-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, P9fC33fC9chqdxkIG+SJlcMdgUktSKsuFg9iScIg7nCDLG71/of6PV0hLS9DlPf7 X7TJE4r8ZJP5QMMw6X/VEg== 0000892569-96-001294.txt : 19960726 0000892569-96-001294.hdr.sgml : 19960726 ACCESSION NUMBER: 0000892569-96-001294 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 11 FILED AS OF DATE: 19960724 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIEDRICH COFFEE CENTRAL INDEX KEY: 0000947661 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-FOOD STORES [5400] IRS NUMBER: 330086628 STATE OF INCORPORATION: CA FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-08633 FILM NUMBER: 96598473 BUSINESS ADDRESS: STREET 1: 2144 MICHELSON DRIVE CITY: IRVINE STATE: CA ZIP: 9262682612 BUSINESS PHONE: 7142601600 S-1/A 1 FORM S-1 DATED JULY 24,1996 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 24, 1996 REGISTRATION NO. 333-08633 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ DIEDRICH COFFEE (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) 2144 MICHELSON DRIVE IRVINE, CALIFORNIA 92612 (714) 260-1600 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) CALIFORNIA 5499 33-0086628 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
------------------------ STEVEN A. LUPINACCI CHIEF EXECUTIVE OFFICER DIEDRICH COFFEE 2144 MICHELSON DRIVE IRVINE, CALIFORNIA 92612 (714) 260-1600 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: MARK W. SHURTLEFF, ESQ. ROBERT B. KNAUSS, ESQ. JOHN M. WILLIAMS, ESQ. SANDRA A. SEVILLE-JONES, ESQ. GIBSON, DUNN & CRUTCHER LLP MUNGER, TOLLES & OLSON 4 PARK PLAZA 355 SOUTH GRAND AVENUE, 35TH FLOOR IRVINE, CALIFORNIA 92614 LOS ANGELES, CA 90071 (714) 451-3800 (213) 683-9100
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this registration statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 DIEDRICH COFFEE CROSS REFERENCE SHEET PURSUANT TO ITEM 501(B) OF REGULATION S-K SHOWING LOCATIONS IN THE PROSPECTUS OF INFORMATION REQUIRED IN PART I OF FORM S-1.
ITEM NUMBER AND HEADING IN LOCATION OR REGISTRATION STATEMENT CAPTIONS IN PROSPECTUS --------------------------------------------- ------------------------------------------ 1. Forepart of the Registration Statement and Outside Front Cover Page of Prospectus....... Facing Page; Cross Reference Sheet; Outside Front Cover Page of Prospectus 2. Inside Front and Outside Back Cover Pages of Prospectus................................... Inside Front Cover Page of Prospectus; Table of Contents; Additional Information; Outside Back Cover Page of Prospectus 3. Summary Information, Risk Factors and Ratio of Earnings to Fixed Charges................. Prospectus Summary; Risk Factors 4. Use of Proceeds.............................. Prospectus Summary; Use of Proceeds 5. Determination of Offering Price.............. Outside Front Cover Page of Prospectus; Underwriting 6. Dilution..................................... Risk Factors; Dilution 7. Selling Security Holders..................... Principal and Selling Stockholders 8. Plan of Distribution......................... Outside Front Cover Page of Prospectus; Underwriting 9. Description of Securities to be Registered... Outside Front Cover Page of Prospectus; Description of Capital Stock 10. Interests of Named Experts and Counsel....... Not Applicable 11. Information with Respect to the Registrant... Outside Front Cover Page of Prospectus; Prospectus Summary; Risk Factors; Use of Proceeds; Dividend Policy; Capitalization; Dilution; Selected Financial Data; Management's Discussion and Analysis of Financial Condition and Results of Operations; Business; Management; Certain Transactions; Principal and Selling Stockholders; Description of Capital Stock; Shares Eligible for Future Sale; Underwriting; Legal Matters; Experts; Financial Statements 12. Disclosure of Commission Position on Indemnification for Securities Act Liabilities.................................. Not Applicable
3 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED JULY 24, 1996 2,200,000 SHARES [LOGO] DIEDRICH COFFEE, INC. COMMON STOCK ------------------------ Of the 2,200,000 shares of common stock, no par value (the "Common Stock"), offered hereby (the "Offering"), 1,600,000 shares are being offered by Diedrich Coffee, Inc. ("Diedrich Coffee" or the "Company") and 600,000 shares are being offered by certain stockholders of the Company (the "Selling Stockholders"). See "Principal and Selling Stockholders." The Company will not receive any of the proceeds from the sale of shares by the Selling Stockholders. Prior to this Offering, there has been no public market for the Common Stock and there can be no assurance that such a market will develop or, if a market develops, that it will be sustained. It is currently anticipated that the initial public offering price will be between $10.50 and $11.50 per share. The initial public offering price of the shares of Common Stock offered hereby will be determined by negotiation between the Company, the Selling Stockholders and The Boston Group, L.P. (the "Representative"), as representative of the several underwriters (the "Underwriters"), and is not necessarily related to the Company's asset value, net worth or other established criteria of value. See "Risk Factors" and "Underwriting." Application has been made for quotation of the Common Stock on the Nasdaq National Market under the proposed symbol "DDRX." THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" ON PAGE 7. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------- UNDERWRITING PROCEEDS TO PRICE TO DISCOUNTS AND PROCEEDS TO SELLING PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDERS - -------------------------------------------------------------------------------------------------- Per Share..................... $ $ $ $ - -------------------------------------------------------------------------------------------------- Total(3)...................... $ $ $ $ - -------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------
(1) Does not include (a) a non-accountable expense allowance payable to the Representative, and (b) the value of the three-year warrants granted to the Representative to purchase up to 160,000 shares of Common Stock at an exercise price per share equal to 120% of the greater of the Price to Public per share or $11.50 ("Representative's Warrants"). For indemnification and contribution arrangements with the Underwriters, see "Underwriting." (2) Before deducting expenses payable by the Company estimated at $900,000, including the Representative's non-accountable expense allowance. See "Underwriting." (3) The Selling Stockholders have granted the Underwriters a 30-day option to purchase up to 330,000 additional shares of Common Stock, solely to cover over-allotments, if any. See "Underwriting." If all such shares of Common Stock are purchased, the total Price to Public, Underwriting Discounts and Commissions and Proceeds to Selling Stockholders will be $ , $ and $ , respectively. The Common Stock is offered by the Underwriters, when, as and if delivered to and accepted by them, and subject to their right to withdraw, cancel or modify the Offering and reject any order in whole or in part. It is expected that delivery of the certificates for the shares of Common Stock will be made on or about , 1996. ------------------------ THE BOSTON GROUP, L.P. The date of this Prospectus is , 1996. 4 [GRAPHICS] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 2 5 PROSPECTUS SUMMARY The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements of the Company, including the notes thereto, appearing elsewhere in this Prospectus. Except as otherwise indicated, the information presented in this Prospectus assumes no exercise of the Underwriters' over-allotment option or the Representative's Warrants, takes into consideration the conversion of the Series A and Series B Preferred Stock to Common Stock on or prior to the consummation of this Offering and gives effect to the reincorporation of the Company in the State of Delaware to be effected on or prior to the consummation of this Offering. Prospective investors should carefully consider the information discussed under "Risk Factors." THE COMPANY Diedrich Coffee is one of the leading specialty coffee roaster/retailers in the United States and currently operates thirty-six coffeehouses located in Southern California, Colorado and Texas. At each of the Diedrich coffeehouses, the Company sells high quality coffee beverages made with its own freshly roasted coffee. In addition to brewed coffee, Diedrich Coffee offers a broad range of Italian-style beverages such as espresso, cappuccino, caffe latte, caffe mocha and espresso machiato. To complement beverage sales, the Company sells light food items and whole bean coffee through its coffeehouses. The first retail store operating under the name Diedrich Coffee commenced operations in Orange County, California in 1972. The Company grew from three coffeehouses in fiscal 1992 to thirty-six coffeehouses as of July 19, 1996 through the construction of new coffeehouses and recent acquisitions. In addition, the Company has entered into leases that will permit the opening of six additional coffeehouses in the next four months. The Company's expansion strategy is to own and operate newly-developed coffeehouses and to acquire and convert existing specialty coffee retailers in geographic regions where it has existing coffeehouses. The Company also evaluates new geographic regions (and analyzes entry through new store openings or acquisitions) where it believes it can operate profitably. The Company seeks to further differentiate itself and increase its strong brand name recognition by developing and operating sophisticated and inviting coffeehouses intended to serve as neighborhood gathering places. Additionally, Diedrich Coffee focuses heavily on the quality of its products through experienced sourcing of the unroasted beans and its proprietary roasting formula developed by the Diedrich family over three generations. To ensure freshness, the Company has roasting facilities in its principal regions of operations (Orange County and Denver) and plans to add roasting facilities in each of the major regions where it establishes operations. The Company believes that this strategy, together with enthusiastic and friendly customer service, creates a loyal customer base. Diedrich coffeehouses are generally established in high-visibility locations, consistent with the Company's strategy of developing a substantial repeat client base. The Company's coffeehouses average approximately 1,540 square feet, ranging in size from 725 to 2,654 square feet. In its continuing efforts to ensure the highest possible standards of quality, the Company sources its unroasted coffee beans directly from coffee-producing nations through its contacts with exporters and growers located in certain of these countries and through specialty coffee brokers. The Company's unroasted coffee beans are purchased from coffee-producing regions throughout the world and are custom roasted in carefully controlled batches according to the Company's standards and proprietary recipes. The beans purchased by the Company are premium grade arabica variety, which are a higher quality than the average arabica or robusta variety of coffee typically found in non-specialty or mass-merchandised coffees. In February 1996, the Company consummated the acquisition of nineteen retail coffeehouse locations from two separate specialty coffee chains. Seventeen of the acquired stores are located in Denver, Colorado and the remaining two stores are located in Houston, Texas. Each of the Denver and Houston markets had been previously identified by the Company as targets for near-term expansion. The Company is in the process of converting eighteen of the acquired stores to the Diedrich coffeehouse format and, as of July 19, 1996, the conversion of eleven stores had been completed. Management believes that the addition of the Denver stores 3 6 will enable the Company to benefit from greater marketing efficiencies resulting from geographic concentration and the addition of the two Houston locations will form the basis for further expansion. Diedrich Coffee, the predecessor of the Company, was incorporated in California in April 1985. In connection with this Offering, Diedrich Coffee will reincorporate in the State of Delaware. The Company's principal executive offices are located at 2144 Michelson Drive, Irvine, California 92612, and its telephone number is (714) 260-1600. ------------------------ The Company intends to furnish its security holders annual reports containing audited financial statements with a report thereon by independent accountants, and such other periodic reports as the Company may determine to be appropriate or as required by law. THE OFFERING Common Stock outstanding prior to the Offering... 3,791,650 shares Common Stock offered by the Company.............. 1,600,000 shares(1) Common Stock offered by the Selling Stockholders................................... 600,000 shares(2) Common Stock to be outstanding after the Offering....................................... 5,391,650 shares(1) Use of proceeds by the Company................... Repayment of the amounts outstanding under the Company's short-term revolving credit facility and a revolving promissory note and funding for the opening of additional coffeehouses (through new store construction and acquisitions), infrastructure enhancements, repayment of certain other indebtedness, working capital and other general corporate purposes. See "Use of Proceeds" and "Certain Transactions." Risk Factors..................................... The Common Stock offered hereby involves a high degree of risk and dilution. See "Risk Factors" and "Dilution." Proposed Nasdaq National Market symbol........... DDRX(3)
- --------------- (1) Excludes (i) 160,000 shares of Common Stock which may be issued by the Company upon the exercise in full of the Representative's Warrants, (ii) 131,350 shares of Common Stock which may be issued by the Company upon the exercise in full of the Chief Executive Officer's stock options, and (iii) an aggregate of 600,000 shares of Common Stock reserved for issuance pursuant to the Company's 1996 Non-Employee Directors Stock Option Plan and 1996 Stock Incentive Plan. See "Underwriting" and "Management." (2) Excludes 330,000 shares of Common Stock subject to the Underwriters' over-allotment option granted by the Selling Stockholders. See "Underwriting." (3) While the Company has applied to list the Common Stock on the Nasdaq National Market, there can be no assurance that if the stock is listed on such exchange, that a public trading market will develop, or, if developed, will be sustained. See "Risk Factors." 4 7 SUMMARY FINANCIAL AND OTHER DATA The summary financial data in the table are derived from the financial statements and related notes thereto of the Company and the pro forma financial statements. The data should be read in conjunction with the financial statements, related notes and other financial information included elsewhere herein.
YEARS ENDED JANUARY 31, TWELVE THIRTEEN --------------------------------------------------- WEEKS WEEKS PRO ENDED ENDED FORMA APRIL 25, MAY 1, 1994 1995 1996 1996(1) 1995(2) 1996(2)(3) -------- -------- ---------- ---------- --------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net sales................. $ 4,414 $ 7,591 $ 10,244 $ 12,601 $ 2,058 $ 4,275 Cost of sales and related occupancy costs......... 1,796 3,164 4,409 5,932 872 1,773 Store operating expenses................ 1,594 2,584 3,520 4,686 669 1,735 Other operating expenses................ 146 282 277 277 64 60 Depreciation and amortization............ 102 255 354 498 62 154 General and administrative expenses................ 809 851 1,335 1,402 277 337 Operating income (loss)... (33) 455 349 (194) 114 216 Net income (loss)......... $ (89) $ 324 $ 186 $ (135) $ 59 $ 107 ======== ======== ========== ========== ======== ========== Pro forma net income (loss) per share (4).... $ 0.06 $ (0.04) $ 0.03 ========== ========== ========== Shares used in pro forma per share calculation (4)..................... 3,153,000 3,153,000 3,906,000 ========== ========== ========== OTHER DATA: Average sales per store (5)..................... $ 883 $ 946 $ 1,002 $ 216 $ 223(6) Percentage change in comparable store sales (7)..................... 8.0% 17.0% 10.2% 19.8% 8.5%(8) Number of stores open for full period............. 4 7 8(9) 8(9) 12 Number of stores open at end of period........... 7 7 12 8 33(10) Pre-opening expenses...... $ 68 $ 0 $ 87 $ 15 $ 44
JANUARY 31, MAY 1, -------------------- -------------------------- PRO FORMA AS ADJUSTED 1996 1996(1) 1996(2)(3) 1996(11) ------ --------- ---------- ----------- BALANCE SHEET DATA: Working capital (deficiency).......................... $ (53) $(1,436) $ (3,819) $11,521 Total assets.......................................... 5,316 6,699 8,915 21,274 Long-term obligations, less current portion........... 829 829 304 -- Total stockholders' equity............................ 3,304 3,304 3,412 19,056
- --------------- (1) The pro forma condensed financial statement information assumes the Company's acquisition of the 12 stores from Brothers Gourmet Coffees, Inc. (the "Brothers Stores") occurred on February 1, 1995 for the statement of operations data and on January 31, 1996 for the balance sheet data. Pro forma statement of operations and balance sheet data excludes the acquisition of 7 former bakery-espresso cafes from an unrelated seller (the "Acquired Cafes") as the acquisition does not require pro forma presentation. See Note 9 of Notes to Financial Statements and the Unaudited Pro Forma Condensed Financial Statements. (2) Effective February 1, 1996, the Company changed its year end from January 31 to a fiscal year ending on the Wednesday nearest January 31. Accordingly, the quarterly period ended May 1, 1996 includes 13 5 8 weeks. Prior to the change in fiscal year end, the Company's quarterly periods included 12 weeks, except for the fourth quarter which had approximately 16 weeks. (3) Includes the results of operations attributable to the Brothers Stores and Acquired Cafes since the acquisitions were completed in February 1996. The pro forma statement of operations data for the 13 weeks ended May 1, 1996 did not differ materially from the historical results of operations for such period and, accordingly, has not been presented. See Note 9 of Notes to Financial Statements. (4) Pro forma net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common and common equivalent shares outstanding during the respective period, assuming the conversion of the Series A and Series B Preferred Stock to Common Stock as of the date of issuance. Dividends on the Series A and Series B Preferred Stock have been excluded from the computation since the preferred stock has been assumed to have been converted to Common Stock. (5) Includes only stores open for the entire period indicated. (6) Sales for the Acquired Cafes and Brothers Stores are not included as none of these stores were open for the entire period. During this period, average weekly per store sales for the Acquired Cafes and Brothers Stores since their respective dates of acquisition were $4,263 while average weekly per store sales for the Company, excluding such stores, were $17,167. (7) Includes only stores open one year or more at the beginning of the period. (8) The percentage change in comparable store sales has been adjusted for the additional week in the quarterly period ended May 1, 1996. (9) Includes one store opened on the second day of the period and considered to have been open for the entire period. (10) In accordance with management's initial evaluation at the time of the acquisition, the Company closed one of the Brothers Stores after May 1, 1996. (11) Adjusted to reflect the sale of 1,600,000 shares of Common Stock offered by the Company hereby, based upon an assumed initial public offering price of $11.00, and the application of the estimated net proceeds therefrom. See "Use of Proceeds." 6 9 RISK FACTORS Each prospective investor should carefully consider, in addition to the other information contained in this Prospectus, the following information in evaluating the Company and its business before making an investment decision. Limited Operating History; History of Operations. As of January 31, 1996, the Company operated twelve coffeehouses, only seven of which had been open more than one year. Although the Company has been profitable for the last two years and has experienced significant recent revenue growth, there can be no assurance that this growth will continue or that the Company will remain profitable on a quarterly or annual basis in the future. Management anticipates that profitability may be adversely affected during the fiscal year ended January 31, 1997 ("fiscal 1997") due to the integration of stores acquired from Brothers Gourmet Coffees, Inc. (the "Brothers Stores") and the acquisition of former bakery-espresso cafes (the "Acquired Cafes") during this period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Rapid Expansion; Growth Strategy. The Company is pursuing an aggressive growth strategy, the success of which will depend in large part upon its ability to open and operate new coffeehouses and to operate a larger business profitably. From the end of fiscal 1992 through July 19, 1996, the Company expanded the number of coffeehouses from three to forty-two, of which six are not yet open but are subject to a binding lease. Although the Company has executed these additional leases for future coffeehouses, there can be no assurance that the Company will be successful in developing and profitably operating additional coffeehouse sites. Eighteen of the Company's current coffeehouses were acquired through two separate acquisitions in February 1996. See "Business -- Recent Acquisitions." The Company intends to convert these stores and operate them as Diedrich coffeehouses. As of July 19, 1996, the Company had completed eleven conversions and as previously anticipated closed one of the acquired stores. Under prior management, these stores were not profitable, and no assurance can be given that the Company's efforts to convert these operations to Diedrich coffeehouses will be successful or result in profitability. Even if the Company is successful in enhancing profitability after converting acquired stores, there can be no assurance as to how long a period of time accomplishing such profitability will take or the levels of future profitability that can be achieved. Acquisitions involve a number of risks, including, the diversion of management's attention, issues related to the assimilation of the operations and personnel of the acquired businesses, and potential adverse effects on the Company's operating results. The Company's recent acquisitions have resulted in increases in general and administrative expense and diversion of management resources. Furthermore, the Company has not yet fully completed the conversion of the Denver coffeehouses to the Company's financial and management control systems. There can be no assurance that the Company will find attractive acquisition candidates, that acquisitions can be consummated on acceptable terms, that any acquired companies can be integrated successfully into the Company's operations or that any such acquisitions will not have an adverse effect on the Company's financial condition or results of operations. The Company's planned expansion will present numerous operational and competitive challenges to the Company's senior management and employees as new potential sites are evaluated, developed and operated. Among other challenges, the Company anticipates that expansion into new geographic regions will entail opening multiple coffeehouses in those other regions in a relatively short period of time. Such growth has, and will continue to place significant demands on the Company's management, working capital and financial and management control systems. Failure to upgrade the Company's operating, management and financial control systems or difficulties encountered during such upgrades could adversely affect the Company's business and results of operations. Although the Company believes that its systems and controls are adequate to address its current needs, there can be no assurance that such systems will be adequate to address future expansion of the Company's business. The Company's results of operations will be adversely affected if revenues do not increase sufficiently to compensate for the increase in operating expenses resulting from expansion and there can be no assurance that any expansion will be profitable or that it will not adversely affect the Company's results of operations. In addition, the success of any expansion plans will depend in part upon the Company's ability to continue to improve and expand its management and financial control systems, to attract, retain and motivate key employees and to raise additional capital. There can be no assurance the Company will be 7 10 successful in these regards. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources," "Business -- Growth Strategy" and "Business -- Coffeehouses -- Diedrich Coffeehouse Locations." Successful achievement of the Company's expansion plans will depend in part upon its ability to: (i) select and compete successfully in new markets; (ii) obtain suitable sites at acceptable costs in highly competitive real estate markets; (iii) hire, train and retain qualified personnel, including additional regional management; (iv) integrate new stores into existing distribution, inventory control and information systems; (v) expand roasting facilities in current and new regions to enable freshly roasted coffee deliveries to coffeehouses in those regions; and (vi) maintain quality control. The Company will incur significant start-up costs in connection with entering new markets, including costs associated with establishing new regional infrastructure that will permit the Company to maintain its strategy of being a regional roaster/retailer. In addition, the opening of additional coffeehouses in current markets could detract from sales at certain of the Company's existing coffeehouses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations." There can be no assurance that the Company will achieve its planned expansion goals, manage its growth effectively or operate its existing and new coffeehouses profitably. The failure of the Company to achieve its expansion goals on a timely basis, if at all, manage its growth effectively or operate existing or any new coffeehouses profitably would have a material adverse effect on the Company's financial condition or results of operations. See "Business -- Growth Strategy," "Business -- Coffeehouses," "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Need for Additional Financing. In order to achieve and maintain the Company's anticipated growth rate, including geographic expansion, the Company believes that it may need to obtain additional bank financing or sell additional debt or equity (or hybrid) securities in future public or private financings. In addition, the Company may incur debt or issue equity securities in order to finance acquisitions. Any such equity-based financings would dilute the interests of investors in this Offering. There can be no assurance that any such additional financing will be available on terms satisfactory to the Company, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Fluctuations in Availability and Cost of Unroasted Coffee. The Company depends upon both its outside brokers and its direct contacts with exporters and growers in countries of origin for the supply of its primary raw material, "green" or "unroasted" coffee. Coffee supply and price are subject to significant volatility beyond the control or influence of the Company. Although most coffee trades in the commodity market, coffee of the quality sought by the Company tends to trade on a negotiated basis at a substantial premium above commodity coffee pricing, depending upon the origin, supply and demand at the time of purchase. Supply and price can be affected by multiple factors in the producing countries, including weather and political and economic conditions. In addition, unroasted coffee prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations, such as the International Coffee Organization or the Association of Coffee Producing Countries, that have historically attempted to establish commodity price controls of unroasted coffee through agreements establishing export quotas or restricting coffee supplies worldwide. No assurance can be given that these organizations (or others) will not succeed in raising unroasted coffee prices or that, in such event, the Company will be able or choose to maintain its gross margins quickly by raising prices without affecting demand. Increases in the price of unroasted coffees, or the unavailability of adequate supplies of unroasted coffees of the quality sought by the Company -- whether due to the failure of its suppliers to perform, conditions in the coffee-producing countries, or otherwise -- could have a material adverse effect on the Company's results of operations. See "Business -- Diedrich's Coffee." To mitigate the risks associated with increases in coffee prices and to provide greater predictability in the prices the Company pays for its coffees, the Company has from time to time, depending upon market volatility, entered into fixed-price purchase commitments for a portion of its unroasted coffee requirements. There can be no assurance that these activities will significantly protect the Company against the risks of increases in coffee prices or that they will not result in the Company's having to pay substantially more for its 8 11 supply of coffee than would have been required absent such activities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Limitations and Vulnerability as a Result of Geographic Concentration of Management's Experience. Until recently, management's experience was limited to operating coffeehouses in Southern California. Because the Company's management has limited operating experience outside of Southern California, there can be no assurance that the Company will be successful in other geographic areas. For example, the Company's experience with construction and development outside the Southern California area is limited, which may increase associated risks of development and construction as the Company expands. Expansion to other geographic areas may require substantially more funds for advertising and marketing since the Company will not initially have name recognition or word-of-mouth advertising as it does in Southern California. The centralization of the Company's management in Southern California may pose difficulties in terms of the Company's current and future expansion to new geographic areas because the Company lacks experience with local distributors, suppliers, consumer factors and other issues as a result of the distance between the Company's main headquarters and its coffeehouses. These factors could impede the growth of the Company and could have an adverse effect on the Company's results of operations. Competition. The market for prepared specialty coffee beverages is fragmented and highly competitive, and competition is expected to continue to increase substantially. The Company's coffee beverages compete directly against all restaurant and beverage outlets that serve coffee as well as a growing number of espresso stands, carts and stores. The Company's whole bean coffees compete directly against specialty coffees sold at retail through supermarkets and a growing number of specialty coffee stores. The coffee industry is currently dominated by several large companies, such as Kraft General Foods, Inc., Proctor & Gamble Co. and Nestle S.A., many of which have begun aggressively marketing gourmet coffee products. While the market for specialty gourmet coffee stores remains fragmented, the Company competes directly with Starbucks Corporation ("Starbucks"), the largest U.S. specialty coffee retailer. Starbucks has substantially greater financial, marketing and other resources than the Company. Other competitors, some of which may have greater financial and other resources than the Company, may also enter the markets in which the Company currently operates or intends to expand. One of the main areas of competition in the specialty coffee retail store marketplace is in the procurement of prime retail store premises. The Company competes against other specialty retailers and restaurants for store sites, and there can be no assurance that management will be able to secure adequate, additional sites at acceptable costs. See "Business -- Competition" and "Business -- Coffeehouses -- Diedrich Coffeehouse Locations." Geographic Concentration. The Company's coffeehouses are currently located in Southern California, Denver, Colorado and Houston, Texas. As a result, the Company's success will also depend in large part upon factors affecting general economic conditions and discretionary consumer spending in these regions. Any economic downturn or reduction in consumer spending in those regions could have a material adverse effect on the Company. See "Business -- Coffeehouses -- Diedrich Coffeehouse Locations." Lack of Diversification. The Company's business is centered around essentially one product: coffee. To date, the Company's operations have been limited to the purchase and roasting of raw coffee beans and the sale of whole bean coffees and coffee beverages, together with other food products, through its coffeehouses. Any decrease in demand for coffee would have a material adverse effect on the Company's business, operating results and financial condition. See "Business -- Diedrich's Coffee." Leases. The Company's thirty-six operating coffeehouses are all on leased premises. Upon the expiration of certain of these leases, there is no automatic renewal or option to renew. See "Business -- Coffeehouses -- Diedrich Coffeehouse Locations." No assurance can be given that leases can be renewed, or, if renewed, that rents will not increase substantially, either of which could adversely affect the Company. Other leases are subject to renewal at fair market value, which could involve substantial rent increases, or are subject to renewal with a scheduled rent increase, which could result in rents being above fair market value. 9 12 Effects of Compliance with Government Regulation. The Company is subject to various federal, state and local laws, rules and regulations affecting its businesses and operations. Each Diedrich coffeehouse and roasting facility is and shall be subject to licensing regulation and reporting requirements by numerous governmental authorities which may include building, land use, environmental protection, health and safety and fire agencies in the state or municipality in which each is located. Difficulties in obtaining or failures to obtain the necessary licenses or approvals could delay or prevent the development or operation of a given coffeehouse, the conversion of the remaining Acquired Cafes and Brothers Stores or limit its products and services available at such coffeehouse. Any problems which the Company may encounter in renewing such licenses in one jurisdiction may adversely affect its licensing status on a federal, state or municipal level in other relevant jurisdictions. See "Business -- Government Regulations." Reliance on Key Existing and Future Personnel. The Company's success will depend to a large degree upon the efforts and abilities of its officers and key management employees, particularly Martin Diedrich (the Company's Chairman and Director of Coffee) and Steven Lupinacci (the Company's President, Chief Executive Officer and Chief Financial Officer). The loss of the services of one or more of its key employees could have a material adverse effect on the Company's business prospects and potential earning capacity. The Company has entered into employment agreements with Messrs. Diedrich and Lupinacci and a stock option agreement with Mr. Lupinacci. See "Management -- Employment Agreements and Compensation Arrangements." The Company maintains and is the sole beneficiary of key person life insurance in the amount of $1,000,000 on the life of Mr. Diedrich. The Company will need to continue to recruit and retain additional key members of senior management to manage anticipated growth, but there can be no assurance that the Company will be able to recruit or retain additional members of senior management on terms suitable to the Company. See "Business -- Employees" and "Management -- Directors, Executive Officers and Other Key Employees." Control by Certain Existing Stockholders. Upon completion of this Offering, the Company's executive officers, directors and stockholders prior to the Offering will beneficially own 59.3% (53.2% if the Underwriters exercise their over-allotment option in full) of the outstanding shares of Common Stock. As a result, such stockholders will be in a position to control or influence significantly the affairs of the Company and certain matters requiring a stockholder vote, including the election of directors, the amendment of the Company's charter documents, the merger or dissolution of the Company and the sale of all or substantially all of the Company's assets. See "Principal and Selling Stockholders." Authorization of Preferred Stock and Other Anti-Takeover Mechanisms. The Company's Certificate of Incorporation authorizes the issuance of preferred stock with such designations, rights and preferences as may be determined from time to time by the Company's Board of Directors. Accordingly, the Board of Directors is empowered, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting and other rights that could adversely affect the voting power or other rights of the holders of the Common Stock. Issuance of the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. Although the Company has no present intention to issue any shares of its preferred stock, there can be no assurance that the Company will not do so in the future. See "Description of Capital Stock -- Preferred Stock." Furthermore, certain other provisions of the Company's Certificate of Incorporation and Bylaws may have the effect of delaying or preventing changes in control or management of the Company, which could adversely affect the market price of the Company's Common Stock. The Company is also subject to the provisions of Section 203 of the Delaware General Corporation Law (the "Delaware Law"), which will prohibit the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Absence of Dividends. The Company has not paid any dividends on any of its shares of capital stock since its inception and does not currently anticipate paying dividends on its Common Stock in the foreseeable future. See "Dividend Policy." 10 13 Immediate and Substantial Dilution. The assumed initial public offering price is substantially higher than the book value per share of Common Stock. Investors purchasing shares of Common Stock offered hereby will experience immediate and substantial dilution equal to $7.62 per share in the net tangible book value of their shares. See "Dilution." Seasonal Fluctuations of Operating Results. The Company's business has been seasonal, with decreased sales (and net income) in the first fiscal quarter of each year. Consequently, the Company's results of operations from any particular quarter may not necessarily be indicative of net income or loss that may be expected for any other particular quarter or for the whole year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Absence of Prior Public Market; Determination of Offering Price; Volatility of Stock Price. Prior to the Offering, there has been no public market for the Common Stock, and there can be no assurance that an active trading market will develop or, if developed, be sustained upon completion of this Offering. There also can be no assurance that the market price of the Common Stock will not decline below the initial public offering price. The initial public offering price of the Common Stock which will be arbitrarily determined by negotiation between the Company, the Selling Stockholders and the Representative, does not necessarily bear any relationship to the Company's asset value, net worth or other established criteria of value, and may not be indicative of the price of the Common Stock that may prevail in the public market after the Offering. The market price of the Common Stock may be significantly affected by numerous factors such as quarter-to-quarter fluctuations in the Company's anticipated or actual results of operations, changes in general market conditions, announcements by the Company or its competitors and the price of unroasted coffee. Securities of issuers having relatively limited capitalization or securities recently issued in an initial public offering are particularly susceptible to volatility based upon the short-term trading strategies of certain investors. See "Underwriting." Shares Eligible for Future Sale. Sales of a substantial number of shares of Common Stock into the public market following the Offering could materially adversely affect the prevailing market price for the Common Stock. Following this Offering, the Company will have outstanding an aggregate of 5,391,650 shares of Common Stock, including 2,200,000 shares of Common Stock offered hereby and "restricted securities" (the "Restricted Shares") pursuant to Rule 144 promulgated under the Securities Act of 1933, as amended (the "Securities Act"). The shares of Common Stock offered hereby will be freely tradeable without restriction or further registration under the Securities Act by persons other than "affiliates" under Rule 144. Beginning 180 days after the Effective Date, 3,191,650 Restricted Shares subject to lock-up agreements will become eligible for sale in the public market pursuant to Rule 144, all of which will be subject to the volume and other resale restrictions pursuant to Rule 144. The Representative may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements. See "Shares Eligible for Future Sale." In addition, holders of 2,108,568 Restricted Shares have registration rights that permit such holders to demand the registration of such shares at the Company's expense and further requires that such holders be given notice of and an opportunity to participate in any registration of other securities by the Company. Recently Formed Representative May Be Unable to Complete Offering or Make a Market. The Representative was formed in March 1995 and has completed four public offerings. However, the Chairman, Vice Chairman, the Senior Vice President of Trading and the Director of Corporate Finance of the Representative have additional prior experience with public offerings. The Chairman of the Representative has been in the securities industry for more than 11 years. He was associated with various national broker-dealers, including as a registered principal and a registered representative. The Vice Chairman of the Representative has been in the securities industry for over 20 years, where he served in various capacities, including executive officer and registered principal and representative, for various firms providing back office and related services to the securities industry, and was employed in various capacities by the National Association of Securities Dealers, Inc. The Senior Vice President of Trading of the Representative has been employed in the securities trading business for over 31 years. He has been responsible for supervising the market making operations, as well as managing the correspondent wire operations, for a financial firm, and worked as an over-the-counter trader at various financial firms. Nonetheless, due to the Representative's limited history, there can be no 11 14 assurance that the Offering will be completed or, if completed, that an active trading market for the Common Stock will develop. The Representative is not affiliated with the Company or any controlling person of the Company. See "Underwriting." USE OF PROCEEDS The net proceeds to the Company from the Offering, at an assumed initial public offering price of $11.00, after deducting underwriting discounts and commissions and estimated offering expenses, are estimated to be approximately $15,644,000. The Company will not receive any proceeds from the sale of shares of Common Stock by the Selling Stockholders, including any shares issued as a result of the exercise of the Underwriters' over-allotment option. The Company expects to use the net proceeds to repay indebtedness outstanding under the Company's short-term revolving credit facility (approximately $3,137,000 with an interest rate of 7.7% as of July 19, 1996). The funds borrowed under this facility, which matures on November 1, 1996 (extended to October 31, 1997 upon consummation of the Offering), were used to pay off the Company's previous line of credit and equipment line which were used for the acquisition of the Brothers Stores, new store construction and refurbishment and general working capital purposes. The Company also expects to use a portion of the net proceeds to repay indebtedness outstanding under a subordinated revolving promissory note with one of the Company's stockholders (approximately $1,415,000 with an interest rate of 11.25% as of July 19, 1996). The funds borrowed pursuant to this note, which matures on September 30, 1996, were used for coffeehouse construction and conversion of acquired stores. The Company also intends to repay the outstanding balance on several other items of indebtedness which, on July 19, 1996, amounted to an aggregate of approximately $433,000 which bore interest at a weighted average interest rate of 13.6%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." The remainder of the net proceeds will be used to fund expansion (through new store construction and acquisitions), infrastructure enhancements, development of additional distribution channels and product development, as well as working capital for general corporate purposes. Although the Company from time to time evaluates potential acquisitions of other existing specialty coffee retail businesses, as of July 19, 1996, it has no understandings, commitments or agreements with respect to any acquisition. The Company intends to use approximately $1.5 million of the net proceeds to fund the infrastructure enhancements, which will primarily include upgrading the Company's management information system and the Company's roasting and packaging facilities in current and new regions in which the Company is operating. Pending use of the net proceeds for the above purposes, the Company will invest such funds in short-term, investment-grade, interest-bearing obligations. The allocation of the use of proceeds represents management's estimate based upon current business and economic conditions. Although the Company does not contemplate material changes in the proposed allocation of the use of proceeds, to the extent the Company believes that adjustment is warranted by reason of existing business conditions, the amounts shown may be adjusted among the uses indicated above. The Company believes that the net proceeds of this Offering together with other financing sources, existing cash and bank financing and net cash from operations will be sufficient to meet the Company's anticipated cash requirements for at least the next twelve months. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." DIVIDEND POLICY The Company has never paid any dividends on its stock and anticipates that, for the foreseeable future, it will continue to retain any earnings for use in the operation of its business. Payment of cash dividends in the future, if any, will depend upon the Company's earnings, financial condition, any contractual restrictions (including restrictions under the Company's credit facility), restrictions imposed by applicable law, capital requirements and other factors deemed relevant by the Company's Board of Directors. 12 15 CAPITALIZATION The following table sets forth the capitalization of the Company as of May 1, 1996 (i) on an actual basis, (ii) on a pro forma basis giving effect to (a) the conversion of Series A and Series B Preferred Stock into Common Stock upon the closing of this Offering and (b) the reincorporation of the Company in the State of Delaware on or prior to the closing of this Offering, and (iii) on a pro forma as adjusted basis giving effect to the sale of the 1,600,000 shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $11.00 per share (after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company) and the initial application of the estimated net proceeds therefrom. The information in the table excludes (i) 160,000 shares of Common Stock which may be issued by the Company upon the exercise in full of the Representative's Warrants, (ii) 131,350 shares of Common Stock which may be issued by the Company upon the exercise in full of the Chief Executive Officer's stock options, and (iii) an aggregate of 600,000 shares of Common Stock reserved for issuance pursuant to the Company's 1996 Non-Employee Directors Stock Option Plan and 1996 Stock Incentive Plan. See "Underwriting" and "Management."
