SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
______________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-32233
PEET'S COFFEE & TEA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
______________________________
WASHINGTON 91-0863396
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1400 PARK AVENUE
EMERYVILLE, CALIFORNIA 94608-3520
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)(ZIP CODE)
(510) 594-2100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, NO PAR VALUE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
________________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No[ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The approximate aggregate market value of the voting stock held by
non-affiliates of the registrant based on the closing price of the Common Stock
on June 30, 2002 (the registrant's most recently completed second quarter) and
March 14, 2003 as reported by the Nasdaq National Market, was $206,446,131 and
$180,755,204, respectively. Shares of Common Stock held by each officer and
director and each person known to
1
the Company to hold 10% or more of the outstanding Common Stock have been
excluded as such persons may be deemed to be affiliates of the Company. Such
determination of affiliate status is not necessarily a conclusive determination
for other purposes. As of March 14, 2003, 12,255,739 shares of registrant's
Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement related to the registrant's 2003 annual
meeting of stockholders, which proxy statement will be filed under the
Securities Exchange Act of 1934 within 120 days of the end of the registrant's
fiscal year ended December 29, 2002, are incorporated by reference into Part III
of this Form 10-K.
2
TABLE OF CONTENTS
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PAGE
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PART I
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Item 1. Business 4
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Item 2. Properties 9
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Item 3. Legal Proceedings 10
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Item 4. Submission of Matters to a Vote of Security Holders 10
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PART II
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Item 5. Market for Registrant's Common equity and Related Stockholder Matters 10
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Item 6. Selected Financial Data 11
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
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Item 7A. Quantitative and Qualitative Disclosure About Market Risk 21
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Item 8 Financial Statements and Supplementary Data 27
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Item 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 27
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PART III
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Item 10. Directors and Executive Officers of the Registrant 28
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Item 11. Executive Compensation 28
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Item 12. Security Ownership of Certain Beneficial Owners and Management 28
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Item 13. Certain Relationships and Related Transactions 28
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Item 14. Controls and Procedures 28
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PART IV
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Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 29
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Signatures 32
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3
FORWARD-LOOKING STATEMENTS
Some of the matters discussed under the captions "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operation," "Business" and elsewhere in this report include forward-looking
statements. We have based these forward-looking statements on our current
expectations and assumptions about future events, including, among other things:
- - Implementing our business strategy;
- - Attracting and retaining customers;
- - Obtaining and expanding our market presence in new geographic regions;
- - The availability of high quality Arabica coffee beans;
- - Consumers tastes and preferences; and
- - Competition in our market.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "could," "predict," "potential," "continue,"
"expect," "anticipate," "future," "intend," "plan," "believe," "estimate" and
similar expressions (or the negative of such expressions). These statements are
based on our current beliefs, expectations and assumptions and are subject to a
number of risks and uncertainties. Actual results, levels of activity,
performance, achievements and events may vary significantly from those implied
by the forward-looking statements. A description of risks that could cause our
results to vary appears under the caption "Risk Factors" and elsewhere in this
report. Forward-looking statements speak only as of the date of this report and
we assume no obligation to update any forward-looking statements.
PART I
ITEM 1. BUSINESS
Peet's is a specialty coffee roaster and marketer of branded fresh roasted
whole bean coffee. We sell our fresh roasted coffee under strict freshness
standards through multiple channels of distribution including grocery stores,
online and mail order, office, restaurant and food service accounts and 68
company-operated stores in four states.
We believe that roasted coffee is a perishable product and we pursue
distribution channels that are consistent with our strict freshness standards.
For instance, our distribution to grocery stores emphasizes the use of an
existing network of distributors who deliver fresh goods to our targeted
accounts. Our online and mail order customers are shipped coffee directly from
our facility and we roast to order. Our goal is to ensure that customers
receive coffee within days of roasting.
Over the past five years, we have expanded from a regional retailer that
operates its own outlets into a national coffee brand available through multiple
channels of distribution. We extended our retail presence to Southern
California in 1997, Chicago and Portland in 1998 and Boston in 1999. We signed
our first office coffee distribution agreement in 1997 and have since added a
number of restaurants, food service accounts, and office coffee distributors in
select markets. We added online ordering capability to our website in 1997 to
complement our existing mail order business and have since invested in marketing
programs designed to support our online and mail order channel. In 1998, we
initiated a strategic expansion into specialty grocery and gourmet food stores.
In 2002, this expansion was further developed to include distribution to
mainstream grocers; as we expanded our grocery accounts from 130 to over 1,400
stores primarily as a result of our distribution agreement with Safeway Inc. We
believe our expansion strategy emphasizes disciplined growth and enhancement of
our brand's image and quality reputation. See Note 13, "Segment Information" to
the "Notes to Consolidated Financial Statements", included elsewhere in this
report.
Our website is located at www.peets.com. Our annual report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any
amendments or exhibits to those reports, are available free of charge through
our website at http://investor.peets.com/edgar.cfm as soon as reasonably
practicable after we file them with, or furnish them to, the SEC. Peet's was
organized as a Washington corporation in 1971.
4
COMPANY RETAIL STORES
We operate 68 retail stores in four states through which we sell whole bean
coffee, beverages and pastries, tea, and other related items. Our stores are
designed to facilitate the sale of fresh whole bean coffee and to encourage
customer trial of our coffee through coffee beverages. Each store has a
dedicated staff person at the bean counter to take orders and assist customers
with questions and issues. Upon order, beans are scooped and ground to the
customer's specific requirement. To ensure that the freshest beans are sold to
customers, we implemented a policy to not sell beans beyond ten days from
roasting and we trained our store managers to order and replenish coffee daily.
Our beverage counter features coffee based beverages that promote the sale of
whole bean coffee with a standard rotation of coffee brewed from each category
of coffees we sell. It is our policy to brew a new batch of coffee every 30
minutes and not re-heat milk in espresso based drinks to ensure freshness. See
"Item 2. Properties" for further discussion about our retail stores.
SPECIALTY SALES
In addition to sales through our retail stores, we have expanded the
availability of our products through a network of grocery stores, including
Safeway Inc., Whole Foods Markets, and Bristol Farms. To support this
expansion, we have developed a direct store delivery ("DSD") sales and
distribution system. Peet's DSD route sales representatives deliver to their
stores weekly, properly shelve the product, work to resolve pricing
discrepancies, rotate to ensure freshness, sell and erect free-standing
displays, and forge store-level selling relationships. We expect to have
approximately 50 DSD route sales representatives in 2003, of which approximately
30 will be full-time Peet's employees, to support the expansion into new grocery
accounts in the western United States as well as existing Safeway stores. In
the food service and office business, we have a staff of sales and account
managers who make sales calls to potential and existing accounts and manage our
distributor network. Additionally we have established relationships with
office, restaurant and food service distributors to expand our account base in
select markets. These distributors have their own sales and account management
resources. In the online and mail order channel, we have a dedicated website
and customer service representatives that provide points of contact to our
customers for coffee ordering and coffee knowledge. Our website features an
Express Buy function for registered customers for speed and ease, special coffee
and tea programs, and a coffee and tea selector to assist the customer in
choosing a product based upon certain characteristics. In addition to our
website, we have a team of mail order customer service representatives who
assist customers in placing customer orders, choosing a gift item, providing
product information, and resolving customer issues. Customer service
representatives are regularly trained on Peet's product offerings through weekly
coffee and tea tastings.
OUR COFFEE
Coffee Beans
Coffee is an agricultural crop that undergoes price fluctuation and quality
differences depending on weather, economic and political conditions in coffee
producing countries. We purchase only Arabica coffee beans, which are
considered superior to the Robusta coffee beans traded in the commodity market.
Arabica beans usually grow at high elevations, absorb little moisture and mature
slowly. Thus, although most coffee trades in the commodity market, the Arabica
beans purchased by us tend to trade on a negotiated basis at a substantial
premium above commodity coffee prices, depending upon the supply and demand at
the time of purchase. Our access to high quality Arabica beans depends on our
relationships with coffee brokers, exporters and growers, with whom we have
built long-term relationships to ensure a steady supply of coffee beans. In
2002, we purchased over half of our coffee beans through one broker. We believe
that, as a result of our reputation that has been built over 37 years, we have
access to some of the highest quality coffee beans from the finest estates and
growing regions around the world and we are occasionally presented with
opportunities to purchase unique and special coffees.
Unlike roasted coffee beans, green coffee beans are not highly perishable.
We generally turn our inventory of green coffee beans two to three times per
year. We generally carry approximately $4 million to $8 million worth of green
coffee beans in our inventory. If Arabica coffee beans from a region become
unavailable or prohibitively expensive, we may be forced to discontinue
particular coffee types and blends or substitute coffee beans from other regions
in our blends. From time to time, we mitigate the risks associated by
fluctuations in coffee prices by entering into fixed price commitments and
hedging agreements for a portion of our green coffee bean requirements.
5
Our Roasting Method
Our roasting method was first developed by Alfred Peet and perfected by our
talented and skilled roasting personnel. We roast by hand in small batches, and
we rely on the skills and training of each roaster to maximize the flavor and
potential in our beans. Our roasters undergo a two year apprenticeship program
to learn our roasting method and to gain the skills necessary to roast coffee at
Peet's.
Coffee Types and Blends
Beyond sourcing and roasting, we have developed a reputation for expert
coffee blending. Our blends, such as Major Dickason's Blend(R), are well
regarded by our customers for their uniqueness, consistency and special flavor
characteristics. We sell approximately 32 types of coffee as regular menu
items. Included in this figure are approximately 21 blends with the balance
being single origin coffees from countries such as Colombia, Guatemala and
Kenya. In 2001, we introduced a line of high-end reserve coffees, such as Kona,
Jamaica Blue Mountain, Aged Moka Java, and JR Reserve Blend(R). We are active
in seeking, roasting and selling unique special lot and one-time coffees. On
average, we offer four to six such coffees every year.
TEA, FOOD AND MERCHANDISE
Peet's offers a line of hand selected whole leaf and bagged tea. Our
quality standards for tea are very high. We purchase tea directly from importers
and brokers and store and pack the tea at our facility in Emeryville. We offer
a limited line of specialty food items, such as jellies, jams and candies.
These products are carefully selected for quality and uniqueness.
Our merchandise program consists of items such as brewing equipment for
coffee and tea, paper filters and brewing accessories and branded and
non-branded cups, saucers, travel mugs and serveware. We do not emphasize these
items, but we carry them in retail stores and offer them through online and mail
order as a means to reinforce our authenticity in coffee and tea.
COMPETITIVE POSITIONING
The specialty coffee market can be characterized as highly fragmented. Our
primary competitors in whole bean specialty coffee sales include Gevalia (Kraft
Foods), Green Mountain Coffee, Illy Caffe , Millstone (Procter & Gamble),
Seattle's Best (AFC Enterprises) and Starbucks. There are numerous smaller,
regional brands that also compete in this category. We also compete indirectly
against all other coffee brands on the market. A number of nationwide coffee
marketers, such as Kraft Foods, Procter & Gamble and Nestle, are distributing
premium coffee brands in supermarkets. These premium coffee brands may serve as
substitutes for our whole bean coffee.
In addition to competing with other distributors of whole bean coffee, we
compete with retailers of prepared beverages, including coffee house chains,
particularly Starbucks, numerous convenience stores, restaurants, coffee shops
and street vendors.
Despite competing in a fragmented category, increased consumer demand has
resulted in specialty coffee brands being established across multiple
distribution channels. Several competitors are aggressive in obtaining
distribution in specialty grocery and gourmet food stores, and in office,
restaurant and food service locations. We have only recently begun to penetrate
these channels.
We believe that our customers choose among specialty coffee brands based
upon quality, variety, convenience, and to a lesser extent, price. Although
consumers may differentiate coffee brands based on freshness (as an element of
coffee quality), to our knowledge, few significant competitors focus on product
freshness and roast-dating in the same manner as Peet's. We believe that our
market share in the specialty category is based on a solidly differentiated
position built on our freshness standards and artisan-roasting style. Because of
the fragmented nature of the specialty coffee market, we cannot accurately
estimate our market share. However, many of our existing competitors have
significantly greater financial, marketing and operating resources than us.
6
Our roasted coffee is priced in tiers. Our regular menu coffees are priced
within a range of $8.95 to $17.95 per pound. Our line of high-end reserve
coffees, which we introduced in 2001, is priced between $49.90 and $79.90 per
pound. We believe our higher quality and freshness standards allow us to charge
a higher price for our coffee products.
INTELLECTUAL PROPERTY
We regard intellectual property and other proprietary rights as important
to our success. We own several trademarks and service marks that have been
registered with the United States Patent and Trademark Office, including
Peet's(R), Peet's Coffee & Tea(R), peets.com(R), Blend 101(R), Garuda Blend(R),
JR Reserve Blend(R), Maduro Blend(R), Major Dickason's Blend(R), Pride of the
Port(R), Pumphrey's Blend(R), Sierra Dorada Blend(R), Summer House(R), Top
Blend(R), and Vine Street Blend(R). We also have registered trademarks on our
stylized logo. In addition, we have applications pending with the United States
Patent and Trademark Office for a number of additional marks, including Espresso
Forte(TM) and Gaia Organic Blend(TM).
We own registered trademarks for our name and logo in Argentina, Australia,
Brazil, Canada, Chile, China, the European Community, Hong Kong, Japan,
Paraguay, Singapore, South Korea, Taiwan, and Thailand. We have filed
additional applications for trademark protection in the Philippines. In
addition to peets.com and coffee.com, we own several other domain names relating
to coffee, Peet's and our roasting process.
In addition to registered and pending trademarks, we consider the packaging
for our coffee beans (consisting of dark brown coloring with African-style motif
and lettering with a white band running around the lower quarter of the bag) and
the design of the interior of our stores (consisting of dark wood fixtures,
classic lighting, granite countertops and understated color) to be strong
identifiers of our brand. Although we consider our packaging and store design
to be essential to our brand identity, we have not applied to register these
trademarks and trade dress, and thus cannot rely on the legal protections
afforded by trademark registration.
Our ability to differentiate our brand from those of our competitors
depends, in part, on the strength and enforcement of our trademarks. We must
constantly protect against any infringement by competitors. If a competitor
infringes on our trademark rights, we may have to litigate to protect our
rights, in which case, we may incur significant expenses and divert significant
attention from our business operations.
INFORMATION SYSTEMS
The information systems installed at Peet's are used to manage our
operations and increase the productivity of our workforce. We have recently
implemented an advanced point-of-sale system to increase store productivity,
provide a higher level of service to our customers and maintain timely
information for performance evaluation. Our new registers have touch screen
components and full point-of-sale capability. We implemented a Peet's cash card
in our retail stores and website that will, in the future, allow us to implement
customer loyalty programs. Currently, we are implementing business intelligence
software to better support and analyze our business in all channels. In
addition, we are also deploying a labor and scheduling system to increase
productivity in our retail stores.
Our website is hosted at our corporate headquarters in Emeryville,
California. All website applications are built on Microsoft ASP with in-house
development. We offer full-functioning e-commerce and our site is integrated
with our call center for access to orders placed at both locations. Online
delivery confirmation is provided by United Parcel Service and United States
Postal Service. Our peets.com site contains several customer-centered functions
such as Express Buy (which stores customer-specific lists of favorite coffee and
items), multiple ''ship-to'' capability on a single bill and extensive coffee
search and product matching. Website and call center system functionality are
designed to accommodate the need for customers to place repeat orders or
automatic orders delivered on a pre-set schedule. We designed our website to
provide fast, easy and effective operation when navigating and shopping on our
site. We have dedicated information technology employees and marketing staffers
for website maintenance, improvement, development and performance.
7
EMPLOYEES
As of March 14, 2003, we employed a workforce of 1,667 people,
approximately 324 of whom are considered full-time employees. None of our
employees are represented by a labor union. We consider our relationship with
our employees to be good. Since 1979, we have provided full benefits to all
employees who work at least 21 hours per week. We continue to offer competitive
benefits packages to attract and retain valuable employees.
GOVERNMENT REGULATION
Our coffee roasting operations and our retail stores are subject to various
governmental laws, regulations, and licenses relating to customs, health and
safety, building and land use, and environmental protection. Our roasting
facility is subject to state and local air-quality and emissions regulation. If
we encounter difficulties in obtaining any necessary licenses or complying with
these laws and regulations, then:
- - The opening of new retail locations could be delayed;
- - The operation of existing retail locations or our coffee roasting
operations could be interrupted; or
- - Our product offerings could be limited.
