coffee is subject to Federal Trade Commission, or FTC,
regulation and state laws that regulate the offer and sale of franchises as well
as the franchise relationship.
The FTC's Trade Regulation Rule relating to Disclosure Requirements and
Prohibitions Concerning Franchising and Business Opportunity Ventures generally
requires us to give prospective franchisees a franchise offering circular
containing information prescribed by the rule.
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<PAGE> 12
A number of states have laws that regulate the offer and sale of franchises
and the franchisor-franchisee relationship. These laws generally require
registration of the franchise offering with state authorities before making
offers or sales and regulate the franchise relationship by, for example:
- prohibiting interference with the right of free association among
franchisees;
- prohibiting discrimination in fees and charges;
- regulating the termination of the relationship by requiring "good cause"
to exist as a basis for the termination, advance notice to the franchisee
of the termination, and an opportunity to cure a default;
- requiring repurchase of inventories in some circumstances;
- restricting nonrenewal by the franchisor;
- limiting restrictions on transfers or inheritance of the franchisee's
interests; and
- regulating placement of competing units that might adversely affect the
franchisee's results.
Failure to comply with these laws may adversely affect us.
Any changes to the FTC rule or state franchise laws, or future court or
administrative decisions, however, could affect our franchise business.
There are also extensive federal, state and local government regulations
relating to the development and operation of food service outlets, including
laws and regulations relating to:
- building and seating requirements;
- the preparation and sale of food;
- cleanliness;
- safety in the workplace; and
- accommodations for the disabled.
Our relationship with our employees is also subject to regulation, such as:
- minimum wage requirements;
- anti-discrimination laws;
- overtime and working conditions; and
- citizenship requirements.
RISK FACTORS AND TRENDS AFFECTING DIEDRICH COFFEE AND ITS BUSINESS
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. Our growth strategy
contemplates franchise area development for additional Diedrich coffeehouses as
well as opening new company-operated coffeehouses. In addition, we plan to
strive to increase wholesale sales. Implementation of our growth strategy may
divert management's attention from other aspects of our business and place a
strain on management, operational and financial resources, and accounting
systems. Our continued growth will require us to:
- attract franchise area developers for Diedrich Coffee in the United
States and internationally;
- expand wholesale sales;
- evaluate the potential acquisition of complementary coffee retailers;
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<PAGE> 13
- 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 net losses of $2,562,000, $9,113,000, and $986,000 for the fiscal
years ended January, 1999, 1998 and 1997, respectively. We expect to sustain net
losses for the foreseeable future. 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 "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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 and cost of coffeehouse 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
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<PAGE> 14
the foregoing, we believe that period-to-period comparisons of our operating
results are not necessarily meaningful and such comparisons should not be relied
upon as indicators of future performance. From time to time in the future, our
operating results likely will fall below the expectations of investors and
public market securities analysts. Quarterly fluctuations, for any reason, could
cause our stock price to decline.
In addition, our business is subject to seasonal fluctuations. The December
holiday season generally experiences the highest sales. Hot weather tends to
depress sales of hot coffee and espresso drinks, especially unseasonably warm
weather. Consequently, we will continue to experience significant fluctuations
in quarterly results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Seasonality and Quarterly Results."
The loss of key personnel or our inability to attract and retain qualified
personnel could significantly disrupt our business
Our continued success largely will depend on the efforts and abilities of
our executive officers and other key employees, 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.
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.
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,
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<PAGE> 15
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 may also be affected by factors
such as traffic patterns and the type, number and proximity of competing
coffeehouses. 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 in particular.
Our lack of diversification may affect business if demand is reduced
Our business is primarily centered on one product: fresh premium
custom-roasted coffee. To date, our operations have been limited to primarily
the purchase and roasting of green coffee beans and the sale of whole bean
coffee, coffee beverages and espresso drinks through our coffeehouses and our
wholesale coffee and mail order businesses. Any decrease in demand for coffee
would have a material adverse effect on our business, operating results and
financial condition.
Our company-operated retail locations are concentrated in the western
region of the United States, and therefore our business is subject to
fluctuations if adverse business conditions occur in that region
Our company-operated retail locations are primarily located in the western
region of the United States. Accordingly, we are susceptible to fluctuations in
our business caused by adverse economic or other conditions in this region,
including natural or other disasters. In addition, some of our competitors have
many more retail locations than we do. Consequently, adverse economic or other
conditions in a region, a decline in the profitability of several existing
retail locations or the introduction of several unsuccessful new retail
locations in a geographic area could have a more significant effect on our
results of operations than would be the case for a company with a larger number
of retail locations or with more geographically dispersed retail locations.
Our supply costs may be higher than we expect because of fluctuations in
availability and cost of unroasted coffee
Increases in the price of green coffee, or the unavailability of adequate
supplies of green coffee of the quality we seek, whether due to the failure of
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.
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RECENT DEVELOPMENTS
On March 16, 1999, we agreed to acquire Coffee People, Inc. 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
from Diedrich Coffee in the aggregate:
- $17.75 million in cash;
- 1.5 million shares of Diedrich Coffee common stock; and
- $5.25 million in cash or shares of Diedrich Coffee common stock,
depending on the success of an equity offering or other type of financing
by Diedrich Coffee.
The acquisition is subject to a number of conditions, including securing
financing, obtaining regulatory and stockholder approval and completing the
acquisition by July 15, 1999. We expect to complete the acquisition before July
15, 1999.
After the completion of the acquisition, we anticipate the combined company
will have annual system-wide sales of more than $150 million through 361 retail
locations in 38 states and 7 countries. The combined company's brands will
include Diedrich Coffee, Coffee People, Coffee Plantation and the Gloria Jean's
mall coffee stores.
Following the acquisition, Coffee People and Coffee Plantation coffeehouses
will be converted into Diedrich coffeehouses. By virtue of the acquisition, we
will acquire significant additional roasting capacity, packaging and
distribution capabilities and valuable infrastructure and management expertise.
We expect to realize some cost savings after the acquisition through greater
efficiencies. However, no assurance can be provided as to the extent, if any, of
savings. The combined company should facilitate further franchise area
development.
ITEM 2. PROPERTIES.
Diedrich Coffee leases approximately 25,000 square feet of office space for
administrative offices, warehousing, roasting and training facilities in Irvine,
California. The lease for this facility expires in October 2000, with an option
for one additional five-year term. As of January 27, 1999, we were also a party
to various leases for a total of 45 retail locations, including 36 operating
coffeehouses, 2 subleased units and 7 carts. We converted and subleased two
retail locations to a franchisee after the year ended January 27, 1999. This was
part of a signed area development agreement that also includes the addition of
48 more locations throughout the San Diego area. We closed 2 retail locations
and the Denver warehouse in fiscal 1999 and 11 retail locations in fiscal 1998
of which 9 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.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of our business, we may become involved in legal
proceedings from time-to-time. As of January 27, 1999, we were not a party to
any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders during the
fourth quarter of the year ended January 27, 1999.
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<PAGE> 17
PART II
ITEM 5.MARKET FOR DIEDRICH COFFEE'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Diedrich Coffee common stock is reported on the Nasdaq National Market
under the symbol "DDRX." The following table sets forth the high and low bid
information for the quarterly periods indicated for our common stock as reported
on the Nasdaq National Market since January 30, 1997.
<TABLE>
<CAPTION>
PRICE RANGE
----------------
PERIOD HIGH LOW
------ ------ ------
<S> <C> <C>
FISCAL YEAR ENDED JANUARY 28, 1998
First Quarter............................................. $8 3/4 $2 3/8
Second Quarter............................................ 4 2 1/2
Third Quarter............................................. 4 1/16 2 7/16
Fourth Quarter............................................ 9 2 3/4
FISCAL YEAR ENDED JANUARY 27, 1999
First Quarter............................................. $8 $5 11/16
Second Quarter............................................ 8 1/4 6 9/16
Third Quarter............................................. 7 1/4 3 3/8
Fourth Quarter............................................ 6 1/2 3 7/8
</TABLE>
At April 7, 1999, there were 6,173,538 shares outstanding and 147
stockholders of record of Diedrich Coffee common stock. Diedrich Coffee has not
paid dividends on its common stock and does not anticipate paying dividends in
the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA.
The following five-year selected financial data may not be indicative of
Diedrich Coffee's future results of operations and should be read in conjunction
with "Item 7. Management's Discussion and Results of Operations" and our
consolidated financial statements and related notes.
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
JANUARY 27, JANUARY 28, JANUARY 29, JANUARY 31, JANUARY 31,
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Retail............................... $21,248 $20,760 $18,118 $ 8,879 $6,673
Wholesale and other.................. 2,767 2,222 1,694 1,365 918
Franchise revenue.................... 200 -- -- -- --
------- ------- ------- ------- ------
Total........................... 24,215 22,982 19,812 10,244 7,591
------- ------- ------- ------- ------
Cost and expenses:
Cost of sales and related occupancy
costs.............................. 10,955 11,458 9,263 4,409 3,164
Store operating expenses............. 8,936 10,448 8,280 3,520 2,584
Other operating expenses............. 634 290 240 277 282
Depreciation and amortization........ 1,941 1,785 1,054 354 255
Provision for asset impairment and
restructuring costs................ -- 3,902 -- -- --
General and administrative
expenses........................... 4,014 4,006 2,003 1,335 851
------- ------- ------- ------- ------
Total........................... 26,480 31,889 20,840 9,895 7,136
------- ------- ------- ------- ------
Operating income (loss)................... (2,265) (8,907) (1,028) 349 455
Interest expense and other, net........... (293) (205) (86) (34) (78)
------- ------- ------- ------- ------
Income (loss) before income taxes......... (2,558) (9,112) (1,114) 315 377
Income tax provision (benefit)............ 4 1 (128) 129 53
------- ------- ------- ------- ------
Net income (loss)......................... $(2,562) $(9,113) $ (986) $ 186 $ 324
======= ======= ======= ======= ======
Basic income (loss) per common share(1)... $ (.43) $ (1.69) $ (.22)
======= ======= =======
Diluted income (loss) per share........... $ (.43) $ (1.69) $ (.22)
======= ======= =======
Pro forma net income per share(2)......... $ .06
=======
BALANCE SHEET DATA:
Working capital (deficiency)............ $ (655) $ (959) $ 1,949 $ (53) $ (418)
Total assets............................ 12,736 13,948 17,471 5,316 2,503
Long-term debt and long-term
obligations, less current portion.... 2,783 2,817 -- 829 471
Total stockholders' equity.............. 6,027 6,835 14,898 3,304 973
</TABLE>
- ---------------
(1) Net income (loss) per share for periods before the year ended January 31,
1996 is not presented due to the noncomparable capital structure. Net loss
per share for fiscal 1999, 1998 and 1997 is presented as basic earnings per
share under the provisions of SFAS 128.