MAY 1, 1996 ----------------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ---------- ---------- ----------- Long-term debt, less current portion.................. $ 304,345 $ 304,345 $ -- ---------- ---------- ---------- Stockholders' equity: Series A convertible cumulative preferred stock, no par value; 1,000,000 shares authorized; 1,000,000 shares outstanding (actual); no shares outstanding (pro forma and as adjusted).......... 800,000 -- -- Series B convertible cumulative preferred stock, no par value; 1,608,568 shares authorized; 1,608,568 shares outstanding (actual); no shares outstanding (pro forma and as adjusted).......... 2,225,813 -- -- Preferred stock, no par value; no shares authorized (actual); 3,000,000 shares authorized (pro forma and as adjusted); no shares outstanding.......... -- -- -- Common stock, no par value; 4,021,437 shares authorized (actual); 25,000,000 shares authorized (pro forma and as adjusted); 1,183,082 shares outstanding (actual); 3,791,650 shares outstanding (pro forma); and 5,391,650 shares outstanding (as adjusted)........................ 330,698 3,356,511 19,000,511 Retained earnings................................... 55,083 55,083 55,083 ---------- ---------- ---------- Total stockholders' equity....................... 3,411,594 3,411,594 19,055,594 ---------- ---------- ---------- Total capitalization........................ $3,715,939 $3,715,939 $19,055,594 ========== ========== ==========
13 16 DILUTION The pro forma net tangible book value of the Company as of May 1, 1996 was $2,569,814, or $0.68 per share of Common Stock, based upon 3,791,650 shares of Common Stock outstanding. Pro forma net tangible book value per share represents the amount of total tangible assets of the Company less total liabilities, divided by the number of shares of Common Stock outstanding, after giving effect to the conversion of all outstanding shares of Preferred Stock into Common Stock upon the consummation of this Offering. The outstanding shares excludes (i) 160,000 shares of Common Stock which may be issued by the Company upon the exercise in full of the Representative's Warrants, (ii) 131,350 shares of Common Stock which may be issued by the Company upon the exercise in full of the Chief Executive Officer's stock options, and (iii) an aggregate of 600,000 shares of Common Stock reserved for issuance pursuant to the Company's 1996 Non-Employee Directors Stock Option Plan and 1996 Stock Incentive Plan. See "Underwriting" and "Management." After giving effect to the sale of the 1,600,000 shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $11.00 per share (after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company), the pro forma net tangible book value of the Company as of May 1, 1996 would have been $18,213,814 or $3.38 per share. This represents an immediate increase in pro forma net tangible book value of $2.70 per share to existing stockholders and an immediate dilution of $7.62 per share to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per share of Common Stock..... $11.00 Pro forma net tangible book value per share before the Offering... $0.68 Increase in net tangible book value per share attributable to new investors...................................................... 2.70 ----- Pro forma net tangible book value per share after the Offering...... 3.38 ------ Dilution per share to new investors................................. $ 7.62 ======
The following table summarizes, on a pro forma basis as of May 1, 1996, the number of shares of Common Stock purchased from the Company, the total cash consideration paid and the average price per share paid by the existing stockholders and to be paid by purchasers of shares offered hereby at an assumed initial public offering price of $11.00 (before deducting underwriting discounts and commissions and estimated offering expenses payable by the Company):
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE --------------------- ----------------------- PRICE PER NUMBER PERCENT AMOUNT PERCENT SHARE --------- ------- ----------- ------- --------- Existing Stockholders.......... 3,791,650 70.3 $ 3,356,511 16.0 $ 0.89 New Investors.................. 1,600,000 29.7 17,600,000 84.0 $ 11.00 --------- ----- ----------- ----- Total................ 5,391,650 100.0 $20,956,511 100.0 ========= ===== =========== =====
14 17 SELECTED FINANCIAL DATA The following selected financial data as of and for the years ended January 31, 1994, 1995 and 1996 were derived from the Company's financial statements, which have been audited by BDO Seidman, LLP, independent certified public accountants. The financial data as of and for the years ended January 31, 1992 and 1993 were derived from unaudited financial statements. The financial data with respect to the statement of operations for the twelve weeks ended April 25, 1995 and the thirteen weeks ended May 1, 1996 and with respect to the balance sheet as of May 1, 1996 were derived from unaudited financial statements appearing herein. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, which the Company considers necessary for a fair presentation of the financial position and results of operations for these periods. The operating results for the thirteen weeks ended May 1, 1996 are not necessarily indicative of the results that may be achieved for the fiscal year ending on January 29, 1997. The financial data set forth below should be read in conjunction with the audited financial statements and accompanying notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein.
YEARS ENDED JANUARY 31, TWELVE THIRTEEN -------------------------------------------------------- WEEKS WEEKS PRO ENDED ENDED MAY FORMA APRIL 25, 1, 1992 1993 1994 1995 1996 1996(1) 1995(2) 1996(2)(3) ------ ------ ------ ------ ------ ------- --------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net sales: Retail...................... $2,382 $2,906 $3,912 $6,673 $8,879 $11,236 $ 1,757 $3,902 Wholesale and other......... -- 33 502 918 1,365 1,365 301 373 ------ ------ ------ ------ ------ ------- ------ ------ Total.................. 2,382 2,939 4,414 7,591 10,244 12,601 2,058 4,275 ------ ------ ------ ------ ------ ------- ------ ------ Costs and expenses: Cost of sales and related occupancy costs........... 883 1,140 1,796 3,164 4,409 5,932 872 1,773 Store operating expenses.... 770 1,064 1,594 2,584 3,520 4,686 669 1,735 Other operating expenses.... -- 6 146 282 277 277 64 60 Depreciation and amortization.............. 71 143 102 255 354 498 62 154 General and administrative expenses.................. 624 762 809 851 1,335 1,402 277 337 ------ ------ ------ ------ ------ ------- ------ ------ Total.................. 2,348 3,115 4,447 7,136 9,895 12,795 1,944 4,059 ------ ------ ------ ------ ------ ------- ------ ------ Operating income (loss)......... 34 (176) (33) 455 349 (194) 114 216 Interest expense and other...... 80 72 55 78 34 34 13 37 ------ ------ ------ ------ ------ ------- ------ ------ Income (loss) before income taxes......................... (46) (248) (88) 377 315 (228) 101 179 Provision (benefit) for income taxes......................... 1 (15) 1 53 129 (93) 42 72 ------ ------ ------ ------ ------ ------- ------ ------ Net income (loss)............... $ (47) $ (233) $ (89) $ 324 $ 186 $ (135) $ 59 $ 107 ====== ====== ====== ====== ====== ======= ====== ====== Pro forma net income (loss) per share(4)...................... $ .06 $ (.04) $ .03 ====== ======= ====== Shares used in pro forma per share calculation(4).......... 3,153,000 3,153,000 3,906,000 ========= ========= =========
15 18
JANUARY 31, -------------------------------------------------------- PRO FORMA MAY 1, 1996 1992 1993 1994 1995 1996 1996(1) (2)(3) ------ ------ ------ ------ ------ ------- ------------ BALANCE SHEET DATA: Working capital (deficiency)......... $ (387) $ 470 $ (364) $ (218) $ (53) $(1,436) $ (3,819) Total assets......................... 866 1,790 2,163 2,503 5,316 6,699 8,915 Long-term obligations, less current portion............................ 239 453 544 471 829 829 304 Total stockholders' equity........... 126 938 849 1,173 3,304 3,304 3,412
- --------------- (1) The pro forma condensed financial statement information assumes the Company's acquisition of the 12 Brothers Stores occurred on February 1, 1995 for the statement of operations data and on January 31, 1996 for the balance sheet data. Pro forma statement of operations and balance sheet data excludes the acquisition of the Acquired Cafes as the acquisition does not require pro forma presentation. See Note 9 of Notes to Financial Statements and the Unaudited Pro Forma Condensed Financial Statements. (2) Effective February 1, 1996, the Company changed its year end from January 31 to a fiscal year ending on the Wednesday nearest January 31. Accordingly, the quarterly period ended May 1, 1996 includes 13 weeks. Prior to the change in fiscal year end, the Company's quarterly periods included 12 weeks, except for the fourth quarter which had approximately 16 weeks. (3) Includes the results of operations attributable to the Brothers Stores and Acquired Cafes since the acquisitions were completed in February 1996. The pro forma statement of operations data for the 13 weeks ended May 1, 1996 did not differ materially from the historical results of operations for such period and, accordingly, has not been presented. See Note 9 of Notes to Financial Statements. (4) Pro forma net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common and common equivalent shares outstanding during the respective period, assuming the conversion of the Series A and Series B Preferred Stock to Common Stock as of the date of issuance. Dividends on the Series A and Series B Preferred Stock have been excluded from the computation since the preferred stock has been assumed to have been converted to Common Stock. 16 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following should be read in conjunction with the financial statements of the Company and notes thereto and other financial information appearing elsewhere in this Prospectus. GENERAL The first retail store operating under the name Diedrich Coffee commenced operations in 1972. At the conclusion of the fiscal year ended January 31, 1996 ("fiscal 1996") there were twelve coffeehouses in operation, all of which were located in Southern California, and as of July 19, 1996, the Company operated a total of thirty-six coffeehouses located in California, Colorado and Texas, with six additional locations subject to a binding lease. On February 15, 1996, the Company acquired seven retail locations in Denver, Colorado that were former bakery-espresso cafes (the "Acquired Cafes"). On February 23, 1996, the Company acquired twelve retail locations from Brothers Gourmet Coffees, Inc., doing business as Brothers Gourmet Coffee Bars (the "Brothers Stores"). Ten of the Brothers Stores are located in Denver, Colorado and two are in Houston, Texas. Both of the transactions took the form of asset acquisitions, accounted for under the purchase method, in which the principal assets acquired were leasehold interests, furniture and fixtures and equipment. No material liabilities were assumed except for the remaining obligations under the operating leases for each of the stores. Management anticipates that the acquisition price, combined with the budgeted improvement and conversion costs will, on average, result in a total cost which is significantly below the typical historical cost to open a similar size Diedrich coffeehouse. The acquired stores operated under prior ownership at sales levels much lower than those historically experienced in the Company's stores in Southern California. Of the twelve acquired Brothers Stores, one store is not subject to a binding lease but such lease is presently being negotiated and one store has been closed. The closed location's post-acquisition operating results confirmed management's initial evaluation that sales levels at this location would not be sufficient to warrant conversion to the Diedrich coffeehouse concept. As of July 19, 1996, eleven of the eighteen remaining acquired stores have been converted to Diedrich coffeehouses which included new signage, decor, recipes, products and service standards. From the respective dates of acquisition until each location is converted, the stores will be operated under the predecessor's name and style. Management expects that the conversion of the remaining locations will be completed before the end of the third quarter of the current fiscal year. The conversion schedule will be affected by the speed with which the landlords and governmental agencies grant their approval for the anticipated changes during the remodeling. Management believes that the conversion of the acquired locations to the Diedrich coffeehouse concept and the operation of the coffeehouses by Diedrich management will, over time, result in a significant improvement from the financial results achieved by these stores prior to their acquisition by the Company. At the end of fiscal 1996, there were twelve coffeehouses in operation, including ten which were located in suburban sites such as neighborhood shopping centers, one which was located in a regional mall and one which was located in a regional entertainment center. The Company also operates one mobile cart located at a regional hospital. In addition to retail sales at coffeehouses, the Company sells roasted coffee and selected coffee brewing and espresso machinery to the food service industry as well as through direct mail order (collectively, the "wholesale division"). In fiscal 1996, the Company derived 86.7% of its net sales from retail operations and 13.3% from wholesale operations. Effective February 1, 1996, the Company changed its year end from January 31 to a fiscal year ending on the Wednesday nearest January 31. Accordingly, the quarterly period ended May 1, 1996 includes thirteen weeks. Prior to the change in fiscal year end, the Company's quarterly periods included twelve weeks, except for the fourth quarter which had approximately sixteen weeks. 17 20 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain information derived from the Company's Statements of Operations expressed as percentages of net sales, except as otherwise noted.
TWELVE THIRTEEN WEEKS ENDED MAY 1, 1996 YEARS ENDED JANUARY 31, WEEKS ----------------------------------- --------------------------------------- ENDED EXCLUDING ACQUIRED PRO FORMA APRIL 25, ACQUIRED STORES 1994 1995 1996 1996(1) 1995 STORES(2) ONLY(3) ACTUAL ----- ----- ----- --------- --------- ---------- --------- ------ Retail Net Sales................. 88.6% 87.9% 86.7% 89.2% 85.4% 88.6% 100.0% 91.3 % Wholesale Net Sales.............. 11.4 12.1 13.3 10.8 14.6 11.4 0.0 8.7 ----- ----- ----- ----- ----- ----- ----- ----- Net Sales........................ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ----- ----- ----- ----- ----- ----- ----- ----- Cost of Sales and Related Occupancy Costs................ 40.7 41.7 43.0 47.1 42.4 41.5 41.3 41.5 Store Operating Expenses (4)..... 40.8 38.7 39.6 41.7 38.1 41.5 53.1 44.5 Other Operating Expenses (5)..... 29.2 30.8 20.3 20.3 21.4 15.8 N/A 15.9 Depreciation and Amortization.... 2.3 3.4 3.5 4.0 3.0 3.6 3.4 3.6 General and Administrative Expenses....................... 18.3 11.2 13.0 11.1 13.4 10.3 N/A 7.9 Operating Income (Loss).......... (0.7) 6.0 3.4 (1.5) 5.5 6.0 2.1 5.1 Net Income (Loss)................ (2.0) 4.3 1.8 (1.1) 2.9 3.4 (0.6) 2.5 ===== ===== ===== ===== ===== ===== ===== =====
- --------------- (1) The pro forma condensed statement of operations assumes the Company's acquisition of the Brothers Stores occurred on February 1, 1995 and excludes the acquisition of the Acquired Cafes as the acquisition does not require pro forma presentation. See Note 9 of Notes to Financial Statements and the Unaudited Pro Forma Condensed Financial Statements. (2) Excludes the results of operations for the Acquired Cafes and Brothers Stores acquired in February 1996. (3) Represents the results of operations for the Acquired Cafes from February 15, 1996 and the Brothers Stores from February 23, 1996 through the period ending May 1, 1996. General and administrative expenses are attributable to all stores and not separately attributable to the acquired stores. (4) Store operating expenses are expressed as a percentage of retail net sales. (5) Other operating expenses are expressed as a percentage of wholesale net sales. YEAR ENDED JANUARY 31, 1996 COMPARED TO YEAR ENDED JANUARY 31, 1995 Net sales. Net sales for the year ended January 31, 1996 were $10,244,000, an increase of $2,653,000, or 35.0% over net sales for fiscal 1995 which were $7,591,000. Retail sales increased 33.1% to $8,879,000 in fiscal 1996 from $6,673,000 in fiscal 1995. The increase resulted from a combination of sales growth at existing locations and sales from new locations. Comparable fiscal 1996 over fiscal 1995 store sales for the seven stores opened prior to fiscal 1995 showed an increase of 10.2% primarily due to increased transaction volume. During fiscal 1996, the Company added five new coffeehouses. These five new stores contributed $1,451,000 to fiscal 1996 sales. The Company's retail sales mix for fiscal 1996 included whole bean coffee (8.6%), brewed coffee and espresso beverages (70.6%), food items (18.9%), and accessories and clothing (1.9%). Wholesale and mail order sales combined increased 48.8% to $1,365,000 in fiscal 1996 from $917,000 in fiscal 1995. The increase was due to a more active sales effort as well as the increased brand recognition resulting from the addition of new coffeehouse locations within the Southern California market. Cost of sales and related occupancy costs. Cost of roasted coffee, dairy, food, paper and bar supplies, accessories and clothing (cost of sales) and rent (related occupancy costs) for the Company increased to $4,409,000 for the year ended January 31, 1996 from $3,164,000 for the comparable period in 1995, an increase of $1,245,000 or 39.4%. As a percentage of net sales, cost of sales and related occupancy costs increased to 43.0% for the year ended January 31, 1996, from 41.7% for the comparable period in 1995. The dollar increase is primarily due to the addition of five new locations during 1996. The percentage increase 18 21 is primarily due to a shift of the sales mix resulting from the addition of two stores which provide more extensive food menus combined with an increase in the cost of paper, cups and bar supplies which resulted from an industry wide price increase in the cost of paper. Store operating expenses. Store operating expenses increased to $3,520,000 for the year ended January 31, 1996, from $2,584,000 for the comparable period in 1995. The $936,000 or 36.2% increase was due primarily to the addition of five locations in 1996. Store operating expenses consist of the store-level components of direct and indirect labor, marketing, utilities, maintenance, supplies, district supervision and overhead, and pre-opening expenses. Pre-opening expenses are comprised of training labor, advertising and marketing and supplies which are accumulated and expensed when a store is opened. In fiscal 1996, store operating expenses as a percent of retail net sales increased to 39.6% from 38.7% in the prior year. The percentage increase was due to an increase in pre-opening expenses over the prior year which was partially offset by a decrease in store labor. Other operating expenses. Other operating expenses decreased to $277,000 for fiscal 1996 from $283,000 in the comparable period in 1995. Other operating expenses include the wholesale division operating costs which consist principally of labor, advertising and supplies. These expenses decreased, as a percent of the net sales from the wholesale division, to 20.3% from 30.8% as a result of increased sales volume. Depreciation and amortization. Depreciation and amortization increased to $354,000 for fiscal 1996 from $255,000 for the comparable period in 1995. As a percentage of net sales, depreciation and amortization increased to 3.5% from 3.4% in the prior year, which reflects the early sales growth stage for the five stores which were added during the year. General and administrative expenses. General and administrative expenses increased to $1,335,000 for fiscal 1996 from $851,000 for fiscal 1995. As a percentage of net sales, general and administrative expenses increased to 13.0% from 11.2% principally due to the additions to the infrastructure in anticipation of growth and also due to higher occupancy costs as a result of the move of the Company's headquarters to larger facilities. Infrastructure increases consisted primarily of additional salaries associated with personnel additions in the real estate, recruiting and training and accounting departments. Interest expense. Interest expense decreased to $50,000 for fiscal 1996 from $83,000 for fiscal 1995. The $33,000 or 39.4% decrease was due primarily to lower average debt outstanding during the year. YEAR ENDED JANUARY 31, 1995 COMPARED TO YEAR ENDED JANUARY 31, 1994 Net sales. Net sales for the year ended January 31, 1995 increased to $7,591,000 from $4,414,000 for the comparable period in 1994, an increase of 72.0%. Retail net sales increased 70.6% to $6,673,000 in fiscal 1995 from $3,912,000 in fiscal 1994 primarily due to increased transaction volume and an approximately 3% increase in beverage prices. Comparable fiscal 1995 over 1994 store sales for the four stores opened prior to fiscal 1994 showed an increase of 17.0% due to increased transaction volume. No new locations were added during the period. As of the end of fiscal 1995, there were seven stores in operation, all of which were located in suburban sites such as neighborhood shopping centers. In addition to the seven stores, the Company operated one mobile cart located at a regional hospital. The Company's retail sales mix for fiscal 1995 included whole bean coffee (9.7%), brewed coffee and espresso beverages (71.8%), food items (16.1%), and accessories, clothing and other (2.4%). Wholesale and mail order sales combined increased 82.6% to $917,000 in fiscal 1995 from $502,000 in fiscal 1994. The increase was due to a more active sales effort and the addition of sales staff. Cost of sales and related occupancy costs. Cost of roasted coffee, dairy, food, paper and bar supplies, accessories and clothing (cost of sales) and rent (related occupancy costs) for the Company increased to $3,164,000 for the year ended January 31, 1995 from $1,796,000 for the comparable period in 1994, an increase of $1,368,000 or 76.2%. As a percentage of net sales, cost of sales and related occupancy costs increased to 41.7% for the year ended January 31, 1995, from 40.7% for the comparable period in 1994. This dollar increase is primarily due to a full year of costs for the three stores opened in the prior year. The percentage increase is primarily due to an increase in the cost of unroasted coffee. 19 22 Store operating expenses. Store operating expenses increased to $2,584,000 for fiscal 1995, from $1,594,000 for fiscal 1994. The $990,000 or 62.1% increase was due primarily to a full year of store operating expenses in 1995 for the three new coffeehouses opened during 1994. Store operating expenses consist of the store-level components of direct and indirect labor, marketing, utilities, maintenance, supplies, district supervision and overhead, and pre-opening expenses. In fiscal 1995, store operating expenses as a percent of retail net sales decreased to 38.7% from 40.8% in the prior year. The decrease was due to a decrease in pre-opening expenses over the prior year. Other operating expenses. Other operating expenses increased to $283,000 for the year ended January 31, 1995 from $146,000 in the comparable period in 1994. Other operating expenses include the wholesale division operating costs which consist principally of labor, advertising and supplies. These expenses increased, as a percent of the net sales from the wholesale division, to 30.8% from 29.2% as a result of the increased sales force and maintenance staff which was added during the year. Depreciation and amortization. Depreciation and amortization increased to $255,000 for fiscal 1995 from $102,000 for fiscal 1994. As a percentage of net sales, depreciation and amortization increased to 3.4% from 2.3% in the prior year, which reflects the early sales growth stage for three of the seven stores which were added during the prior year. General and administrative expenses. General and administrative expenses increased to $851,000 for fiscal 1995 from $809,000 for fiscal 1994. As a percentage of net sales, general and administrative expenses decreased to 11.2% from 18.3% principally because the Company's infrastructure had been augmented in fiscal 1994 to provide the quality of support to facilitate an anticipated increased coffeehouse count. Management and support staff salary expense at the principal executive offices decreased to 7.1% from 12.1% of net sales. Interest expense. Interest expense decreased to $83,000 for the year ended January 31, 1995 from $91,000 for the comparable year in 1994. The $8,000 or 8.6% decrease was due primarily to lower average debt outstanding during the year. THIRTEEN WEEKS ENDED MAY 1, 1996 COMPARED TO THE TWELVE WEEKS ENDED APRIL 25, 1995 Net sales. Net sales of the Company's retail operations, excluding the Acquired Cafes and Brothers Stores for the thirteen weeks ended May 1, 1996 increased to $2,907,000 from $1,757,000 for the twelve weeks ended April 25, 1995. The increase in sales due to reporting thirteen weeks rather than twelve weeks was $217,000. The percentage sales increase adjusted for the extra week was 53.1%. The acquisitions of the Acquired Cafes and Brothers Stores were consummated on February 15, 1996 and February 23, 1996, respectively. The two acquisitions, comprising nineteen stores, contributed $995,000 to net sales in the quarter. For the thirteen weeks ended May 1, 1996, net sales for comparable Diedrich coffeehouses that were opened prior to the first quarter of fiscal 1996 increased to $2,029,000 from $1,732,000 for the twelve weeks ended April 25, 1995. The increase in sales due to reporting thirteen weeks rather than twelve weeks was $150,000. The percentage sales increase, adjusted for the extra week, was 8.5%. Wholesale and mail order sales combined increased 23.9% to $373,000 in the thirteen weeks ended May 1, 1996 from $301,000 in the twelve weeks ended April 25, 1995. The increase was due to a more active sales effort and the addition of sales staff. No wholesale or mail order activities were contributed by the Brothers Stores or Acquired Cafes. Cost of sales and related occupancy costs. Cost of roasted coffee, dairy, food, paper and bar supplies, accessories and clothing (cost of sales) and rent (related occupancy costs) for the Company, excluding the acquisitions, increased to $1,362,000 for the thirteen weeks ended May 1, 1996 from $872,000 for the twelve weeks ended April 25, 1995, an increase of $490,000 or 56.2%. This dollar increase is primarily due to the operations of five Diedrich coffeehouses which were opened in the latter part of fiscal 1996. As a percentage of retail net sales, cost of sales and related occupancy costs decreased to 41.5% for the first quarter of fiscal 1997 from 42.4% for the first quarter of fiscal 1996. This decrease is principally a result of a decrease in the cost of unroasted coffee, which was lower in the first quarter of the current fiscal year as compared to the first quarter 20 23 of the prior fiscal year, during which the Company was still liquidating higher cost coffee inventory. This decrease was partially offset by the increase in the food cost of sales element caused by a shift in the product mix due to the addition of several new stores which offer a more extensive food menu. Collectively, cost of sales and related occupancy costs for the Brothers Stores and Acquired Cafes was 41.3% of their net sales for the period from acquisition date to May 1, 1996. Store operating expenses. Store operating expenses, excluding the acquisitions, increased to $1,207,000 for the thirteen weeks ended May 1, 1996, from $669,000 for the twelve weeks ended April 25, 1995. For the first quarter of fiscal 1997, store operating expenses, excluding the Brothers Stores and Acquired Cafes, as a percent of retail sales increased to 41.5% from 38.1% in the prior fiscal year's first quarter. The increase was due to increased labor and opening costs relating to the opening of two Diedrich coffeehouses in the first quarter of fiscal 1997. Store operating expenses for the acquired stores were $528,000 or 53.1% of net sales from the nineteen acquired stores. Other operating expenses. Other operating expenses decreased to $59,000 for the first quarter of fiscal 1997 from $64,000 in the first quarter of fiscal 1996. These expenses decreased, as a percent of the net sales from the wholesale division, to 15.9% from 21.4% as a result of a decrease in the overall salary expense of the sales force due to the reduction of the sales management overhead component. Depreciation and amortization. Depreciation and amortization excluding the acquired stores increased by 93.5% to $120,000 for the thirteen weeks ended May 1, 1996 from $62,000 for the twelve weeks ended April 25, 1995. As a percentage of net sales, depreciation and amortization increased to 3.6% from 3.0% in the prior year, principally due to the increase in depreciable assets as a result of the Company operating six more coffeehouses this quarter than during the same period in the prior fiscal year. Depreciation and amortization for the Brothers Stores and Acquired Cafes was $34,000, or 3.4% of net sales from those stores. General and administrative expenses. General and administrative expenses increased to $337,000 for the first quarter of fiscal 1997 from $277,000 for the first quarter of fiscal 1996. As a percentage of net sales, general and administrative expenses decreased to 7.9% from 13.4% due to the addition of the acquired stores sales in the revenue base. Management is currently adding selected resources and personnel to aid in the conversion and control of the new markets according to the integration plan established prior to the acquisitions. General and administrative expenses are not directly attributable to specific stores. Accordingly, no separate analysis of the general and administrative expenses excluding the Brothers Stores and Acquired Cafes is included here. Interest expense. Interest expense increased to $39,000 for the thirteen weeks ended May 1, 1996 from $15,000 for the twelve weeks ended April 25, 1995. The $24,000 increase was due primarily to higher average debt outstanding as a result of the acquisition of the Brothers Stores and Acquired Cafes. INCOME TAXES Net operating losses generated in fiscal 1994 and prior were carried forward and utilized to offset the allowable portion of income tax in fiscal 1995 and 1996. As of January 31, 1996, a net operating loss for federal income tax purposes of $115,000 remains to be utilized against future taxable income for years through fiscal 2008, subject to an annual limitation due to the change in ownership rules under the Internal Revenue Code. As of January 31, 1996, the Company had deferred tax assets aggregating $48,000. Management has determined, based upon the Company's history of operating earnings and its expectations for the future, that operating income for the Company will more likely than not be sufficient to fully recognize these deferred tax assets. See Note 8 of Notes to Financial Statements. LIQUIDITY AND CAPITAL RESOURCES The Company's principal capital requirements are for the active expansion of its retail operations, through construction and/or acquisition, and for the infrastructure to support such expansion. Working capital requirements also include inventory associated with stores, seasonal fluctuations in inventory to accommodate holiday merchandise and the funding of obligations under future coffee delivery contracts. The Company plans 21 24 to continue its expansion efforts. In fiscal 1996, the average cost to open a new store, including leasehold improvements, equipment and inventory, was approximately $320,000 per store. Infrastructure additions consist principally of additional roasting and packaging capacity as well as development of enhancements to the management information systems at the store level and at the principal executive offices. In February 1996, the Company funded the acquisition of the Brothers Stores and the Acquired Cafes by utilizing the Company's then existing line of credit which had a maturity date of February 1997. Accordingly, all amounts drawn and outstanding under that line of credit were classified as current liabilities, and included in the calculation of working capital, notwithstanding the fact that the proceeds had been used to finance capital assets. The working capital deficiency as of May 1, 1996 was $3,819,000 compared to $53,000 as of January 31, 1996. At May 1, 1996, the Company had forward inventory purchase commitments of $252,000. During the eighteen months following the Offering, the Company expects to spend approximately $13 million to finance construction and acquisition of new coffeehouses, the addition of roasting and packaging facilities and the development and installation of management information system enhancements. Through May 1, 1996, the Company has funded its capital requirements through the issuance of equity securities and through debt from financial institutions as well as loans from a shareholder. See "Certain Transactions." To a lesser extent, the Company has utilized an increase in the average balance of accounts payable to fund short term cash needs for working capital. In the absence of receiving the funds from the completion of this Offering, the Company would continue to fund its cash requirements in this manner. Through July 19, 1996, the Company has entered into lease agreements for its principal executive office, coffeehouses and warehouse locations which, as of February 1, 1996, require minimum rental payments as follows: Fiscal 1997.............................................. $1,568,000 Fiscal 1998.............................................. $1,850,000 Fiscal 1999.............................................. $1,860,000 Fiscal 2000.............................................. $1,847,000 Fiscal 2001.............................................. $1,531,000 Thereafter............................................... $5,209,000
