10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-K

(Mark One)

 

  þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 24, 2009

OR

 

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

Commission file number 0-21203

DIEDRICH COFFEE, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   33-0086628

(State or Other Jurisdiction

of Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

28 Executive Park, Suite 200

Irvine, California 92614

(Address of Principal Executive Offices)

Registrant’s telephone number, including area code

(949) 260-1600

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class    Name of each exchange on which registered
Common Stock, $0.01 par value    The NASDAQ Capital Market

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [    ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [    ] No [X]

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [    ] 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]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer [    ]   Accelerated filer [    ]
Non-accelerated filer [    ] (Do not check if a smaller reporting company)   Smaller reporting company [X]

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [    ] No [X]

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of December 10, 2008 was $1,658,230.

The number of shares of the registrant’s common stock outstanding, as of September 9, 2009, was 5,726,813.

DOCUMENTS INCORPORATED BY REFERENCE

None.


Table of Contents

TABLE OF CONTENTS

 

          Page

A Warning About Forward-Looking Statements

   1
PART I   

Item 1.

  

Business

   1

Item 1A.

  

Risk Factors

   6

Item 1B.

  

Unresolved Staff Comments

   7

Item 2.

  

Properties

   7

Item 3.

  

Legal Proceedings

   8

Item 4.

  

Submission of Matters to a Vote of Security Holders

   9
PART II   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   10

Item 6.

  

Selected Financial Data

   10

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   10

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   22

Item 8.

  

Financial Statements and Supplementary Data

   22

Item 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   22

Item 9A.

  

Controls and Procedures

   23

Item 9B.

  

Other Information

   23
PART III   

Item 10.

  

Directors, Executive Officers and Corporate Governance

   24

Item 11.

  

Executive Compensation

   27

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   31

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

   34

Item 14.

  

Principal Accountant Fees and Services

   35
PART IV   

Item 15.

  

Exhibits and Financial Statement Schedules

   36
  

Signatures

   37
  

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 annual report on Form 10-K that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our financial condition, operations, plans, objectives and performance. 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 annual report on Form 10-K, along with the following possible events or factors:

 

   

the financial and operating performance of our wholesale operations;

 

   

our ability to achieve and/or maintain profitability over time;

 

   

the successful execution of our growth strategies;

 

   

the impact of competition; and

 

   

the availability of working capital.

Additional risks and uncertainties are described elsewhere in this annual report on Form 10-K and in detail under “Item 1A. Risk Factors.” You are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this annual report on Form 10-K. Except where required by law, we do not undertake an obligation to revise or update any forward-looking statements, whether as a result of new information, future events or changed circumstances. Unless the context requires otherwise, the terms “we,” “us,” and “our” refer to Diedrich Coffee, Inc., a Delaware corporation, and its predecessors and subsidiaries.

PART I

 

Item 1. Business.

Overview

Diedrich Coffee, Inc. (the “Company”) specializes in sourcing, roasting and selling the world’s highest quality coffees. In recent years, the primary driver of the Company’s growth has been the sale of K-Cup® portion pack coffees and teas. Diedrich Coffee is one of only four roasters under non-exclusive license to produce K-Cups® for Keurig Incorporated’s (“Keurig”) top selling single-cup brewing system. Keurig is the wholly owned subsidiary of Green Mountain Coffee Roaster, Inc. The Company markets its three leading brands of specialty coffees – Diedrich Coffee, Coffee People and Gloria Jean’s Coffees – through office coffee distributors (“OCS”), restaurants and specialty retailers and via the Company’s web stores. In addition, the Company operates a coffee roasting facility and a distribution center in central California that supplies freshly roasted coffee beans to our wholesale customers.

Recent Developments

Our strategy is to capitalize on the growth of the wholesale specialty coffee market and our strength as a premier roaster and distributor of the world’s finest coffees. In conjunction with the transaction with Praise International North America, Inc., which is described in more detail below, we sold the Gloria Jean’s U.S. franchise and retail operations. Our results of the Gloria Jean’s franchise and retail operations are reported as discontinued operations for all periods presented.

 

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As previously announced, on March 27, 2009, we and Praise International North America, Inc., a Delaware corporation (“Praise”), entered into an agreement (the “Agreement”) pursuant to which we agreed to sell all of the issued and outstanding shares (the “Shares”) of common stock, par value $0.01 per share, of Praise U.S. Holdings, Inc. (formerly known as Coffee People Worldwide, Inc.), a Delaware corporation and wholly-owned subsidiary of Diedrich Coffee Inc. that owned assets used in the Company’s U.S. franchise operations (such purchase, the “Transaction”). On June 12, 2009, the Company completed the Transaction, and pursuant to the Agreement Praise purchased the Shares for $3,100,000, of which $1,500,000 was paid in cash and the remainder paid in the form of a twelve-month promissory note with an aggregate principal amount of $1,600,000 and an interest rate equal to 7.0% per annum, issued by Praise to the Company. In addition, we entered into several ancillary agreements, including a roasting agreement whereby we agreed to provide coffee roasting services to Praise for a period of five years and a trademark license agreement whereby we granted to Praise a license to use the Company’s Gloria Jean’s Gourmet Coffees Corp. U.S. trademarks in the United States of America (including the Commonwealth of Puerto Rico) until these trademarks are transferred to Gloria Jean’s Coffees International Pty. Ltd.

Praise is an affiliate of Gloria Jean’s Coffees International Pty. Ltd., which was a party to the purchase of the Company’s international franchise operations in February 2005.

Company Information

Diedrich Coffee, Inc. is a Delaware corporation formed in August 1996. Our company headquarters are located at 28 Executive Park, Suite 200, Irvine, California 92614 and the main telephone number is (949) 260-1600. Our roasting and distribution facilities are located in Castroville, California and Salinas, California, respectively. More information about the Company can be found by visiting our website at www.diedrich.com. The information contained on our website shall not be deemed to be incorporated into this report.

Our Business Model

Our business objective is a logical extension of our Mission Statement, which states: “Every single cup matters.” Therefore, our objective is to roast and sell only the finest coffees in a variety of packaging formats, without compromising our commitment to quality. We buy only the highest quality green coffee beans available, fresh roast them with our proprietary recipes and subject them to a rigorous internal quality control process. We ensure that care is taken at each and every step of the production and distribution process to preserve that quality.

We sell our coffee through selected distribution channels, and strive to target our resources to increase efficiency and profitability while growing the business within this framework. These distribution channels include specialty retailers, mass merchandisers, office coffee distributors, grocery, foodservice distributors and our internet web stores. While each of these channels have different customers, cost structures, overhead requirements, competitors, and other fundamental differences, we believe our commitment to quality is essential to successful growth in all of these distribution channels. Important financial information for each of our business segments can be found in Note 14 to our consolidated financial statements.

Wholesale Distribution

Our strategy is to use our strength as a premier roaster and distributor of the world’s finest coffees to capitalize on the growth of the wholesale specialty coffee market and more specifically, the strong growth of K-Cups®. The Company markets its three leading brands of specialty coffees, Diedrich Coffee, Coffee People and Gloria Jean’s Coffees, through office coffee service distributors, restaurants and specialty retailers, and via the Company’s web stores.

 

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Single Serve Coffee

Diedrich Coffee is one of only four roasters under non-exclusive license to produce K-Cups® for Keurig’s top selling single-cup brewing system. During fiscal 2004, we entered into a license and distribution agreement with Keurig which amended and restated the 2000 license agreement with Keurig, whereby we utilize Keurig’s patented single service coffee brewing technology and its extensive distribution channels within the Away from Home (AFH) and At Home (AH) single serve markets. This multi-channel strategy provides widespread exposure to our three brands in a variety of settings.

In addition to being a leader in office-based single-cup brewing choices, K-Cups® are growing in the AH single serve market. Keurig brewers and K-Cups® are currently sold in over 17,100 retail locations including Bed, Bath & Beyond, Target, Walmart, Macy’s, Bloomingdale’s, Kohl’s and Costco as well as Amazon.com and the QVC shopping network. We are the second largest producer of K-Cups® in the Keurig system and our three branded coffees in K- Cups® are sold through many of these retailers. In addition, we sell our K- Cups® through the Company’s internet web stores and, as a result of the Transaction, we will continue to be the sole supplier of K- Cups® to the Gloria Jean’s retail locations.

Our current license and distribution agreement with Keurig, which expires in July 2013, provides for automatic five-year renewals of the agreement if we meet certain volume thresholds, which we are currently exceeding.

Foodservice & Other Wholesale Accounts

As specialty coffee has grown in overall popularity, more foodservice customers are demanding a high quality cup of coffee as a supplement to a meal. We supply coffee on a wholesale basis to a wide variety of foodservice customers from large chain restaurants to smaller, often independent, operators in the restaurant and hospitality industries and to specialty retailers. Many of our wholesale accounts, such as hotels, restaurants, golf courses and airport concessions have their own “captive” customer base. It is common for our foodservice customers to specify in their menus that they serve Diedrich Coffee which provides us with additional exposure to the restaurants’ patrons and help build brand awareness.

Discontinued Retail Outlets

Our strategy is to capitalize on the growth of the wholesale specialty coffee market and our strength as a premier roaster and distributor of the world’s finest coffees. In the Transaction with Praise, we sold the Gloria Jean’s U.S. franchise operations which included the transfer of 12 company-operated and 90 franchised Gloria Jean’s retail coffeehouses. As of the fiscal year ended June 24, 2009, we have four Coffee People, Inc. and two Diedrich Coffee Inc. franchise locations. In conjunction with our current strategy, subsequent to the fiscal year ended June 24, 2009, the two Diedrich Coffee Inc. franchise locations were terminated. The Company currently has no plans to open any additional company-operated or franchised Diedrich Coffee or Coffee People coffeehouses.

Growth Strategy

In recent years, the primary growth in the coffee industry has come from the specialty coffee category, driven by the wider availability of high quality coffee, the emergence of upscale coffeehouses throughout the country and the general level of consumer knowledge and appreciation of specialty coffee. Diedrich Coffee has benefited from the overall specialty coffee market trends and what we believe are distinctive advantages over our competitors.

We are focused on building our wholesale business and more specifically the sale of K-Cups® in our existing business channels. We believe that we can continue to grow sales by increasing market share in our existing business channels, expanding into new geographic markets, entering new distribution channels, and

 

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selectively pursuing other opportunities. Among other statements, this statement is forward looking and subject to the risks and uncertainties outlined in “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and as described elsewhere in this annual report on Form 10-K.

We continue to expand and strengthen our wholesale sales organization, and we are actively seeking new distribution channels for our coffee products. We intend to pursue continued growth within the AFH single serve coffee market by expanding the number of OCS distributors that carry our K-Cups® as well as our whole bean and ground coffee product lines. We will target large chain foodservice and hospitality customers that are moving up to specialty coffee to satisfy the demands of their guests for high quality coffee.

Product Supply and Roasting

Sourcing.    We are committed to selling only the world’s highest quality coffees. Coffee beans are an agricultural product grown in over 50 countries in tropical regions of the world. The supply and price of coffee are subject to significant volatility and we depend upon our relationships with coffee producers, outside trading companies and exporters for our supply of green coffee. Supply and price can be affected by multiple factors in the producing countries, including weather, political and economic conditions. Although the broader coffee market generally treats coffee as a fungible commodity, the specialty coffee industry focuses on the highest grades of coffee. We purchase primarily premium grade Arabica coffee beans that we believe to be the best available from each producing region.

Roasting.    We employ a roasting process that varies based upon the variety, quality, origin and physical characteristics of the coffee beans being roasted. Our roast masters are responsible for the green coffee bean 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 roast master determines and carefully controls the roasting conditions in an effort to maximize the flavor potential of each batch of coffee. The roast master hears how the roast pops, smells the developing aroma and identifies the right shades of color. They draw upon experience and knowledge to properly adjust airflow, time and temperature while the roast is in progress in order to optimize each roast.

Competition

The specialty coffee market is intensely competitive and generally highly fragmented. The competitive factors within the specialty coffee market include product quality, product offerings, customer service, product differentiation and, to a lesser extent, on price. We are one of only four roasters licensed on a non-exclusive basis to produce K-Cups® for Keurig’s top selling single-cup brewing system. Diedrich Coffee competes against all sellers of specialty coffee in multiple sales channels including Green Mountain, Timothy’s, Starbucks, Peet’s and other competitors.

Seasonality

Our business experiences some variations in sales from quarter to quarter due to the holiday season and other factors including, but not limited to, general economic trends, competition, marketing programs and the weather. The fall and winter months are generally the best sales months but our geographic and product line diversity provide for some sales stability in the warmer months when coffee consumption ordinarily decreases. Because of the seasonality of our business, results from any quarter may not be indicative of the results that may be achieved in any other quarter or the full fiscal year, especially for our first fiscal quarter which tends to be the weakest.

 

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Intellectual Property

We own several trademarks and service marks that have been registered with the United States Patent and Trademark Office, including Diedrich Coffee®, Gloria Jean’s®, Coffee People®, Black Tiger®, Morning Edition Blend®, Wiener Melange Blend®, Nepenthe Blend®, and Flor de Apanas®, as well as other slogans, product names, design marks and logos. We also own registrations in numerous foreign countries for the protection of the Diedrich Coffee and Coffee People trademark and service mark. These trademark registrations can generally be renewed as long as we continue to use the marks protected by the registrations. The Gloria Jean’s, Coffee People and Diedrich Coffee trademarks are material to our business.

On June 12, 2009, we completed the Transaction with Praise and entered into a U.S. Trademark License Agreement, whereby we granted to Praise the exclusive, royalty-free, fully-paid license to use the Gloria Jean’s Gourmet Coffees Corp. U.S. trademarks in the United States of America (including the Commonwealth of Puerto Rico) until these trademarks are transferred to Gloria Jean’s Coffees International Pty. Ltd.

On February 11, 2005, we sold Gloria Jean’s international franchise operations to Jireh International Pty. Ltd., formerly the Gloria Jean’s master franchisee for Australia, and certain of its affiliates (collectively, “Jireh”) for $16,000,000 in cash and an additional $7,020,000 payable over the next six years under license, roasting and consulting agreements. After all payments have been made to us under the license, roasting and consulting agreements, all remaining Gloria Jean’s trademarks, including those in the U.S., will be transferred to Jireh. Concurrent with such future transfer, Diedrich will enter into a perpetual, royalty-free trademark assignment agreement with Jireh under which we will continue to have exclusive rights to continue our wholesale operations for the manufacturing and distribution of the Gloria Jean’s branded K-Cups® worldwide under the Gloria Jean’s Coffees brand in these same markets.

We also own a number of common law service marks and trademarks in the United States including “Gloria Jean’s Coffee Bean.” We have also received trademark and service mark protection for the name Coffee People and related marks in Canada and Japan. 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

At June 24, 2009, we employed 150 people, 149 of whom were employed full-time. None of our employees are represented by a labor union, and no employees are currently covered by collective bargaining agreements. We consider our relations with our employees to be good. We regularly review our employee benefits, training and other aspects of employment to attract and to retain valuable employees and managers. Franchise employees are not employees of the Company.

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and other documents that we may file with or furnish to the SEC from time to time are available on our internet website, free of charge, as soon as reasonably practicable after the reports are electronically filed with or furnished to the United States Securities and Exchange Commission. These reports are available at www.diedrich.com under the heading “Investor Services.” We intend to disclose future amendments to certain provisions of our Code of Conduct, which is available on the www.diedrich.com website, within four business days following the date of such amendment on our website.

 

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Item 1A. Risk factors

RISK FACTORS RELATING TO DIEDRICH COFFEE AND ITS BUSINESS

Historical losses from continuing operations may continue and, as a result, the price of our common stock may be negatively affected.

We had net losses from continuing operations of $179,000 for the fiscal year ended June 24, 2009 and $11,385,000 for the fiscal year ended June 25, 2008. We could continue to suffer losses in the future, which may negatively affect our stock price.

If we are not able to grow our business, the results of our operations and our financial condition may be adversely impacted.

We are a specialty coffee roaster, wholesaler and ecommerce retailer. The majority of our revenue is generated from wholesale customers. To grow, we must:

 

   

expand Diedrich Coffee, Coffee People and Gloria Jean’s wholesale sales;

 

   

continue to add additional production capacity to meet planned product demands;

 

   

continue to upgrade 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.

Future inability to grow our business resulting from, among other things, failing to execute any of the above factors may adversely affect the results of our operations and our financial condition.

Our operating results may fluctuate significantly, which could have a negative effect on the price of our common stock.

From time to time, our operating results may fall below investor expectations. These results are likely to fluctuate from quarter to quarter as a result of a number of factors, including the fluctuations in the price of green coffee; competition from existing and new competitors; and changes in consumer preferences. Quarterly fluctuations in our operating results as the result of these factors or for any other reason could cause our stock price to decline.

Because we have only one roasting facility, a significant interruption in the operation of this facility could potentially disrupt our operations.

We currently operate one coffee roasting facility and one distribution facility. A significant interruption in the operation of either of these facilities, whether as a result of a natural disaster or other causes, could significantly impair our ability to operate our business on a day-to-day basis and could have a material adverse effect on our results of operations and financial condition.

Our industry is highly competitive and we may not have the resources to compete effectively.

With low barriers to entry, competition in our industry is expected to increase from national and regional chains. Our whole bean coffees compete directly against specialty coffees sold at specialty retailers, variety and discount stores, and a growing number of specialty coffee stores. Many specialty coffee companies, including Green Mountain Coffee Roasters, S&D Coffee, Boyd Coffee and Starbucks sell whole bean coffees through

 

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these channels. In addition, we compete to draw customers of standard or commercial coffee, and consumers of substitute coffee products manufactured by a number of nationwide coffee manufacturers, such as Kraft Foods, Proctor & Gamble and Nestlé, to specialty grade coffee.

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. Should this happen, we may not be able to maintain our gross margins by raising prices without affecting demand.

Compliance with government regulations applicable to us could have a material adverse effect on our business, financial condition and results of operations.

Our roasting facility is subject to licensing and reporting requirements by a number of governmental authorities. These governmental authorities include federal, state and local health, environmental, labor relations, sanitation, building, zoning, fire, safety and other departments. Changes in any of these laws or regulations could have a material adverse effect on our business, financial condition and results of operations.

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. In addition, our success will depend upon our ability to attract and retain highly motivated and qualified employees. The inability to recruit and retain such individuals may have a material adverse effect on our business or results of operations.

Our lack of diversification may affect business if demand is reduced.

Our business is primarily centered on one product: specialty grade coffee. Our operations have been limited to primarily the roasting and packaging of green coffee beans and the sale of coffee in a variety of packaging formats, especially K-Cups®, through our wholesale business channel. Any decrease in demand for specialty coffee would have a material adverse effect on our business, operating results and financial condition.

Our wholesales revenues are generated substantially all from the sale of K-Cups.

We generate substantially all of our revenues from the sale of K-Cups® which is licensed from Keurig on a non-exclusive basis. Any issues with this licensing arrangement will have a material adverse effect on our operations. Keurig is also our largest customer. Our relationship with Keurig is critical to the success of our business.

 

Item 1B. Unresolved Staff Comments.

Not applicable.

 

Item 2. Properties.

Office Space and Plant

We currently lease approximately 17,620 square feet of office space in Irvine, California and approximately 6,192 square feet of warehouse space in Irvine, California. The lease for the office space will expire in January 2011 and the lease for the warehouse space will expire in December 2010. We also lease a 66,237 square foot roasting facility located in Castroville, California. The term of the current lease expires in December 2015, and is

 

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renewable, at our option, for a term of 15 additional years. Additionally, we lease approximately 40,000 square feet of a warehouse in Salinas, California that we use as our distribution facility. The lease expires May, 2010. On or before the lease expiration, we expect to either renew this lease or obtain a new lease in a similar distribution facility. We believe that our facilities are generally adequate for our current needs, and that suitable additional production and administrative space will be available as needed for the foreseeable future.

