10-Q 1 peets_10q3.htm PEET'S 10-Q 9-26-04 Peet's 10-Q 9-26-04



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

__________

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 26, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

Commission file number 000-32233

PEET'S COFFEE & TEA, INC.
(Exact Name of Registrant as Specified in Its Charter)

Washington
91-0863396
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)

1400 Park Avenue
Emeryville, California 94608-3520
(Address of Principal Executive Offices) (Zip Code)

(510) 594-2100
(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Securities Exchange Act Rule 12b-2). Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, no par value
 
13,376,306
(Class)
 
(Outstanding at November 2, 2004)



 
 
   

 


     
 
PEET'S COFFEE & TEA, INC.
 
 
INDEX
 
     
PART I
Financial Information
 
     
Item 1.
Financial Statements
3
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
10
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
15
Item 4.
Controls and Procedures
16
     
PART II
Other Information
 
     
Item 1.
Legal Proceedings
16
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
16
Item 6.
Exhibits
16
 
Signatures
 
     


 
 
  2  

 
 
PART I - FINANCIAL INFORMATION
 
           
ITEM 1. FINANCIAL STATEMENTS
         
           
PEET’S COFFEE & TEA, INC.
 
           
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(Unaudited, in thousands, except share amounts)
 
           
   
September 26,
 
December 28,
 
   
2004
 
2003
 
               
ASSETS
             
               
Current Assets
             
Cash and cash equivalents
 
$
3,797
 
$
30,263
 
Short-term investments
   
11,967
   
12,328
 
Accounts receivable
   
3,732
   
3,115
 
Income tax receivable
   
-
   
340
 
Inventories
   
14,882
   
10,720
 
Prepaid expenses and other
   
2,142
   
2,111
 
Total current assets
   
36,520
   
58,877
 
           
 
Property and equipment, net
   
38,017
   
32,322
 
Intangible and other assets, net
   
3,675
   
2,684
 
Long-term U.S. Government and Agency Securities
   
40,285
   
16,572
 
           
 
Total assets
 
$
118,497
 
$
110,455
 
           
 
               
LIABILITIES AND SHAREHOLDERS' EQUITY
             
               
Current liabilities
             
Accounts payable
 
$
5,204
 
$
4,770
 
Accrued compensation and benefits
   
3,932
   
4,157
 
Accrued litigation expense
   
127
   
2,343
 
Other accrued liabilities
   
4,017
   
3,122
 
Total current liabilities
   
13,280
   
14,392
 
           
 
Deferred lease credits and other long-term liabilities
   
1,344
   
829
 
               
Total liabilities
   
14,624
   
15,221
 
               
Shareholders' equity
             
Common Stock, no par value; authorized 50,000,000 shares; issued and outstanding 13,353,000 and 12,983,000
   
90,955
   
87,808
 
Accumulated other comprehensive income (loss), net of tax
   
(78
)
 
23
 
Retained earnings
   
12,996
   
7,403
 
               
Total shareholders' equity
   
103,873
   
95,234
 
               
Total liabilities and shareholders' equity
 
$
118,497
 
$
110,455
 
               
See notes to condensed consolidated financial statements.
             

 
 
  3  

 
 
PEET’S COFFEE & TEA, INC.
               
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in thousands, except per share amounts)

   
Thirteen weeks ended
 
Thirty-nine weeks ended
 
   
September 26,
 
September 28,
 
September 26,
 
September 28,
 
   
2004
 
2003
 
2004
 
2003
 
                           
Retail stores
 
$
23,917
 
$
20,706
 
$
70,063
 
$
61,794
 
Specialty sales
   
10,549
   
8,127
   
30,550
   
23,517
 
Net revenue
   
34,466
   
28,833
   
100,613
   
85,311
 
                           
Operating expenses:
                         
Cost of sales and related occupancy expenses
   
16,143
   
13,308
   
46,355
   
39,297
 
Operating expenses
   
11,903
   
9,426
   
34,260
   
28,183
 
Marketing and advertising expenses
   
762
   
958
   
2,613
   
3,357
 
General and administrative expenses
   
1,221
   
4,860
   
4,724
   
7,722
 
Depreciation and amortization expenses
   
1,487
   
1,228
   
4,166
   
3,547
 
                           
Total operating costs and expenses
   
31,516
   
29,780
   
92,118
   
82,106
 
                           
Income (loss) from operations
   
2,950
   
(947
)
 
8,495
   
3,205
 
                           
Investment income, net
   
(227
)
 
(499
)
 
(655
)
 
(972
)
                           
Income (loss) before income taxes
   
3,177
   
(448
)
 
9,150
   
4,177
 
                           
Income tax provision (benefit)
   
1,168
   
(125
)
 
3,557
   
1,679
 
                           
Net income (loss)
 
$
2,009
 
$
(323
)
$
5,593
 
$
2,498
 
                           
Net income (loss) per share:
                         
Basic
 
$
0.15
 
$
(0.03
)
$
0.42
 
$
0.20
 
Diluted
 
$
0.14
 
$
(0.03
)
$
0.40
 
$
0.19
 
                           
Shares used in calculation of net income (loss) per share:
                 
Basic
   
13,420
   
12,778
   
13,269
   
12,472
 
Diluted
   
14,115
   
12,778
   
13,915
   
13,155
 
                           
See notes to condensed consolidated financial statements.
                 