(2) Pro forma net income per share is computed by dividing net income by the
weighted average number of common and common equivalent shares outstanding
during the respective period, assuming the conversion of the series A and
series B preferred stock into common stock as of the date of issuance.
Dividends on the series A and series B preferred stock have been excluded
from the computation since the preferred stock has been assumed to have been
converted to common stock.
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ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Effective February 1, 1996, Diedrich Coffee changed its fiscal year end
from January 31 to a fiscal year ending on the Wednesday nearest January 31. In
connection with the change in fiscal year end, we began reporting quarterly
results in thirteen-week periods. Before the change in fiscal year end, our
quarterly periods included twelve weeks, except for the fourth quarter, which
had approximately sixteen weeks. References to fiscal 1999 refer to the fiscal
year ended January 27, 1999, references to fiscal 1998 refer to the fiscal year
ended January 28, 1998 and references to fiscal 1997 refer to the fiscal year
ended January 29, 1997. Following the merger with Coffee People, Diedrich Coffee
intends to change its 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
closures as well as provisions for other
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contingencies resulted in additional operating expenses of approximately $1.7
million in the fourth quarter of fiscal 1998.
According to Diedrich Coffee's strategic plan, the roasting facility in
Denver, Colorado was closed in the first quarter of fiscal 1999 and roasting was
consolidated in Southern California. We also closed an under-performing store in
San Diego, California and one in Denver, Colorado. Four coffee cart locations at
premium Irvine Office Company locations were opened in the first quarter of
fiscal 1999. Additional coffee cart and kiosk locations are under consideration
and in discussion with the Irvine Office Company and similar commercial property
managers, but no assurances can be given as to when or how many more coffee
carts may be installed. We recruited several senior level executives during
fiscal 1999 as part of our strategic growth plan in the areas of finance,
marketing and franchise development.
Management undertook several steps to ensure that the base business was
operating well before initiating the franchising sales program. It upgraded the
quality of the store management teams and then undertook a program to retrain
every Diedrich 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.
FRANCHISE AREA DEVELOPMENT AGREEMENTS
Management's franchise area development goal is to enter into franchise
area development agreements covering most major U.S. markets. On September 16,
1998, Diedrich Coffee announced its first franchise area development agreement,
which calls for the development of 44 coffeehouses and an undisclosed number of
carts and kiosks in the state of North Carolina over a five year period. In
connection with the signing of this agreement, we recorded and collected area
development fee income of $100,000. On November 16, 1998, we announced our
second franchise area development agreement, which provides for the development
of 50 coffeehouses and an undisclosed number of carts and kiosks in San Diego,
Palm Springs and Temecula, California over the next five years. This franchise
area development agreement includes a one-year option to begin development of 45
coffeehouses in Arizona. In connection with the signing of this agreement, we
recorded area development fee income of $100,000 and a note receivable for
$100,000. 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
wholesale sales grew to
18
<PAGE> 21
$2,222,000, an increase of 31.1% from the prior year. The new management team
focused on continued sales growth in the wholesale sales division in fiscal 1999
and delivered improved results: $2,767,000 in total sales, an increase of 24.5%
from fiscal 1998. In fiscal 1999, the wholesale division placed its emphasis on
upgrading coffee consumed at chain restaurants. As a result, we added regional
divisions of a number of well-known restaurant groups as wholesale customers
such as: Islands Restaurants, Inc., Ruth's Chris Steakhouses (California/Arizona
locations), El Torito, Claim Jumper and Island Restaurants.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to total sales,
unless otherwise indicated, of certain items included in Diedrich Coffee's
statements of income for the years indicated:
<TABLE>
<CAPTION>
YEAR YEAR YEAR
ENDED ENDED ENDED
JANUARY 27, JANUARY 28, JANUARY 29,
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Retail.................................................. 87.8% 90.3% 91.4%
Wholesale and Other..................................... 11.4 9.7 8.6
Franchise revenues...................................... 0.8 -- --
----- ----- -----
Total........................................... 100.0% 100.0% 100.0%
----- ----- -----
Cost and Expenses:
Cost of sales and related occupancy costs............... 45.2% 49.9% 46.8%
Store operating expenses(1)............................. 41.7 50.3 45.7
Other operating expenses(2)............................. 22.9 13.0 14.2
Depreciation and amortization........................... 8.0 7.8 5.3
Asset impairment and restructuring costs................ -- 17.0 --
General and administrative expenses..................... 16.6 17.4 10.1
Operating (loss) income................................... (9.4) (38.8) (5.2)
Interest expense.......................................... (1.6) (0.8) (1.0)
Interest and other (expense) income....................... 0.4 (0.1) 0.5
----- ----- -----
Loss before income taxes.................................. (10.6) (39.6) (5.6)
----- ----- -----
Income tax provision (benefit)............................ -- -- (0.6)
----- ----- -----
Net (loss) income......................................... (10.6)% (39.7)% (5.0)%
===== ===== =====
</TABLE>
- ---------------
(1) As a percentage of revenues from retail operations and franchise operations.
(2) As a percentage of revenues from wholesale operations.
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
19
<PAGE> 22
prices and other efficiencies gained at the coffeehouse level. Interactive
training programs were developed during fiscal 1999 covering guest satisfaction
and product training. These programs assisted management in scrutinizing and
reducing the cost of sales. This reduction more than offset the impact of
increased occupancy costs and an increase in the percentage of total revenues
contributed by wholesale sales.
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.
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
20
<PAGE> 23
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
Diedrich Coffee had a working capital deficit, as of January 27, 1999, of
$655,000 compared to $959,000 at January 28, 1998. Cash used in operating
activities totaled $351,000 for fiscal 1999 as compared to $2,489,000 for fiscal
1998.
Net cash used in investing activities for fiscal 1999 totaled $1,523,000,
which consisted entirely of capital expenditures for property and equipment. Net
cash provided by financing activities for fiscal 1999 totaled $1,667,000. This
consists of the net proceeds from the issuance of common stock and stock options
exercised.
On March 30, 1998, we agreed to a private placement of 200,000 shares of
our common stock to Franchise Mortgage Acceptance Company, or the FMAC, at a
price of $6.375 (the stock's closing sale price for that day on the Nasdaq
National Market). In addition, the FMAC also received an option to purchase
100,000 additional shares of our common stock. This option may be exercised in
increments of 25,000 shares or more and expires on April 3, 2000. The exercise
prices of this option are as follows: 50,000 shares are exercisable at $10.00
per share and $12.50 per share, respectively. We completed this transaction on
April 3, 1998.
21
<PAGE> 24
We announced on April 14, 1998 that we were in the process of obtaining a
financing from FMAC to meet its expected capital requirements. After extensive
discussions, we determined that the structure required by FMAC was not in our
best interest. In anticipation of this possible outcome, we engaged an
investment banker in November 1998 to seek alternative sources of capital.
On April 6, 1999, Diedrich Coffee entered into a $1,000,000 loan agreement
and security agreement with Amre Youness, a former director of Diedrich Coffee.
All outstanding principal and interest is due and payable on April 6, 2000. The
loan is secured by our assets with interest accruing and paid monthly at the
prime rate plus 3%. In connection with the loan agreement, we issued warrants to
Mr. Youness to purchase 70,000 shares of our common stock at a price of $5.625
per share.
We believe that cash from operations and the additional loan described
above will be sufficient to satisfy our working capital needs at the anticipated
operating levels for the next twelve months. However, if the proposed merger
with Coffee People is completed, additional capital will be required to finance
the cash portion of the payment to the Coffee People stockholders and to pay
related fees and expenses. See "Item 1. Business -- Recent Developments."
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 issues SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" was issued. This statement established
standards for derivative instruments and for hedging activities and requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. We have no
instruments or transactions subject to this statement.
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
22
<PAGE> 25
expenditures related to the upgrade of the information systems are expected to
cost less than $20,000. As of January 27, 1999, we had incurred and expensed
approximately $34,000 of expenditures consisting of internal staff costs,
outside consulting and other expenditures related to this upgrade process. These
costs are being funded through operating cash flows. To the extent possible, we
will be developing and executing contingency plans designed to allow continued
operation in the event of failure of our or third parties' computer information
systems.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
DERIVATIVE INSTRUMENTS
Diedrich Coffee does not and did not invest in market risk sensitive
instruments in fiscal 1999. From time to time, we enter into agreements to
purchase green coffee in the future at prices to be determined within two to
twelve months of the time of actual purchase. At January 27, 1999, these
commitments totaled $1,135,000. These agreements are tied to specific market
prices, defined by both the origin of the coffee and the month of delivery, but
we have significant flexibility in selecting the date of the market price to be
used in each contract. We do not use commodity based financial instruments to
hedge coffee or any other commodity, as we believe there will continue to be a
high probability of maintaining a strong correlation between increases in green
coffee prices and the final selling prices of our products.
We do not and have not used derivative financial instruments for any
purpose, including hedging or mitigating interest rate risk.