We believe that we are in compliance in all material respects with all such
laws and regulations and that we have obtained all material licenses that are
required for the operation of our business. We are not aware of any
environmental regulations that have or that we believe will have a material
adverse effect on our operations.
OUR EXECUTIVE OFFICERS
Set forth below is information with respect to the names, ages, positions
and offices of our executive officers as of March 14, 2003.
NAME AGE POSITION
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Patrick J. O'Dea 41 Chief Executive Officer, President and Director
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Mark N. Rudolph 44 Chief Financial Officer, Vice President, Treasurer and Secretary
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Michael J. Cloutier 48 Vice President, Information Technology
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James E. Grimes 47 Vice President, Operations and Information Systems
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William M. Lilla 47 Vice President, Foodservice/Office and New Business Development
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Deborah McGraw 61 Vice President, Retail Operations
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Peter B. Mehrberg 44 Vice President, New Store Development & International and General Counsel
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James A. Reynolds 64 Vice President, Coffee and Tea
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Patrick J. O'Dea has served as Chief Executive Officer, President and as a
director since May 2002. From April 1997 to March 2001, he was CEO of
Archway/Mother's Cookies and Mother's Cake & Cookie Company. From 1995 to 1997,
Mr. O'Dea was the Vice President and General Manager of the Specialty Cheese
Division of Stella Foods. From 1984 to 1995, he was with Procter & Gamble,
where he marketed several of the company's snack and beverage brands.
Mark N. Rudolph has served as Chief Financial Officer since September 1988. He
was appointed Vice President in September 1994 and Treasurer and Secretary in
May 2001. Mr. Rudolph served as Assistant Secretary from September 1994 to May
2001.
Michael J. Cloutier has served as Vice President, Information Systems since
August 1999. He was a Systems Manager for Peet's from August 1999 to December
1999. Between October 1997 and August 1999, Mr. Cloutier founded two computer
consulting businesses, 1 - 2 - 1 Solutions and Pleasanton Partners, Inc. From
April 1996 to October 1997, Mr. Cloutier served as Vice President, Operations of
M1 Software, Inc., a software development company. From 1993 to April 1996, Mr.
Cloutier was the Deputy Business and Strategic Planning Officer at the Mare
Island Naval Shipyard.
8
James E. Grimes has served as Vice President of Operations and Information
Systems since July 2002. In August 2001, Mr. Grimes founded Supply Chain
Consulting, where he provided supply chain management expertise. From January
2001 through August 2001, Mr. Grimes was Senior Vice President of Strategic
Planning-Operations at Parmalat Bakery Division, North America. From 1998 to
2001, he was Senior Vice President of Operations at Archway/Mother's Cookies.
Previously, Mr. Grimes held various positions at Mother's Cake and Cookie
Company. Before joining Mother's, he was at Frito Lay and Procter & Gamble.
William M. Lilla has served as Vice President since April 1998. He has served
the Company in several roles, including Vice President, Marketing and Strategy
and Vice President, Food Service and New Business Development. Before joining
Peet's, Mr. Lilla was employed by The Heublein Wines Group as Vice President of
Strategy from October 1997 to April 1998, Vice President of Marketing from
September 1994 to October 1997, and Director of Marketing from September 1993 to
September 1994.
Deborah McGraw has served as Vice President, Retail Operations since October
1995. She has worked for Peet's in various capacities since 1983. Ms. McGraw
became a store manager in 1989 and was promoted to District Manager in March
1989, to Regional Director in January 1994, and to Director of Retail Operations
in September 1994.
Peter B. Mehrberg has served as Vice President since 1997. He has served the
Company in several roles, including Vice President, Business Development and
Vice President, Real Estate. Mr. Mehrberg has also served as General Counsel
since September 1994. From July 1994 to June 1997, Mr. Mehrberg was Director of
Real Estate.
James A. Reynolds has served as Vice President, Coffee and Tea since February
1994, and served as Secretary from February 1988 to May 2001. He also served as
a director from 1985 to 1997. He joined Peet's in 1984.
ITEM 2. PROPERTIES
Peet's headquarters are located in Emeryville, California, where the
Company leases approximately 60,000 square feet of office and production space,
including roasting and direct delivery fulfillment facilities. Within these
facilities, we have 15,000 square feet devoted to general corporate and retail
overhead and a call center for the direct delivery business. Our lease expires
in 2005 and we have an option to extend the lease for an additional ten years.
We operate 68 retail stores in four states. Our retail locations are all
company operated in leased facilities. Our store size averages approximately
1,800 square feet. Our stores are typically located in urban neighborhoods,
suburban shopping centers (usually consisting of grocery, specialty and service
stores) and high-traffic streets.
The following table lists the number of retail stores we have in each
location as of March 14, 2003:
LOCATION NUMBER
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San Francisco Bay Area, California 34
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San Jose, California 6
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Sacramento, California 4
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Santa Cruz, California 1
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Santa Barbara, California 1
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Greater Los Angeles, California 8
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Orange County, California 1
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San Diego, California 2
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Chicago, Illinois 2
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Portland, Oregon 3
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Boston, Massachusetts 6
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TOTAL 68
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9
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of our business, we may from time to time become
involved in certain legal proceedings. On February 25, and March 7, 2003, two
lawsuits were filed against the Company entitled Brian Taraz, et al vs. Peet's
Coffee & Tea, Inc., and Tracy Coffee, et al. vs. Peet's Coffee & Tea, Inc. Each
was filed in Superior Court of the State of California, County of Orange, and
seeks class action certification. These suits were filed by one former and one
current store manager alleging misclassification of employment position and
seeking damages, restitution, reclassification and attorneys fees and costs. We
are investigating and intend to vigorously defend this litigation, but because
the cases are in their early stages, the financial impact to the Company, if
any, cannot be predicted.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
quarter ended December 29, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET FOR THE REGISTRANT'S STOCK
The Company's common stock commenced regular trading on the Nasdaq National
Market System under the symbol ''PEET'' on January 25, 2001. Prior to that
time, there was no public market for the Company's common stock. The following
table sets forth, for the periods indicated, the high and low closing prices for
our common stock as reported on the Nasdaq National Market since January 25,
2001.
HIGH LOW
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FISCAL YEAR ENDED DECEMBER 29, 2002
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Fourth Quarter $16.240 $10.800
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Third Quarter $17.030 $12.000
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Second Quarter $18.890 $12.880
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First Quarter $16.150 $10.850
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FISCAL YEAR ENDED DECEMBER 30, 2001
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Fourth Quarter $11.500 $ 7.350
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Third Quarter $ 9.060 $ 6.180
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Second Quarter $10.000 $ 7.250
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First Quarter (commencing January 25, 2001) $16.125 $ 6.125
- ------------------------------------------------ ------- -------
As of March 14, 2003, there were approximately 282 registered holders of
record of the Company's common stock. On March 14, 2003, the last sale price
reported on the Nasdaq National Market System for the common stock was $15.79
per share.
DIVIDEND POLICY
We have not declared or paid any dividends on our capital stock since 1990.
We expect to retain any future earnings to fund the development and expansion
our business. Therefore, we do not anticipate paying cash dividends on our
common stock in the foreseeable future. Our current credit facility restricts
our ability to pay dividends. See ''Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources.''
USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES
We completed our initial public offering of our common stock in January and
February 2001 pursuant to a Registration Statement on Form S-1 initially filed
on October 13, 2000, as subsequently amended (the ''Registration Statement'')
(File No. 333-47597). As of March 14, 2003, $17.4 million of the net proceeds
from the offering had been used for debt reduction, and the remainder of the net
proceeds was invested in short-term, interest-bearing, investment grade
securities.
10
We completed our secondary public offering of our common stock in April
2002 pursuant to a Registration Statement on Form S-3 initially filed on March
27, 2002, as subsequently amended (the "Registration Statement" (File No.
333-85085). The aggregate proceeds to us from the offering were $43.9 million.
We paid expenses of approximately $2.9 million, of which approximately $2.4
million represented expenses related to underwriters' fees. Net proceeds from
the offering were $41.0 million. As of March 14, 2003, all of the net proceeds
were invested in short-term and long-term, United States Government and Agency
securities. We expect that our use of proceeds from the offering will conform
to the intended use of proceeds as describe in our prospectus dated April 19,
2002, except that the proceeds have been invested in short-term and long-term,
interest-bearing United States Government and Agency securities until required
for working capital purposes.
ITEM 6. SELECTED FINANCIAL DATA
The table below shows selected consolidated financial data for our last
five fiscal years. Our fiscal year is based on a 52 or 53 week year and ends on
the Sunday closest to the last day in December.
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this report.
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
YEAR
----------------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- ---------
STATEMENT OF OPERATIONS DATA:
Net revenue $59,787 $69,059 $84,302 $94,400 $104,073
Cost of sales and related occupancy expenses 30,303 33,641 40,655 45,357 48,146
Operating expenses 18,175 22,115 28,073 30,617 33,221
Marketing and advertising expenses 2,176 3,491 6,069 4,812 4,554
General and administrative expenses 5,303 5,551 5,893 6,243 6,732
Depreciation and amortization expenses 2,711 3,404 4,576 5,038 4,568
-------- -------- -------- -------- ---------
Income (loss) from operations 1,119 857 (964) 2,333 6,852
Interest income (expense), net (709) (985) (1,907) (429) 540
-------- -------- -------- -------- ---------
Income (loss) before income taxes 410 (128) (2,871) 1,904 7,392
Income tax (provision) benefit (242) (16) 596 (749) (2,735)
-------- -------- -------- -------- ---------
Net income (loss) $ 168 $ (144) $(2,275) $ 1,155 $ 4,657
======== ======== ======== ======== =========
Net income (loss) per share:
Basic $ 0.04 $ (0.03) $ (0.50) $ 0.15 $ 0.43
======== ======== ======== ======== =========
Diluted $ 0.03 $ (0.03) $ (0.50) $ 0.14 $ 0.40
======== ======== ======== ======== =========
Shares used in calculation of net income (loss) per share:
Basic 4,397 4,489 4,515 7,941 10,919
======== ======== ======== ======== =========
Diluted 5,710 4,489 4,515 8,212 11,627
======== ======== ======== ======== =========
BALANCE SHEET DATA:
Cash and cash equivalents $ 873 $ 1,074 $ 1,598 $ 2,718 $ 19,672
Working capital (deficit) (1,333) (5,486) (2,853) 3,315 22,499
Total assets 29,864 34,650 39,721 41,409 95,145
Borrowings under line of credit 4,472 5,600 4,246 1,968 -
Current portion of long-term borrowings 1,701 2,816 2,037 513 468
Long-term borrowings, less current portion 5,962 7,240 14,544 895 424
Total shareholders' equity 10,791 11,191 9,167 28,770 80,504
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
our consolidated financial statements and related notes included elsewhere in
this report. Except for historical information, the discussion below contains
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934.
COMPANY OVERVIEW AND INDUSTRY OUTLOOK
Peet's is a specialty coffee roaster and marketer of branded fresh roasted
whole bean coffee sold through multiple channels of distribution. Since the
founding of our business in 1966, we have established a customer base and brand
recognition in California. Our national expansion strategy is based on the sale
of whole bean coffee in multiple channels of distribution. While we intend to
continue the sale of whole bean coffee through strategically located retail
stores, we expect revenue in our other distribution channels, namely grocery
stores, online and mail order and office, restaurant and food service accounts,
to increase at a more rapid rate. We are also continuing to explore
opportunities internationally through strategic relationships.
We expect the specialty coffee industry to continue to grow. We believe
that this growth will be fueled by continued consumer interest in high quality
coffee and related products.
Our operations are vertically integrated. We purchase Arabica coffee beans
from countries around the world, apply our artisan-roasting techniques and ship
fresh coffee daily to our stores and customers within 24 hours of roasting.
Control of purchasing, roasting, packaging and distribution of our coffee allows
us to maintain our commitment to freshness, is cost effective and enhances our
margins and profit potential.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the appropriate application of certain
accounting policies, many of which require us to make estimates and assumptions
about future events and their impact on amounts reported in our financial
statements and related notes. Since future events and their impact cannot be
determined with certainty, the actual results will inevitably differ from our
estimates. Such differences could be material to the financial statements.
We believe our application of accounting policies, and the estimates
inherently required therein, are reasonable. These accounting policies and
estimates are constantly reevaluated, and adjustments are made when facts and
circumstances dictate a change. Historically, we have found our application of
accounting policies to be appropriate, and actual results have not differed
materially from those determined using necessary estimates.
Our accounting policies are more fully described in Note 2 "Summary of
Significant Accounting Policies" in the "Notes to the Consolidated Financial
Statements," included elsewhere in this report. We have identified the
following critical accounting policies:
- -Inventory. Raw materials consist primarily of green bean coffee. Finished
goods include roasted coffee, tea, accessory products, spices, and packaged
foods. All products are valued at the lower of cost or market using the
first-in, first-out method, except green bean and roasted coffee, which is
valued at the average cost. We continually evaluate the composition of our
coffee related merchandise and mark down such inventory as needed. Our
historical inventory write-offs have been immaterial.
- -Intangibles and other assets. During 2002, we entered into a contractual
agreement with Safeway Inc., a national grocery chain, to sell Peet's coffee
through its grocery stores. We began shipping during the third quarter of this
year. The agreement included an upfront payment to Safeway Inc. that we
recorded in intangibles and other assets and is being amortized as a reduction
of revenue based upon estimated sales during the contract period.
- -Long-lived assets. In evaluating the fair value and future benefits of
long-lived assets, we perform an analysis of the anticipated undiscounted future
net cash flows of the related long-lived asset and reduce
12
their carrying value by the excess, if any, of the result of such calculation.
We believe at this time that the long-lived assets' carrying values and useful
lives continue to be appropriate.
- -Accrued compensation. In March 2002, we modified our workers' compensation
insurance policy to a high deductible insurance program with an overall program
ceiling to minimize exposure. We began recording an estimated liability for the
self-insured portion of the workers' compensation claims. The liability is
determined actuarially, based on claims paid, filed and reserved for, and
projected using an industry loss development factor, as well as using historical
experience ratings. As of December 29, 2002, the first 10 months of the policy
period, we had $703,000 accrued for workers' compensation. Should a greater
amount of claims occur compared to what is estimated or the medical costs
increase beyond what was anticipated, the recorded liability may not be
sufficient.
- -Income taxes. We have federal and state net operating loss carryforwards and
charitable contribution carryforwards. The utilization of these carryforwards
is dependent on future income. We have established a valuation allowance for
the portion of the carryforwards that we do not expect to utilize. Although we
believe the valuation allowance is appropriate, if future taxable income were to
differ significantly from the amounts estimated, the valuation allowance would
need to be adjusted.
- -Hedge accounting. We use coffee futures and options to hedge price increases
in price-to-be-fixed coffee purchase commitments and anticipated coffee
purchases. These derivative instruments qualify for hedge accounting which is
permitted if the hedging relationship is expected to be highly effective.
Effectiveness is determined by how closely the changes in the fair value of the
derivative instrument offset the changes in the fair value of the hedged item.
If the derivative is determined to qualify for hedge accounting, the effective
portion of the change in the fair value of the derivative instrument is recorded
in other comprehensive income and recognized in earnings when the related hedged
item is sold. The ineffective portion of the change in the fair value of the
derivative instrument is recorded directly to earnings. If these derivative
instruments did not qualify for hedge accounting, we would have to record the
changes in the fair value of the derivative instruments directly to earnings.
See "Item 7A. Quantitative and Qualitative Disclosures about Market Risk" and
Note 12 "Hedging Activities" in the "Notes to Consolidated Financial Statements"
included elsewhere in this report.
We have also chosen certain accounting policies when options are available,
including the intrinsic value method under APB Opinion No. 25, "Accounting for
Stock Issued to Employees," to account for our stock option awards. These
accounting policies are applied consistently for all years presented. Our
operating results would be affected if other alternatives were used.