 
 
  4  

 
PEET’S COFFEE & TEA, INC.
 
           
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(Unaudited, in thousands)
 
   
Thirty-nine weeks ended
 
   
September 26,
 
 September 28,
 
   
2004
 
 2003
 
               
Cash flows from operating activities:
             
Net income
 
$
5,593
 
$
2,498
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation and amortization
   
4,983
   
4,199
 
Tax benefit from exercise of stock options and amortization of discounted stock options
   
2,843
   
3,118
 
Other
   
188
   
(1,647
)
Changes in other assets and liabilities:
             
Receivables
   
(277
)
 
196
 
Inventories
   
(4,162
)
 
(2,051
)
Prepaid expenses and other current assets
   
(31
)
 
(537
)
Other assets
   
(1,066
)
 
189
 
Accounts payable and accrued liabilities
   
(1,109
)
 
1,338
 
Deferred lease credits and other long-term liabilities
   
525
   
-
 
               
Net cash provided by operating activities
   
7,487
   
7,303
 
               
Cash flows from investing activities:
             
Purchases of property and equipment
   
(10,576
)
 
(7,979
)
Proceeds from sale of property and equipment
   
9
   
3
 
Proceeds from sale (purchases) of investments, net
   
(23,687
)
 
3,045
 
               
Net cash used in investing activities
   
(34,254
)
 
(4,931
)
               
Cash flows from financing activities:
             
Repayments of debt
   
(3
)
 
(357
)
Purchase of common stock
   
(4,631
)
 
-
 
Net proceeds from issuance of common stock
   
4,935
   
5,488
 
               
Net cash provided by financing activities
   
301
   
5,131
 
               
Change in cash and cash equivalents
   
(26,466
)
 
7,503
 
               
Cash and cash equivalents, beginning of period
   
30,263
   
19,672
 
           
 
Cash and cash equivalents, end of period
 
$
3,797
 
$
27,175
 
               
See notes to condensed consolidated financial statements.
             

  5  


PEET’S COFFEE & TEA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

1.      BASIS OF PRESENTATION
 
The accompanying condensed consolidated financial statements of Peet’s Coffee & Tea, Inc. and its subsidiaries (collectively, the “Company”) for the thirteen and thirty-nine weeks ended September 26, 2004 and September 28, 2003 are unaudited and, in the opinion of management, contain all adjustments (consisting only of normal recurring items) necessary to present fairly the financial position and results of operations for such periods. The condensed consolidated financial statements have been prepared using the same accounting policies and methods of computation and should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 28, 2003. The results of operations for the thirteen and thirty-nine weeks ended September 26, 2004 are not necessarily indicative of the results expected for the full year.

The balance sheet information as of December 28, 2003, presented herein, has been derived from the audited consolidated financial statements of the Company included in the Annual Report on Form 10-K for the year ended December 28, 2003.

Certain reclassifications of prior year balances have been made to conform to the current presentation.
 
2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Stock Based Compensation

The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principle Board No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost has been recognized for the stock option awards granted at fair market value. Through 2001, the Company granted options at 85% of fair value and recorded compensation expense equal to the intrinsic value over the vesting period. Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation”, requires the disclosure of pro forma net income (loss) and earnings (loss) per share as if the Company had adopted the fair value method. Had compensation cost for the Company’s stock option plans and employee stock purchase plan been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company’s net income would have been reduced to the pro forma amounts indicated below (in thousands):
   
Thirteen weeks ended
 
Thirty-nine weeks ended
 
   
September 26,
 
September 28,
 
September 26,
 
September 28,
 
   
2004
 
2003
 
2004
 
2003
 
                           
Net income (loss) - as reported
 
$
2,009
 
$
(323
)
$
5,593
 
$
2,498
 
Stock-based employee compensation included in reported net income (loss), net of tax
   
15
   
70
   
46
   
93
 
Stock-based compensation expense determined under fair value based method, net of tax
   
(955
)
 
(826
)
 
(3,333
)
 
(2,816
)
Net income (loss) - pro forma
 
$
1,069
 
$
(1,079
)
$
2,306
 
$
(225
)
                           
Basic net income (loss) per share - as reported
 
$
0.15
 
$
(0.03
)
$
0.42
 
$
0.20
 
Basic net income (loss) per share - pro forma
 
$
0.08
 
$
(0.08
)
$
0.17
 
$
(0.02
)
                           
Diluted net income (loss) per share - as reported
 
$
0.14
 
$
(0.03
)
$
0.40
 
$
0.19
 
Diluted net income (loss) per share - pro forma
 
$
0.08
 
$
(0.08
)
$
0.17
 
$
(0.02
)
 

 
  6  

 

The Company uses the Black-Scholes option-pricing model for determining the fair value of options, which requires the input of certain estimates that may affect the determination of fair value. The existing model may not necessarily provide a reliable single measure of the value of its stock options. Management will continue to evaluate alternative methodologies that may more appropriately reflect pro forma compensation expense. During the thirty-nine week period ended September 26, 2004, the Company corrected certain computational items, resulting in a decrease to pro forma net income as reported of $42,000 and $82,000 for the thirteen and thirty-nine weeks ended September 28, 2003, respectively. 