MARKET RISK
Diedrich Coffee's market risk exposure with regard to financial instruments
is to changes in the "prime rate" in the United States. We borrowed $2,500,000
at the prime rate plus 3 1/2% and $1,000,000 at the prime rate plus 3%. At
January 27, 1999, a hypothetical 100 basis point increase in the prime rate
would result in additional interest expense of $25,000 on an annualized basis.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required by this item are
set forth at the end of this annual report on Form 10-K beginning on page F-1.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
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<PAGE> 26
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Diedrich Coffee's directors, executive officers and other key employees,
and their ages as of January 27, 1999, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION(S) HELD
---- --- ----------------
<S> <C> <C>
John E. Martin.......... 53 Chairman of the Board and Director
Timothy J. Ryan......... 59 President, and Chief Executive Officer and Director
Martin R. 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)........
Ann Wride............... 37 Vice President and Chief Financial Officer
Dolf Berle.............. 36 Vice President of Franchise Development and Operations
Catherine Saar.......... 39 Vice President of Marketing and Wholesale Sales
</TABLE>
- ---------------
(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 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
24
<PAGE> 27
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.
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.
BOARD COMMITTEES AND MEETINGS
Diedrich Coffee's board of directors has standing compensation and audit
committees. We do not have a standing nominating committee. Instead, the board
acts as a committee of the whole with respect to nominations for membership on
the board. The members of each committee and the functions performed thereby are
described below:
Audit Committee. The audit committee of the board currently consists of Mr.
Churm, Mr. Heeschen and Mr. Goelman, each of whom have been a member of the
audit committee since its formation. The audit committee reviews the results and
scope of the audit and other services provided by our independent auditors,
reviews and evaluates our internal control functions and monitors transactions
between Diedrich Coffee and its employees, officers and directors.
Compensation Committee. The compensation committee of the board consists of
Messrs. Churm, Goelman and Heeschen. The compensation committee administers our
stock option plans and sets compensation levels for our executive officers.
During our fiscal year ended January 27, 1999, there were five meetings of
the board of directors, one meeting of the audit committee and one meeting of
the compensation committee. While a director, each of the current board members
attended 100% of the meetings of the board of directors and meetings of the
committees on which he served during such period.
DIRECTORS' COMPENSATION
Directors who are also employees of Diedrich Coffee receive no extra
compensation for their service on the board. Non-employee directors receive
reimbursement for out-of-pocket expenses incurred in attending board meetings
and receive stock option grants under our 1996 Non-Employee Directors Stock
Option Plan.
Under our non-employee directors plan, each non-employee director
automatically receives, upon becoming a director, a one-time grant of an option
to purchase up to 10,000 shares of Diedrich Coffee common stock. These initial
options will vest and become exercisable with respect to 50% of the underlying
shares upon the earlier of (1) the first anniversary of the grant date or (2)
immediately before the first annual
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<PAGE> 28
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.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the securities laws of the United States, the directors and officers
of Diedrich Coffee and persons who own more than 10% of our equity securities
are required to report their initial ownership of our equity securities and any
subsequent changes in that ownership to the Commission and the Nasdaq National
Market. Specific due dates for these reports have been established, and we are
required to disclose in this document any late filings during the fiscal year
ended January 27, 1999. To our knowledge, based solely on our review of the
copies of such reports required to be furnished to the company during the fiscal
year ended January 27, 1999, all of these reports were timely filed.
26
<PAGE> 29
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth certain information with respect to
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 $105,519 54,000
Vice President of Franchise Development and Operations 1998 -- --
1997 -- --
</TABLE>
- ---------------
(1) Mr. Martin was appointed Chairman of the Board on November 17, 1997.
Accordingly, he did not earn or receive any compensation from Diedrich
Coffee before fiscal 1998.
(2) Mr. Ryan was appointed President and Chief Executive Officer on November 17,
1997. Accordingly, he did not earn or receive any compensation from Diedrich
Coffee before fiscal 1998.
(3) Ms. Wride joined Diedrich Coffee as Vice President and Chief Financial
Officer in April 1998. Accordingly, she did not earn or receive any
compensation from Diedrich Coffee until fiscal 1999.
(4) Mr. Berle joined Diedrich Coffee as Vice President of Franchise Development
in May 1998. Accordingly, he did not earn or receive any compensation from
Diedrich Coffee until fiscal 1999.
27
<PAGE> 30
STOCK OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options granted
to the following executive officers during the fiscal year ended January 27,
1999.
<TABLE>
<CAPTION>
POTENTIAL
PERCENT OF REALIZABLE VALUE AT
TOTAL ASSUMED ANNUAL RATES
NUMBER OF OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES EXERCISE TERM(1)
OPTIONS IN FISCAL PRICE EXPIRATION -----------------------
NAME GRANTED(#) YEAR ($/SHARE) DATE 5%($) 10%($)
---- ---------- ---------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
John E. Martin..................... -- -- -- -- -- --
Timothy J. Ryan.................... -- -- -- -- -- --
Martin R. Diedrich(2).............. 4,000 2.1% $7.00 6/23/08 $ 16,209 $ 41,825
Ann Wride(3)....................... 50,000 25.9 5.81 3/25/08 168,169 433,932
4,000 2.1 7.00 6/23/08 16,209 41,825
Dolf Berle(4)...................... 50,000 25.9 6.25 3/23/08 180,905 466,795
4,000 2.1 7.00 6/23/08 16,209 41,825
</TABLE>
- ---------------
(1) The potential realizable values listed are based on an assumption that the
market price of Diedrich Coffee common stock appreciates at the stated rate,
compounded annually, from the date of grant to the expiration date. The 5%
and 10% assumed rates of appreciation are determined by the rules of the
Commission and do not represent our estimate of the future market price of
our common stock.
(2) All of Mr. Diedrich's options were granted pursuant to the 1996 Stock
Incentive Option Plan, which was approved by our board of directors on June
23, 1998.
(3) 50,000 of Ms. Wride's options were granted pursuant to her employment letter
dated April 8, 1998, the terms of which are described under "-- Employment
Agreements and Compensatory Arrangements." 4,000 of Ms. Wride's options were
granted pursuant to the 1996 Stock Incentive Option Plan.
(4) 50,000 of Mr. Berle's options were granted pursuant to her employment letter
dated April 8, 1998, the terms of which are described under "-- Employment
Agreements and Compensatory Arrangements." 4,000 of Mr. Berle's options were
granted pursuant to the 1996 Stock Incentive Option Plan.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth information concerning the number and value
of unexercisable options held by the following executive officers on January 27,
1999. None of these executive officers exercised any stock options during fiscal
year 1999.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
FISCAL YEAR END(#) FISCAL YEAR END($)(1)
------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE(2) EXERCISABLE UNEXERCISABLE(2)
---- ----------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C>
John E. Martin........................ 550,000 300,000 $198,000 --
Timothy J. Ryan....................... 250,000 350,000 47,000 --
Martin Diedrich....................... -- 4,000 -- --
Ann Wride............................. -- 54,000 -- --
Dolf Berle............................ -- 54,000 -- --
</TABLE>
- ---------------
(1) These amounts represent the difference between the exercise price of the
in-the-money options and the market price of Diedrich Coffee common stock on
January 27, 1999. The closing price of our common stock on that day on the
Nasdaq National Market was $4.44. Options are in-the-money if the market
value of the shares covered thereby is greater than the option exercise
price.
(2) Future exercisability is subject to a number of factors, including, but not
limited to, the optionee remaining employed by Diedrich Coffee.
28
<PAGE> 31
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 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
29
<PAGE> 32
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.
Diedrich Coffee 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 the
other directors and executive officers of Diedrich Coffee; and (3) to reimburse
Mr. Martin for reasonable legal and accounting fees incurred in connection with
the negotiation and execution of the agreement in an amount not to exceed
$10,000. Finally, the agreement recognizes that Mr. Martin's other business
interests relate to restaurants and provides that we waive any rights or claims
to other business opportunities involving the restaurant business which may
become available to Mr. Martin, other than opportunities involving the
coffeehouse business or other businesses in which the principal activity
involves the sale of coffee and coffee beverages.
On November 17, 1997, Mr. Martin also entered into a stock option plan and
agreement with Diedrich Coffee. 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 common stock for the
purpose of encouraging and rewarding Mr. Martin's contributions to the
performance of Diedrich Coffee 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:
(1) 450,000 shares of common stock at an exercise price of $4.00 per share;
(2) 100,000 shares of common stock at an exercise price of $5.00 per share;
(3) 150,000 shares of common stock at an exercise price of $8.00 per share;
and
(4) 150,000 shares of common stock at an exercise price of $10.00 per
share.
All of the options granted to Mr. Martin become exercisable on the earlier
of May 15, 2002 or as soon as the closing price of our common stock on the
Nasdaq National Market exceeds the respective exercise price for at least seven
trading days in any period of ten consecutive trading days. All options are to
terminate if unexercised on November 17, 2002 or, if Mr. Martin resigns from
Diedrich Coffee or we terminate Mr. Martin's employment for cause, the options
will become unexercisable within sixty days. Only Mr. Martin is eligible to
receive options under his option agreement and the options are not transferable
or assignable. Subject to the discretion of the compensation committee of the
board, 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
30
<PAGE> 33
other business expenses incurred in connection with the performance of services
under the agreement, and the payment of a monthly car allowance of $600. 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
Diedrich Coffee 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 Diedrich Coffee 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:
(1) 50,000 shares of common stock at an exercise price of $3.50 per share;
(2) 75,000 shares of common stock at an exercise price of $4.50 per share;
(3) 125,000 shares of common stock at an exercise price of $5.00 per share;
(4) 175,000 shares of common stock at an exercise price of $8.00 per share;
and
(5) 175,000 shares of common stock at an exercise price of $10.00 per
share.