Until recently, the Company had two credit facilities with Wells Fargo Bank. One facility was a revolving line of credit that permitted maximum borrowings equal to $2 million, was collateralized by substantially all of the Company's assets and bore interest at the prime rate plus 0.75% ("Wells Line"). The other facility was a loan commitment available for the purchase of equipment that permitted maximum borrowings equal to $1 million, was collateralized by equipment and bore interest at the prime rate plus 1% ("Equipment Loan"). The Wells Line and the Equipment Loan were both scheduled to expire in February 1997. Aggregate borrowings under the Wells Line and the Equipment Loan were $2,827,776 at May 1, 1996 at a weighted average interest rate of 9.1%. In July 1996, the Company entered into a new revolving line of credit with Bank of America and used the proceeds of such line to repay the outstanding balances under the Wells Line and the Equipment Loan, which were then terminated. The new facility permits maximum borrowings equal to $4,100,000. At July 19, 1996, borrowings under this facility were approximately $3,137,000 at an interest rate of 7.7% and $963,000 was available for borrowing under this facility. Borrowings under the Bank of America line of credit are secured by substantially all of the Company's assets and bear interest at Bank of America's prime rate plus 0.25% or, at the Company's option, certain other rates established by Bank of America's Grand Cayman branch or London branch plus 2.25%. This facility expires on November 1, 1996. Subsequent to the completion of this Offering, this line of credit will be unsecured, the maturity date will be extended to October 31, 1997 and maximum borrowings will, assuming the receipt of net proceeds by the Company from this Offering in excess of $15 million, be increased to $7 million. This line of credit is currently the primary external source of liquidity available to the Company. The Company's credit agreement in connection with the Bank of America line of credit contains various covenants which, among other things, requires the delivery of regular financial information and the 22 25 maintenance of positive net income. In addition, the credit agreement imposes certain restrictions on the Company, including, with respect to the incurrence of additional indebtedness, the payment of dividends and the ability to make acquisitions. On May 20, 1996, the Company entered into a revolving promissory note with a maximum principal amount of $2,000,000 payable to Redwood Enterprises VII, L.P, a stockholder of the Company. This note is subordinate to the Company's line of credit with Bank of America. The interest rate on the note is the prime rate plus three percent, and the note expires on September 30, 1996. The outstanding balance on the note as of July 15, 1996 was $1,415,000 and the interest rate was 11.25%. See "Certain Transactions." The Company believes that the borrowing under its credit facility, together with the proceeds of this Offering, other financing sources, anticipated cash flow from operations and existing cash will be sufficient to meet the Company's anticipated cash requirements for at least the next twelve months. COFFEE PRICES AND AVAILABILITY The Company believes that it has adequate sources of supply of high quality arabica coffee to meet its expansion needs for the foreseeable future. The average cost of coffee acquired by the Company during the first four months of the current fiscal year declined by approximately 15% as compared to fiscal 1996 principally due to fluctuations in the unroasted coffee market as well as economies of scale due to increasing order quantities. While the Company seeks to anticipate its coffee needs carefully, there can be no assurance that the prices it will have to pay for the highest quality coffee available will remain stable in the future. SEASONALITY AND QUARTERLY RESULTS The Company's business is subject to seasonal fluctuations as well as general economic trends that affect retailers in general. Historically, the Company's net sales are not realized ratably in each quarter, with net sales being the highest during the last fiscal quarter which includes the December holiday season. Quarterly results are affected by the timing of the opening of new stores which may not occur as anticipated due to factors outside the Company's control. As a result of the combination of the seasonality of the retail operations and the high level of anticipated expansion, the financial results for any individual quarter may not be indicative of the results that may be achieved for a full fiscal year. PRO FORMA CONDENSED FINANCIAL DATA FOR FISCAL 1996 During the first quarter of fiscal 1997, the Company acquired nineteen stores from two unrelated sellers. The results of operations of the acquired stores are included in the first quarter of fiscal 1997 from the dates of the closing of each acquisition through the end of the quarter. Of the two transactions, the acquisition of the seven Acquired Cafes did not require pro forma presentation but the twelve acquired Brothers Stores were significant enough to warrant pro forma disclosure, as discussed below. The pro forma condensed statement of operations for the thirteen weeks ended May 1, 1996 did not differ materially from the historical results of operations for such period and, accordingly, has not been presented. The purpose of the pro forma condensed financial statements is to present (i) what the operating results of the Company might have been for the year ended January 31, 1996 had the acquisition of the Brothers Stores occurred on February 1, 1995, the beginning of the fiscal year, and (ii) what the Company's financial position might have been at January 31, 1996 if the acquisition had been completed as of that date. The pro forma condensed financial statements, however, do not purport to represent what the Company's actual results of operations or financial position would have been had the acquisition been completed on those dates, as there are numerous aspects of the Company's operations that would have been affected by the combination of the business on one date that cannot be accounted for in the pro forma condensed financial statements. Moreover, the pro forma condensed financial statements do not purport to be a projection of the results of operations or financial position of the Company either for the current fiscal year ending January 29, 1997 or for any future period and such financial statements should not be relied upon to project future operating results of the Company, as such operating results will be affected by a number of circumstances, the nature and effect of which cannot be predicted. 23 26 Pro Forma Condensed Statement of Operations. The Pro Forma Condensed Statement of Operations for the year ended January 31, 1996 was prepared by (i) combining the historical statement of operations of the Company for that period with the historical statement of operations of the Brothers Stores for the year ended December 29, 1995 in the manner described in the Pro Forma Condensed Financial Statements and (ii) adjusting the combined results of operations to give retroactive effect, for financial reporting purposes, to certain changes that would have occurred either in the operations of the Company or in the Brothers Stores as a direct result of the acquisition. See Notes 1 through 4 of Notes to Pro Forma Condensed Financial Statements. Net sales. Pro forma net sales combine the historical actual net sales of the Company with that of the Brothers Stores as if the Brothers Stores were acquired on February 1, 1995, the beginning of the fiscal year. For fiscal 1996, the Company's net sales were $10,244,000 and net sales for the acquired Brothers Stores during the same period were $2,356,000. Cost of sales and related occupancy costs. The historical Brothers Stores' cost of sales and related occupancy costs (64.6% of Brothers Stores' net sales) were combined with the Company's (43.0% of the Company's net sales) for a total of 47.1% of combined pro forma net sales. Store operating expenses. Store operating expenses were combined on a historical basis which blends the Company's expenses at 34.4% of its net sales with the Brothers Stores' expenses at 49.5% of its net sales for a total of 37.2% of combined pro forma net sales. Other operating expenses. Other operating expenses consist solely of the Company's expenses of operating the wholesale division for the year. Depreciation and amortization. Depreciation and amortization combines the historical expenses of the two operations with a net pro forma adjustment of $483,000 for a pro forma combined total of $498,000, or 4.0% of pro forma combined net sales. The net adjustment gives effect to (i) the difference in depreciation for the historical cost basis of the property and equipment for the Brothers Stores and the fair value of such assets, and (ii) the amortization of the cost in excess of net assets acquired. General and administrative expenses. General and administrative expenses comprise the combination of the historical amounts for the Company and Brothers Stores (13.0% and 19.0%, respectively) with an adjustment of $380,000 which eliminates management's estimation of the duplicated overhead and administrative burden, for a combined amount of $1,402,000, which reflects management's estimate of the appropriate on-going overhead expense level at 11.1%. Pro Forma Condensed Balance Sheet. The Pro Forma Condensed Balance Sheet as of January 31, 1996 combines the historical balance sheet of the Company with that of the Brothers Stores and adjusts the combined balance sheet to record (i) the elimination of assets and liabilities of the Brothers Stores that were not acquired or assumed, (ii) the fair value of the net assets acquired in accordance with the purchase method of accounting and (iii) the debt incurred as a result of the acquisition. See Note 1 of Notes to Pro Forma Condensed Financial Statements. NEW ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of," requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company is in the process of analyzing the impact of this statement and does not believe that it will have a material impact on the Company's financial position or results of operations. The Company anticipates adopting the provisions of the statement for fiscal 1997. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," established financial accounting and reporting standards for stock-based employee compensation plans and 24 27 certain other transactions involving the issuance of stock. The Company is in the process of analyzing the impact of this statement and does not believe that it will have a material impact on the Company's financial position or results of operations. The Company anticipates adopting the provisions of the statement for fiscal 1997. INFLATION Inflation has not had a material impact on operating results of the Company in the past. There can be no assurance, however, that the Company's business will not be affected by inflation. 25 28 BUSINESS GENERAL Diedrich Coffee is one of the leading specialty coffee roaster/retailers in the United States and currently operates thirty-six coffeehouses located in Southern California, Denver, Colorado and Houston, Texas. At each of the Diedrich coffeehouses, the Company sells high quality coffee beverages made with its own freshly roasted coffee. In addition to brewed coffee, Diedrich Coffee offers a broad range of Italian-style beverages such as espresso, cappuccino, caffe latte, caffe mocha and espresso machiato. To complement beverage sales, the Company sells light food items, whole bean coffee and accessories through its coffeehouses. The first retail store operating under the name Diedrich Coffee commenced operations in Orange County, California in 1972. The Company grew from three coffeehouses in fiscal 1992 to thirty-six coffeehouses as of July 19, 1996 through the construction of new coffeehouses and recent acquisitions. See "Business -- Recent Acquisitions." In addition, the Company has entered into leases that will permit the opening of six additional coffeehouses in the next four months. The Company's expansion strategy is to own and operate newly- developed coffeehouses and to acquire and convert existing specialty coffee retailers in geographic regions where it has existing coffeehouses. The Company also evaluates new geographic regions (and analyzes entry through new store openings or acquisitions) where it believes it can operate profitably. The Company seeks to differentiate itself and build strong brand name recognition by developing and operating sophisticated and inviting coffeehouses intended to serve as neighborhood gathering places. Additionally, Diedrich Coffee focuses heavily on the quality of its products through experienced sourcing of the unroasted beans and its proprietary roasting formula. To ensure freshness, the Company has roasting facilities in its principal regions of operations (Orange County and Denver) and plans to add roasting facilities in each of the major regions where it establishes operations. The Company believes that this strategy, together with enthusiastic and friendly customer service, creates a loyal customer base. Diedrich coffeehouses are generally established in high-visibility locations, consistent with the Company's strategy of developing a substantial repeat client base. The Company's coffeehouses average approximately 1,540 square feet, ranging in size from 725 to 2,654 square feet. In its continuing efforts to ensure the highest possible standards of quality, the Company sources its unroasted coffee beans directly from coffee-producing nations through its contacts with exporters and growers located in certain of these countries and through specialty coffee brokers. The Company's unroasted coffee beans are purchased from coffee-producing regions throughout the world and are custom roasted in carefully controlled batches according to the Company's standards and proprietary recipes. The beans purchased by the Company are premium grade arabica variety, which are a higher quality than the average arabica or robusta variety of coffee typically found in non-specialty or mass-merchandised coffees. See "Business -- Diedrich's Coffee." RECENT ACQUISITIONS In February 1996, the Company consummated the acquisition of nineteen retail coffeehouse locations from two separate specialty coffee chains. Seventeen of the acquired stores are located in Denver, Colorado and the remaining two stores are located in Houston, Texas. Recently, one of the acquired stores in Denver was closed. The closed location's post-acquisition operating results confirmed management's initial evaluation that sales levels at this location would not be sufficient to warrant conversion to the Diedrich format. Although operated by the Company, one of the acquired stores is not subject to a binding lease but such lease is presently being negotiated. Each of the Denver and Houston markets had been previously identified by the Company as targets for near-term expansion. The Company believes that the addition of the stores in Denver results in Diedrich Coffee being a major competitor in this market. The Company also believes that the addition of these stores results in sufficient critical mass for effective market penetration and will permit the Company to benefit from greater marketing efficiencies resulting from geographic concentration. The addition of the two Houston locations will form the basis for further expansion, initially in the Houston area, and subsequently in other metropolitan areas in Texas. The Company has recently entered into binding leases to open one new coffeehouse in Houston and one new coffeehouse in Dallas. 26 29 Until the conversion of an acquired store is completed, it continues to operate under the predecessor company's name. The Company is in the process of converting each of the acquired stores to the Diedrich coffeehouse format. As of July 19, 1996, the conversion of eleven stores had been completed. The Company anticipates that the remaining conversions will be completed within the next four months. The average cost of acquisition and conversion of the eleven stores converted to date was approximately $160,000, which is substantially less than the historical average cost to build a new store, and the Company anticipates that the per store costs associated with the remaining conversions should not materially differ. See "Risk Factors." The Company believes that, through the introduction of its proprietary products and recipes as well as its operational systems and service techniques, the financial performance of the eighteen remaining acquired stores can be improved significantly. As operated by the previous owners, the historical financial performance in terms of sales, cost of sales and labor expense was at a level substantially below the historical performance of Diedrich coffeehouses in Southern California. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." INDUSTRY OVERVIEW Almost fifty percent of Americans drink coffee and on average they drink 1.7 cups per day according to the National Coffee Association's 1996 study. The U.S. coffee market consists of two distinct product categories: (i) commercial ground roast, mass-merchandised coffee and (ii) specialty coffees, which include gourmet coffees (premium grade arabica coffees sold in whole bean and ground form) and premium coffees (upscale coffees mass-marketed by the leading coffee companies). The Company believes that the market for specialty coffee is large and growing but tends to be fragmented. The gourmet coffee segment of the specialty coffee market has experienced strong growth over the past decade and is expected to continue to grow through the end of the century. According to Avenues For Growth: A 20-Year Review of the U.S. Specialty Coffee Market, January 1993, a report published by the Specialty Coffee Association of America (the "SCAA Report"), the market for gourmet coffee nearly doubled during the 1980's, as retail sales grew from approximately $763 million in 1979 to $1.5 billion in 1989. The SCAA Report also predicts that the gourmet coffee industry will approach $5.0 billion in retail sales by the year 2000. A National Association of Specialty Food Trade survey in 1992 confirms the upward trends in gourmet coffee consumption and notes that the percentage of coffee consumers purchasing gourmet coffee increased from 22% in 1990 to 31% in 1992. The Company believes that several factors have contributed to the increase in demand for gourmet coffee including: - greater consumer awareness of gourmet coffee as a result of its increasing availability; - increased quality differentiation over commercial grade coffees by consumers; - increasing demand for all premium food products, including gourmet coffee, where the differential in price from the commercial brands is small compared to the perceived improvement in product quality and taste; - ease of preparation of gourmet coffees resulting from the increased use of automatic drip coffee makers and home espresso machines; and - the decline in alcoholic beverage consumption. The Specialty Coffee Association of America estimates that the number of specialty coffee beverage outlets in the United States jumped from approximately 200 in 1989 to approximately 4,000 in 1995, and projects this number to continue increasing to over 10,000 by the end of 1999. The Company believes that, despite the increase in the number of specialty coffee stores, retail distribution of specialty coffees continues to be highly fragmented and, with the exception of a few retailers, the industry remains relatively unbranded. 27 30 BUSINESS STRATEGY The Company's objective is to become the leading high quality specialty coffee retailer in each market in which it operates. Each element of the Company's strategy is designed to differentiate and reinforce Diedrich Coffee's brand identity, to engender a high degree of customer loyalty and to position the Company as a leading specialty coffee retailer. The key elements of this strategy include: - High Quality, Guaranteed Fresh Roasted Coffee. The Company strives to deliver only high quality, freshly roasted coffee to its customers. Diedrich Coffee purchases premium grade arabica beans from throughout the world which are then roasted by the Company in accordance with the Company's standards and recipes. Roasted beans are delivered to each Diedrich coffeehouse promptly after roasting, and they are typically either sold or brewed as "coffee of the day" within one week of roasting. The Company has roasting facilities in Orange County, California and has recently added a roasting facility in Denver, Colorado. Diedrich Coffee plans to add roasting facilities in each of the major regions it enters in order to ensure that the Company's roasted coffee beans are delivered promptly to each Diedrich coffeehouse. The Company believes its multiregional roasting and guaranteed freshness strategy distinguishes Diedrich Coffee from its competitors, many of whom rely upon packaging, rather than more frequent roasting, to preserve freshness. Diedrich Coffee maintains a policy that if any customer is dissatisfied with one of the Company's coffee products, the Company will refund the purchase price or replace the coffee. - Superior Customer Service. The friendliness, speed and consistency of the service and the coffee knowledge of Diedrich Coffee's employees are critical to developing the Company's quality brand identity and to building a loyal customer base. To this end, the Company places strong emphasis on identifying, hiring and retaining employees and invests substantial resources in training them in customer service, sales skills, coffee knowledge and beverage preparation. The Company evaluates customer service performance on a regular basis and incorporates these findings into its employee training program. All Diedrich Coffee store-level employees receive ongoing customer service training as part of the Company's efforts to enable its employees to take on increasing levels of responsibility within the stores. - Comfortable and Inviting Environment. The Company's coffeehouses are designed to be more comfortable than those of its competitors while creating an inviting atmosphere through the use of natural wood, soft color schemes, outdoor patios, live music and warm lighting. The Diedrich coffeehouses are designed to reflect the particular character of the neighborhood in which the coffeehouse is situated. The Company believes these elements help create its brand image and establish it as a desirable, high quality tenant. - Brand Marketing. The Company's marketing strategy is to differentiate its concept and create brand name recognition based upon Diedrich Coffee's quality and the image of its coffeehouses as neighborhood gathering places. The Company implements this strategy by promoting the distinctive qualities of Diedrich Coffee products, educating customers about Diedrich Coffee's offering of various coffees and roasts, seeking to deliver enthusiastic customer service and sponsoring local and regional community events. Diedrich Coffee believes that these activities generate initial and repeat purchases by reinforcing positive experiences with the Company's products. - Rapid Expansion. An important aspect of the Company's business strategy is its growth strategy, in which the Company seeks to rapidly expand its retail store base in both existing and new markets in an effort to secure a leading presence in each of its markets and to enhance brand awareness. The Company currently intends to focus on opening additional stores in Southern California, Colorado and Texas, while simultaneously evaluating other markets in the Western United States. As of July 19, 1996, the Company had executed leases for six additional coffeehouses which are not yet open for business. 28 31 GROWTH STRATEGY The Company's growth strategy centers around its objective to sustain its high-growth rate through a strategy of internal growth, growth through acquisitions, strategic alliances and sales through other selected distribution channels. - Internal Growth. The Company will continue to seek new locations to build additional coffeehouses. In the current fiscal year, in addition to the nineteen stores recently acquired, the Company has opened six newly constructed coffeehouses as of July 19, 1996. Six additional new store sites have recently been leased. The expansion is anticipated to take place principally in the Southern California, Colorado and Texas markets where the Company currently operates. The criteria for store locations emphasizes high visibility, high traffic locations ranging from 1,200 to 1,800 square feet plus an exterior patio. The Diedrich coffeehouse design is based upon diversity and the unique character of each community. This design philosophy is inherently flexible and adaptable to a broader range of potential retail sites, including unique locations that would be unable to accommodate rigid and repetitive store formats. - Acquisitions. The Company intends to achieve its new store goals through a combination of original construction and its ongoing evaluation of potential acquisitions that bring accelerated critical mass to existing or new markets. The Company believes that its unique, high-quality product and efficient operational systems can add value to acquired locations. Management also believes that acquisitions will continue to be available at a discount to the cost to construct new stores, especially where, despite attractive real estate attributes, acquisition targets may be currently underperforming. While the Company is continually evaluating acquisition opportunities, Diedrich Coffee is not presently committed to acquiring any existing coffeehouses. - Strategic Alliances. The Company strives to identify opportunities for retail alliances. In the latter half of fiscal year 1996, the Company opened its first two shared retail spaces utilizing interior passways and open common walls. These spaces, shared with Barnes & Noble and Sports Chalet, illustrate the Company's desire and ability to design unique coffeehouses for its customers. The Company does not have any current commitments to develop additional shared spaces with these retailers. The Company is, however, currently negotiating similar shared retail space agreements with several additional complementary national retailers. The Company intends to pursue other such alliances with multi-site retailers to enable it to accelerate its site and brand development. In July 1996, the Company signed a development agreement with a Singapore company which calls for the establishment of a total of at least thirty Diedrich coffeehouses in Singapore, Malaysia and Indonesia within the next five years. The development agreement also provides for the possible expansion into Japan, China, Hong Kong and other Asian countries. See "Business -- Coffeehouses -- International Development." - Other Distribution Channels. The Company is actively seeking new distribution channels for its products. The Company has engaged in wholesale and mail order distribution of its products for more than five years. In fiscal year 1996, these activities accounted for approximately 13% of total Company sales. While the primary focus for growth will be coffeehouse unit expansion, the Company intends to continue to pursue appropriate growth opportunities in the wholesale and mail order distribution channels. In 1996, the Company introduced a proprietary, branded coffee ice cream which it currently sells in selected Diedrich coffeehouses. The Diedrich Coffee ice cream is also the base component of the new Diedrich ice cream shakes, parfaits and floats, which were introduced in Southern California stores in May 1996. The Company anticipates distribution of this branded ice cream product through other retail channels, although it has no current commitments or agreements with respect to such distribution. DIEDRICH'S COFFEE Coffee beans are an agricultural product grown commercially in over fifty countries in the tropical regions of the world. There are many varieties of coffee and a broad range of quality grades within each variety. While the broader coffee market generally treats coffee as a fungible commodity, the specialty coffee industry focuses on the highest grades of coffee available from the best crops in small quantities. The Company seeks to 29 32 purchase only the finest qualities and varieties of coffee generally available to this industry by sampling the unique characteristics and flavor of the varieties in each region. The background and experience of the Company's personnel provides the skill necessary to maintain the Company's commitment to serve and sell only the highest-quality coffee. History Diedrich Coffee is one of the few roaster/retailers with a genuine and long standing heritage spanning three generations in the specialty coffee industry. Since the early part of this century, when the Diedrich family acquired a coffee plantation in Central America, the Diedrich family has been involved in growing and roasting coffee beans. This knowledge and understanding of coffee growing was passed to Martin Diedrich, the Company's Chairman and Director of Coffee, from Carl Diedrich, Martin's father and the founder of the Company. Martin Diedrich's experience and knowledge enables the Company to consider and analyze many different factors in selecting the coffee beans that the Company purchases from the various coffee-growing regions around the world. During the 1970's, the Diedrich family pioneered new roasting techniques from the mechanical process to the development of proprietary roasting and blending formulas. Through their experience as coffee growers, Carl and Martin Diedrich were able to develop roasting and blending formulas that enhanced the characteristics of high-quality specialty coffees. Carl Diedrich opened his first retail store in 1972 to sell his roasted coffees. The store became quite popular and subsequently, drawing upon the concept of the European coffeehouse, Martin opened the Company's first European-style coffeehouse. Building upon this foundation, Martin and his father expanded the business and exposed more people to the coffeehouse culture without sacrificing the commitment to a high-quality coffee product. Today, the Company continues to draw upon this knowledge and passion to provide each community that houses a Diedrich coffeehouse with an opportunity to experience the unique coffeehouse culture in an atmosphere where customers can enjoy the quality and heritage of Diedrich coffee. Sourcing Martin Diedrich and his staff, who are responsible for purchasing unroasted coffee beans, evaluate numerous product samples from different crops each week and purchase a selection of high quality coffee beans on the basis of quality, taste and availability. In any given month, the Company may make forward commitments for the purchase of more than a dozen different types of coffee plus specially featured coffees that may only be available in small quantities. Rotating its coffee selection enables the Company to provide its customers with a wider variety of coffees and with certain coffees that are available only on a seasonal basis. The Diedrich family has built relations with coffee brokers, growers and exporters worldwide since the beginning of the century, and these long standing relationships provide the Company with access to the highest quality beans available. Diedrich Coffee purchases only premium grade arabica coffee beans and believes these beans are the best available from each producing region. The premium grade arabica bean is a higher quality variety than the average grade arabica or robusta variety coffee bean. These lower quality beans are typically found in non-specialty or mass-merchandised coffees. The Company contracts for future delivery of unroasted coffee beans for the Company's account to help ensure adequacy of supply and typically maintains a minimum six-week supply of each variety of whole beans then available. Roasting The roasting of commercial coffee beans is often accomplished through a uniform roasting process that does not differentiate between the types of coffee being roasted. Surprisingly, some specialty roasters also employ this commercial method. Diedrich Coffee, however, embraces a roasting process that varies based upon the variety, quality, origin and physical characteristics of the coffee beans being roasted. The Company utilizes formulas and recipes that have been developed over three generations to bring out the best 30 33 characteristics of the coffee during the roasting process and develop the optimal flavor conditions that a coffee has to offer. Diedrich Coffee has several master roasters who are directly responsible for overseeing the roasting process. These master roasters are trained by the Company. This training includes serving an apprenticeship under Martin Diedrich before being permitted to take responsibility for roasting. These master roasters are craftsmen who are trained to employ the Company's proprietary roasting formulas while adjusting the formula to take into account the specific attributes of the coffee being roasted. Each coffee bean contains aromatic oils and flavor characteristics that develop from the soil, climate and environment where the bean is grown. The skill of the roaster is employed by analyzing the unroasted beans and carefully controlling the roasting process in an effort to maximize the flavor potential of the coffee. Freshness Diedrich Coffee is committed to serving its customers beverages and whole bean products from coffee beans that are freshly roasted. Serving only freshly roasted coffee is imperative because roasted coffee is a highly perishable product that begins to grow stale and lose flavor immediately after roasting. Within two weeks, roasted coffee has lost a significant amount of quality. To address this concern, the Company has developed a multiregional roasting approach to ensure freshness. While the Company presently has roasting facilities in its principal regions of operations, Orange County and Denver, the Company plans to add roasting facilities in each of the major regions where the Company has coffeehouses. The Company believes that its freshly roasted product is superior to product offerings that use various types of packaging in an effort to preserve freshness rather than more frequent roasting. The Company's coffee is delivered to its coffeehouses promptly after roasting to enable the Company to guarantee the freshness of each cup of coffee or whole coffee beans sold in its coffeehouses. The Company's coffeehouses are required to sell or brew coffee within one week of roasting. Specialty Coffee Beverages In addition to brewed coffee, Diedrich Coffee offers a broad range of Italian-style beverages such as espresso, cappuccino, caffe latte, caffe mocha and espresso machiato. All espresso-based drinks are prepared to order to ensure quality and consistency. The Company uses high quality ingredients and condiments such as hand grated chocolate, all natural syrups and fresh whipping cream. Diedrich Coffee also offers a wide array of frozen specialty drinks, including its version of iced mocha, and the Diedrich Granita, a frozen combination of espresso and milk. The Company's most recent creation is its own signature line of coffee ice cream which is used in its very popular shakes and parfaits. COFFEEHOUSES As each coffee that the Company serves is unique, Diedrich Coffee strives to create an environment in each coffeehouse that is unique, dynamic and comfortable. The Company attempts to design each coffeehouse to reflect the character of the community in which the coffeehouse is located so that the coffeehouse serves as a community meeting place which is comfortable and inviting. The Coffeehouse Concept The Company's coffeehouse concept is based upon traditional European coffeehouses, such as those in Vienna and throughout Italy. These coffeehouses often served as the town meeting hall and provided a receptive environment for discussion of the day's issues. In a similar vein, Diedrich Coffee attempts to absorb the character of the community or neighborhood in which a coffeehouse is to be located and reflect an interpretation of that character through the design and construction of the coffeehouse. In order to avoid the labor-intensive work that would be required to design completely original coffeehouses for each new store opening, the Company starts with one of a dozen basic concepts and design layouts and then tailors the coffeehouse to the specific site and the surrounding neighborhood. In general, Diedrich coffeehouses are designed to encourage customers to relax and linger in a warm and comfortable environment. The 31 34 coffeehouses feature varying amenities to promote this environment, such as live music or outdoor patios where customers can enjoy their coffee. The coffeehouse concept, however, is not limited to the physical structure of the store. The relaxed and inviting environment is created in large part by the employees in each coffeehouse. Employees are encouraged to know their customers and are trained to make "on the spot" decisions to promote customer service. See "Business -- Customer Service and Training." Site Selection and Design The Company's site selection strategy is to open coffeehouses in high-traffic, high-visibility locations in each of its target markets. A Real Estate Committee, which consists of senior members of management and a dedicated real estate staffperson, evaluates potential coffeehouse sites based upon the demographics of the neighborhood, existing traffic patterns and the proximity of other destination retailers and potential competitors. This evaluation includes analysis of available statistical data and examination of physical properties through site visits. The Real Estate Committee has historically approved a relatively small percentage of the sites that it reviewed for development into Diedrich coffeehouses. On a regional basis, the Real Estate Committee has also considered several potential markets that the Company may wish to enter. Diedrich Coffee designs each of its coffeehouses based upon one of twelve successful unique layouts. While each layout offers a different format and appearance with respect to the front counter and seating area, the service areas are nearly identical compartmentalized units. This approach permits the Company to create unique coffeehouses in each location while keeping design costs to a minimum. Coffeehouse Unit Economics As of January 31, 1996, seven coffeehouses had been open for two years or more, the oldest of which was opened in 1986. These coffeehouses range in size from 936 to 1,746 square feet, with an average size of 1,430 square feet. The average initial cost for these coffeehouses, excluding pre-opening costs, was approximately $227,000 or an average of $159 per square foot. During fiscal 1996, these seven coffeehouses recorded aggregate net sales of $7,292,000 or an average of $729 per square foot. These stores earned an average operating profit after depreciation of approximately $275,000 per store. During the same year, five new stores were opened at an average per store cost (excluding pre-opening costs) of approximately $320,000, or approximately $181 per square foot. The Company's policy is to expense pre-opening costs, consisting principally of training labor and promotion, in the month in which a new store is opened. The average pre-opening cost for the five newly-opened stores was approximately $17,000. Coffeehouse Operations The typical Diedrich coffeehouse is staffed with one to three managers, and a staff of ten to fifteen part-time hourly employees from which the operating shifts are filled. The hours for each store are established based upon location and customer demand, but typically are from 6:00 a.m. to 9:00 p.m. (or later) in residential locations and from 6:00 a.m. to 6:00 p.m. in commercial locations. The store managers are overseen by a district manager, who is responsible for supervising the operations of up to ten stores and reports to senior management. In addition to coffee beverages, all Diedrich coffeehouses serve a select offering of light food items (bagels, croissants and pastries) and dessert items (pastries and cakes). Management is consistently working with its suppliers to develop a selection of food items that will complement beverage sales. The Company also currently operates three Diedrich Espresso Cafes. These stores offer an expanded menu that includes gourmet style pastas and pizzas, sandwiches and soups, fresh fruit salads and pasta salads. Diedrich coffeehouses also sell more than twenty different selections of regular and decaffeinated roasted whole bean coffee. The Company's coffeehouses also carry select coffee related merchandise items. In fiscal 1996, the Company's retail sales mix was 70.6% coffee beverages, 18.9% food items, 8.6% whole bean coffee and 1.9% accessories and clothing. 32 35 Diedrich Coffeehouse Locations Set forth below is a list of each of the Company's coffeehouse locations as of July 19, 1996, separated by the metropolitan areas in which such coffeehouses are located. The status of each of the coffeehouses is indicated including, with respect to the acquired stores, whether the conversion to the Diedrich coffeehouse format has been completed. Until the conversion of an acquired store is completed, it continues to operate under the predecessor company's name. As indicated in the table, as of July 19, 1996, the Company was operating thirty-six coffeehouses and had entered into leases that will permit the opening of six additional coffeehouses this year.