The fair value of each option grant and ESPP award is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

   
Options Granted for the Period Ended
 
   
September 26,
 
September 28,
 
   
2004
 
2003
 
               
Expected dividend rate
   
0.00
%
 
0.00
%
Expected volatility
             
- Options
   
44.17
%
 
52.01
%
- ESPP awards
   
52.33
%
 
53.34
%
Risk free interest rate
             
- Options
   
3.97
%
 
1.94
%
- ESPP awards
   
1.33
%
 
1.25
%
Expected lives (years)
             
- Options
   
5.21
   
4.97
 
- ESPP awards
   
1.34
   
1.00
 
 
Comprehensive Income

For the thirteen week period ended September 26, 2004 and September 28, 2003, comprehensive income (loss) was $2,113,000 and ($520,000), respectively. For the thirty-nine week period ended September 26, 2004 and September 28, 2003, comprehensive income (loss) was $5,492,000 and $2,269,000, respectively. Comprehensive income consists of net income, the effect of accounting for hedges under SFAS No. 133, and net unrealized gains on investments.

Net Income per Share

The following table summarizes the differences between basic weighted average shares outstanding and diluted weighted average shares outstanding used to compute diluted net income per share (in thousands):

   
Thirteen weeks ended
 
Thirty-nine weeks ended
 
   
September 26,
 
September 28,
 
September 26,
 
September 28,
 
   
2004
 
2003
 
2004
 
2003
 
                           
Basic weighted average shares outstanding
   
13,420
   
12,778
   
13,269
   
12,472
 
Incremental shares from assumed exercise of stock options
   
695
   
-
   
646
   
683
 
Diluted weighted average shares outstanding
   
14,115
   
12,778
   
13,915
   
13,155
 

The number of incremental shares from the assumed exercise of stock options was calculated applying the treasury stock method.

For the thirteen week period ended September 26, 2004 and September 28, 2003, there were no options with an exercise price greater than the average market price of common shares, and 211,495 and 98,663 for the thirty-nine week period ended September 26, 2004 and September 28, 2003, respectively, that were not included in the computation of diluted earnings per share.     
 
 
  7  

 
Recently Issued Accounting Standards

In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides a three-step impairment model for determining whether an investment is other-than-temporarily impaired and requires the Company to recognize such impairments as an impairment loss equal to the difference between the investment’s cost and fair value at the reporting date. The implementation of this guidance has been delayed pending the resolution of certain implementation issues and the expected issuance of a FASB Staff Position on this matter in December 2004. The Company does not believe that the adoption of EITF 03-1 will have a significant effect on its financial statements.
 
3.     INVESTMENTS

The Company’s investment balances include U.S. government, municipal, and agency securities with both short and long-term maturities, including those with maturities less than 90 days, classified as available for sale. Gains and losses are due to fluctuations in interest rates and are considered temporary impairments as management has the intent and ability to hold the securities to maturity.
 
4.     INVENTORIES
 
The Company’s inventories consist of the following:
   
September 26,
 
December 28,
 
   
2004
 
2003
 
Raw materials
 
$
9,733
 
$
6,144
 
Finished goods
   
5,149
   
4,576
 
Total
 
$
14,882
 
$
10,720
 

5.  SHARE PURCHASE

In February 2004, the Board of Directors approved the purchase of up to one million shares of the Company’s common stock. During the thirteen weeks ended September 26, 2004, the Company purchased and retired 198,648 shares of common stock at an average price of $22.23, in accordance with the share purchase program. As of September 26, 2004, the Company purchased a total of 208,133 shares at an average price of $22.21.     

6.    LEGAL PROCEEDINGS
 
During the thirteen weeks ended September 26, 2004, the Company substantially completed the payout pursuant to a settlement approved by the Superior Court of the State of California, County of Orange, related to the two lawsuits filed against the Company entitled Brian Taraz, et al vs. Peet's Coffee & Tea, Inc., and Tracy Coffee, et al. vs. Peet's Coffee & Tea, Inc. on February 25, 2003 and March 7, 2003. These suits were filed by one former and one current store manager alleging misclassification of employment position and sought damages, restitution, reclassification and attorneys’ fees and costs. During 2003, the Company recorded a charge of $2.7 million for the estimated payment of claims to eligible class members, attorneys’ fees and costs, costs to a third-party claims administrator, as well as applicable employer payroll taxes. Based on the final settlement, fees and costs incurred, the Company reduced general and administrative expenses by $548,000 for the thirteen and thirty-nine weeks ended September 26, 2004.
 
In addition to the lawsuits described above, we may from time to time become involved in certain legal proceedings in the ordinary course of business. Currently, the Company is not party to any other legal proceedings that management believes would have a material adverse effect on the financial position or results of operations of the Company.

 
  8  

 
7.     SEGMENT INFORMATION

The Company operates in two reportable segments: retail and specialty sales. Retail store operations consist of sales of whole bean coffee, beverages, tea and related products through Company-operated retail stores. Specialty sales consists of online and mail order sales of whole bean coffee shipped directly to the consumer and whole bean coffee sales to grocery, foodservice and office coffee accounts.