The options become exercisable on the earlier of May 15, 2002 or upon the
satisfaction of two conditions: (1) the options having vested pursuant to a
vesting schedule set forth in the agreement and (2) after the date of the
agreement, the closing price of the common stock on the Nasdaq National Market
shall have exceeded the option price per share for at least seven trading days
in any period of ten consecutive trading days. All options are to terminate if
unexercised on November 17, 2002 or, if Mr. Ryan resigns from Diedrich Coffee
without good cause or we terminate Mr. Ryan's employment for cause, the options
will become unexercisable within sixty days. Only Mr. Ryan is eligible to
receive options under the his option agreement and the options are not
transferable or assignable. Subject to the discretion of the compensation
committee of the board, 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 our 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 common stock at an exercise price of $5.8125, vesting over
two years. Ms. Wride receives employee benefits consistent with Diedrich
Coffee's policies from other senior executives.
Dolf Berle
In April 1998, Dolf Berle entered into an employment agreement with
Diedrich Coffee appointing him Vice President of Franchise Development. The
agreement provides for a base salary of $155,000 per annum
31
<PAGE> 34
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 Diedrich Coffee's policies from other senior
executives.
Catherine Saar
On June 11, 1998, Catherine Saar entered into an employment agreement with
Diedrich Coffee appointing her Vice President, Marketing. The agreement provides
for a base salary of $120,000 per annum and an annual incentive bonus of up to
25% of base salary based on the company's performance and Ms. Saar's performance
against objectives approved by the board. If terminated without cause, Ms. Saar
is entitled to four months salary as severance compensation. Ms. Saar also
received options to purchase up to 20,000 shares of our common stock at an
exercise price of $7.75, vesting over two years. Ms. Saar receives employee
benefits consistent with Diedrich Coffee's policies for other senior executives.
REPORT OF THE COMPENSATION COMMITTEE
The compensation committee consists of Messrs. Churm, Goelman and Heeschen.
The compensation committee administers Diedrich Coffee's stock option plans and
sets compensation levels for our executive officers. Our executive compensation
policies and programs are designed to:
- provide competitive levels of overall compensation that will attract and
retain the best executive talent in the industry;
- motivate executive officers to perform at their highest level;
- align executive officer and stockholder interests to create stockholder
value; and
- reward executive officers for achievement of corporate and individual
objectives.
To achieve these goals, the compensation committee and the board of
directors have established an executive compensation program consisting
primarily of three integrated components: base salary, annual bonus and stock
options.
Base Salary. Base salaries for executive officers are set by the
compensation committee after considering factors such as competitive
environment, experience level, position, responsibility and overall contribution
of the executive. Base salaries for the executive officers were established in
their respective employment agreements.
Annual Bonus. All executive officers, including the Chief Executive
Officer, are eligible to receive an annual bonus. The employment agreements for
the executive officers provide for discretionary performance bonuses based upon
Diedrich Coffee's performance and the respective executive officer's
contribution to this performance. The board awarded annual bonuses to sixteen
employees, including three of the executive officers, for the fiscal year ended
January 27, 1999 because of outstanding performance by such persons during the
year. These bonuses were paid after the fiscal year ended January 27, 1999 but
related to performance during the fiscal year.
Stock Options. The third component of the compensation program for
executive officers is in the form of stock option awards. Diedrich Coffee's 1996
Stock Incentive Plan provides for long-term incentive compensation for Diedrich
Coffee employees, including executive officers. Stock option awards align the
interests of executive officers with those of stockholders by providing an
equity interest in Diedrich Coffee, thereby providing incentive for the
executive officers to maximize stockholder value. Option awards directly tie
executive compensation to the value of our stock. The compensation committee is
responsible for determining, subject to the terms of the 1996 Stock Incentive
Plan, the individuals to whom grants are made, the timing of
32
<PAGE> 35
grants and the number of shares per grant. The number of shares are determined
based upon the individual's position in Diedrich Coffee, competitive company
practices and the number of unvested shares already held by the individual.
Stock options are generally granted with an exercise price equal to the fair
market value of Diedrich Coffee common stock on the date of grant. During fiscal
1999, the compensation committee granted stock options to approximately 76
employees. This was a wider employee base than in past years. The goal of the
compensation committee was to ensure employees were focused on increasing
stockholder value. The group included the majority of corporate office employees
as well as general managers and assistant managers at the coffeehouse level.
Chief Executive Officer. In November 1997, Diedrich Coffee entered into an
employment agreement as well as a stock option plan and agreement with Mr. Ryan.
The stockholders of Diedrich Coffee approved the Stock Option Plan and Agreement
at a special meeting called for that purpose on January 22, 1998. The terms of
Mr. Ryan's employment agreement and stock option plan and agreement are
described under "-- Employment Agreements and Compensation Arrangements." The
process of establishing the Chief Executive Officer's compensation parallels the
process and criteria used in establishing compensation levels for other
executive officers. There were no changes made during the fiscal year ended
January 27, 1999 to Mr. Ryan's employment agreement or his compensation package.
Policy with Respect to Internal Revenue Code Section 162(m). In 1993, the
Internal Revenue Code was amended to add Section 162(m). Section 162(m) and the
regulations thereunder place a limit of $1 million on the amount of compensation
that may be deducted by Diedrich Coffee in any year with respect to certain of
our most highly compensated officers. Section 162(m) does not, however, disallow
a deduction for qualified "performance-based compensation," the material terms
of which are disclosed to and approved by stockholders. At the present time, our
executive officer compensation levels, other than "perform once-based
compensation," do not exceed $1 million. The compensation committee and the
board of directors plan to take such actions in the future to minimize the loss
of tax deductions related to compensation as they deem necessary and appropriate
in light of specific compensation objectives.
Respectfully submitted,
Peter Churm
Paul C. Heeschen
Lawrence Goelman
COMPENSATION COMMITTEE INTERLOCKS
During the fiscal year ended January 27, 1999, the compensation committee
of Diedrich Coffee's board of directors consisted of Mr. Churm, Mr. Goelman and
Mr. Heeschen. No member of the compensation committee was, at any time during
the fiscal year ended January 27, 1999 or at any other time, an officer or
employee of Diedrich Coffee. There are no compensation committee interlocks
between Diedrich Coffee and other entities involving our executive officers and
board members who serve as executive officers or board members of such other
entities.
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<PAGE> 36
STOCK PERFORMANCE GRAPH
The following graph shows a comparison of the cumulative total returns for
the period beginning on September 12, 1996, the date Diedrich Coffee common
stock was first publicly traded, and ending on January 27, 1999 for:
- Diedrich Coffee common stock;
- the Total Return Index for the Nasdaq National Market (U.S. companies);
and
- the Total Return Index for Nasdaq Retail Trade Stocks.
Each of the above assumes an initial value of $100 and reinvestment of
dividends. Although the graph would normally cover a five-year period, our
common stock has been publicly traded only since September 12, 1996, so the
graph begins on that date. The comparisons in the graph are required by the
Commission and are not intended to forecast or be indicative of possible future
performance of our common stock.
<TABLE>
<CAPTION>
RETAIL NASDAQ DDRX
------ ------ ----
<S> <C> <C> <C>
'9/12/96' 100.00 100.00 100.00
'10/30/96' 98.41 102.88 97.62
'1/29/97' 97.34 116.09 80.95
'4/30/97' 88.70 107.83 25.00
'7/30/97' 107.69 136.25 27.38
'10/29/97' 111.49 137.99 26.79
'1/28/98' 114.79 139.16 59.52
'4/29/98' 134.05 159.67 76.19
'7/29/98' 131.19 161.73 64.89
'10/28/98' 108.69 150.99 40.48
'1/27/99' 136.62 209.69 42.27
</TABLE>
34
<PAGE> 37
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information regarding the beneficial
ownership of our common stock as of June 1, 1999, 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>
NAME AND ADDRESS AMOUNT AND NATURE PERCENT OF
OF BENEFICIAL OWNER(1) OF BENEFICIAL OWNERSHIP(2) CLASS
---------------------- -------------------------- ----------
<S> <C> <C>
D.C.H., L.P................................................. 1,473,197(3) 23.9%
450 Newport Center Drive
Suite 450
Newport Beach, CA 92660
Amre A. Youness............................................. 500,958(4) 7.6%
301 North Lake Avenue
Suite 910
Pasadena, CA 91101
Cosleno, Inc................................................ 340,000(5) 5.2%
3753 Howard Hughes Parkway
Suite 200
Las Vegas, NV 89109
Steven A. Lupinacci......................................... 309,061(6) 5.0%
Dolf A. Berle............................................... 26,000(7) *
Peter Churm................................................. 50,000(8) *
Martin Diedrich............................................. 656,107(9) 10.6%
Lawrence Goelman............................................ 117,700(10) 1.9%
Paul C. Heeschen............................................ 1,796,480(11) 29.0%
John E. Martin.............................................. 1,258,533(12) 17.9%
Timothy J. Ryan............................................. 629,367(13) 9.3%
Catherine Saar.............................................. 11,000(14) *
Ann Wride................................................... 26,000(15) *
All directors and executive officers
as a group (9 persons).................................... 4,571,187(16) 58.1%
</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 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.
35
<PAGE> 38
(3) Paul C. Heeschen, a director of Diedrich Coffee, is the sole general
partner of this limited partnership with voting and investment power as to
all shares beneficially owned by the limited partnership.
(4) Pursuant to Schedule 13D filed with the Commission and dated as of October
14, 1997, includes 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.
(5) Pursuant to Schedule 13D as filed with the Commission and dated as of
October 14, 1997, Cosleno, Inc. and Amre A. Youness, who is the sole
stockholder of Cosleno, Inc., have shared voting and dispositive power of
the 340,000 shares that are subject to warrants exercisable within 60 days.
(6) Mr. Lupinacci resigned as Chief Executive Officer, President and Chief
Financial Officer effective March 12, 1997.