COFFEEHOUSE DATE OPENED STATUS - ------------------------------------------------------------------------------- ---------------- ------------------- ORANGE COUNTY, CALIFORNIA Brea....................................................................... July 1996 Open Costa Mesa................................................................. August 1988 Open Crown Valley............................................................... June 1995 Open Crystal Court.............................................................. February 1995 Open Huntington Beach........................................................... December 1995 Open Irvine-Crossroads.......................................................... December 1993 Open Irvine-Spectrum............................................................ November 1995 Open Laguna Beach............................................................... May 1996 Open Lake Forest................................................................ December 1993 Open La Paz..................................................................... September 1995 Open Newport Beach.............................................................. October 1991 Open Ocean Ranch................................................................ October 1993 Open San Juan Capistrano........................................................ February 1996 Open Trabuco Hills.............................................................. August 1992 Open Tustin..................................................................... August 1986 Open Irvine-Park Place.......................................................... N/A Under Construction Laguna Niguel.............................................................. N/A Binding Lease DENVER, COLORADO (1) Boulevard Center........................................................... February 1996 Open (2) Cherry Creek............................................................... February 1996 Open (2) Colorado Boulevard......................................................... February 1996 Open (3) Denver Place............................................................... February 1996 Open (3) Equitable Building......................................................... February 1996 Open (3) The Garage................................................................. February 1996 Open (3) Green Mountain............................................................. February 1996 Open (2) Independence Building...................................................... February 1996 Open (3)(4) Larimar Square............................................................. February 1996 Open (2) Mile High Center........................................................... February 1996 Open (3) Mission Plaza.............................................................. February 1996 Open (2) Petroleum Building......................................................... February 1996 Open (3) Republic Plaza............................................................. February 1996 Open (2) Tiffany Plaza.............................................................. February 1996 Open (3) 9th and Downing............................................................ February 1996 Open (3) 17th St. Plaza............................................................. February 1996 Open (2) HOUSTON, TEXAS Montrose................................................................... February 1996 Open (3) Vanderbilt................................................................. February 1996 Open (3) Westheimer................................................................. N/A Binding Lease SAN DIEGO, CALIFORNIA Del Mar.................................................................... March 1996 Open Encinitas.................................................................. N/A Under Construction Hillcrest.................................................................. N/A Under Construction LOS ANGELES, CALIFORNIA Malibu..................................................................... June 1996 Open Santa Monica............................................................... June 1996 Open DALLAS, TEXAS Addison.................................................................... N/A Binding Lease
- --------------- (footnotes on following page) 33 36 - --------------- (1) Does not include one of the Brothers Stores that, in accordance with management's initial evaluation at the time of the acquisition, was closed in July 1996. (2) Conversion to Diedrich coffeehouse format pending. (3) Conversion to Diedrich coffeehouse format completed. (4) The lease for this coffeehouse is presently under negotiation and the premises are not subject to a binding lease. International Development In July 1996, the Company entered into a Development Agreement (the "Development Agreement") with a Singapore company that specializes in assisting U.S. companies to establish a presence in Asia (the "Developer"). The Development Agreement grants the Developer the exclusive right to open and operate Diedrich coffeehouses in the countries of Singapore, Indonesia and Malaysia pursuant to a pre-negotiated form of franchise agreement. In return, the Developer agrees to develop at least thirty stores in these countries according to the following schedule: two stores by May 1, 1997, six stores by May 1, 1998, eleven stores by May 1, 1999, twenty-one stores by May 1, 2000 and thirty stores by May 1, 2001. The Company has the right to terminate the agreement if the Developer fails to meet this schedule. The Company also has the right to approve each Diedrich coffeehouse site. In addition, until January 1, 2000, the Developer shall have the right of first refusal to acquire the development rights for Hong Kong, Vietnam, China, Thailand, Philippines, Taiwan, Korea and Japan. The Company shall provide certain training and assistance to the Developer, including furnishing written and other materials to communicate the Company's roasting process and techniques to the Developer. The Company will enter into a pre-negotiated form of franchise agreement with respect to each Diedrich coffeehouse opened under the Development Agreement. Under this agreement, the Company will grant the franchise owner a franchise to operate a Diedrich coffeehouse and will agree to provide the franchise owner with such opening assistance and guidance as it deems necessary to effectively open the Diedrich coffeehouse franchise store. Each franchise owner shall agree to pay the Company a one-time franchise fee and a monthly royalty fee based upon the gross sales of all the Diedrich coffeehouses owned and operated by the same franchise owner. The franchise owner shall agree not to use the Company's proprietary and confidential information in any other business or capacity, and to maintain the absolute confidentiality of such information during and after the term of this agreement. The franchise agreements shall generally have a term of 20 years, unless sooner terminated by the Company in accordance with the specific provisions of the agreement. Management Information System Over the last two years, the Company has implemented a comprehensive management information system (MIS). The MIS maintains financial accounting controls for each coffeehouse through the use of a centralized accounting system and, in the California coffeehouses, an automated data link from each of the retail point of sale (POS) devices to the Company's principal executive offices. The data links provide daily performance statistics through the use of nightly polling, as well as real-time analysis of coffeehouse sales and other operating measures. From the MIS, detailed daily, weekly and periodic management reports are prepared and provided to store managers and other operating personnel. The MIS and its continued improvement contributes to the Company's efforts and success in controlling store labor costs, the largest cost element of the coffeehouse profit center. These improvements have enabled continued daily managerial supervision and control without additional overhead despite increasing geographical expansion. All newly constructed coffeehouses are equipped with linked POS devices and the conversion process for the recently acquired stores in Denver and Houston will ultimately include the addition of new POS equipment. The Company has recently begun implementation of an internetworked communication system which, when complete, will provide more timely information concerning inventory turnover, policies, procedures and recipes, human resources data (including personnel changes), equipment maintenance tips 34 37 and requests and problem solving forums. The Company intends to utilize a portion of the net proceeds of this Offering to complete this phase of MIS upgrades and to continue to exploit technological opportunities to maximize management's efficiency. See "Use of Proceeds." CUSTOMER SERVICE AND TRAINING The Company believes that the training and knowledge of its employees and the consistency and quality of the service they deliver are fundamental to the Company's success. Management believes that an employee oriented culture creates a sense of personal responsibility among all employees and pride in the Company's products, resulting in a higher level of customer service. Once hired, counter staff employees who are new to the industry or are staffing new Diedrich coffeehouses receive training about coffee, beverage preparation, customer service and sales skills. This training includes written training materials, lectures, observation and simulation exercises. The final stage of training is in-store training where employees work for a two-week period implementing their newly learned skills. Staff level employees with significant coffeehouse experience hired to work in existing coffeehouses are trained by the general managers. Topics include Diedrich Coffee culture, recipes, products and customer service techniques. This general orientation and training is supplemented by comprehensive in-store training from the general manager, assistant managers and trainers. Diedrich Coffee seeks to attract and retain qualified personnel by offering an attractive package of compensation, benefits and career growth potential. The Company's incentive compensation system rewards management employees for high quality service and productivity from a store-level bonus pool. The Company's benefits package includes medical coverage for full-time and qualifying part-time workers. In addition, as a rapidly growing business, Diedrich Coffee is able to offer career advancement opportunities to talented personnel. To date, the Company has not experienced any material difficulties in retaining qualified personnel. MARKETING The Company's marketing strategy is to differentiate itself and build a brand identity for its freshly roasted coffee and its coffeehouses. The Company implements this strategy by promoting the distinctive qualities of its Diedrich Coffee products, educating consumers about Diedrich Coffee's offering of various coffees, including private estate coffees and roasts, seeking to deliver enthusiastic customer service and sponsoring local and regional community events. Diedrich Coffee's marketing efforts are based upon the belief that the fresh roasted flavor achieved by the Company's commitment to quality and freshness delivers a distinguishable advantage in coffee flavor to the consumer. A steady introduction of new coffee, drink and food products is part of the Company's marketing strategy to keep the concept fresh and drive incremental sales volume. To date, Diedrich Coffee has relied primarily upon the high visibility of its real estate locations, word-of-mouth, public relations, local store marketing and the inviting atmosphere of its coffeehouses. The Company also conducts in-store coffee tastings, provides brewed coffee at local neighborhood events, donates coffee to local charities and mails periodic announcements to neighborhood residents to announce a store opening or the introduction of a new product. The costs of these promotions do not have a material impact on the Company's operating results. In addition, Diedrich Coffee seeks to develop its brand identity through participation in local community events. Diedrich Coffee recently launched an ice cream based, dessert oriented, beverage promotion. By using point of purchase advertising materials, local store marketing efforts, direct mail, public relations, bounceback coupons and external marketing, the Company was able to introduce its new products while simultaneously attracting first time customers. As the Company enters new markets, it plans to tailor its marketing strategy to the overall level of awareness and availability of specialty coffee in that market. In markets that have a less developed specialty coffee presence, the emphasis of the Company's promotions will initially be focused on the fundamental 35 38 distinctions between Diedrich Coffee and prepackaged ground coffee. In markets that are more knowledgeable about specialty coffees, the Company's advertising will focus on the superiority of Diedrich Coffee's guaranteed freshly roasted products versus competitive specialty brands. The Company plans to use direct mail, print and other mass media advertising to expand brand awareness when the Company has achieved a market penetration which, in the Company's judgment, would make such efforts cost-effective. There can be no assurance that the Company will achieve such a level of market penetration. COMPETITION In providing coffee beverages, the Company competes directly against all restaurant and beverage outlets that serve coffee and a growing number of espresso stands, carts and stores. The Company's whole bean coffees compete directly against specialty coffees sold at retail through supermarkets, specialty retailers and a growing number of specialty coffee stores. Both the Company's whole bean coffees and its coffee beverages compete to a greater or lesser extent against all other coffees on the market. The Company believes that its customers choose among retailers primarily on the basis of quality, taste and convenience and, to a lesser extent, on price. The Company competes for beverage and whole bean coffee sales with franchise operators and locally owned specialty coffee stores in the United States. There are a number of competing specialty coffee retailers, such as Starbucks, Timothy's Coffees of the World, Inc., Pasqua's, Inc. and New World Coffee, Inc. In addition, in virtually every major metropolitan area in which Diedrich Coffee operates or may operate, local or regional competitors already exist. Although competition in the specialty coffee market is currently fragmented, the Company competes and, in the future, will increasingly compete with Starbucks, the market's largest retailer. Starbucks and other competitors have significantly greater financial, marketing and other resources than the Company. In addition to Starbucks and other current competitors, the attractiveness of the gourmet specialty coffee store market could draw at any time one or more new major competitors with substantially greater financial, marketing and operating resources than the Company. The Company also expects that competition for suitable sites for new stores will be intense. The Company competes against other specialty retailers and restaurants for these sites, and there can be no assurance that management will be able to continue to secure adequate sites at acceptable rent levels. Management believes that supermarkets pose one of the greatest competitive challenges in the whole bean coffee market, in part because supermarkets offer customers the convenience of not having to make a separate trip to the Company's stores. A number of nationwide coffee manufacturers, such as Kraft General Foods, Inc., Proctor & Gamble Co. and Nestle S.A., are distributing premium coffee products in supermarkets which may serve as substitutes for the Company's coffees. Regional specialty coffee companies also sell whole bean coffees in supermarkets. FACILITIES Diedrich Coffee leases approximately 25,000 square feet of office space for administrative offices, warehousing, roasting and training facilities in Irvine, California. The lease for this facility expires in October 2000, with an option for one additional five-year term. Recently, the Company has entered into a lease in Denver, Colorado for a 2,500 square foot facility to be used for warehousing and roasting. This lease expires on May 31, 1999. In addition, as of July 19, 1996, the Company was a party to various leases for a total of forty- two retail coffeehouses. All of the Company's operating coffeehouses are on leased premises and are subject to varying arrangements specified in property specific leases, except that the lease for one coffeehouse is presently under negotiation and that site is not subject to a binding lease. For example, some of the leases require a flat rent, subject to regional cost-of-living increases, while others are based upon a percentage of gross sales. In addition, certain of these leases expire in the near future, and there is no automatic renewal or option to renew. No assurance can be given that leases can be renewed, or if renewed, that rents will not increase substantially, both of which would adversely affect the Company. Other leases are subject to renewal at fair market value, 36 39 which could involve substantial increases or are subject to renewal with a scheduled rent increase, which could result in rents being above fair market value. TRADEMARKS The Company owns several trademarks and servicemarks that have been registered with the United States Patent and Trademark Office, including Diedrich Coffee(R), Wiener Melange(R) and Flor de Apanas(R). In addition, the Company has applications pending with the United States Patent and Trademark Office for a number of additional marks, including Harvest Peak(TM) and Ambrosia Blend(TM). The Company has also made application in Canada for trademark protection of Flor de Apanas(R) and the related design. The Company has received an allegation that Ambrosia Blend(TM) infringes on a registered trademark. The Company disputes this allegation, but believes that if any resulting claim was determined adversely to the Company, it would not result in a material adverse effect on the Company's financial position or results of operations. GOVERNMENT REGULATIONS The Company is subject to various federal, state and local laws, rules and regulations that affect its business. Each of the Company's coffeehouses and roasting facilities is subject to licensing and regulation by a number of governmental authorities, which may include building, land use, health, safety and fire agencies in the state or municipality in which the coffeehouse or facility is located. Difficulties obtaining the required licenses or approvals could delay or prevent the development of a new coffeehouse in a particular area, the conversion of the remaining Acquired Cafes and Brothers Stores or could adversely affect the operation of an existing coffeehouse. Management believes that the Company is in compliance in all material respects with all relevant laws, rules and regulations. Furthermore, the Company has never experienced abnormal difficulties or delays in obtaining the required licenses or approvals required to open a new coffeehouse or continue the operation of its existing coffeehouses. Additionally, management is not aware of any environmental regulations that have had or that it believes will have a materially adverse effect upon the operations of the Company. EMPLOYEES As of July 15, 1996, the Company employed a work force of 627 persons, 80 of whom are employed full-time. No employees are currently covered by collective bargaining agreements, and the Company believes its relations with its employees are satisfactory. LEGAL PROCEEDINGS In the ordinary course of its business, the Company may become involved in legal proceedings from time to time. As of the date of this Prospectus, the Company is not a party to any material pending legal proceedings. 37 40 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES The directors, executive officers and other key employees of the Company, and their ages as of July 15, 1996, are as follows:
NAME AGE POSITION(S) HELD -------------------------------------- --- -------------------------------------- Martin R. Diedrich.................... 37 Chairman of the Board, Secretary and Director of Coffee Steven A. Lupinacci................... 43 President, Chief Executive Officer, Chief Financial Officer and Director Edwin P. Ott.......................... 37 Controller Patrick D. Inaba...................... 34 Manager of Store Construction Cary C. Peterson...................... 30 Manager of Training and Recruiting Paul C. Heeschen...................... 39 Director
Martin R. Diedrich has been the Secretary and Director of Coffee and has served on the Company's Board of Directors since its incorporation. He was elected as Chairman of the Board in January 1996 and also presently serves on the Real Estate Committee. Mr. Diedrich is an internationally recognized specialty coffee expert who is a frequent speaker at industry functions and recently addressed the 1995 World Specialty Coffee Conference & Exhibition in Venice, Italy, where he presented material on roasting techniques and philosophy. Steven A. Lupinacci has been the President, Chief Executive Officer and Chief Financial Officer of the Company since December 1992. Mr. Lupinacci has served as a member of the Board of Directors since December 1992, with the exception of a six-month period from January to July 1996. In addition, he currently serves on the Real Estate Committee. From July 1990 to December 1992, Mr. Lupinacci was a private investor and prior to July 1990, he was a partner with Price Waterhouse where his practice primarily focused on mergers and acquisitions. Edwin P. Ott joined the Company in January 1993 as Controller and also serves on the Real Estate Committee. From 1991 until joining the Company, Mr. Ott served as a law clerk for the law firm of Hannan & Cote. Prior to that time, Mr. Ott worked for twelve years in the restaurant industry serving in a financial capacity for Taco Bell (a division of PepsiCo), the Sizzler Restaurant Division of Collins Foodservice International, El Torito Restaurants (W.R. Grace) and International Onion, Inc. Patrick D. Inaba joined the Company in January 1993 as a general manager of one of the Diedrich coffeehouses. In February 1995, Mr. Inaba was promoted to Manager of New Store Operations and in October 1995, he assumed the position of Manager of Store Construction. Prior to joining the Company, Mr. Inaba served as Director of Operations at Wahoo's Fish Taco from 1989. As Director of Operations, Mr. Inaba designed menus and recipes, operating systems, purchasing systems, marketing and advertising programs and staff training procedures. Cary C. Peterson joined the Company in November 1995 as Manager of Training and Recruiting. From January 1993 to November 1995, Mr. Peterson served as Regional Training and Recruiting Manager at Chevys Mexican Restaurants, a division of PepsiCo. Prior to January 1993, Mr. Peterson spent seven years with Cantina Restaurants, a chain of Mexican restaurants, as Director of Operations. Paul C. Heeschen became a director of the Company in January 1996 and serves as a member of the Real Estate Committee. For the past five years, Mr. Heeschen has been a principal of Heeschen & Associates, a private investment firm. He is also the sole general partner of D.C.H., L.P. and Redwood Enterprises VII, L.P., each of which are stockholders of the Company. See "Principal and Selling Stockholders." The Company intends to elect two independent directors within 90 days after the completion of the Offering. All directors currently serve for one-year terms and until their successors have been elected and qualified. Officers are elected annually and serve at the discretion of the Board. There are no family relationships between any of the directors or executive officers of the Company. 38 41 BOARD COMMITTEES Shortly after completion of the Offering, the Board of Directors intends to establish an Audit Committee composed of at least two independent directors and a Compensation Committee composed of a majority of independent directors. The Audit Committee shall review the results and scope of the audit and other services provided by the Company's independent auditors, review and evaluate the Company's internal control functions and monitor transactions between the Company and its employees, officers and directors. The Compensation Committee will administer the Company's stock option plans and designate compensation levels for officers and directors of the Company. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Company's Compensation Committee shall consist of Mr. Heeschen and the two independent directors to be appointed shortly after completion of the Offering. Mr. Heeschen was not, nor shall any other member of the Compensation Committee have been, at any time during the year ended January 31, 1996 or at any other time an officer or employee of the Company. No executive officer of the Company serves as a member of the Board of Directors or Compensation Committee of any other entity which has one or more executive officers serving as a member of the Company's Board of Directors or Compensation Committee. During fiscal 1996, all compensation was determined by the Company's Board of Directors because the Company had not yet established a Compensation Committee. Steven Lupinacci, the Company's President, and Martin Diedrich, the Company's Secretary, served as members of the Board of Directors during this period when compensation matters were considered. On May 20, 1996, the Company entered into a revolving promissory note with a maximum principal amount of $2,000,000 payable to Redwood Enterprises VII, L.P. ("Redwood Enterprises"). This note is subordinate to the Company's line of credit with Bank of America. The interest rate on the note is the prime rate plus three percent, and the note expires on September 30, 1996. The outstanding balance on the note as of July 19, 1996 was $1,415,000 and the interest rate was 11.25%. Redwood Enterprises owns approximately 8.8% of the Company's outstanding Common Stock after giving effect to the issuance of shares in the Offering. In addition, Mr. Heeschen, a director of the Company, is the sole general partner of Redwood Enterprises. On June 29, 1995, the Company issued a total of 1,608,568 shares of Series B Preferred Stock to Redwood Enterprises and Diedrich Partners I, L.P. ("Diedrich Partners") for an aggregate consideration of $2,305,000. Redwood Enterprises and Diedrich Partners own approximately 8.8% and 11.8%, respectively, of the Company's outstanding Common Stock after giving effect to the issuance of shares in the Offering. Mr. Heeschen, a director of the Company, is the sole general partner of Redwood Enterprises. On June 29, 1995, the Company entered into an agreement which acknowledged that the Company owed D.C.H., L.P. ("D.C.H.") $200,000 as a result of a post-closing adjustment to the purchase price for the 1,000,000 shares of Series A Preferred Stock purchased on December 11, 1992. D.C.H. purchased from the Company 268,097 shares of Common Stock in consideration for the $200,000 purchase price refund. D.C.H. owns approximately 21.7% of the Company's outstanding Common Stock after giving effect to the issuance of shares in the Offering. In addition, Mr. Heeschen, a director of the Company, is the sole general partner of D.C.H. On June 29, 1995, the Company issued 17,112 shares of Common Stock to Mr. Lupinacci to address the dilution resulting from the issuance of shares in connection with the post-closing adjustment described in the preceding paragraph. Mr. Lupinacci owns approximately 4.5% of the Company's outstanding Common Stock after giving effect to the issuance of shares in the Offering. On October 10, 1995, Wells Fargo Bank extended to the Company a revolving line of credit in the amount of $750,000 that was guaranteed by Martin R. Diedrich. On February 20, 1996, the line of credit was amended and the borrowing base was increased to $2,000,000, the guarantee was released and the due date was extended to February 1997. This line of credit, which was collateralized by substantially all of the Company's assets, was replaced by the Company with a new line of credit and terminated on July 19, 1996. 39 42 In April 1995, the Company borrowed $80,000 from Redwood Enterprises pursuant to an unsecured installment note bearing interest at a rate of 12%. Mr. Heeschen, a director of the Company, is the sole general partner of Redwood Enterprises. In July 1995, this note was repaid in full. During the period from 1990 to 1995, the Company made a series of unsecured loans to Martin R. Diedrich, the Company's Chairman of the Board and Secretary. At January 31, 1995 and 1996, the aggregate outstanding balance of these loans was $32,000 and $35,546, respectively. The loans bear interest at a rate of 5.19% and are due on February 1, 1999. The aggregate outstanding balance on the notes as of July 15, 1996 was $36,150. The Company has agreed to pay certain expenses of the Selling Stockholders in connection with this Offering. Mr. Heeschen, a director of the Company, is the sole general partner of Redwood Enterprises and D.C.H., two of the Selling Stockholders. Amre A. Youness, a former director of the Company, is the sole general partner of Diedrich Partners, a Selling Stockholder. If the Underwriters elect to exercise the over-allotment option to purchase 30,000 shares of Common Stock granted by Mr. Diedrich, the Secretary of the Company, certain of his expenses will be paid by the Company. See "Underwriting." DIRECTOR COMPENSATION Non-employee directors receive reimbursement for out-of-pocket expenses incurred in attending Board meetings and will receive certain stock option grants. See "Management -- 1996 Non-Employee Directors Stock Option Plan." Directors of the Company who are officers or employees of the Company receive no extra compensation for their service on the Board. 1996 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN The Company has adopted the 1996 Non-Employee Directors Stock Option Plan (the "Non-Employee Directors Plan"). The purpose of the Non-Employee Directors Plan is to promote the interests of the Company and its stockholders by using investment interests in the Company to attract and retain highly qualified independent directors. The Non-Employee Directors Plan provides for the grant of non-qualified stock options only. A total of 125,000 shares have been reserved for issuance under the Non-Employee Directors Plan. No options have been granted under the Non-Employee Directors Plan to date. Pursuant to the terms of the Non-Employee Directors Plan, each non-employee director will automatically receive an initial, one-time grant of an option to purchase up to 5,000 shares of the Company's Common Stock. These initial options will vest and become exercisable with respect to 50% of the underlying shares upon the earlier of (i) the first anniversary of the grant date or (ii) immediately prior to the first annual meeting of stockholders of the Company following the grant date, if the recipient has remained a non-employee director for the entire period from the grant date to such earlier date, and with respect to the remaining 50% of the underlying shares upon the earlier of (i) the second anniversary of the grant date or (ii) immediately prior to the second annual meeting of shareholders of the Company following the grant date, if the recipient has remained a non-employee director for the entire period from the grant date to such earlier date. In addition to an initial grant, each non-employee director will also receive, upon each re-election to the Company's Board, an automatic grant of an option to purchase up to 5,000 additional shares of the Company's Common Stock. These additional options will vest and become exercisable upon the earlier of (i) the first anniversary of the grant date or (ii) immediately prior to the annual meeting of stockholders of the Company next following the grant date, if the recipient has remained a non-employee director for the entire period from the grant date to such earlier date. All non-employee director options will have a term of ten years and an exercise price equal to the fair market value of the Company's Common Stock on the date of grant. The Non-Employee Directors Plan provides that the exercise price may be paid by Company loan or withholding of underlying stock, or deferred until completion of broker-assisted exercise and sale transactions. Vesting of non-employee director options accelerates if the recipient of the option ceases to be a director of the Company in connection with a change in control. 40 43 EXECUTIVE COMPENSATION Summary Compensation The following table sets forth all compensation awarded or paid by the Company during the fiscal year ended January 31, 1996 to its Chief Executive Officer and the Company's other executive officer (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION AWARDS ANNUAL COMPENSATION ($) --------------------- ----------------------- SECURITIES UNDERLYING NAME AND PRINCIPAL POSITION SALARY OPTIONS(#) - --------------------------------------------------- ----------------------- --------------------- Martin R. Diedrich................................. $ 87,500 -- Chairman of the Board, Secretary and Director of Coffee Steven A. Lupinacci................................ $ 113,720 131,350 President, Chief Executive Officer, Chief Financial Officer and Director
Stock Option Grants in Last Fiscal Year The following table sets forth information regarding each grant of stock options made during the fiscal year ended January 31, 1996 to each of the Named Executive Officers. No stock appreciation rights ("SARs") were granted during such period to such persons.
POTENTIAL INDIVIDUAL GRANTS REALIZABLE --------------------------------------------------------- VALUE AT ASSUMED PERCENT OF ANNUAL RATES NUMBER OF TOTAL OPTIONS OF STOCK PRICE SECURITIES GRANTED TO APPRECIATION FOR UNDERLYING EMPLOYEES OPTION TERM (2) OPTIONS IN FISCAL EXERCISE EXPIRATION ------------------- NAME GRANTED(#)(1) YEAR(%) PRICE ($/SH) DATE 5% ($) 10% ($) - ---------------------------- ------------- ------------- ------------ ---------- -------- -------- Martin R. Diedrich.......... -- -- -- -- -- -- Steven A. Lupinacci......... 131,350 100% $ 1.45 6/29/05 $119,778 $303,540
- --------------- (1) This option was granted on June 29, 1995 pursuant to Mr. Lupinacci's Stock Option Plan and Agreement and has a maximum term of ten years measured from the grant date, subject to earlier termination under certain circumstances. A maximum of 85,350 option shares vest in twelve equal monthly installments following this Offering and a maximum of 46,000 option shares vest in six equal monthly installments following a secondary offering. Any unvested shares become vested eight years after the date of grant. See "Management -- Employment Agreement and Compensation Arrangements." (2) The potential realizable value is calculated based on the fair market value of the underlying Common Stock on the date of grant as determined by the Board of Directors. If such values were based on the assumed initial public offering price of $11.00 per share, the potential realizable value at assumed annual rates of stock price appreciation for the option term at 5% and 10% would be $2,163,051 and $3,557,111, respectively. The actual value realized may be greater or less than the potential realizable values set forth in the table. 41 44 Aggregated Stock Option Exercises in Last Fiscal Year and Fiscal Year End Option Values The following table sets forth the number and value of the exercisable and unexercisable options held by each of the Named Executive Officers at January 31, 1996. None of the Named Executive Officers exercised any options during the fiscal year ended January 31, 1996.
NUMBER OF SECURITIES VALUES OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT FISCAL YEAR-END (#) FISCAL YEAR-END ($)(1) ------------------------------ ------------------------------ NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ------------------------------- ----------- ------------- ----------- ------------- Martin R. Diedrich............. -- -- -- -- Steven A. Lupinacci............ -- 131,350 -- $ 1,254,393
- --------------- (1) These values are calculated using the assumed initial public offering price of $11.00 per share, less the exercise price of the options. 1996 Stock Incentive Plan The Board of Directors has adopted the 1996 Stock Incentive Plan (the "Incentive Plan"). The purpose of the Incentive Plan is to promote the interests of the Company and its stockholders by using investment interests in the Company to attract, retain and motivate its management and other persons, to encourage and reward their contributions to the performance of the Company and to align their interests with the interests of the Company's stockholders. The Incentive Plan enables the Company to grant a variety of stock-based incentive awards, including incentive and nonstatutory stock options, restricted stock, stock appreciation rights, stock payments, dividend equivalents, stock bonuses, stock sales, phantom stock and other stock-based benefits. An award may consist of one such arrangement or benefit or two or more of them in tandem or in the alternative. A total of 475,000 shares have been reserved for issuance under the Incentive Plan. No options have been granted under the Incentive Plan to date. The Incentive Plan will be administered by a committee of two or more directors (the "Committee") who are disinterested within the meaning of Rule 16b-3 promulgated under Section 16 of the Securities Exchange Act of 1934, as amended, and who are eligible to receive only automatic, nondiscretionary awards under the Non-Employee Directors Plan. The Incentive Plan permits the Committee to select eligible persons to receive awards and to determine the terms and conditions of awards. Under the Incentive Plan, options to purchase Common Stock may be granted with an exercise price below the market value of such stock on the grant date. The Board of Directors or the Committee may amend, suspend or terminate the Incentive Plan at any time. However, only the Committee may take actions affecting selection of award recipients or the timing, pricing and amounts of any awards. In addition, the maximum number of shares that may be sold or issued under the Incentive Plan may be increased and the class of persons eligible to participate in the Incentive Plan may be altered only with the approval of the Company's stockholders. With respect to all other amendments to the Incentive Plan, the Board may, in its discretion, determine that such amendment shall only become effective upon approval by the stockholders of the Company if the Board determines that such stockholder approval may be advisable, such as for the purpose of obtaining or retaining any statutory or regulatory benefits under federal or state securities laws, federal or state tax laws, or for the purpose of satisfying applicable stock exchange listing requirements. EMPLOYMENT AGREEMENTS AND COMPENSATION ARRANGEMENTS Employment Agreement with Martin R. Diedrich In June 1995, Martin R. Diedrich entered into a three-year employment agreement with the Company. The agreement provided for an annual base salary of $100,000 per year, subject to periodic adjustment by the Board of Directors. The Board of Directors may also grant Mr. Diedrich performance bonuses based upon the Company's performance and Mr. Diedrich's contributions thereto. Mr. Diedrich is also entitled to receive employee benefits consistent with the Company's policies for other senior executives. The agreement further 42 45 provides that Mr. Diedrich shall not be required to relocate outside of Orange County, California as a condition to his employment. Employment Agreement and Compensation Arrangements with Steven A. Lupinacci In June 1995, Steven A. Lupinacci entered into a three-year employment agreement with the Company. The agreement provided for an annual base salary of $125,000 per year, subject to periodic adjustment by the Board of Directors. The Board of Directors may also grant Mr. Lupinacci performance bonuses based upon the Company's performance and Mr. Lupinacci's contributions thereto. Mr. Lupinacci is also entitled to receive employee benefits consistent with the Company's policies for other senior executives. In June 1995, the Company entered into a stock option plan and agreement with Steven A. Lupinacci, the Company's President, Chief Executive Officer and Chief Financial Officer. The agreement expires on June 29, 2005. The agreement provides for a grant of options to purchase 131,350 shares of Common Stock at an exercise price of $1.45 per share. Upon the closing of this Offering or certain other extraordinary events, Mr. Lupinacci shall be able to exercise a maximum of 85,350 option shares, subject to adjustment based upon the initial public offering price, which will vest in twelve equal installments at the end of each month after the closing of the Offering. Upon the closing of a secondary offering or certain other extraordinary events, Mr. Lupinacci shall be able to exercise a maximum of 46,000 option shares, subject to adjustment based upon the public offering price in connection with the secondary offering, which will vest in six equal installments at the end of each month after the closing of such secondary offering. In the event of a change in control under certain circumstances, the vesting schedule for all or a portion of the option shares may be accelerated. If not exercisable earlier, the option shares are exercisable in June 2003 and expire in June 2005. INDEMNIFICATION OF DIRECTORS AND OFFICERS AND RELATED MATTERS The Company's Certificate of Incorporation limits, to the maximum extent permitted by the Delaware General Corporation Law, the personal liability of directors and officers for monetary damages for breach of their fiduciary duties as directors and officers (other than liabilities arising from acts or omissions that involve intentional misconduct, fraud or knowing violations of law or the payment of distributions in violation of Delaware General Corporation Law). The Certificate of Incorporation provides further that the Company shall indemnify, to the fullest extent permitted by Delaware General Corporation Law, any person made a party to an action or proceeding by reason of the fact that such person was a director, officer, employee or agent of the Company. Subject to the Company's Certificate of Incorporation, the Bylaws provide that the Company shall indemnify directors and officers for all costs reasonably incurred in connection with any action, suit or proceeding in which such director or officer is made a party by virtue of his being an officer or director of the Company except where such director or officer is finally adjudged to have been derelict in the performance of his duties as such director or officer. The Company has entered into separate indemnification agreements with its directors and officers containing provisions that provide for the maximum indemnity allowed to directors and officers by the Delaware General Corporation Law and the Company's Bylaws, subject to certain exceptions. The indemnification agreements may require the Company, among other obligations, to indemnify such directors and officers against certain liabilities that may arise by reason of their status as directors and officers, other than liabilities arising from willful misconduct of a culpable nature, provided that such person acted in good faith and in a manner that he or she reasonably believed to be in or not opposed to the best interests of the Company and, in the case of a criminal proceeding, had no reasonable cause to believe that his conduct was unlawful. In addition, the indemnification agreements provide generally that the Company will, subject to certain exceptions, advance the expenses incurred by directors and officers as a result of any proceeding against them as to which they may be entitled to indemnification. The Company believes these agreements are necessary to attract and retain qualified persons as directors and officers. The Company also maintains directors' and officers' liability insurance. The indemnification provisions in the Company's Bylaws, and the indemnity agreements entered into between the Company and its directors and executive officers, may permit indemnification for liabilities arising 43 46 under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. KEY MAN LIFE INSURANCE The Company currently maintains a term life insurance policy in the amount of $1,000,000 on the life of Martin Diedrich under which the Company is the beneficiary. CERTAIN TRANSACTIONS Until 1987, Diedrich Coffee was also engaged in the design and manufacture of coffee roasters. Beginning in 1987, however, this business was separated from the Company and operated independently as a sole proprietorship by Stephan Diedrich, brother of Martin Diedrich, the Company's Chairman. The sole proprietorship operated under the name Diedrich Manufacturing until it was incorporated in 1991 as Diedrich Manufacturing, Inc. Presently, Diedrich Manufacturing, Inc. is doing business as Diedrich Coffee Roasters. The Company purchases roasting equipment and display bins from Diedrich Coffee Roasters from time to time. The Company made purchases in the amounts of approximately $52,000, $3,000 and $16,000 in fiscal years 1996, 1995 and 1994, respectively. As of April 30, 1996, the Company had purchased approximately $29,000 worth of goods from Diedrich Coffee Roasters in fiscal 1997. On June 13, 1995, the Company entered into an agreement to redeem an aggregate of 229,787 shares of Common Stock owned by Donald Holly at an aggregate price of $305,000. Mr. Holly was formerly a director and Chief Financial Officer of the Company. In connection with the purchase of the Series A Preferred Stock and Series B Preferred Stock, the Company granted registration rights to certain stockholders. See "Description of Capital Stock -- Registration Rights." Reference is hereby made to the transactions described under "Management -- Compensation Committee Interlocks and Insider Participation." All future transactions, including loans, between the Company and its officers, directors, principal stockholders and affiliates will be approved by a majority of the Board of Directors, including a majority of the independent and disinterested outside directors on the Board of Directors, and will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties. 44 47 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of July 15, 1996, and as adjusted to reflect the sale of Common Stock offered by this Prospectus, (i) by each person (or group of affiliated persons) who is known by the Company to own beneficially more than five percent of the Company's Common Stock, (ii) by each of the Named Executive Officers, (iii) by each of the Company's directors, and (iv) by all directors and executive officers as a group. The Company believes that the persons and entities named in the table have sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by them, subject to community property laws, where applicable.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED OWNED PRIOR TO THE OFFERING NUMBER OF AFTER OFFERING NAME AND ADDRESS OF BENEFICIAL --------------------- SHARES BEING --------------------- OWNER(1) NUMBER PERCENT OFFERED(2) NUMBER PERCENT - -------------------------------------- --------- ------- ------------ --------- ------- D.C.H., L.P. ......................... 1,268,097 33.4 100,000 1,168,097 21.7 450 Newport Center Drive Suite 450 Newport Beach, CA 92660 Redwood Enterprises VII, L.P. ........ 804,284 21.2 332,247 472,037 8.8 450 Newport Center Drive Suite 450 Newport Beach, CA 92660 Diedrich Partners I, L.P. ............ 804,284 21.2 167,753 636,531 11.8 3 Civic Plaza Suite 170 Newport Beach, CA 92660 Martin R. Diedrich.................... 685,107 18.1 -- 685,107 12.7 Steven A. Lupinacci................... 229,878 6.1 -- 244,103(3) 4.5 Paul C. Heeschen...................... 2,072,381(4) 54.7 432,247 1,640,134 30.4 All directors and executive officers as a group (3 persons).............. 2,987,366 78.8 432,247 2,569,344(3) 47.5
- --------------- (1) Unless otherwise indicated, the business address of each of the stockholders named in this table is Diedrich Coffee, Inc., 2144 Michelson Drive, Irvine, California 92612. (2) Does not include 216,123 shares beneficially owned by Redwood Enterprises VII, L.P., 83,877 shares beneficially owned by Diedrich Partners I, L.P. and 30,000 shares beneficially owned by Martin R. Diedrich that are subject to the Underwriters' over-allotment option. (3) Includes 14,225 shares that Mr. Lupinacci has the right to acquire within 60 days of the consummation of the Offering upon exercise of stock options. (4) Includes 1,268,097 shares beneficially owned by D.C.H., L.P. and 804,284 shares beneficially owned by Redwood Enterprises VII, L.P. Mr. Heeschen is the sole general partner of each of these partnerships with voting and investment power as to all of such shares. Does not include a limited partnership interest of approximately 2.2% of Diedrich Partners I, L.P. owned by Mr. Heeschen as he does not exercise any voting or investment power with respect to the shares owned by Diedrich Partners I, L.P. 45 48 DESCRIPTION OF CAPITAL STOCK GENERAL Upon consummation of the Offering, the Company will be reincorporated in Delaware and the Company's new certificate of incorporation (the "Certificate of Incorporation") will authorize 25,000,000 shares of a single class of Common Stock, no par value per share, and 3,000,000 shares of preferred stock, no par value per share, none of which shares of preferred stock will be issued and outstanding immediately after completion of the Offering. All outstanding shares of Common Stock are, and the shares offered hereby will be, when issued and sold, fully paid and nonassessable. The discussion below describes the capital stock of the Company as it will exist upon the closing of this Offering, unless otherwise noted. COMMON STOCK As of July 19, 1996, there were 1,183,082 shares of Common Stock outstanding held of record by three stockholders and three stockholders who held the right to receive 2,608,568 shares of Common Stock upon the conversion of preferred stock. The holders of Common Stock are entitled to one vote per share on all matters to be voted on by stockholders and are entitled to receive such dividends, if any, as may be declared from time to time by the Board of Directors from funds legally available therefor, subject to the dividend preferences of any preferred stock that may be designated and issued by the Company in the future. Upon liquidation or dissolution of the Company, the holders of Common Stock are entitled to share ratably in all assets available for distribution after payment of liabilities and liquidation preferences of the Preferred Stock, if any. Holders of Common Stock have no preemptive rights, no cumulative voting rights and no rights to convert their Common Stock into any other securities. Any action taken by common stockholders must be taken at an annual or special meeting and may not be taken by written consent. The outstanding shares of Common Stock are, and the shares of Common Stock to be outstanding upon the completion of this Offering will be fully paid and nonassessable. Pursuant to Section 2115 of the California Corporations Code (the "California Law"), a corporation incorporated in a State other than California (such as the Company, which is incorporated in Delaware) may nevertheless be subject to certain of the provisions of the California Law (as specified in Section 2115 of the California Law) applicable to California corporations (commonly designated a "Quasi-California Corporation") if more than one-half of its outstanding voting securities are owned of record by persons having addresses in California and more than half of its business is conducted in California (generally, if the average of its property factor, payroll factor and sales factor (as defined in Sections 25129, 25132 and 25134 of the California Revenue and Taxation Code) is more than 50 percent during its latest full income year). Such a foreign corporation will not be treated as a Quasi-California Corporation, however, if it has more than 800 holders of record of a class of securities qualified for trading on the Nasdaq National Market. Prior to this Offering, 100% of the outstanding shares of the Company's Common Stock were owned of record by persons having addresses in California. It is expected that such percentage will be reduced significantly as a result of this Offering. To the extent, however, that the Company meets the requirements set forth in Section 2115 of the California Law, the Company could become a Quasi-California Corporation subject to the California Law which, among other things, requires cumulative voting and is more restrictive than Delaware law concerning dividends and other distributions to stockholders. PREFERRED STOCK Effective upon the closing of this Offering, the Board of Directors will have the authority, without any further vote or action by the stockholders, to provide for the issuance of up to 3,000,000 shares of preferred stock from time to time in one or more series, to establish the number of shares to be included in each such series, to fix the designations, preferences, limitations and relative, participating, optional or other special rights and qualifications or restrictions of the shares of each series and to determine the voting powers, if any, 46 49 of such shares. The issuance of preferred stock could adversely affect, among other things, the rights of existing stockholders or could delay or prevent a change in control of the Company without further action by the stockholders. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of Common Stock. In addition, any such issuance could have the effect of making removal of the present management of the Company more difficult, or resulting in restrictions upon the payment of dividends and other distributions to the holders of Common Stock. The Company has no current plans to issue any preferred stock. WARRANTS The Company does not have any outstanding warrants other than the Representative's Warrants described in this Prospectus. See "Underwriting." REGISTRATION RIGHTS After this Offering, the holders of 2,108,568 shares of Common Stock, or their permitted transferees, will be entitled to certain rights with respect to registration of such shares under the Securities Act. These rights were granted pursuant to purchase agreements entered into with the Company by the holders of the Company's Series A and Series B Preferred Stock prior to this Offering. Such holders have been granted certain demand and incidental registration rights with respect to the Common Stock issuable upon conversion of the Series A and Series B Preferred Stock (the "Registrable Securities"). After the expiration of the 180-day lock-up period, the demand registration rights can be exercised a maximum of three times by holders of the Registrable Securities. See "Underwriting." With respect to the Common Stock issuable upon conversion of the Series B Preferred Stock, however, holders of at least 50% of such Registrable Securities must make such a demand. The incidental registration rights provide that if the Company proposes to register any of its securities under the Securities Act, either for its own account or the account of other security holders exercising registration rights, such holders are entitled to notice of such registration and are entitled to include shares of such Common Stock therein. The Company is required to bear substantially all of the expenses of all such registrations, except for underwriting discounts and commissions. In connection with this Offering, the Company has granted registration rights to the Representative in connection with the Representative's Warrants. See "Underwriting." TRANSFER AGENT The transfer agent for the Common Stock is U.S. Stock Transfer Corporation. SHARES ELIGIBLE FOR FUTURE SALE Prior to this Offering, there has not been any public market for the Common Stock. Sale of a substantial number of shares of Common Stock into the public market following the Offering could adversely affect prevailing market prices for the Common Stock. Following the completion of this Offering, the Company will have outstanding an aggregate of 5,391,650 shares of Common Stock. In addition to the 2,200,000 shares of Common Stock offered hereby, as of the date of this Prospectus, there will be 3,191,650 shares of Common Stock outstanding, all of which are Restricted Shares under the Securities Act. Beginning 180 days after the Effective Date, 3,191,650 Restricted Shares subject to lock-up agreements will become eligible for sale in the public market pursuant to Rule 144, all of which will be subject to the volume and other resale restrictions pursuant to Rule 144. The Representative may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements prior to the expiration of the applicable lock-up period. 47 50 In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated) who has beneficially owned shares for at least two years (including the holding period of any prior owner except an affiliate) is entitled to sell in "broker's transactions" or to market makers, within any three-month period, a number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock (53,916 shares immediately after this Offering) or (ii) generally, the average weekly trading volume in the Common Stock during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to the filing of a Form 144 with respect to such sale and certain other limitations and restrictions. Under Rule 144(k), a person who is not deemed to have been an affiliate of the Company at any time during the ninety (90) days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least three years, would be entitled to sell such shares without having to comply with the manner of the sale, volume limitation or notice filing provisions described above. Certain holders of shares of Common Stock of the Company are entitled to certain registration rights. See "Description of Capital Stock -- Registration Rights" and "Underwriting." The Company intends to file registration statements on Form S-8 under the Securities Act to register up to 600,000 shares of Common Stock reserved for issuance under its 1996 Stock Incentive Plan and the 1996 Non-Employee Directors Stock Option Plan, thus permitting the resale of such shares by nonaffiliates in the public market without restriction under the Securities Act, subject to vesting restrictions with the Company or the lock-up agreements described above. As of July 19, 1996, there were no shares subject to options which had been granted under either of the 1996 plans. 48 51 UNDERWRITING The Underwriters named below, represented by The Boston Group, L.P. (the "Representative"), have severally agreed, subject to the terms and conditions contained in the Underwriting Agreement, to purchase from the Company the number of shares of Common Stock indicated below opposite their respective names at the initial public offering price less the underwriting discounts and commissions set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions and that the Underwriters are committed to purchase all of such shares, if any are purchased.
