Diedrich Coffee Passes Word of Losses Ahead

Diedrich Coffee Inc., the second largest U.S. operator of specialty coffee shops, warned Thursday that it expects to record substantial losses for the fourth quarter and fiscal year, largely from its Gloria Jean’s unit.

Diedrich, which is battling New World Coffee-Manhattan Bagel Inc. to remain second fiddle to Starbucks Corp., also said it will violate its bank lending agreements today unless its efforts to renegotiate terms are successful.

The disclosures sent the Irvine company’s stock tumbling to a 52-week low in Nasdaq trading. The shares, which have lost nearly 48% of their value so far this year, slumped to $2 before closing at $2.13, down 75 cents. The 26% decline was one of the largest Thursday in U.S. markets.

Diedrich said the losses stem largely from closing 39 Gloria Jean’s mall-based stores and other operating shortfalls in the division.

With 360 stores in 38 states and nine other countries, the company remains a distant No. 2 to Starbucks, which has more than 3,000 locations.

Diedrich Chief Executive Timothy J. Ryan said the Gloria Jean’s closures are bitter but necessary medicine.

To stay alive and advance in this competitive, multibillion-dollar industry, Diedrich had to move boldly to shed poorly performing stores.

“We think that the company has strong legs and a bright future,” said Ryan. “And it needs to be repositioned. It’s suffering from fatigue right now.”

Many of the mall-based Gloria Jean’s stores, which Diedrich acquired with the purchase of Coffee People last summer, are in lackluster shopping centers, he said. Others are in malls where rents have mushroomed.

Furthermore, Ryan sees as his target market Generation Y patrons who go to coffeehouses for a cup of joe and a social atmosphere. Gloria Jean’s, however, was focused on an older clientele and devoting too much space to such merchandise as kitchen and gift ware.

Reorienting the stores to focus on higher-margin coffee and beverage sales, he argues, is necessary to keep Diedrich in fighting form.

While one might expect coffeehouse owners to be laid-back bohemians, they are as pragmatic and competitive as those of any company working to dominate a hot new market.

“At the end of football season there are only a couple of teams left,” said New World Coffee Chief Executive R. Ramin Kamfar. “That’s what’s going to happen in this market.”

As Diedrich, New World and a few smaller companies vie for spots in the finals, the highly fractured specialty coffee industry is likely to continue to experience consolidation. And as the competition intensifies, many smaller outfits will simply go out of business, said Mark Ferguson, spokesman for the Specialty Coffee Assn. of America.

“The people who are vulnerable now are people who love coffee but don’t know how to run a business and people who know how to run a business but don’t love coffee,” Ferguson said. “If you know how to run a business and love coffee, you’re less vulnerable.”

Ferguson thinks that as this shakeout progresses over the next two years the number of coffeehouses in the U.S. will actually decline to about 10,000 from 12,000, despite 8% growth in the industry. He thinks the store numbers will grow at a measured pace thereafter.

“We don’t see consumption going down. It’s that there will be fewer people selling more coffee to more people,” he said.

Diedrich, which also faces costly delays in opening stores as well as hefty expenses in beefing up its management ranks, expects to disclose the charges before the end of July.

For the fourth quarter of fiscal 1999, the company lost $446,000, or 7 cents a share, including a provision of $648,000 for store closings and restructuring, on revenue of about $6.2 million.

For fiscal 1999, the company lost about $2.6 million, or 43 cents a share, including a provision of $3.9 million for store closings and restructuring. Revenue was about $24.2 million.

Analyst Andrew Barish, who still considers the Diedrich stock a buy, said the Gloria Jean’s closures and the steep drop in stock price are only temporary setbacks, and that the company still has a solid growth strategy.

“I don’t think this is anything terminal, by any means,” said Barish, an analyst with Robertson Stephens in San Francisco. “They’ll enter their next fiscal year with a clean slate.”

The company said it is expanding its Diedrich Coffee brand coffeehouses, whose same-store sales continue to rise.

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Dow Jones Newswires were used in compiling this report.

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In the Drink

Diedrich Coffee Inc.’s stock, which has been in a year-long tailspin, moved lower Thursday after the Irvine company warned of larger losses for the fourth quarter and fiscal year. Weekly trend:

SOURCE: Bloomberg News