(7) Includes 26,000 shares subject to options that are exercisable within 60
days.
(8) Includes 30,000 shares subject to options that are exercisable within 60
days.
(9) Includes 1,000 shares subject to options that are exercisable within 60
days.
(10) Includes 105,000 shares subject to options that are exercisable within 60
days. This number does not include the 85,000 shares subject to warrants
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.
(11) 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 and 30,000 shares held personally by Mr.
Heeschen subject to options that are exercisable within 60 days and 25,000
shares purchased on the open market by the Palm Trust, of which Mr.
Heeschen is a trustee with shared voting and investment power as to all of
such shares.
(12) Includes 850,000 shares subject to options that are exercisable within 60
days.
(13) Includes 600,000 shares subject to options that are exercisable within 60
days.
(14) Includes 11,000 shares subject to options that are exercisable within 60
days.
(15) Includes 26,000 shares subject to options that are exercisable within 60
days.
(16) Includes 1,679,000 shares subject to options that are exercisable within 60
days.
36
<PAGE> 39
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
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.
37
<PAGE> 40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. FINANCIAL STATEMENTS.
The financial statements required to be filed hereunder are set forth
at the end of this document beginning on page F-1.
2. EXHIBITS.
<TABLE>
<S> <C>
2.1 Form of Agreement and Plan of Merger by and between Diedrich
Coffee, a California corporation, and Diedrich Coffee, Inc.,
a Delaware corporation(1)
2.2 Agreement and Plan of Merger dated as of March 16, 1999, by
and among Diedrich Coffee, CP Acquisition Corp., a wholly
owned subsidiary of Diedrich Coffee, and Coffee People(2)
3.1 Certificate of Incorporation of the company(1)
3.2 Bylaws of the company(1)
4.1 Purchase Agreement for Series A Preferred Stock dated as of
December 11, 1992 by and among Diedrich Coffee, Martin R.
Diedrich, Donald M. Holly, SNV Enterprises and D.C.H.,
L.P.(1)
4.2 Purchase Agreement for Series B Preferred Stock dated as of
June 29, 1995 by and among Diedrich Coffee, Martin R.
Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, L.P.
and Diedrich Partners I, L.P.(1)
4.3 Specimen Stock Certificate(1)
4.4 Form of Conversion Agreement in connection with the
conversion of Series A and Series B Preferred Stock into
Common Stock(1)
4.5 Form of Lock-up Letter Agreement among The Second Cup, Ltd.
and Diedrich Coffee, Inc.(3)
4.6 Voting Agreement and Irrevocable Proxy dated as of March 16,
1999 by and among Diedrich Coffee, Inc., D.C.H., L.P., Peter
Churm, Martin R. Diedrich, Lawrence Goelman, Paul C.
Heeschen, John E. Martin, Timothy J. Ryan, and Second Cup
USA Holdings Ltd.(3)
10.1 Form of Indemnification Agreement(1)
10.2 Diedrich Coffee 1996 Stock Incentive Plan(1)
10.3 Diedrich Coffee 1996 Non-Employee Directors Stock Option
Plan(1)
10.4 Agreement of Sale dated as of February 23, 1996 by and among
Diedrich Coffee (as purchaser) and Brothers Coffee Bars,
Inc. and Brothers Gourmet Coffees, Inc. (as sellers)(1)
10.5 Separation agreement dated May 13, 1997 between Steven A.
Lupinacci and Diedrich Coffee, Inc.(4)
10.6 Letter agreement by and between the Company and John E.
Martin appointing Mr. Martin Chairman of the Board, dated as
of November 17, 1997(5)
10.7 Stock Option Plan and Agreement by and between the Company
and John E. Martin granting Mr. Martin the option to
purchase up to 850,000 shares of the Common Stock of the
Company, dated as of November 17, 1997(5)
10.8 Common Stock Purchase Agreement by and between the Company
and John E. Martin under which Mr. Martin agrees to purchase
333,333 shares of the Common Stock of the Company, dated as
of November 17, 1997(5)
</TABLE>
38
<PAGE> 41
<TABLE>
<S> <C>
10.9 Employment Agreement by and between the Company and Timothy J. Ryan retaining Mr. Ryan as Chief
Executive Officer, dated as of November 17, 1997(5)
10.10 Stock Option Plan and Agreement by and between the Company and Timothy J. Ryan granting Mr. Ryan
the option to purchase up to 600,000 shares of the Common Stock of the Company, dated as of
November 17, 1997(5)
10.11 Common Stock Purchase Agreement by and between the Company and Timothy J. Ryan under which Mr.
Ryan agrees to purchase 16,667 shares of the Common Stock of the Company, dated as of November 17,
1997(5)
10.12 Form of Promissory Note made in favor of Nuvrty, Inc., the Ocean Trust and the Grandview Trust(6)
10.13 Form of Term Loan Agreement made in favor of Nuvrty, Inc., the Ocean Trust and the Grandview
Trust(6)
10.14 Form of Security Agreement made in favor of Nuvrty, Inc., the Ocean Trust and the Grandview
Trust(6)
10.15 Form of Warrant Agreement made in favor of Nuvrty, Inc., the Ocean Trust and the Grandview
Trust(6)
10.16 Form of Intercreditor Agreement made in favor of Nuvrty, Inc., the Ocean Trust and the Grandview
Trust(6)
10.17 Form of Common Stock and Option Purchase Agreement with Franchise Mortgage Acceptance Company
dated as of April 3, 1998(7)
10.18 Separation and Release Agreement dated January 28, 1998 with Kerry W. Coin(7)
10.19 Employment Agreement with Ann Wride dated April 8, 1998(8)
10.20 Employment Agreement with Dolf Berle dated April 8, 1998(9)
10.21 Employment Agreement with Catherine Saar dated June 11, 1998(9)
10.22 Form of Franchise Agreement(10)
10.23 Form of Area Development Agreement(10)
10.24 Employment Agreement with Martin Diedrich dated June 29, 1998(3)
10.25 1997 Non-Employee Director Stock Option Plan and Agreement*
11.1 Statement re: Computation of Per Share Earnings(11)
21.1 List of Subsidiaries(3)
24.1 Power of Attorney(11)
27.1 Financial Data Schedule(11)
</TABLE>
- ---------------
* Filed herewith
(1) Previously filed as an exhibit to Diedrich Coffee's Registration
Statement on Form S-1(No. 333-08633), as amended, as declared
effective by the Securities and Exchange Commission on September
11, 1996.
(2) Previously filed as Appendix A to Amendment No. 1 to Diedrich
Coffee's Registration Statement on Form S-4, filed with the
Securities and Exchange Commission on June 7, 1999.
(3) Previously filed as an exhibit to Diedrich Coffee's Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on April 23, 1999.
(4) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q, for the period ended April 30, 1997, filed
with the Securities and Exchange Commission on June 13, 1997.
(5) Previously filed as an exhibit to Diedrich Coffee's Current Report
on Form 8-K, filed with the Securities and Exchange Commission on
November 25, 1997.
39
<PAGE> 42
(6) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q, for the period ended October 29, 1997, filed
with the Securities and Exchange Commission on December 11, 1997.
(7) Previously filed as an exhibit to Diedrich Coffee's annual report
on Form 10-K for the fiscal year ended January 28, 1998.
(8) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q, for the period ended April 29, 1998, filed
with the Securities and Exchange Commission on June 11, 1998.
(9) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q, for the period ended July 29, 1998, filed with
the Securities and Exchange Commission on September 10, 1998.
(10) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q, for the period ended October 28, 1998, filed
with the Securities and Exchange Commission on December 11, 1998.
(11) Previously filed as an exhibit to Diedrich Coffee's Annual Report
on Form 10-K for the fiscal year ended January 27, 1999, as filed
with the Securities and Exchange Commission on April 27, 1999.
(b) REPORTS ON FORM 8-K.
None.
40
<PAGE> 43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, Diedrich Coffee has duly caused this Amendment
No. 1 to the Annual Report on Form 10-K to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Irvine, State of
California, on the 7th day of June 1999.
DIEDRICH COFFEE, INC.
By: /s/ TIMOTHY J. RYAN
------------------------------------
Timothy J. Ryan
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Amendment No. 1 to the Annual Report on Form 10-K has been signed
by the following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
* Chairman of the Board June 7, 1999
- ---------------------------------------------
John E. Martin
/s/ TIMOTHY J. RYAN President, Chief Executive Officer June 7, 1999
- --------------------------------------------- and Director (Principal Executive
Timothy J. Ryan Officer)
* Vice President and Chief Financial June 7, 1999
- --------------------------------------------- Officer (Principal Financial and
Ann Wride Accounting Officer)
* Chief Coffee Officer, Vice Chairman June 7, 1999
- --------------------------------------------- of the Board of Directors and
Martin R. Diedrich Secretary
* Director June 7, 1999
- ---------------------------------------------
Lawrence Goelman
* Director June 7, 1999
- ---------------------------------------------
Peter Churm
* Director June 7, 1999
- ---------------------------------------------
Paul C. Heeschen
</TABLE>
*By: /s/ TIMOTHY J. RYAN
---------------------------
Timothy J. Ryan
Attorney-in-fact
41
<PAGE> 44
DIEDRICH COFFEE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-1
Balance Sheets.............................................. F-2
Statements of Operations.................................... F-3
Statements of Stockholders' Equity.......................... F-4
Statements of Cash Flows.................................... F-5
Notes to Financial Statements............................... F-6
</TABLE>
<PAGE> 45
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-1
<PAGE> 46
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-2
<PAGE> 47
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-3
<PAGE> 48
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-4
<PAGE> 49
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-5
<PAGE> 50
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.