Company-Operated Locations and Franchised Stores

As discussed under “Item 1. Recent Developments,” and “Item 7. Overview-Recent Developments,” we and Praise entered into the Agreement pursuant to which we agreed to sell all of the shares of common stock of Praise U.S. Holdings, Inc. (formerly known as Coffee People Worldwide, Inc.) which owned assets used in the Company’s U.S. franchise operations. On June 12, 2009, we completed the Transaction which included the transfer of 12 Gloria Jean’s company-operated and 90 franchised Gloria Jean’s locations to Praise. Our strategic direction is currently focused on growing the wholesale business segment and the related distribution channels. As of June 24, 2009, we no longer operated company-operated retail locations and we have four Coffee People, Inc. and two Diedrich franchise locations. In conjunction with our current strategy, subsequent to the fiscal year ended June 24, 2009, the two Diedrich Coffee Inc. franchise locations were terminated. The Company currently has no plans to open any additional company-operated or franchised Diedrich or Coffee People coffeehouses.

 

Item 3. Legal Proceedings.

In the ordinary course of business, the Company may become involved in legal proceedings from time to time. Material pending legal proceedings to the business, to which we became or were a party to during the current fiscal year or subsequent thereto, but before the filing of this report, are summarized below:

On September 21, 2006, a purported class action complaint entitled Jason Reid; Kimberly Cornia, et al. v. Diedrich Coffee., et al. was filed against the Company in United States District Court Central District of California by two former employees, who worked in the positions of team member and shift manager. During the fiscal year 2009, the Company paid approximately $700,000 to fully settle this lawsuit.

On February 2, 2007, a second similar purported class action complaint entitled Deborah Willems, et al. v. Diedrich Coffee., et al. was filed in Orange County, California Superior Court on behalf of another former employee who worked in the position of general manager. This case currently involves the issue of whether employees and former employees who worked in California stores during specified time periods were deprived of overtime pay, missed meal and rest breaks. In addition to unpaid overtime, this case seeks to recover waiting time penalties, interest, attorneys’ fees and other types of relief on behalf of the current and former employees in the purported class.

The Company entered into a settlement with the plaintiffs in the Willems v. Diedrich lawsuit. On September 14, 2009, we received a judgment based on Order of Final Approval. As of June 24, 2009, the Company estimated that the required amount to settle this claim is $376,000 and has recorded an accrual for this amount included in discontinued operations in the accompanying consolidated statement of operations.

Based on our examination of this matter and our experience to date, we have recorded our best estimate of liability with respect to this matter. However, the ultimate liability cannot be determined with certainty.

A lawsuit entitled Leader Bank v. Ajay Misra, et al v. Diedrich Coffee et al, is currently pending in the Middlesex Superior Court, Middlesex, Massachusetts. In that case the Plaintiff, Leader Bank, filed a complaint to collect on a defaulted promissory note it had with the franchisee, Defendant Amtek Group, LLC, on February 23, 2009. Ajay and Priya Misra were named defendants as well. On June 16, 2009, Defendants filed a third-party complaint against Diedrich Coffee alleging breach of contract, aiding and abetting Leader Bank in its takeover of the store and breach of privacy. In their complaint, third-party plaintiffs claim that they are entitled to

 

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$2,477,500. We are contesting the third-party complaint vigorously and have filed a motion to dismiss that will be heard on October 9, 2009. The Company believes that liability is not probable and the potential settlement is not estimable under this lawsuit and has therefore not accrued any amounts related to the damages claimed under this lawsuit in the accompanying consolidated financial statements.

 

Item 4. Submission of Matters to a Vote of Security Holders.

None.

 

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PART II

 

Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock is reported on the Nasdaq Capital Market under the symbol “DDRX.” The following table sets forth, for the periods indicated, the high and low sales prices for our common stock as reported on the Nasdaq Capital Market.

 

     Price Range

Period

   High    Low

Fiscal Year Ended June 25, 2008

     

Twelve Weeks Ended September 19, 2007

   $ 4.41    $ 3.52

Twelve Weeks Ended December 12, 2007

     3.91      3.16

Twelve Weeks Ended March 5, 2008

     3.79      2.71

Sixteen Weeks Ended June 25, 2008

     3.00      1.75

Fiscal Year Ended June 24, 2009

     

Twelve Weeks Ended September 17, 2008

     2.35      1.36

Twelve Weeks Ended December 10, 2008

     2.29      0.23

Twelve Weeks Ended March 4, 2009

     0.90      0.25

Sixteen Weeks Ended June 24, 2009

     19.20      0.21

At September 1, 2009, there were 5,726,813 shares of our common stock outstanding and 507 stockholders of record. We have not paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future. Information required by Item 201(d) of Regulation S-K is included in Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

Item 6. Selected Financial Data.

Not applicable.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

INTRODUCTION

Management’s discussion and analysis of financial condition and results of operations is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, the changes in our financial condition and the results of operations. Our discussion is organized as follows:

 

   

Overview.    This section provides a general description of our business, as well as recent significant transactions or events that we believe are important in understanding the results of operations, as well as to anticipate future trends in those operations.

 

   

Results of operations.    This section provides an analysis of our results of operations presented in the accompanying consolidated statements of operations by comparing the results for fiscal 2009 to fiscal 2008.

 

   

Financial condition and liquidity and capital resources.    This section provides an analysis of our cash flows, as well as a discussion of our outstanding debt that existed as of June 24, 2009. Included in the discussion of outstanding debt is a discussion of the amount of financial capacity available to fund our future commitments, as well as a discussion of other financing arrangements.

 

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Critical accounting estimates.    This section discusses those accounting policies that both are considered important to our financial condition and results, and require significant judgment and estimates on the part of management in their application. In addition, all of our significant accounting policies, including the critical accounting policies, are summarized in Note 1 to the accompanying consolidated financial statements.

 

   

New accounting pronouncements.    This section discusses new accounting pronouncements, dates of implementation and impact on our accompanying consolidated financial statements, if any.

OVERVIEW

Recent Developments

On March 27, 2009, we and Praise entered into an Agreement pursuant to which we agreed to sell all of the shares of common stock of Praise U.S. Holdings, Inc. (formerly known as Coffee People Worldwide, Inc.), which owned assets used in the Company’s U.S. franchise operations. On June 12, 2009, the Company completed the Transaction, and pursuant to the Agreement, Praise purchased the Shares for $3,100,000, of which $1,500,000 was paid in cash and the remainder paid in the form of a twelve-month promissory note with an aggregate principal amount of $1,600,000 and an interest rate equal to 7.0% per annum, issued by Praise to the Company. The Transaction included the transfer of 12 Gloria Jean’s company-operated and 90 franchised Gloria Jean’s locations to Praise. In conjunction with the Transaction, Praise entered into a five-year coffee roasting agreement whereby we will roast and package coffee for all of the Gloria Jean’s U.S. retail locations. Our results of the Gloria Jean’s franchise operations are reported as discontinued operations for all periods presented. Wholesale sales to former franchisees are included in continuing operations for all periods since the Company will continue to provide coffee roasting services to Praise.

Praise is an affiliate of Gloria Jean’s Coffees International Pty. Ltd., which was a party to the purchase of the Company’s international franchise and retail operations in February 2005.

Business

We are a specialty coffee roaster and wholesaler. Our brands include Diedrich Coffee, Coffee People and Gloria Jean’s. The majority of our revenue is generated from wholesale customers located across the United States. Our wholesale operation sells a wide variety of whole bean and ground coffee as well as single serve coffee products through a network of OCS distributors, chain and independent restaurants, coffeehouses, other hospitality operators and specialty retailers. We operate a roasting facility and a distribution facility in central California that supplies our coffee products to all of our customers.

The Company’s costs of operations include cost of sales consisting of raw materials including green coffee beans, flavorings and packaging materials; royalty payments due to the licensor; equipment lease expense related to some of our packaging lines; a portion of our facility lease expense; the salaries and related expenses of production and distribution personnel; depreciation on production equipment; and freight and delivery expenses. Operating expenses include the salaries and related expenses for those employees directly supporting our wholesale distribution channels. In addition to salaries and associated costs, these expenses include marketing expenses; free product supplied for inclusion in brewer sample packs and in-store demonstrations; and a portion of our facility lease expense. General and administrative expenses consist of expenses incurred for corporate support and administration, including a portion of our facility lease expense and the salaries and related expenses for personnel not elsewhere categorized.

 

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RESULTS OF OPERATIONS

The following table sets forth the percentage relationship to total revenue of certain items included in our consolidated statements of income for the years indicated:

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Net revenue:

    

Wholesale

   98.6   97.8

Retail sales

   1.3      2.0   

Franchise revenue

   0.1      0.2   
            

Total revenue

   100.0   100.0
            

Costs and expenses:

    

Cost of sales and related occupancy costs

   76.9   82.5

Operating expenses

   7.0      10.4   

Depreciation and amortization

   3.0      2.9   

General and administrative expenses

   11.6      17.5   

Provision for goodwill and asset impairment

   —        15.8   

(Gain) loss on asset disposals

   —        0.2   
            

Total costs and expenses

   98.5   129.3
            

Operating income (loss) from continuing operations

   1.5   (29.3 )% 

Interest (expense) income and other, net

   (2.0   0.8   
            

Loss from continuing operations before income tax benefit

   (0.5   (28.5

Income tax benefit

   (0.1   —     
            

Loss from continuing operations

   (0.4 )%    (28.5 )% 
            

Discontinued operations:

    

Loss from discontinued operations, net of income tax

   (1.3 )%    (9.2 )% 

Gain on sale of discontinued operations, net of income tax

   4.2      3.2   
            

Income (loss) from discontinued operations, net of income tax

   2.9   (6.0 )% 
            

Net Income (loss)

   2.5   (34.5 )% 
            

Sale of Retail Operations

Our strategy is to capitalize on the growth of the wholesale specialty coffee market and our strength as a premier roaster and distributor of the world’s finest coffees. In keeping with that strategy, we completed the sale of the Gloria Jean’s U.S. franchise operations to Praise in June 2009. Our results of the Gloria Jean’s franchise and retail operations are reported as discontinued operations for all periods presented.

As previously announced, on March 27, 2009, we and Praise entered into an Agreement pursuant to which we agreed to sell all of the shares of common stock of Praise U.S. Holdings, Inc. (formerly known as Coffee People Worldwide, Inc.) which owned assets used in the Company’s U.S. franchise operations. On June 12, 2009, the Company completed the Transaction. The Transaction included the transfer of 12 company-operated and 90 franchised Gloria Jean’s locations to Praise.

Praise is an affiliate of Gloria Jean’s Coffees International Pty. Ltd., which was a party to the purchase of the Company’s international franchise operations in February 2005.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the financial results of the retail operations

 

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that were sold or closed and Gloria Jean’s franchised operations are reported as discontinued operations for all periods presented.

Results of Operations

Year Ended June 24, 2009 Compared To Year Ended June 25, 2008

Total Revenue.    Our revenue from continuing operations for the year ended June 24, 2009 increased by $22,331,000, to $62,310,000 from $39,979,000 for the year ended June 25, 2008. This result was the net effect of a 57.1% increase in wholesale revenue, a 1.3% increase in retail sales, and a 3.6% decrease in domestic franchise revenue. Each component of total revenue is discussed below.

Wholesale Revenue.    Our wholesale sales for the year ended June 24, 2009 increased by $22,324,000, or 57.1%, to $61,427,000 from $39,103,000 for the year ended June 25, 2008. Wholesale sales to OCS and other third party wholesale sales increased $22,788,000, or 65.8% to $57,434,000 led by strong growth in the Keurig “K-Cup” sales which increased by 76.0% or $23,537,000 from the prior year. We generated 87.5% and 77.5% of our total revenues from the sale of K-Cups® for the year ended June 24, 2009 and June 25, 2008, respectively. We are one of only four roasters under a non-exclusive license to produce K-Cups®. Sales to our licensor represented approximately $24,441,000 or 39.8% of wholesale sales and $9,269,000 or 23.7% of wholesale sales for the years ended June 24, 2009 and June 25, 2008, respectively. Roasted coffee sales to Gloria Jean’s retail locations decreased $464,000 for the year ended June 24, 2009 primarily due to a decrease in store count for the Gloria Jean’s U.S. franchise system, which is now owned by Praise. Wholesale sales to former franchisees are included in continuing operations for all periods since the Company will continue to provide coffee roasting services to Praise.

Retail Sales.    Our retail sales revenue for the year ended June 24, 2009 increased by a net $10,000, or 1.3%, to $803,000 from $793,000 for the year ended June 25, 2008. All of our retail sales are related to our ecommerce business through our three web stores.

Franchise Revenue.    Our franchise revenue decreased by $3,000, or 3.6%, to $80,000 for the year ended June 24, 2009 from $83,000 for the year ended June 25, 2008. Our franchise revenue consists primarily of royalties received on sales at the four remaining Coffee People franchised locations. The decrease in franchise revenue resulted from a decrease in royalty income for Diedrich Coffee franchise locations compared to fiscal 2008.

Cost of Sales.    As a percentage of total revenue, cost of sales decreased from 82.5% in fiscal 2008 to 76.9% in fiscal 2009. Wholesale cost of sales as a percentage of wholesale sales decreased from 83.5% in the prior year to 77.4% in the current fiscal year primarily due to higher machine utilization, lower temporary help and overtime, the reduction of scrap and waste due to improved inventory controls, lower outbound freight costs and the ability to leverage our fixed manufacturing costs over higher production volumes. Retail cost of sales as a percentage of retail sales increased from 43.8% to 49.0% in the current year due primarily to a higher sales mix of K-Cups through our internet web stores that generate a lower margin as compared to whole bean coffee products.

Operating Expenses.    Total operating expenses for the year ended June 24, 2009 increased $178,000 from $4,182,000 to $4,360,000 and resulted primarily from an increase in wholesale and franchise operating costs of $164,000 and $36,000, respectively, and was offset by a decrease in retail operating costs of $22,000. The increase in operating costs for wholesale of $164,000 resulted primarily from an increase in marketing costs of $1,118,000 and was partially offset by decreases in compensation costs of $292,000, allowance for doubtful accounts of $156,000, equipment costs of $277,000, travel costs of $76,000, outside services of $72,000 and other costs, net of $81,000. Franchise operating expense increased by $36,000 and resulted from an increase in allowance for doubtful accounts compared to the prior year. The decrease in retail operating costs of $22,000

 

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resulted from a decrease of $95,000 in marketing costs associated with internet sales and was partially offset by an increase in labor and other costs of $52,000 and $21,000, respectively.

Depreciation and Amortization.    Depreciation and amortization increased $743,000, or 64.8% to $1,889,000 for the year ended June 24, 2009 from $1,146,000 for the year ended June 25, 2008 and was primarily the result of an increase in capital improvements at our Castroville roasting facility.

General and Administrative Expenses.    Our general and administrative expenses increased by $181,000, or 2.6%, to $7,197,000 for the year ended June 24, 2009 compared to $7,016,000 for the year ended June 25, 2008. The increase in general administrative expenses was primarily due to increases in compensation costs of $1,054,000 and other costs of $44,000. The increase in compensation costs included an increase in bonus expense of $629,000. The increase in general and administrative expenses was partially offset by a decrease in legal fees of $917,000 resulting from costs associated with strategic planning incurred in fiscal 2008. As a percentage of total revenue, general and administrative expenses decreased from 17.5% for fiscal 2008 to 11.5% for fiscal 2009.

Provision for goodwill and asset impairment.    During fiscal 2008, we recorded an impairment charge of $6,311,000 to fully impair goodwill associated with our wholesale operations.

Interest Expense.    Interest expense increased by $1,375,000 from $136,000 for the year ended June 25, 2008 to $1,511,000 for the year ended June 24, 2009. Of the $1,375,000 increase in interest expense, $440,000 was the result of the issuance of 70,000 new stock purchase warrants to extend the repayment of the Note Purchase Agreement to March 31, 2010 and $935,000 of interest expense resulted primarily from additional borrowings, higher interest rate costs and amortization of our warrants associated with the Loan Agreement (as described below under “Financial Condition and Liquidity and Capital Resources”).

Income Tax Benefit.    We had losses from continuing operations for the years ended June 24, 2009 and June 25, 2008. In accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), the income tax benefit generated by the loss from continuing operations were $95,000 and $34,000 for the years ended June 24, 2009 and June 25, 2008, respectively. As of June 24, 2009, net operating loss carryforwards of $11,170,000 and $11,451,000 for federal and state income tax purposes, respectively are available to be utilized against future taxable income for years through fiscal 2027, subject to annual limitation pertaining to change in ownership rules under the Internal Revenue Code. Based upon the level of historical taxable income and projections of future taxable income over the periods which the deferred tax assets are deductible, the Company’s management believes it is not more likely than not that the Company will not realize the benefits of these deductible differences, and thus has recorded a valuation allowance against the entire deferred tax asset balance.

Results of Discontinued OperationsRetail.    The Transaction with Praise International, which closed on June 12, 2009, included the transfer of 12 company-operated and 90 franchised Gloria Jean’s locations to Praise. The financial results of the retail operations that were sold or closed and Gloria Jean’s franchised operations are reported as discontinued operations for all periods presented in accordance with SFAS 144. For the fiscal year ended June 24, 2009, income from discontinued operations was $1,771,000 net of $81,000 in taxes. For the fiscal year ended June 25, 2008, loss from discontinued operations was $2,391,000 and included proceeds from escrow of $1,274,000 as part of the transaction with Starbucks in fiscal 2007. The tax expense associated with the discontinued retail operations differed from the statutory federal effective tax rate primarily due to changes in the valuation allowance and permanently nondeductible goodwill associated with the discontinued operations.

 

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FINANCIAL CONDITION AND LIQUIDITY AND CAPITAL RESOURCES

Current Financial Condition

At June 24, 2009, we had working capital of $8,828,000, long term debt, deferred rent, income tax and other liabilities of $2,005,000 and $13,774,000 of stockholders’ equity, compared to working capital of $135,000, long term tax liabilities, deferred rent and deferred compensation of $677,000 and $9,172,000 of stockholders’ equity at June 25, 2008. The increase in working capital of $8,693,000 in the current fiscal year resulted primarily from proceeds received from the sale of discontinued operations, payments received on notes receivable, borrowings under credit agreements and exercise of stock options and warrants.

Cash Flows

The following is a summary of our consolidated cash flows for each of the two years ended June 24, 2009 and June 25, 2008:

 

     June 24, 2009     June 25, 2008  

Cash flows used in operating activities:

    

Net income (loss)

   $ 1,592,000      $ (13,776,000

Loss from discontinued operations, net

     838,000        3,667,000   

Gain on disposal of discontinued operations, net

     (2,609,000     (1,276,000
                

Net loss from continuing operations

     (179,000     (11,385,000

Net non-cash charges to income

     3,168,000        7,792,000   

Net increase in operating assets

     (3,444,000     (1,150,000

Net increase in operating liabilities

     850,000        271,000   
                

Cash flows provided by (used in) continuing operating activities

     395,000        (4,472,000

Cash flows used in discontinued operations

     (3,405,000     (1,625,000

Cash flows provided by (used in) investing activities of continuing operations

     397,000        (3,237,000

Cash flows provided by investing activities of discontinuing operations

     1,295,000        1,074,000   

Cash flows provided by financing activities of continuing operations

     4,220,000        2,057,000   
                

Net increase (decrease) in cash

     2,902,000        (6,203,000

Cash at beginning of year

     670,000        6,873,000   
                

Cash at end of year

   $ 3,572,000      $ 670,000   
                

Capital expenditure commitments at end of year

   $ 460,000      $ 542,000   
                

The changes in cash from continuing operations in fiscal year 2009 as compared to fiscal year 2008 are more fully enumerated in the consolidated statements of cash flows in the accompanying consolidated financial statements.

The Company has incurred losses from continuing operations of $179,000 and $11,385,000 for the 2009 and 2008 fiscal years, respectively. Net cash provided by continuing operations was $395,000 for fiscal 2009 compared to net cash used in continuing operations of $4,472,000 for fiscal 2008. An increase in wholesale sales of 57.1% and a reduction in cost of goods sold improved gross margins and reduced the net loss from continuing operations in fiscal 2009. Since the terms of our wholesale sales are credit, an increase in wholesale sales results in an increase in accounts receivable. An increase in our wholesale business also requires us to carry higher inventory to meet market demand. While the growth in business increased the working capital requirements, the Company was able to improve cash from operations in fiscal 2009 through faster collections of accounts receivable and higher inventory turnover rate. For fiscal 2008, cash used in continuing operations was $4,472,000 and was primarily the result of operating losses and an increase in accounts receivable, offset by an increase in accounts payable, as our wholesale business grew by 38.9% over fiscal 2007.