The following table presents certain financial information for each segment. Segment income before taxes excludes unallocated marketing expenses and general and administrative expenses. Unallocated assets include cash, coffee inventory in the warehouse, corporate headquarter assets and intangibles and other assets.

       
Specialty
         
   
Retail
 
Sales
 
Unallocated
 
Total
 
Thirteen weeks ended September 26, 2004:
                         
Net revenue
 
$
23,917
 
$
10,549
       
$
34,466
 
Cost of sales and occupancy
   
11,095
   
5,048
         
16,143
 
Operating expenses
   
9,672
   
2,231
         
11,903
 
Depreciation and amortization
   
1,065
   
270
 
$
152
   
1,487
 
Segment operating income (loss)
   
2,085
   
3,001
   
(2,136
)
 
2,950
 
Investment income, net
               
227
   
227
 
Income before income taxes
                     
3,177
 
Total assets
   
27,079
   
8,169
   
83,249
   
118,497
 
Capital expenditures
   
3,332
   
964
   
478
   
4,774
 
                           
Thirteen weeks ended September 28, 2003:
                         
Net revenue
 
$
20,706
 
$
8,127
       
$
28,833
 
Cost of sales and occupancy
   
9,525
   
3,783
         
13,308
 
Operating expenses
   
7,420
   
2,006
         
9,426
 
Depreciation and amortization
   
849
   
239
 
$
140
   
1,228
 
Segment operating income (loss)
   
2,861
   
2,100
   
(5,908
)
 
(947
)
Investment income, net
               
499
   
499
 
Loss before income taxes
                     
(448
)
Total assets
   
20,959
   
7,156
   
78,737
   
106,852
 
Capital expenditures
   
459
   
953
   
765
   
2,177
 
                           
Thirty-nine weeks ended September 26, 2004:
                         
Net revenue
 
$
70,063
 
$
30,550
       
$
100,613
 
Cost of sales and occupancy
   
31,598
   
14,757
         
46,355
 
Operating expenses
   
27,354
   
6,906
         
34,260
 
Depreciation and amortization
   
2,945
   
779
 
$
442
   
4,166
 
Segment operating income (loss)
   
8,165
   
8,108
   
(7,778
)
 
8,495
 
Investment income, net
               
655
   
655
 
Income before income taxes
                     
9,150
 
Total assets
   
27,079
   
8,169
   
83,249
   
118,497
 
Capital expenditures
   
7,712
   
1,365
   
1,499
   
10,576
 
                           
Thirty-nine weeks ended September 28, 2003:
                         
Net revenue
 
$
61,794
 
$
23,517
       
$
85,311
 
Cost of sales and occupancy
   
28,112
   
11,185
         
39,297
 
Operating expenses
   
22,015
   
6,168
         
28,183
 
Depreciation and amortization
   
2,486
   
694
 
$
367
   
3,547
 
Segment operating income (loss)
   
9,017
   
5,471
   
(11,283
)
 
3,205
 
Investment income, net
               
972
   
972
 
Income before income taxes
                     
4,177
 
Total assets
   
20,959
   
7,156
   
78,737
   
106,852
 
Capital expenditures
   
4,839
   
1,354
   
1,786
   
7,979
 

 
 
  9  

 
ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our financial statements and related notes included elsewhere in this report. Except for historical information, the discussion in this report contains certain forward-looking statements that involve risks and uncertainties. We have based these forward-looking statements on our current expectations and assumptions about future events. In some cases, you can identify forward-looking statements by terminology, such as “may,” “will,” “should,” “could,” “predict,” “potential,” “continue, “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate” and similar expressions (or the negative of such expressions). These statements are based on our current beliefs, expectations and assumptions and are subject to a number of risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors including but not limited to, coffee and other raw material prices and availability, successful execution of business strategies and plans for expansion, competition, general economic conditions, economic or political instability related to potential terrorist attacks, the popularity of specialty coffee due to consumer trends, labor relations, health factors or other issues, as well as other risk factors as described more fully in our Annual Report on Form 10-K for the year ended December 28, 2003. Forward-looking statements speak only as of the date of this report.

COMPANY OVERVIEW AND INDUSTRY OUTLOOK

Peet’s is a specialty coffee roaster and marketer of fresh, deep-roasted whole bean coffee sold through multiple channels of distribution.  Founded in Berkeley, California in 1966, Peet's has established a loyal customer base with strong brand awareness in California.  Our national expansion strategy is based on the sale of whole bean coffee in multiple channels of distribution.  Our current expansion strategy is focused in the western United States, where we have more physical presence and higher customer awareness.    
 
We expect the specialty coffee industry to continue to grow.  We believe that this growth will be fueled by continued consumer interest in high quality coffee and related products. 

Our operations are vertically integrated.  We purchase Arabica coffee beans from countries around the world, apply our artisan-roasting techniques and ship fresh coffee daily to our stores and customers.  Control of purchasing, roasting, packaging and distribution of our coffee allows us to maintain our commitment to freshness, is cost effective, and enhances our margins and profit potential.

Our coffee and related items are sold through two segments as defined under Statement of Financial Accounting Standards No. 131 (“SFAS No. 131”), “Disclosures About Segment of Enterprise and Related Information.”  These segments are Company-operated retail outlets and specialty sales, consisting of home delivery (on-line and mail order), grocery, food service and office.  We evaluate segment performance primarily based on revenue and segment operating income. 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to our financial statements.