F-6
<PAGE> 51
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Net Income (Loss) per Common Share
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings per Share" in fiscal 1998. SFAS 128 requires the presentation
of "basic" earnings per share which represents net earnings divided by the
weighted average shares outstanding excluding all common stock equivalents. Dual
presentation of "diluted" earnings per-share reflecting the dilutive effect of
all common stock equivalents is also required.
Costs in Excess of Net Assets Acquired
Costs in excess of net assets acquired is amortized on a straight-line
basis over the expected periods to be benefited. The Company assesses the
recoverability of this intangible asset by determining whether the amortization
of the goodwill balance over its remaining life can be recovered through
undiscounted future operating cash flows of the acquired operations. The amount
of goodwill impairment, if any, is measured based on projected discounted future
operating cash flows using a discount rate reflecting the Company's average cost
of funds. The assessment of the recoverability of goodwill will be impacted if
estimated future operating cash flows are not achieved.
Stock Option Plans
Prior to February 1, 1996, the Company accounted for its stock option plans
in accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
February 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which permits entities to recognize as expense over the vesting
period the fair value of all stock-based awards on the date of the grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosures for employee stock option grants made in fiscal
1996 and future years as if the fair-value-based method defined in SFAS No. 123
had been applied. The Company has elected to continue to apply the provisions of
APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No.
123.
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
F-7
<PAGE> 52
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
administrative expenses included approximately $98,000 for the year ended
January 27, 1999, $377,000 for the year ended January 28, 1998 and $157,000 for
the year ended January 29, 1997.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Business Segment Reporting
The Company adopted SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information," effective in 1999. SFAS No. 131 establishes
new standards for reporting information about business segments and related
disclosures about products and services, geographic areas and major customers.
The business segments of the Company are wholesale and retail. Information
regarding these segments are in Note 11.
Revenue Recognition
Sales are recorded when payment is tendered at point of sale for retail and
upon shipment of product for wholesale.
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>
F-8
<PAGE> 53
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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).
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.
F-9
<PAGE> 54
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
In connection with the Ocean Trust Loan Documents and the Grandview Trust
Loan Documents the Company issued warrants to each Trust respectively to
purchase 255,000 shares of the Company's common stock at a price of $2.25 per
share. The warrants are exercisable immediately and expire on the later of
October 16, 2003 or one year following payment in full of the respective loans.
The warrants associated with all the above debt were accounted for in
accordance with the provisions of APB 14, "Accounting for Convertible Debt and
Debt Issued Stock Purchase Warrants." In accordance with APB 14, none of the
proceeds from issuance of the debt was allocated to the warrants based on their
relative fair value, which is insignificant, calculated using both a Cost of
Replacement Model and the Monte Carlo simulation of possible warrant exercise
and no expense was recognized.
At January 27, 1999 the prime rate was 7.75%.
6. COMMITMENTS AND CONTINGENCIES
Lease Commitments
As of January 27, 1999, the Company leases warehouse and office space in
Irvine, California, warehouse space in Denver, Colorado, and thirty-six
coffeehouse locations in Southern California, Colorado and Texas expiring
through February 2009. The leases for five of the coffeehouse locations are
guaranteed by an officer/ director of the Company. Certain of the coffeehouse
leases require the payment of property taxes, normal maintenance and insurance
on the properties and additional rents based on percentages of sales in excess
of various specified retail sales levels. Contingent rent expense was
insignificant for all periods presented.
Future minimum lease payments under non-cancelable operating leases as of
January 27, 1999 are as follows:
<TABLE>
<CAPTION>
NON-CANCELABLE
YEAR ENDING JANUARY OPERATING LEASES CAPITAL LEASES
------------------- ---------------- --------------
<S> <C> <C>
2000.................................................... $1,842,000 $169,488
2001.................................................... 1,711,000 169,488
2002.................................................... 1,413,000 165,672
2003.................................................... 1,172,000 95,179
2004.................................................... 974,000 1,389
Thereafter.............................................. 1,957,000 --
---------- --------
$9,069,000 $601,216
========== ========
Less amount representing interest....................... 148,622
--------
Present value of minimum lease payments................. 452,594
Less current portion.................................... 169,488
--------
Long-term portion....................................... $283,106
========
</TABLE>
Rent expense under operating leases approximated $2,070,000, $2,232,000,
and $1,772,000 for the years ended January 27, 1999, January 28, 1998 and
January 29, 1997, respectively.
Purchase Commitments
As of January 27, 1999 and January 28, 1998, the Company had entered into
fixed price purchase contracts for unroasted coffee aggregating approximately
$1,135,000 and $451,500, respectively. Such
F-10
<PAGE> 55
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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.
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
F-11
<PAGE> 56
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
agreed to revise the exercise price of these options to $3.00 per share (the
closing price of the Company's stock on that date). In January 1998, in
connection with the termination of executive's employment agreement, the Company
and the executive agreed to terms under which the employee retained options to
purchase 80,000 shares. The remaining 40,000 options were canceled. Options to
purchase 62,500 shares were exercised in fiscal 1999 and options to purchase
17,500 shares were exercised in fiscal 2000.
In September 1996, the holders of the Series A and Series B Preferred
Shares converted their shares into shares of common stock on a one-for-one
basis.
On September 11, 1996, the Company completed an initial public offering of
2,530,000 shares (including an over-allotment option). The offering consisted of
1,600,000 shares of common stock sold on behalf of the Company and 930,000
shares of common stock sold on behalf of certain selling stockholders. The net
proceeds of the offering to the Company, after deducting approximately
$2,621,000 in related expenses, were approximately $12,579,000.
In connection with the IPO, the managing underwriter received warrants
exercisable for 160,000 shares of the Company's common stock at $11.50 per
share. The warrants were exercisable commencing September 1997 and were to
expire in September 1999. The warrants were repriced to $5.25 and the exercise
period was shortened to provide for expiration in December 1998 pursuant to
written agreement on December 10, 1997. During fiscal 1999, 28,960 warrants were
exercised and the remaining 131,040 expired.
On April 25, 1997, the Company's Board of Directors approved the 1997
Non-Employee Director's Stock Option Plan which granted options to purchase
10,000 shares each to two non-employee directors. These options have an exercise
price of $2.75, became vested on April 25, 1998 and expire on April 25, 2007.
On November 18, 1997, Mr. John E. Martin joined the Company's Board of
Directors as Chairman. The Company and Mr. Martin entered into an agreement
under which Mr. Martin was granted the option to purchase 850,000 shares of the
common stock of the Company. Mr. Martin and the Company also agreed to terms
under which Mr. Martin purchased 333,333 shares of the Company's common stock at
$3.00 per share.
On November 18, 1997, Mr. Timothy J. Ryan joined the Company as Diedrich
Coffee's President and Chief Executive Officer. The Company entered into a
performance based Stock Option Plan and Agreement under which Mr. Ryan was
granted the option to purchase up to 600,000 shares of the common stock of the
Company. In addition, Mr. Ryan purchased 16,667 shares of common stock at $3.00
per share pursuant to a private sale of restricted stock.
On January 22, 1998 the stockholders of the Company approved the stock
option plans and agreements with John Martin and Timothy Ryan. On January 28,
1998 Messrs. Martin and Ryan completed their respective private purchases of
Company stock of $1,000,000 and $50,000, respectively.
On March 30, 1998 the Company agreed to a private placement of 200,000
shares of the Company's common stock to Franchise Mortgage Acceptance Company
("FMAC") at a price 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-12
<PAGE> 57
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-13
<PAGE> 58
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-14
<PAGE> 59
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
F-15
<PAGE> 60
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
remain open. During fiscal 1998, most of the lease terminations provided for in
the restructuring had been completed at less cost than originally anticipated.
As a result of these two factors, management determined that the remaining
restructuring reserve could be reduced by $648,000 to $237,000. The remaining
balance of $112,000 at the end of fiscal 1999 is designated for costs related to
two closed locations currently under sublease.
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
F-16
<PAGE> 61
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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 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-17
<PAGE> 62
DIEDRICH COFFEE, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGES
- ------- ----------- ------------
<C> <S> <C>
2.1 Form of Agreement and Plan of Merger by and between Diedrich
Coffee, a California corporation, and Diedrich Coffee, Inc.,
a Delaware corporation(1)
2.2 Agreement and Plan of Merger dated as of March 16, 1999, by
and among Diedrich Coffee, CP Acquisition Corp., a wholly
owned subsidiary of Diedrich Coffee, and Coffee People(2)
3.1 Certificate of Incorporation of the company(1)
3.2 Bylaws of the company(1)
4.1 Purchase Agreement for Series A Preferred Stock dated as of
December 11, 1992 by and among Diedrich Coffee, Martin R.
Diedrich, Donald M. Holly, SNV Enterprises and D.C.H.,
L.P.(1)
4.2 Purchase Agreement for Series B Preferred Stock dated as of
June 29, 1995 by and among Diedrich Coffee, Martin R.
Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, L.P.
and Diedrich Partners I, L.P.(1)
4.3 Specimen Stock Certificate(1)
4.4 Form of Conversion Agreement in connection with the
conversion of Series A and Series B Preferred Stock into
Common Stock(1)
4.5 Form of Lock-up Letter Agreement among The Second Cup, Ltd.
and Diedrich Coffee, Inc.(3)
4.6 Voting Agreement and Irrevocable Proxy dated as of March 16,
1999 by and among Diedrich Coffee, Inc., D.C.H., L.P., Peter
Churm, Martin R. Diedrich, Lawrence Goelman, Paul C.