 

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Cash flow used in operating activities of discontinued operations in 2009 and 2008 of $3,405,000 and $1,625,000 respectively, were primarily the result of losses in our franchise and retail operations before the consummation of the Transaction in fiscal year 2009.

Cash flows provided by investing activities of continuing operations during fiscal 2009 totaled $397,000. During fiscal 2009, capital expenditures totaled $659,000 and was used to invest in property and equipment primarily related to our Castroville roasting facility. These expenditures were partially offset by $1,000,000 of payments received on notes receivable. Cash flows used by investing activities of continuing operations during fiscal 2008 totaled $3,237,000. During fiscal 2008, a total of $4,304,000 was used to invest in property with $3,550,000, $226,000, and $527,000 spent on our roasting facility, wholesale business, and home office facility, respectively. These expenditures were primarily offset by $1,000,000 of payments received on notes receivable. Cash flows provided by investing activities of discontinued operations for 2009 and 2008 of $1,295,000 and $1,074,000 respectively, were primarily the result of the sale of Gloria Jean’s franchise to Praise in 2009 and the sale of retail locations to Starbucks in 2007.

Net cash provided by financing activities of continuing operations for fiscal 2009 of $4,220,000 was primarily the result from borrowings under our credit facility and the exercise of stock options and warrants. Net cash provided by financing activities of continuing operations for 2008 of $2,057,000 was primarily the result of borrowings under our credit facility during the 2008 fiscal year.

Outstanding Debt and Financing Arrangements

Note Purchase Agreement:

On May 10, 2004, we entered into a $5,000,000 Contingent Convertible Note Purchase Agreement with Sequoia Enterprises, L.P. (“Sequoia”), a limited partnership whose sole general partner is a significant shareholder of the Company and also serves as the Chairman of the board of directors of the Company (the “Note Purchase Agreement”), which provided, at our election, the ability to issue notes with up to an aggregate principal amount of $5,000,000. We have amended the Note Purchase Agreement from time to time and have agreed to refrain from further borrowings under the Note Purchase Agreement in connection with the entry into the Loan Agreement (as defined below) entered into on August 26, 2008. As amended, the notes issued under the Note Purchase Agreement are due in full on March 31, 2010, and we are only required to make monthly payments of interest and the monthly commitment fee, but not principal, until such date. On the maturity date, all outstanding principal, interest and other amounts payable under the Note Purchase Agreement will be due unless due earlier pursuant to the terms of the Note Purchase Agreement upon a change in control of the Company or an event of default. Interest is payable at three-month LIBOR plus 9.30% for any period during which the ratio of Indebtedness (as defined in the Note Purchase Agreement) on a consolidated basis to Effective Tangible Net Worth (as defined in the Note Purchase Agreement) is greater than 1.75:1.00 or the three-month LIBOR plus 6.30% for any other period, in each case reset on a periodic basis as provided in the Note Purchase Agreement. The Note Purchase Agreement contains covenants, among others, that limit the amount of indebtedness that we may have outstanding in relation to our tangible net worth. As of June 24, 2009, we had $2,000,000 of issued notes outstanding under the Note Purchase Agreement. As of June 24, 2009, we were in compliance with all covenants contained in the Note Purchase Agreement.

Loan Agreement:

On August 26, 2008, we entered into a loan agreement with Sequoia (the “Loan Agreement”). The Loan Agreement provides for a $3,000,000 term loan (the “Term Loan”). As amended, interest is payable at one-month LIBOR plus 9.30% for any period during which the ratio of Indebtedness (as defined in the Loan Agreement) on a consolidated basis to Effective Tangible Net Worth (as defined in the Loan Agreement) is greater than 1.75:1.00 or one-month LIBOR plus 6.30% for any other period, resetting on the first calendar day of each month. We are required to make regular monthly payments of interest, and to cause the principal amount to be reduced to $2 million no later than August 26, 2009. All outstanding principal and interest will be due on

 

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the maturity date of August 26, 2011, unless due earlier pursuant to the terms of the Loan Agreement upon a change of control of the Company or an event of default. As of June 24, 2009, $3,000,000 was outstanding under the Loan Agreement. Subsequently the Company paid $1 million due to Sequoia under the Loan Agreement on July 29, 2009.

The Loan Agreement requires the Company to refrain from further borrowings under the Note Purchase Agreement and contains restrictions on incurring indebtedness on par with, or senior to, the Term Loan. The Loan Agreement also contains a covenant that limits the amount of indebtedness that the Company may have outstanding in relation to tangible net worth, in addition to other standard covenants and events of default.

The Term Loan is senior to all other indebtedness of the Company, except indebtedness pursuant to notes under the Note Purchase Agreement and certain permitted indebtedness identified in the Loan Agreement. Upon repayment of the notes under the Note Purchase Agreement, the Term Loan will be senior to all other indebtedness of the Company, except such permitted indebtedness.

Warrants:

2001 Sequoia Warrant

On May 8, 2001, in connection with the sale of 2,000,000 shares of Company common stock, the Company issued warrants to Sequoia to purchase 250,000 shares of the Company’s common stock at a price of $4.80 per share (“2001 Sequoia Warrant”). Other investors also received warrants to purchase an additional 250,000 shares at a price of $4.80 per share. The warrants were exercisable immediately upon issuance.

The other investors exercised their warrants during the fourth fiscal quarter ending June 24, 2009 at an exercise price of $4.80 per share. The Company received cash proceeds of $1.2 million in connection with the warrant exercises.

On November 10, 2008 the exercise price of the 2001 Sequoia Warrant was decreased to $1.65 per share in connection with the Waiver Agreement (as defined below). The fair value of these amended warrants was approximately $53,000 which was recorded as a debt discount. At June 24, 2009, all 2001 Sequoia Warrants were outstanding with an expiration date of June 30, 2014.

2008 Sequoia Warrant

In connection with the Loan Agreement and an amendment to the Note Purchase Agreement, on August 26, 2008, the Company issued to Sequoia a warrant (the “2008 Sequoia Warrant”) to purchase 1,667,000 shares of common stock of the Company. On November 10, 2008 the exercise price was decreased to $1.65 per share in connection with the Waiver Agreement. The fair value of these amended warrants was approximately $300,000 which was recorded as a debt discount. At June 24, 2009, all 2008 Sequoia Warrants were outstanding with an expiration date of August 26, 2013. The 2008 Warrant is not eligible for cashless exercise, but the Company is obligated to cause the common stock issued upon exercise of the 2008 Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

2009 Sequoia Warrant

In connection with the extension of the Note Purchase Agreement, after the close of the Nasdaq Stock Market on April 29, 2009, the Company issued to Sequoia a warrant to purchase 70,000 shares of common stock of the Company at an exercise price of $7.40 per share (the “2009 Sequoia Warrant”), which was the closing price of the Company’s common stock on such date. The fair value of these warrants was approximately $440,000 which was immediately recorded as interest expense. The 2009 Sequoia Warrant is exercisable by

 

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Sequoia, in whole or in part, at any time or from time to time, prior to April 29, 2014. The 2009 Sequoia Warrant is not eligible for cashless exercise, but the Company is obligated to cause the common stock issued upon exercise of the 2009 Sequoia Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

Waiver Agreement:

On September 17, 2008 we were not in compliance with covenants under the Note Purchase Agreement and the Loan Agreement. On November 10, 2008, we entered into a Waiver Agreement, Amendment No. 1 to 2008 Warrant and Amendment No. 2 to 2001 Warrant (the “Waiver Agreement”) with Sequoia. Pursuant to the Waiver Agreement, Sequoia waived the requirement set forth in the Note Purchase Agreement and the Loan Agreement with Sequoia (collectively, the “Loan Agreements”) that we shall not permit, as of the end of any fiscal quarter, the ratio of our Indebtedness on a consolidated basis to Effective Tangible Net Worth to be more than 1.75:1.00 (as such terms are defined in the Loan Agreements). Such waiver is effective until the earlier of (a) October 31, 2009 and (b) the end of any fiscal quarter at which the foregoing ratio is greater than 2.10:1.00. As part of the waiver and amendment, the exercise price of the 2008 Sequoia Warrant and the 2001 Sequoia Warrants for 250,000 shares of common stock was reduced to $1.65 from $2.00 per share. In consideration of the foregoing waiver, (a) the interest rates under the Note Purchase Agreement and the Term Loan were set at LIBOR plus 9.3% for any period during which the ratio of indebtedness of the Company on a consolidated basis to effective tangible net worth is greater than 1.75:1.00 and (b) the interest rates under the Note Purchase Agreement and the Term Loan were set at LIBOR plus 6.30% for any other period. The Company is in compliance with all debt covenants as of June 24, 2009.

Letter of Credit:

In addition, we entered into a Credit Agreement with Bank of the West on November 4, 2005. The agreement provides for a $750,000 letter of credit facility that expires on October 15, 2009. The letter of credit facility is secured by a deposit account at Bank of the West. As of June 24, 2009, this deposit account had a balance of $623,000, which is shown as restricted cash on the consolidated balance sheets. As of June 24, 2009, $472,000 of letters of credit was outstanding under the letter of credit facility. The agreement contains covenants that, among other matters, require us to submit financial statements to the bank within specified time periods. As of June 24, 2009, the Company was in compliance with all Bank of the West agreement covenants.

Liquidity and Management Plans:

For the fiscal year 2009, we reported net income of $1,592,000, which included a gain on sale of discontinued operations of $2,609,000 which was net of tax of $81,000. We had a cash balance of $3,572,000 and no ability to access credit under our current credit facility as of June 24, 2009.

The Note Purchase Agreement with Sequoia expires on March 31, 2010 and the $2,000,000 balance on the outstanding note is due in full on that date.

We are required to make regular monthly payments of interest on the $3,000,000 Term Loan with Sequoia, and to cause the principal amount to be reduced to $2 million no later than August 26, 2009. All outstanding principal and interest will be due on the maturity date of August 26, 2011, unless due earlier pursuant to the terms of the Loan Agreement upon a change of control of the Company or an event of default. The Company paid $1 million due to Sequoia under the Term Loan on July 29, 2009.

The Company believes that cash flow from operations and payments from notes receivable due from Praise and Gloria Jean’s Coffees International Pty. Ltd. will be sufficient to satisfy working capital needs at the anticipated operating levels and debt service requirements for at least the next twelve months.

 

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The Company’s future capital requirements will depend on many factors, including the extent and timing of the rate at which the business grows, if at all, with corresponding demands for working capital. The Company may be required to seek additional funding through debt financing, equity financing or a combination of funding methods to meet capital requirements and sustain operations. However, additional funds may not be available on terms acceptable to the Company, or at all.

Off-Balance Sheet Arrangements

As of June 24, 2009, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.

Commitments and Contractual Obligations

The following is a summary of our contractual obligations and commitments as of June 24, 2009:

 

     Payments Due By Period
     Total    Less than
1 year
   1-3
years
   3-5
years
   More than
5 years
     (In thousands)

Operating leases

   $ 7,025    $ 2,853    $ 2,381    $ 1,068    $ 723

Green coffee commitments

     3,578      3,578      —        —        —  

Note Payable

     5,000      3,000      2,000      —        —  
                                  
   $ 15,603    $ 9,431    $ 4,381    $ 1,068    $ 723
                                  

At June 24, 2009, the Company had capital commitments of $460,000 for our roasting facility.

We have also entered into an employment agreement with one executive that provides for a severance payment of nine months salary in the event that this individual is terminated without cause. Our maximum liability for severance under this contract is currently $169,000. Because such amount is contingent, it has not been included in the above table.

We have obligations under non-cancelable operating leases for our roasting facility and administrative offices. Lease terms are generally for up to 15 years with renewal options and generally require us to pay a proportionate share of real estate taxes, insurance, common area and other operating costs. Some leases provide for contingent rental payments based on sales thresholds.

 

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CRITICAL ACCOUNTING ESTIMATES

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts. The estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and on various other factors that are believed to be reasonable. Accounts significantly impacted by estimates and assumptions include, but are not limited to, receivables, allowance for bad debt reserves, fixed asset lives, income taxes, self-insurance and workers’ compensation reserves, store closure reserves, stock-based compensation, the valuation allowance for net deferred tax assets and contingencies. We believe that the following represent our critical accounting policies and estimates used in the preparation of our consolidated financial statements. The following discussion, however, does not list all of our accounting policies and estimates.

Impairment of Property and Equipment and Other Amortizable Long-Lived Assets Held and Used

Each quarter, or upon the occurrence of a triggering event as defined in SFAS No. 144, we evaluate the carrying value of fixed assets and long-lived assets. In determining impairment of the assets we compare the carrying value of the assets to projected future cash flows in addition to other analyses.

The most significant assumptions in our analysis are those used when we estimate the unit’s future cash flows. We generally use the assumptions in our strategic plan and modify them as necessary based on unit specific information. If our assumptions are incorrect, the carrying value of our operating assets may be overstated or understated.

Estimated Liability for Closed Stores

The estimated liability for closed stores on properties vacated is generally based on the term of the lease and the lease termination fee that we expect to pay, as well as the estimated maintenance costs that we expect to pay until the lease has been abated. A significant assumption used in determining the amount of the estimated liability for closing stores is the amount of the estimated liability for future lease payments on vacant stores, which we determine based on our assessment of our ability to successfully negotiate early terminations of our lease agreements with the lessors. Additionally, we estimate the cost to maintain leased and owned vacant properties until the lease has been abated. If the costs to maintain properties increases or it takes longer than anticipated to terminate the lease, we may need to record additional estimated liabilities. If the leases on the vacant stores are not terminated on the terms we used to estimate the liabilities, we may be required to record losses in future periods. Conversely, if the leases on the vacant stores are terminated on more favorable terms than we used to estimate the liabilities, we reverse previously established estimated liabilities through the line item in which it was originally recorded, resulting in an increase in operating income.

Estimated Liability for Self-Insured Workers’ Compensation

We are self-insured for a portion of our losses related to workers’ compensation insurance for policy years ended prior to October 2006. We obtained stop loss insurance for individual workers’ compensation claims with a $250,000 deductible per occurrence and a program maximum for all claims of $750,000. Insurance liabilities and reserves are accounted for based on actuarial estimates of the amount of incurred and unpaid losses. These estimates rely on actuarial observations of historical claim loss development. Management, in determining the estimated liability, bases the assumptions on the average historical losses on claims we have incurred. The actual loss development may be better or worse than the development we estimated in conjunction with the actuary. In that event, we will modify the reserve. As a result, if we experience a higher than expected number of claims or the costs of claims are greater than expected, then we may adjust the expected losses upward and our future self-insurance expenses will rise.

 

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Stock-Based Compensation

As discussed in the notes to consolidated financial statements, we have various stock-based compensation plans that provide options for certain employees and outside directors to purchase common shares of stock. Starting June 30, 2005, we adopted the provisions of SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”) which sets accounting requirements for “share-based” compensation to employees and non-employee directors, including employee stock purchase plans, and requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation.

We determine the estimated fair value of stock-based compensation on the date of the grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires us to apply highly subjective assumptions, including our historical stock price volatility, expected life of the option and the risk-free interest rate. A change in one or more of the assumptions used in the Black-Scholes option-pricing model may result in a material change to the estimated fair value of the stock-based compensation. See Note 1 of Notes to Consolidated Financial Statements for assumptions used to determine the fair value of stock-based compensation.

Valuation Allowance for Net Deferred Tax Assets and Contingencies

As discussed above, we have recorded a 100% valuation allowance against our net deferred tax assets. If we have been profitable for a number of years and our prospects for the realization of our deferred tax assets are more likely than not, we would then reverse our valuation allowance and credit income tax expense. When circumstances warrant, we assess the likelihood that our net deferred tax assets will more likely than not be realized from future taxable income. As of June 24, 2009, our net deferred tax assets and related valuation allowance totaled approximately $16,863,000.

NEW ACCOUNTING PRONOUNCEMENTS

Recently Adopted Accounting Pronouncements

On June 24, 2009, the Company adopted SFAS No. 165, “Subsequent Events.” This statement establishes general standards of accounting and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The adoption of this standard required the Company to evaluate all subsequent events that occurred after the balance sheet date through the date and time the financial statements are issued.

Newly Issued Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — A Replacement of FASB Statement No. 162.” The FASB Accounting Standards Codification (“Codification”) will become the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date, the Codification will supersede all then-existing non-SEC accounting and reporting standards. This standard will become effective for the Company on June 25, 2009. We do not expect that this standard will have a material impact on our consolidated financial statements upon adoption.

Accounting Pronouncements Not Yet Adopted

In December 2007, the FASB issued SFAS No. 141R, (“SFAS No. 141R”), “Business Combinations.” SFAS No. 141R establishes the principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree as well as the recognition and measurement of goodwill acquired in a business combination. SFAS

 

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No. 141R also requires certain disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS No. 141R is effective for business combinations occurring in fiscal years beginning after December 15, 2008. Early adoption of SFAS No. 141R is not permitted. Acquisitions, if any, after the effective date will be accounted for in accordance with SFAS No. 141R.

In December 2007, the FASB issued SFAS No. 160, (“SFAS No. 160”), “Noncontrolling Interests in Consolidated Financial Statements – an Amendment of ARB No. 51.” SFAS No. 160 applies to all entities that prepare consolidated financial statements but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 establishes accounting and reporting standards that require noncontrolling interests to be reported as a component of equity, changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions and any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS No. 160 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008. Acquisitions, if any, after the effective date will be accounted for in accordance with SFAS No. 160.

In June, 2008, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 outlines a two-step approach to evaluate the instrument’s contingent exercise provisions, if any, and to evaluate the instrument’s settlement provisions when determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. EITF 07-5 is effective for fiscal years beginning after December 15, 2008 and must be applied to outstanding instruments as of the beginning of the fiscal year of adoption as a cumulative-effect adjustment to the opening balance of retained earnings. Early adoption is not permitted. The Company is currently evaluating the impact of adopting EITF 07-5 on its results of operations and financial position.

OTHER MATTERS

Seasonality and Quarterly Results

Our business experiences some variations in sales from quarter to quarter due to the holiday season and other factors including, but not limited to, general economic trends, competition, marketing programs and the weather. The fall and winter months are generally the best sales months but our geographic and product line diversity provide for some sales stability in the warmer months when coffee consumption ordinarily decreases. 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 any other quarter or in a full fiscal year, especially for our first fiscal quarter which tends to be the weakest.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

 

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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Item 9A. Controls and Procedures.

Disclosure Controls and Procedures.    Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), in connection with the preparation of this Annual Report on Form 10-K, as of June 24, 2009.

Based on the review described above, our Chief Executive Officer and Chief Financial Officer determined that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Internal Control Over Financial Reporting.    Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. In addition, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

Our management assessed our internal control over financial reporting as of June 24, 2009 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on such assessment, our management concluded that our internal control over financial reporting was effective as of June 24, 2009 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

This annual report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report on Form 10-K.

There were no changes in our internal control over financial reporting that occurred during the fourth quarter ended June 24, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information.

None.

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance.

Information Regarding the Directors of Diedrich Coffee, Inc.

Our directors are elected once a year at our annual meeting of stockholders. Our bylaws provide that our board of directors shall consist of between three and seven directors with the precise number to be determined by resolution of our board of directors. The authorized number of members of our board of directors is currently four.

On December 19, 2008, our board of directors appointed James W. Stryker as a director and a member of the audit committee. Mr. Stryker currently serves as Chairman of the audit committee.

The following table lists our directors and provides their respective ages and titles as of June 24, 2009.

 

Name    Age    Title    Director Since

Paul C. Heeschen (1)

   52    Chairman of the Board of Directors    1996

Gregory D. Palmer (2)

   52    Director    2006

J. Russell Phillips

   59    Director, President and Chief Executive Officer    2007

Timothy J. Ryan (1) (2)

   69    Vice Chairman of the Board of Directors    2005

James W. Stryker (2)

   62    Director    2008

 

  (1) Member of the compensation committee of the board of directors.

 

  (2) Member of the audit committee of the board of directors.

There are no family relationships among any of the directors or executive officers of Diedrich Coffee. The principal occupation for at least the last five years of each director, as well as other information, is set forth below.