 
  10  

 
We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate and actual results have not differed materially from those determined using necessary estimates.
 
Our accounting policies are more fully described in Note 2 in the “Notes to the Consolidated Financial Statements,” included in our Annual Report on Form 10-K for the year ended December 28, 2003. These accounting policies are applied consistently for all years presented. We have identified the following critical accounting policies:

Inventory. Raw materials consist primarily of green bean coffee. Finished goods consist primarily of roasted coffee, tea, accessory products, spices and packaged foods. All products are valued at the lower of cost or market using the first-in, first-out method, except green bean and roasted coffee, which is valued at the average cost. We continually evaluate the composition of our coffee related merchandise and mark down such inventory as needed. Our historical inventory write-offs have been immaterial.

Intangibles and other assets. During 2002, we entered into a contractual agreement with Safeway Inc., a national grocery chain, to sell Peet's coffee through its grocery stores. We began shipping during the third quarter of 2002. The agreement included an upfront payment to Safeway Inc. that we recorded in intangibles and other assets and amortized as a reduction of revenue based upon estimated sales during the contract period. As of September 26, 2004, the asset has been completely amortized.

Long-lived assets. In evaluating the fair value and future benefits of long-lived assets, we perform an analysis of the anticipated undiscounted future net cash flows of the related long-lived asset and reduce their carrying value by the excess, if any, of the result of such calculation. We believe at this time that the long-lived assets’ carrying values and useful lives continue to be appropriate.

Accrued workers’ compensation. In March 2002, we modified our workers’ compensation insurance policy to a high deductible insurance program with an overall program ceiling to minimize exposure. We began recording an estimated liability for the self-insured portion of the workers’ compensation claims. The liability of $1.5 million recorded as of September 26, 2004 is determined based on information received from our insurance carrier including claims paid, filed and reserved for, as well as using historical experience. Should a greater amount of claims occur compared to what is estimated or the settlement costs increase beyond what was anticipated, the recorded liability may not be sufficient.

Income taxes. In establishing deferred income tax assets and liabilities, we make judgments and interpretations based on enacted tax laws and published tax guidance applicable to its operations. We record deferred tax assets and liabilities and evaluate the need for valuation allowances to reduce deferred tax assets to realizable amounts. Changes in our valuation of the deferred tax assets or changes in the income tax provision may affect its annual effective income tax rate.

Stock-Based Compensation. The Company has chosen to account for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principle Board No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees.” Information about the impact on our operating results of using the alternative of Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation” is included in Note 2 elsewhere in this report.
 

.

 
  11  

 
RESULTS OF OPERATIONS

The following discussion of results of operations should be read in conjunction with our financial statements and accompanying notes and other financial data included elsewhere in this report. The following table sets forth certain financial data for the periods indicated.
   
Thirteen weeks ended
 
Thirty-nine weeks ended
 
   
September 26,
 
September 28,
 
September 26,
 
September 28,
 
   
2004
 
2003
 
2004
 
2003
 
Statement of operations data as a percent of net revenue:
                         
Net revenue
   
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales and related occupancy expenses
   
46.9
   
46.1
   
46.1
   
46.1
 
Operating expenses
   
34.5
   
32.7
   
34.1
   
33.0
 
Marketing and advertising expenses
   
2.2
   
3.3
   
2.6
   
3.9
 
General and administrative expenses
   
3.5
   
16.9
   
4.7
   
9.1
 
Depreciation and amortization expenses
   
4.3
   
4.2
   
4.1
   
4.1
 
Income (loss) from operations
   
8.6
   
(3.2
)
 
8.4
   
3.8
 
Investment income, net
   
0.6
   
(1.7
)
 
(0.7
)
 
(1.1
)
Income (loss) before income taxes
   
9.2
   
(1.5
)
 
9.1
   
4.9
 
Income tax provision (benefit)
   
3.4
   
(0.4
)
 
3.5
   
2.0
 
Net income (loss)
   
5.8
%
 
(1.1
)%
 
5.6
%
 
2.9
%
                           
Percent of net revenue by business segment:
                         
Retail stores
   
69.4
%
 
71.8
%
 
69.6
%
 
72.4
%
Specialty sales
   
30.6
%
 
28.2
%
 
30.4
%
 
27.6
%
                           
Percent of net revenue by business category:
                         
Whole bean coffee and related products
   
57.1
%
 
57.8
%
 
58.1
%
 
58.8
%
Beverages and pastries
   
42.9
%
 
42.2
%
 
41.9
%
 
41.2
%
                           
Cost of sales and related occupancy expenses:
                         
Retail stores
   
46.4
%
 
46.0
%
 
45.1
%
 
45.5
%
Specialty sales
   
47.9
%
 
46.5
%
 
48.3
%
 
47.6
%
                           
Operating expenses:
                         
Retail stores
   
40.4
%
 
35.8
%
 
39.0
%
 
35.6
%
Specialty sales
   
21.1
%
 
24.7
%
 
22.6
%
 
26.2
%
                           
Percent increase (decrease) from prior year:
                         
