Prospects Perking Up for Diedrich’s Coffee Enterprise

Shares of Diedrich Coffee Inc. appeared as hot as the steaming lattes and cappuccinos served in the Irvine company’s chain of coffeehouses for a brief time over the last month.

Although the stock has since cooled, what’s left of the gain represents a striking turnaround for the perennial Starbucks wannabe that nearly went out of business this year after a series of missteps left it with excessive debt.

Today, Irvine-based Diedrich is a company in transition, moving from a primary focus on owning and franchising coffeehouses to become more of a coffee wholesaler and distributor, a strategy that has begun to pay off, analysts and investors say.

The beginnings of a turnaround have emerged despite a string of calamities that hit the company in quick succession this year, including the death of its namesake and founder, Carl Diedrich, the disclosure that Chief Executive J. Michael Jenkins was undergoing treatment for gastric cancer, a threatened delisting of its stock by Nasdaq and a plunge in sales.

Yet when shareholders meet at Diedrich’s annual kaffeeklatsch at the Irvine Marriott today, they will find a company in far better financial position than it was a year ago, when its shares traded at $1 after adjusting for a reverse stock split. The stock price hit a one-year closing high of $6 on Nov. 19, up from $2.74 at the start of October, before sliding back Monday to close at $4, down 35 cents, on Nasdaq.

“They have made a lot of progress turning the company around, and the market is just starting to recognize it,” said Richard Spencer, who heads Westcliff Capital Management, a small-company investment fund that controls about 21% of Diedrich.

Among other things, a major recapitalization in March raised $6million and allowed the company to pay off half its debt and still maintain a comfortable cushion of working capital, he said.

The company began operations in California in 1972 as an importer of roasted coffee grown on a family-owned plantation in Guatemala. Diedrich, who died in July of Parkinson’s disease at the age of 86, opened the first Diedrich coffee store in Newport Beach almost 20 years ago. His sons helped develop the business into a chain of coffeehouses that went public in 1996.

By 1999, the company had hired former Taco Bell executive John Martin to run the business. Martin embarked on a buying spree, snapping up such chains as Coffee Plantation, Coffee People and Gloria Jean’s Coffees. Those acquisitions boosted Diedrich’s retail outlets to its current 382, the majority of which are franchised.

But the strategy put the company “on a death spiral,” Spencer said.

“They had trouble integrating the acquisitions, their credit line disappeared, and they didn’t have the funds to do the franchising campaign,” Spencer said.

Paul C. Heeschen, Diedrich’s largest shareholder and a money manager whose investment funds control 32% of the company, replaced Martin as chairman in February. Heeschen worked with Jenkins to engineer the March refinancing of the company and to start shedding unprofitable assets, including 12 Coffee Plantation outlets in Phoenix last month.

Diedrich chief Jenkins returned to work in September following surgery. He and other company executives declined to talk about their strategy, but it is clear from the company’s Securities and Exchange Commission filings and other public disclosures that the divestiture of the Coffee Plantation outlets is among efforts by management to trim debt, reduce administrative expenses and eliminate under-performing stores.

Although Diedrich still is losing money, it has slashed the rate of loss. The company reported a net loss of $546,000, or 11 cents per share, for its fiscal first quarter ended Sept. 19, half the loss of $1.1million or 35 cents, for the same period a year earlier.

Revenue, however, fell 16.2% to $14.1 million. The decline was broad-based, resulting from a dip in franchise fees and less wholesale revenue due to the closure of some money-losing Gloria Jean’s franchise units and declining same-store sales.

Sales reports also show that the company is boosting its wholesale business. Two years ago, wholesale distribution of coffee beans was less than $3 million, or just 11.4%, of Diedrich’s revenue. When the fiscal year ended June 27, wholesale distribution had grown to $18.5 million, representing 25.6% of the company’s sales.

Diedrich’s list of customers for its wholesale coffee includes its own retail and franchised outlets as well as the Ruth’s Chris Steak House restaurants and the Newport Beach-based Ruby’s chain of diners.

Such a strategy takes advantage of Diedrich’s industry reputation for buying and roasting high-quality coffee beans-and moves it away from a bruising matchup with Starbucks. Diedrich’s total market value is barely $20 million, equivalent to the annual sales of about two dozen Starbucks stores.