Paul C. Heeschen joined our board of directors in January 1996. In February 2001, the board of directors elected him as Chairman. Since 1995, Mr. Heeschen has been a principal of Heeschen & Associates, a private investment firm. He is also the sole general partner of Sequoia Enterprises, LP, WF Trust, D.C.H., LP and a trustee of the Paul C. Heeschen Revocable Living Trust, each of which are stockholders of Diedrich Coffee. Mr. Heeschen serves on the board of directors of PC Mall, Inc., a publicly traded supplier of technology solutions for business, government and educational institutions, as well as consumers.

Gregory D. Palmer joined our board of directors in September 2006. From January 1998 to June 2006, Mr. Palmer was the President and Chief Executive Officer of RemedyTemp, Inc., a staffing services company. Mr. Palmer also served as a director of RemedyTemp, Inc. from January 2001 to June 2006.

J. Russell Phillips joined our board of directors on April 18, 2007 through appointment by our board of directors. On February 7, 2008, Mr. Phillips was appointed our Chief Executive Officer. From 2004 to 2008, Mr. Phillips served as Managing Principal of Transom Partners, an executive consultancy group that facilitates and develops new strategies with CEOs and executive teams. From 1994 to 2004, Mr. Phillips served as Chief Executive Officer and President of SHURflo, the leading manufacturer of high quality precision pumps, controls, motors and systems serving the food service, industrial and RV/marine markets. From 1972 to 1994, Mr. Phillips worked for several pump companies in various managerial capacities.

 

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Timothy J. Ryan joined our board of directors in October 2005. Effective April 8, 2009, Mr. Ryan was appointed Vice Chairman of the board. Mr. Ryan previously served as our Chief Executive Officer from November 1997 to October 2000. Since April 1999, he has been a director of Rubio’s Restaurants, Inc., a publicly traded fast-casual fresh Mexican grill restaurant chain. From December 1995 to December 1996, Mr. Ryan served as President and Chief Operating Officer of Sizzler U.S.A., a division of Sizzler International, Inc., and as a director of Sizzler International, Inc., of which he also served as a Senior Vice President. From November 1988 to December 1993, Mr. Ryan served as Senior Vice President of Marketing at Taco Bell Worldwide and, from December 1993 to December 1995, he served as Senior Vice President of Taco Bell’s Casual Dining Division.

James W. Stryker joined our board of directors in December 2008 through appointment by our board of directors and currently serves as Chairman of the audit committee. From May 2006 to April 2008, Mr. Stryker was the Executive Vice President and Chief Financial Officer (“CFO”) of Perkins & Marie Callender’s Inc., a chain of two restaurant concepts. From October 2001 to April 2006, Mr. Stryker served as Executive Vice President, CFO of Wilshire Restaurant Group, Inc. (dba Marie Callender’s). From March 1999 to October 2001, Mr. Stryker was Senior Vice President, CFO of The Johnny Rockets Group, Inc. From January 1996 to March 1999 Mr. Stryker was Vice President, Finance and CFO of Rubio’s Restaurants, Inc. From 1994 to December 1995, Mr. Stryker was Vice President, Finance and Administration of American Restaurant Group, Inc. Prior to that, Mr. Stryker spent sixteen years with El Torito Restaurants, Inc. including eight years as Executive Vice President and Chief Financial Officer.

Committees of the Board of Directors

The Company has two standing committees: an audit committee and a compensation committee. Each member of the audit and compensation committees of the board of directors has been determined by our board of directors to be “independent.” The committees operate under written charters that are available for viewing on the “Investor Services” segment of our website: www.diedrich.com.

Audit Committee

It is the responsibility of the audit committee to oversee our accounting and financial reporting processes and the audits of our financial statements. In addition, the audit committee assists the board of directors in its oversight of our compliance with legal and regulatory requirements. The specific duties of the audit committee include monitoring the integrity of our financial process and systems of internal controls regarding finance, accounting and legal compliance; selecting our independent registered public accounting firm; monitoring the independence and performance of our independent registered public accounting firm; and facilitating communication among the independent registered public accounting firm, our management and our board of directors. The audit committee has the authority to conduct any investigation appropriate to fulfill its responsibilities and has direct access to all of our employees and the independent registered public accounting firm. The audit committee also has the authority to retain, at our expense and without further approval of the board of directors, special legal, accounting or other consultants or experts that it deems necessary in the performance of its duties.

The audit committee met four times during the 2009 fiscal year and otherwise accomplished its business without formal meetings. The audit committee was composed of Mr. Palmer and Mr. Ryan until the addition of Mr. Stryker effective December 19, 2008. Our board of directors has determined that each of Mr. Palmer, Mr. Ryan and Mr. Stryker is “independent” within the meaning of the enhanced independence standards contained in Nasdaq Marketplace Rule 4350(d) and regulations adopted by the Securities and Exchange Commission that relate specifically to members of audit committees. Our board of directors has also determined that Mr. Ryan is qualified to serve as our “audit committee financial expert,” as that term is defined in Item 407(d)(5) of Regulation S-K.

 

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Effective February 7, 2008, J. Russell Phillips resigned from our audit committee due to his appointment as our President and Chief Executive Officer. Although Mr. Phillips continues to serve as a member of our board of directors, due to his departure from the audit committee, we had only two directors eligible to serve on our audit committee. NASDAQ Rule 4350(d)(2)(A) requires that a registrant’s audit committee must consist of at least three independent directors. We provided Nasdaq with written notice of this matter on February 7, 2008 and had until the earlier of our next annual meeting of stockholders or February 7, 2009 to regain compliance with NASDAQ Rule 4350(d)(2)(A). On December 19, 2008, the board of directors appointed James W. Stryker as a director and member of the audit committee, resulting in our audit committee being comprised of three independent directors.

Information Regarding Executive Officers of Diedrich Coffee, Inc.

Diedrich Coffee’s executive officers as of June 24, 2009 are as follows and will serve in such capacities until his or her successor is duly appointed or until his or her resignation or removal:

 

Name    Age    Position(s) Held

J. Russell Phillips

   59        Director, President and Chief Executive Officer

Sean M. McCarthy

   48        Chief Financial Officer and Secretary

James L. Harris

   45        Vice President—Sales

Dana A. King

   46        Vice President—Information Services & Customer Fulfillment

The following is information regarding those persons currently serving as executive officers of Diedrich Coffee:

J. Russell Phillips became our Chief Executive Officer on February 7, 2008. See “Information Regarding the Directors of Diedrich Coffee, Inc.” for information relating to Mr. Phillips.

Sean M. McCarthy became our Chief Financial Officer and Secretary in January 2006, after serving as Vice President, Controller of Diedrich Coffee since April 2004. From February 2003 to April 2004, Mr. McCarthy was Vice President of ASM Hospitality Group, a privately owned consulting company. From June 1998 to February 2003, Mr. McCarthy served in various financial capacities for FRD Acquisition Company, Inc. (d/b/a. Coco’s & Carrows Restaurants), a subsidiary of Advantica Restaurants Group, Inc., a publicly traded food service company, first as Manager, Field Finance, then Manager, Financial Planning & Analysis, and finally as Director, Finance. From May 1997 to June 1998, Mr. McCarthy was a Business Analyst for Taco Bell, Inc. From August 1986 through May 1997, Mr. McCarthy served in various accounting and financial capacities for El Torito Restaurants, a subsidiary of Family Restaurants, Inc. Mr. McCarthy earned a B.S. degree in business management from Pepperdine University and a master’s degree in business administration from the University of Southern California.

James L. Harris joined Diedrich Coffee in June 2008 as Vice President—Sales. From late 2007 to 2008, Mr. Harris was with Hansen’s Beverage Company, a publicly owned company and manufacturer and seller of premium beverages and Monster Energy Drink, as the Vice President of International Sales. From 1997 to 2007, Mr. Harris was with FIJI Water, LLC, a privately owned manufacturer and seller of premium-bottled water in a variety of capacities ultimately serving as the Senior Vice President of Sales, Western Region. From 1991 to 1997, Mr. Harris was with Haagen-Dazs Ice Cream first as an Account Executive and ultimately as a Division Manager. From 1985 to 1991, Mr. Harris worked for Pepsi-Cola Bottling Group working his way up to Account Executive and relocating to Southern California.

Dana A. King became our Vice President-Information Services & Customer Fulfillment effective January 2009 after serving as Vice President-Information and Customer Services. Ms. King joined Diedrich Coffee, Inc. in November 2005 as the Director of Information Services. From 2001 until joining Diedrich, Ms. King led the

 

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Application Development group at Del Taco, a Mexican quick-service restaurant chain. From 1996 until 2000, Ms. King worked for Professional Computing, Inc. as a programmer/analyst before being promoted to IS Assistant Manager. After PCI was acquired by IKON in 1997, she was promoted to the Director of IS, and, in 1999 was promoted to VP of IS and Managing Consultant and led a team consisting of developers, engineers and project managers in three locations across two states. After leaving IKON, Ms. King ran her own consulting business. Ms. King holds a B.S. degree in Business with an emphasis in Computer Information Services from California State Polytechnic University, Pomona.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16 of the Securities Exchange Act of 1934 requires our directors and executive officers and persons who own more than ten percent of a registered class of our equity securities to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. These Section 16 reporting persons are required by Securities and Exchange Commission regulations to furnish us with copies of all Section 16 forms they file.

To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations from Section 16 reporting persons, we believe that during our fiscal year ended June 24, 2009 all Section 16 reporting persons complied with all applicable filing requirements.

Code of Conduct

We have adopted a code of conduct that describes the ethical and legal responsibilities of all of our employees and, to the extent applicable, the members of our board of directors. This code includes, but is not limited to, the requirements of the Sarbanes-Oxley Act of 2002 pertaining to codes of ethics for chief executives and senior financial and accounting officers. Our board of directors has reviewed and approved this code of conduct. Our employees agree in writing to comply with the code at commencement of employment and periodically thereafter. Our employees are encouraged to report suspected violations of the code through various means, and they may do so anonymously. Our code of conduct is available for viewing on the “Investor Services” segment of our website: www.diedrich.com. If we make substantive amendments to the code or grant any waiver, including any implicit waiver, to our principal executive, financial or accounting officer, or persons performing similar functions, we will disclose the nature of such amendment or waiver on our website and/or in a report on Form 8-K in accordance with applicable rules and regulations.

 

Item 11. Executive Compensation.

Summary Compensation Table

The following table sets forth compensation earned or paid during the fiscal year ended June 24, 2009 by our Chief Executive Officer and two other most highly compensated executive officers who were serving as our executive officers at the end of the last completed fiscal year (collectively, the “named executive officers”).

 

Name and Principal Position

   Year    Salary ($)    Bonus ($)
(1)
   Option
Awards ($) (2)
   Non-equity
Incentive Plan
Compensation
($) (3)
   All Other
Compensation
($)
    Total
($)

J. Russell Phillips,

   2009    $ 275,000    $ 62,700    $ 203,890    $ 165,000    $ 720 (5)    $ 707,310

President and Chief

Executive Officer (4)

   2008      105,769      —        99,908      —        26,917 (6)      232,594

Sean M. McCarthy,

   2009      225,000      90,000      —        90,000      3,016 (7)      408,016

Chief Financial Officer and Secretary

   2008      214,425      —        —        —        4,014 (8)      218,439

James L. Harris,

   2009      180,000      —        11,499      54,000      15,190 (9)      260,689

Vice President—Sales

   2008      2,077      —        —        —        462 (10)      2,539

 

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(1) The Company paid discretionary bonuses in the amounts identified in this column for fiscal year 2009 to the Chief Executive Officer and Chief Financial Officer for the completion of the Transaction with Praise.

 

(2) This column represents the dollar amount recognized for financial statement reporting purposes with respect to the 2009 and 2008 fiscal years for the fair value of stock options for each of the named executive officers in accordance with SFAS No. 123R. Pursuant to rules of the Securities and Exchange Commission, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to the 2009 and 2008 grants, refer to Note 1 to our consolidated financial statements. These amounts reflect our accounting expense for these awards, and do not correspond to the actual value that may be received by the named executive officers.

 

(3) Amounts identified in this column for fiscal year 2009 were earned by the Chief Executive Officer and Chief Financial Officer based on achievement of certain targets of the Company’s financial performance. The amount identified for fiscal year 2009 earned by the Vice President of Sales was primarily based on specific sales and profitability targets.

 

(4) Mr. Phillips became our President and Chief Executive Officer in February 2008. Mr. Phillips’ annual base salary is $275,000.

 

(5) Consists of health fitness membership reimbursement in the amount of $720.

 

(6) Consists of a signing bonus payment in the amount of $25,000 and health fitness membership reimbursement in the amount of $1,917.

 

(7) Consists of 401(k) matching contributions by Diedrich Coffee in the amount of $2,271 and health fitness membership reimbursement in the amount of $745.

 

(8) Consists of 401(k) matching contributions by Diedrich Coffee in the amount of $2,077 and health fitness membership reimbursement in the amount of $1,937.

 

(9) Consists of auto allowance in the amount of $12,000, 401(k) matching contributions by Diedrich Coffee in the amount of $138 and health fitness membership reimbursement in the amount of $3,052.

 

(10) Consists of auto allowance in the amount of $462.

Employment Agreements with Current Named Executive Officers

J. Russell Phillips.    Effective February 7, 2008, Mr. Phillips entered into an employment agreement with us appointing him President and Chief Executive Officer. Mr. Phillips’s employment agreement provides for compensation consisting of, among other things, (i) an annual base salary of $275,000 and (ii) a grant of options to purchase 275,000 shares of our common stock, (the “Options”) pursuant to a Stock Option Agreement described below. In addition, Mr. Phillips is eligible to receive (i) a bonus equal to up to 75% of his annual base salary, 80% of which would be paid upon achievement of certain defined objectives and 20% of which would be paid based upon the discretion of our compensation committee and (ii) benefits under all other benefit plans generally provided to our other executive officers.

Mr. Phillips’s Options consist of non-qualified stock options to purchase up to 275,000 shares of our common stock, which vest over three (3) years, with one-third (1/3) of the options vesting on each anniversary of the effective date until all options have vested. The Options will fully vest and become immediately exercisable upon a change of control (as such term is defined in Mr. Phillip’s employment agreement). Unless an earlier termination occurs, the Options will expire ten years after the effective date of the Stock Option Agreement.

 

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Sean M. McCarthy.    On January 1, 2006, Mr. McCarthy was promoted to Chief Financial Officer. Effective May 1, 2008, our compensation committee approved the following compensatory arrangements for Mr. McCarthy: (i) annual base salary of $225,000; (ii) an annual bonus of up to 40% of his annual base salary based upon objective performance criteria; (iii) a severance payment equal to nine months of annual base salary if Mr. McCarthy is terminated by us without cause, provided that he executes customary releases of us; and (iv) in the event of a “change of control,” Mr. McCarthy shall be entitled to a stock appreciation payment upon consummation of the change of control transaction provided that he executes a general release of us.

Change in Control Agreements

Potential Payments Upon Termination or Change in Control

Some of our officers are entitled to receive certain payments upon a change in control under individual employment agreements or may be entitled to receive certain payments under severance agreements. In addition, our board of directors may in its discretion accelerate the vesting of options upon a change in control.

Upon a termination for cause, officers are not entitled to receive compensation after such termination and their options terminate upon such termination. In the event of an involuntary not for cause termination, termination following a change in control and in the event of disability of the executive officer, certain executive officers may be entitled to receive compensation or payments upon such termination as described below. The amounts shown below assume that such termination was effective as of June 24, 2009 and use the closing price of our common stock as of June 24, 2009 ($16.93), and thus include amounts earned through such time. These figures are estimates of the amounts that would be paid out to the executive officers upon their termination. The actual amounts to be paid can only be determined at the time of such executive officer’s separation from Diedrich Coffee.

J. Russell Phillips.    In the event of a change of control, (as such term is defined in Mr. Phillips’s Employment Agreement), Mr. Phillips’ shall be entitled to receive, upon timely execution of a general release of us, (i) a payment in cash equal to 100% of the base salary and (ii) benefits as set forth in the Stock Option Agreement. As described above, upon a change of control, his Options will fully vest and become immediately exercisable.

Sean M. McCarthy.    As described above, (i) Mr. McCarthy shall be entitled to a severance payment equal to nine months of annual base salary if he is terminated by us without cause, provided that he executes customary release of us; and (ii) in the event of a “change of control,” Mr. McCarthy shall be entitled to a stock appreciation payment upon consummation of the change of control transaction, provided that he executes a general release of us. A change of control is defined as a transaction that results in a non-affiliate of us acquiring 90% of our outstanding common stock. A stock appreciation payment is equal to the product of (i) the difference determined by subtracting $5.00 from the per share price at which at least 90% of our outstanding common stock is acquired, multiplied by (ii) 100,000. Because the disposition value in the event of such an acquisition is indeterminable, the payment to Mr. McCarthy is not calculable.

 

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Outstanding Equity Awards at the 2009 Fiscal Year End

The following table sets forth information relating to stock options held by the named executive officers as of June 24, 2009.

 

   
      Option Awards
Name   

Number of
Securities
Underlying
Unexercised

Options

(#)

   

Number of

Securities

Underlying

Unexercised

Options

(#)

   

Option

Exercise

Price

($)

  

Option

Expiration

Date

   Exercisable     Unexercisable       

J. Russell Phillips

   7,500 (1)    —        $ 3.83    4/18/2017
     91,666 (2)    183,334 (2)      3.23    2/07/2018

Sean M. McCarthy

   20,000 (2)    —          3.69    4/26/2014

James L. Harris

   —        20,000 (2)      2.32    9/17/2018

 

(1) These options vest over a two-year period at a rate of one-half per year.

 

(2) These options vest over a three-year period at a rate of one-third per year.

Director Compensation

Directors who are also our employees receive no extra compensation for their service on the board of directors. Non-employee directors receive an annual fee of $12,000, which is paid quarterly. In addition, non-employee directors earn fees of $1,000 per board meeting attended in person, $500 per board meeting attended telephonically and $500 per committee meeting attended, whether in person or telephonically. Non-employee directors are also reimbursed for out-of-pocket expenses incurred in connection with attending meetings of the board of directors and its committees. In the fiscal year ended June 24, 2009, Mr. Heeschen earned $22,000, Mr. Palmer earned $23,500, Mr. Ryan earned $50,062 and Mr. Stryker earned $10,500. In addition, non-employee directors are eligible to receive stock option grants under the Diedrich Coffee, Inc. 2000 Equity Incentive Plan. In the fiscal year ended June 24, 2009, each person who was then a non-employee director was granted 15,000 stock options under the 2000 Equity Incentive Plan.

Under our 2000 Equity Incentive Plan, each non-employee director automatically receives, upon first becoming a director, a one-time grant of an option to purchase up to 15,000 shares of our common stock. The initial options vest and become exercisable with respect to 50% of the underlying shares upon the earlier of the first anniversary of the grant date or immediately before the first annual meeting of stockholders following the grant date, provided that the recipient has remained a non-employee director for the entire period from the grant date to such earlier date. The remaining 50% of the underlying shares vest upon the earlier of the second anniversary of the grant date or immediately before the second annual meeting of stockholders following the grant date, provided that the recipient has remained a non-employee director for the entire period from the grant date to such date. In addition to the initial grant, each non-employee director also automatically receives, upon re-election to our board of directors, an additional option to purchase up to 15,000 shares of our common stock. These additional options vest and become exercisable upon the earlier of the first anniversary of the grant date or immediately before the annual meeting of stockholders following the grant date, provided that the recipient has remained a non-employee director for the entire period from the grant date to such date. In addition to the initial and additional options, under the 2000 Equity Incentive Plan, each director, including each non-employee director, is eligible to receive other awards under the 2000 Equity Incentive Plan at the discretion of the administrator of the plan.

 

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All non-employee director options granted under the 2000 Equity Incentive Plan 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. Vesting of non-employee director options granted under the 2000 Equity Incentive Plan accelerates in certain circumstances in connection with a change in control. During the fiscal year ended June 24, 2009, an aggregate of 185,000 options to purchase shares of our common stock were issued to non-employee directors under the 2000 Equity Incentive Plan.

Director Compensation Table

The following table shows the 2009 fiscal year compensation for our non-employee directors.