NUMBER OF UNDERWRITERS SHARES ------------------------------------------------------------------ --------- The Boston Group, L.P. ........................................... --------- Total................................................... 2,200,000 =========
The Representative was organized in California and its principal business function is to underwrite and sell securities. The Representative has been recently formed and has underwritten only a limited number of public offerings. After interviewing various underwriters, the Company has advised the Representative that it chose the Representative based upon various factors, including the Company's belief that the Representative has an understanding of the Company and its business. The Company has been advised by the Representative that the Underwriters propose to offer shares to the public at the initial public offering price set forth on the cover page of this Prospectus, and to certain securities dealers at such price less a concession of not more than $ per share, and that the Underwriters and such dealers may reallow to other dealers, including the Underwriters, at a discount not in excess of $ per share. After the initial public offering, the public offering price and concessions and discounts may be changed by the Representative. No reduction in such terms shall change the amount of proceeds to be received by the Company as set forth on the cover page of this Prospectus. The Company will bear the expenses of the Selling Stockholders in connection with the registration of shares, other than underwriting discounts and commissions. The Selling Stockholders have granted the Underwriters an option, exercisable within thirty days after the date of this Prospectus, to purchase up to an aggregate of an additional 330,000 shares of Common Stock, all of which will be sold by such Selling Stockholders to cover over-allotments, at the same price per share of Common Stock being paid by the Underwriters for the other shares of Common Stock offered hereby. None of the proceeds of sales by Selling Stockholders will be received by the Company. The Representative has informed the Company that it does not expect any sales of the shares of Common Stock offered hereby to be made by the Underwriters to any accounts over which they exercise discretionary authority. The Company's officers, directors and stockholders have agreed not to, directly or indirectly, offer, offer to sell, sell, grant an option to purchase or sell, or transfer any shares of Common Stock owned by them for a 49 52 period of 180 days from the date of this Prospectus without the prior written consent of the Representative (other than with respect to the over-allotment option). The Company has agreed to pay the Representative a non-accountable expense allowance of two percent of the gross proceeds from the sale of all shares of Common Stock offered hereby (including any shares sold by the Selling Stockholders in the Offering or pursuant to the Underwriters' over-allotment option), up to a maximum of $500,000. To date, the Company has not paid any of the non-accountable expense allowance to the Representative. The Representative's expenses in excess of the non-accountable expense allowance, including its legal expenses, will be borne by the Representative. To the extent that the expenses of the Representative are less than the non-accountable expense allowance, the excess shall be deemed to be compensation to the Representative. The Underwriting Agreement provides that the Company and the Selling Stockholders will indemnify the Underwriters against certain liabilities under the Securities Act or will contribute payments the Underwriters may be required to make in respect thereof. The Company has been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. Prior to this Offering, there has not been an established public market for the Common Stock. The initial public offering price will be determined by negotiations between the Company, the Selling Stockholders and the Representative. Among the major factors to be considered in determining the initial public offering price of the Common Stock will be the prevailing market conditions, the market prices relative to earnings, cash flow and assets for publicly traded common stocks of comparable companies, the sales and earnings of the Company and comparable companies in recent periods, the Company's earning potential, the experience of its management, and the position of the Company in the industry. The initial public offering price set forth on the cover page of this Prospectus should not be considered an indication of the actual value of the Common Stock. Such price is subject to change as a result of market conditions and other factors and no assurance can be given that the Common Stock can be resold at the initial public offering price. The Company has agreed to sell to the Representative, for $50, Representative's Warrants to purchase up to 160,000 shares of Common Stock at an exercise price per share equal to 120% of the greater of the actual public offering price or $11.50. The Representative's Warrants are exercisable for a period of two years beginning one year from the date of this Prospectus, and are not transferable except to the officers or employees of the Representative. The Representative's Warrants include a net exercise provision permitting the holder, upon consent of the Company, to pay the exercise price by cancellation of a number of shares with a fair market value equal to the exercise price of the Representative's Warrants. The Representative's Warrants provide certain rights with respect to the registration under the Securities Act of up to 160,000 shares of Common Stock issuable upon exercise thereof. The holders of the shares issuable upon exercise of the Representative's Warrants may require the Company to file a registration statement under the Securities Act with respect to such shares. In addition, if the Company registers any of its Common Stock for its own account, the holders of the shares issuable upon exercise of the Representative's Warrants are entitled to include their shares of Common Stock in the registration. The foregoing sets forth the material terms and conditions of the Underwriting Agreement, but does not purport to be a complete statement of the terms and conditions thereof, copies of which are on file at the offices of the Representative, the Company, and the Securities and Exchange Commission. See "Additional Information." LEGAL MATTERS Certain legal matters with respect to the shares of Common Stock offered hereby will be passed upon for the Company by Gibson, Dunn & Crutcher LLP, Orange County, California. Munger, Tolles & Olson, Los Angeles, California, will act as counsel for the Underwriters. 50 53 EXPERTS The financial statements of the Company and the Acquired Stores of Brothers Gourmet Coffees, Inc. included in this Prospectus and in the Registration Statement have been audited by BDO Seidman, LLP, independent certified public accountants, to the extent and for the periods set forth in their reports appearing elsewhere herein and in the Registration Statement, and are included in reliance upon such reports given upon the authority of said firm as experts in auditing and accounting. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") in Washington, D.C. a Registration Statement on Form S-1 (together with all amendments thereto, the "Registration Statement"), under the Securities Act with respect to the shares of Common Stock offered hereby. This Prospectus does not contain all the information set forth in the Registration Statement and the exhibits and schedules filed therewith, certain portions of which have been omitted as permitted by the rules and regulations of the Commission. For further information with respect to the Company and the Common Stock offered hereby, reference is hereby made to the Registration Statement and to the exhibits and schedules filed therewith. Statements contained in this Prospectus regarding the contents of any contract or other document referred to are not necessarily complete and in each such instance, reference is made to the copy of such contract, agreement or other document filed as an exhibit to the Registration Statement, each such statement being deemed to be qualified in its entirety by such reference. The Registration Statement, including all exhibits and schedules thereto, may be inspected without charge at the principal office of the Commission, at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and at the Midwest Regional Office of the Commission at 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511 and at the Northeast Regional Office of the Commission at Seven World Trade Center, Suite 1300, New York, New York 10048. Copies of such material may be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, upon the payment of prescribed fees. The Commission maintains a web site that contains reports, proxy and information statements and other information filed electronically with the Commission at http://www.sec.gov. 51 54 DIEDRICH COFFEE INDEX TO FINANCIAL STATEMENTS HISTORICAL FINANCIAL STATEMENTS OF DIEDRICH COFFEE Report of Independent Certified Public Accountants.................................... F-2 Balance Sheets as of January 31, 1995 and 1996 and May 1, 1996 (unaudited)............ F-3 Statements of Operations for the years ended January 31, 1994, 1995 and 1996 and the twelve weeks ended April 25, 1995 (unaudited) and the thirteen weeks ended May 1, 1996 (unaudited).................................................................... F-4 Statements of Stockholders' Equity for the years ended January 31, 1994, 1995 and 1996 and the thirteen weeks ended May 1, 1996 (unaudited)................................ F-5 Statements of Cash Flows for the years ended January 31, 1994, 1995 and 1996 and the twelve weeks ended April 25, 1995 (unaudited) and the thirteen weeks ended May 1, 1996 (unaudited).................................................................... F-6 Notes to Financial Statements......................................................... F-7 HISTORICAL FINANCIAL STATEMENTS OF THE ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. Report of Independent Certified Public Accountants.................................... F-17 Balance Sheets as of December 30, 1994, December 29, 1995 and January 26, 1996.................................................................... F-18 Statements of Operations and Store Equity for the period from inception (June 1, 1994) to December 30, 1994, the year ended December 29, 1995 and the four weeks ended January 26, 1996.................................................................... F-19 Statements of Cash Flows for the period from inception (June 1, 1994) to December 30, 1994, year ended December 29, 1995 and the four weeks ended January 26, 1996........ F-20 Notes to Financial Statements......................................................... F-21 UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS OF DIEDRICH COFFEE Pro Forma Condensed Financial Statements.............................................. F-24 Pro Forma Condensed Balance Sheet as of January 31, 1996.............................. F-25 Pro Forma Condensed Statement of Operations for the year ended January 31, 1996....... F-26 Notes to Pro Forma Condensed Financial Statements..................................... F-27
F-1 55 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors Diedrich Coffee Irvine, California We have audited the accompanying balance sheets of Diedrich Coffee as of January 31, 1995 and 1996, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended January 31, 1996. 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 generally accepted auditing standards. 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, the financial statements referred to above present fairly, in all material respects, the financial position of Diedrich Coffee at January 31, 1995 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended January 31, 1996 in conformity with generally accepted accounting principles. BDO SEIDMAN, LLP Costa Mesa, California March 11, 1996, except as to Note 9, which is as of July 19, 1996 F-2 56 DIEDRICH COFFEE BALANCE SHEETS
JANUARY 31, ------------------------- MAY 1, 1995 1996 1996 ---------- ---------- ----------- (UNAUDITED) ASSETS (NOTES 4 AND 9) Current Assets: Cash.......................................................... $ 58,884 $ 94,659 $ 79,222 Accounts receivable........................................... 66,542 134,573 159,049 Inventories (Note 2).......................................... 300,103 645,493 849,631 Deferred income taxes (Note 8)................................ 9,082 14,079 14,079 Prepaid expenses.............................................. 70,753 106,367 141,961 Other current assets.......................................... 25,985 12,890 11,390 ---------- ---------- ---------- Total current assets................................... 531,349 1,008,061 1,255,332 Property and equipment, net (Notes 3, 4 and 5).................. 1,760,872 4,100,898 6,580,413 Costs in excess of net assets acquired, net (Note 9)............ -- -- 841,780 Deferred income taxes (Note 8).................................. 30,892 34,113 34,113 Other assets (Note 5)........................................... 180,064 172,600 203,068 ---------- ---------- ---------- $2,503,177 $5,315,672 $8,914,706 ========== ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Checks issued against future deposits......................... $ -- $ -- $ 395,239 Current portion of long-term debt (including related party) and revolving line of credit (Notes 4 and 9)................ 40,940 117,538 2,941,307 Current portion of obligation under capital lease -- related party (Note 5).............................................. 34,143 -- -- Notes payable................................................. 39,398 39,398 39,398 Accounts payable.............................................. 417,057 635,428 1,387,657 Accrued compensation.......................................... 88,723 184,891 140,493 Accrued expenses.............................................. 40,328 32,237 82,366 Income taxes payable (Note 8)................................. 88,277 51,235 87,884 ---------- ---------- ---------- Total current liabilities.............................. 748,866 1,060,727 5,074,344 Long-term debt (including related party), less current portion (Notes 4 and 9)............................................... 338,180 829,320 304,345 Obligation under capital lease -- related party, less current portion (Note 5).............................................. 132,729 -- -- Deferred rent................................................... 110,378 121,144 124,423 ---------- ---------- ---------- Total liabilities...................................... 1,330,153 2,011,191 5,503,112 ---------- ---------- ---------- Commitments and contingencies (Notes 6, 7 and 9) Subsequent events (Note 9) Stockholders' equity (Note 7): Series A convertible cumulative preferred stock, no par value; liquidation preference of $1.00 per share, aggregating $1,000,000; authorized, 1,000,000 shares; issued and outstanding, 1,000,000 shares............................... 1,000,000 800,000 800,000 Series B convertible cumulative preferred stock, no par value; liquidation preference of $1.433 per share, aggregating $2,305,000; authorized, 1,608,568 shares; issued and outstanding, 0 shares at January 31, 1995 and 1,608,568 shares at January 31, 1996 and May 1, 1996.................. -- 2,225,813 2,225,813 Common stock, no par value; authorized, 4,021,437 shares; issued and outstanding, 1,127,660 shares at January 31, 1995 and 1,183,082 shares at January 31, 1996 and May 1, 1996.... 147,000 330,698 330,698 Retained earnings (accumulated deficit)....................... 51,024 (52,030) 55,083 Stockholder receivable........................................ (25,000) -- -- ---------- ---------- ---------- Total stockholders' equity............................. 1,173,024 3,304,481 3,411,594 ---------- ---------- ---------- $2,503,177 $5,315,672 $8,914,706 ========== ========== ==========
See accompanying notes to financial statements. F-3 57 DIEDRICH COFFEE STATEMENTS OF OPERATIONS
YEARS ENDED JANUARY 31, TWELVE THIRTEEN ------------------------------------ WEEKS ENDED WEEKS ENDED 1994 1995 1996 APRIL 25, MAY 1, ---------- ---------- ---------- 1995 1996 ----------- ----------- (UNAUDITED) (UNAUDITED) Net sales: Retail............................. $3,911,784 $6,673,330 $8,878,904 $ 1,757,205 $ 3,901,997 Wholesale and other................ 502,377 917,423 1,365,271 300,963 372,733 ---------- ---------- ---------- ---------- ---------- Total...................... 4,414,161 7,590,753 10,244,175 2,058,168 4,274,730 ---------- ---------- ---------- ---------- ---------- Costs and expenses: Cost of sales and related occupancy costs........................... 1,795,866 3,163,812 4,409,485 872,214 1,772,892 Store operating expenses........... 1,594,144 2,583,998 3,520,140 668,990 1,734,879 Other operating expenses........... 146,466 282,603 276,788 64,410 59,320 Depreciation and amortization...... 101,692 254,708 353,840 61,995 153,925 General and administrative expenses........................ 808,831 851,011 1,334,694 276,735 337,375 ---------- ---------- ---------- ---------- ---------- Total...................... 4,446,999 7,136,132 9,894,947 1,944,344 4,058,391 ---------- ---------- ---------- ---------- ---------- Operating income (loss).............. (32,838) 454,621 349,228 113,824 216,339 Interest expense..................... (90,543) (82,788) (50,187) (14,932) (38,841) Interest and other income............ 35,383 4,702 15,814 1,793 1,264 ---------- ---------- ---------- ---------- ---------- Income (loss) before income taxes.... (87,998) 376,535 314,855 100,685 178,762 Provision for income taxes (Note 8)........................... 800 52,704 129,211 41,281 71,649 ---------- ---------- ---------- ---------- ---------- Net income (loss).................... $ (88,798) $ 323,831 $ 185,644 $ 59,404 $ 107,113 ========== ========== ========== ========== ========== Pro forma information (Note 1): Net income per share............... $ .06 $ .03 ========== ========== Weighted average shares outstanding..................... 3,153,000 3,906,000 ========== ==========
See accompanying notes to financial statements. F-4 58 DIEDRICH COFFEE STATEMENTS OF STOCKHOLDERS' EQUITY
SERIES A SERIES B RETAINED PREFERRED STOCK PREFERRED STOCK COMMON STOCK EARNINGS --------------------- --------------------- -------------------- (ACCUMULATED STOCKHOLDER SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT DEFICIT) RECEIVABLE TOTAL --------- ---------- --------- ---------- --------- -------- ------------ ----------- ---------- Balance, January 31, 1993......... 1,000,000 $1,000,000 -- $ -- 1,127,660 $147,000 $ (184,009) $ (25,000) $ 937,991 Net loss for the year............. -- -- -- -- -- -- (88,798) -- (88,798) --------- ---------- --------- ---------- --------- -------- --------- -------- ---------- Balance, January 31, 1994......... 1,000,000 1,000,000 -- -- 1,127,660 147,000 (272,807) (25,000) 849,193 Net income for the year............. -- -- -- -- -- -- 323,831 -- 323,831 --------- ---------- --------- ---------- --------- -------- --------- -------- ---------- Balance, January 31, 1995......... 1,000,000 1,000,000 -- -- 1,127,660 147,000 51,024 (25,000) 1,173,024 Repurchase of common stock (Note 7)......... -- -- -- -- (229,787) (16,302) (288,698) 25,000 (280,000) Issuance of Series B preferred stock (Note 7)......... -- -- 1,608,568 2,225,813 -- -- -- -- 2,225,813 Common stock issued upon adjustment of original purchase price of Series A preferred stock (Note 7)......... -- (200,000) -- -- 285,209 200,000 -- -- -- Net income for the year............. -- -- -- -- -- -- 185,644 -- 185,644 --------- ---------- --------- ---------- --------- -------- --------- -------- ---------- Balance, January 31, 1996......... 1,000,000 800,000 1,608,568 2,225,813 1,183,082 330,698 (52,030) -- 3,304,481 Net income for the period (unaudited)...... -- -- -- -- -- -- 107,113 -- 107,113 --------- ---------- --------- ---------- --------- -------- --------- -------- ---------- Balance, May 1, 1996 (unaudited). 1,000,000 $ 800,000 1,608,568 $2,225,813 1,183,082 $330,698 $ 55,083 $ -- $3,411,594 ========= ========== ========= ========== ========= ======== ========= ======== ==========
See accompanying notes to financial statements. F-5 59 DIEDRICH COFFEE STATEMENTS OF CASH FLOWS
TWELVE YEARS ENDED JANUARY 31, WEEKS THIRTEEN ---------------------------------- ENDED WEEKS ENDED 1994 1995 1996 APRIL 25, MAY 1, --------- --------- ---------- 1995 1996 --------- ----------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net income (loss)............................ $ (88,798) $ 323,831 $ 185,644 $ 59,404 $ 107,113 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization............. 101,692 254,708 353,840 61,995 153,925 Deferred income taxes..................... -- (39,974) (8,218) -- -- Increase (decrease) from changes in: Accounts receivable..................... (40,950) (2,924) (68,031) (58,172) (24,476) Inventories............................. (87,530) (123,623) (345,390) 91,260 (204,138) Prepaid expenses........................ (28,183) (42,570) (35,614) (126,238) (35,594) Other current assets.................... (1,023) 6,541 13,095 25,995 1,500 Other assets............................ (18,429) (13,301) (12,768) 53,690 (30,468) Accounts payable........................ 386,421 (97,624) 218,371 (48,846) 752,229 Accrued compensation.................... (11,733) 67,651 83,505 41,201 (44,398) Accrued expenses........................ (6,647) (1,371) 4,572 30,545 23,349 Income taxes payable.................... -- 88,277 (37,042) (80,867) 36,649 Deferred rent............................. 41,748 27,592 10,766 2,842 3,279 --------- --------- ----------- --------- ----------- Cash provided by operating activities.......... 246,568 447,213 362,730 52,809 738,970 --------- --------- ----------- --------- ----------- Cash flows from investing activities: Capital expenditures for property and equipment................................. (964,822) (342,110) (2,673,634) (142,474) (1,648,440) Acquisition of coffeehouses.................. -- -- -- -- (1,800,000) --------- --------- ----------- --------- ----------- Cash used in investing activities.............. (964,822) (342,110) (2,673,634) (142,474) (3,448,440) --------- --------- ----------- --------- ----------- Cash flows from financing activities: Checks issued against future deposits........ -- -- -- 125,800 395,239 Proceeds from (payments on) notes payable.... (19,102) 13,500 -- -- -- Proceeds from long-term debt................. 173,500 62,446 580,000 108,747 2,327,776 Principal payments on long-term debt......... (77,795) (108,083) (93,674) (15,218) (28,982) Principal payments on obligation under capital lease -- related party............ (24,722) (35,999) (85,460) (166,872) -- Proceeds from sale of preferred stock........ -- -- 2,225,813 -- -- Repurchase of common stock................... -- -- (280,000) -- -- --------- --------- ----------- --------- ----------- Net cash provided by (used in) financing activities................................... 51,881 (68,136) 2,346,679 52,457 2,694,033 --------- --------- ----------- --------- ----------- Net increase (decrease) in cash................ (666,373) 36,967 35,775 (37,208) (15,437) Cash at beginning of period.................... 688,290 21,917 58,884 58,884 94,659 --------- --------- ----------- --------- ----------- Cash at end of period.......................... $ 21,917 $ 58,884 $ 94,659 $ 21,676 $ 79,222 ========= ========= =========== ========= =========== Supplemental Disclosure of Cash Flow Information Cash paid during the period for: Interest.................................. $ 91,403 $ 82,384 $ 50,187 $ 14,932 $ 38,841 Income taxes.............................. $ 800 $ 4,440 $ 89,458 $ 61,500 $ 39,000
See accompanying notes to financial statements. F-6 60 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS (INFORMATION AS OF MAY 1, 1996 AND FOR THE TWELVE WEEKS ENDED APRIL 25, 1995 AND THE THIRTEEN WEEKS ENDED MAY 1, 1996 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Diedrich Coffee (the "Company") operates a chain of coffeehouses located in Southern California, Colorado and Texas, which sell coffee beverages made with its own freshly roasted coffee. In addition, the Company sells light food items and whole bean coffee through its coffeehouses. In February 1996, the Company acquired 19 retail coffeehouse locations in Colorado and Texas (see Note 9). Change in Fiscal Year Effective February 1, 1996, the Company changed its year end from January 31 to a fiscal year ending on the Wednesday nearest January 31. Accordingly, the quarterly period ended May 1, 1996 includes thirteen weeks. Prior to the change in fiscal year end, the Company's quarterly periods included twelve weeks, except for the fourth quarter which had approximately sixteen weeks. Inventories Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over estimated useful lives of five to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the term of the related leases. Expenditures for major renewals and betterments that extend the useful life of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Store Pre-opening Costs Certain direct and incremental costs incurred prior to the opening of a coffeehouse location are deferred and expensed upon the opening of the coffeehouse. Fair Value of Financial Instruments The carrying amount of cash, accounts receivable, accounts payable and accrued expenses are reasonable estimates of their fair value because of the short maturity of these items. The Company believes the carrying amounts of the Company's notes payable and long-term debt approximate fair value because the interest rates on these instruments are subject to change with, or approximate, market interest rates. Rent Expense Certain of the Company's lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing on a date other than the date of initial occupancy. Rent expense is recorded on a straight-line basis over the respective terms of the leases. Income Taxes The Company uses the liability method of accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting For Income Taxes." Deferred income taxes are recognized based on the differences between financial statement and income tax bases of assets and liabilities F-7 61 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Pro Forma Net Income per Share Pro forma net income per share is based on the weighted average number of shares outstanding during the period after consideration of the dilutive effect, if any, of stock options granted and after giving pro forma effect to the conversion of the Company's outstanding preferred stock to common stock in connection with the initial public offering. Dividends on the preferred stock have been excluded from the computation since the preferred stock has been assumed to have been converted to common stock. New Accounting Standards Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of" requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company is in the process of analyzing the impact of this statement and does not believe that it will have a material impact on the Company's financial position or results of operations. The Company anticipates adopting the provisions of the statement for fiscal year 1997. Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" established financial accounting and reporting standards for stock-based employee compensation plans and certain other transactions involving the issuance of stock. The Company is in the process of analyzing the impact of this statement and does not believe it will have a material impact on the Company's financial position or results of operations. The Company anticipates adopting the provisions of the statement for fiscal year 1997. Interim Financial Information The accompanying unaudited financial statements as of May 1, 1996 and for the twelve weeks ended April 25, 1995 and the thirteen weeks ended May 1, 1996 have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the footnote information required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation have been included. Results for the interim periods are not necessarily indicative of the results for an entire year. F-8 62 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 2. INVENTORIES Inventories consist of the following:
JANUARY 31, ------------------------- MAY 1, 1995 1996 1996 ---------- ---------- ---------- (UNAUDITED) Unroasted coffee............................... $ 47,679 $ 128,369 $ 159,451 Roasted coffee................................. 20,214 24,274 69,939 Accessory and specialty items.................. 105,091 74,299 119,684 Other food, beverage and supplies.............. 127,119 418,551 500,557 ---------- ---------- ---------- $ 300,103 $ 645,493 $ 849,631 ========== ========== ==========
3. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
JANUARY 31, ------------------------- MAY 1, 1995 1996 1996 ---------- ---------- ---------- (UNAUDITED) Leasehold improvements......................... $1,017,649 $2,107,408 $3,072,007 Equipment...................................... 833,882 1,542,436 2,246,945 Furniture and fixtures......................... 414,174 772,936 1,242,390 Construction in progress....................... 96,382 609,305 1,102,603 ---------- ---------- ---------- 2,362,087 5,032,085 7,663,945 Accumulated depreciation and amortization...... (601,215) (931,187) (1,083,532) ---------- ---------- ---------- $1,760,872 $4,100,898 $6,580,413 ========== ========== ==========
F-9 63 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 4. LONG-TERM DEBT AND REVOLVING LINE OF CREDIT Long-term debt consists of the following:
JANUARY 31, MAY 1, --------------------- ---------- 1995 1996 1996 -------- -------- ---------- (UNAUDITED) ---------- $750,000 bank revolving line of credit, collateralized by substantially all assets, with interest at prime (8.5% at January 31, 1996) plus .75%. Interest payable monthly; all outstanding principal and accrued interest due and payable in October 1996. In February 1996, the line of credit was amended and the borrowing base was increased to $2,000,000 and the due date was extended to February 1997. Repaid in July 1996 (see Note 9)............................................... $ -- $500,000 $2,000,000 $500,000 bank loan commitment available for the purchase of equipment; advances are collateralized by equipment; payable in equal monthly installments over a three-year period with interest at prime plus 1%. In February 1996, the agreement was amended and the committed borrowing base was increased to $1,000,000 for which advances are available through February 1997. Repaid in July 1996 (see Note 9)................ -- -- 827,776 Notes payable to landlord, payable in monthly installments aggregating $5,213 including interest at 15% per annum through various dates ending December 2008. Notes are collateralized by certain property and equipment used in coffeehouse operations and personally guaranteed by a stockholder/officer of the Company............................................... 326,390 309,013 303,638 Note payable bearing interest at 12% per annum; payable in monthly principal and interest installments of $3,725; all unpaid principal and interest due July 1, 1997 (see Note 5)..................................... -- 61,089 51,652 Unsecured notes payable to related parties, payable in monthly installments aggregating $3,821 including 12% interest, due through March 1997 (see Note 5)......... -- 49,699 39,329 Note payable to a former stockholder under a non-compete agreement, payable in monthly installments of $2,125 including interest at 10% per annum through October 1995 (see Note 5)..................................... 18,351 -- -- Other................................................... 34,379 27,057 23,257 -------- -------- ---------- 379,120 946,858 3,245,652 Less current portion.................................... 40,940 117,538 2,941,307 -------- -------- ---------- $338,180 $829,320 $ 304,345 ======== ======== ==========
F-10 64 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Principal maturities of long-term debt as of January 31, 1996 are as follows:
YEAR ENDING JANUARY 31, -------------------------------------------------- 1997.............................................. $117,538 1998.............................................. 556,987 1999.............................................. 26,691 2000.............................................. 27,922 2001.............................................. 31,932 Thereafter........................................ 185,788 -------- $946,858 ========
5. RELATED PARTY TRANSACTIONS Related Party Receivables The Company has an amount receivable pursuant to a promissory note from a stockholder/officer aggregating $32,000 and $35,546 at January 31, 1995 and 1996, respectively, which is included in the other assets in the accompanying balance sheets. The promissory note accrues interest at a rate of 5.19% and is due in February 1999. Covenant-Not-To-Compete On November 1, 1990, the Company's founder entered into an agreement with one of the Company's stockholders whereby the founder sold all of his shares of common stock of the Company to the then sole remaining stockholder. As part of the agreement, the founder also signed a non-compete agreement with the Company in which the Company was to pay the founder an aggregate of $100,000 over 5 years (see Note 4). Obligation Under Capital Lease -- Related Party The Company was the general partner of Diedrich Coffeehouse Partners I (a California limited partnership). The limited partnership was formed for the purpose of acquiring equipment, furniture and fixtures and leasehold improvements for the Company's Newport Beach coffeehouse location. Acquired assets were leased to the Company under a capital lease agreement expiring in 1998. As of January 31, 1995, $250,000 of asset cost had been capitalized with accumulated depreciation and amortization aggregating $121,242. In March 1995, the Company executed agreements with investors in the partnership to either repay the outstanding principal and accrued interest balances or convert the outstanding principal and accrued interest balances into 12%, two-year, unsecured and fully amortized notes. On March 20, 1995, the Company paid $85,460 of principal and interest to investors and converted $81,412 into two-year notes (see Note 4). In connection with such transactions, Diedrich Coffeehouse Partners I was dissolved. Note Payable In April 1995, the Company borrowed $80,000 from a related party pursuant to an unsecured installment note bearing interest at 12% and due July 1997, which was refinanced with an unrelated third party in July 1995 (see Note 4). F-11 65 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 6. COMMITMENTS AND CONTINGENCIES Operating Leases As of January 31, 1996, the Company leases warehouse and office space in Irvine, California and twelve coffeehouse locations in Orange County, California expiring through February 2007. The leases for five of the coffeehouse locations are guaranteed by an officer/director of the Company. Certain of the coffeehouse leases require the payment of property taxes, normal maintenance and insurance on the properties and additional rents based on percentages of sales in excess of various specified retail sales levels. Contingent rent expense was insignificant during the years ended January 31, 1994, 1995 and 1996, and the twelve and thirteen weeks ended April 25, 1995 and May 1, 1996, respectively. Future minimum lease payments under non-cancelable operating leases as of January 31, 1996 are as follows:
YEAR ENDING JANUARY 31, ------------------------------------------------- 1997............................................. $ 856,000 1998............................................. 831,000 1999............................................. 817,000 2000............................................. 822,000 2001............................................. 731,000 Thereafter....................................... 2,252,000 ---------- $6,309,000 ==========
Rent expense under operating leases was approximately $324,000, $479,000, $667,000 and $356,000 (unaudited) for the years ended January 31, 1994, 1995, 1996 and the thirteen weeks ended May 1, 1996, respectively (see Note 9). As of January 31, 1996, the Company had entered into fixed price purchase contracts for unroasted coffee aggregating approximately $245,000. Such contracts are generally short-term in nature and the Company believes that their cost approximates fair market value. 7. STOCKHOLDERS' EQUITY In June 1995, the Company repurchased 229,787 shares of common stock from a stockholder for $305,000, which consideration was offset by a $25,000 stockholder receivable related to the original purchase of the shares. In June 1995, the Company amended and restated its articles of incorporation and authorized the issuance of 1,608,568 shares of new preferred stock designated as Series B Preferred Stock ("Series B"). The amended and restated articles of incorporation also changed the characteristics of the previously issued Series A Preferred Stock ("Series A") to conform with that of the newly authorized Series B, except for the liquidation preference. The Series A and Series B have the following characteristics: (i) Liquidation Preference Holders of the Series A are entitled to receive from the assets of the Company a liquidation value of $1.00 per share, plus all accrued but unpaid dividends prior to distribution of assets to any other class or series of capital stock. After payments to the holders of Series A, the holders of Series B are entitled to receive from the remaining assets of the Company a liquidation value of $1.433 per share, plus all accrued but unpaid dividends prior to distribution of assets to any holders of common stock. F-12 66 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (ii) Voting Rights Each share of Series A and Series B may vote on all matters presented before the stockholders, including the election of the Board of Directors of the Company. (iii) Conversion Rights Up until the close of business of the day immediately preceding the day of a Qualified Public Offering (the "Automatic Conversion Date"), the holders of Series A and Series B may, at their option, convert their shares into shares of common stock on a one-for-one basis. On the Automatic Conversion Date, all shares of Series A and Series B then outstanding will automatically convert to shares of common stock. The initial conversion price is subject to adjustment in the event of stock splits or combinations. (iv) Dividends Holders of Series A and Series B are entitled to a cumulative 6% per annum dividend only in the event of a liquidation or winding up of the Company prior to the Automatic Conversion Date, for all dividends not declared and paid by the Company prior to that time. As of January 31, 1996, the cumulative dividends were $188,384 for Series A and $81,843 for Series B, none of which had been declared, accrued or paid. In June 1995, the Company entered into a Series B Preferred Stock Purchase Agreement for the sale of 1,608,568 shares of Series B Preferred Stock in exchange for an aggregate purchase price of $2,305,000. Issuance costs aggregating $79,187 have been netted against the proceeds received. In June 1995, the Company and the original purchaser of the Series A Preferred Stock (the "Purchaser") agreed to a postclosing adjustment to the purchase price from the terms of the original stock purchase. The Company and the Purchaser agreed to reduce the original purchase price of the Series A by $200,000. In lieu of receiving cash, the Purchaser agreed to receive 268,097 shares of the Company's common stock. Accordingly, the Company recorded this transaction by reducing the cost basis of the Series A by the $200,000 and issuing the 268,097 shares of common stock to the Purchaser. Additionally, to address the dilution resulting from the issuance of shares to the Purchaser, the Company issued an additional 17,112 shares of common stock to a common stock shareholder. In June 1995, one executive officer was granted an option to purchase 131,350 shares of the Company's common stock at $1.45 per share, the estimated fair value of the common stock on the grant date. The option has exercise provisions pursuant to certain events, including an initial public offering and a change in control (as defined). If not exercisable earlier, the option is exercisable in June 2003, and expires 10 years from the date of grant. F-13 67 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 8. INCOME TAXES The components of the provision for income taxes are as follows:
YEARS ENDED JANUARY 31, ----------------------------- 1994 1995 1996 ----------------------------- Current: Federal....................... $ -- $67,456 $106,297 State......................... 800 25,222 31,132 ---- ------- -------- 800 92,678 137,429 ---- ------- -------- Deferred: Federal....................... -- (33,972) (6,483) State......................... -- (6,002) (1,735) ---- ------- -------- -- (39,974) (8,218) ---- ------- -------- $800 $52,704 $129,211 ==== ======= ========
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of deferred tax assets and deferred tax liabilities are as follows:
JANUARY 31, ------------------- 1995 1996 ------- ------- Deferred tax assets: Net operating loss carryforwards................... $50,570 $44,091 Accrued expenses................................... 9,082 14,079 ------- ------ Total deferred tax assets............................ 59,652 58,170 ------- ------ Deferred tax liabilities: Depreciation and amortization...................... (10,915) (9,978) Store pre-opening costs............................ (8,763) -- ------- ------ Total deferred tax liabilities....................... (19,678) (9,978) ------- ------ Net deferred tax assets.............................. $39,974 $48,192 ======= ======