Net revenue
   
19.5
%
       
17.9
%
     
Retail stores
   
15.5
         
13.4
       
Specialty sales
   
29.8
         
29.9
       
Cost of sales and related occupancy expenses
   
21.3
         
18.0
       
Operating expenses
   
26.3
         
21.6
       
Marketing and advertising expenses
   
(20.5
)
       
(22.2
)
     
General and administrative expenses
   
(74.9
)
       
(38.8
)
     
Depreciation and amortization expenses
   
21.1
         
17.5
       
                           
Selected operating data:
                         
Number of retail stores in operation:
                         
Beginning of the period
   
82
   
69
   
75
   
65
 
Store openings
   
5
   
3
   
12
   
7
 
End of period
   
87
   
72
   
87
   
72
 


 
  12  

 

Thirteen Weeks Ended September 26, 2004 Compared to Thirteen Weeks Ended September 28, 2003

Net revenue

Net revenue for the thirteen weeks ended September 26, 2004 increased versus the same prior year period primarily as a result of the continued expansion of our retail and specialty sales segments. Whole bean and related sales increased 18.1%, to $19.7 million, mostly due to specialty sales, while beverage and pastry sales increased 21.5%, to $14.8 million.
In the retail segment, our revenue increased by $3.2 million primarily as a result of increased sales from the 15 stores we opened in the last twelve months and secondarily from existing stores. Sales of whole bean coffee and related products in the retail segment increased by 6.8%, to $9.4 million, while sales of beverages and pastries increased by 22.0%, to $14.5 million. The higher increase in beverage and pastry sales was primarily caused by sales at the stores we opened since last year and increased traffic in our existing stores. The slower growth in whole bean and related products was due to the increased availability of Peet’s coffee in grocery stores and the slower maturation of whole bean sales in new stores. We opened five new stores during this quarter, including four in the month of September. We opened one store in October and expect to open an additional three to four stores by the end of the year. In the specialty sales segment, revenue increased $2.4 million. The increase primarily consisted of a $1.5 million increase in grocery sales, a $0.5 million increase in sales to restaurants and foodservice companies, and a $0.3 million increase in home delivery sales. The growth in the grocery channel was primarily due to the increased number of grocery stores selling our products to approximately 3,500. We also continue to experience increased volume in our existing accounts as we promote special and limited coffees. In the restaurant and food service area, the sales increase was primarily due to the addition of selected new accounts, such as new licensed locations at the San Francisco International Airport (“SFO”), and the new Omni Hotel in Orlando (“Omni”). In home delivery, the sales increase was primarily due to continued emphasis on retaining customers. These loyalty programs include rewarding customers who sign-up for subscription deliveries with earned dividends for future purchases.

Cost of sales and related occupancy expenses

Cost of sales as a percent of net revenue increased 0.8% primarily due to higher costs from new stores and a change in mix in the specialty channels. The increases were partially offset by cost improvements in our existing stores.
 
In the retail segment, cost of sales increases were primarily due to more new stores that with lower volumes have higher occupancy and product costs as a percent of sales. The increase was partially offset by better waste management of our pastries and lower shipping costs. In the specialty segment, cost of sales as a percent of net revenue increased as a result of higher sales growth from foodservice channels and higher shipping costs in our home delivery channel. In the foodservice channel, cost of sales as a percent of net revenue was higher due to the rollout of the new licensed locations at SFO and Omni. Initial orders to these locations include more merchandise and supplies that have lower margins.

Operating expenses

Operating expenses as a percent of net revenue for the current quarter increased as compared to the same period last year due to the higher operating expenses from stores, partially offset by improvements in the specialty sales channels. Operating expenses from stores increased as the result of the 15 new stores we opened in the last twelve months, maintenance and repairs in our existing stores, and workers’ compensation expenses. Specialty sales operating expenses decreased compared to the same period last year as we continued to leverage the higher sales growth on a more fixed cost operating structure.     
 
Marketing and advertising expenses

Marketing and advertising expenses were $0.8 million, or 2.2% of net revenue, compared to $1.0 million, or 3.3% of net revenue, for the same period last year. We will continue to focus our marketing efforts primarily on new store openings and retaining existing customers in other channels.

General and administrative expenses
 
General and administrative expenses in the current quarter were $1.2 million, or 3.5% of revenue, compared to $4.9 million, or 16.9% for the same period last year. The decrease of $3.7 million included $3.4 million related to the wage and hour lawsuit and severance charges recorded last year, $0.5 million for the credit recorded this quarter based on the final settlement, offset by $0.2 million of spending growth. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements.


 
  13  

 

Depreciation and amortization expenses

Depreciation and amortization expenses were higher compared to the same period last year due primarily to the 15 stores we opened during the last twelve months. As a percent of net revenue, depreciation and amortization expenses were mostly consistent with the prior year period.

Investment income, net

We currently invest in U.S. government, municipal, and agency securities. Investment income includes interest income and gains from the sale of these investments. We earned $0.2 million in interest income, compared to $0.5 million in interest income and gains last year. The decrease was primarily due to a $0.3 million investment gain recorded last year when we sold certain securities.