 

Name

   Fees Earned or
Paid in Cash
($)
   Option Awards
($) (1)
   Total
($)

Paul C. Heeschen

   $ 22,000    $ 13,013    $ 35,013

Gregory D. Palmer

     23,500      15,340      38,840

Timothy J. Ryan (2)

     50,062      28,363      78,425

James W. Stryker

     10,500      2,999      13,499

 

 

 

(1) This column represents the dollar amount recognized for financial statement reporting purposes with respect to the 2009 fiscal year for the fair value of stock options for each of the directors in accordance with SFAS No. 123R. Pursuant to rules of the Securities and Exchange Commission, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to the 2009 grants, refer to Note 1 to our consolidated financial statements. These amounts reflect our accounting expense for these awards, and do not correspond to the actual value that may be received by the directors.

 

(2) Fees earned include compensation as Vice Chairman of the board in the amount of $27,562.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth information regarding the beneficial ownership of our common stock as of September 9, 2009 by:

 

   

each person or group of affiliated persons who we know beneficially owns more than 5% of our common stock;

 

   

each of our directors and nominees;

 

   

each of our named executive officers; and

 

   

all of our directors and executive officers as a group.

 

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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 and warrants that are exercisable within 60 days from September 9, 2009.

 

Name And Address

Of Beneficial Owner (1)

   Amount And Nature Of
Beneficial Ownership (2)
    Percent
Of Class (%)(2)

Sequoia Enterprises, LP
450 Newport Center Drive, Suite 450
Newport Beach, CA 92660

   3,260,604 (3)    44.0

WF Trust
450 Newport Center Drive, Suite 450
Newport Beach, CA 92660

   750,000 (4)    12.4

Financial & Investment Management Group, LTD
111 Cass Street, Traverse City, MI 49684

   533,342 (5)    9.3

D.C.H., L.P.
450 Newport Center Drive, Suite 450
Newport Beach, CA 92660

   419,268 (6)    7.3

Clarus Capital Group Management LP
237 Park Avenue, Suite 900
New York, NY 10017

   287,733 (7)    5.0

Paul C. Heeschen

   4,512,293 (8)    57.9

Timothy J. Ryan

   60,000 (9)    1.0

Gregory D. Palmer

   45,000 (10)    *

James W. Stryker

   8,000 (11)    *

J. Russell Phillips

   102,166 (12)    1.8

Sean M. McCarthy

   25,000 (13)    *

James L. Harris

   6,666 (14)    *

All directors and executive officers as a group (9 persons)

   4,780,211 (15)    59.4

 

 

 

* Less than 1%

 

(1) Unless otherwise indicated, the address of each person in this table is c/o Diedrich Coffee, Inc., 28 Executive Park, Suite 200, Irvine, California 92614, Attn: Corporate Secretary.

 

(2) Calculated pursuant to Rule 13d-3(d) under the Securities Exchange Act of 1934. Shares not outstanding that are subject to options or warrants exercisable by the holder thereof within 60 days of September 9, 2009 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 of any other person. Unless otherwise noted, all shares listed as beneficially owned by a stockholder are actually outstanding.

 

(3) Paul C. Heeschen, the Chairman of our board of directors, is the sole general partner of this limited partnership with voting and investment power as to all shares beneficially owned by the limited partnership. Includes 250,000 shares subject to warrants that are immediately exercisable and will expire on June 30, 2014, 1,367,000 shares subject to warrants that are immediately exercisable and will expire on August 26, 2013 and 70,000 shares subject to warrants that are immediately exercisable and will expire on April 29, 2014.

 

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(4) Paul C. Heeschen, the Chairman of our board of directors, is the sole trustee with sole voting and investment power as to all shares beneficially owned by the trust. Includes 300,000 shares subject to warrants that are immediately exercisable and will expire on August 26, 2013.

 

(5) According to the Schedule 13G filed on March 23, 2009 Financial & Investment Management Group, LTD (“FIMG”) is a registered investment advisor that manages individual client accounts. All 533,342 shares represented in that filing have shared voting power and are held in accounts owned by the clients of FIMG. FIMG disclaims beneficial ownership of all such shares.

 

(6) Paul C. Heeschen, the Chairman of our board of directors, is the sole general partner of this limited partnership with voting and investment power as to all shares beneficially owned by the limited partnership.

 

(7) According to the Schedule 13G filed on February 13, 2007 includes sole voting power relating to 235,713 and shared voting power relating to 52,020 shares beneficially owned by Clarus Capital Group Management LP. The general partner to Clarus Capital Group Management LP is Clarus Capital Management, LLC. Ephraim Fields is the managing member of Clarus Capital Group Management, LLC and as such controls Clarus Capital Group Management LP.

 

(8) Includes (i) 3,260,604 shares beneficially owned by Sequoia Enterprises, LP (250,000 shares subject to warrants that are immediately exercisable and will expire on June 30, 2014, 1,367,000 shares subject to warrants that are immediately exercisable and will expire on August 26, 2013 and 70,000 shares subject to warrants that are immediately exercisable and will expire on April 29, 2014), and (ii) 419,268 shares beneficially owned by D.C.H., LP. Mr. Heeschen is the sole general partner of each of these partnerships with voting and investment power as to all of such shares. Includes 750,000 shares beneficially owned by WF Trust (300,000 shares subject to warrants that are immediately exercisable and will expire on August 26, 2013). Mr. Heeschen is the sole trustee with sole voting and investment power as to all shares beneficially owned by the trust. Includes 82,421 shares owned personally by Mr. Heeschen (81,250 shares subject to options that are exercisable within 60 days), and 250 shares held by Paul C. Heeschen Revocable Living Trust.

 

(9) Includes 60,000 shares subject to options that are exercisable within 60 days.

 

(10) Includes 45,000 shares subject to options that are exercisable within 60 days.

 

(11) Includes 7,500 shares subject to options that are exercisable within 60 days.

 

(12) Includes 99,166 shares subject to options that are exercisable within 60 days.

 

(13) Includes 20,000 shares subject to options that are exercisable within 60 days.

 

(14) Includes 6,666 shares subject to options that are exercisable within 60 days.

 

(15) Includes 2,325,748 shares subject to options and warrants that are exercisable within 60 days.

 

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Equity Compensation Plan Information.

The following table summarizes the equity compensation plans under which our common stock may be issued as of June 24, 2009.

 

     (a)   (b)   (c)
Plan category  

Number of securities to
be issued upon exercise
of outstanding options,

warrants and rights

  Weighted-average
exercise price of
outstanding options,
warrants and rights
  Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))

Equity compensation plans approved by security holders

  750,300(1)   $3.36   303,917(2)
       

Equity compensation plans not approved by security holders

  —         —     —      
             
             

Total

  750,300       $3.36   303,917    
             

 

(1) Represents options to purchase shares of our common stock issued under: the Diedrich Coffee, Inc. 2000 Equity Incentive Plan; the 2000 Non-Employee Directors Stock Option Plan; the Amended and Restated Diedrich Coffee, Inc. 1996 Stock Incentive Plan; the Diedrich Coffee, Inc. 1996 Non-Employee Directors Stock Option Plan; and the J. Russell Phillips Stock Option Agreement.

 

(2) Represents securities available for issuance under the Diedrich Coffee, Inc. 2000 Equity Incentive Plan.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence.

2009 Sequoia Warrant.    In connection with the extension of the Note Purchase Agreement, after the close of the Nasdaq Stock Market on April 29, 2009, the Company issued to Sequoia a warrant to purchase 70,000 shares of common stock of the Company at an exercise price of $7.40 per share (the “2009 Sequoia Warrant”), which was the closing price of the Company’s common stock on such date. The fair value of these warrants was approximately $440,000 which was immediately recorded as interest expense. The 2009 Sequoia Warrant is exercisable by Sequoia, in whole or in part, at any time or from time to time, prior to April 29, 2014. The 2009 Sequoia Warrant is not eligible for cashless exercise, but the Company is obligated to cause the common stock issued upon exercise of the 2009 Sequoia Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

Consistent with the Company’s procedures for approving related party transactions, the audit committee of the board of directors, comprised of Gregory D. Palmer, Timothy J. Ryan and James W. Stryker, authorized and approved the 2009 Sequoia Warrant and the transactions contemplated thereby.

Waiver Agreement.    On September 17, 2008 we were not in compliance with covenants under the Note Purchase Agreement and the Loan Agreement. On November 10, 2008, we entered into a Waiver Agreement, Amendment No. 1 to 2008 Warrant and Amendment No. 2 to 2001 Warrant (the “Waiver Agreement”) with Sequoia. Pursuant to the Waiver Agreement, Sequoia waived the requirement set forth in the Note Purchase Agreement and the Loan Agreement with Sequoia (collectively, the “Loan Agreements”) that we shall not permit, as of the end of any fiscal quarter, the ratio of our Indebtedness on a consolidated basis to Effective

 

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Tangible Net Worth to be more than 1.75:1.00 (as such terms are defined in the Loan Agreements). Such waiver is effective until the earlier of (a) October 31, 2009 and (b) the end of any fiscal quarter at which the foregoing ratio is greater than 2.10:1.00. As part of the waiver and amendment, the exercise price of the 2008 Sequoia Warrant and the 2001 Sequoia Warrants for 250,000 shares of common stock was reduced to $1.65 from $2.00 per share. In consideration of the foregoing waiver, (a) the interest rates under the Note Purchase Agreement and the Term Loan were set at LIBOR plus 9.3% for any period during which the ratio of indebtedness of the Company on a consolidated basis to effective tangible net worth is greater than 1.75:1.00 and (b) the interest rates under the Note Purchase Agreement and the Term Loan were set at LIBOR plus 6.30% for any other period. The Company is in compliance with all debt covenants as of June 24, 2009.

Consistent with the Company’s procedures for approving related party transactions, the audit committee of the board of directors, as of November 2008, comprised of Gregory D. Palmer and Timothy J. Ryan, authorized and approved the Waiver Agreement and the transactions contemplated thereby.

Director Independence.    Our board of directors has affirmatively determined that four of our five directors are independent within the meaning of Nasdaq Marketplace Rule 4200(a)(15). Our independent directors are Paul C. Heeschen, Gregory D. Palmer, Timothy J. Ryan and James W. Stryker. During its review, the board of directors considered transactions and relationships between each director or any member of his or her immediate family and Diedrich Coffee and its subsidiaries and affiliates.

 

Item 14. Principal Accountant Fees and Services.

The following table presents the aggregate fees billed by BDO Seidman, LLP for services provided during our 2009 and 2008 fiscal years.

 

     2009    2008

Audit Fees

   $ 329,000    $ 308,000

Audit Related Fees

     22,000      32,000

Tax Fees

     104,000      145,000
             

Total

   $ 455,000    $ 485,000
             

Audit Fees.    The fees identified under this caption were for professional services rendered by BDO Seidman, LLP for fiscal years 2009 and 2008 in connection with the audit of our annual financial statements and review of the financial statements included in our quarterly reports on Form 10-Q. The amounts also include fees for services that are normally provided by the independent public registered accounting firm in connection with statutory and regulatory filings and engagements for the years identified.

Audit-Related Fees.    The fees identified under this caption were for assurance and related services that were related to the performance of the audit or review of our financial statements and were not reported under the caption “Audit Fees.” Audit-related fees consisted primarily of fees paid for Securities and Exchange Commission reporting matters and consents related to our uniform franchise offering circulars.

Tax Fees.    Tax fees consist principally of assistance related to tax compliance and reporting.

Approval Policy.    Our audit committee approves in advance all services provided by our independent registered public accounting firm. All engagements of our independent registered public accounting firm in fiscal years 2009 and 2008 were pre-approved by the audit committee.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedules.

Financial Statements and Schedules.

The financial statements and schedules required to be filed hereunder are set forth at the end of this Annual Report on Form 10-K beginning on page F-1.

Exhibits.

The Exhibit Index attached hereto is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    DIEDRICH COFFEE, INC.

September 22, 2009

  By:  

/s/ J. RUSSELL PHILLIPS

    J. Russell Phillips
    Chief Executive Officer
    (on behalf of the registrant)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

  

Title

 

Date

/s/ PAUL HEESCHEN

Paul Heeschen

   Chairman of the Board of Directors   September 22, 2009

/s/ J. RUSSELL PHILLIPS

J. Russell Phillips

   Director, President and Chief Executive Officer   September 22, 2009

/s/ SEAN M. MCCARTHY

Sean M. McCarthy

   Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)   September 22, 2009

/s/ TIMOTHY J. RYAN

Timothy J. Ryan

   Vice Chairman   September 22, 2009

/s/ GREGORY D. PALMER

Gregory D. Palmer

   Director   September 22, 2009

/s/ JAMES W. STRYKER

James W. Stryker

   Director   September 22, 2009

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Balance Sheets

   F-3

Consolidated Statements of Operations

   F-4

Consolidated Statements of Stockholders’ Equity

   F-5

Consolidated Statements of Cash Flows

   F-6

Notes to Consolidated Financial Statements

   F-8

Schedule II – Valuation and Qualifying Accounts

   F-31

 

F-1


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Diedrich Coffee, Inc.:

We have audited the accompanying consolidated balance sheets of Diedrich Coffee, Inc. and subsidiaries (the “Company”) as of June 24, 2009 and June 25, 2008, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the two years in the period ended June 24, 2009. In connection with our audits of the consolidated financial statements, we also have audited the supplementary information included in Schedule II. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Diedrich Coffee, Inc. and subsidiaries as of June 24, 2009 and June 25, 2008, and the consolidated results of their operations and their cash flows for each of the two years in the period ended June 24, 2009, in conformity with accounting principles generally accepted in the United States.

Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ BDO Seidman, LLP

Costa Mesa, California

September 22, 2009

 

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Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

     June 24, 2009     June 25, 2008
(Restated)
 

Assets

    

Current assets:

    

Cash

   $ 3,572,000      $ 670,000   

Restricted cash and short term investments

     623,000        623,000   

Accounts receivable, less allowance for doubtful accounts of $266,000 at June 24, 2009 and $508,000 at June 25, 2008

     6,335,000        5,015,000   

Inventories

     5,510,000        4,652,000   

Income tax refund receivable

     40,000          

Current portion of notes receivable, less allowance of $75,000 at June 24, 2009 and $247,000 at June 25, 2008

     3,604,000        1,074,000   

Advertising fund assets, restricted

            6,000   

Prepaid expenses

     293,000        412,000   
                

Total current assets

     19,977,000        12,452,000   

Property and equipment, net

     5,416,000        6,757,000   

Notes receivable, less allowance of $0 at June 24, 2009 and June 25, 2008

     812,000        2,663,000   

Cash surrender value of life insurance policy

            162,000   

Other assets

     723,000        132,000   
                

Total assets

   $ 26,928,000      $ 22,166,000   
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Note payable, net of discount

   $ 2,687,000      $ 1,741,000   

Accounts payable

     5,228,000        5,169,000   

Accrued compensation

     1,816,000        1,412,000   

Accrued expenses

     1,418,000        3,995,000   
                

Total current liabilities

     11,149,000        12,317,000   

Long term note payable, net of discount

     1,594,000          

Income tax liability

     33,000        261,000   

Deferred rent

     133,000        190,000   

Deferred compensation

            226,000   

Other liabilities

     245,000          
                

Total liabilities

     13,154,000        12,994,000   
                

Commitments and contingencies (Notes 8 and 9)

    

Stockholders’ equity:

    

Preferred stock, $0.01 par value, authorized 3,000,000 shares; issued and outstanding 0 shares at June 24, 2009 and June 25, 2008

              

Common stock, $0.01 par value; authorized 17,500,000 shares; issued and outstanding 5,727,000 shares at June 24, 2009 and 5,468,000 shares at June 25, 2008

     57,000        55,000   

Additional paid-in capital

     63,289,000        60,281,000   

Accumulated deficit

     (49,572,000     (51,164,000
                

Total stockholders’ equity

     13,774,000        9,172,000   
                

Total liabilities and stockholders’ equity

   $ 26,928,000      $ 22,166,000   
                

See accompanying notes to consolidated financial statements.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Net revenue:

    

Wholesale and other

   $ 61,427,000      $ 39,103,000   

Retail sales

     803,000        793,000   

Franchise revenue

     80,000        83,000   
                

Total revenue

     62,310,000        39,979,000   
                

Costs and expenses:

    

Cost of sales (exclusive of depreciation shown separately below)

     47,918,000        32,968,000   

Operating expenses

     4,360,000        4,182,000   

Depreciation and amortization

     1,889,000        1,146,000   

General and administrative expenses

     7,197,000        7,016,000   

Provision for goodwill and asset impairment

            6,311,000   

(Gain) loss on asset disposals

     (14,000     77,000   
                

Total costs and expenses

     61,350,000        51,700,000   
                

Operating income (loss) from continuing operations

     960,000        (11,721,000

Interest expense

     (1,511,000     (136,000

Interest and other income, net

     277,000        438,000   
                

Loss from continuing operations before income tax benefit

     (274,000     (11,419,000

Income tax benefit

     (95,000     (34,000
                

Loss from continuing operations

     (179,000     (11,385,000

Discontinued operations:

    

Loss from discontinued operations

     (838,000     (3,667,000

Gain on sale of discontinued operations, net of tax expense of $81,000 and $0, respectively

     2,609,000        1,276,000   
                

Net income (loss)

   $ 1,592,000      $ (13,776,000
                

Basic and diluted net income (loss) per share:

    

Loss from continuing operations

   $ (0.03   $ (2.08
                

Income (loss) from discontinued operations, net

   $ 0.32      $ (0.44
                

Net income (loss)

   $ 0.29      $ (2.52
                

Weighted average and equivalent shares outstanding:

    

Basic and diluted

     5,507,000        5,459,000   
                

See accompanying notes to consolidated financial statements.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

     Common Stock                  
     Shares    Amount    Additional
Paid-In
Capital
   Accumulated
Deficit
    Total
Stockholders’
Equity
 

Balance, June 27, 2007

   5,448,000    $ 54,000    $ 59,671,000    $ (36,573,000   $ 23,152,000   

Adjustment to fixed assets (Note 1)

                  (570,000     (570,000
                                   

Balance, June 27, 2007 (restated)

   5,448,000      54,000      59,671,000      (37,143,000     22,582,000   

Adjustment to adopt FIN 48

                  (245,000     (245,000

Exercise of stock options

   20,000      1,000      56,000             57,000   

Stock compensation expense

             280,000             280,000   

Common stock warrants

             274,000             274,000   

Net loss

                  (13,776,000     (13,776,000
                                   

Balance, June 25, 2008

   5,468,000      55,000      60,281,000      (51,164,000     9,172,000   

Exercise of stock options

   9,000           20,000             20,000   

Exercise of stock warrants

   250,000      2,000      1,198,000             1,200,000   

Stock compensation expense

             295,000             295,000   

Common stock warrants

             1,495,000             1,495,000   

Net income

                  1,592,000        1,592,000   
                                   

Balance, June 24, 2009

   5,727,000    $ 57,000    $ 63,289,000    $ (49,572,000   $ 13,774,000   
                                   

See accompanying notes to consolidated financial statements.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Cash flows from operating activities:

    

Net income (loss)

   $ 1,592,000      $ (13,776,000

Loss from discontinued operations

     838,000        3,667,000   

Gain on disposal of discontinued operations, net

     (2,609,000     (1,276,000
                

Loss from continuing operations:

     (179,000     (11,385,000

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     1,889,000        1,146,000   

Amortization and write off of loan fees

     9,000          

Amortization of note payable discount

     1,034,000        15,000   

Provision for bad debt

     125,000        245,000   

Income tax benefit

     (95,000     (34,000

Provision for inventory obsolescence

     69,000        (34,000

Provision for goodwill and asset impairment

            6,311,000   

Stock compensation expense

     295,000        280,000   

Notes receivable issued

     (144,000     (214,000

(Gain) loss on disposal of assets

     (14,000     77,000   

Changes in operating assets and liabilities:

    

Accounts receivable

     (1,802,000     (1,292,000

Inventories

     (959,000     (308,000

Prepaid expenses

     66,000        (116,000

Notes receivable

     (271,000     (260,000

Income tax refund

     (40,000     533,000   

Other assets

     (438,000     293,000   

Accounts payable

     59,000        1,355,000   

Accrued and deferred compensation

     574,000        (1,014,000

Accrued expenses

     240,000        (35,000

Deferred franchise fee income and franchise deposits

            (13,000

Deferred rent

     (23,000     (22,000
                

Net cash provided by (used in) continuing operations

     395,000        (4,472,000

Net cash used in discontinued operations

     (3,405,000     (1,625,000
                

Net cash used in operating activities

     (3,010,000     (6,097,000
                

Cash flows from investing activities:

    

Capital expenditures for property and equipment

     (659,000     (4,304,000

Proceeds from disposal of property and equipment

     56,000        21,000   

Payments received on notes receivable

     1,000,000        1,000,000   

Change in restricted money market account

            46,000   
                

Net cash provided by (used in) investing activities of continuing operations

     397,000        (3,237,000

See accompanying notes to consolidated financial statements.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

 

     Year Ended
June 24, 2009
   Year Ended
June 25, 2008
 

Payments received on notes receivable of discontinued operations

     182,000      92,000   

Capital expenditures for property and equipment of discontinued operations

          (292,000

Proceeds from sale of discontinued operations, net of cash transferred

     1,113,000      1,274,000   
               

Net cash provided by (used in) investing activities

     1,692,000      (2,163,000
               

Cash flows from financing activities:

     

Exercise of stock and warrant options

     1,220,000      57,000   

Borrowings under credit agreement

     3,000,000      2,000,000   
               

Net cash provided by financing activities

     4,220,000      2,057,000   
               

Net increase (decrease) in cash

     2,902,000      (6,203,000

Cash at beginning of year

     670,000      6,873,000   
               

Cash at end of year

   $ 3,572,000    $ 670,000   
               

Supplemental disclosure of cash flow information:

     

Cash paid during the period for:

     

Interest

   $ 457,000    $ 114,000   
               

Income taxes

   $ 23,000    $ 46,000   
               

Non-cash transactions:

     

Issuance of notes receivable related to sale of Gloria Jean’s

   $ 1,600,000    $   
               

See accompanying notes to consolidated financial statements.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.    Summary of Significant Accounting Policies and Practices

Business

Diedrich Coffee, Inc. (“Company”) is a specialty coffee roaster and wholesaler whose brands include Diedrich Coffee, Gloria Jean’s, and Coffee People. The Company has wholesale accounts with businesses and restaurant chains. In addition, the Company operates a coffee roasting facility and a distribution facility in central California that supplies roasted coffee in a variety of packaging formats to its wholesale customers.