A reconciliation of the statutory Federal income tax rate with the Company's effective income tax rate is as follows:
YEARS ENDED JANUARY 31, ------------------------- 1994 1995 1996 ----- ----- ----- Federal statutory rate........................... (34.0)% 34.0% 34.0% State income taxes, net of Federal benefit....... 0.9 5.1 6.1 Net operating loss carryforward without (with) current benefit................................ 34.0 (23.5) (2.0) Other............................................ -- (1.6) 2.9 ----- ----- ----- 0.9% 14.0% 41.0% ===== ===== =====
As of January 31, 1996, the Company had net operating loss (NOL) carryforwards of approximately $115,000 and $82,000 for Federal and state purposes, respectively. The Federal NOL is available to offset future taxable income through 2008, and the state NOL expires in 1998. The utilization of these NOL F-14 68 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) carryforwards could be limited due to restrictions imposed under Federal and state laws upon a change in ownership. Management has determined, based upon the Company's history of operating earnings and its expectations for the future, that operating income for the Company will more likely than not be sufficient to fully recognize these deferred tax assets. 9. SUBSEQUENT EVENTS Acquisitions On February 23, 1996, the Company purchased substantially all of the assets of twelve coffeehouses previously owned by Brothers Gourmet Coffees, Inc. ("Brothers"). Under the terms of the Brothers purchase agreement, the acquisition of the twelve coffeehouses is contingent upon the successful assignment of the building leases to the Company. The cash consideration paid by the Company totaled $1,350,000 ($675,000 of which is to be held in escrow until all the related building leases have been assigned to the Company). Management of the Company anticipates that all leases will be assigned by October 1996. The Company has been operating the acquired coffeehouses since the acquisition dates. The following pro forma results of operations assume the acquisition of the Brothers coffeehouses occurred on February 1, 1995. The pro forma results have been prepared for comparative purposes only and do not purport to indicate the results of operations which would actually have occurred had the combinations been in effect during the year ended January 31, 1996, or which may occur in the future. The pro forma results are as follows:
YEAR ENDED JANUARY 31, 1996 ---------------- (UNAUDITED) Net sales.................................................. $ 12,600,572 Net loss................................................... $ (134,724) Net loss per share......................................... $ (.04) Shares used in per share calculation....................... 3,153,000
The pro forma results of operations for the thirteen weeks ended May 1, 1996 did not differ materially from the historical results for such period and, accordingly, have not been presented. On February 15, 1996, the Company purchased substantially all of the assets of seven bakery-espresso cafes from an unrelated third party for cash consideration of $450,000. This acquisition was immaterial and, accordingly, pro forma results of operations have not been presented. These acquisitions will be accounted for using the purchase method of accounting, and accordingly the results of operations of the coffeehouses acquired will be included with those of the Company as of their respective acquisition date. The costs in excess of the net assets acquired will be amortized on a straight-line basis over 15 years, based on management's estimate of its economic life. Leases Subsequent to year end and through July 19, 1996, the Company entered into lease agreements for additional coffeehouse and warehouse locations in addition to the lease commitments included in Note 6. The locations, certain of which have not yet been constructed, generally require rental payments to begin upon occupancy. The new leases, including the lease obligations for the acquired coffeehouses and bakery-cafes discussed above, will require expected minimum rental payments aggregating approximately $7,556,000 over the life of the leases. F-15 69 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Debt On May 20, 1996, the Company entered into a revolving promissory note with a shareholder. The note provides for borrowings up to $2,000,000 with interest accruing at prime plus 3%. All unpaid principal and accrued interest is due and payable on September 30, 1996. On July 19, 1996, the Company entered into a bank revolving line of credit agreement which provides for borrowings up to $4,100,000 with interest payable monthly at the bank's reference rate plus .25% or, at the Company's option, certain other international interest rates established by the bank plus 2.25%. Borrowings are collateralized by substantially all of the Company's assets. Proceeds from the line of credit agreement were used to retire the Company's previous line of credit agreement and equipment loan (see Note 4). In the absence of an initial public offering, the line of credit is available through November 1, 1996, at which time all amounts are due and payable. The agreement also provides for certain unsecured borrowing arrangements subsequent to a successful initial public offering. The line of credit agreement has certain covenants and imposes certain restrictions on the Company, including the payment of dividends. Stockholders' Equity On July 16, 1996, the Company adopted the 1996 Stock Incentive Plan (the "Incentive Plan"), which authorized the granting of a variety of stock-based incentive awards, including incentive and nonstatutory stock options. A total of 475,000 shares have been reserved for issuance under the Incentive Plan. The Incentive Plan is administered by a committee of the Board of Directors, who determine the recipients and terms of the awards granted. Under the Incentive Plan, options to purchase common stock may be granted with an exercise price below market value of such stock on the grant date. On July 16, 1996, the Company adopted the 1996 Non-Employee Directors Stock Option Plan (the "Directors Plan"), which authorized the granting of non-qualified stock options to independent directors. A total of 125,000 shares have been reserved for issuance under the Directors Plan. Pursuant to the Directors Plan, each non-employee director receives certain automatic grants of options which generally vest over two years. All non-employee director options have a term of ten years and an exercise price equal to the fair market value of the Company's common stock on the date of grant. F-16 70 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors Diedrich Coffee Irvine, California We have audited the accompanying balance sheets of the Acquired Stores of Brothers Gourmet Coffees, Inc. as of December 30, 1994, December 29, 1995 and January 26, 1996, and the related statements of operations and store equity, and cash flows for the period from inception (June 1, 1994) to December 30, 1994, the year ended December 29, 1995 and the four weeks ended January 26, 1996. 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 generally accepted auditing standards. 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, the financial statements referred to above present fairly, in all material respects, the financial position of the Acquired Stores of Brothers Gourmet Coffees, Inc. at December 30 1994, December 29, 1995 and January 26, 1996, and the results of their operations and their cash flows for the period from inception (June 1, 1994) to December 30, 1994, the year ended December 29, 1995 and the four weeks ended January 26, 1996, in conformity with generally accepted accounting principles. BDO SEIDMAN, LLP Costa Mesa, California April 19, 1996 F-17 71 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. BALANCE SHEETS
DECEMBER 30, DECEMBER 29, JANUARY 26, 1994 1995 1996 ------------ ------------ ------------ ASSETS Current Assets: Cash............................................. $ 23,274 $ 40,426 $ 50,663 Accounts receivable.............................. 3,453 1,326 1,621 Inventories (Note 3)............................. 76,703 68,112 72,234 ---------- ---------- ---------- Total current assets..................... 103,430 109,864 124,518 Property and equipment, net (Note 4)............... 2,247,178 3,712,316 3,666,881 Other assets....................................... 28,801 27,218 16,479 ---------- ---------- ---------- $2,379,409 $3,849,398 $3,807,878 ========== ========== ========== LIABILITIES AND STORE EQUITY Current Liabilities: Accrued compensation............................. $ 12,689 $ 32,229 $ 30,715 Accrued expenses................................. 8,919 16,859 2,525 ---------- ---------- ---------- Total current liabilities................ 21,608 49,088 33,240 Deferred rent...................................... 12,342 46,400 48,382 ---------- ---------- ---------- Total liabilities........................ 33,950 95,488 81,622 Commitments (Note 5) Subsequent event (Note 6) Store equity (Note 2).............................. 2,345,459 3,753,910 3,726,256 ---------- ---------- ---------- $2,379,409 $3,849,398 $3,807,878 ========== ========== ==========
See accompanying notes to financial statements. F-18 72 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. STATEMENTS OF OPERATIONS AND STORE EQUITY
INCEPTION FOUR WEEKS (JUNE 1, 1994) YEAR ENDED ENDED TO DECEMBER 30, DECEMBER 29, JANUARY 26, 1994 1995 1996 --------------- ------------ ----------- Net sales............................................. $ 615,113 $2,356,397 $ 179,243 Cost of sales and related occupancy costs............. 292,420 1,522,674 109,268 Store operating expenses.............................. 266,834 1,165,727 80,378 Depreciation and amortization......................... 40,770 626,758 56,174 ---------- ---------- ---------- Store operating income (loss)......................... 15,089 (958,762) (66,577) Corporate general and administrative expenses (Note 2)............................................ 126,098 447,306 37,276 ---------- ---------- ---------- Net loss.............................................. (111,009) (1,406,068) (103,853) Store equity, beginning of period..................... -- 2,345,459 3,753,910 Net change in parent company investment (Note 2)...... 2,456,468 2,814,519 76,199 ---------- ---------- ---------- Store equity, end of period........................... $ 2,345,459 $3,753,910 $ 3,726,256 ========== ========== ==========
See accompanying notes to financial statements. F-19 73 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. STATEMENTS OF CASH FLOWS
INCEPTION FOUR WEEKS (JUNE 1, 1994) YEAR ENDED ENDED TO DECEMBER 30, DECEMBER 29, JANUARY 26, 1994 1995 1996 --------------- ----------- ----------- Cash flows from operating activities: Net loss.......................................... $ (111,009) $(1,406,068) $ (103,853) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization.................. 40,770 626,758 56,174 Increase (decrease) from changes in: Accounts receivable.......................... (3,453) 2,127 (295) Inventories.................................. (76,703) 8,591 (4,122) Accrued compensation......................... 12,689 19,540 (1,514) Accrued expenses............................. 8,919 7,940 (14,334) Deferred rent................................ 12,342 34,058 1,982 --------- ----------- -------- Cash used in operating activities................... (116,445) (707,054) (65,962) --------- ----------- -------- Cash flows from investing activities: Capital expenditures for property and equipment... (2,278,266) (1,970,512) -- Other assets...................................... (38,483) (119,801) -- --------- ----------- -------- Cash used in investing activities................... (2,316,749) (2,090,313) -- --------- ----------- -------- Cash flows from financing activities: Increase in parent company investment............. 2,456,468 2,814,519 76,199 --------- ----------- -------- Net increase in cash................................ 23,274 17,152 10,237 Cash at beginning of period......................... -- 23,274 40,426 --------- ----------- -------- Cash at end of period............................... $ 23,274 $ 40,426 $ 50,663 ========= =========== ========
See accompanying notes to financial statements. F-20 74 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 30, 1994, DECEMBER 29, 1995 AND JANUARY 26, 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying financial statements include the accounts of twelve coffeehouses (collectively, the "Acquired Stores") owned by Brothers Gourmet Coffees, Inc. ("Brothers"). On February 23, 1996, the Acquired Stores were sold to Diedrich Coffee (see Note 6). Inventories Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over estimated useful lives of five to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the term of the related leases. Expenditures for major renewals and betterments that extend the useful life of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Store Pre-opening Costs Costs incurred prior to the opening of a coffeehouse location such as advertising, training expenses and salaries of newly hired employees are capitalized and amortized using the straight-line method over a one-year period commencing with the coffeehouse opening. Rent Expense Certain of the Company's lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing on a date other than the date of initial occupancy. Rent expense is recorded on a straight-line basis over the respective terms of the leases. Income Taxes The results of operations of the Acquired Stores for the period from inception (June 1, 1994) to December 30, 1994, the year ended December 29, 1995 and the four weeks ended January 26, 1996 are included in the consolidated tax return of Brothers. As the Acquired Stores operated at a loss for the periods presented, no allocation of corporate income taxes or income tax benefit has been provided. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. RELATED PARTY TRANSACTIONS The operations of the Acquired Stores through the date of the sale (see Note 6), were controlled by Brothers. In that regard, cash deposited to the Acquired Stores operating accounts was transferred to Brothers which used the funds to pay operating expenses, along with the funds from the other Brothers non-acquired F-21 75 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) operating entities, on a company-wide basis. Brothers also paid for the build-out of the Acquired Stores as well as operating equipment. The net effect of the above noted intra-company transactions has been included as a component of net store equity in the accompanying balance sheets. In addition to the normal operating expenses, the Acquired Stores were allocated corporate overhead and general and administrative expenses from Brothers which allocations aggregated $126,098 for the period from inception (June 1, 1994) to December 30, 1994, $447,306 for the year ended December 29, 1995 and $37,276 for the four weeks ended January 26, 1996. 3. INVENTORIES Inventories consist of the following:
DECEMBER 30, DECEMBER 29, JANUARY 26, 1994 1995 1996 ------------ ------------ ------------ Roasted coffee................................ $ 17,948 $ 15,540 $ 17,288 Food, beverage and supplies................... 58,755 52,572 54,946 ---------- ---------- ---------- $ 76,703 $ 68,112 $ 72,234 ========== ========== ==========
4. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
DECEMBER 30, DECEMBER 29, JANUARY 26, 1994 1995 1996 ------------ ------------ ------------ Leasehold improvements........................ $1,757,832 $3,463,137 $3,463,137 Furniture, fixtures and equipment............. 520,434 785,641 785,641 ---------- ---------- ---------- 2,278,266 4,248,778 4,248,778 Accumulated depreciation and amortization..... (31,088) (536,462) (581,897) ---------- ---------- ---------- $2,247,178 $3,712,316 $3,666,881 ========== ========== ==========
5. OPERATING LEASES Brothers leases the coffeehouse locations in Colorado and Texas pursuant to operating lease agreements. Future minimum lease payments under non-cancelable operating leases for the Acquired Stores as of January 26, 1996 are as follows:
YEAR ENDING DECEMBER 29, ----------------------------------------------- 1996 (eleven months)........................... $ 287,000 1997........................................... 333,000 1998........................................... 349,000 1999........................................... 348,000 2000........................................... 214,000 Thereafter..................................... 354,000 ---------- $1,885,000 ==========
Rent expense under operating leases was approximately $91,000 for the period from inception (June 1, 1994) to December 30, 1994, $479,000 for the year ended December 29, 1995 and $34,000 for the four weeks ended January 26, 1996. F-22 76 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 6. SUBSEQUENT EVENT On February 23, 1996, substantially all of the assets of the Acquired Stores were sold to Diedrich Coffee for $1,350,000, of which $675,000 is to be held in escrow until all the related building leases have been assigned to Diedrich Coffee. F-23 77 DIEDRICH COFFEE PRO FORMA CONDENSED FINANCIAL STATEMENTS (UNAUDITED) On February 23, 1996, the Company acquired certain assets from Brothers Gourmet Coffees, Inc. ("Brothers"), which assets included real property leasehold interests for twelve coffeehouse stores (the "Acquired Stores"), and assumed certain liabilities for a purchase price of $1,350,000. Fifty percent of the purchase price was payable upon the closing and the remaining portion is held in escrow and is payable upon satisfaction of certain conditions, including the assignment of property leases. The acquisition will be accounted for using the purchase method of accounting, with the assets acquired and liabilities assumed recorded at fair values. The results of operations of the Acquired Stores will be included with those of the Company as of the acquisition date. The accompanying pro forma condensed financial statements illustrate the effect of the acquisition on the Company's financial position and results of operations. The pro forma condensed balance sheet as of January 31, 1996 is based on the historical balance sheet of the Company as of that date and the historical balance sheet of the Acquired Stores as of December 29, 1995 and assumes the acquisition took place on January 31, 1996. The pro forma condensed statement of operations for the year ended January 31, 1996 is based on the historical statement of operations of the Company for that period and the historical statement of operations of the Acquired Stores for the year ended December 29, 1995. The pro forma condensed statement of operations assumes the acquisition took place on February 1, 1995. The pro forma condensed statement of operations for the thirteen weeks ended May 1, 1996 did not differ materially from the historical results of operations for such period and, accordingly, has not been presented. The pro forma condensed financial statements are not intended to be indicative of the financial position or results of operations which actually would have been realized had the acquisition occurred at the times assumed, nor of the future results of operations of the combined entities. The accompanying pro forma condensed financial statements should be read in conjunction with the historical financial statements and notes of the Company and the Acquired Stores. F-24 78 DIEDRICH COFFEE PRO FORMA CONDENSED BALANCE SHEET JANUARY 31, 1996 (UNAUDITED)
DIEDRICH ACQUIRED STORES COFFEE OF BROTHERS ADJUSTMENTS PRO FORMA ---------- --------------- ----------- ---------- ASSETS Current Assets: Cash................................ $ 94,659 $ 40,426 (40,426)(1) $ 94,659 Accounts receivable................. 134,573 1,326 (1,326)(1) 134,573 Inventories......................... 645,493 68,112 (68,112)(1) 645,493 Prepaid expenses and other current assets........................... 133,336 -- 133,336 ---------- ---------- ---------- Total current assets........ 1,008,061 109,864 1,008,061 Property and equipment, net........... 4,100,898 3,712,316 (2,887,316)(1) 4,925,898 Cost in excess of net assets acquired............................ -- -- 548,000(1) 548,000 Other assets.......................... 206,713 27,218 (27,218)(1) 216,713 10,000(1) ---------- ---------- ---------- $5,315,672 $ 3,849,398 $6,698,672 ========== ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt... $ 117,538 $ -- $ 117,538 Notes payable....................... 39,398 -- 675,000(1) 714,398 Obligation to seller for acquisition...................... -- -- 675,000(1) 675,000 Accounts payable.................... 635,428 -- 635,428 Accrued compensation................ 184,891 32,229 (32,229)(1) 184,891 Accrued expenses.................... 83,472 16,859 (16,859)(1) 116,472 33,000(1) ---------- ---------- ---------- Total current liabilities... 1,060,727 49,088 2,443,727 Long-term debt, less current portion............................. 829,320 -- 829,320 Deferred rent......................... 121,144 46,400 (46,400)(1) 121,144 ---------- ---------- ---------- Total liabilities........... 2,011,191 95,488 3,394,191 Stockholders' equity.................. 3,304,481 3,753,910 (3,753,910)(1) 3,304,481 ---------- ---------- ---------- $5,315,672 $ 3,849,398 $6,698,672 ========== ========== ==========
See accompanying notes to pro forma condensed financial statements. F-25 79 DIEDRICH COFFEE PRO FORMA CONDENSED STATEMENT OF OPERATIONS YEAR ENDED JANUARY 31, 1996 (UNAUDITED)
DIEDRICH ACQUIRED STORES COFFEE OF BROTHERS ADJUSTMENTS PRO FORMA ----------- --------------- ----------- ----------- Net sales........................... $10,244,175 $ 2,356,397 $12,600,572 Cost of sales and related occupancy costs............................. 4,409,485 1,522,674 5,932,159 Store operating expenses............ 3,520,140 1,165,727 4,685,867 Other operating expenses............ 276,788 -- 276,788 Depreciation and amortization....... 353,840 626,758 (482,658)(2) 497,940 General and administrative expenses.......................... 1,334,694 447,306 (380,210)(3) 1,401,790 ----------- ----------- ----------- Operating income (loss)............. 349,228 (1,406,068) (193,972) Interest expense.................... (50,187) -- (50,187) Interest and other income........... 15,814 -- 15,814 ----------- ----------- ----------- Income (loss) before income taxes... 314,855 (1,406,068) (228,345) Provision (benefit) for income taxes............................. 129,211 -- (222,832)(4) (93,621) ----------- ----------- ----------- Net income (loss)................... $ 185,644 $(1,406,068) $ (134,724) =========== =========== =========== Pro forma information: Net income (loss) per share................... $ .06 $ (.04) =========== =========== Shares used in per share calculation............. 3,153,000 3,153,000 =========== ===========
See accompanying notes to pro forma condensed financial statements. F-26 80 DIEDRICH COFFEE NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. Pro forma adjustments to record the purchase of the Acquired Stores: Components of purchase price: Cash from borrowings under the Company's credit facility.................... $ 675,000 Obligation to seller upon satisfaction of certain conditions................ 675,000 ---------- Total purchase price.................................................. 1,350,000 Allocation of purchase price: Equity of the Acquired Stores............................................... (3,753,910) Elimination of assets and liabilities not acquired or assumed as part of the acquisition: Cash..................................................................... 40,426 Accounts receivable...................................................... 1,326 Inventories.............................................................. 68,112 Accrued compensation..................................................... (32,229) Accrued expenses......................................................... (16,859) Deferred rent............................................................ (46,400) Write-down of property and equipment to fair value.......................... 2,887,316 Write-off of capitalized pre-opening costs.................................. 27,218 Accrual for store to be closed.............................................. 33,000 Covenant not to compete..................................................... (10,000) ---------- Cost in excess of net assets acquired......................................... $ 548,000 ========= 2. Pro forma adjustment to adjust depreciation and amortization: Elimination of depreciation and amortization expense on assets of the Acquired Stores...................................................................... $ (626,758) Depreciation and amortization on new cost basis of property and equipment of the Acquired Stores......................................................... 107,600 Amortization of cost in excess of net assets acquired over 15 years........... 36,500 ---------- $ (482,658) ========= 3. Pro forma adjustment to eliminate 85% of the Brothers corporate allocation of general and administrative expenses for the Acquired Stores that is estimated to be non-continuing subsequent to the acquisition. 4. Pro forma adjustment to adjust tax expense to reflect the income tax effects of the pro forma loss before income taxes, at the Company's effective tax rate.
F-27 81 - ------------------------------------------------------ - ------------------------------------------------------ NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER CONTAINED HEREIN, AND IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SHARES OF COMMON STOCK IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE ANY SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary.................... 3 Risk Factors.......................... 7 Use of Proceeds....................... 12 Dividend Policy....................... 12 Capitalization........................ 13 Dilution.............................. 14 Selected Financial Data............... 15 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 17 Business.............................. 26 Management............................ 38 Certain Transactions.................. 44 Principal and Selling Stockholders.... 45 Description of Capital Stock.......... 46 Shares Eligible for Future Sale....... 47 Underwriting.......................... 49 Legal Matters......................... 50 Experts............................... 51 Additional Information................ 51 Index to Financial Statements......... F-1
------------------------ UNTIL , 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ 2,200,000 SHARES [LOGO] DIEDRICH COFFEE, INC. ------------------------ COMMON STOCK -------------------- PROSPECTUS -------------------- THE BOSTON GROUP, L.P. , 1996 - ------------------------------------------------------ - ------------------------------------------------------ 82 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the various expenses and costs (other than underwriting discounts and commissions) expected to be incurred in connection with the sale and distribution of the securities being registered. All of the amounts shown are estimated except the registration fee of the Securities and Exchange Commission and the filing fee for the National Association of Securities Dealers, Inc. The Selling Stockholders will not be required to pay any portion of such expenses or costs.
AMOUNT TO BE ITEM PAID BY COMPANY ------------------------------------------------------------------ --------------- Securities and Exchange Commission registration fee............... $ 10,032.76 National Association of Securities Dealers, Inc. filing fee....... 3,410.00 Nasdaq National Market listing fee................................ * Blue Sky fees and expenses........................................ * Accounting fees and expenses...................................... * Legal fees and expenses........................................... * Transfer Agent and registrar fees................................. * Printing and engraving expenses................................... * Officers and directors insurance.................................. * Representative's nonaccountable expense allowance................. * Miscellaneous..................................................... * ----------- Total................................................... $ * ===========
- --------------- * To be provided by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS As of the consummation of this Offering, Diedrich Coffee, Inc. (the "Company") shall be a Delaware corporation. Article VII of the Company's Bylaws provides that the Company may indemnify its officers and directors to the full extent permitted by law. Section 145 of the General Corporation Law of the State of Delaware (the "GCL") provides that a Delaware corporation has the power to indemnify its officers and directors in certain circumstances. Subsection (a) of Section 145 of the GCL empowers a corporation to indemnify any director or officer, or former director or officer, who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation), against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred in connection with such action, suit or proceeding provided that such director or officer acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, provided that such director or officer had no cause to believe his or her conduct was unlawful. Subsection (b) of Section 145 of the GCL empowers a corporation to indemnify any director or officer, or former director or officer, who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person acted in any of the capacities set forth above, against expenses actually and reasonably incurred in connection with the defense or settlement of such action or suit provided that such director or officer acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the corporation, except that no indemnification may be made in respect of any claim, issue or matter as to which such director or officer shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action was brought shall determine II-1 83 that despite the adjudication of liability such director or officer is fairly and reasonably entitled to indemnity for such expenses which the court shall deem proper. Section 145 of the GCL further provides that to the extent a director or officer of a corporation has been successful in the defense of any action, suit or proceeding referred to in subsections (a) and (b) or in the defense of any claim, issue or matter therein, he or she shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him or her in connection therewith; that indemnification provided for in Section 145 shall not be deemed exclusive of any other rights to which the indemnified party may be entitled; and that the corporation shall have power to purchase and maintain insurance on behalf of a director or officer of the corporation against any liability asserted against him or her or incurred by him or her in any such capacity or arising out of his or her status as such whether or not the corporation would have the power to indemnify him or her against such liabilities under Section 145. Article VII of the Company's Certificate of Incorporation currently provides that each Director shall not be personally liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Directors' duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the GCL, or (iv) for any transaction from which the Director derived an improper benefit. Reference is made to the Form of Underwriting Agreement (which will be filed as Exhibit 1.1 to this Registration Statement) which provides for indemnification by the Underwriters under certain circumstances of the directors and officers of the Company signing the Registration Statement and certain controlling persons of the Company against certain liabilities, including those arising under the Securities Act. The Company intends to carry directors' and officers' liability insurance covering its directors and officers. Insofar as indemnification for liabilities under the Securities Act may be permitted to directors, officers or persons controlling the Registrant pursuant to the foregoing provisions, the Registrant has been informed that, in the opinion of the Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES On June 13, 1995, an aggregate of 229,787 shares of Common Stock owned by an employee of the Company were redeemed by the Company. These shares were valued at $305,000 on the date of redemption. On June 29, 1995, the Company issued a total of 1,608,568 shares of Series B Preferred Stock to Redwood Enterprises VII, L.P. and Diedrich Partners I, L.P. for an aggregate consideration of $2,305,000. With respect to the issuance of these securities, the Company relied upon the provisions of Rule 505 of Regulation D promulgated under the Securities Act, in that such transaction did not involve a public offering and was thereby exempt from registration under the Securities Act. The purchasers were accredited investor (as defined under Regulation D of the Securities Act). The securities were not offered or sold by means of a general solicitation and the purchasers represented that they were not acquiring the securities with a view toward distribution thereof. The securities were offered and sold in compliance with all of the provisions of Rule 505, and the shares were issued with an investment legend thereon. On June 29, 1995, the Company issued 268,097 shares of Common Stock to D.C.H., L.P. for an aggregate consideration of $200,000 that was owed to D.C.H., L.P. by the Company. With respect to the issuance of these securities, the Company relied upon the provisions of Rule 505 of Regulation D promulgated under the Securities Act, in that such transaction did not involve a public offering and was thereby exempt from registration under the Securities Act. The purchaser was an accredited investor (as defined under Regulation D of the Securities Act). The securities were not offered or sold by means of a general solicitation and the purchaser represented that it was not acquiring the securities with a view toward distribution thereof. The securities were offered and sold in compliance with all of the provisions of Rule 505, and the shares were issued with an investment legend thereon. II-2 84 On June 29, 1995, the Company issued 17,112 shares of Common Stock to the Company's Chief Executive Officer to address the dilution resulting from the issuance of shares described in the preceding paragraph. With respect to the issuance of these securities, the Company relied upon the provisions of Rule 505 of Regulation D promulgated under the Securities Act, in that such transaction did not involve a public offering and was thereby exempt from registration under the Securities Act. As the Chief Executive Officer, the purchaser was familiar with the business and financial affairs of the Company. The securities were not offered or sold by means of a general solicitation and the purchaser represented that it was not acquiring the securities with a view toward distribution thereof. The securities were offered and sold in compliance with all of the provisions of Rule 505, and the shares were issued with an investment legend thereon. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) EXHIBITS. Set forth below is a list of the exhibits included as part of this Registration Statement:
EXHIBIT NUMBER DESCRIPTION ------ ---------------------------------------------------------------------------------- 1.1 Form of Underwriting Agreement* 2.1 Form of Agreement and Plan of Merger* 3.1 Certificate of Incorporation of the Company* 3.2 Bylaws of the Company* 4.1 Purchase Agreement for Series A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee, Martin R. Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P. 4.2 Series B Preferred Stock Purchase Agreement dated as of June 29, 1995 by and among Diedrich Coffee, Martin R. Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, L.P. and Diedrich Partners I, L.P. 4.3 Representative's Warrant Agreement* 5.1 Opinion of Gibson, Dunn & Crutcher LLP* 10.1 Martin R. Diedrich Employment Agreement dated June 29, 1995 10.2 Steven A. Lupinacci Employment Agreement, dated June 29, 1995* 10.3 Stock Option Plan and Agreement of Steven A. Lupinacci, dated June 29, 1995* 10.4 Form of Indemnification Agreement 10.5 Diedrich Coffee 1996 Stock Incentive Plan 10.6 Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan 10.7 Business Loan Agreement dated as of July 19, 1996 by and between Bank of America National Trust and Savings Association and Diedrich Coffee* 10.8 Revolving Promissory Note dated May 20, 1996 by Diedrich Coffee in favor of Redwood Enterprises VII, L.P. 10.9 Agreement of Sale by and among Diedrich Coffee (as purchaser) and Brothers Coffee Bars, Inc. and Brothers Gourmet Coffees, Inc. (as sellers) dated as of February 23, 1996 23.1 Consent of BDO Seidman, LLP re: Diedrich Coffee 23.2 Consent of BDO Seidman, LLP re: Acquired Stores of Brothers Gourmet Coffees, Inc. 23.3 Consent of Gibson, Dunn & Crutcher LLP (included in Exhibit 5.1)* 24.1 Powers of Attorney (contained on page II-5)
- --------------- * To be filed by amendment. II-3 85 (b) FINANCIAL STATEMENT SCHEDULE All schedules are omitted because they are not applicable or the required information is shown in the financial statements of the Registrant or notes thereto. ITEM 17. UNDERTAKINGS The undersigned Registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the Offering of such securities at that time shall be deemed to be the initial bona fide Offering thereof. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described in Item 14 hereof, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. II-4 86 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Amendment No. 1 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on July 24, 1996. DIEDRICH COFFEE By: /s/ STEVEN A. LUPINACCI ---------------------------------- Steven A. Lupinacci Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Steven A. Lupinacci and Martin R. Diedrich his true and lawful attorneys-in-fact and agents, each acting alone, with full powers of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, with full powers and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 1 to the Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
NAME TITLE DATE - ----------------------------------- ----------------------------------------- -------------- /s/ MARTIN R. DIEDRICH Chairman of the Board, Secretary and - ----------------------------------- Director of Coffee Martin R. Diedrich July 24, 1996 /s/ STEVEN A. LUPINACCI President, Chief Executive Officer, Chief - ----------------------------------- Financial Officer and Director (Principal Steven A. Lupinacci Executive Officer and Principal Financial July 24, 1996 Officer) /s/ EDWIN P. OTT Controller (Principal Accounting Officer) - ----------------------------------- Edwin P. Ott July 24, 1996 /s/ PAUL C. HEESCHEN Director - ----------------------------------- Paul C. Heeschen July 24, 1996
II-5 87 EXHIBIT INDEX
SEQUENTIALLY EXHIBIT NUMBERED NO. DESCRIPTION PAGES - ------------ -------------------------------------------------------------------- ------------- 1.1 Form of Underwriting Agreement*..................................... 2.1 Form of Agreement and Plan of Merger*............................... 3.1 Certificate of Incorporation of the Company*........................ 3.2 Bylaws of the Company*.............................................. 4.1 Purchase Agreement for Series A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee, Martin R. Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P. ............................ 4.2 Series B Preferred Stock Purchase Agreement dated as of June 29, 1995 by and among Diedrich Coffee, Martin R. Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, L.P. and Diedrich Partners I, L.P. ............................................................... 4.3 Representative's Warrant Agreement*................................. 5.1 Opinion of Gibson, Dunn & Crutcher LLP*............................. 10.1 Martin R. Diedrich Employment Agreement dated June 29, 1995......... 10.2 Steven A. Lupinacci Employment Agreement, dated June 29, 1995*...... 10.3 Stock Option Plan and Agreement of Steven A. Lupinacci, dated June 29, 1995*........................................................... 10.4 Form of Indemnification Agreement................................... 10.5 Diedrich Coffee 1996 Stock Incentive Plan........................... 10.6 Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan....... 10.7 Business Loan Agreement dated as of July 19, 1996 by and between Bank of America National Trust and Savings Association and Diedrich Coffee*............................................................. 10.8 Revolving Promissory Note dated May 20, 1996 by Diedrich Coffee in favor of Redwood Enterprises VII, L.P. ............................. 10.9 Agreement of Sale by and among Diedrich Coffee (as purchaser) and Brothers Coffee Bars, Inc. and Brothers Gourmet Coffees, Inc. (as sellers) dated as of February 23, 1996.............................. 23.1 Consent of BDO Seidman, LLP re: Diedrich Coffee..................... 23.2 Consent of BDO Seidman, LLP re: Acquired Stores of Brothers Gourmet Coffees, Inc. ...................................................... 23.3 Consent of Gibson, Dunn & Crutcher LLP (included in Exhibit 5.1)*... 24.1 Powers of Attorney (contained on page II-5).........................