Provision for income taxes

We have revised our full year effective tax rate to 38.9%, resulting in an adjusted tax rate of 36.8% recorded in the thirteen weeks ended September 26, 2004. The revision was due primarily to two factors: 1) the allocation of a significant portion of our investment portfolio into tax-free instruments and 2) our recent election not to take advantage of accelerated depreciation on certain assets. Foregoing this election will allow us to use expiring charitable contribution deductions and retain the future tax benefit of the acquired assets.


Thirty-nine Weeks Ended September 26, 2004 Compared to Thirty-nine Weeks Ended September 28, 2003

Net revenue

Net revenue for the thirty-nine weeks ended September 26, 2004 increased versus the same prior year period primarily as a result of the continued expansion of our retail and specialty sales segments. Whole bean and related sales increased 16.6%, to $58.5 million, and beverage and pastry sales increased 19.8%, to $42.1 million.In the retail segment, our revenue increased by $8.3 million primarily as a result of increased sales from the 22 stores we opened in the last twenty-one months and secondarily from existing stores. Sales of whole bean coffee and related products in the retail segment increased by 4.7%, to $28.7 million, while sales of beverages and pastries increased by 20.3%, to $41.3 million. The higher increase in beverage and pastry sales is primarily due to additional stores, increased traffic in our existing stores, and our introduction of new iced drinks and a revamped bar menu mid-last year. The slower growth in whole bean and related products was due to the cannibalization of bean sales in retail stores from grocery, and the slower maturation of whole bean sales in new stores. Year to date, we have opened 12 new stores compared to seven last year. In the specialty sales segment, revenue increased $7.0 million. The increase consisted of a $4.9 million increase in grocery sales, a $1.2 million increase in sales to restaurants and foodservice companies, and a $0.8 million increase in home delivery sales. The growth in the grocery channel was primarily due to new grocery accounts we added during the last twelve months and increased volume in existing accounts. In the restaurant and food service area, the sales increase was primarily due to the addition of selected new accounts. As discussed above, the home delivery sales increase was primarily due to continued emphasis on increasing the purchase frequency of our existing customer base. 
 
Cost of sales and related occupancy expenses

Cost of sales as a percent of net revenue was consistent with prior year at 46.1%. Improvement at our retail stores was offset by a higher sales mix from specialty sales, which has slightly lower margins. Within retail, the improvement at stores was primarily due to higher price points generated from our revamped bar menu and better waste management of our pastries. This improvement was partially offset by higher milk costs and expenses from new stores. Within specialty sales, cost of sales as a percent of sales decreased because of sales mix changes within the segment.

Operating expenses

Operating expenses as a percent of net revenue for the current period increased compared to the same period last year due to the higher operating expenses from stores, partially offset by improvements in the specialty sales channels. Operating expenses from stores increased as a result of the 22 new stores we opened in the last twenty-one months, maintenance and improvements in our existing stores, workers’ compensation expenses and investments made in store training and development programs. Specialty sales operating expenses decreased comparatively mainly because last year we incurred expenses in connection with the set-up phase of the direct-store delivery operation, as well as leverage gained from other specialty channels.     
 
Marketing and advertising expenses

Marketing and advertising expenses were $2.6 million, or 2.6% of net revenue, compared to $3.4 million, or 3.9% of net revenue, for the same period last year.

General and administrative expenses
 
General and administrative expenses were $4.7 million, or 4.7% of revenue, compared to $7.7 million, or 9.1%, for the same period last year. The decrease of $3.0 million included $3.4 million related to the wage and hour lawsuit and severance charges recorded last year, $0.5 million for the credit recorded this quarter based on the final settlement, offset by $0.9 million of spending growth. This $0.9 million increase from prior year was primarily due to the people and initiatives in place to support the growth of the company.
 
Investment income, net

Investment income decreased compared to prior year primarily because of the $0.3 million investment gains in the prior year.

Provision for income taxes

As discussed above, we revised our expected full year and year to date effective tax rate to 38.9%.

 
  14  

 
Liquidity and Capital Resources

At September 26, 2004, we had $3.8 million in cash and cash equivalents, $12.0 million in short-term investments and $40.3 million in long-term investments for a total of $56.1 million. Working capital was $23.2 million as of the end of this quarter.

Net cash provided by operations was $7.5 million during the first thirty-nine weeks of 2004 compared to $7.3 million in the same prior year period. Current year operating cash flows were positively impacted by increased net income and depreciation and amortization compared to the same period last year, mostly offset by increases in inventory due to increased volume and seasonally higher coffee purchases and increased cash deposits required for the self-insured portion of our workers’ compensation policy.

Net cash used in investing activities was $34.3 million during the first thirty-nine weeks of 2004 compared to $4.9 million in the same prior year period. Investing activities primarily relate to the purchases of U.S. government, municipal, and agency securities in addition to purchases of property and equipment.

Net cash provided by financing activities was $0.3 million during the first thirty-nine weeks of 2004. Financing activities during the period consisted primarily of the exercise of stock options and sales of our common stock to our employees through our employee stock purchase plan and the purchase of 208,133 shares of the Company’s common stock.

We have a credit facility with General Electric Capital Corporation that provides for a revolving line of credit of $15.0 million that expires in 2005. At September 26, 2004, there was no outstanding balance and $14.9 million available under the revolving line of credit after other senior funded debt of $0.1 million, consisting of capital leases.