Information about the impact on our operating results of using the alternative
of SFAS No. 123, "Accounting for Stock-Based Compensation," is included in Note
2 "Summary of Significant Accounting Policies" and Note 10 "Stock Option and
Employee Purchase Plans" in the "Notes to Consolidated Financial Statements,"
included elsewhere in this report.
BUSINESS SEGMENTS
Our coffee and related items are sold through multiple channels of
distribution that are considered separate segments under Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information." These channels provide broad market exposure to potential
purchasers of fresh roasted whole bean coffee. Historically, we have operated
in three reportable segments: retail, online and mail order and specialty
sales. Management evaluates segment performance primarily based on revenue and
segment operating income. Effective at the beginning of the second quarter of
2002, due to the nature of cross-channel marketing and consumer purchase
behavior from our multi-channel selling strategy, we have had an organizational
change, combining the online and mail order segment and the specialty sales
segment. We are indifferent as to where consumers purchase our coffees and
teas, so we have aggregated these individual sales channels into one reportable
segment. Company-operated retail stores operations remain a separate channel
due to the beverage component of this business and the percent of overall
revenues it represents. Therefore, we have two reportable segments, consisting
of:
- - Our retail stores; and
- - Specialty sales, which consist of sales to online and mail order
customers, and sales to grocery stores, restaurant and food service
companies, and office accounts.
13
We believe growth opportunities exist in all these channels. Our expansion
is focused first in developing the western U.S. existing markets where we
already have a presence and have a higher customer awareness. We will continue
to open new stores in strategic locations that meet our demographic profile in
these markets, make our coffees more broadly and conveniently located in grocery
stores, and partner with distributors and companies who share our passion for
quality and freshness and are willing and able to execute accordingly in the
food service and office environment. We also will penetrate new markets and
channels that we believe can support the sale of specialty coffee, and continue
to explore opportunities internationally.
BUSINESS CATEGORIES
In addition to our reportable segments, we measure our business by
monitoring the volume and revenue growth of two distinct business categories:
- - Whole bean coffee and related products; and
- - Beverages and pastries.
We believe these business categories are useful in understanding our
results of operations for the periods presented because we operate our stores
and record sales through these two categories. Our stores are primarily
designed to facilitate the sale of whole bean coffee. The format of our stores
replicates that of a specialty grocer. Beans are scooped from under the counter
bins, weighed on counter top scales and hand packed into branded bags.
In addition, each store has a beverage bar that is dedicated to the sale of
prepared beverages and pastries. Moreover, our two business categories within a
store mature at different rates. When we open a store, the initial sales are
primarily beverage and pastry related. The distance a consumer will travel, or
trade area, for beverages and pastries is short (usually one to three miles)
representing a convenience purchase. Consequently, the beverage and pastry
business matures rapidly. The trade area for whole bean coffee is much larger
(usually three to five miles), representing destination shopping. Whole bean
sales from stores mature more slowly (typically three to five years).
Therefore, sales at newer stores have a much higher beverage and pastry
component and shift to a higher whole bean percentage as the store matures. In
2002, whole bean coffee and related products sales from stores opened for less
than 5 years was 41.9% of net revenue versus 50.9% for stores opened for more
than 5 years. The dynamics of opening many new stores over the past few years
have resulted in a higher beverage and pastry percentage within our net revenue.
14
RESULTS OF OPERATIONS
The following discussion on results of operations should be read in
conjunction with "Item 6. Selected Consolidated Financial Data," the
consolidated financial statements and accompanying notes and the other financial
data included elsewhere in this report. Our fiscal year is based on a 52 or 53
week year. The fiscal year ends on the Sunday closest to the last day of
December.
YEAR
---------------------
2000 2001 2002
------ ------ ------
STATEMENT OF OPERATIONS DATA AS A PERCENT OF NET REVENUE:
Net revenue 100.0% 100.0% 100.0%
Cost of sales and related occupancy expenses 48.2 48.1 46.3
Operating expenses 33.3 32.4 31.9
Marketing and advertising expenses 7.2 5.1 4.4
General and administrative expenses 7.0 6.6 6.5
Depreciation and amortization expenses 5.4 5.3 4.4
------ ------ ------
Income (loss) from operations (1.1) 2.5 6.5
Interest income (expense), net (2.3) (0.5) 0.5
------ ------ ------
Income (loss) before income taxes (3.4) 2.0 7.0
Income tax (provision) benefit 0.7 (0.8) (2.6)
------ ------ ------
Net income (loss) (2.7)% 1.2% 4.4%
====== ====== ======
PERCENT OF NET REVENUE BY BUSINESS SEGMENT:
Retail stores 81.0% 79.5% 75.2%
Specialty sales 19.0 20.5 24.8
PERCENT OF NET REVENUE BY BUSINESS CATEGORY:
Whole bean coffee and related products 59.7% 59.3% 60.1%
Beverages and pastries 40.3 40.7 39.9
OPERATING EXPENSES AS A PERCENT OF SEGMENT REVENUE:
Retail stores 36.8% 35.5% 35.2%
Specialty sales 18.3 20.4 22.1
PERCENT INCREASE (DECREASE) FROM PRIOR YEAR:
Net revenue 12.0% 10.2%
Retail stores 9.9 4.3
Specialty sales 51.5 33.2
Cost of sales and related occupancy expenses 11.6 6.1
Operating expenses 9.1 8.5
Marketing and advertising expenses (20.7) (5.4)
General and administrative expenses 5.9 7.8
Depreciation and amortization expenses 10.1 (9.3)
SELECTED OPERATING DATA:
Number of retail stores in operation:
Beginning of the period 53 58 60
Stores openings 5 2 5
Store closure 0 0 0
End of the period 58 60 65
15
2002 COMPARED WITH 2001
Net revenue
Net revenue for 2002 increased by 10.2% for the two business segments and
categories as compared to 2001. During 2002, we continued our strategy of
selling through multiple channels of distribution. A key element of our
strategy involves increasing the percentage of revenue from sales of whole bean
coffee and related products, which have a higher net margin than beverages and
pastries. By accelerating growth in the specialty sales segment, especially in
the grocery and foodservice channels, revenue derived from the sale of whole
bean coffee and related products as a percent of net revenue increased from
59.3% in 2001 to 60.1% in 2002.
In the retail segment, revenue increased 4.3% compared to 2001 primarily as
a result of increased sales in existing stores and the opening of new retail
stores. The $3.2 million revenue increase consisted of $2.8 million from
existing stores and $0.4 million from new stores. The revenue increase of $2.0
million in existing stores was due to increased traffic and $0.8 million was due
to higher average sales transactions. There were no price increases during the
year. During 2002, we opened five new stores compared to two stores opened in
2001. One store was opened during the third quarter while the remaining four
stores were opened during the fourth quarter. We opened more new stores in 2002
as we saw the cost and availability of real estate become more favorable in
2002. We expect to open approximately 8 new stores in 2003.
In the specialty sales segment, revenue increased primarily due to sales
initiatives focused in the grocery and foodservice channels. The $6.4 million
revenue increase consists of $3.5 million in grocery, $1.6 million in
foodservice, and $1.3 million in all other channels such as online and mail
order, kiosks and license partners, and office coffee sales. The accelerated
growth in grocery was the result of developing relationships with larger
multi-location chains such as Safeway Inc. and Whole Foods Markets. We
increased the number of grocery stores selling Peet's coffee from 130 locations
in 2001 to over 1,400 in 2002. In 2002, we entered into an agreement with
Safeway to distribute our coffees to approximately 1,200 Safeway stores across
the country. In July 2002, we rolled out distribution to approximately 860
stores in the western United States, including California, Colorado, Pacific
Northwest, Arizona, and New Mexico. In September, we rolled out distribution to
the remaining 340 stores in the eastern United States, including Texas,
Illinois, and Pennsylvania. We expect to expand this sales effort to grocers
with similar profiles in the next few years. In the foodservice area, the sales
increase was due to acquisition of new customers like the Omni Hotel and the
full year impact of existing customers like Wolfgang Puck Fine Dining and Anton
Airfoods. In the other channels, including online and mail order, office coffee,
and kiosk operations, the sales increase was entirely attributable the full year
impact of our kiosk operations in Larry's Markets.
Cost of sales and related occupancy expenses
Cost of sales and related occupancy expenses consist of product costs,
including hedging costs, manufacturing costs, rent and other occupancy costs.
Primarily as a result of increased net revenue and the addition of five new
stores, cost of sales increased by 6.1% in 2002. As a percent of net revenue,
cost of sales decreased mainly because of lower coffee costs, lower world
commodity coffee prices and the sales of special lot and seasonal coffees, which
have a higher margin than regular menu coffees. These benefits were partially
offset by the increase in revenue from the specialty sales segment, which has a
lower price point than retail and higher shipping and packaging costs.
Operating expenses
Operating expenses for 2002 increased as compared to 2001 as we grew our
business. However, operating expenses as a percent of net revenue decreased
primarily due to the continued productivity initiative affecting our retail
stores and the revenue increase in our specialty sales segment, which has lower
operating expenses without the intensive labor component of the retail stores.
Our focus on growing the specialty sales segment led to an increase in specialty
sales operating expenses as a percent of segment revenue. The factors
contributing to the increase included the continued upgrade and addition of
sales staff and an increase in consulting and distribution costs in the grocery
channel. We hired a sales brokerage firm to aide us in selling coffee in the
grocery channel. Further, distribution expenses have increased as we have
dedicated DSD route sales representatives delivering our product to grocery
stores weekly, including the associated commission and vehicle expenses. We
expect to have approximately 50 DSD route sales representatives in 2003, of
which approximately 30 will be full-time Peet's employees, to support the
expansion into grocery stores in the western United States as well as existing
accounts,
16
such as Safeway and Whole Foods Markets. The related operating expenses, such
as commissions and vehicle expenses, are expected to increase, however, we
believe the increased revenue will positively offset these expenses over time.
Marketing and advertising expenses
We believe the decrease in marketing and advertising expenses in 2002 as
compared to 2001 is attributable to the leverage gained from marketing across
multiple channels of distribution, as well as the shift in spending to improve
stores operations, recognizing stores are our most valuable marketing tool.
General and administrative expenses
General and administrative expenses increased by 7.8% in 2002 as the result
of higher expenses in the areas of stock plan administration, public relations
and proxy related activities, higher insurance coverage for directors and
officers, and our CEO search.
Depreciation and amortization expenses
Depreciation and amortization expenses decreased in 2002 due primarily to
certain assets becoming fully depreciated during the year. In addition, while
we opened 3 more stores than last year, depreciation expense was minimally
impacted as most of the stores were opened in the fourth quarter.
Interest (income) expense, net
Net interest income was generated in 2002 from the investment of the
proceeds of our secondary offering in April 2002. The investments are short and
long term interest bearing, U.S. Government and Agency securities.
Income tax provision
Taxes on net income in 2002 were $2.7 million, reflecting an effective tax
rate of 37.0%. The decrease in the effective rate over the prior year is
attributable to the change in the valuation allowance of charitable
contributions carryforwards.
2001 COMPARED WITH 2000
Net revenue
Net revenue for 2001 increased 12.0% as compared to 2000. Revenue derived
from the sale of whole bean coffee and related products as a percent of net
revenue actually decreased slightly in 2001 from 59.7% to 59.3%, primarily as a
result of the opening of eighteen retail stores over the past three years.
In the retail segment, revenue increased primarily as a result of increased
sales in existing stores, price increases on whole bean coffee and beverages and
pastries effective in December 2000, the opening of new retail stores and the
introduction of a line of high-end reserve coffees. During 2001, we opened two
new stores compared to five stores opened in 2000. One was in Studio City,
Southern California, and the other was in Wellesley, Massachusetts. We opened
fewer new stores in 2001 because the cost and availability of real estate was
less attractive during 2000 and the first half of 2001.
17
The following table sets forth the sources of revenue increases in 2001 by
business category for the retail segment (in millions).
Increased volume and change in mix of whole bean coffee $1.5
Price increase in December 2000 0.8
----
Total existing stores 2.3
Total new stores 0.4
----
Total whole bean coffee and related products $2.7
====
Increased volume of beverages and pastries $2.2
Price increase in December 2000 $1.3
----
Total existing stores $3.5
Total new stores $0.5
----
Total beverages and pastries $4.0
====
In the specialty sales segment, revenue increased 21.0% primarily due to
increases from the grocery and online and mail order channels. The $3.4 million
increase consisted of $1.2 million increase in sales to online and mail order
customers, $0.8 million in incremental sales to specialty groceries and gourmet
food stores, $0.6 million in sales to restaurants and food service companies,
and $0.8 million in additional sales to office accounts and Larry's Market
kiosks. In the online and mail order channel, our marketing efforts resulted in
a 13.2% increase in active customer during 2001. In the grocery channel, we
increased the number of specialty grocery and gourmet food stores from 25 in
2000 to over 130 in 2001, including multi-location chains such as Von's Pavilion
and Beverages &more!. In the restaurant and food service area, we entered into
agreements with companies such as The Wolfgang Puck Fine Dining and Catering
Group and Anton Airfoods. We also began operations of 6 kiosks within Larry's
Markets, a specialty grocery chain in Seattle.
Cost of sales and related occupancy expenses
Cost of sales increased by 11.9% in 2001 primarily as a result of increased
net revenue and the addition of two new stores. The lower cost of green bean
coffee was partially offset by higher hedging costs. Cost of sales actually
decreased as a percent of net revenue mainly because of:
- - The December 2000 price increase, which resulted in a higher average sale
at our retail store beverage bars and a higher price per pound of whole
bean coffee purchased at our retail stores and by online and mail order
customers;
- - Sales of high-end reserve coffees, which have a higher margin than regular
menu coffees; and
- - Fewer new stores opened during 2001.
These benefits were partially offset by the increase in revenue from the
specialty sales segment, which has a lower price point than retail and a higher
shipping cost.
Operating expenses
Operating expenses as a percent of net revenue decreased primarily due to the
increase in our net revenue, a more favorable hiring environment, and a
productivity improvement initiative affecting our retail stores. This included
programs to increase efficiency in our bar operations and a more standardized
scheduling practice.
Our focus on growing the specialty sales segment led to an increase in
specialty sales operating expenses as a percent of segment revenue. The factors
contributing to the increase included the payroll expense of new sales staff for
the grocery segment expansion, their travel and related expenses, the expenses
related to distribution, and the pre-opening and startup costs related to the
opening of kiosks in Larry's Markets stores in Seattle. These increases were
partially offset by decreases in payroll, order processing and outside services
expenses in the online and mail order channel.
18
Marketing and advertising expenses
The decrease in marketing and advertising expenses in 2001 as compared to
2000 is attributable to the leverage gained from marketing across multiple
channels of distribution, a shift from customer acquisition to customer
retention, which is generally more cost effective, and fewer new store openings
in 2001.
General and administrative expenses
We were able to reduce our general and administrative expenses as a percent
of net revenue in 2001 as compared to 2000 primarily by maintaining prior year
employee base levels and lowering recruiting expenses in a less-competitive job
market. Our efforts to reduce general and administrative expenses were
partially offset by higher outside services expenses related to stock plan
administration and public relations activities associated with being a publicly
held company.
Depreciation and amortization expenses
Depreciation and amortization expenses increased in 2001 as compared to
2000 due to the openings of new stores and kiosks and investments in
manufacturing and systems. However, as a percent of net revenue, these expenses
decreased compared to the prior year primarily due to fewer stores being opened
as well as the increase in revenue from the less capital-intensive specialty
sales channel.
Interest expense, net
Net interest expense decreased in 2001 as compared to 2000 as a result of
repayment of debt using the net proceeds from our initial public offering in
January 2001.
Income tax provision (benefit)
Taxes on net income in 2001 were $0.7 million, reflecting an effective tax
rate of 39.3%. The increase in the effective rate over the prior year is
attributable to the increase in income and the change in the valuation allowance
of charitable contributions carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
At December 29, 2002, we had $19.7 million in cash and cash equivalents,
invested in U.S. Government and Agency securities, and $22.5 million working
capital.
Net cash provided by operations was $11.8 million in 2002 compared to $5.8
million in 2001. Operating cash flows were positively impacted in 2002 by
increased net income and higher accounts payable and accrued liabilities. The
increase was partially offset by an increase in green coffee bean inventory as
we increased our purchases in response to historically low coffee prices and
potential longshoremen lockout in the West Coast.