Heeschen, John E. Martin, Timothy J. Ryan, and Second Cup
USA Holdings Ltd.(3)
10.1 Form of Indemnification Agreement(1)
10.2 Diedrich Coffee 1996 Stock Incentive Plan(1)
10.3 Diedrich Coffee 1996 Non-Employee Directors Stock Option
Plan(1)
10.4 Agreement of Sale dated as of February 23, 1996 by and among
Diedrich Coffee (as purchaser) and Brothers Coffee Bars,
Inc. and Brothers Gourmet Coffees, Inc. (as sellers)(1)
10.5 Separation agreement dated May 13, 1997 between Steven A.
Lupinacci and Diedrich Coffee, Inc.(4)
10.6 Letter agreement by and between the Company and John E.
Martin appointing Mr. Martin Chairman of the Board, dated as
of November 17, 1997(5)
10.7 Stock Option Plan and Agreement by and between the Company
and John E. Martin granting Mr. Martin the option to
purchase up to 850,000 shares of the Common Stock of the
Company, dated as of November 17, 1997(5)
</TABLE>
<PAGE> 63
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGES
- ------- ----------- ------------
<C> <S> <C>
10.8 Common Stock Purchase Agreement by and between the Company
and John E. Martin under which Mr. Martin agrees to purchase
333,333 shares of the Common Stock of the Company, dated as
of November 17, 1997(5)
10.9 Employment Agreement by and between the Company and Timothy
J. Ryan retaining Mr. Ryan as Chief Executive Officer, dated
as of November 17, 1997(5)
10.10 Stock Option Plan and Agreement by and between the Company
and Timothy J. Ryan granting Mr. Ryan the option to purchase
up to 600,000 shares of the Common Stock of the Company,
dated as of November 17, 1997(5)
10.11 Common Stock Purchase Agreement by and between the Company
and Timothy J. Ryan under which Mr. Ryan agrees to purchase
16,667 shares of the Common Stock of the Company, dated as
of November 17, 1997(5)
10.12 Form of Promissory Note made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(6)
10.13 Form of Term Loan Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust(6)
10.14 Form of Security Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust(6)
10.15 Form of Warrant Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(6)
10.16 Form of Intercreditor Agreement made in favor of Nuvrty,
Inc., the Ocean Trust and the Grandview Trust(6)
10.17 Form of Common Stock and Option Purchase Agreement with
Franchise Mortgage Acceptance Company dated as of April 3,
1998(7)
10.18 Separation and Release Agreement dated January 28, 1998 with
Kerry W. Coin(7)
10.19 Employment Agreement with Ann Wride dated April 8, 1998(8)
10.20 Employment Agreement with Dolf Berle dated April 8, 1998(9)
10.21 Employment Agreement with Catherine Saar dated June 11,
1998(9)
10.22 Form of Franchise Agreement(10)
10.23 Form of Area Development Agreement(10)
10.24 Employment Agreement with Martin Diedrich dated June 29,
1998(3)
10.25 1997 Non-Employee Director Stock Option Plan and Agreement*
11.1 Statement re: Computation of Per Share Earnings(11)
21.1 List of Subsidiaries(3)
24.1 Power of Attorney(11)
27.1 Financial Data Schedule(11)
</TABLE>
<PAGE> 64
- ---------------
* Filed herewith
(1) Previously filed as an exhibit to Diedrich Coffee's Registration Statement
on Form S-1(No. 333-08633), as amended, as declared effective by the
Securities and Exchange Commission on September 11, 1996.
(2) Previously filed as Appendix A to Diedrich Coffee's Registration Statement
on Form S-4, filed with the Securities and Exchange Commission on April 23,
1999.
(3) Previously filed as an exhibit to Diedrich Coffee's Registration Statement
on Form S-4, filed with the Securities and Exchange Commission on April 23,
1999.
(4) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended April 30, 1997, filed with the Securities
and Exchange Commission on June 13, 1997.
(5) Previously filed as an exhibit to Diedrich Coffee's Current Report on Form
8-K, filed with the Securities and Exchange Commission on November 25,
1997.
(6) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended October 29, 1997, filed with the Securities
and Exchange Commission on December 11, 1997.
(7) Previously filed as an exhibit to Diedrich Coffee's annual report on Form
10-K for the fiscal year ended January 28, 1998.
(8) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended April 29, 1998, filed with the Securities
and Exchange Commission on June 11, 1998.
(9) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended July 29, 1998, filed with the Securities
and Exchange Commission on September 10, 1998.
(10) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended October 28, 1998, filed with the Securities
and Exchange Commission on December 11, 1998.
(11) Previously filed as an exhibit to Diedrich Coffee's Annual Report on Form
10-K for the fiscal year ended January 27, 1999, as filed with the
Securities and Exchange Commission on April 27, 1999.
<PAGE> 1
EXHIBIT 10.25
1997 NON-EMPLOYEE DIRECTOR
STOCK OPTION PLAN AND AGREEMENT
This 1997 Non-Employee Director Stock Option Plan and Agreement, dated
as of April 25, 1997 (the "AGREEMENT") is entered into by and among Diedrich
Coffee, Inc., a Delaware corporation (the "COMPANY"), on the one hand, and Peter
Churm and Paul C. Heeschen (individually, the "GRANTEE" and collectively, the
"GRANTEES") on the other hand.
RECITALS
A. Messrs. Churm and Heeschen have served as independent directors of
the Company since the Company's initial public offering in September 1996. In
light of the operational challenges and management transition that the Company
has experienced this year, the independent directors have been called upon to
work closely with the Company's officers providing invaluable advice and
direction beyond that which would ordinarily be expected from members of the
Board of Directors.
B. In appreciation of the service rendered by the independent directors
and for the purpose of encouraging and rewarding their continuing contributions
to the performance of the Company and further aligning their interests with the
interests of the Company's stockholders, the Company believes that it is in the
best interests of the Company and its stockholders to grant to each of the
Grantees options to purchase 10,000 shares of common stock, $0.01 par value per
share (the "COMMON STOCK"), of the Company .
AGREEMENT
NOW, THEREFORE, to evidence the grant of options by the Company and to
set forth the terms and conditions of the grant of options, the Company and
Grantees hereby agree as follows:
1. DEFINITIONS. The following terms, as used in this Agreement, have
the meanings ascribed to them in this Section 1.
(a) "BOARD" means the Board of Directors of the Company.
(b) "CLOSING PRICE" means the closing price on any given trading day
of the Common Stock on the Nasdaq National Market (or any subsequent exchange or
market system upon which the Company's Common Stock is principally traded) as
reported in the Transaction Index of the Wall Street Journal.
(c) "EXCHANGE ACT" means the Securities Exchange Act of 1934, as
amended.
(d) "EXERCISE DATE" means any date on which Grantee exercises
Options.
<PAGE> 2
(e) "EXERCISE DATE VALUE" means the product of: (i) the number of
shares of Common Stock delivered to the Company and (ii) the Closing Price of
the Common Stock on the Exercise Date.
(f) "EXERCISE SHARES" means those shares of Common Stock with
respect to which Options are being exercised.
(g) "NON-EMPLOYEE DIRECTOR" means a duly elected or appointed member
of the Company's Board of Directors who is not and has not since the beginning
of the Company's most recently completed fiscal year been an employee of or a
compensated consultant to the Company or any of its affiliates.
(h) "OPTIONS" means options to purchase shares of Common Stock
granted under this Agreement.
(i) "SECURITIES ACT" means the Securities Act of 1933, as amended.
2. GRANT OF OPTIONS. The Company hereby grants options to Grantees
as follows:
(a) The Company grants to Mr. Churm, effective as of the date
hereof, Options to purchase up to 10,000 shares of Common Stock on the terms and
subject to the conditions set forth herein; and
(b) The Company grants to Mr. Heeschen, effective as of the date
hereof, Options to purchase up to 10,000 shares of Common Stock on the terms and
subject to the conditions set forth herein.
3. EXERCISABILITY AND EXERCISE PRICES. The Options will become
exercisable at an option exercise price of $2.75 per share of Common Stock on
April 25, 1998, if the Grantee has remained a Non-Employee Director for the
entire period from the date hereof to April 25, 1998. Any Options that have not
become exercisable at the time the Grantee ceases to be a Non-Employee Director
shall terminate.
4. TERMINATION OF OPTIONS.
(a) Unless an earlier termination date occurs as specified in
Section 4(b), the Options will expire and become unexercisable (whether or not
then exercisable) on the tenth (10th) anniversary of the date hereof
("EXPIRATION DATE").
(b) If a Grantee ceases to be a Non-Employee Director for any reason
prior to the Expiration Date: (i) all Options that have not otherwise become
exercisable, as of the date Grantee ceases to be a Non-Employee Director, will
immediately terminate and become unexercisable; and (ii) all Options that have
become exercisable will terminate and become unexercisable on and after the date
one hundred eighty (180) days following the date of Grantee's termination of
employment.
2
<PAGE> 3
5. REGISTRATION OF OPTIONS. After execution of this Agreement, the
Company, at its expense, shall file a registration statement on Form S-8 to
register the issuance and exercise of the Options.
6. RESTRICTIONS ON EXERCISE. All options granted under the Plan shall
be subject to the requirement that, if at any time the Company shall determine,
in its discretion, that the listing, registration or qualification of the shares
subject to options granted under the Plan upon any securities exchange or under
any state or federal law, or the consent or approval of any government or
regulatory body or authority, is necessary or desirable as a condition of, or in
connection with, the granting of such an option or the issuance, if any, or
purchase of shares in connection therewith, such option may not be exercised in
whole or in part unless such listing, registration, qualification, consent or
approval shall have been effected or obtained free of any conditions not
acceptable to the Company. Unless the shares of stock to be issued upon exercise
of an option granted under the Plan have been effectively registered under the
Securities Act of 1933, as amended (the "Securities Act") as now in force or
hereafter amended, the Company shall be under no obligation to issue any shares
of stock covered by any option unless the person who exercises such option, in
whole or in part, shall give a written representation and undertaking to the
Company satisfactory in form and scope to counsel to the Company and upon which,
in the opinion of such counsel, the Company may reasonably rely, that he or she
is acquiring the shares of stock issued to him or her pursuant to such exercise
of the option for his or her own account as an investment and not with a view
to, or for sale in connection with, the distribution of any such shares of
stock, and that he or she will make no transfer of the same except in compliance
with any rules and regulations in force at the time of such transfer under the
Securities Act, or any other applicable law or regulation, and that if shares of
stock are issued without such registration, a legend to this effect may be
endorsed upon the securities so issued and the Company may order its transfer
agent to stop transfer of such shares.