Basis of Presentation and Fiscal Year End

The consolidated financial statements include the accounts of Diedrich Coffee, Inc. and its wholly owned subsidiaries. All significant intercompany transactions are eliminated. The Company’s fiscal year end is the Wednesday closest to June 30. In fiscal years 2009 and 2008, this resulted in a 52-week year.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events” (“SFAS No. 165”), the Company evaluated all subsequent events that occurred after the balance sheet date through the date the financial statements were issued on September 22, 2009.

Restatement of Financial Statements

During the 2009 fiscal year, a detailed review of the Company’s fixed asset subsidiary ledger was performed. The Company noted certain reconciling differences between the general ledger and the fixed asset subsystem for both cost and accumulated depreciation causing an out of balance with the general ledger by $570,000. These differences were caused by several assets which were acquired and impaired prior to fiscal year 2002 but had remaining net book value reflected in the Company’s consolidated financial statements.

In accordance with the Securities and Exchange Commission’s (“SEC”) Staff Accounting Bulletin No. 108, “Financial Statements—Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”), in assessing the identified error, the Company should consider both the “rollover” approach, which quantifies misstatements originating in the current year statement of operations and the “iron curtain” approach, which quantifies misstatements based on the effects of correcting the misstatements existing in the balance sheet at the end of the reporting period. The principal difference between these two methods lies in how income statement errors are quantified. The “rollover” method quantifies income statement errors based on the amount by which the income statement is actually misstated – including the reversing effect of any prior errors. The “iron curtain” method quantifies income statement errors based on the amount by which the income statement would be misstated if the accumulated amount of the errors that remain in the balance sheet were corrected through the income statement of that period.

Based on the recent guidance from the SEC, if the errors are material when evaluated under the “rollover” method, the previously-issued financial statements are considered materially misstated. The “iron curtain” error analysis does not drive the decision regarding whether or not previously issued financial statements are materially misstated. However, if an error in previously issued financial statements is not material under the “rollover” method, but would be material under the “iron curtain” method, then the error must be corrected. The error can be corrected either as an “out-of-period” adjustment or by revising the previously-issued financial statements the next time they are filed.

Based on the Company’s review, this error did not impact the financial statements for the fiscal years 2002 through 2009 when evaluated under the “rollover” approach. But the error is material to its fiscal year 2009 results of operations under the “iron-curtain” method. Therefore the Company recorded an adjustment of $570,000 as a decrease to its opening retained earnings balance at the beginning of fiscal 2008 as a cumulative effect adjustment with the offset to fixed assets.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Discontinued Operations

The Company’s strategic direction is to focus on growing the wholesale business segment and the related distribution channels. In conjunction with the transaction with Praise International North America, Inc., which is described in more detail below, the Company sold the Gloria Jean’s U.S. franchise and retail operations. The Company’s results of the Gloria Jean’s franchise and retail operations are reported as discontinued operations for all periods presented.

As previously announced, on March 27, 2009, the Company and Praise International North America, Inc., a Delaware corporation (“Praise”), entered into an agreement (the “Agreement”) pursuant to which the Company agreed to sell all of the issued and outstanding shares (the “Shares”) of common stock, par value $0.01 per share, of Praise U.S. Holdings, Inc. (formerly known as Coffee People Worldwide, Inc.), a Delaware corporation and wholly-owned subsidiary of Diedrich Coffee Inc. that owned assets used in the Company’s U.S. franchise operations (such purchase, the “Transaction”). On June 12, 2009, the Company completed the Transaction, and pursuant to the Agreement Praise purchased the Shares for $3,100,000, of which $1,500,000 was paid in cash and the remainder paid in the form of a twelve-month promissory note with an aggregate principal amount of $1,600,000 and an interest rate equal to 7.0% per annum, issued by Praise to the Company. In addition, the Company entered into several ancillary agreements, including a roasting agreement whereby the Company agreed to provide coffee roasting services to Praise for a period of five years and a trademark license agreement whereby the Company granted to Praise a license to use the Company’s Gloria Jean’s Gourmet Coffees Corp. U.S. trademarks in the United States of America (including the Commonwealth of Puerto Rico) until these trademarks are transferred to Gloria Jean’s Coffees International Pty. Ltd.

Praise is an affiliate of Gloria Jean’s Coffees International Pty. Ltd., which was a party to the purchase of the Company’s international franchise operations in February 2005.

In a separate transaction, the one remaining Diedrich Coffee Inc. retail location closed during the current fiscal year due to lease expiration.

In accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the financial results of the Gloria Jean’s franchise operations, retail operations and the one Diedrich Coffee retail location are reported as discontinued operations for all periods presented. Wholesale sales to former franchisees are included in continuing operations for all periods since the Company will continue to provide coffee roasting services to Praise.

The following accounts are reflected in Loss from Discontinued Operations in the consolidated statements of operations:

 

   

Franchise revenues for Gloria Jean’s Gourmet Coffees Franchising Corp.

 

   

Retail revenues for Gloria Jean’s Gourmet Coffees Corp. and Diedrich Coffee Inc.

 

   

Cost of sales and related occupancy costs

 

   

Operating expenses

 

   

Depreciation and amortization

 

   

General and administrative expenses

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

 

   

Provision for taxes paid

 

   

Impairment of assets

During the fiscal year ended June 25, 2008, the Company recorded income from discontinued operations of $1,276,000 in connection with cash received from escrow account related to the sale of certain assets to Starbucks Corporation.

The financial results included in discontinued operations were as follows:

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Net retail revenue

   $ 4,522,000      $ 3,603,000   

Net franchise revenue

     2,048,000        2,760,000   
                

Net revenue from discontinued operations

   $ 6,570,000      $ 6,363,000   
                

Loss from discontinued operations, net of $0 tax for 2009 and 2008

   $ (838,000   $ (3,667,000

Gain on sale of discontinued operations, net of tax of $81,000 and $0, respectively

     2,609,000        1,276,000   
                

Total income (loss) discontinued operations, net of tax

   $ 1,771,000      $ (2,391,000
                

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company had $0 of invested cash at June 24, 2009 and June 25, 2008. The Company maintains cash balances at financial institutions that are in excess of FDIC insurance coverage limits.

Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is based on management’s best estimate of the amount of probable credit losses in existing accounts receivable. The Company evaluates its allowance for doubtful accounts based upon knowledge of its customers and their compliance with credit terms. The evaluation process includes a review of customers’ accounts on a regular basis. The review process evaluates all account balances with amounts outstanding 90 days and other specific amounts for which information obtained indicates that the balance may be uncollectible. The allowance for doubtful accounts is adjusted based on such evaluation, with a corresponding provision included in operating expenses. Account balances are charged off against the allowance when management believes it is probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its customers.

Inventories

Raw materials consist primarily of green bean coffee. Finished goods include roasted coffee, tea, accessory products, and packaged foods. All products are valued at the lower of cost or market using the first-in, first-out method.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Property and Depreciation

Property and equipment, including assets under capital leases, are recorded at cost. Depreciation for property and equipment is calculated using the straight-line method over estimated useful lives of three to seven years. Property and equipment held under capital leases and leasehold improvements are generally amortized using the straight-line method. Property and equipment held under capital leases are generally amortized over the shorter of their estimated useful lives or the term of the related leases. Leasehold improvements are generally amortized over the shorter of their estimated useful lives or 9 years or the term of the related leases.

Major remodels and improvements are capitalized. Maintenance and repairs that do not improve or extend the life of the respective assets are charged to expense as incurred.

Deferred Financing Costs

Costs related to the issuance of debt are deferred and amortized using a method that approximates the effective interest method as a component of interest expense over the terms of the respective debt issues.

Fair Value of Financial Instruments

The carrying amounts of cash, accounts receivable, inventories, other assets, notes receivable, accounts payable, accrued compensation, 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 long-term debt approximates fair value because the interest rate on these instrument are subject to change with market interest rates and other terms and conditions are consistent with terms currently available to the Company.

Cost of Sales

Cost of sales include cost of purchased products, royalty payments due to the licensor, equipment lease expenses, inbound freight charges, purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs and all other costs of the distribution network.

Operating Expenses

Operating expenses include compensation costs, utilities, advertising and marketing, free product supplied for inclusion in brewer sample packs and in-store demonstrations, business insurance, taxes, licenses, fees and bank charges.

General and Administrative Expenses

General and administrative expenses include compensation costs, consulting and outside services, auditing and accounting, legal, office rent, telephone, and Director’s and Officer’s insurance.

Income Taxes

The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”). This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company’s financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax bases of the Company’s assets and liabilities result in a

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

Net Income (Loss) Per Common Share

“Basic” earnings per-share represents net earnings divided by the weighted average shares outstanding, excluding all potentially dilutive common shares. “Diluted” earnings per-share reflects the dilutive effect of all potentially dilutive common shares.

Goodwill

In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, “Business Combinations,” (“SFAS No. 141”) and SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of acquired assets or the strategy for the overall business, and significant negative industry or economic trends. The Company’s annual impairment measurement date is the fiscal year end. The Company has performed annual evaluations of its goodwill since June 30, 2001 in order to properly state its goodwill (see Note 12). The Company recorded impairment charges during fiscal year 2008 to fully impair goodwill with $6,311,000 included in continuing operations related to the wholesale operations and $521,000 included in discontinued operations related to the franchise operations.

Stock Option Plans

On June 30, 2005, the Company adopted the provisions of SFAS No. 123R, Share-Based Payment“ (“SFAS No. 123R”). SFAS No. 123R sets accounting requirements for “share-based” compensation to employees and non-employee directors, including employee stock purchase plans, and requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation.

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of the price of the Company’s stock. The Company uses historical data to estimate option exercise and employee termination rates within the valuation model. The expected term of options is derived from the output of the option valuation model and represents the period of time that options are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The fair values of the options were estimated using the Black-Scholes option-pricing model based on the following weighted average assumptions:

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

     Year Ended
June 24, 2009
   Year Ended
June 25, 2008

Risk free interest rate

   1.21% - 3.11%    1.91% - 4.91%

Expected life

   3 years    2 - 3 years

Expected volatility

   56%  - 119%    53% - 59%

Expected dividend yield

   0%    0%

Forfeiture rate

   5.58% - 7.48%    4.52% - 9.38%

Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144. This requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Revenue Recognition

The Company’s wholesale sales terms are FOB shipping point. Revenue from the sale of the wholesale products is recognized when ownership legally transfers to the customer, which is upon shipment. These sales are not subject to customer right of inspection or acceptance. Revenue from retail sales are recognized at shipping point. Initial franchise fees (“Front end fees”) are recognized when a franchised coffeehouse begins operations, at which time the Company has performed its obligations related to such fees. Initial franchise fees apply primarily in the case of domestic franchise development. Franchise royalties are recognized as earned, based upon a percentage of a franchise coffeehouse sales over time.

Shipping and Handling Costs

Shipping and handling costs are included as a component of cost of sales and related occupancy costs. A corresponding amount is billed to the Company’s wholesale customers, and is included as a component of wholesale and other revenue.

Concentrations

The Company generated 87.5% and 77.5% of its total revenues from the sale of K-Cups® for fiscal 2009 and 2008, respectively. The manufacturing and distribution of K-Cups® is licensed from a single licensor on a non-exclusive basis. During fiscal 2009 and 2008, the Company had sales to this licensor that represented approximately $24,441,000 or 39.8% of wholesale sales and $9,269,000 or 23.7% of wholesale sales, respectively.

The Company’s current agreement with the licensor expires in July 2013. The agreement provides for automatic five-year renewals if certain volume thresholds are met, which the Company is currently exceeding. In their Fiscal 2008 Form 10-K, Green Mountain Coffee Roasters, Inc. (NASDAQ: GMCR), which owns Keurig

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Incorporated, states that the two principal patents associated with the current generation K-Cup portion packs, will expire in 2012 pending patent applications associated with this technology which, if ultimately issued as patents, would have expiration dates in 2023. Any major disruptions in this relationship could cause a material adverse effect on the Company’s business and operations.

Accrued Expenses

Accrued expenses consist of the accrued legal settlements, legal fees, provision for store closures, deferred franchise fees, gift card liabilities and other liabilities.

Cash Surrender Value of Life Insurance

The change in the cash surrender value (“CSV”) of company owned life insurance (“COLI”) contracts excluding distributions, net of insurance premiums paid and gains realized, is reported in compensation and benefits expense (see Note 16).

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

Recently Adopted Accounting Pronouncement

On June 24, 2009, the Company adopted SFAS No. 165, “Subsequent Events.” This statement establishes general standards of accounting and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The adoption of this standard required the Company to evaluate all subsequent events that occurred after the balance sheet date through the date and time the financial statements are issued. The Company has evaluated subsequent events through September 22, 2009, which is the date the financial statements were issued.

Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — A Replacement of FASB Statement No. 162.” The FASB Accounting Standards Codification (“Codification”) will become the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date, the Codification will supersede all then-existing non-SEC accounting and reporting standards. This standard will become effective for the Company in the first quarter of the fiscal year ending on June 30, 2010. The Company does not expect that this standard will have a material impact on the consolidated financial statements upon adoption.

In December 2007, the FASB issued Statement on Financial Accounting Standards No. 141R, “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R establishes the principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree as well as the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141R also requires certain disclosures to enable users of the financial

 

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Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS No. 141R is effective for business combinations occurring in fiscal years beginning after December 15, 2008. Early adoption of SFAS No. 141R is not permitted. Acquisitions, if any, after the effective date, will be accounted for in accordance with SFAS No. 141R.

In December 2007, the FASB issued Statement on Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an Amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 160 applies to all entities that prepare consolidated financial statements but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 establishes accounting and reporting standards that require noncontrolling interests to be reported as a component of equity, changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions and any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS No. 160 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008. Acquisitions, if any, after the effective date will be accounted for in accordance with SFAS No. 160.

In June, 2008, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF 07-5). EITF 07-5 outlines a two-step approach to evaluate the instrument’s contingent exercise provisions, if any, and to evaluate the instrument’s settlement provisions when determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. EITF 07-5 is effective for fiscal years beginning after December 15, 2008 and must be applied to outstanding instruments as of the beginning of the fiscal year of adoption as a cumulative-effect adjustment to the opening balance of retained earnings. Early adoption is not permitted. The Company is currently evaluating the impact of adopting EITF 07-5 on its results of operations and financial position.

Reclassifications

Certain reclassifications have been made to prior periods to conform to the 2009 presentation.

2.    Liquidity and Management Plans

For the fiscal year 2009, the Company reported net income of $1,592,000 which included a gain on sale of discontinued operations of $2,609,000 which was net of tax of $81,000. The Company had a cash balance of $3,572,000 and no ability to access credit under the current credit facility as of June 24, 2009.

The Contingent Convertible Note Purchase Agreement with Sequoia Enterprises, L.P. (“Sequoia”), a limited partnership whose sole general partner is a significant shareholder of the Company and also serves as the Chairman of the Company’s board of directors (the “Note Purchase Agreement”), expires on March 31, 2010 and the $2,000,000 balance on the outstanding note is due in full on that date. In addition, the Company obtained a $3,000,000 term loan on August 26, 2008. See Note 8. The Company is required to make regular monthly payments of interest on the $3,000,000 Term Loan with Sequoia, and to cause the principal amount to be reduced to $2 million no later than August 26, 2009. All outstanding principal and interest will be due on the maturity date of August 26, 2011, unless due earlier pursuant to the terms of the Loan Agreement upon a change of control of the Company or an event of default. Subsequently the Company paid $1 million due to Sequoia under the Term Loan on July 29, 2009.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

The Company believes that cash flow from operations and payments from notes receivable due from Praise and Gloria Jean’s Coffees International Pty. Ltd will be sufficient to satisfy working capital needs at the anticipated operating levels and debt service requirements for at least the next twelve months.

The Company’s future capital requirements will depend on many factors, including the extent and timing of the rate at which the business grows, if at all, with corresponding demands for working capital. The Company may be required to seek additional funding through debt financing, equity financing or a combination of funding methods to meet capital requirements and sustain operations. However, additional funds may not be available on terms acceptable or at all.

3.    Accounts Receivable

During the current fiscal year, the Company provided for $64,000 of additional allowance for doubtful accounts related to wholesale accounts and charged off $172,000 of accounts receivable against the reserve for wholesale accounts.

The following table details the components of net accounts receivable:

 

     June 24, 2009     June 25, 2008  

Wholesale receivables

   $ 6,496,000      $ 4,814,000   

Allowance for wholesale receivables

     (180,000     (285,000
                
     6,316,000        4,529,000   
                

Franchise and other receivables

     105,000        709,000   

Allowance for franchise and other receivables

     (86,000     (223,000
                
     19,000        486,000   
                

Total accounts receivable, net

   $ 6,335,000      $ 5,015,000   
                

4.    Inventories

Inventories consist of the following:

 

     June 24, 2009    June 25, 2008

Unroasted coffee

   $ 422,000    $ 1,608,000

Roasted coffee

     2,404,000      1,163,000

Accessory and specialty items

     49,000      104,000

Other food, beverage and supplies

     2,635,000      1,777,000
             
   $ 5,510,000    $ 4,652,000
             

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

5.    Notes Receivable

Notes receivable consist of the following:

 

     June 24, 2009     June 25, 2008  
Notes receivable due on March 1, 2010. Notes are secured by the assets sold under the asset purchase and sale agreements or general security agreement. Fiscal 2009 amounts are net of a $75,000 allowance and fiscal 2008 amounts are net of a $247,000 allowance.    $      $ 177,000   
Notes receivable from a corporation discounted at an annual rate of 7.0% and 8.0%, payable annually in installments varying between $800,000 and $2,000,000, due between December 12, 2009 and January 31, 2011.      4,416,000        3,560,000   
Less: current portion of notes receivable      (3,604,000     (1,074,000
                
Long-term portion of notes receivable    $ 812,000      $ 2,663,000   
                

6.    Property and Equipment

Property and equipment is summarized as follows:

 

     June 24, 2009     June 25, 2008  

Leasehold improvements

   $ 2,388,000      $ 2,238,000   

Equipment

     16,092,000        16,888,000   

Furniture and fixtures

     396,000        427,000   

Construction in progress

     119,000        1,871,000   
                
     18,995,000        21,424,000   

Accumulated depreciation and amortization

     (13,579,000     (14,667,000
                
   $ 5,416,000      $ 6,757,000   
                

As described in Note 1, the Company recorded an adjustment of $570,000 to the carrying amount of fixed assets by restating the beginning balance as of the beginning of the fiscal year 2008.