Net cash used in investing activities was $37.2 million in 2002. Investing
activities primarily consisted of the purchase of $27.9 million of long term
U.S. Government and Agency securities, and $9.3 million in capital expenditures
for property, plant and equipment. Capital expenditures included:
- - $4.9 million used for the buildout of new stores and remodel of existing
stores;
- - $1.9 million used for information technology support systems, and software
to support our growing infrastructure;
- - $1.0 million used for kiosks and equipment for specialty sales;
- - $1.2 million used for manufacturing plant capacity and additional
machinery; and
- - $0.3 million for various projects in progress.
Net cash provided by financing activities was $42.4 million in 2002.
Financing activities in 2002 consisted primarily of $44.9 million in net
proceeds received from our secondary public offering in April and exercise of
stock options, partially offset by $2.5 million of repayment of debt.
19
We have a credit facility with General Electric Capital Corporation, that
provides for a revolving line of credit of $15.0 million that expires in 2005.
At December 29, 2002, there was no outstanding balance and $14.1 million
available under the revolving line of credit after other senior funded debt of
$0.9 million, consisting of industrial development revenue bonds and capital
leases.
Due to the significant repayment of debt from the net proceeds of our
initial public offering, we amended our existing credit facility in June 2001
and March 2002 (effective December 24, 2001), December 2002 (effective October
1, 2002), and February 2003 (effective December 1, 2002) to reflect our updated
cash and capital requirements. The March 2002, December 2002, and February 2003
amendments include an increase in the capital expenditure limit, an increase in
the number of new stores per year, and a relaxation of certain financial
covenants. In addition, interest rates on the revolving line of credit have
been reduced. We were in compliance with all financial covenants as of December
29, 2002. See Note 6 "Borrowings" in the "Notes to Consolidated Financial
Statements," included elsewhere in this report.
Our 2003 capital expenditure requirements consist primarily of expenditures
relating to new store openings, remodeling of existing stores, upgrade of our
packaging system, and continued improvement of our data processing capabilities.
Our 2003 capital expenditures are expected to be between $9.0 and $10.0 million.
Approximately $5.0 million is expected to be used for the opening of eight new
retail stores scheduled for 2003 and expenditures for new stores in progress for
2004. Approximately $2.0 million is expected to be used for purchase of new
packaging equipment. The remaining $2.5 million is expected to be used for the
remodeling of existing stores, equipment for the grocery channel, and
information technology enhancements.
PAYMENTS DUE BY PERIOD
(IN THOUSANDS)
------------------------
LESS THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS
- --------------------------------------- ------------------------ ---------- ---------- ---------- --------------
Industrial development revenue bonds $ 860 $ 440 $ 420
Capital lease obligations 32 28 4
Equipment leases 87 17 35 $ 35
Retail store operating leases 23,915 5,083 9,071 5,980 $ 3,781
Fixed-price coffee purchase commitments 18,149 12,018 5,842 289
------------------------ ---------- ---------- ---------- --------------
Total contractual cash obligations $ 43,043 $ 17,586 $ 15,372 $ 6,304 $ 3,781
======================== ========== ========== ========== ==============
In addition, as of December 29, 2002, we have an outstanding standby letter
of credit of $0.9 million backing the long-term borrowings.
We expect cash flows from operations, cash and investments, and borrowing
capacity under our current line of credit to be sufficient for our operating
requirements for at least the next twelve months and to meet our contractual
obligations as they come due. However, we may require or desire additional
funds to support our capital requirements or for other purposes, such as
acquisitions or for competitive reasons, and may seek to raise such additional
funds through public or private debt or equity financings. We cannot assure you
that additional financing will be available on satisfactory terms, if at all.
Our future liquidity and cash requirements will depend on numerous factors,
including the implementation and success of our business strategy, competitive
conditions in the specialty coffee market, and general economic conditions.
Please see "Risk Factors" below for a discussion of the risks that may affect
our revenue and operations.
INFLATION
We do not believe that inflation has had a material impact on our results
of operation in recent years. However, we cannot predict what effect inflation
may have on our results of operation in the future.
20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on our
outstanding bank debt. Our revolving line of credit bears interest at certain
applicable margin levels contingent upon our leverage ratio on a quarterly
basis. The interest rate, which is either the Index rate (the higher of prime
or 50 basis points over the average of rates for overnight federal funds
transactions) plus a range from 0.00% to 0.25% or a rate equal to LIBOR plus a
range from 2.00% to 2.50%, increases as our leverage ratio increases.
Adjustments to the applicable margin level are implemented quarterly on a
prospective basis. The interest cost of our bank debt is affected by changes in
either prime, federal funds rates, or LIBOR. Such changes could adversely
impact our cost of borrowing.
The supply and price of coffee are subject to significant volatility and
can be affected by multiple factors in the producing countries, including
weather, political and economic conditions. In addition, green coffee bean
prices have been affected in the past, and may be affected in the future, by the
actions of certain organizations and associations that have historically
attempted to influence commodity prices of green coffee beans through agreements
establishing export quotas or restricting coffee supplies worldwide.
Our hedging strategy is intended to limit the cost exposure of the main
commodity used in our business, green coffee beans. We use the following
instruments to manage coffee supply and price risk:
- - Fixed-price purchase commitments;
- - Coffee futures; and
- - Coffee futures options.
We use coffee futures and coffee futures options to reduce the price risk
of our coffee purchase requirements that we cannot make or have not made on a
contractual basis. These coffee futures and coffee futures options are traded
on the New York Coffee, Sugar &Cocoa Exchange. We use these futures and options
solely for financial hedging purposes and never take actual delivery of the
coffee traded on the exchange.
Fixed-Price Purchase Commitments
We enter into fixed-price purchase commitments in order to secure an
adequate supply of quality green coffee beans and fix our cost of green coffee
beans. These commitments are made with established coffee brokers and are
denominated in U.S. dollars. As of December 29, 2002, we had approximately
$18.1 million in open fixed-priced purchase commitments with delivery dates
ranging from January 2003 through November 2006. We believe, based on
relationships established with our suppliers in the past, that the risk of
non-delivery on such purchase commitments is low.
Coffee Futures
A coffee future is a contract to buy 37,500 pounds of green coffee beans at
a contracted price and date. The price of coffee traded on the exchange is
known as the New York "C" market price. We buy higher-quality coffee that
trades at premiums to the New York "C" market price. Although this premium
varies depending on the supply and demand at the time of purchase, generally,
the price of the coffee we purchase tends to fluctuate with the New York "C"
market price. This allows us to use coffee futures and coffee futures options
to manage our exposure to price fluctuations.
We use coffee futures to hedge the price of anticipated coffee purchases to
achieve a target gross margin for roasted coffee. We convert this margin
requirement into an equivalent New York "C" market price for green coffee beans,
which we call our "threshold."
When the current New York "C" market price is below our threshold, we may
purchase coffee futures to fix the cost of our anticipated needs. Once we
contract to purchase coffee from the supplier at a fixed price, we sell the
related future. If market prices decline, we forego potential additional gross
margin and incur potential cash margin calls. However, we are comfortable with
this cost structure and enjoy the security of reduced risk.
21
Coffee Futures Options
When the current New York "C" market price is above our threshold, we may
purchase coffee futures options to limit the cost exposure for our anticipated
needs.
A coffee futures option is an option to buy a coffee future at a specific
price, known as a "trade price." The cost of the option is based on the
relationship of the trade price to the current New York "C" market price.
When we commit to purchase a specified quantity of green coffee beans and
do not fix a price, we will hedge this ''not-yet-priced'' purchase commitment by
purchasing a coffee futures option. This coffee futures option locks in a
specific price for the not-yet-priced purchase commitment but does not obligate
us to take delivery on the contract. If market prices rise, we realize gains on
the coffee futures option, which offset the increase in price we have to pay for
the coffee beans. If the market prices decline, we will set the contract price
of the not-yet-priced purchase commitment at the market price and we will let
the option expire, taking advantage of the declining market.
We also use coffee futures options to hedge anticipated coffee purchases.
When the current New York ''C'' market price is above our threshold, we may
purchase coffee futures options to limit the risk that coffee prices will
continue to rise. If market prices rise, the higher prices of our future
fixed-price coffee commitments will be offset by gains from the option. If
market prices decline, our future fixed-price coffee commitments will be set at
lower prices and the option will expire resulting in no further liability or
obligation.
The extent of our coffee futures and coffee futures options positions at
any given time depends on the amount of coffee we have contracted to purchase
and general market conditions and trends. We anticipate continuing this hedging
strategy for the foreseeable future.
We held no coffee futures options as of December 29, 2002 and we did not
enter into any coffee futures options during 2002 or 2001.
Our hedging positions are only placed by the Chief Financial Officer
through one brokerage firm that we believe to be reputable.
The following table reflects the outstanding coffee futures hedging
positions as of December 29, 2002 and December 30, 2001.
CONTRACT TRADE SETTLEMENT
NUMBER OF CONTRACTS MONTH PRICE PRICE GAIN/(LOSS)
- ------------------- -------- ------ ----------- ------------
25 May-03 $60.50 63.85 $ 31,410
------------
Unrealized Gain as of December 29, 2002 $ 31,410
============
25 May-02 $60.10 $ 48.15 $ (112,031)
------------
Unrealized (Loss) as of December 30, 2001 $ (112,031)
============
These derivative instruments qualify for hedge accounting. The effective
portion of the gains and losses are accounted for as inventory costs and are
recorded as expense or income when the related coffee is sold. The ineffective
portion is recorded as an expense or income immediately. We do not hold or
issue derivative instruments for trading purposes.
22
RECENT ACCOUNTING PRONOUNCEMENTS
In October 2001, the Financial Accounting Standards Board, (FASB), issued
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
This statement supercedes SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the
accounting and reporting provision of APB Opinion No. 30, Reporting the Results
of Operations - Reporting the Effects of Disposal of Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of business. SFAS No. 144 became effective for the
Company on December 31, 2001. Adoption of this standard did not have a material
effect on the Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit of Disposal Activities, which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt
the provision of SFAS No. 146 for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires that liability for costs associated
with an exit or disposal activity be recognized when the liability is incurred.
Under Issue 94-3, a liability for an exit cost is recognized at the date of a
company's commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amounts recognized.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002; while, the provisions of the disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002. The adoption of the measurement provisions of
FIN 45 is not expected to have a material impact on our financial position or
results of operations.
RISK FACTORS
WE MAY NOT BE SUCCESSFUL IN THE IMPLEMENTATION OF OUR BUSINESS STRATEGY OR OUR
BUSINESS STRATEGY MAY NOT BE SUCCESSFUL, EITHER OF WHICH WILL IMPEDE OUR GROWTH
AND OPERATING RESULTS.
Our business strategy emphasizes the expansion of our non-retail
distribution channels - including grocery stores, online and mail order, and
office, restaurant and food service accounts. This business strategy represents
a shift from our historic business strategy, which largely emphasized opening
and operating retail stores. Despite the change in our strategy, our retail
stores, which generated nearly 75% of our 2002 net revenue, continue to be an
important element of our business. We do not know whether we will be able to
successfully implement our business strategy or whether our business strategy
will be successful. Our ability to implement this business strategy is
dependent on our ability to:
- - Market our products on a national or international scale and over the
internet;
- - Enter into distribution and other strategic arrangements with third party
retailers and other potential distributors of our coffee;
- - Increase our brand recognition on a national and international scale;
- - Identify and lease strategic locations suitable for new stores; and
- - Manage growth in administrative overhead and distribution costs likely to
result from the planned expansion of our retail and non-retail
distribution channels.
Our revenue may be adversely affected if we fail to implement our business
strategy or if we divert resources to a business strategy that ultimately proves
unsuccessful.
23
BECAUSE OUR BUSINESS IS CENTERED ON A SINGLE PRODUCT, SPECIALTY COFFEE, IF THE
DEMAND FOR SPECIALTY COFFEE DECREASES, OUR BUSINESS COULD SUFFER.
Sales of specialty coffee constituted nearly 83% of our 2002 net revenue.
Demand for specialty coffee is affected by many factors, including:
- - Consumer tastes and preferences;
- - National, regional and local economic conditions; and
- - Demographic trends.
Because we are highly dependent on consumer demand for specialty coffee, a
shift in consumer preferences away from specialty coffee would harm our business
more than if we had more diversified product offerings. If customer demand for
specialty coffee decreases, our sales would decrease accordingly.
IF WE FAIL TO CONTINUE TO DEVELOP AND MAINTAIN OUR BRAND, OUR BUSINESS COULD
SUFFER.
We believe that maintaining and developing our brand is critical to our
success and that the importance of brand recognition may increase as a result of
competitors offering products similar to ours. Because the majority of our
retail stores are located on the west coast, primarily in California, our brand
recognition remains largely regional. Our brand building initiative involves
increasing the availability of our products, increasing marketing expenditures
and opening new stores in flagship locations to increase awareness of our brand
and create and maintain brand loyalty. If our brand building initiative is
unsuccessful, we may never recover the expenses incurred in connection with
these efforts and we may be unable to increase our future revenue or implement
our business strategy.
Our success in promoting and enhancing the Peet's brand will also depend on
our ability to provide customers with high quality products and customer
service. Although we take measures to ensure that we sell only fresh roasted
whole bean coffee and or retail employees properly prepare our coffee beverages,
we have no control over our whole bean coffee products once purchased by
customers. Accordingly, customers may prepare coffee from our whole bean coffee
inconsistent with our standards, store our whole bean coffee for long periods of
time or resell our whole bean coffee without our consent, which in each case,
potentially affects the quality of the coffee prepared from our products. If
customers do not perceive our products and service to be of high quality, then
the value of our brand may be diminished and, consequently, our ability to
implement our business strategy may be adversely affected.
BECAUSE OUR BUSINESS IS BASED PRIMARILY IN CALIFORNIA, A WORSENING OF ECONOMIC
CONDITIONS, A DECREASE IN CONSUMER SPENDING OR A CHANGE IN THE COMPETITIVE
CONDITIONS IN THIS MARKET MAY SUBSTANTIALLY DECREASE OUR REVENUE AND MAY
ADVERSELY IMPACT OUR ABILITY TO IMPLEMENT OUR BUSINESS STRATEGY.
Our California retail stores generated 67% of our 2002 net revenue and a
substantial portion of the revenue from our other distribution channels is
generated in California. We expect that our California operations will continue
to generate a substantial portion of our revenue. In addition, our California
retail stores provide us with means for increasing brand awareness, building
customer loyalty and creating a premium specialty coffee brand. As a result, an
economic downturn or other decrease in consumer spending in California may not
only lead to a substantial decrease in revenue, but may also adversely impact
our ability to market our brand, build customer loyalty, or otherwise implement
our business strategy.
IF WE ARE UNABLE TO CONTINUE LEASING OUR RETAIL LOCATIONS OR OBTAIN LEASES FOR
NEW STORES, OUR EXISTING OPERATIONS AND OUR ABILITY TO EXPAND MAY BE ADVERSELY
AFFECTED.
All of our 68 retail locations are on leased premises. If we are unable to
renew these leases, our revenue and profits could suffer. In addition, we
intend to lease other premises in connection with the planned expansion of our
retail operations. Because we compete with other retailers and restaurants for
store sites and some landlords may grant exclusive locations to our competitors,
we may not be able to obtain new leases or renew existing leases on acceptable
terms. This could adversely impact our revenue growth and brand building
initiatives.
24
THE DIRECT STORE DELIVERY SYSTEM HAS SIGNIFICANT START UP COSTS AND ONGOING
OPERATING EXPENSES AND OUR PROFIT MARGIN COULD BE ADVERSELY IMPACTED IF
CORRESPONDING NET REVENUE DOES NOT MATERIALIZE.
We implemented a direct store delivery sales and distribution system during
the fourth quarter of 2002 to support growth in the grocery area and to ensure
store level execution is being managed to our standards. This DSD system
requires our route sales representatives to make weekly deliveries to stores in
our own trucks, properly shelve the product, work to resolve pricing
discrepancies, rotate to ensure freshness, sell and erect free-standing
displays, and forge store-level selling relationships. The deployment of the
DSD system has substantial startup and continuing fixed costs which we expect to
be offset by significant revenue increase over time. If we are not able to
increase the expected number of grocery accounts and/or related net revenue to
support the expenses we have incurred and will continue to incur, this could
adversely impact our profit margin.