7. NON-TRANSFERABILITY OF OPTIONS. None of the Options are assignable
or transferable, in whole or in part, and may not, directly or indirectly, be
offered, transferred, sold, pledged, assigned, alienated, hypothecated or
otherwise disposed of or encumbered (including without limitation by gift,
operation of law or otherwise) other than by will or by the laws of descent and
distribution to the estate of Grantee upon his death, provided that the deceased
Grantee's beneficiary or the representative of his estate acknowledge and agree
in writing, in a form reasonably acceptable to the Board of Directors to be
bound by this Agreement as if such beneficiary or the estate were Grantee.
8. WITHHOLDING. Whenever shares of Common Stock are to be issued
pursuant to the exercise of Options, the Board of Directors may require the
recipient of the shares of Common Stock to remit to the Company an amount
sufficient to satisfy any applicable federal, state and local tax withholding
requirements. Upon request by Grantee, the Company may also withhold shares of
Common Stock to satisfy applicable withholding requirements, subject to any
rules adopted by the Board of Directors regarding compliance with applicable
law, including, but not limited to, Section 16(b) of the Exchange Act.
3
<PAGE> 4
9. MANNER OF EXERCISE.
(a) To the extent that the Options have become and remain
exercisable as provided in Sections 3 and 4, and subject to such reasonable
administrative regulations as the Board of Directors may adopt, the Options may
be exercised, by written notice to the Board of Directors, specifying the number
of Exercise Shares and the Exercise Date. On or before the Exercise Date,
Grantee shall deliver to the Company full payment for the Options being
exercised in cash, or cash equivalent satisfactory to the Board of Directors,
and in an amount equal to the aggregate purchase price for the Exercise Shares.
(b) Subject to the discretion of the Board of Directors, Grantee
may, in lieu of cash, either: (i) deliver shares of Common Stock having an
Exercise Date Value equal to the purchase price of the Exercise Shares; or (ii)
deliver a combination of cash and shares of Common Stock with an aggregate value
and Exercise Date Value equal to the purchase price of the Exercise Shares,
subject to such rules and regulations as may be adopted by the Board of
Directors to provide for the compliance of such payment procedure with
applicable law, including Section 16(b) of the Exchange Act.
(c) The Board of Directors may require Grantee to furnish or execute
such other documents as the Board of Directors reasonably deems necessary: (i)
to evidence such exercise and (ii) to comply with or satisfy the requirements of
the Securities Act, applicable state securities laws or any other law.
10. NO RIGHTS AS STOCKHOLDER. Grantee will have no voting or other
rights as a stockholder of the Company with respect to any shares of Common
Stock covered by the Options until the exercise of such Options and the issuance
of a certificate or certificates to him for such shares of Common Stock. No
adjustment will be made for dividends or other rights for which the record date
is prior to the issuance of such certificate or certificates.
11. CAPITAL ADJUSTMENTS. The number and any applicable option price of
the shares of Common Stock covered by the Options will be proportionately and
appropriately adjusted by the Board of Directors to reflect any stock dividend,
stock split or share combination of the Common Stock or any recapitalization of
the Company. Subject to any required action by the stockholders of the Company,
in any merger, consolidation, reorganization, exchange of shares, liquidation or
dissolution, the Options will pertain to the securities and other property, if
any, that a holder of the number of shares of Common Stock covered by the
Options would have been entitled to receive in connection with such event.
12. REORGANIZATIONS; MERGERS; CHANGES IN CONTROL. Subject to the other
provisions of this Section 12, if the Company shall consummate any
reorganization or merger or consolidation in which holders of shares of the
Company's Common Stock are entitled to receive in respect of such shares any
other consideration (including, without limitation, a different number of such
shares), each option outstanding under this Agreement shall thereafter be
exercisable, in accordance with the Agreement, only for the kind and amount of
securities, cash and/or other property receivable upon such reorganization or
merger or consolidation by a holder of the same number of shares of Common Stock
as are subject to that option immediately prior to
4
<PAGE> 5
such reorganization or merger or consolidation, and any appropriate adjustments
will be made to the exercise price thereof. In addition, if a Change in Control
occurs and in connection with such Change in Control any recipient of an option
granted under the Plan ceases to be a director of the Company, then such
recipient shall have the right to exercise his or her options granted under the
Plan in whole or in part during the applicable time period provided in Section 4
without regard to any vesting requirements. For purposes hereof, but without
limitation, a director will be deemed to have ceased to be a director of the
Company in connection with a Change in Control if such director (i) is removed
by or resigns upon request of a Person (as defined in paragraph (a) below)
exercising practical voting control over the Company following the Change in
Control, or a person acting upon authority or at the instruction of such Person,
or (ii) is willing and able to continue as a director of the Company but is not
re-elected to or retained on the Company's Board of Directors by the Company's
stockholders through the stockholder vote or consent action for election of
directors that precedes and is taken in connection with, or next follows, the
Change of Control. For purposes hereof, a "Change in Control" means the
following and shall be deemed to occur if any of the following events occur:
(a) Any person, entity or group, within the meaning of Section 13(d)
or 14(d) of the Exchange Act, but excluding the Company and its subsidiaries and
any employee benefit or stock ownership plan of the Company or its subsidiaries
and also excluding an underwriter or underwriting syndicate that has acquired
the Company's securities solely in connection with a public offering thereof
(such person, entity or group being referred to herein as a "Person"), becomes
the beneficial owner (within the meaning of Rule 13d-3 promulgated under the
Exchange Act) of 50% or more of either the then outstanding shares of Common
Stock or the combined voting power of the Company's then outstanding securities
entitled to vote generally in the election of directors; or
(b) Individuals who, as of the effective date hereof, constitute the
Board of Directors of the Company (the "Incumbent Board") cease for any reason
to constitute at least a majority of the Board of Directors of the Company,
provided that any individual who becomes a director after the effective date
hereof whose election, or nomination for election by the Company's stockholders,
is approved by a vote of at least a majority of the directors then comprising
the Incumbent Board shall be considered to be a member of the Incumbent Board
unless that individual was nominated or elected by any Person having the power
to exercise, through beneficial ownership, voting agreement and/or proxy, 20% or
more of either the then outstanding shares of Common Stock or the combined
voting power of the Company's then outstanding voting securities entitled to
vote generally in the election of directors, in which case that individual shall
not be considered to be a member of the Incumbent Board unless such individual's
election or nomination for election by the Company's stockholders is approved by
a vote of at least two-thirds of the directors then comprising the Incumbent
Board; or
(c) Consummation by the Company of the sale or other disposition by
the Company of all or substantially all of the Company's assets or a
reorganization or merger or consolidation of the Company with any other person,
entity or corporation, other than
5
<PAGE> 6
(i) a reorganization or merger or consolidation that would
result in the voting securities of the Company outstanding immediately prior
thereto (or, in the case of a reorganization or merger or consolidation that is
preceded or accomplished by an acquisition or series of related acquisitions by
any Person, by tender or exchange offer or otherwise, of voting securities
representing 5% or more of the combined voting power of all securities of the
Company, immediately prior to such acquisition or the first acquisition in such
series of acquisitions) continuing to represent, either by remaining outstanding
or by being converted into voting securities of another entity, more than 50% of
the combined voting power of the voting securities of the Company or such other
entity outstanding immediately after such reorganization or merger or
consolidation (or series of related transactions involving such a reorganization
or merger or consolidation), or
(ii) a reorganization or merger or consolidation effected to
implement a recapitalization or reincorporation of the Company (or similar
transaction) that does not result in a material change in beneficial ownership
of the voting securities of the Company or its successor; or
(d) Approval by the stockholders of the Company or an order by a
court of competent jurisdiction of a plan of liquidation of the Company.
13. NOTICES. All notices and other communications required or permitted
to be given under this Agreement shall be in writing and shall be deemed to have
been given if delivered personally or sent by certified or express mail, return
receipt requested, postage prepaid, or by any recognized international
equivalent of such delivery, to the Company, or Grantee, as the case may be, at
the address of the Company's principal executive office. All such notices and
communications shall be deemed to have been received on the date of delivery or
on the third business day after the mailing thereof.
14. BINDING EFFECT; BENEFITS. This Agreement shall be binding upon and
inure to the benefit of the parties to this Agreement and their respective
successors and assigns. Nothing in this Agreement, express or implied, is
intended or shall be construed to give any person other than the parties to this
Agreement or their respective successors or assigns any legal or equitable
right, remedy or claim under or in respect of any agreement or any provision
contained herein.
15. AMENDMENT. This Agreement may be amended, modified or supplemented
only by a written instrument executed by Grantees and the Company.
16. APPLICABLE LAW. This Agreement shall be governed by and construed
in accordance with the law of the State of Delaware, regardless of the law that
might be applied under principles of conflict of laws.
17. SECTION AND OTHER HEADINGS. The section and other headings
contained in this Agreement are for reference purposes only and shall not affect
the meaning or interpretation of this Agreement.
6
<PAGE> 7
\
18. COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which shall be deemed to be an original and all of which
together shall constitute one and the same instrument.
IN WITNESS WHEREOF, the Company and Grantees have executed this
Agreement as of the date first above written.
DIEDRICH COFFEE, INC.,
a Delaware corporation
BY: /s/ MARTIN DIEDRICH
-------------------------------
NAME: MARTIN DIEDRICH
TITLE: VICE CHAIRMAN
THE GRANTEES
/s/ PETER CHURM
-----------------------------------
PETER CHURM
/s/ PAUL C. HEESCHEN
-----------------------------------
PAUL C. HEESCHEN
7