- --------------- * To be filed by amendment. EX-4.1 2 PURCHASE AGREEMENT FOR SERIES A PREFERRED STOCK 1 EXHIBIT 4.1 PURCHASE AGREEMENT This Purchase Agreement (the "Agreement") is made and entered into as of the 11th day of December, 1992, by and among Diedrich Coffee, a California corporation (the "Company"), Martin R. Diedrich, Donald M. Holly and SNV Enterprises, a California corporation (the "Shareholders"), and D.C.H., L.P., a California limited partnership (the "Purchaser"). In consideration of the mutual covenants and agreements hereinafter set forth, the parties to this Agreement agree as follows: 1. Sale and Purchase of the Series A Preferred Stock. Subject to the terms and conditions set forth in this Agreement, the Company hereby agrees to sell and issue at the Closing to the Purchaser, and the Purchaser hereby agrees to purchase at the Closing from the Company, for one dollar ($1.00) per share, one million (1,000,000) shares of the Company's Series A Preferred Stock (the "Series A Preferred Stock"). The Series A Preferred Stock has the rights, preferences, privileges and restrictions set forth in the Restated Articles of Incorporation attached hereto as Exhibit 1, which has been filed with the California Secretary of State. The Company acknowledges receipt of Purchaser's check for one million dollars ($1,000,000) representing the purchase price for the Series A Preferred Stock and Purchaser acknowledges receipt of the Company's stock certificate representing the Series A Preferred Stock. 2. Representations and Warranties of the Company and the Shareholders. Except as set forth in the Schedule of Exceptions attached hereto as Schedule 2, the Company and each of the Shareholders jointly and severally represent and warrant to the Purchaser that: (a) Organization and Standing; Articles and Bylaws. The Company is a corporation duly organized, validly existing under and by virtue of the laws of the State of California and is in good standing under such laws. (b) Authorization. This Agreement and each of the other agreements referred to herein (the "Other Agreements") have been duly authorized, executed and delivered by the Company and the Shareholders, and constitute valid and binding obligations of the Company and the Shareholders, enforceable in accordance with their respective terms. The shares of the Series A Preferred Stock are duly authorized and, when delivered, will be duly and validly issued and outstanding, fully paid and nonassessable, and are free to the holder thereof of any liens, encumbrances or restrictions. The rights, privileges and preferences of the 2 Series A Preferred Stock are as set forth in the Restated Articles of Incorporation. The Common Stock of the Company issuable upon conversion of the Series A Preferred Stock (the "Conversion Shares") have been duly authorized and, when delivered, will be duly and validly issued and outstanding, fully paid and nonassessable and will be free to the holder thereof of any liens, encumbrances or restrictions. (c) Capital Stock. The authorized capital of the Company consists of one million (1,000,000) shares of Series A Preferred Stock, all of which are outstanding after the sale contemplated by this Agreement, and two million one hundred twenty-seven thousand six hundred sixty (2,127,660) shares of Common Stock (the "Common Stock"), of which 1,127,660 are outstanding. The Company has neither issued nor granted any option, warrant, convertible security or other right or agreement which affords any person the right to purchase or otherwise acquire any shares of the Common Stock, the Series A Preferred Stock, or any other security of the Company and the Company is not subject to any obligation (contingent or otherwise) to purchase or otherwise acquire or retire any shares of its securities except as set forth on Schedule 2(c). No person has any right of first refusal or any preemptive rights in connection with the issuance of the Series A Preferred Stock or the Conversion Shares, or with respect to any future offer, sale or issuance of securities by the Company, or its shareholders, other than as provided in this Agreement or the agreements referred to herein to be executed at or prior to the date hereof. (d) Compliance With Other Instruments. The Company is not in violation of any term of its Articles of Incorporation or Bylaws, or any agreement, mortgage, indenture, debenture, trust, instrument, judgment, decree, order, statute, rule or governmental regulation to which it is subject (the "Other Instruments"). The execution, delivery and performance of this Agreement and the Other Agreements, the issuance and sale of the Series A Preferred Stock, the issuance of the Conversion Shares, or the taking of any other action contemplated by this Agreement or the Other Agreements will not result in any violation of or be in conflict with or constitute a default (with or without notice, lapse of time or both) under any of the Other Instruments. (e) Financial Statements. Attached to this Agreement as Schedule 2(e) is (i) the year-end balance sheet of the Company at January 31, 1992, and related statements of operation and cash flows of the Company for the year then ended, accompanied by notes thereto, and (ii) the balance sheet of the Company at September 30, 1992, (the "Latest Balance Sheet") and related statements of operation and changes in financial condition of the Company for the eight-month period then ended, accompanied by notes thereto. Each of the foregoing Financial Statements (the "Financial Statements") are accompanied by a certificate signed by the Company's chief executive officer and 2 3 chief financial officer which confirms that they have reviewed the Financial Statements and that, to the best of their knowledge, such Financial Statements fairly present the financial condition and results of operations of the Company at the dates and for the periods covered thereby. The Financial Statements are in accordance with the books and records of the Company (which, in turn, are accurate and complete in all material respects), have been prepared in accordance with generally accepted accounting principles, consistently applied over the periods covered thereby, and fairly present the financial condition of the Company as of the dates thereof and the periods covered thereby. Other than liabilities which have arisen since the Latest Balance Sheet in the ordinary course of the business of the Company (none of which relates to a liability for breach of contract, breach of warranty, infringement of proprietary rights, lawsuits or similar claims), the Company has no material obligation or liability (whether accrued, contingent, unliquidated or otherwise, whether or not known to the Company, whether due or to become due) which is not reflected in the Financial Statements. (f) Absence of Changes. Since the Latest Balance Sheet: (i) the Company has not entered into any transaction which was not in the ordinary course of its business; (ii) there has been no materially adverse change in the condition (financial or otherwise), business, properties, assets, or liabilities of the Company; and (iii) to the best knowledge of the Company or the Shareholders, after due inquiry, there has been no event or condition of any character specifically relating to the Company which pertains to and materially adversely affects its businesses, properties, prospects, or condition, financial or otherwise. (g) Good and Marketable Title. The Company owns, or has a valid leasehold interest in, all assets necessary for the conduct of its business as presently conducted, in each case free and clear of all liens, claims, security interests, royalty payments, charges and encumbrances. All of such assets are reflected on the Financial Statements, except those acquired in the ordinary course of business subsequent to the Latest Balance Sheet. (h) Litigation. There are no litigation, claims, actions, proceedings or investigations pending against the Company or the Shareholders (or, to the best knowledge of the Company or the Shareholders, after due inquiry, any basis therefor or threat thereof). (i) Tax Matters. The Company (i) has timely filed all tax returns that are required to have been filed by it with all appropriate federal, state, county and local governmental agencies (and all such returns are true and correct in all material respects) and (ii) has timely paid all taxes owed 3 4 by it or which it is obligated to withhold from amounts owing to any employee (including, but not limited to, social security taxes), creditor or third party. (j) Registration Rights. Except as set forth in Section 4(g), the Company is not a party to any agreement or commitment which obligates the Company to register under the Securities Act of 1933, as amended, (the "Securities Act") any of its presently outstanding securities or any of its securities which may hereafter be issued. (k) Offering. Subject to the accuracy of the Purchasers' representations in Section 3 of this Agreement, the offer, issuance and sale of the Series A Preferred Stock and the Conversion Shares constitute, and will constitute, transactions exempt from the registration and prospectus delivery requirements of Section 5 of the Securities Act and the Company has obtained (or is exempt from the requirement to obtain) all qualifications, permits, and other consents required by all applicable state laws governing the offer, sale or issuance of securities. (l) Insurance. The Company maintains (i) adequate insurance on all assets and activities of a type customarily insured, covering property damage and loss of income by fire or other casualty, and (ii) adequate insurance protection against all liabilities (including products liability), claims and risks against which it is customary for companies similarly situated as the Company to insure. (m) Certain Transactions. The Company is not indebted, either directly or indirectly, to any of the officers, directors or shareholders of the Company, or to members of their respective immediate families, in any amount whatsoever, other than for payment of salary for services rendered and reasonable expenses; none of said officers, directors, or shareholders, or any members of their immediate families, are indebted to the Company or, to the best knowledge of the Company, after due inquiry, have any direct or indirect ownership interest in, or any contractual relationship with, any firm, corporation or other person with which the Company is or was affiliated or with which the Company has a business relationship, or any firm, corporation or other person which, directly or indirectly, competes with the Company. No such officer, director or shareholder, or any member of their immediate families, is, directly or indirectly, a party to or otherwise an interested party with respect to any contract with the Company. (n) Contracts and Commitments. Except as expressly contemplated by this Agreement, or as set forth in the Contracts Schedule attached to this Agreement as Schedule 2(n) (which is a list of all material agreements to which the Company is party or by which the Company or any of its property is bound), the Company is not presently a party to, or bound by, any written or oral contract, agreement, lease, guarantee, credit or 4 5 security instrument or employee plan or arrangement pursuant to which the Company has payment or performance obligations in excess of $10,000 in value or is entitled to receive payment or services in excess of $10,000 in value. (o) Governmental Consents. No permit, consent, approval or authorization of, or declaration to or filing with, any governmental authority is required in connection with the execution, delivery or performance of this Agreement or any of the other agreements referred to herein or the consummation of any transaction contemplated hereby or thereby, except as have been obtained or accomplished. (p) Compliance with Laws. The Company is not in violation of any law or any regulation or requirement (including, but not limited to, any law, regulation or requirement governing the quality of the environment) which might have a material adverse effect upon its business, and has not received notice of any such violation. (q) Patents, Copyrights and Trademarks. Except as set forth in the Schedule of Exceptions, the Company owns and possesses or is licensed under all patents, patent applications, licenses, trademarks, trade names, brand names, inventions and copyrights necessary for the operation of its business as now conducted and as proposed to be conducted, with no infringement of or conflict with the rights of others; the Company is not obligated or under any liability whatsoever to make any payments by way of royalties, fees or otherwise to any owner, licensor of, or other claimant to any patent, trademark, trade name, copyright or other intangible asset, with respect to the use thereof or in connection with the conduct of its business, or otherwise; and there have been no claims made against the Company for the assertion of the invalidity, abuse, misuse or unenforceability of any of its patent, trademark, copyright, trade secret or other proprietary rights and there are no grounds for the same. (r) Brokers. No finder, broker, agent, financial advisor or other intermediary has acted on behalf of the Company in connection with the offering of the Series A Preferred Stock or the negotiation or consummation of this Agreement or any of the transactions contemplated hereby. (s) Diedrich Name. Martin R. Diedrich has, to the extent to which he is personally capable, granted to the Company the exclusive right in perpetuity to use his name as part of Company's name for and in connection with all business of whatever kind and character conducted previously or in the future by Company, and has not granted and will not grant to any other person, firm or corporation the right to use, and will not himself use (except in connection with Company), his name as part of the corporate or firm name of any other firm, entity, corporation or business, or as part of any trade name or trademark not belonging to Company or any subsidiary of Company. 5 6 (t) Disclosure. Neither this Agreement nor any exhibit or schedule hereto nor any certificate, document, writing or other instrument referred to herein or furnished to the Purchaser by the Company or any employee or shareholder thereof, contains any untrue statement of any material fact or omits to state a material fact necessary in order to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading and there is no fact material to the Purchaser's decision to purchase the Series A Preferred Stock known to the Company which has not been disclosed to the Purchaser in writing by the Company. 3. Representations and Warranties of the Purchaser. The Purchaser represents and warrants to the Company that: (a) Investment Intent. The Series A Preferred Stock to be purchased by the Purchaser pursuant to this Agreement is being acquired by the Purchaser solely for its own account, for investment purposes only, and with no present intention of distributing, selling or otherwise disposing of it. (b) Sophistication. The Purchaser is able to bear the economic risk of an investment in the Series A Preferred Stock acquired by it pursuant to this Agreement, has been given sufficient access to records and information concerning the Company for purposes of evaluating such investment and can afford to sustain a total loss on such investment, and either (i) has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the proposed investment and therefore has the capacity to protect its own interests in connection with the purchase of the Series A Preferred Stock; or (ii) has a pre-existing personal or business relationship with the Company or one or more of its officers, directors or controlling persons. 4. Covenants of the Company. The Company agrees as follows, and each of the Shareholders agrees to use his or its best efforts to cause the Company to perform or observe the following agreements: (a) Financial Statements; Other Information; and Inspection Rights. (i) Financial Statements. The Company shall deliver to the Purchaser such monthly, quarterly and annual financial statements of the Company as Purchaser shall reasonably request. Such Financial Statements shall be in reasonable detail and shall be accompanied by a certificate of the Chief Financial Officer of the Company to the effect that such Financial Statements have been prepared from the books and records of the Company and in accordance with generally accepted accounting principles consistently applied, and that such Financial Statements are true and correct in all material respects. Upon the written request of holders of at least 66-2/3% of the 6 7 outstanding Series A Preferred Stock, the Company's annual financial statements shall be audited by a firm of independent certified public accountants approved by such holders. (ii) Other Information. The Company shall deliver to the Purchaser, promptly after the occurrence thereof, written notice and a description of any default or other event which might have a materially adverse impact upon the Company, its financial condition, results of operations, prospects or business. (iii) Annual Operating Plan. (A) The Company has prepared and delivered to the Purchaser a Business Plan dated __________, 1992 (the "Business Plan"), including a cash flow budget (the "Budget") and other financial information and projections. The Company agrees to conduct its business in conformity with the Business Plan. Prior to each January 1, the Company shall prepare an operating plan, including a budget, for each succeeding thirty-six month period commencing each subsequent February 1, which shall meet the approval of a majority of the members of the Company's Board of Directors and which shall be in at least as much detail as the Business Plan and Budget. The Company agrees to conduct its business in conformity with said operating plan. The Company shall furnish to the Purchaser (in person or by first-class mail) a copy of such operating plan at least 45 days prior to the commencement of the period covered by such operating plan. (iv) Inspection Rights. The Company shall permit any representative designated by the Purchaser, at Purchaser's expense, to visit and inspect any of the properties of the Company or any of its subsidiaries, including its and their books of account (and to make copies thereof and to take extracts therefrom), and to discuss its and their affairs, finances and accounts with its and their officers or employees, all at such reasonable times and as often as may be reasonably requested, and with representatives of the Company's lenders; provided that such rights shall be exercised in a manner so as not to materially and adversely disrupt the ordinary course of business of the Company or any of its subsidiaries. (b) Amendment to Articles of Incorporation, By-Laws, and Certificate of Amendment. The Company shall not amend, and shall not permit any of its subsidiaries to amend, its Articles of Incorporation, Certificate of Amendment or By-Laws, in any manner whatsoever without the prior written consent of the Purchaser. (c) Proprietary Information Agreements. The Company shall require, as a condition to employment with the Company, or continued employment with the Company, that each of its managers and all employees having access to the Company's 7 8 proprietary information, and each of the managers or employees having access to proprietary information of each of its subsidiaries, enter into Proprietary Information Agreements in form and substance identical to Exhibit 4(c) to this Agreement. (d) Shareholder Agreement. Concurrently with the execution and delivery of this Agreement, the Company and the Shareholders have executed and delivered a Shareholder Agreement (the "Shareholder Agreement"), substantially in the form attached hereto as Exhibit 4(d), covering certain voting agreements and rights of first refusal with respect to the Company's Common Stock owned by the Shareholders. The Company shall enforce each and every one of its obligations under the Shareholder Agreement and shall not, without the consent of the holders of at least 66-2/3% of the Series A Preferred Stock, amend, modify or waive any of its rights thereunder. (e) Right of First Refusal. (i) If the Company determines to issue any additional shares of its capital stock, or warrants, options, rights or other securities convertible into its capital stock, (collectively the "Equity Securities") from and after the date of this Agreement, the Company shall first give the Purchaser the right to purchase such Equity Securities by delivering to it a written offer which shall state the price and other terms and conditions of the proposed issuance. If the Company proposes to issue the Equity Securities for consideration other than solely cash and/or promissory notes, the offer to the Purchaser shall, to the extent of such consideration, permit the Purchaser to pay in lieu thereof, cash equal to the fair market value of such consideration, and the offer shall state the Company's estimate of such fair market value. The Board of Directors shall fix the period of the offer which shall be a minimum of 30 days or such longer period as is necessary to determine the fair market value of the consideration referred to in the preceding sentence. The Purchaser shall have the right to assign any of the rights the Purchaser may have to purchase Equity Securities under this Section 4(e) to any person affiliated with such holder. (ii) The Purchaser may accept an offer only by giving written notice to the Company before the offer expires that the Purchaser has accepted the offer to purchase some or all of the securities offered (the "Accepted Securities"). Within 10 days following receipt of such notice, the Purchaser shall deliver to the Company payment in full for the Accepted Securities purchased by it against delivery by the Company to the Purchaser of a certificate or certificates evidencing the Accepted Securities purchased by it. To the extent the offer is not subscribed in full by the Purchaser, the Company may, for a period of 90 days thereafter, issue and sell the unaccepted securities, or any of 8 9 them, at the same price, and upon the other terms and conditions specified in such offer, to any person or persons. (iii) Notwithstanding the provisions of this Section 4(e), the Company shall not be required to first offer the Equity Securities to the Purchaser if the issuance is pursuant to the conversion of any shares of the Series A Preferred Stock. (f) Termination of Certain Company Agreements. The provisions of Sections 4(a) through 4(e) above shall terminate upon the consummation of a Qualified Public Offering, which means a firmly underwritten public offering of the Company's Common Stock registered under the Securities Act of 1933, as amended (the "Act") and involving net proceeds to the Company of at least $5,000,000 and a price to the public of at least $5.00 per share. (g) Registration Rights. (i) Required Registration. The Company agrees that, at any time after the earlier to occur of January 1, 1998 or the effective date of a Qualified Public Offering, it shall register under the Act and take all necessary steps to facilitate the public sale (the "Public Offering"), at the Company's sole cost and expense, of all or any portion of the Conversion Shares designated in writing for such sale by the Purchaser, provided that the Company shall not be required to undertake and complete (A) more than three such registrations or (B) prior to a Qualified Public Offering, any such registration, unless an underwriter of national or regional reputation shall have agreed to serve as an underwriter for purposes of such registration. If the Purchaser is precluded from including any Conversion Shares in any Public Offering as a result of the request or decision of the underwriters involved therein, such Public Offering shall not count against the three Public Offerings limit available to the Purchaser. (ii) Incidental Registration. If the Company at any time proposes to register any of its securities for sale for its own account or for the account of any other person, it shall each such time give written notice (the "Company's Notice"), at its expense, to the Purchaser of its intention to do so at least 45 days prior to the filing of a registration statement with respect to such registration with the Commission. If the Purchaser desires to dispose of all or part of its Conversion Shares, it may request registration thereof in connection with the Company's registration by delivering to the Company, within 30 days after receipt of the Company's Notice, written notice of such request (the "Investors' Notice"). The Company shall use its best efforts to cause all shares of Conversion Shares specified in the Investors' Notice to be registered under the Securities Act so as to permit the sale or other disposition by the Purchaser. 9 10 (iii) Indemnification. In connection with any Public Offering, the Company agrees to indemnify the Purchaser to the same extent as the Company indemnifies any underwriter participating therein (or as the Purchaser shall reasonably request in the absence of underwriter participation therein). (h) Rule 144 Compliance. At all times after completion of a Qualified Public Offering, the Company agrees to take such action as may be necessary to enable the Purchaser to complete the public sale of Conversion Shares in accordance with Rule 144 of the Securities and Exchange Commission under the Act. (i) Key Man Life Insurance. The Company shall obtain and keep in effect term life insurance in the amount of one million dollars ($1,000,000) on the life of Martin R. Diedrich with the proceeds payable to the Company. (j) Actions Requiring Notice and Approval. (i) Anything in this Agreement to the contrary notwithstanding, the following actions may be taken by the Company only with prior notice to and approval of the Purchaser, as provided in Section 4(j)(iii) hereof: (A) the filing on behalf of the Company of an application for bankruptcy or similar relief; (B) any confession of a judgment against the Company; (C) any purchase of equity securities or instruments representing indebtedness of any Person; (D) any amendment of this Agreement; (E) the appointment, employment, removal and compensation of, and approval of any employment contracts with, the Chief Executive Officer of the Company, any other officers of the Company and the Shareholders; and (ii) In addition to the other requirements of this Section 4(j), the Purchaser may demand at any time that the following actions be taken by the Company only with prior notice to and approval of the Purchaser, as provided in Section 4(j)(iii) hereof: (A) the incurrence of any obligation in a principal amount of more than $20,000 at any time outstanding. 10 11 Such obligation may include, but is not limited to, any contract (or series of related contracts), lease or form of indebtedness; and (B) any expenditure (or series of related expenditures) involving more than $20,000; (iii) In the event that the Company determines to take any of the actions specified in Section 4(j)(i) (or Section 4(j)(ii) if the Purchaser has made a demand as provided for therein), the following procedures shall be applicable: (A) The Company shall deliver to Purchaser written notice of the proposed action (the "Company Notice"), specifying the dollar amount and terms and conditions of the proposed action. (B) If Purchaser disapproves of such action, it shall do so by delivering a written notice signed by Purchaser (the "Disapproval Notice"). The Disapproval Notice must be delivered to the Company within 10 business days from the receipt by Purchaser of the Company Notice. Receipt of the Disapproval Notice by the Company shall prohibit the Company from undertaking the action specified in the Company Notice. (C) If the Purchaser does not tender a Disapproval Notice within the 10 business day period, the Company shall be entitled to undertake the action specified in the Company Notice after the end of the 10 business day period, but only upon terms and conditions which are in all material respects (including, without limitation, price and interest rates) identical to those set forth in the Company Notice; provided, that if the Company does not undertake the action specified in the Company Notice within 30 days following the expiration of the 10 business day period, any approval theretofore extended pursuant to this section shall be deemed rescinded and any subsequent actions shall again be subject to all of the restrictions set forth herein. (iv) The Purchaser may, by prior written consent, waive its rights under this Section 4(j), provided that, unless otherwise specifically agreed to by the Purchaser in writing, such waivers shall be on a case-by-case basis and shall be limited to the corporate acts specified therein. 11 12 (k) Chief Executive Officer. (i) The Chief Executive Officer shall be the chief executive officer of the Company and, subject to the control of the Board, shall have general and active supervision and management over the business of the Company and over its officers and employees. The Chief Executive Officer shall be Steven Lupinacci, who shall receive restricted stock pursuant to the terms and conditions of a restricted stock agreement in the form attached as Exhibit 4(k) hereto. (ii) The Chief Executive Officer shall be appointed only with the approval of Purchaser and may be removed, with or without cause, only with Purchaser's approval. In addition, Purchaser shall have the right independently, in Purchaser's sole discretion, to require the removal of the Chief Executive Officer. 5. Restrictions on Transfer. None of the shares of the Series A Preferred Stock purchased hereunder or the Conversion Shares shall be sold, transferred, assigned, pledged, hypothecated or otherwise disposed of unless and until one of the following events shall have occurred: (a) Such securities are disposed of pursuant to and in conformity with an effective registration statement filed with the Commission pursuant to the Securities Act or pursuant to Rule 144 of the Securities and Exchange Commission (the "Commission") thereunder; or (b) The seller shall have delivered to the Company a written opinion by counsel which is reasonably acceptable to the Company to the effect that the proposed transfer is exempt from the registration and prospectus delivery requirements of the Securities Act; or (c) The seller shall have transferred such securities to an affiliate of the seller and such affiliate has delivered to the Company a written agreement making the representations set forth in Sections 3(a) and 3(b) and agreeing to be bound by the restrictions of this Section 5 with respect to the shares so transferred. For purposes of this Agreement, the definition of "Purchaser" as used herein shall be deemed to include any such affiliate of Purchaser. The parties hereto further agree that any certificate evidencing the Series A Preferred Stock or the Conversion Shares shall bear the following legend: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, HAVE BEEN 12 13 TAKEN FOR INVESTMENT, AND MAY NOT BE SOLD, TRANSFERRED, ASSIGNED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF EXCEPT IN ACCORDANCE WITH THE TERMS OF AN AGREEMENT BETWEEN THE COMPANY AND THE REGISTERED HOLDER HEREOF, A COPY OF WHICH AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICES OF THE COMPANY. The Company shall, within 10 days of the request of any holder of a certificate bearing the foregoing legend and the surrender of such certificate, issue a new stock certificate without the foregoing legend if any of the events set forth in Sections 5(a) or (b) above have occurred. 6. The Closing. The closing of the transactions contemplated by this Agreement (the "Closing") shall take place on December 11, 1992, at the offices of Gibson, Dunn & Crutcher, 4 Park Plaza, Irvine, California, or at such other place and at such time and date as Purchaser, Company and Shareholders shall mutually agree. 7. Conditions to Obligations of Purchaser. The obligations of Purchaser to purchase the Series A Preferred Stock at the Closing and the other obligations of Purchaser under this Agreement are subject to the fulfillment at or prior to the Closing of the following conditions, any of which may be waived in writing in whole or in part by Purchaser: (a) Representations and Warranties. On the date of the Closing, the representations and warranties of Company and Shareholders set forth in this Agreement shall be true and correct in all respects with the same effect as though such representations and warranties had been made at and as of such time, except to the extent that any changes therein are specifically contemplated by this Agreement. (b) Performance. The Company and Shareholders shall have performed and complied in all respects with all agreements and conditions contained herein required to be performed or complied with by them prior to or at the Closing. (c) Absence of Litigation. No suit, action, proceeding or investigation shall have occurred, be pending or threatened which would or seeks to prevent or delay beyond the date of the Closing the consummation of the transactions contemplated by this Agreement. (d) Opinion of Counsel to Company and Shareholders. Purchaser shall have received from Voss, Cook, Casselberry & Thel, counsel for Company and Shareholders, a written opinion, substantially identical in form and substance to that attached hereto as Exhibit 7(d). (e) Contemporaneous Transactions. Prior to or contemporaneously with the Closing, the Company and Shareholders 13 14 shall have executed and delivered to Purchaser the Other Agreements contemplated by this Agreement. (f) Closing Papers. Company and Shareholders shall have delivered to Purchaser all of the following: (A) a certificate signed by the Chairman of the Board and President of Company, dated the date of the Closing, stating that (i) the persons signing such certificate have made or have caused to be made such investigations as are necessary to permit them to certify the accuracy of the information set forth therein, (ii) such certificate does not misstate any material fact and does not omit to state any fact necessary to make the certificate not misleading and (iii) the conditions specified in Sections 7(a), 7(b), 7(c), 7(d) and 7(e) of this Agreement have been satisfied; (B) copies (certified by the President, Secretary or Assistant Secretary of the Company) of the resolutions duly adopted by the board of directors and shareholders of Company authorizing, as appropriate, the execution, delivery and performance of this Agreement and the Other Agreements referred to in this Agreement as being executed at or prior to the Closing; (C) copies (certified by the President, Secretary or Assistant Secretary of the Company) of the Company's Articles of Incorporation and Bylaws as amended through the date of the Closing; (D) a certified copy of the Restated Articles of Incorporation (identical in form to Exhibit 1 attached hereto) as filed with the California Secretary of State; and (E) such other documents relating to the transactions contemplated by this Agreement as Purchaser may reasonably request. (g) Proceedings. All corporate and other proceedings taken or to be taken by the Company in connection with the transactions contemplated hereby to be consummated at the Closing and all documents incident thereto shall be reasonably satisfactory in form and substance to Purchaser. 8. Conditions to Obligations of Company and Shareholders. The obligations of Company and Shareholders under this Agreement are subject to the fulfillment at or prior to the date of the Closing of the following conditions, any of which may be waived in writing, in whole or in part, by Company and Shareholders: (a) Representations and Warranties. On the date of the Closing, the representations and warranties of Purchaser 14 15 set forth in this Agreement shall be true and correct in all respects with the same effect as though such representations and warranties were made at and as of such time, except to the extent that any changes therein are contemplated by this Agreement. (b) Performance. Purchaser shall have performed and complied in all respects with all agreements and conditions contained herein required to be performed by or complied with by it prior to the Closing. (c) Contemporaneous Transaction. Prior to or contemporaneously with the Closing, the Purchaser shall have executed and delivered to the Company and Shareholders the Other Agreements contemplated by this Agreement. 9. Miscellaneous Provisions. (a) Notices. All notices, demands or other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered in person, or by United States mail, certified or registered, with return receipt requested, or otherwise actually delivered: If to the Purchaser: D.C.H., L.P. 450 Newport Center Drive, Suite 570 Newport Beach, CA 92660 With Copies to: E. Michael Greaney, Esq. Gibson, Dunn & Crutcher 4 Park Plaza Irvine, CA 92714 If to the Company: Diedrich Coffee 474 E. 17th Street Costa Mesa, CA 92627 If to Shareholders: Martin R. Diedrich 474 E. 17th Street Costa Mesa, CA 92627 Donald M. Holly 474 E. 17th Street Costa Mesa, CA 92627 SNV Enterprises 474 E. 17th Street Costa Mesa, CA 92627 With Copies to: Raymond Lee Voss, Cook, Casselberry & Thel 840 Newport Center Drive, Suite 700 Newport Beach, CA 92660 15 16 or at such other address as may have been furnished by such person in writing to the other parties. Any such notice, demand or other communication shall be deemed to have been given on the date actually delivered or as of the date mailed, as the case may be. (b) Severability and Governing Law. Should any Section or any part of a Section within this Agreement be rendered void, invalid or unenforceable by any court of law for any reason, such invalidity or unenforceability shall not void or render invalid or unenforceable any other Section or part of a Section in this Agreement. This Agreement is made and entered into in the State of California and the laws of said state shall govern the validity and interpretation hereof and the performance by the parties hereto of their respective duties and obligations hereunder. (c) Amendments and Waivers. The provisions of this Agreement may not be changed, waived, discharged or terminated orally or in writing, except with (but only with) the written consent of the Company and the holders of at least 66-2/3% of the Series A Preferred Stock then outstanding; provided, however, that no such amendment or waiver shall affect the provisions of this Section 9(c) and no such waiver shall extend to or affect any obligation not expressly waived or impair any right consequent therein. (d) Survival of Representations and Warranties, Etc. All agreements, representations and warranties contained herein shall survive the execution and delivery of this Agreement, any investigation at any time made, the sale and purchase of the Series A Preferred Stock and payment therefor, the conversion or redemption of the Series A Preferred Stock as provided for in the Restated Articles of Incorporation, and, as to the Purchaser as defined herein, any disposition of the Series A Preferred Stock or the Conversion Shares. All statements contained in any certificate or other instrument executed and delivered by the Company or its duly authorized officers pursuant to this Agreement in connection with the transactions contemplated hereby shall constitute additional representations and warranties by the Company hereunder. (e) Expenses. The Company agrees to pay, and save any Purchaser (or any subsequent holder of Series A Preferred Stock or Conversion Shares) harmless against liability for the payment of, (i) the fees and expenses of the Purchasers' special counsel, Messrs. Gibson, Dunn & Crutcher, arising in connection with the negotiation, execution and consummation of the transactions contemplated by this Agreement, (ii) reasonable fees and expenses of counsel incurred with respect to any amendments or waivers (whether or not they become effective) under or in respect of the Articles of Incorporation, Bylaws, Certificate of Amendment, or this Agreement or any of the Other Agreements, and (iii) in the event of breach or default of the 16 17 Company's obligations to the Purchaser under the Articles of Incorporation, the Bylaws, Certificate of Amendment, or this Agreement or any agreement contemplated hereby, fees and expenses of the Purchasers or such holders incurred in respect of the enforcement of the rights granted under any of the foregoing whether or not suit is brought. (f) Exercise of Contractual Rights. Each of the Company and the Shareholders recognize, acknowledge and agree that the Purchaser has a major financial interest in the Company to preserve and that the exercise by Purchaser of any of its contractual rights under this Agreement or any of the Other Agreements contemplated hereby shall not be deemed to constitute a lack of good faith or unfair dealing. (g) Entire Agreement. This Agreement and the attached Schedules and Exhibits contain the entire understanding of the parties and there are no further or other agreements or understandings, written or oral, in effect between the parties relating to the subject matter hereof unless expressly referred to herein. IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the date first above written. "SHAREHOLDERS" "COMPANY" MARTIN R. DIEDRICH DIEDRICH COFFEE - ------------------------- -------------------------------- Martin R. Diedrich By: ---------------------------- Name: -------------------------- Title: ------------------------- DONALD M. HOLLY - ------------------------- Donald M. Holly By: --------------------------- Name: -------------------------- Title: ------------------------- SNV ENTERPRISES "PURCHASER" By: D.C.H., L.P. --------------------- Steven Lupinacci President -------------------------------- By: ---------------------------- Name: -------------------------- Title: -------------------------