BECAUSE WE RELY HEAVILY ON COMMON CARRIERS TO SHIP OUR COFFEE ON A DAILY BASIS,
ANY DISRUPTION IN THEIR SERVICES OR INCREASE IN SHIPPING COSTS COULD ADVERSELY
AFFECT OUR BUSINESS.
We rely on a number of common carriers to deliver coffee to our customers
and retail stores. We consider roasted coffee a perishable product and we rely
on these common carriers to deliver fresh roasted coffee on a daily basis. We
have no control over these common carriers and the services provided by them may
be interrupted as a result of labor shortages, contract disputes or other
factors. If we experience an interruption in these services, we may be unable
to ship our coffee in a timely manner. A delay in shipping could:
- - Have an adverse impact on the quality of the coffee shipped, and thereby
adversely affect our brand and reputation;
- - Result in the disposal of an amount of coffee that could not be shipped in
a timely manner; and
- - Require us to contract with alternative, and possibly more expensive,
common carriers.
Any significant increase in shipping costs could lower our profit margins
or force us to raise prices, which could cause our revenue and profits to
suffer.
WE DEPEND ON THE EXPERTISE OF KEY PERSONNEL. IF THESE INDIVIDUALS LEAVE OR
CHANGE THEIR ROLE WITHIN OUR COMPANY WITHOUT EFFECTIVE REPLACEMENTS, OUR
OPERATIONS MAY SUFFER.
The success of our business is dependent to a large degree on our
management and our coffee roasters and purchasers. If members of our management
leave without effective replacements, our ability to implement our business
strategy could be impaired. If we lost the services of our coffee roasters and
purchasers, our ability to source and purchase a sufficient supply of high
quality coffee beans and roast coffee beans consistent with our quality
standards could suffer. In either case, our business and operations could be
adversely affected.
WE MAY NOT BE ABLE TO HIRE OR RETAIN ADDITIONAL MANAGEMENT AND OTHER PERSONNEL
AND OUR RECRUITING AND TRAINING COSTS MAY INCREASE AS A RESULT OF TURNOVER, BOTH
OF WHICH MAY INCREASE OUR COSTS AND REDUCE OUR PROFITS AND MAY ADVERSELY IMPACT
OUR ABILITY TO IMPLEMENT OUR BUSINESS STRATEGY.
The success of our business depends upon our ability to attract and retain
highly motivated, well-qualified management and other personnel, including
technical personnel and retail employees. We face significant competition in
the recruitment of qualified employees. Our ability to execute our business
strategy may suffer if:
- - We are unable to recruit or retain a sufficient number of qualified
employees;
- - The costs of employee compensation or benefits increase substantially; or
- - The costs of outsourcing certain tasks to third party providers increase
substantially.
We expend significant resources in training our retail managers and
employees. During the past few years, retail employee turnover has increased to
approximately 75% per year. If turnover continues to increase, we may incur
additional recruiting and training costs.
25
BECAUSE WE HAVE ONLY ONE ROASTING FACILITY, A SIGNIFICANT INTERRUPTION IN THE
OPERATION OF THIS FACILITY COULD POTENTIALLY DISRUPT OUR OPERATIONS.
We have only one coffee roasting and distribution facility. A significant
interruption in the operation of this facility, 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. Moreover, our roasting and distribution
facility and most of our stores are located near several major earthquake
faults. The impact of a major earthquake on our facilities, infrastructure and
overall operations is difficult to predict and an earthquake could seriously
disrupt our entire business process.
Our earthquake insurance covers net income, continuing normal operating
expenses and extra expenses incurred during the period of restoration. However,
in the event of a catastrophic earthquake, our coverage is limited and we would
incur additional expenses.
INCREASES IN THE COST OF HIGH QUALITY ARABICA COFFEE BEANS COULD REDUCE OUR
GROSS MARGIN AND PROFIT.
Coffee is a trade commodity and, in general, its price can fluctuate
depending on:
- - Weather patterns in coffee-producing countries;
- - Economic and political conditions affecting coffee-producing countries;
- - Foreign currency fluctuations; and
- - The ability of coffee-producing countries to agree to export quotas.
Coffee prices are currently near historical lows and we believe they are
likely to increase in the future. If the cost of our green coffee beans
increases due to any of these or other factors, we may not be able to pass along
those costs to our customers because of the competitive nature of the specialty
coffee industry. If we are unable to pass along increased coffee costs, our
margins will decrease and our profitability will suffer accordingly. In
addition, our hedging policy may not be effective in controlling our coffee
costs and the brokers with whom we have fixed price coffee purchase commitments
may not deliver under those commitments. In either case, our coffee costs may
increase and our profitability may suffer.
DECREASED AVAILABILITY OF HIGH QUALITY ARABICA COFFEE BEANS COULD RESULT IN A
DECREASE IN REVENUE AND JEOPARDIZE OUR ABILITY TO EXPAND OUR BUSINESS.
Arabica coffee beans of the quality we purchase are not readily available
on the commodity markets. We depend on our relationships with coffee brokers,
exporters and growers for the supply of our primary raw material, high quality
Arabica coffee beans. In both 2002 and 2001, we purchased over half of our
green coffee beans through one broker. If our relationships with coffee
brokers, exporters and growers deteriorate, we may be unable to procure a
sufficient quantity of high quality coffee beans. In such case, we may not be
able to fulfill the demand of our existing customers, supply new retail stores
or expand other channels of distribution. A raw material shortage could result
in decreased revenue or could impair our ability to expand our business.
POLITICAL INSTABILITY IN COFFEE GROWING REGIONS COULD RESULT IN A DECREASE IN
THE AVAILABILITY OF HIGH QUALITY ARABICA COFFEE BEANS NEEDED FOR THE CONTINUED
OPERATION AND GROWTH OF OUR BUSINESS AND AN INCREASE IN OUR OPERATING COSTS.
We roast Arabica coffee beans from many different regions to produce 32
types and blends of coffee. The political situation in many of those regions,
including Africa, Indonesia and Central and South America, can be unstable, and
such instability could affect our ability to purchase coffee from those regions.
If Arabica coffee beans from a region become unavailable or prohibitively
expensive, we may be forced to discontinue particular coffee types and blends or
substitute coffee beans from other regions in our blends. Frequent
substitutions and changes in our coffee product lines may lead to cost
increases, customer alienation and fluctuations in our gross margins.
Furthermore, a worldwide supply shortage of the high quality Arabica coffee
beans we purchase could have a material adverse effect on our business.
26
OUR ROASTING METHODS ARE NOT PROPRIETARY, SO COMPETITORS MAY BE ABLE TO
DUPLICATE THEM, WHICH COULD HARM OUR COMPETITIVE POSITION.
We consider our roasting methods essential to the flavor and richness of
our roasted whole bean coffee and, therefore, essential to our brand. Because
we do not hold any patents for our roasting methods, it may be difficult for us
to prevent competitors from copying our roasting methods. If our competitors
copy our roasting methods, the value of our brand may be diminished, and we may
lose customers to our competitors. In addition, competitors may be able to
develop roasting methods that are more advanced than our roasting methods, which
may also harm our competitive position.
COMPETITION IN THE SPECIALTY COFFEE MARKET IS INTENSE AND COULD AFFECT OUR
PROFITABILITY.
The specialty coffee market is highly fragmented. Our primary competitors
in whole bean specialty coffee sales include Gevalia (Kraft Foods), Green
Mountain Coffee, Illy Caffe , Millstone (Procter & Gamble), Seattle's Best (AFC
Enterprises) and Starbucks. There are numerous smaller, regional brands that
also compete in this category. In addition, we compete indirectly against all
other coffee brands on the market. A number of nationwide coffee marketers,
such as Kraft Foods, Procter & Gamble and Nestle, are distributing premium
coffee brands in supermarkets. These premium coffee brands may serve as
substitutes for our whole bean coffee. In addition to competing with other
distributors of whole bean coffee, we compete with retailers of prepared
beverages, including coffee house chains, particularly Starbucks, numerous
convenience stores, restaurants, coffee shops and street vendors. If we do not
succeed in effectively differentiating ourselves from our competitors or our
competitors adopt our strategies, then our competitive position will be
weakened.
Despite competing in a fragmented product category, whole bean specialty
coffee brands are being established across multiple distribution channels.
Several competitors are aggressive in obtaining distribution in specialty
grocery and gourmet food stores, through online and mail order and in office,
restaurant and food service locations. We have only recently begun to penetrate
these channels. Other competitors may have an advantage over us based on their
earlier entry into these distribution channels.
Competition in the specialty coffee market is becoming increasingly intense
as relatively low barriers to entry encourage new competitors to enter the
specialty coffee market. Many of these new market entrants may have
substantially greater financial, marketing and operating resources than us. In
addition, many of our existing competitors have substantially greater financial,
marketing and operating resources than us.
ADVERSE PUBLIC OR MEDICAL OPINION ABOUT CAFFEINE MAY HARM OUR BUSINESS.
Our specialty coffee contains significant amounts of caffeine and other
active compounds, the health effects of some of which are not fully understood.
A number of research studies conclude or suggest that excessive consumption of
caffeine may lead to increased heart rate, nausea and vomiting, restlessness and
anxiety, depression, headaches, tremors, sleeplessness and other adverse health
effects. An unfavorable report on the health effects of caffeine or other
compounds present in coffee could significantly reduce the demand for coffee,
which could harm our business and reduce our sales and profits.
ADVERSE PUBLICITY REGARDING CUSTOMER COMPLAINTS MAY HARM OUR BUSINESS.
We may be the subject of complaints or litigation from customers alleging
beverage and food-related illnesses, injuries suffered on the premises or other
quality, health or operational concerns. Adverse publicity resulting from such
allegations may materially adversely affect us, regardless of whether such
allegations are true or whether we are ultimately held liable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
All information required by this item is included on pages F-1 to F-7 in
Item 15 of this Report and is incorporated in this item by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information respecting continuing directors and nominees of the Company is
set forth under the caption "Election of Directors" in the Company's Proxy
Statement relating to its 2003 Annual Meeting of Stockholders and is
incorporated by reference into this Form 10-K Report. The Proxy Statement will
be filed with the Securities and Exchange Commission in accordance with Rule
14a-6(c) promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act."). With the exception of the foregoing information and other
information specifically incorporated by reference into this Form 10-K Report,
the Proxy Statement is not being filed as a part hereof. Information respecting
executive officers of the Company is set forth at Part I of this Report.
Information respecting compliance with Section 16(a) of the Exchange Act is
set forth under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement and is incorporated by reference into this
Form 10-K Report.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation required by Item 11 is set
forth under the captions "Executive Compensation," "Stock Option Grants and
Exercises," "Employment Agreements" and "Compensation Committee Interlocks" in
the Proxy Statement and is incorporated by reference into this Form 10-K Report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management required by Item 12 is set forth under the caption "Security
Ownership of Certain Beneficial Owners and Management" and "Our Equity Incentive
Plans" in the Proxy Statement and is incorporated by reference into this Form
10-K Report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions
required by Item 13 is set forth under the captions "Employment Agreements" and
"Certain Transactions" in the Proxy Statement and is incorporated by reference
into this Form 10-K Report.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Based upon their evaluation of our disclosure controls and procedures
conducted within 90 days of the date of filing this report on Form 10-K, our
Chief Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c)
of the Securities Exchange Act of 1934, as amended) are effective.
(b) Changes in Internal Controls
There were no significant changes in the internal controls of Peet's or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Limitations on the Effectiveness of Controls.
Despite the periodic review of our disclosure controls and procedures, such
controls and procedures may not prevent all error and all fraud. Inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Because of the inherent limitations in any control system, no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within the company have been detected. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the controls.
28
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-K.
(a)(1) Index to Consolidated Financial Statements.
The following Consolidated Financial Statements of Peet's Coffee &Tea, Inc.
and its subsidiaries are filed as part of this Form 10-K:
PAGE
----
Independent Auditors' Report F-2
- ----------------------------------------------------------------------------------------------- ----
Consolidated Balance Sheets as of December 30, 2001 and December 29, 2002 F-3
- ----------------------------------------------------------------------------------------------- ----
Consolidated Statements of Operations for the Years Ended December 31, 2000, December 30, 2001,
and December 29, 2002 F-4
- ----------------------------------------------------------------------------------------------- ----
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2000, December
30, 2001, and December 29, 2002 F-5
- ----------------------------------------------------------------------------------------------- ----
Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, December 30, 2001,
and December 29, 2002 F-6
- ----------------------------------------------------------------------------------------------- ----
Notes to Consolidated Financial Statements F-7
- ----------------------------------------------------------------------------------------------- ----
(a)(2) Index to Financial Statement Schedule.
Schedules are omitted because they are not applicable, not required or
because the required information is included in the Consolidated Financial
Statements or Notes thereto.
(a)(3) Listing of Exhibits
EXHIBIT DESCRIPTION
- ------- -----------
3.1 Amended and Restated Articles of Incorporation.*
3.2 Amended and Restated Bylaws.*
4.1 Form of common stock certificate.*
10.1 Credit Agreement, dated as of September 1, 2000, among Peet's Coffee
and Tea, Inc., Peet's Companies, Inc., Peet's Trademark Company and
General Electric Capital Corporation.*
10.2 Letter Agreement dated October 11, 2000 among Peet's Coffee and Tea,
Inc., Peet's Companies, Inc., Peet's Trademark Company and General
Electric Capital Corporation.*
10.3 First Amendment to Credit Agreement dated as of January 19, 2001 among
Peet's Operating Company, Inc. (formerly Peet's Coffee and Tea, Inc.),
Peet's Coffee & Tea, Inc. (formerly Peet's Companies, Inc.), Peet's
Trademark Company and General Electric Capital Corporation.*
10.4 Loan Agreement, dated as of December 1, 1995, by and between California
Statewide Communities Development Authority and Peet's Coffee and Tea,
Inc.*
10.5 Amended and Restated 1993 Stock Option Plan. (1)*
29
10.6 1994 California Stock Option Plan. (1)*
10.7 1997 Equity Incentive Plan and form of Stock Option Agreement. (1)*
10.8 Peet's Operating Company, Inc. Savings and Retirement Plan. (1)*
10.9 2000 Equity Incentive Plan and form of Stock Option Agreement. (1)*
10.10 2000 Non-Employee Director Plan and form of Stock Option Agreement.
(1)*
10.11 2000 Employee Stock Purchase Plan and form of Offering. (1)*
10.12 Peet's Operating Company, Inc. Key Employee Severance Benefit Plan.
(2)*
10.13 Change of Control Option Acceleration Plan. (1)*
10.14 Advisory Engagement Letter dated December 9, 1996, between Peet's
Operating Company, Inc. and Jesse.Hansen&Co.*
10.15 Peet's Operating Company, Inc. Key Employment Agreement for Chairman
dated as of January 4, 1999. (2)*
10.16 Peet's Operating Company, Inc. Key Employment Agreement for Chief
Executive Officer dated as of May 9, 2000. (2)*
10.17 Peet's Operating Company, Inc. Key Employment Agreement for Vice
President, Coffee dated as of June 6, 2000. (2)*
10.18 Peet's Operating Company, Inc. Key Employment Agreement for Chief
Financial Officer dated as of January 4, 1999. (2)*
10.19 Peet's Operating Company, Inc. Key Employment Agreement for Vice
President, Marketing dated as of January 4, 1999. (2)*
10.20 Form of Indemnity Agreement between the registrant and each of its
directors and officers. (2)
10.21 Second Amendment to Credit Agreement, dated as of June 29, 2001, among
Peet's Operating Company, Inc., Peet's Trademark Company, Peet's
Coffee & Tea, Inc. and General Electric Capital Corporation.
Incorporated by reference to Exhibit 10.23 to the Company's quarterly
report on Form 10-Q for the quarter ended July 1, 2001.
10.22 Third Amendment to Credit Agreement, dated as of March 1, 2002, among
Peet's Operating Company, Inc., Peet's Trademark Company, Peet's
Coffee & Tea, Inc. and General Electric Capital Corporation.
Incorporated by reference to Exhibit 10.24 to the Company's annual
filing on Form 10-K for the year ended December 30, 2001.