7.    Other Assets

Other assets are summarized as follows:

 

     June 24, 2009    June 25, 2008

Debenture certificate

   $ 489,000    $

Other

     234,000      132,000
             
   $ 723,000    $ 132,000
             

The Company and its lessor, International Financial Services Corporation entered into a Pledge Agreement dated September 19, 2008 whereby the Company paid the lender $489,000 and obtained a Debenture Certificate to secure certain manufacturing equipment leases. The pledge agreement is for 36 months and will terminate on September 19, 2011 at which time, the funds and interest earned will be returned to the Company.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

8.    Note Payable

 

     June 24, 2009     June 25, 2008  

Note payable amount bearing interest at a rate of three-month LIBOR plus 6.30% (7.48% as of June 24, 2009) is due and payable on March 31, 2010. Note is unsecured.

   $ 2,000,000      $ 2,000,000   

Note payable amount bearing interest at a rate of one-month LIBOR plus 6.30% (6.62% as of June 24, 2009). Note is unsecured.

     3,000,000          

Discount on note payable

     (719,000     (259,000
                
     4,281,000        1,741,000   

Less: current portion of notes payable, net of discount

     (2,687,000     (1,741,000
                
   $ 1,594,000      $   
                

Note Purchase Agreement:

On May 10, 2004 the Company entered into a $5,000,000 Note Purchase Agreement with Sequoia Enterprises, L.P. (“Sequoia”), a limited partnership whose sole general partner is a significant shareholder of the Company and also serves as the Chairman of the board of directors of the Company (the “Note Purchase Agreement”), which provided, at the Company’s election, the ability to issue notes with up to an aggregate principal amount of $5,000,000. The Company has amended the Note Purchase Agreement from time to time and has agreed to refrain from further borrowings under the Note Purchase Agreement in connection with the entry into the Loan Agreement (as defined below) entered into on August 26, 2008. As amended, the notes issued under the Note Purchase Agreement are due in full on March 31, 2010, the Company is only required to make monthly payments of interest and the monthly commitment fee, but not principal, until such date. Interest is payable at three-month LIBOR plus 9.30% for any period during which the ratio of Indebtedness (as defined in the Note Purchase Agreement) on a consolidated basis to Effective Tangible Net Worth (as defined in the Note Purchase Agreement) is greater than 1.75:1.00 or the three-month LIBOR plus 6.30% for any other period, in each case reset on a periodic basis as provided in the Note Purchase Agreement. The Note Purchase Agreement contains covenants, among others, that limit the amount of indebtedness that the Company may have outstanding in relation to its tangible net worth. As of June 24, 2009, the Company had $2,000,000 of issued notes outstanding under the Note Purchase Agreement. As of June 24, 2009, the Company was in compliance with all covenants contained in the Note Purchase Agreement.

Loan Agreement:

On August 26, 2008, the Company entered into a loan agreement with Sequoia (the “Loan Agreement”). The Loan Agreement provides for a $3,000,000 term loan (the “Term Loan”). As amended, interest is payable at one-month LIBOR plus 9.30% for any period during which the ratio of Indebtedness (as defined in the Loan Agreement) on a consolidated basis to Effective Tangible Net Worth (as defined in the Loan Agreement) is greater than 1.75:1.00 or the one-month LIBOR plus 6.30% for any other period, in each case reset on a periodic basis as provided in the Loan Agreement. The Company is required to make regular monthly payments of interest, and to cause the principal amount to be reduced to $2 million no later than August 26, 2009. All outstanding principal and interest will be due on the maturity date of August 26, 2011, unless due earlier pursuant to the terms of the Loan Agreement upon a change of control of the Company or an event of default. As of June 24, 2009, the Company had $3,000,000 outstanding under the Loan Agreement. Subsequently the Company paid $1 million due to Sequoia under the Loan Agreement on July 29, 2009.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

The Loan Agreement requires the Company to refrain from further borrowings under the Note Purchase Agreement and contains restrictions on incurring indebtedness on par with, or senior to, the Term Loan. The Loan Agreement also contains a covenant that limits the amount of indebtedness that the Company may have outstanding in relation to tangible net worth, in addition to other standard covenants and events of default.

The Term Loan is senior to all other indebtedness of the Company, except indebtedness pursuant to notes under the Note Purchase Agreement and certain permitted indebtedness identified in the Loan Agreement. Upon repayment of the notes under the Note Purchase Agreement, the Term Loan will be senior to all other indebtedness of the Company, except such permitted indebtedness.

Warrants:

2001 Sequoia Warrant

On May 8, 2001, in connection with the sale of 2,000,000 shares of Company common stock, the Company issued warrants to Sequoia Enterprises, L.P., of which the Company’s chairman and significant shareholder, Paul C. Heeschen, is the general partner, to purchase 250,000 shares of the Company’s common stock at a price of $4.80 per share (“2001 Sequoia Warrant”). Other investors also received warrants to purchase an additional 250,000 shares at a price of $4.80 per share. The warrants were exercisable immediately upon issuance.

The other investors exercised their warrants during the fourth fiscal quarter ending June 24, 2009 at an exercise price of $4.80 per share. The Company received cash proceeds of $1.2 million in connection with the warrant exercises.

On November 10, 2008 the exercise price of the 2001 Sequoia Warrant was decreased to $1.65 per share in connection with the Waiver Agreement (as defined below). The fair value of these amended warrants was approximately $53,000 which was recorded as a debt discount. At June 24, 2009, all 2001 Sequoia Warrants were outstanding with an expiration date of June 30, 2014.

2008 Sequoia Warrant

In connection with the Loan Agreement and an amendment to the Note Purchase Agreement, on August 26, 2008, the Company issued to Sequoia a warrant (the “2008 Sequoia Warrant”) to purchase 1,667,000 shares of common stock of the Company. On November 10, 2008 the exercise price was decreased to $1.65 per share in connection with the Waiver Agreement. The fair value of these amended warrants was approximately $300,000 which was recorded as a debt discount. At June 24, 2009, all 2008 Sequoia Warrants were outstanding with an expiration date of August 26, 2013. The 2008 Warrant is not eligible for cashless exercise, but the Company is obligated to cause the common stock issued upon exercise of the 2008 Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

2009 Sequoia Warrant

In connection with the extension of the Note Purchase Agreement, after the close of the Nasdaq Stock Market on April 29, 2009, the Company issued to Sequoia a warrant to purchase 70,000 shares of common stock of the Company at an exercise price of $7.40 per share (the “2009 Sequoia Warrant”), which was the closing price of the Company’s common stock on such date. The fair value of these warrants was approximately $440,000 which was immediately recorded as interest expense. The 2009 Sequoia Warrant is exercisable by Sequoia, in whole or in part, at any time or from time to time, prior to April 29, 2014. The 2009 Sequoia Warrant is not eligible for cashless exercise, but the Company is obligated to cause the common stock issued upon

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

exercise of the 2009 Sequoia Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

Waiver Agreement:

On September 17, 2008, the Company was not in compliance with covenants under the Note Purchase Agreement and the Loan Agreement. On November 10, 2008, the Company entered into a Waiver Agreement, Amendment No. 1 to 2008 Warrant and Amendment No. 2 to 2001 Warrant (the “Waiver Agreement”) with Sequoia. Pursuant to the Waiver Agreement, Sequoia waived the requirement set forth in the Note Purchase Agreement and the Loan Agreement with Sequoia (collectively, the “Loan Agreements”) that the Company shall not permit, as of the end of any fiscal quarter, the ratio of the Indebtedness on a consolidated basis to Effective Tangible Net Worth to be more than 1.75:1.00 (as such terms are defined in the Loan Agreements). Such waiver is effective until the earlier of (a) October 31, 2009 and (b) the end of any fiscal quarter at which the foregoing ratio is greater than 2.10:1.00. As part of the waiver and amendment, the exercise price of the 2008 Sequoia Warrant and the 2001 Sequoia Warrants for 250,000 shares of common stock was reduced to $1.65 from $2.00 per share. In consideration of the foregoing waiver, (a) the interest rates under the Note Purchase Agreement and the Term Loan were set at LIBOR plus 9.3% for any period during which the ratio of indebtedness of the Company on a consolidated basis to effective tangible net worth is greater than 1.75:1.00 and (b) the interest rates under the Note Purchase Agreement and the Term Loan were set at LIBOR plus 6.30% for any other period. The Company is in compliance with all debt covenants as of June 24, 2009.

Letter of Credit:

In addition, the Company entered into a Credit Agreement with Bank of the West on November 4, 2005. The agreement provides for a $750,000 letter of credit facility that expires on October 15, 2009. The letter of credit facility is secured by a deposit account at Bank of the West. As of June 24, 2009, this deposit account had a balance of $623,000, which is shown as restricted cash on the consolidated balance sheets. As of June 24, 2009, $472,000 of letters of credit was outstanding under the letter of credit facility. The agreement contains covenants that, among other matters, require the Company to submit financial statements to the bank within specified time periods. As of June 24, 2009, the Company was in compliance with all Bank of the West agreement covenants.

9.    Commitments and Contingencies

Lease Commitments

As of June 24, 2009, the Company leases warehouse and office space in Irvine, Castroville and Salinas, California. The leases expire at various dates through December 2015. Contingent rent expense was insignificant for all periods presented. In addition, the Company leases equipment with various expiration dates through January 2014.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Future minimum lease payments under non-cancelable operating leases and minimum future sublease rentals expected to be received as of June 24, 2009, are as follows:

 

Year Ending June

   Non-Cancelable Operating Leases
     Total    Building and
equipment
leases (A)
   Other
locations (B)

2010

   $ 2,853,000    $ 2,612,000    $ 241,000

2011

     1,706,000      1,558,000      148,000

2012

     675,000      534,000      141,000

2013

     539,000      396,000      143,000

2014

     529,000      385,000      144,000

Thereafter

     723,000      554,000      169,000
                    
   $ 7,025,000    $ 6,039,000    $ 986,000
                    

 

  (A) Includes Irvine and Castroville office and warehouse space and company-operated equipment leases.

 

  (B) The Company has leased and subleased land and buildings to others. Many of these leases provide for fixed payments with contingent rents when sales exceed certain levels, while others provide for monthly rentals based on a percentage of sales. The Company directly pays the rents on these master leases, and collects associated rent amounts directly from its sublessees. The total sublease rentals receivable by the Company under non-cancelable subleases is approximately $403,000 as of June 24, 2009.

Continuing operations, rent expense under operating leases approximated $877,000 and $742,000, for the years ended June 24, 2009 and June 25, 2008, respectively. These amounts are net of sublease rental income of $211,000 and $266,000, for the years ended June 24, 2009 and June 25, 2008, respectively.

Rent expense under equipment leases approximated $1,658,000 and $866,000, for the years ended June 24, 2009 and June 25, 2008, respectively.

Purchase Commitments

At June 24, 2009 the Company had commitments to purchase coffee through fiscal year 2010, totaling $3,578,000 for 2,457,000 pounds of green coffee, the majority of which were fixed as to price. Such contracts are generally short-term in nature, and the Company believes that their cost approximates fair market value.

Capital Commitments

At June 24, 2009, the Company had capital expenditure commitments of $460,000 for its roasting facility.

Indemnifications

The Company agrees to provide for the indemnification of and the advancement of certain costs, judgments, penalties, fines, liabilities, expenses incurred and amounts paid in settlement to the fullest extent permitted by the Company’s charter, bylaws and applicable law to each of the Company’s directors and executive officers that become a party to the Indemnification Agreement.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Contingencies

In the ordinary course of business, the Company may become involved in legal proceedings from time to time. Material pending legal proceedings to the business, to which the Company became or were a party during the current fiscal year or subsequent thereto, but before the filing of this report, are summarized below:

On September 21, 2006, a purported class action complaint entitled Jason Reid; Kimberly Cornia, et al. v. Diedrich Coffee., et al. was filed against the Company in United States District Court Central District of California by two former employees, who worked in the positions of team member and shift manager. During the fiscal year 2009, the Company paid approximately $700,000 to fully settle this lawsuit.

On February 2, 2007, a second similar purported class action complaint entitled Deborah Willems, et al. v. Diedrich Coffee., et al. was filed in Orange County, California Superior Court on behalf of another former employee who worked in the position of general manager. This case currently involves the issue of whether employees and former employees who worked in California stores during specified time periods were deprived of overtime pay, missed meal and rest breaks. In addition to unpaid overtime, this case seeks to recover waiting time penalties, interest, attorneys’ fees and other types of relief on behalf of the current and former employees in the purported class.

The Company has entered into a settlement with the plaintiffs in the Willems v. Diedrich lawsuit. On September 14, 2009, the Company received a judgment based on Order of Final Approval. As of June 24, 2009, the Company estimated that the required amount to settle this claim is $376,000 and has recorded an accrual for this amount included in discontinued operations in the accompanying consolidated statement of operations.

Based on the Company’s examination of this matter and its experience to date, the Company has recorded its best estimate of liability with respect to this matter. However, the ultimate liability cannot be determined with certainty.

A lawsuit entitled Leader Bank v. Ajay Misra, et al v. Diedrich Coffee et al, is currently pending in the Middlesex Superior Court, Middlesex, Massachusetts. In that case the Plaintiff, Leader Bank, filed a complaint to collect on a defaulted promissory note it had with the franchisee, Defendant Amtek Group, LLC, on February 23, 2009. Ajay and Priya Misra were named defendants as well. On June 16, 2009, Defendants filed a third-party complaint against Diedrich Coffee alleging breach of contract, aiding and abetting Leader Bank in its takeover of the store and breach of privacy. In their complaint, third-party plaintiffs claim that they are entitled to $2,477,500. The Company is contesting the third-party complaint vigorously and has filed a motion to dismiss that will be heard on October 9, 2009. The Company believes that liability is not probable and the potential settlement is not estimable under this lawsuit and has therefore not accrued any amounts related to the damages claimed under this lawsuit in the accompanying consolidated financial statements.

10.    Stockholders’ Equity

Stock Options

On October 20, 2000, the Company’s board of directors authorized the adoption of the Diedrich Coffee, Inc. 2000 Equity Incentive Plan (the “2000 Equity Incentive Plan”) and the concurrent discontinuation of the option grants under the Diedrich Coffee, Inc. Amended and Restated 1996 Stock Incentive Plan and the Diedrich Coffee, Inc. 1996 Non-Employee Directors Stock Option Plan. The Company’s stockholders approved the 2000 Equity Incentive Plan on October 16, 2000. A total of 1,087,500 shares of the Company’s common stock may be

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

issued under the 2000 Equity Incentive Plan, as amended. The board of directors determines the number of shares, terms and exercise periods for awards under the 2000 Equity Incentive Plan on a case by case basis, except for automatic annual grants of options to non-employee directors. Employee options generally vest ratably over three years and expire ten years from the date of grant. The exercise price of options is generally equivalent to the fair market value of the Company’s common stock on the date of grant.

The Company entered into the Phillips Option Agreement on February 7, 2008. Under the Phillips Option Agreement, Mr. Phillips, was granted, subject to stockholder approval, options to purchase up to 275,000 shares of the Company’s common stock. On January 22, 2009, the stockholders approved the Phillips Option Agreement. Options granted to Mr. Phillips will be exercisable at an exercise price of $3.23 per share and will vest in three equal installments on each of the first three anniversary dates of February 7, 2008. The options granted to Mr. Phillips will become immediately vested and fully exercisable upon a change in control and the options will terminate and become unexercisable on the earlier of February 7, 2018 or the first anniversary of the change of control.

Information regarding the Company’s stock options is summarized below:

 

     Options     Weighted
Average
Exercise
Price
   Aggregate
Intrinsic
Value

Number of options available for future grant at June 24, 2009

     303,917        
             

Outstanding at June 27, 2007

     554,675      $ 4.76    $ 209,000

Granted

     342,500      $ 3.30    $

Exercised

     (20,000   $ 2.84    $ 13,000

Forfeited

     (258,875   $ 5.27    $
             

Outstanding at June 25, 2008

     618,300      $ 3.80    $

Granted

     245,000      $ 2.53    $ 3,528,000

Exercised

     (8,500   $ 2.35    $ 125,000

Forfeited

     (104,500   $ 3.65    $ 863,000
             

Outstanding at June 24, 2009

     750,300      $ 3.36    $ 10,198,000
             

Weighted-average fair value of options granted:

       

Year ended June 25, 2008

   $ 1.60        

Year ended June 24, 2009

   $ 1.16        

Options exercisable:

       

At June 25, 2008

     239,966        

At June 24, 2009

     334,466        

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

The following table summarizes information about nonvested stock option transactions from June 27, 2007 through June 24, 2009:

 

     Number
of Shares
    Weighted Average
Grant Date
Fair Value
per Share
   Weighted Average
Remaining

Contractual Life
(years)
   Aggregate
Intrinsic

Value

Nonvested, June 27, 2007

   121,667      $      

Granted

   342,500      $ 1.60      

Vested

   (93,333   $ 1.49      

Forfeited/cancelled

        $      
                        

Nonvested, June 25, 2008

   370,834      $ 1.63    9.49    $

Granted

   245,000      $ 1.16      

Vested

   (151,666   $ 1.54      

Forfeited/cancelled

   (48,334   $ 1.63      
                        

Nonvested, June 24, 2009

   415,834      $ 1.38    9.19    $ 5,838,800
                        

Stock option-based compensation expense included in the statement of operations for the fiscal years ended June 24, 2009 and June 25, 2008 was $295,000 and $280,000, respectively. As of June 24, 2009, there was approximately $354,000 of total unrecognized stock option-based compensation cost related to options granted under the Company’s plans that will be recognized over a weighted average period of 1.9 years. The total intrinsic value of options exercised during the years ended June 24, 2009 and June 25, 2008 was approximately $125,000 and $375,000, respectively.

Stock Purchase Warrants

2001 Sequoia Warrant

On May 8, 2001, in connection with the sale of 2,000,000 shares of Company common stock, the Company issued warrants to Sequoia Enterprises, L.P., of which the Company’s chairman and significant shareholder, Paul C. Heeschen, is the general partner, to purchase 250,000 shares of the Company’s common stock at a price of $4.80 per share (“2001 Sequoia Warrant”). Other investors also received warrants to purchase an additional 250,000 shares at a price of $4.80 per share. The warrants were exercisable immediately upon issuance.

The other investors exercised their warrants during the fourth fiscal quarter ending June 24, 2009 at an exercise price of $4.80 per share. The Company received cash proceeds of $1.2 million in connection with the warrant exercises.

On November 10, 2008 the exercise price of the 2001 Sequoia Warrant was decreased to $1.65 per share in connection with the Waiver Agreement (see Note 8). The fair value of these amended warrants was approximately $53,000 which was recorded as a debt discount. At June 24, 2009, all 2001 Sequoia Warrants were outstanding with an expiration date of June 30, 2014.

2008 Sequoia Warrant

On August 26, 2008, the Company issued to Sequoia a warrant (the “2008 Sequoia Warrant”) for the right to purchase 1,667,000 shares of common stock of the Company at an exercise price of $2.00 per share. The 2008 Sequoia Warrant is exercisable by Sequoia, in whole or in part, at any time or from time to time, prior to August 26, 2013. The 2008 Sequoia Warrant is not eligible for cashless exercise, but the Company is obligated to

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

cause the common stock issued upon exercise of the 2008 Sequoia Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

On November 10, 2008 the exercise price of the 2008 Sequoia Warrant was decreased to $1.65 per share in connection with the Waiver Agreement (see Note 8). The fair value of these amended warrants was approximately $300,000 which was recorded as a debt discount. At June 24, 2009, all 2008 Sequoia Warrants were outstanding with an expiration date of August 26, 2013.

2009 Sequoia Warrant

On April 29, 2009, the Company issued to Sequoia a warrant to purchase 70,000 shares of common stock of the Company at an exercise price of $7.40 per share (the “2009 Sequoia Warrant”). The fair value of these warrants was approximately $440,000 which was immediately recorded as interest expense. The 2009 Sequoia Warrant is exercisable by Sequoia, in whole or in part, at any time or from time to time, prior to April 29, 2014. The 2009 Sequoia Warrant is not eligible for cashless exercise, but the Company is obligated to cause the common stock issued upon exercise of the 2009 Sequoia Warrant to be registered with the SEC and applicable state governmental authorities and to be listed on the stock exchange on which the Company’s stock is traded at the time of exercise, in each case at the Company’s expense.