Our 2004 capital requirements consist primarily of expenditures relating to new store openings, remodeling of existing stores, upgrade of our packaging system and continued improvement of our data processing capabilities. During the first thirty-nine weeks of 2004, we spent $10.6 million, of which $5.8 was spent on new stores. Our remaining 2004 capital expenditures are expected to be approximately $3.4 million. We expect to spend approximately $1.4 million for the construction of new retail stores scheduled to open during balance of the year and for new stores in progress for 2005. We expect to use approximately $0.8 million to purchase new packaging and roasting equipment, $0.5 million in equipment and support for the grocery channel and licensed locations, and $0.7 million for the remodeling of existing stores, and information technology enhancements.

We are exploring capacity and office space needs as we continue to grow our business. The lease for our corporate office and plant facilities expires in 2005 and we have an option to extend the lease for an additional ten years. We believe that in 2005 we will need additional production and office space that will exceed our current facilities. We are in the process of exploring alternatives including but not limited to extending the existing lease and leasing additional production, warehouse, and office space.

For the next twelve months, we expect our cash flows from operations and cash and investments to be sufficient for our operating and capital requirements, our share purchase program, and our contractual obligations as they come due. Other business opportunities or store expansion rates substantially in excess of those presently planned may require outside funding.


ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We invest excess cash in money market accounts, short-term investments and long-term U.S. government, municipal, and agency securities. These financial instruments are all subject to fluctuations of daily interest rates. Therefore our investment portfolio is exposed to market risk from these changes.

The supply and price of coffee are subject to significant volatility and can be affected by multiple factors in the producing countries, including weather, political and economic conditions. In addition, green coffee bean prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations that have historically attempted to influence commodity prices of green coffee beans through agreements establishing export quotas or restricting coffee supplies worldwide.

Our coffee hedging strategy is intended to limit the cost exposure of the main commodity used in our business, green coffee beans. In the past, we have used fixed-price purchase commitments, coffee futures, and coffee futures options to manage coffee supply and price risk. Currently, we utilize only fixed-price purchase commitments and have no coffee futures or futures options.

As of September 26, 2004, we had approximately $22.3 million in open fixed-priced purchase commitments with delivery dates ranging from October 2004 through July 2007. Those commitments, combined with our current inventory, cover 100% of our inventory needs for the remainder of the year. We believe, based on relationships established with our suppliers in the past that the risk of non-delivery on such purchase commitments is remote.

There have been no substantial changes in the nature of our risks since December 28, 2003. Please refer to our Annual Report on Form 10-K for the year ended December 28, 2003.
 

 
  15  

 


ITEM 4.     CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of September 26, 2004, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable-assurance level.

There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.



PART II - OTHER INFORMATION

ITEM 1.     LEGAL PROCEEDINGS

During the thirteen weeks ended September 26, 2004, the Company substantially completed the payout pursuant to a settlement approved by the Superior Court of the State of California, County of Orange, related to the two lawsuits filed against the Company entitled Brian Taraz, et al vs. Peet's Coffee & Tea, Inc., and Tracy Coffee, et al. vs. Peet's Coffee & Tea, Inc. on February 25, 2003 and March 7, 2003. These suits were filed by one former and one current store manager alleging misclassification of employment position and sought damages, restitution, reclassification and attorneys’ fees and costs. During 2003, the Company recorded a charge of $2.7 million for the estimated payment of claims to eligible class members, attorneys’ fees and costs, costs to a third-party claims administrator, as well as applicable employer payroll taxes. Based on the final settlement, fees and costs incurred, the Company reduced general and administrative expenses by $548,000 for the thirteen and thirty-nine weeks ended September 26, 2004.
 
In addition to the lawsuits described above, we may from time to time become involved in certain legal proceedings in the ordinary course of business. Currently, the Company is not party to any other legal proceedings that management believes would have a material adverse effect on the financial position or results of operations of the Company.


ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth all purchases made by us or any “affiliated purchaser” as defined in Rule 10b-18(a)(3) of the Exchange Act of the Company’s common stock during the third quarter of 2004.

Period
 
(a) Total Number of Shares Purchased
 
(b) Average Price Paid per Share
 
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
 
August 2 - August 29, 2004
   
84,599
 
$
21.81
   
84,599
   
905,917
 
August 30 - September 26, 2004
   
114,050
 
$
22.53
   
114,050
   
791,867
 
Total
   
198,649
 
$
22.23
   
198,649
   
791,867
 

The Company announced its plan to purchase shares on February 12, 2004 on Form 8-K. As of September 26, 2004, and the Company has purchased 208,133 shares.
 
 
ITEM 6.     EXHIBITS

Exhibit Number
Description
31.1
Certification of the Company's Chief Executive Officer, Patrick O'Dea, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
31.2
Certification of the Company's Chief Financial Officer, Thomas Cawley, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
32.1
Certification of the Company's Chief Executive Officer, Patrick O'Dea, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
32.2
Certification of the Company's Chief Financial Officer, Thomas Cawley, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.



 
 
  16  

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
PEET’S COFFEE & TEA, INC.
    Date:    November 4, 2004    
                  By: /s/ Thomas Cawley             Thomas Cawley
Vice President, Chief Financial Officer, and Secretary


 


  17