10.23 Fourth Amendment to Credit Agreement dated as of April 23, 2002 among
Peet's Operating Company, Inc., Peet's Trademark Company, Peet's
Coffee & Tea, Inc. and General Electric Capital Corporation.
Incorporated by reference to Exhibit 10.24 to the Company's quarterly
report on Form 10-Q for the quarter ended March 31, 2002.
10.24 Peet's Coffee & Tea, Inc. Key Employment Agreement for Chief Executive
Officer dated as of May 6, 2002. Incorporated by reference to Exhibit
10.17 to the Company's quarterly report on Form 10-Q for the quarter
ended June 30, 2002. (1)
10.25 Peet's Coffee & Tea, Inc. Amended and Restated 2000 Non-Employee
Director Stock Option Plan and Form of Stock Option Agreement.
Incorporated by reference to Exhibit 10.10 to the Company's quarterly
report on Form 10-Q for the quarter ended September 29, 2002. (1)
30
10.26 Fifth Amendment to Credit Agreement dated as of December 31, 2002
among Peet's Operating Company, Inc., Peet's Trademark Company, Peet's
Coffee & Tea, Inc. and General Electric Capital Corporation.
10.27 Sixth Amendment to Credit Agreement dated as of February 21, 2003
among Peet's Operating Company, Inc., Peet's Trademark Company, Peet's
Coffee & Tea, Inc. and General Electric Capital Corporation.
21.1 Subsidiaries of the registrant.*
23.1 Consent of Deloitte & Touche LLP.
99.1 Certification of the Company's Chief Executive Officer, Patrick O'Dea,
pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
99.2 Certification of the Company's Chief Financial Officer, Mark N.
Rudolph, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
______________
* Incorporated by reference to Exhibit 10.18 to the Registrant's Information
Statement on Form S-1 (File No. 333-47957) filed on October 13, 2000, as
subsequently amended.
(1) Compensatory plan or arrangement.
(2) Management contract.
(b) No reports on Form 8-K were filed by the Company during the quarter
ended December 29, 2002.
31
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.
Date: March 28, 2003 PEET'S COFFEE & TEA, INC.
By: /s/ Patrick J. O'Dea
-----------------------
Patrick J. O'Dea
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Patrick J. O'Dea and Mark N. Rudolph and
each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place, and
stead, in any and all capacities, to sign any and all amendments to this report
and to file the same, with all granting unto said attorneys-in-fact and agents,
and each of them, full power and authority to do and perform each and every act
and thing requisite and necessary to be done in connection therewith, as fully
to all intents and purposes as he might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or any of them, or
their or his substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ PATRICK J. O'DEA President, Chief Executive Officer March 28, 2003
- -----------------------
Patrick J. O'Dea and Director (Principal Executive
Officer)
/s/ MARK N. RUDOLPH Vice President, Chief Financial March 28, 2003
- ---------------------
Mark N. Rudolph Officer, Secretary and Treasurer
(Principal Financial and Accounting
Officer)
/s/ CHRISTOPHER P. MOTTERN Chairman March 28, 2003
- -----------------------------
Christopher P. Mottern
/s/ GERALD BALDWIN Director March 28, 2003
- --------------------
Gerald Baldwin
/s/ HILARY BILLINGS Director March 28, 2003
- ---------------------
Hilary Billings
/s/ GORDON A. BOWKER Director March 28, 2003
- -----------------------
Gordon A. Bowker
/s/ H. WILLIAM JESSE, JR. Director March 28, 2003
- ----------------------------
H. William Jesse, Jr.
/s/ JEAN-MICHEL VALETTE Director March 28, 2003
- -------------------------
Jean-Michel Valette
32
CERTIFICATIONS
I, Patrick J. O'Dea, certify that:
1. I have reviewed this annual report on Form 10-K of Peet's Coffee &
Tea, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Patrick J. O'Dea
-----------------------
Patrick J. O'Dea
President and Chief Executive Officer
33
I, Mark N. Rudolph, certify that:
1. I have reviewed this annual report on Form 10-K of Peet's Coffee &
Tea, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Mark N. Rudolph
----------------------
Mark N. Rudolph
Vice President, Chief Financial Officer,
Treasurer and Secretary
34
INDEX TO FINANCIAL STATEMENTS
Page
- --------------------------------------------------------------------------------------
Independent Auditors' Report F-2
- -------------------------------------------------------------------------------------- ---
Consolidated Balance Sheets as of December 30, 2001 and December 29, 2002 F-3
- -------------------------------------------------------------------------------------- ---
Consolidated Statements of Operations for the Years Ended December 31, 2000,
December 30, 2001, and December 29, 2002 F-4
- -------------------------------------------------------------------------------------- ---
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2000,
December 30, 2001, and December 29, 2002 F-5
- -------------------------------------------------------------------------------------- ---
Consolidated Statements of Cash Flows for the Years Ended December 31, 2000,
December 30, 2001, and December 29, 2002 F-6
- -------------------------------------------------------------------------------------- ---
Notes to Consolidated Financial Statements F-7
- -------------------------------------------------------------------------------------- ---
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Peet's Coffee & Tea, Inc.
We have audited the accompanying consolidated balance sheets of Peet's
Coffee & Tea, Inc and subsidiaries as of December 30, 2001 and December 29,
2002, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
29, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Peet's Coffee & Tea, Inc. and
subsidiaries as of December 30, 2001 and December 29, 2002 and the results of
their operations and their cash flows for each of the three years in the period
ended December 29, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 12 to the financial statements, effective January 1,
2001, the Company changed its method of accounting for derivative financial
instruments to conform to Statement of Financial Accounting Standards No. 133.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
February 13, 2003
F-2
PEET'S COFFEE & TEA, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 30, DECEMBER 29,
2001 2002
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,718 $ 19,672
Accounts receivable (net of allowance of $58 and $75) 1,371 2,210
Income tax receivable 1,117
Inventories 8,945 11,007
Deferred income taxes 288 461
Prepaid expenses 1,100 1,342
-------------- -------------
Total current assets 14,422 35,809
Property and equipment, net 23,629 27,929
Deferred income taxes 1,305
Intangible and other assets, net 2,053 3,305
Long-term U.S. Government & Agency securities 28,102
-------------- -------------
Total assets $ 41,409 $ 95,145
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------
Current liabilities:
Borrowings under line of credit $ 1,968
Accounts payable 4,166 $ 6,463
Accrued compensation and benefits 2,355 3,741
Other accrued liabilities 2,105 2,638
Current portion of long-term borrowings 513 468
-------------- -------------
Total current liabilities 11,107 13,310
Long-term borrowings, less current portion 895 424
Deferred income taxes 181
Deferred lease credits 637 726
-------------- -------------
Total liabilities 12,639 14,641
-------------- -------------
Commitments and contingencies
Shareholders' equity:
Common stock, no par value; authorized 50,000,000 shares; issued and
outstanding: 8,272,000 shares and 12,103,000 shares 31,609 78,014
Accumulated other comprehensive income (loss), net of tax (407) 265
Retained earnings (accumulated deficit) (2,432) 2,225
-------------- -------------
Total shareholders' equity 28,770 80,504
-------------- -------------
Total liabilities and shareholders' equity $ 41,409 $ 95,145
============== =============
See notes to consolidated financial statements.
F-3
PEET'S COFFEE & TEA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2000 2001 2002
-------- -------- ---------
Net revenue $84,302 $94,400 $104,073
-------- -------- ---------
Operating expenses:
Cost of sales and related occupancy expenses 40,655 45,357 48,146
Operating expenses 28,073 30,617 33,221
Marketing and advertising 6,069 4,812 4,554
Depreciation and amortization 4,576 5,038 4,568
General and administrative expenses 5,893 6,243 6,732
-------- -------- ---------
Total operating costs and expenses 85,266 92,067 97,221
-------- -------- ---------
Income (loss) from operations (964) 2,333 6,852
Interest income 25 47 660
Interest expense (1,933) (476) (120)
-------- -------- ---------
Income (loss) before income taxes (2,872) 1,904 7,392
Income tax provision (benefit) (596) 749 2,735
-------- -------- ---------
Net income (loss) $(2,276) $ 1,155 $ 4,657
======== ======== =========
Net income (loss) per share:
Basic $ (0.50) $ 0.15 $ 0.43
======== ======== =========
Diluted $ (0.50) $ 0.14 $ 0.40
======== ======== =========
Shares used in calculation of net income (loss) per share:
Basic 4,515 7,941 10,919
======== ======== =========
Diluted 4,515 8,212 11,627
======== ======== =========
See notes to consolidated financial statements.
F-4
PEET'S COFFEE & TEA, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
SERIES A RETAINED ACCUMULATED
PREFERRED STOCK COMMON STOCK EARNINGS/ OTHER TOTAL
--------------- ------------
SHARES SHARES ACCUMULATED COMPREHENSIVE SHAREHOLDERS'
OUTSTANDING AMOUNT OUTSTANDING AMOUNT DEFICIT INCOME/(LOSS) EQUITY
------------ -------- ----------- ------- ------------- --------------- ---------------
Balance at January 2, 2000 471 $ 4,537 4,514 $ 7,966 $ (1,312) $ 11,191
---------------
Stock options exercised,
including tax benefit 2 13 13
----------- ---------------
Amortization of
stock compensation 238 238
------- ---------------
Net loss (2,275) (2,275)
------------- ---------------
Balance at December 31, 2000 471 $ 4,537 4,516 $ 8,217 $ (3,587) $ 9,167
Conversion of preferred shares (471) (4,537) 943 4,537 -
Stock sold in
Initial Public Offering,
net of expenses 2,682 17,793 17,793
Stock options exercised,
including tax benefit 94 507 507
Stock sold in Employee
Stock Purchase Program 37 250 250
Amortization of
stock compensation 305 305
Cumulative effect of
accounting change
(FAS 133), net of tax of $519 $ (785)
Unrealized losses
on cash flow hedges,
net of tax of $195 (295)
Reclassification of
net losses on cash
flow hedges to
to cost of goods sold,
net of tax of $445 673
---------------
Other comprehensive loss (407) (407)
Net income 1,155 1,155
------------- ---------------
Balance at December 30, 2001 - - 8,272 $31,609 $ (2,432) $ (407) $ 28,770
Stock sold in public offering,
net of expenses 3,138 41,030 41,030
Stock options and
warrants exercised,
including tax benefit 610 4,517 4,517
Stock sold in Employee
Stock Purchase Program 83 568 568
Amortization of
stock compensation 290 290
Unrealized gains on
cash flow hedges,
net of tax of $38 66
Reclassification of
net losses on cash
flow hedges to
cost of goods sold,
net of tax of $252 379
Net unrealized gain
on investments,
net of tax of $133 227
---------------
Other comprehensive income 672 672
Net income 4,657 4,657
------------- ---------------
Balance at December 29, 2002 - $ - 12,103 $78,014 $ 2,225 $ 265 $ 80,504
============ ======== =========== ======= ============= =============== ===============
COMPREHENSIVE
INCOME/(LOSS)
---------------
Balance at January 2, 2000 $ (144)
===============
Stock options exercised,
including tax benefit
Amortization of
stock compensation
Net loss $ (2,275)
---------------
Balance at December 31, 2000 $ (2,275)
===============
Conversion of preferred shares
Stock sold in
Initial Public Offering,
net of expenses
Stock options exercised,
including tax benefit
Stock sold in Employee
Stock Purchase Program
Amortization of
stock compensation
Cumulative effect of
accounting change
(FAS 133), net of tax of $519
Unrealized losses
on cash flow hedges,
net of tax of $195
Reclassification of
net losses on cash
flow hedges to
to cost of goods sold,
net of tax of $445
Other comprehensive loss (407)
Net income 1,155
---------------
Balance at December 30, 2001 $ 748
===============
Stock sold in public offering,
net of expenses
Stock options and
warrants exercised,
including tax benefit
Stock sold in Employee
Stock Purchase Program
Amortization of
stock compensation
Unrealized gains on
cash flow hedges,
net of tax of $38
Reclassification of
net losses on cash
flow hedges to
cost of goods sold,
net of tax of $252
Net unrealized gain
on investments,
net of tax of $133
Other comprehensive income $ 672
Net income 4,657
---------------
Balance at December 29, 2002 $ 5,329
===============
See notes to consolidated financial statements.
F-5
PEET'S COFFEE & TEA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
2000 2001 2002
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $ (2,275) $ 1,155 $ 4,657
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 5,210 5,693 5,251
Tax benefit from exercise of stock options and amortization of discounted
stock options 238 305 1,543
Deferred income taxes (472) 718 1,274
Reclassification of hedging losses in OCI 673 379
Ineffective portion of hedges 169 27
Loss on disposition of assets 188 6 11
Changes in other assets and liabilities:
Accounts receivable (214) (309) (1,956)
Inventories (1,730) (1,309) (2,062)
Prepaid expenses and other 115 (217) (211)
Other assets (207) 22 (1,530)
Accounts payable, accrued liabilities and other liabilities 1,816 (1,123) 4,419
--------- --------- ---------
Net cash provided by operating activities 2,669 5,783 11,802
--------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment (5,518) (6,511) (9,316)
Proceeds from sales of property and equipment 4 17
Additions to intangible assets (276) (350) (35)
Purchase of long term U.S. Government & Agency securities, net (27,875)
--------- --------- ---------
Net cash used in investing activities (5,790) (6,844) (37,226)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from borrowings 46,258
Repayments of debt (41,544) (17,451) (2,484)
Payments of stock offering costs (completed in January 2001) (1,082)
Net proceeds from issuance of common stock 13 19,632 44,862
--------- --------- ---------
Net cash provided by financing activities 3,645 2,181 42,378
--------- --------- ---------
Change in cash and cash equivalents 524 1,120 16,954
Cash and cash equivalents, beginning of period 1,074 1,598 2,718
--------- --------- ---------
Cash and cash equivalents, end of period $ 1,598 $ 2,718 $ 19,672
========= ========= =========
Supplemental cash flow disclosures:
Cash paid for:
Interest $ 1,668 $ 478 $ 48
Income taxes 108 29 2,050
NON CASH INVESTING AND FINANCING ACTIVITIES -
Property acquired under capital lease $ 476
Conversion of preferred stock to common stock upon IPO $ 4,537
IPO fees accrued at December 31, 2000 applied to proceeds in 2001 1,082
FAS 133 coffee hedging activities:
Inventory (1,304)
Deferred taxes 269 $ (39)
Other comprehensive loss 407 (65)
Other liabilities 628 104
See notes to consolidated financial statements.
F-6
PEET'S COFFEE & TEA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. HISTORY AND ORGANIZATION
Peet's Coffee & Tea, Inc., (the ''Company'') sells fresh roasted coffee,
hand selected tea and related items in several distribution channels, including
specialty grocery and gourmet food stores, online and mail order, office and
restaurant accounts and company-operated retail stores. At December 30, 2001
and December 29, 2002, the Company operated 60 and 65 retail stores,
respectively, in California, Illinois, Oregon, and Massachusetts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of the Company and its subsidiaries. All significant intercompany
transactions have been eliminated in consolidation.
USE OF ESTIMATES - The preparation of 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 disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
RECLASSIFICATIONS - Certain reclassifications have been made to prior
years' financial statements in order to conform with the current year's
presentation.
YEAR END - The Company's year end is the Sunday closest to December 31. The
years 2002, 2001, and 2000 included 52 weeks.
CASH AND CASH EQUIVALENTS - The Company considers all liquid investments
with original maturities of three months or less to be cash equivalents.
INVENTORIES - Raw materials consist primarily of green bean coffee.
Finished goods include roasted coffee, tea, accessory products, spices, and
packaged foods. All products are valued at the lower of cost or market using the
first-in, first-out method, except green bean and roasted coffee, which is
valued at the average cost.
PROPERTY AND EQUIPMENT are stated at cost. Depreciation and amortization
are recorded on the straight-line method over the estimated useful lives of the
property and equipment, which range from 3 to 10 years. Leasehold improvements
are amortized using the straight-line method over the lesser of the estimated
useful life or the term of the related lease, which range from 3 to 10 years.
INTANGIBLES AND OTHER ASSETS include lease rights, contract acquisition
costs, deposits, and restricted cash. Lease rights represent payments made to
lessors and others to secure retail locations and are amortized on the
straight-line method over the life of the related lease from 5 to 15 years.