The following table summarizes information about warrant transactions from June 27, 2007 through June 24, 2009:

 

     Number
of Shares
    Weighted
Average
Exercise

Price (A)

Warrants outstanding, June 27, 2007

   504,219      $ 3.23

Granted

         

Exercised

         

Forfeited/cancelled

         
            

Warrants outstanding, June 25, 2008

   504,219      $ 3.23

Granted

   1,737,000      $ 1.88

Exercised

   (250,000   $ 4.80

Forfeited/cancelled

   (4,219   $ 3.95
            

Warrants outstanding, June 24, 2009

   1,987,000      $ 1.85
            

 

(A) The weighted average exercise price of the 2001 and 2008 amended Sequoia Warrants outstanding at June 24, 2009 reflect the decrease in the exercise price from $4.80 to $1.65 in connection with the Waiver Agreement.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

11.    Income Taxes

The components of income tax benefit from continuing and discontinued operations are as follows:

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Continuing Operations:

    

Current:

    

Federal

   $ (40,000   $ (71,000

State

     26,000        37,000   
                

Current tax (benefit) provision

     (14,000     (34,000
                

Deferred:

    

Federal

     (66,000       

State

     (15,000       
                

Deferred tax benefit

     (81,000       
                

Total tax benefit from continuing operations

     (95,000     (34,000
                
Discontinued Operations:     

Deferred:

    

Federal

     66,000          

State

     15,000          
                

Total tax provision discontinued operations

     81,000          
                

Total consolidated tax benefit

   $ (14,000   $ (34,000
                

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:

 

Deferred tax assets:

    

Net operating loss carryforwards

   $ 4,289,000      $ 5,867,000   

Capital loss carryforwards

     9,966,000          

Intangible assets

     549,000        8,000   

Property and equipment

     396,000        573,000   

Accrued expenses

     451,000        742,000   

Other, net

     1,212,000        1,358,000   
                

Total gross deferred tax assets

     16,863,000        8,548,000   

Less: valuation allowance

     (16,863,000     (7,215,000

Deferred tax liabilities:

    

Installment gain and other

            (1,333,000
                

Net deferred tax assets

   $      $   
                

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

A reconciliation of the statutory federal income tax rate with the Company’s effective income tax provision (benefit) rate for continuing operations is as follows:

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Federal statutory rate

   (34.0 )%    (34.0 )% 

State income taxes, net of Federal benefit

   6.2      (2.0

Goodwill and other non-deductible costs

   9.1      20.3   

Valuation allowance

   (21.8   5.9   

Other

        9.5   
            
   (40.5 )%    (0.3 )% 
            

As of June 24, 2009, net operating loss carryforwards of $11,170,000 and $11,451,000 for federal and state income tax purposes, respectively, are available to be utilized against future taxable income for years through fiscal 2027, and capital loss carryforwards of $25,018,000 which are available to offset future capital gains and will expire in fiscal 2014 if unutilized subject to possible annual limitation pertaining to change in ownership rules under the Internal Revenue Code.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is not more likely than not that the Company will not realize the benefits of these deductible differences, and thus has recorded a valuation allowance against the entire deferred tax asset balance. As of June 24, 2009 and June 25, 2008, the valuation allowance was $16,863,000 and $7,215,000, respectively. The change in the valuation allowance during 2009 was an increase of $9,648,000.

Included in the net operating loss carryforwards is $247,000 related to excess stock compensation, the benefit of which will be recorded as additional paid-in-capital if and when realized.

On June 28, 2007, the Company adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). The Company recorded a cumulative effect adjustment of $245,000 including interest and penalties, which was accounted for as an increase to the June 28, 2007 balance of accumulated deficit on the consolidated balance sheet. A tabular reconciliation of the total amounts (in absolute values) of unrecognized tax benefits at the beginning and end of the periods is as follows:

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008

Unrecognized tax benefits beginning of year

   $ 261,000      $ 245,000

Increase in tax positions for prior year

     17,000        16,000

Decrease in tax positions for prior year

     (245,000    
              

Unrecognized tax benefits at end of year

   $ 33,000      $ 261,000
              

The unrecognized tax liabilities of $33,000 at June 24, 2009, if recognized, would affect the effective tax rate. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months. The fiscal 2009 decrease in unrecognized tax position relates to the discontinued operations. These liabilities are included in other liabilities in the accompanying consolidated balance sheets.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

The Company files income tax returns in the U.S. and in various state jurisdictions with varying statutes of limitations. The Company is no longer subject to U.S. income tax examinations for the fiscal years prior to 2005 and is no longer subject to state income tax examinations for years prior to 2001. The Company’s policy is to recognize interest expense and penalties related to income tax matters as a component of income tax expense. There was $8,000 interest and penalties associated with uncertain tax positions as of June 24, 2009.

12.    Impairment and Restructuring Charges

The Company recorded impairment charges of $6,311,000 for fiscal 2008 to fully impair goodwill associated with the wholesale operations.

13.    Earnings Per Share

The following table sets forth the computation of basic and diluted net income per share from continuing operations:

 

     Year Ended
June 24, 2009
    Year Ended
June 25, 2008
 

Numerator:

    

Net loss from continuing operations

   $ (179,000   $ (11,385,000
                

Denominator:

    

Basic weighted average shares outstanding

     5,507,000        5,459,000   

Effect of dilutive securities

              
                

Diluted adjusted weighted average shares

     5,507,000        5,459,000   
                

Basic and diluted net loss per share from continuing operations

   $ (0.03   $ (2.08
                

For the years ended June 24, 2009, and June 25, 2008, employee stock options of approximately 750,000, and 618,000, respectively, and warrants of approximately 1,987,000 and 504,000 respectively, (as described in Note 10), were excluded from the computation of diluted earnings per share as their impact would have been anti-dilutive.

The following table sets forth the computation of basic and diluted net income (loss) per share:

 

     Year Ended
June 24, 2009
   Year Ended
June 25, 2008
 

Numerator:

     

Net Income (loss)

   $ 1,592,000    $ (13,776,000
               

Denominator:

     

Basic and diluted weighted average shares outstanding

     5,507,000      5,459,000   
               

Basic and diluted net income (loss) per share

   $ 0.29    $ (2.52
               

14.    Segment Information

The Company has three reportable segments, wholesale operations, franchise operations and ecommerce retail operations. The Company evaluates performance of its operating segments based on income before provision for asset impairment and restructuring costs, income taxes, interest expense, depreciation and amortization, and general and administrative expenses.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Reported revenues for the wholesale segment include sales to third parties and franchisees. Wholesale segment income before tax includes a manufacturing profit on all sales. Wholesale segment income before tax also is net of specifically identified selling, general and administrative expenses and costs of the Company’s coffee roasting facility and a goodwill impairment charge in the fiscal year 2008.

The franchise operations segment revenues include franchise royalty fees. Franchise segment income before tax is net of specifically identified operating, general and administrative expenses.

The retail operations segment includes ecommerce revenue. Revenues are derived from sales of products through the websites www.diedrich.com, www.coffeepeople.com and www.coffeeteastore.com. Retail segment income before tax is net of cost of goods sold and related occupancy costs, operating, general and administrative expenses.

Summarized financial information of continuing operations of the Company’s reportable segments is shown in the following table. The other total assets consist of corporate cash, corporate notes receivable, corporate prepaid expenses, corporate property, plant and equipment, and cash surrender value of life insurance policy. The other component of segment loss before tax includes corporate general and administrative expenses, depreciation and amortization expense, and interest expense.

 

     Wholesale
Operations
    Franchise
Operations
   Retail
Operations
   Other     Total  
     (in thousands)  

Year ended June 24, 2009

            

Total revenue

   $ 61,427      $ 80    $ 803    $      $ 62,310   

Interest expense

                      1,511        1,511   

Depreciation and amortization

     1,549             29      311        1,889   

Segment income (loss) before tax

     8,233        39      182      (8,728     (274

Total assets as of June 24, 2009

   $ 15,995      $ 22    $ 204    $ 10,707      $ 26,928   

Year ended June 25, 2008

            

Total revenue

   $ 39,103      $ 83    $ 793    $      $ 39,979   

Interest expense

                      136        136   

Depreciation and amortization

     805             32      309        1,146   

Segment income (loss) before tax

     (4,692     70      218      (7,015     (11,419

Total assets as of June 25, 2008

   $ 14,594      $ 1,084    $ 170    $ 6,318      $ 22,166   

Intercompany sales from wholesale operations to retail operations of $460,000 for fiscal year 2009, and $404,000 for fiscal year 2008 have been eliminated.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

15.    Selected Quarterly Financial Data (Unaudited)

The quarterly results of operations for the years ended June 24, 2009 and June 25, 2008 were as follows:

 

    First Quarter     Second Quarter     Third Quarter     Fourth Quarter  
    (in thousands, except per share data)  

Fiscal 2009

       

Total revenue

  $ 10,408      $ 13,870      $ 17,884      $ 20,148   

Operating income (loss) from continuing operations

    (1,224     (717     1,632        1,269   

Income (loss) from continuing operations before tax

    (1,467     (908     1,468        633   

Income (loss) from discontinued operations before tax

    (316     (83     (102     2,353   

Net Income (loss)

    (1,783     (995     1,358        3,012   

Basic income (loss) per share

    (0.33     (0.18     0.25        0.54   

Diluted income per share

                  0.25        0.40   

Fiscal 2008

       

Total revenue

  $ 6,625      $ 10,600      $ 9,904      $ 12,850   

Operating loss from continuing operations

    (1,243     (709     (1,091     (8,678

Loss from continuing operations before tax

    (1,073     (642     (1,014     (8,690

Income (loss) from discontinued operations before tax

    770        (517     (1,070     (1,574

Net loss

    (270     (1,159     (2,153     (10,194

Basic and diluted loss per share

    (0.05     (0.21     (0.39     (1.86

Quarterly operating results are not necessarily representative of operations for a full year for various reasons, including the seasonal nature of the Company’s business, which may affect sales volume and food costs. All quarters have 12-week accounting periods, except the fourth quarter, which has a 16-week accounting period.

During the fourth fiscal quarter of 2008, the Company recorded net loss of $10,194,000 which reflects a charge to goodwill and asset impairment of $6,311,000 relating to the wholesale operations.

During the first fiscal quarter of 2008, the Company recorded a gain from sale of discontinued operations of $1,276,000 in connection with the Starbucks transaction.

During the fourth fiscal quarter of 2009, the Company recorded a gain from sale of discontinued operations of $2,690,000 before income taxes of $81,000 in connection with the Praise transaction.

During the fourth fiscal quarter of 2009, the Company recorded interest expense of approximately $440,000 in connection with the issuance of 2009 Sequoia Warrant (see Note 10).

16.    Employee Benefit Plans

401(k) Plan

The Company has a 401(k) Plan that covers eligible employees. The Company contributions to this plan were $36,000 and $42,000 for the fiscal years 2009 and 2008, respectively.

Deferred Compensation Plan

The Company terminated the deferred compensation plan effective December 31, 2008 and provided 60-day notice of the termination of the trust agreement effective February 28, 2009. All remaining amounts were fully distributed as of March 4, 2009.

 

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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS

 

     Balance at
Beginning of
Period
   Provisions    Accounts
Written Off
    Balance at
End of
Period

Allowance for Bad Debt:

          

Year ended June 25, 2008

   $ 163,000    $ 978,000    $ (633,000   $ 508,000
                            

Year ended June 24, 2009

   $ 508,000    $ 577,000    $ (819,000   $ 266,000
                            

 

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DIEDRICH COFFEE, INC.

 

INDEX TO EXHIBITS

 

Exhibit No.


  

Description


2.1    Agreement and Plan of Merger, dated March 16, 1999, among Diedrich Coffee, Inc., CP Acquisition Corp., a wholly owned subsidiary of Diedrich Coffee, Inc., and Coffee People, Inc.(1)
3.1    Restated Certificate of Incorporation of the Company, dated May 11, 2001(2)
3.2    Certificate of Amendment of Restated Certificate of Incorporation of Diedrich Coffee, Inc., dated January 26, 2009(26)
3.3    Amended and Restated Bylaws of Diedrich Coffee, Inc.(19)
4.1    Specimen Stock Certificate(4)
4.2    Common Stock and Warrant Purchase Agreement, dated March 14, 2001(3)
4.3    Form of Warrant, dated May 8, 2001(2)
4.4    Registration Rights Agreement, dated May 8, 2001(2)
4.5    Amendment No. 1 to 2001 Warrant, dated August 26, 2008(21)
4.6    Warrant, dated as of August 26, 2008, issued by Diedrich Coffee Inc. to Sequoia Enterprises, L.P.(21)
4.7    Waiver, Agreement, Amendment No. 1 to 2008 Warrant and Amendment No. 2 to 2001 Warrant with Sequoia Enterprises, L.P., dated November 10, 2008(23)
4.8    Warrant, dated as of April 29, 2009, issued by Diedrich Coffee Inc. to Sequoia Enterprises, L.P.(27)
10.1    Form of Diedrich Coffee, Inc. Indemnification Agreement*(19)
10.2    Diedrich Coffee, Inc. 2000 Equity Incentive Plan*(10)
10.3    Diedrich Coffee, Inc. 2000 Non-Employee Directors Stock Option Plan*(5)
10.4    Amended and Restated Diedrich Coffee, Inc. 1996 Stock Incentive Plan*(6)
10.5    Diedrich Coffee, Inc. 1996 Non-Employee Directors Stock Option Plan*(7)
10.6    Form of Diedrich Coffee Franchise Agreement(9)
10.7    Form of Area Development Agreement(9)
10.8    Contingent Convertible Note Purchase Agreement, dated May 10, 2004 (includes form of convertible promissory note and form of warrant)(13)

 

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10.9    Standard Industrial/Commercial Multi-Tenant Lease Agreement by and between The Westphal Family Trust and Diedrich Coffee, Inc., dated September 10, 2003(8)
10.10    Office Space Lease Agreement by and between The Irvine Company and Diedrich Coffee, Inc., dated August 1, 2003(8)
10.11   

Amendment No. 1 to Contingent Convertible Note Purchase Agreement dated June 30, 2004(17)

10.12   

Amendment No. 2 to Contingent Convertible Note Purchase Agreement dated March 31, 2006(12)

10.13   

Letter Agreement with Sean M. McCarthy, effective January 1, 2006*(11)

10.14    Agreement of Purchase and Sale of Assets by and between Starbucks Corporation, Diedrich Coffee, Inc. and Coffee People, Inc.(15)
10.15    Credit Agreement with Bank of the West dated November 4, 2005(14)
10.16    Amendment No. 3 to Contingent Convertible Note Purchase Agreement dated September 22, 2006(16)
10.17    Chief Executive Officer Employment Agreement between J. Russell Phillips and Diedrich Coffee, Inc., effective as of February 7, 2008*(18)
10.18    Stock Option Agreement between Diedrich Coffee, Inc. and J. Russell Phillips, effective as of February 7, 2008*(18)
10.19    Amending Agreement by and between Diedrich Coffee, Inc. and Sequoia Enterprises, L.P., dated June 19, 2008(20)
10.20    Amendment No. 4 to Contingent Convertible Note Purchase Agreement dated August 26, 2008 (includes removal of conversion feature of notes, no further warrant issuances)(21)
10.21    Loan Agreement by and between Diedrich Coffee, Inc. and Sequoia Enterprises, L.P., dated August 26, 2008(21)
10.22    License and Distribution Agreement between Keurig, Incorporated and Diedrich Coffee, Inc., dated July 29, 2003**(22)
10.23    Licensed Roaster K-Cup Sales Agreement between Keurig, Incorporated and Diedrich Coffee, Inc., dated October 22, 2004**(22)
10.24    Amendment to License and Distribution Agreement, dated August 31, 2005**(22)
10.25    Amendment to License and Distribution Agreement, dated August 31, 2005**(22)
10.26    Amendment to Licensed Roaster K-Cup Sales Agreement, dated September 30, 2006**(22)
10.27    Royalty Alteration notice relating to License and Distribution Agreement, dated July 30, 2007**(22)
10.28    Waiver and Amendment to License and Distribution Agreement, dated July 2, 2008(22)
10.29    Amendment No. 5 to Contingent Convertible Note Purchase Agreement, dated as of March 27, 2009, by and between Diedrich Coffee, Inc. and Sequoia Enterprises, L.P.(24)

 

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10.30    Stock Purchase Agreement, dated March 27, 2009, by and between Diedrich Coffee Inc. and Praise International North America, Inc.(25)
10.31    Amendment No. 6 to Contingent Convertible Note Purchase Agreement, dated as of April 29, 2009, by and between Diedrich Coffee Inc. and Sequoia Enterprises, L.P.(27)
10.32    Amendment No. 1 dated May 29, 2009 to the Stock Purchase Agreement dated March 27, 2009(28)
10.33    Royalty Alteration notice relating to License and Distribution Agreement, dated November 26, 2008**
23.1    Consent of Independent Registered Public Accounting Firm – BDO Seidman, LLP
31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 


 

  * Management contract or compensatory plan or arrangement

 

  ** Confidential treatment has been requested for portions of this document. The omitted portions of this document have been filed with the Securities and Exchange Commission.

 

  (1) 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.

 

  (2) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 16, 2001.

 

  (3) Previously filed as an exhibit to Diedrich Coffee Inc.’s Definitive Proxy Statement, filed with the Securities and Exchange Commission on April 12, 2001.

 

  (4) Previously filed as an exhibit to Diedrich Coffee’s Registration Statement on Form S-3 (Registration No. 333-66744), filed with the Securities and Exchange Commission on August 3, 2001.

 

  (5) Previously filed as an exhibit to Diedrich Coffee’s Registration Statement on Form S-8, filed with the Securities and Exchange Commission on November 21, 2000.

 

  (6) Previously filed as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the period ended September 22, 1999, filed with the Securities and Exchange Commission on November 5, 1999.

 

  (7) Previously filed as an exhibit to Diedrich Coffee’s Registration Statement on Form S-1/A (Registration No. 333-08633), filed with the Securities and Exchange Commission on August 12, 1996 and declared effective on September 11, 1996.

 

  (8) Previously filed as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscal year ended July 2, 2003, filed with the Securities and Exchange Commission on September 30, 2003.

 

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  (9) Previously filed as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the period ended September 24, 2003, filed with the Securities and Exchange Commission on November 7, 2003.

 

  (10) Previously filed as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the period ended December 17, 2003, filed with the Securities and Exchange Commission on January 30, 2004.

 

  (11) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on January 5, 2006.

 

  (12) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 31, 2006.

 

  (13) Previously filed as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004, filed with the Securities and Exchange Commission on September 28, 2004.

 

  (14) Previously filed as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the period ended March 8, 2006, filed with the Securities and Exchange Commission on April 21, 2006.

 

  (15) Previously filed as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscal year ended June 28, 2007, filed with the Securities and Exchange Commission on September 26, 2006.

 

  (16) Previously filed as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscal year ended June 28, 2006, filed with the Securities and Exchange Commission on September 26, 2006.

 

  (17) Previously filed as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the period ended September 19, 2007, filed with the Securities and Exchange Commission on November 5, 2007.

 

  (18) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 8, 2008.

 

  (19) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 3, 2008.

 

  (20) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 25, 2008.

 

  (21) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 28, 2008.

 

  (22) Previously filed as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscal year ended June 25, 2008, filed with the Securities and Exchange Commission on October 10, 2008.

 

  (23) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 17, 2008.

 

  (24) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 30, 2009.

 

  (25) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 2, 2009.

 

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  (26) Previously filed as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Qfor the period ended March 4, 2009, filed with the Securities and Exchange Commission on April 20, 2009.

 

  (27) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 4, 2009.

 

  (28) Previously filed as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 1, 2009.

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description

10.33    Royalty Alteration notice relating to License and Distribution Agreement, dated November 26, 2008**
23.1    Consent of Independent Registered Public Accounting Firm – BDO Seidman, LLP
31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

  ** Confidential treatment has been requested for portions of this document. The omitted portions of this document have been filed with the Securities and Exchange Commission.