Intangibles, net of amortization, were $1,251,000 and $1,040,000 at December 30,
2001 and December 29, 2002, respectively. The related accumulated amortization
was $1,636,000 and $1,882,000 at December 30, 2001 and December 29, 2002,
respectively. Amortization expense for 2000, 2001, and 2002 was $220,000,
$238,000 and $246,000, respectively. Future amortization expense for 2003
through 2007 is estimated at $153,000, $168,000, $148,000, $123,000, and
$114,000, respectively. Contract acquisition costs represents a payment made to
a retailer to obtain distribution for a specified period of time and is being
amortized as a reduction of revenue over the contract period.
INVESTMENT POLICY - Investments are classified as available for sale and
are recorded at fair market value. Any unrealized gains and losses are recorded
in other comprehensive income/loss.
F-7
IMPAIRMENT OF LONG-LIVED ASSETS - The Company evaluates the recoverability
of its long-lived assets whenever events or changes in circumstances have
indicated that the carrying amount of its assets might not be recoverable. If
the fair value is less than the carrying amount of the asset, a loss is
recognized for the difference. In 2000, an impairment loss of $129,000 was
recorded as general and administrative expense. No impairment loss was recorded
in 2001 or in 2002.
ACCRUED COMPENSATION AND BENEFITS - Beginning in March 2002, the Company
modified its workers' compensation insurance policy to a high deductible program
with an overall program ceiling to minimize exposure. We began recording an
estimated liability for the self-insured portion of the workers' compensation
claims. The liability is determined actuarially, based on claims paid, filed
and reserved for, and projected using an industry loss development factor, as
well as using historical experience ratings. As of December 29, 2002, the first
10 months of the policy period, we had $703,000 accrued for workers'
compensation.
STORE CLOSURE - The Company accrues an estimate for the costs associated
with closing under-performing stores in the period in which the store is
identified and approved by management under a plan of termination. The plan
includes the method of disposition and the expected date of completion. Costs,
which are considered to have no future economic benefit, include direct costs to
terminate a lease or sublease a property and the difference between the book
value and estimated recovery of fixed assets. Significant changes to the plan
are unlikely. The operating costs, including depreciation, of stores or other
facilities to be sold or closed are expensed during the period they remain in
use.
The Company recorded expenses of $456,000 representing the write off of
leasehold improvements, fixed assets and estimated future rental payments for
store closures during 2000. No expense was recorded in 2001 or 2002. As of
December 30, 2001, the Company had an accrual of $59,000, representing estimated
future rental payments.
In August 2001, the Company assigned, with the consent of the landlord, the
existing lease for the Naperville location to another entity. The Company
remains liable for rent and other charges under the lease, which expires
December 31, 2008. However, the assignee's parent company has guaranteed the
payment by the assignee of rent and other charges under the lease assignment up
to $313,000 (equivalent to approximately four years of rent due under the
lease). The Company expects that the assignee will make all future rent
payments required under the lease and during 2001 reduced the accrual for
estimated future payments under the lease by $134,000. The remaining accrual at
year end 2001 represents the Company's remaining obligation for rental payments
of seven months during the assignee's construction and rent abatement period.
All rental obligations had been paid and no accrual relating to store closures
remained at December 29, 2002. See Note 11.
A summary of the accrual activity is as follows (excluding write-off of
assets) (in thousands):
BALANCE AT ADDITIONS BALANCE
BEGINNING CHARGED TO AT END OF
OF PERIOD EXPENSE DEDUCTIONS PERIOD
----------- ----------- ----------- ----------
Accrual related to store closures:
Year ended December 31, 2000 $ 48 $ 327 ($74) $ 301
Year ended December 30, 2001 301 - (242) 59
Year ended December 29, 2002 59 - (59) -
REVENUE RECOGNITION - Net revenue is recorded upon purchases by customers
at retail locations or when merchandise is received by customers in the
specialty sales channel. Sales returns are insignificant. The Company
establishes an allowance for estimated doubtful accounts based on historical
experience and current trends, which management believes are appropriate.
The Company records shipping revenue in net revenue. The Company recorded
shipping revenue of $1,371,000, $1,522,000, and $1,617,000 related to online and
mail order and specialty sales in 2000, 2001, and 2002, respectively.
F-8
A summary of the allowance for doubtful accounts is as follows (in
thousands):
BALANCE AT ADDITIONS BALANCE
BEGINNING CHARGES TO AT END OF
OF PERIOD EXPENSE WRITEOFFS PERIOD
----------- ----------- ---------- ----------
Allowance for doubtful accounts:
Year ended December 31, 2000 $ 61 $ 23 ($15) $ 69
Year ended December 30, 2001 69 30 (41) 58
Year ended December 29, 2002 58 162 (145) 75
COST OF SALES AND RELATED OCCUPANCY EXPENSES consist primarily of coffee
and other product costs. It also includes plant manufacturing (including
depreciation), freight and distribution costs. Occupancy expenses include rent
and related expenses such as utilities.
PREOPENING COSTS or costs associated with the opening or remodeling of
stores, such as payroll and rent, are expensed as incurred.
HEDGING ACTIVITIES - The Company uses coffee futures and options to hedge
price increases in price-to-be- fixed coffee purchase commitments and
anticipated coffee purchases. These derivative instruments qualify for hedge
accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. See Note 12. Prior to the adoption of SFAS No. 133 on January 1,
2001, the contracts also qualified for hedge accounting and the gains and losses
were accounted for as inventory costs and were recorded as expense or income as
the related coffee was sold. The Company does not hold or issue derivative
instruments for trading purposes.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying value of cash and
equivalents, receivables and accounts payable approximates fair value.
Investments are recorded at fair value. The carrying value of debt approximates
the estimated fair value due to floating interest rates on the debt. The fair
value of futures contracts is the amount at which they could be settled, based
on estimates obtained from dealers. At December 30, 2001 and December 29, 2002,
the net unrealized gain/(loss) on such contracts was ($112,000) and $31,000,
respectively. See Note 12.
ADVERTISING COSTS are expensed as incurred. Advertising expense was
$5,158,000, $3,860,000, and $3,856,000 in 2000, 2001, and 2002, respectively.
DEFERRED LEASE CREDITS - Certain of the Company's lease agreements provide
for scheduled rent increases during the term of the lease. Rent is expensed on
a straight-line basis over the term of the lease.
INCOME TAXES -Income taxes are accounted for using the asset and liability
method, under which deferred tax assets and liabilities are determined based on
the difference between the financial statements and tax bases of assets and
liabilities using enacted tax rates currently in effect.
STOCK-BASED COMPENSATION - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principle Board, (APB), No. 25, Accounting for Stock Issued to Employees.
Accordingly, no compensation cost has been recognized for the stock option
awards granted at fair market value. Through 2001, the Company granted options
at 85% of fair value and recorded compensation expense equal to the intrinsic
value over the vesting period. The Company has recorded compensation expense of
$238,000 in 2000, $305,000 in 2001, and $290,000 in 2002. Statement of
Financial Accounting Standards, (SFAS), No. 123, Accounting for Stock-Based
Compensation, requires the disclosure of pro forma net income and earning per
share as if the Company had adopted the fair value method. Had compensation
cost for the Company's stock option plans and ESPP been determined based on the
fair value at the grant date consistent with the provisions of SFAS No. 123, the
Company's net income would have been reduced to the pro forma amounts indicated
below (in thousands):
F-9
2000 2001 2002
--------- ------- ---------
Net income (loss) - as reported ($2,275) $1,155 $ 4,657
Stock-based employee compensation included in
reported net income (loss), net of tax effects $ 143 $ 183 $ 174
Stock-based compensation expense determined
under fair value based method, net of tax effects ($833) ($511) ($2,295)
--------- ------- ---------
Net income (loss) - pro forma ($2,965) $ 827 $ 2,536
========= ======= =========
Basic net income (loss) per share - as reported ($0.50) $ 0.15 $ 0.43
Basic net income (loss) per share - pro forma ($0.66) $ 0.10 $ 0.23
Diluted net income (loss) per share - as reported ($0.50) $ 0.14 $ 0.40
Diluted net income (loss) per share - pro forma ($0.66) $ 0.10 $ 0.22
The Company uses the Black-Scholes option-pricing model for determining the
fair value of options, which requires the input of certain estimates that may
affect what is deemed fair value. The existing model may not necessarily
provide a reliable single measure of the value of its stock options. Management
will continue to evaluate alternative methodologies that may more appropriately
reflect pro forma compensation expense.
Additional disclosure requirements of SFAS No. 123, Accounting for
Stock-Based Compensation, are set forth in Note 10.
NET INCOME (LOSS) PER SHARE - Basic net income per share is computed as net
income (loss) divided by the weighted average number of common shares
outstanding for the period. Diluted net income (loss) per share reflects the
potential dilution that could occur from common shares issued through stock
options, warrants and the conversion of preferred stock. Diluted net loss per
share for the year ended December 31, 2000 does not include the common shares
issued through stock options, warrants and the conversion of preferred stock
because they are anti-dilutive. Anti-dilutive shares of 110,750 and 630,621 have
been excluded from diluted weighted average shares outstanding in 2001 and 2002,
respectively.
The following table summarizes the differences between basic weighted
average shares outstanding and diluted weighted average shares outstanding used
to compute diluted net income (loss) per share (in thousands):
2000 2001 2002
----- ----- ------
Basic weighted average shares outstanding 4,515 7,941 10,919
Incremental shares from assumed exercise of
stock options and warrants 0 271 708
----- ----- ------
Diluted weighted average shares outstanding 4,515 8,212 11,627
===== ===== ======
The number of incremental shares from the assumed exercise of stock options
and warrants was calculated applying the treasury stock method.
RECENTLY ISSUED ACCOUNTING STANDARDS - In October 2001, the Financial
Accounting Standards Board, (FASB), issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. This statement supercedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, and the accounting and reporting provision of APB
Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of
Disposal of Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of business.
SFAS No. 144 became
F-10
effective for the Company on December 31, 2001. Adoption of this standard did
not have a material effect on the Company's financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit of Disposal Activities, which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt
the provision of SFAS No. 146 for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires that liability for costs associated
with an exit or disposal activity be recognized when the liability is incurred.
Under Issue 94-3, a liability for an exit cost is recognized at the date of a
company's commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future store closure and
restructuring costs as well as the amounts recognized.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002; while, the provisions of the disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002. The adoption of the measurement of provisions
of FIN 45 is not expected to have a material impact on our financial position or
results of operations.
3. INVENTORIES
The Company's inventories consist of the following at year end 2001 and
2002 (in thousands):
2001 2002
------ -------
Raw materials $5,722 $ 7,130
Finished goods 3,223 3,877
------ -------
Total $8,945 $11,007
====== =======
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at year end 2001 and 2002
(in thousands):
2001 2002
--------- ---------
Leasehold improvements $ 22,007 $ 23,518
Furniture, fixtures, and equipment 23,609 25,158
Plant equipment 4,244 7,442
Construction in progress 514 3,216
--------- ---------
Total 50,374 59,334
Less accumulated depreciation (26,745) (31,405)
--------- ---------
Total $ 23,629 $ 27,929
========= =========
Depreciation expense was $4,990,000 in 2000, $5,455,000 in 2001, and
$5,005,000 in 2002, respectively. Construction in progress includes
manufacturing plant equipment, new store fixtures and other capital projects not
yet placed in service.
F-11
5. INVESTMENTS
The Company invested the proceeds of the secondary public offering in April
2002 in investment grade securities. At December 29, 2002, the Company
maintained long term investments classified as available for sale of
$28,100,000. The long term investments are comprised of United States Treasury
Notes and Bonds, and Federal Agency notes and bonds, maturing within five years.
Gross unrealized holding gains were $360,000 for the period ended December 29,
2002, of which $223,000 related to U.S. Treasury Notes and Bonds and $137,000
related to Federal Agency notes and bonds.
The company sold securities for net proceeds of $18,144,000 and realized a
gain of $27,000. For the periods ended December 29, 2002, net unrealized gains
of $227,000 (net of $133,000 tax), were recorded in accumulated other
comprehensive income (loss).
6. BORROWINGS
In September 2000, the Company entered into a credit facility with General
Electric Capital Corporation. The facility expires in September 2005 and
provides for a revolving line of credit up to $15,000,000, the issuance of up to
$3,000,000 in letters of credit, and $15,000,000 in term loans. The term loans
were repaid during 2001 upon the closing of the Company's initial public
offering. Total availability under the revolving line of credit is determined
by subtracting our funded debt from our trailing twelve month earnings before
interest, taxes, depreciation and amortization, or (EBITDA), multiplied by 3.75
for the period before September 1, 2001, 3.5 for the period after September 1,
2001 and before September 1, 2002, and 2.5 thereafter. As of December 29, 2002,
there was no outstanding balance and $14,057,000 was available under the
Company's line of credit.
Borrowings under the credit facility are secured by a lien on substantially
all of the Company's assets. The credit facility contains covenants restricting
the Company's ability to make capital expenditures, incur additional
indebtedness and lease obligations, open retail stores, make restricted
payments, merge into or with other companies and sell all or substantially all
of its assets and requiring the Company to meet certain financial tests.
Long term borrowings consist of the following at year end 2001 and 2002 (in
thousands):
2001 2002
------- ------
Industrial development revenue bond, interest at a weekly floating
rate of 1.65% at December 29, 2002, until maturity in 2006. 1,300 860
Capital lease obligations 108 32
------- ------
Total 1,408 892
Less current portion (513) (468)
------- ------
Total $ 895 $ 424
======= ======
Scheduled maturities of the Company's borrowings at December 29, 2002
(excluding capital lease obligations, see Note 11) are as follows (in
thousands):
Year:
2003 $440
2004 140
2005 140
2006 140
----
Total $860
====
F-12
7. INCOME TAXES
The income tax provision (benefit) consists of the following (in
thousands):
2000 2001 2002
------ ----- ------
Current:
Federal $ (66) $ 467 $1,470
State (58) 9 377
------ ----- ------
Total (124) 476 1,847
Deferred:
Federal (569) 133 827
State 97 140 61
------ ----- ------
Total (472) 273 888
------ ----- ------
Total $(596) $ 749 $2,735
====== ===== ======
The difference between the effective income tax rate and the United States
federal income tax rate is summarized as follows:
2000 2001 2002
------ ----- -----
Statutory Federal rate 34.0% 34.0% 34.0%
State income taxes less federal benefit 5.8 5.8 5.8
Change in valuation allowance (14.8) 3.7 (3.0)
Non-deductible items (0.6) 0.8 1.4
California net operating loss limitation (3.6) (2.1) 0.0
California Manufacturer Investment Credit 0.0 (2.9) (1.2)
------ ----- -----
Total 20.8% 39.3% 37.0%
====== ===== =====
Deferred tax assets (liabilities) consist of the following at year end 2001
and 2002 (in thousands):
2001 2002
------- --------
Net operating loss carryforwards $ 153 $ 165
Charitable contribution carryforwards 439 269
Credit carryforwards 861 382
Scheduled rent 273 311
Accrued reserves 329 436
Accrued compensation 267 319
State taxes 43 68
------- --------
Gross deferred tax assets 2,365 1,950
------- --------
Property and equipment (238) (1,207)
Other (214)
------- --------
Gross deferred tax liabilities (238) (1,421)
------- --------
Valuation allowance (534) (249)
------- --------
Net deferred tax assets $1,593 $ 280
======= ========
F-13
The Company has state net operating loss carryforwards of $1,867,000, which
expire between 2004 and 2007. A valuation allowance is provided when it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.
8. EMPLOYEE BENEFIT PLAN
The Company's 401(k) plan covers substantially all employees. Employees
may contribute up to 60% of their annual salary up to a maximum of $11,000. The
Company matches 50% of amounts contributed by its employees. The Company
contribution was $347,000, $413,000, and $438,000 in 2000, 2001, and 2002
respectively. The plan does not offer investments in Company stock.
9. SHAREHOLDERS' EQUITY
In April 2002, the Company issued 3,137,500 shares of common stock at
$14.00 per share of its common stock. The Company received net proceeds of
$41,030,000.
During 2001, the Company issued 2,682,623 shares of stock at $8.00 per
share in an initial public offering of its common stock and received net
proceeds of $17,790,000. Upon the closing of the initial public offering, each
of the outstanding shares of preferred stock converted into shares of common
stock at a conversion rate of one to two. On January 30, 2001, the Company
amended and restated its articles of incorporation, pursuant to which the
Company's authorized capital stock consists of 50,000,000 shares of common stock
without par value and 10,000,000 shares of preferred stock without par value.
None of the preferred stock has been issued or designated as of December 29,
2002.
Prior to the Company's initial public offering in January 2001, the Company
was authorized to issue 10,000,000 shares of preferred stock without par value,
of which 1,000,000 and 98,000 shares were designated for issuance as Series A
and Series B preferred stock (preferred stock), respectively.
In May of 1997, the Company issued warrants to a consultant to purchase
200,000 shares of common stock at $7.50 per share. These warrants, which were
exercisable at the option of the holder, were exercised on the first day of
fiscal year 2002.
10. STOCK OPTION AND EMPLOYEE PURCHASE PLANS
In 1994, the Company established two stock option plans, of which one
includes only California residents, both of which provide for incentive and
nonqualified stock options for the purchase of 831,600 shares of common stock of
the Company. During 1999, the Board of Directors approved a reduction of
208,914 shares available under these plans. Incentive stock options may be
granted to employees of the Company. Nonqualified stock options may be granted
only to employees, directors, officers, agents, consultants or advisors of the
Company. The purchase price of the common stock issuable under the stock option
plans is determined by the Board of Directors and may not be less than the fair
market value of the common stock at the grant date for incentive stock options
and not less than 85% of the fair market value of the common stock at the grant
date for nonqualified stock options. The term of a granted stock option is 10
years from the grant date. Stock options granted through December 30, 1994 vest
20% on each anniversary of the employee's date of hire and, accordingly, are
fully vested and exercisable after five years of employment. Stock options
granted subsequent to December 30, 1994 generally vest over three to four years.
In 1997, the Company adopted a successor equity incentive plan to the
Company's existing stock option plans, which provides a means by which selected
employees, directors, and consultants of the Company may benefit from increased
stock value through the granting of incentive and nonstatutory stock options.
The Company has reserved 1,280,000 shares of common stock for issuance pursuant
to the plan. The purchase price of the common stock issuable under this plan is
determined by the Board of Directors, however may not be less than 85% of the
fair market value of common stock at the grant date. The term of a granted stock
option is 10 years from the grant date. Stock options generally vest over three
to four years.
In 2000, the Company adopted a new stock option plan (effective January 24,
2001). The Company had reserved 700,000 shares of common stock for issuance
pursuant to the plan. As of each annual meeting of the
F-14
Company's shareholders, beginning in 2002, and continuing through and including
the annual meeting of the Company's shareholders in 2010, the number of shares
of common stock reserved for issuance under the 2000 plan will be increased
automatically by the lesser of (i) three percent (3%) of the total number of
shares of common stock outstanding on such date, (ii) five hundred thousand
(500,000) shares, or (iii) a number of shares determined by the Board prior to
such date, which number shall be less than (i) and (ii) above. At the May 2002
annual meeting, the shareholders approved an amendment to the plan to increase
the aggregate number of shares of common stock authorized for issuance by
800,000 shares and to increase the annual increase of shares reserved for
issuance from 3% to 5%. The purchase price of the common stock issuable under
this plan is determined by the Board of Directors, however may not be less than
85% of the fair market value of common stock at the grant date. The term of a
granted stock option is 10 years from the grant date. All stock options vest at
a minimum rate of 20% per year.
The Company also adopted a 2000 Non-Employee Director Plan that provides
for the automatic grant of nonstatutory stock options to purchase shares of
common stock to non-employee directors which is administered by the Board of
Directors (effective January 24, 2001). The aggregate number of shares of common
stock that may be issued pursuant to these options under the plan is 330,000. As
of each annual meeting of the Company's shareholders, beginning in 2002, and
continuing through and including the annual meeting of the Company's
shareholders in 2020, the number of shares of common stock reserved for issuance
under the 2000 plan will be increased automatically by the lesser of (i) three
quarters of one percent (0.75%) of the total number of shares of common stock
outstanding on such date, (ii) sixty thousand (60,000) shares, or (iii) a number
of shares determined by the Board prior to such date, which number shall be less
than (i) and (ii) above. The exercise price of options granted will be equal to
the fair market value of the common stock on the date of grant and have a term
no more than ten years from the date granted. Option grants vest over a period
of three years from the date of grant. In 2001 and 2002, the Company granted
non-employee director options to purchase an aggregate of 120,000 and 110,000
shares of common stock, respectively.
As of December 29, 2002, there were no shares available for grant under
1997 stock option plan, 350,593 shares available for grant under the 2000 stock
option plan, and 160,000 shares available for grant under the 2000 Non-Employee
Director stock option plan. Changes in stock options were as follows:
WEIGHTED-AVERAGE
OPTIONS EXERCISE PRICE
OUTSTANDING PER SHARE
------------ -----------------
Outstanding at January 2, 2000 1,347,930 $ 5.68
Granted 280,750 7.27
Canceled (37,600) 5.75
Exercised (2,872) 4.64
------------
Outstanding at December 31, 2000 1,588,208 5.96
Granted 729,326 7.69
Canceled (52,601) 6.96
Exercised (94,081) 5.39
------------
Outstanding at December 30, 2001 2,170,852 6.54
Granted 1,344,719 14.97
Canceled (48,637) 9.81
Exercised (541,162) 6.03
------------
Outstanding at December 29, 2002 2,925,772 $ 10.47
============
F-15
At December 31, 2000, December 30, 2001, and December 29, 2002, 1,202,493,
1,392,087, and 1,428,323 options, respectively, were exercisable with a
weighted-average exercise price of $5.54, $5.93, and $7.05, respectively.
The following table summarizes stock option information at year end 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
RANGE OF NUMBER OF WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER OF WEIGHTED-AVERAGE
EXERCISE PRICES OPTIONS REMAINING CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
$ 3.85 to $6.38 962,739 5.16 years $ 5.93 953,668 $ 5.93
$ 7.23 to $10.20 633,779 8.24 7.90 402,851 8.04
$11.11 to $14.90 269,518 9.21 12.07 7,639 11.11
$15.49 to $15.49 854,736 9.42 15.49 - 0.00
$16.41 to $17.00 205,000 9.47 16.65 64,165 17.00
--------- -------------------------- --------- -----------------
$ 3.85 to $17.00 2,925,772 7.74 10.47 1,428,323 7.05
========= ========================== ========= =================
During 2001, the Company adopted a 2000 Employee Stock Purchase Plan
("ESPP"), where eligible employees can choose to have up to 15% of their annual
base earnings withheld to purchase the Company's common stock. The purchase
price of stock is 85% of the lower of the beginning of the offering period or
end of the offering period market price. The Company authorized 200,000 shares
of common stock available for issuance under the plan, which will be increased
as of each annual meeting of the Company's shareholders, beginning 2002 until
2020, by the lesser of 200,000 shares or 1.5% of the number of shares of common
stock outstanding on that date. However, the Board of Directors has the
authority to designate a smaller number of shares by which the authorized number
of shares of common stock will be increased on that date. During 2002 and 2001,
employees purchased 82,865 and 36,789 shares, respectively, of the Company's
common stock under the plan at a weighted-average per share price of $6.86 and
$6.80, respectively. At December 29, 2002, 259,171 shares remain available for
future issuance.
The weighted average fair value of the stock options granted during 2000,
2001, and 2002 was $2.91, $6.56, and $9.42, respectively. The weighted average
fair value of each 2001 and 2002 ESPP award was $3.91 and $3.84, respectively,
per share. The fair value of each option grant and ESPP award is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following assumptions:
2000 2001 2002
----- ----- -----
Expected dividend rate 0% 0% 0%
Expected volatility
Options 0% 77.6% 68.1%
ESPP awards 77.6% 68.1%
Risk-free interest rate
Options 6.33% 4.88% 3.79%
ESPP awards 4.24% 1.87%
Expected lives (years)
Options 5 5 5
ESPP awards 0.5 0.5
See Note 2 for the pro forma effect of accounting for stock options using
the fair value method.
F-16
11. COMMITMENTS AND CONTINGENCIES
LEASES - The Company leases its Emeryville, California coffee roasting
plant, distribution center and administrative offices, warehouse, its retail
stores and certain equipment under operating leases that expire from 2003
through 2012. Certain leases contain renewal options for an additional five to
fifteen years, and also provide for contingent rents to be paid equal to a
stipulated percentage of sales. The lease agreements also provide for periodic
adjustments to the minimum lease payments based on changes in cost of living
indices or other scheduled increases.
Future minimum lease payments required under non-cancelable capital and
operating leases subsequent to December 29, 2002 are as follows (amounts in
thousands):
CAPITAL OPERATING
LEASES LEASES
--------- ----------
Years:
2003 $ 29 $ 5,101
2004 4 4,695
2005 4,411
2006 - 3,485
2007 - 2,529
Thereafter - 3,781
--------- ----------
Total minimum lease payments 33 $ 24,002
==========
Less amounts representing interest (1)
---------
Present value of net minimum lease payments 32
less current obligations (28)
---------
Long-term obligations $ 4
=========
Rent expense was $4,329,000, $4,738,000 and $5,077,000 for 2000, 2001, and
2002 respectively, including contingent rents of $129,000, $146,000, and
$139,000.
In August 1998, the Company entered into an occupancy lease agreement in
Naperville, Illinois for a term of 10 years beginning January 1, 1999. The
Company assigned the lease in August 2001 and is liable for lease payments in
the event the assignee or its guarantor defaults through the end of the first
lease term, expiring on December 31, 2008. As of December 29, 2002, the Company
may be liable for $542,000 of remaining lease payments, offset by the assignee's
security deposit of $6,000 and its guarantor's maximum liability of $313,000.
See Note 2.
PURCHASE COMMITMENTS - As of December 29, 2002, the Company had
approximately $18,149,000 of outstanding coffee purchase commitments from 2003
to 2006 with fixed prices.
EMPLOYMENT AGREEMENTS - The Company has agreements with certain officers to
provide severance benefits in the event their employment is terminated under
certain defined circumstances resulting in a contingent liability at December
29, 2002.
LEGAL PROCEEDINGS - The Company is party to various legal proceedings
arising from normal business activities. In February and March 2003, a former
and a current store manager have each filed a lawsuit with potential class
action certification, against the Company. They allege misclassification of
employment job classification. The Company is investigating and intends to
vigorously defend this litigation, but because the cases are in the early
stages, the financial impact to the Company, if any, cannot be predicted.
F-17
12. HEDGING ACTIVITIES
The Company is exposed to price risk related to price-to-be-fixed coffee
purchase commitments and anticipated coffee purchases. The Company uses coffee
futures and options to manage price increases and designates these derivative
instruments as cash-flow hedges of its price-to-be-fixed coffee purchase
commitments and anticipated coffee purchases. The Company does not hold or
issue derivative instruments for trading purposes.
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133, as amended, establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. All derivatives,
whether designated in hedging relationships or not, are required to be recorded
on the balance sheet at fair value. If the derivative is designated in a
fair-value hedge, the changes in the fair value of the derivative and the hedged
item will be recognized in earnings. If the derivative is designated in a
cash-flow hedge, the effective portions of changes in the fair value of the
derivative will be recorded in other comprehensive income and will be recognized
in earnings when the hedged item affects earnings. Ineffective portions of
changes in the fair value of cash-flow hedges are recognized immediately in
earnings.
The adoption of SFAS No. 133 on January 1, 2001 resulted in a liability of
$1,304,000 representing the fair value of the open futures at January 1, 2001, a
deferred tax asset of $519,000 and accumulated other comprehensive loss of
$785,000 net of tax.
During 2001 and 2002, the effective portion of the cash-flow hedges
amounted to a loss of $295,000 (net of $195,000 tax) and a gain of $66,000 (net
of $38,000 of tax), respectively, and was recorded in other comprehensive income
(loss). The ineffective portion of the hedges of $169,000 and $27,000 was
recorded as cost of sales during 2001 and 2002, respectively. Other
comprehensive income (loss), net of tax, was ($407,000) and $38,000 as of
December 30, 2001 and December 29, 2002, respectively, all of which is expected
to be reclassified into cost of sales over the next twelve months as the related
inventory is sold. For the years ended December 30, 2001 and December 29, 2002,
$673,000 and $379,000 of coffee futures losses included in other comprehensive
loss were reclassified into cost of goods sold. The fair value of the open
futures contracts as of December 30, 2001 and December 29, 2002 was a net
liability of $112,000, and a net asset $31,000 respectively, and is reflected in
other liabilities and prepaid assets.
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13. SEGMENT INFORMATION
Beginning in 2002, the Company operates in two reportable segments: retail
and specialty sales. Retail store operations consist of sales of whole bean
coffee, beverages, tea and related products through Company-operated retail
stores. Specialty sales consist of whole bean coffee sales through online, mail
order, grocery, wholesale and office coffee accounts. Management evaluates
segment performance primarily based on revenue and segment operating income. The
following table presents certain financial information for each segment. Segment
income before taxes excludes unallocated marketing expenses and general and
administrative expenses. Unallocated assets include cash, coffee inventory in
the warehouse, corporate headquarter assets and intangibles and other assets.
Prior to 2002, the Company reported three segments, which have been restated to
reflect the current presentation.
RETAIL SPECIALTY UNALLOCATED TOTAL
------- ---------- ------------- ---------
2000
Net revenue $68,322 $ 15,980 $ 84,302
Depreciation and amortization 3,556 497 $ 523 4,576
Segment operating income (loss) 6,782 4,565 (12,311) (964)
Interest expense, net 1,907 1,907
Loss before income taxes (2,871)
Total assets 18,547 1,631 19,543 39,721
Capital expenditures 3,578 974 966 5,518
2001
Net revenue $75,055 $ 19,345 $ 94,400
Depreciation and amortization 3,659 737 $ 642 5,038
Segment operating income (loss) 8,963 4,904 (11,534) 2,333
Interest expense, net 429 429
Income before income taxes 1,904
Total assets 17,676 3,886 19,847 41,409
Capital expenditures 1,882 1,321 3,308 6,511
2002
Net revenue $78,300 $ 25,773 $104,073
Depreciation and amortization 3,193 878 $ 497 4,568
Segment operating income (loss) 11,618 6,829 (11,595) 6,852
Interest income, net 540 540
Income before income taxes 7,392
Total assets 20,753 4,330 70,062 95,145
Capital expenditures 4,930 1,332 3,090 9,352
Net revenue from external customers for the two major product lines are as
follows:
2000 2001 2002
------- ------- --------
Whole bean coffee, tea, and related products $50,290 $55,944 $ 62,583
Beverages and pastries 34,012 38,456 41,490
------- ------- --------
Total $84,302 $94,400 $104,073
======= ======= ========
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14. RELATED PARTY TRANSACTIONS
A member of the Board of Directors is the Chairman of Jesse.Hansen&Co, a
strategic and financial advisor to the Company pursuant to an engagement letter
dated as of December 9, 1996 between Jesse.Hansen&Co and the Company. The
Company paid Jesse.Hansen&Co $60,000 ($5,000 per month) in fiscal 2000 and 2001,
and $30,000 in 2002 for advisory services. This advisory relationship was
terminated in June 2002.
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
QUARTER ENDED
-------------
MARCH 31, JUNE 30, SEPTEMBER 29, DECEMBER 29,
2002 2002 2002 2002
Net revenue $ 24,456 $ 24,889 $ 25,366 $ 29,362
Income from operations 805 1,024 1,809 3,214
Net income 488 718 1,279 2,172
Basic income per share $ 0.06 $ 0.06 $ 0.11 $ 0.18
Diluted income per share $ 0.05 $ 0.06 $ 0.10 $ 0.17
QUARTER ENDED
--------------
APRIL 1, JULY 1, SEPTEMBER 30, DECEMBER 30,
2001 2001 2001 2001
Net revenue $ 22,568 $ 22,727 $ 22,715 $ 26,390
Income (loss) from operations (308) 158 822 1,661
Net income (loss) (304) 64 430 965
Basic income (loss) per share $ (0.04) $ 0.01 $ 0.05 $ 0.12
Diluted income (loss) per share $ (0.04) $ 0.01 $ 0.05 $ 0.11
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