17 EX-4.2 3 PURCHASE AGREEMENT FOR SERIES B PREFERRED STOCK 1 EXHIBIT 4.2 SERIES B PREFERRED STOCK PURCHASE AGREEMENT ------------------ This Series B Preferred Stock Purchase Agreement (the "Agreement") is made and entered into as of the 29th day of June, 1995, by and among Diedrich Coffee, a California corporation (the "Company"), Martin R. Diedrich ("Diedrich") and Steven A. Lupinacci ("Lupinacci"), (Diedrich and Lupinacci are collectively referred to herein as the "Management Shareholders"), and Redwood Enterprises VII, L.P., a California limited partnership ("Redwood") and Diedrich Partners I, L.P., a Delaware limited partnership ("DPL") (Redwood and DPL are collectively referred to herein as the "Purchasers"). In consideration of the mutual covenants and agreements hereinafter set forth, the parties to this Agreement agree as follows: 1. Sale and Purchase of the Series B Preferred Stock. Subject to the terms and conditions set forth in this Agreement, the Company agrees to sell and issue at the Closing to each of the Purchasers, and each of the Purchasers severally and not jointly agrees to purchase at the Closing from the Company, 804,284 shares of the Company's Series B Preferred Stock (the "Series B Preferred Stock") in exchange for the payment of an aggregate purchase price of one million one hundred fifty-two thousand five hundred dollars ($1,152,500), resulting in a total purchase by the Purchasers collectively of 1,608,568 shares of Series B Preferred Stock in exchange for the payment of an aggregate total purchase price of two million three hundred five thousand dollars ($2,305,000). The Series B Preferred Stock has the rights, preferences, privileges and restrictions set forth in the Amended and Restated Articles of Incorporation attached hereto as Exhibit 1, which have been filed with the California Secretary of State. 2. Representations and Warranties of the Company. Except as set forth in the Schedule of Exceptions attached hereto as Schedule 2 which exceptions specifically identify the relevant subparagraph hereof, the Company represents and warrants to the Purchasers, and each of them, that: (a) Organization and Standing. The Company is a corporation duly organized, validly existing under and by virtue of the laws of the State of California and is in good standing under such laws. The Company is qualified, licensed or domesticated as a foreign corporation in all jurisdictions where the failure to be so qualified, licensed or domesticated would have a material adverse effect upon its businesses, properties, prospects, or condition, financial or otherwise. The Company holds all franchises, grants, licenses, certificates, permits, consents and orders, all of which are valid and in full force and effect, from all state, federal and other domestic and foreign regulatory authorities necessary to own and operate its properties and to conduct its business in the manner and at the places presently conducted, except where the failure to hold such franchises, grants, licenses, certificates, permits, consents and orders would not, in the aggregate, result in a material adverse change in the condition (financial or other), business, prospects, assets, liabilities or operations of the Company taken as a whole ("Material Adverse Change"). The Company has full power and authority (corporate and other) to own, lease and operate its properties and assets and to carry on its business as presently conducted and as proposed to be conducted, except where the failure to have such power and authority would not, in the aggregate, result in a Material Adverse Change. 2 (b) Authorization. (i) The Company and the Management Shareholders have the right, power and authority (corporate and other) to enter into and carry out the terms and conditions of this Agreement and each of the other agreements referred to herein to be entered into at or prior to the Closing (the "Other Agreements") and all of the transactions contemplated hereunder and thereunder, including the sale and issuance of the Series B Preferred Stock to be purchased by the Purchasers at the Closing, without obtaining the approval or consent of any other party or governmental authority. All corporate proceedings have been taken and all corporate authorizations have been secured which are necessary to authorize the execution, delivery and performance of this Agreement and each of the Other Agreements. (ii) This Agreement and each of the Other Agreements have been duly and validly executed and delivered by the Company and the Management Shareholders and this Agreement constitutes, and each of the Other Agreements when executed and delivered by the Company and the Management Shareholders will constitute, valid and binding obligations of the Company and the Management Shareholders, enforceable in accordance with their respective terms, except that such enforceability may be limited by (A) bankruptcy, insolvency, reorganization, moratorium or other similar laws, or by equitable principles, relating to or limiting the rights of creditors generally and (B) limitations imposed by law or equitable principles upon the availability of specific performance, injunctive relief or other equitable remedies. (iii) The shares of Series B Preferred Stock to be purchased by the Purchasers at the Closing have been duly authorized and, when delivered, will be duly and validly issued and outstanding, fully paid and nonassessable, and will be free to the holder thereof of any liens, encumbrances and restrictions. The rights, privileges and preferences of the Series B Preferred Stock are as set forth in the Amended and Restated Articles of Incorporation. The Common Stock of the Company issuable upon conversion of the Series B Preferred Stock (the "Conversion Shares") have been duly authorized and, when delivered in accordance with the provisions of the Amended and Restated Articles of Incorporation, will be duly and validly issued and outstanding, fully paid and nonassessable and will be free to the holder thereof of any liens, encumbrances or restrictions. (c) Capital Stock. The authorized capital stock of the Company consists of 1,000,000 shares of Series A Preferred Stock, all of which are issued and outstanding, 1,608,568 shares of Series B Preferred Stock, all of which will be issued and outstanding immediately after the sale contemplated by this Agreement and 4,021,437 shares of Common Stock (the "Common Stock"), of which 1,412,869 shares will be issued and outstanding immediately after the consummation of the transactions contemplated in that certain Common Stock Purchase Agreement of even date herewith (the "Common Stock Agreement") by and among the Company, D.C.H., L.P., a California limited partnership ("DCH") and Lupinacci. All of the outstanding securities of the Company have been duly authorized and validly issued, are fully paid and nonassessable and were issued in compliance with all applicable state and federal laws regulating the offer, sale or issuance of securities. Except as set forth in the Amended and Restated Articles of Incorporation, that certain purchase agreement for Series A Preferred Stock between D.C.H., Diedrich, Donald M. Holly ("Holly"), SNV Enterprises, a California corporation, and the Company dated December 11, 1992 (the "Series A Purchase Agreement"), the Common Stock Agreement, this Agreement or that certain Redemption Agreement dated as of June 13, 1995 by and between the Company and Holly (the "Redemption Agreement"), the Company has neither issued nor granted any option, warrant, convertible security or other right or agreement which affords any person the right to purchase or otherwise acquire any shares of the Common Stock, the Series A 2 3 Preferred Stock, the Series B Preferred Stock or any other security of the Company and the Company is not subject to any obligation (contingent or otherwise) to purchase or otherwise acquire or retire any shares of its securities. No person has any right of first refusal or any preemptive rights in connection with the issuance of the Series B Preferred Stock or the Conversion Shares, or with respect to any future offer, sale or issuance of securities by the Company, or its shareholders, other than as provided in the Series A Purchase Agreement, the Common Stock Agreement, this Agreement or the Other Agreements to be executed at or prior to the date hereof. (d) Compliance With Other Instruments. The Company is not in violation of any term of its Amended and Restated Articles of Incorporation or Bylaws, or any agreement, mortgage, indenture, debenture, trust, instrument, judgment, decree, order, statute, rule or governmental regulation to which it is subject (the "Other Instruments"), except for such violations which would not, in the aggregate, result in a Material Adverse Change. The execution, delivery and performance of this Agreement and the Other Agreements, the issuance and sale of the Series B Preferred Stock, the issuance of the Conversion Shares, or the taking of any other action contemplated by this Agreement or the Other Agreements will not (i) result in any violation of or be in conflict with or constitute a default (with or without notice, lapse of time or both) under any of the Other Instruments, except for such violations, conflicts or defaults which would not, in the aggregate, result in a Material Adverse Change, (ii) accelerate or constitute an event entitling the holder of any indebtedness of the Company to accelerate the maturity of any such indebtedness or to increase the rate of interest presently in effect with respect to such indebtedness, or (iii) result in the creation of any mortgage, lien, charge, security interest or encumbrance upon any of the properties or assets of the Company, except for those which would not, in the aggregate, result in a Material Adverse Change. (e) Financial Statements. Attached to this Agreement as Schedule 2(e) is (i) the audited year-end balance sheet of the Company at January 31, 1995, (the "Balance Sheet Date") and related statements of operations and cash flows of the Company for the year then ended, accompanied by notes and the certificate of BDO Seidman, independent certified public accountants (the "Audited Financial Statements"), and (ii) the unaudited balance sheet of the Company at May 31, 1995 and related statements of operations, cash flows and changes in financial condition of the Company for the four-month period then ended, accompanied by notes thereto (the "Interim Financial Statements"). Each of the Audited Financial Statements and the Interim Financial Statements (collectively, the "Financial Statements") are accompanied by a certificate signed by the Company's chief executive officer and chief financial officer which confirms that they have reviewed the Financial Statements and that, such Financial Statements fairly present the financial condition and results of operations of the Company at the dates and for the periods covered thereby. The Interim Financial Statements have been prepared in accordance with the books and records of the Company (which, in turn, are accurate and complete in all material respects) and are consistent with the Audited Financial Statements. Other than liabilities which have arisen since the period covered by the Interim Financial Statements in the ordinary course of the business of the Company (none of which relates to a liability for breach of contract, breach of warranty, infringement of proprietary rights, lawsuits or similar claims), the Company has no material obligation or liability (whether accrued, contingent, unliquidated or otherwise, whether or not known to the Company, whether due or to become due) which is not reflected in the Financial Statements other than liabilities which are not required to be reflected on the Financial Statements in accordance with Generally Accepted Accounting Principles, consistently applied ("GAAP") and liabilities which individually or in the aggregate do not exceed the sum of $50,000. (f) Absence of Changes. Since the Balance Sheet Date: (i) the Company has not entered into any material transaction which was not in the ordinary course of 3 4 its business; (ii) there has been no Material Adverse Change; (iii) the Company has not declared or paid any dividend or made any distribution on its capital stock; redeemed, purchased or otherwise acquired any of its capital stock; granted any options, warrants or other rights to purchase shares of its capital stock except in connection with the transactions contemplated herein; or issued any shares of its capital stock; (iv) there has been no material labor dispute involving the Company or any of its employees and none is pending or, to the best knowledge of the Company and the Management Shareholders, after due inquiry, threatened; (v) there has been no material change, except in the ordinary course of its business, in the contingent obligations of the Company, by way of guaranty, endorsement, indemnity, warranty, or otherwise; (vi) there have been no loans or guarantees made by the Company to or for the benefit of its employees, officers or directors, or any members of their immediate families, other than travel advances and other similar advances made in the ordinary course of its business; (vii) the Company has not mortgaged, pledged, transferred a security interest in, or subjected to lien any of its properties or assets, except liens for taxes not yet due or payable; and (viii) the Company has not sold, assigned or transferred any patents, trademarks, copyrights, trade secrets or other intangible assets, or disclosed any proprietary confidential information to any person. (g) Good and Marketable Title. The Company has good and marketable title to, or a valid leasehold interest in, all properties and assets used by it, or located on its premises, or shown on the Financial Statements or acquired by the Company thereafter, in each case free and clear of all liens, claims, security interests, royalty payments, charges and encumbrances. All of such assets are reflected on the Financial Statements, except those acquired in the ordinary course of business subsequent to the period covered by the Interim Financial Statements. The Company's buildings, equipment and other tangible assets are in all material respects in good operating condition and are usable in the ordinary course of its business; and the Company owns, or has a valid leasehold interest in, all assets necessary for the conduct of its business as presently conducted. (h) Litigation. There are no litigation, claims, actions, proceedings or investigations (collectively, "Claims") pending against the Company or the Management Shareholders (or, to the best knowledge of the Company and the Management Shareholders, after due inquiry, any basis therefor or threat thereof), except for Claims which, if adversely determined, would not, individually or in the aggregate, result in a Material Adverse Change. (i) Tax Matters. The Company (i) has timely filed all tax returns that are required to have been filed by it with all appropriate federal, state, county and local governmental agencies (and all such returns are true and correct in all material respects); (ii) has timely paid when due all taxes owed by it or which it is obligated to withhold from amounts owing to any employee (including, but not limited to, social security taxes), creditor or third party; and (iii) has not waived any statute of limitations with respect to taxes or agreed to any extension of time with respect to a tax assessment or deficiency. The assessment of any additional taxes for periods for which returns have been filed is not expected to exceed the recorded liability therefor, and there are no material unresolved questions or claims concerning the Company's tax liability. There is no pending dispute with any taxing authority relating to any of said returns which if determined adversely to the Company would result in the assertion by any taxing authority of any valid deficiency in a material amount for taxes, and the Company and the Management Shareholders do not, after due inquiry, have any knowledge of any proposed liability for any such deficiency. (j) Registration Rights. Except as set forth in this Agreement or the Series A Purchase Agreement, the Company is not a party to any agreement or commitment which obligates the Company to register under the Securities Act of 1933, as amended, (the 4 5 "Securities Act") any of its presently outstanding securities or any of its securities which may hereafter be issued. (k) Offering. Subject to the accuracy of the Purchasers' representations in Section 3 of this Agreement, the offer, issuance and sale of the Series B Preferred Stock and the Conversion Shares constitute, and will constitute, transactions exempt from the registration and prospectus delivery requirements of Section 5 of the Securities Act and the Company has obtained (or is exempt from the requirement to obtain) all qualifications, permits, and other consents required by all applicable state laws governing the offer, sale or issuance of securities. (l) Insurance. The Company maintains to the extent and in a manner customary for the industry in which the Company is engaged (i) insurance on all assets and activities of a type customarily insured, covering property damage and loss of income by fire or other casualty, and (ii) insurance protection against all liabilities (including products liability), claims and risks against which it is customary for companies similarly situated as the Company to insure. (m) Certain Transactions. Except as disclosed in the Audited Financial Statements, the Company is not indebted, either directly or indirectly, to any of the officers, directors or shareholders of the Company, or to members of their respective immediate families, in any amount whatsoever, other than for payment of salary for services rendered and reasonable expenses; none of said officers, directors, or shareholders, or any members of their immediate families, are indebted to the Company or, to the best knowledge of the Company and the Management Shareholders, after due inquiry, have any direct or indirect ownership interest in, or any contractual relationship with, any firm, corporation or other person with which the Company is or was affiliated or with which the Company has a business relationship, or any firm, corporation or other person which, directly or indirectly, competes with the Company. No such officer, director or shareholder, or any member of their immediate families, is, directly or indirectly, a party to or otherwise an interested party with respect to any contract with the Company. (n) Contracts and Commitments. Except as expressly contemplated by this Agreement, or as set forth in the Contracts Schedule attached to this Agreement as Schedule 2(n) (which is a list of all material agreements to which the Company is party or by which the Company or any of its property is bound), the Company is not presently a party to, or bound by, any written or oral contract, agreement, lease, guarantee, credit or security instrument or employee plan or arrangement (i) with any employee, director or shareholder of the Company or (ii) pursuant to which the Company has payment or performance obligations in excess of $60,000 in value or is entitled to receive payment or services in excess of $60,000 in value. (o) Governmental Consents. No permit, consent, approval or authorization of, or declaration to or filing with, any governmental authority is required in connection with the execution, delivery or performance of this Agreement or any of the Other Agreements or the consummation of any transaction contemplated hereby or thereby, except as have been obtained or accomplished. (p) Compliance with Laws. The Company is not in violation of any law or any regulation or requirement (including, but not limited to, any law, regulation or requirement governing the quality of the environment) which might result in a Material Adverse Change, and has not received notice of any such violation. 5 6 (q) Patents, Copyrights and Trademarks. The Company owns and possesses or is licensed under all patents, patent applications, licenses, trademarks, trade names, brand names, inventions and copyrights necessary for the operation of its business as now conducted and as proposed to be conducted, with no infringement of or conflict with the rights of others, except such infringements or conflicts which would not in the aggregate result in a Material Adverse Change; except as disclosed in the Audited Financial Statements, the Company is not obligated or under any liability whatsoever to make any payments by way of royalties, fees or otherwise to any owner, licensor of, or other claimant to any patent, trademark, trade name, copyright or other intangible asset, with respect to the use thereof or in connection with the conduct of its business, or otherwise; and there have been no claims made against the Company for the assertion of the invalidity, abuse, misuse or unenforceability of any of its patent, trademark, copyright, trade secret or other proprietary rights and to the best knowledge of the Company and the Management Shareholders, there are no grounds for the same. (r) Brokers. No finder, broker, agent, financial advisor or other intermediary has acted on behalf of the Company in connection with the offering of the Series B Preferred Stock or the negotiation or consummation of this Agreement or any of the transactions contemplated hereby. (s) Subsidiaries. The Company has no subsidiaries and does not control, directly or indirectly, any other corporation, association, partnership or other business entity or own any shares of capital stock or other securities of any other person. (t) Employees and Labor. Neither the Company nor the Management Shareholders, after due inquiry, are aware that any officer, director, executive or key employee of the Company or any group of employees of the Company has any plans to terminate his, her or its employment with the Company. The Company has complied in all material respects with all laws relating to the employment of labor, including provisions thereof relating to wages, hours, equal opportunity and collective bargaining. The Company does not have any material labor relations problems. The Company is not, and has not been, subject to any pension, profit sharing or other similar plan which is subject to the Employee Retirement Income Security Act of 1974, as amended. (u) Disclosure. Neither this Agreement nor any exhibit or schedule hereto nor any certificate or other instrument delivered hereunder to the Purchasers by the Company or the Management Shareholders, contains any untrue statement of any material fact or omits to state a material fact necessary in order to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading and there is no fact that would be material to the Purchasers' decision to purchase the Series B Preferred Stock known to the Company or the Management Shareholders which has not been disclosed to the Purchasers in writing by the Company or the Management Shareholders. 3. Representations and Warranties of the Purchasers. Each Purchaser, severally and not jointly, represents and warrants to the Company that: (a) Investment Intent. The shares of Series B Preferred Stock to be purchased by such Purchaser pursuant to this Agreement (the "Shares") are being acquired by such Purchaser solely for its own account, for investment purposes only, and not with a view to the distribution of such shares within the meaning of the Securities Act of 1933, as amended (the "Securities Act"). Such Purchaser acknowledges that the sale of the Shares to it is not being registered under the Securities Act or qualified under any applicable state securities laws. 6 7 (b) Sophistication. Such Purchaser is able to bear the economic risk of an investment in the Shares and is able to bear the risk of losing part or all of such Purchaser's investment in the Shares, and the inability to sell or transfer the Shares for an indefinite period of time or at a price which would enable such Purchaser to recoup its investment in the Shares, and either (i) has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the proposed investment and therefore has the capacity to protect its own interests in connection with the purchase of the Shares; or (ii) has a pre-existing personal or business relationship with the Company or one or more of its officers, directors or controlling persons. SUCH PURCHASER UNDERSTANDS THAT NO PUBLIC MARKET NOW EXISTS FOR THE SHARES. (c) Shares not Registered. Such Purchaser has been advised that the Shares have not been registered under the Securities Act or under the securities laws of any state, and that the Shares must be held until the Shares are registered under the Securities Act and applicable state securities law or an exemption from such registration is available. (d) Restricted Securities. Such Purchaser has been advised that the Shares are deemed "restricted securities" as that term is defined in Rule 144 promulgated under the Securities Act; that the exemption from registration under Rule 144 will not be available in any event for at least two years from the date of issuance, and even then will not be available unless (i) a public trading market then exists for such Shares (ii) adequate information concerning the Company is then available to the public, and (iii) other terms and conditions of Rule 144 are complied with; and that any sale of the Shares may be made by such Purchaser only in accordance with such terms and conditions. (e) Information Regarding the Company. Such Purchaser has received such information as it deems necessary in order to understand the nature and scope of the properties and business owned and operated by the Company, has been provided with the opportunity to obtain any additional information deemed necessary by such Purchaser and has been advised by the Company that such Purchaser may ask, and the Company will answer to the best of its knowledge, any questions from such Purchaser or from any person acting on behalf of such Purchaser, concerning the Company. Based on such information, and the representations and warranties contained herein, such Purchaser acknowledges that it has acquired sufficient information about the Company to reach an informed and knowledgeable decision to acquire the Shares. (f) Accredited Investor. Such Purchaser is an "accredited investor" within the meaning of Rule 501(a) of Regulation D promulgated under the Securities Act and an "excluded purchaser" as defined in Section 260.102.13 of Title 10 of the California Code of Regulations. 4. Covenants of the Company. The Company agrees as follows, and each of the other parties to this Agreement agrees to use his or its best efforts to cause the Company to perform or observe the following agreements: (a) Financial Statements, Other Information and Inspection Rights. (i) Financial Statements. The Company shall deliver to the Purchasers and Diedrich such monthly, quarterly and annual financial statements of the Company as the Purchasers and Diedrich shall reasonably request. Such financial statements shall be in reasonable detail and shall be accompanied by a certificate of the Chief Financial Officer of the Company to the effect that such financial statements have been prepared from the books and records of the Company and in accordance with generally accepted accounting principles consistently applied, and that such financial statements fairly present the financial 7 8 condition and results of operations of the Company at the dates and for the periods covered thereby. Upon the written request of holders of at least 66-2/3% of the outstanding Series A Preferred Stock and Series B Preferred Stock, the Company's annual financial statements shall be audited by a firm of independent certified public accountants approved by such holders. (ii) Other Information. The Company shall deliver to the Purchasers and Diedrich, promptly after the occurrence thereof, written notice and a description of any default or other event which, in the reasonable judgment of the Company, might have a materially adverse impact upon the Company, its financial condition, results of operations, prospects or business. (iii) Annual Operating Plan. The Company shall prepare an operating plan, including a budget, for each thirty-six month period commencing each February 1, which shall be approved by a majority of the members of the Company's Board of Directors. The Company agrees to conduct its business in conformity with said operating plan. The Company shall furnish to the Purchasers and Diedrich (in person or by first-class mail) a copy of such operating plan at least 45 days prior to the commencement of the period covered by such operating plan. (iv) Inspection Rights. The Company shall permit any representative designated by the Purchasers or Diedrich, at Purchasers' or Diedrich's, as applicable, expense, to visit and inspect any of the properties of the Company or any of its subsidiaries, including its and their books of account (and to make copies thereof and to take extracts therefrom), and to discuss its and their affairs, finances and accounts with its and their officers or employees, all at such reasonable times and as often as may be reasonably requested, and with representatives of the Company's lenders; provided that such rights shall be exercised in a manner so as not to materially and adversely disrupt the ordinary course of business of the Company or any of its subsidiaries. (v) Termination of Diedrich's Rights. The rights provided to Diedrich pursuant to this Section 4(a) shall terminate (but only with respect to Diedrich) in the event that he is no longer an officer of the Company and he is carrying on any business directly or indirectly competitive with the business of the Company (or any subsidiary or affiliate thereof) as previously or currently conducted or as currently proposed to be conducted. Each of the following categories of activity shall, without limitation, be deemed to constitute carrying on business within the meaning of this paragraph: to engage in, work for or with, have an interest or concern in, advise, lend money to, guarantee the debts or obligations of, or permit one's name or any part thereof to be used in connection with, an enterprise or endeavor, either individually, in partnership, or in conjunction with any person or persons, firm, association, company or corporation, whether as a principal, agent, shareholder, partner, employee, consultant, independent contractor or in any other manner whatsoever; provided, however, that nothing herein shall prohibit Diedrich from owning less than five percent (5%) of the capital stock of a corporation the common stock of which is publicly traded on a national securities exchange or through NASDAQ. Without limiting the foregoing, involvement in the production, roasting, pricing, marketing or sale of coffee or coffee-related products shall be deemed to be competitive with the business of the Company (or any subsidiary or affiliate thereof) within the meaning of this paragraph. (b) Amendment to Amended and Restated Articles of Incorporation and By-Laws. The Company shall not amend, and shall not permit any of its subsidiaries to amend, its Amended and Restated Articles of Incorporation or By-Laws, in any manner whatsoever except in accordance with the provisions of the Amended and Restated Articles of Incorporation and Bylaws. Notwithstanding the foregoing, the Company shall not amend Sections 1(a), 1(d), 2(a), 2(d), 4(b) or 4(c) of Article III of its Amended and Restated Articles 8 9 of Incorporation without obtaining the prior written consent of Diedrich to such amendment, provided that Diedrich and any of his spouse, parents, lineal descendants or whole blood siblings or a trust established for the benefit of any such persons collectively own at least 10% of the outstanding voting capital stock of the Company. (c) Shareholder Agreement. Concurrently with the execution and delivery of this Agreement, the Company, the Purchasers and the Management Shareholders have executed and delivered the Amended and Restated Shareholder Agreement (the "Shareholder Agreement"), substantially in the form attached hereto as Exhibit 4(c), covering certain voting rights and rights of first refusal with respect to the Company's capital stock. The Company shall enforce each and every one of its obligations under the Shareholder Agreement and shall not amend, modify or waive any of its rights thereunder except in accordance with the provisions thereof. (d) Termination of Certain Company Agreements. The provisions of Sections 4(a) through 4(c) above shall terminate upon the consummation of a Qualified Public Offering, which means a firmly underwritten public offering of the Common Stock on a Form S-1, Form SB-1 or Form SB-2 Registration Statement filed with the Securities and Exchange Commission under the Securities Act with respect to which the Company receives net proceeds of at least $10,000,000 and the price to the public is at least $6.00 per share. (e) Registration Rights. (i) Required Registration. The Company agrees that, at any time after the earlier to occur of June 1, 2000 or the effective date of a Qualified Public Offering, it shall register under the Securities Act and take all necessary steps to facilitate the public sale (the "Public Offering"), at the Company's sole cost and expense except for underwriting discounts and commissions, of all or any portion of the Conversion Shares or any shares of Common Stock issued or issuable with respect to the Conversion Shares by reason of a stock dividend or stock split or in connection with a combination of shares, recapitalization, merger, consolidation or other reorganization (the "Registrable Stock") designated in writing for such sale by the holders of 50% of the Registrable Stock, provided that the Company shall not be required to undertake and complete (A) more than three such registrations, (B) prior to a Qualified Public Offering, any such registration, unless an underwriter of national or regional reputation shall have agreed to serve as an underwriter for purposes of such registration or (C) any such registration within six months following the consummation of a Qualified Public Offering. If the Purchasers are precluded from including any Registrable Stock in any Public Offering as a result of the request or decision of the underwriters involved therein, such Public Offering shall not count against the three Public Offerings limit available to the Purchasers. (ii) Incidental Registration. If the Company at any time proposes to register any of its securities for sale for its own account or for the account of any other person, it shall each such time give written notice (the "Company's Notice"), at its expense, to all holders of Registrable Stock of its intention to do so at least 45 days prior to the filing of a registration statement with respect to such registration with the Commission. If any holder of Registrable Stock desires to dispose of all or part of its Registrable Stock, it may request registration thereof in connection with the Company's registration by delivering to the Company, within 30 days after receipt of the Company's Notice, written notice of such request (the "Investors' Notice"). The Company shall use its best efforts to cause all shares of Registrable Stock specified in the Investors' Notice to be registered under the Securities Act so as to permit the sale or other disposition by such holder or holders of the shares so registered. 9 10 Notwithstanding the foregoing, if an underwriter involved with any registered offering of shares of the Company advises the Company in writing that marketing factors (including, without limitation, an adverse effect on the per share offering price) require a limitation of the number of shares to be underwritten, then the Company shall so advise the holders of Registrable Stock and the number of shares of registrable securities that may be included in the registration and underwriting shall be reduced accordingly. For purposes of any underwriter cutback, all shares of Registrable Stock for which an Investor Notice has been delivered to the Company and all shares which the Company intended to register shall be cut back on a pro rata basis calculated based on the ratio which the number of shares which each holder of Registrable Stock requested or the Company intended, as applicable, to be included in the registered offering bears to the total number of shares which were requested and intended to be included in the registered offering. (iii) Indemnification. In connection with any Public Offering, the Company agrees to indemnify the holders of Registrable Stock to the same extent as the Company indemnifies any underwriter participating therein (or as the holders of Registrable Stock shall reasonably request in the absence of underwriter participation therein). (f) Rule 144 Compliance. At all times after completion of a Qualified Public Offering, the Company agrees to take such action as may be necessary to enable the holders of Registrable Stock to complete the public sale of Registrable Stock in accordance with Rule 144 promulgated by the Securities and Exchange Commission under the Securities Act. (g) Key Man Life Insurance. The Company shall obtain and keep in effect term life insurance in the amount of one million dollars ($1,000,000) on the life of Martin R. Diedrich with the proceeds payable to the Company. (h) Employee Stock Arrangements. The Company will not, without the approval of the Board of Directors, issue any of its capital stock, or grant an option or rights to subscribe for, purchase or acquire any of its capital stock, to any employee, consultant, officer or director of the Company. The Company shall, however, establish a stock option plan for management and key employees (the "Option Plan") to be administered by the Board of Directors. The Option Plan shall provide that the Company will enter into an agreement with each employee of the Company who receives options pursuant to the Option Plan (an "Optionee") whereby the shares of the Company's capital stock issued to such Optionee upon exercise of any options may be redeemed, at the option of the Company, upon the employee's cessation of employment at its then current market value. The Company may, if determined necessary by the Board of Directors, maintain a life insurance policy with the proceeds payable to the Company on each Optionee during the term of his or her employment in an amount sufficient to pay for the redemption of such Optionee's shares. (i) Actions Requiring Notice and Approval. (i) Anything in this Agreement to the contrary notwithstanding, the following actions may be taken by the Company only with prior notice to and approval of 66-2/3% of the Shares and Conversion Shares held by the Purchasers, as provided in Section 4(i)(ii) hereof: (A) the filing on behalf of the Company of an application for bankruptcy or similar relief; 10 11 (B) any confession of a judgment against the Company; (C) any purchase of equity securities or instruments representing indebtedness of any Person; (D) the creation by the Company of any subsidiaries; (E) any amendment of this Agreement; and (F) the appointment, employment, removal and compensation of, and approval of any employment contracts with, the Chief Executive Officer of the Company, any other officers of the Company and the Management Shareholders. (ii) In the event that the Company determines to take any of the actions specified in Section 4(i)(i), the following procedures shall be applicable: (A) The Company shall deliver to the Purchasers written notice of the proposed action (the "Company Notice"), specifying the dollar amount and terms and conditions of the proposed action. (B) If Purchasers disapprove of such action, they shall do so by delivering a written notice signed by either Purchaser (the "Disapproval Notice"). The Disapproval Notice must be delivered to the Company within 10 business days from the receipt by Purchasers of the Company Notice. Receipt of the Disapproval Notice by the Company shall prohibit the Company from undertaking the action specified in the Company Notice. (C) If the Purchasers do not tender a Disapproval Notice within the 10 business day period, the Company shall be entitled to undertake the action specified in the Company Notice after the end of the 10 business day period, but only upon terms and conditions which are in all material respects (including, without limitation, price and interest rates) identical to those set forth in the Company Notice; provided, that if the Company does not undertake the action specified in the Company Notice within 30 days following the expiration of the 10 business day period, any approval theretofore extended pursuant to this section shall be deemed rescinded and any subsequent actions shall again be subject to all of the restrictions set forth herein. (iii) The Purchasers may, by prior written consent, waive their rights under this Section 4(i), provided that, unless otherwise specifically agreed to by the Purchasers in writing, such waivers shall be on a case-by-case basis and shall be limited to the corporate acts specified therein. (j) Other Affirmative Covenants. The Company shall: (i) at all times cause to be done all things necessary to maintain, preserve and renew its corporate existence and all licenses and permits necessary to the conduct of its businesses; (ii) maintain and keep its properties in good repair, working order and condition excepting ordinary wear and tear, and from time to time make all necessary or desirable repairs, renewals and replacements; 11 12 (iii) pay and discharge, when payable, all taxes, assessments and governmental charges imposed upon its properties or upon the income or profits therefrom (in each case before the same become delinquent and before penalties accrue thereon), and all claims for labor, materials or supplies, which if unpaid might by law become a lien upon any of its properties, unless and only to the extent that the same are being contested in good faith and by appropriate proceedings and adequate reserves have been set aside on its books with respect thereto; (iv) comply with all other obligations which it incurs or to which it becomes subject pursuant to any contract or agreement, whether oral or written, express or implied, the breach of which might result in a Material Adverse Change, unless and only to the extent that the same are being contested in good faith and by appropriate proceedings and adequate reserves have been set aside on its books with respect thereto; (v) comply with all applicable laws, rules and regulations of all governmental authorities, the violation of which might result in a Material Adverse Change; (vi) apply for and, when obtained, continue in force, with good and reputable insurance companies, adequate insurance covering risks of such types and in such amounts as are referred to in Section 2(l) hereof; and (vii) operate its business only in the ordinary course, substantially as presently operated under its existing management, preserve intact its present business organization and all licenses and permits necessary to the conduct of its business, and use its best efforts to keep available on customary terms the services of its present officers and key employees. (k) Release of Diedrich as Guarantor of Certain Company Obligations. The Company shall use its best efforts to obtain the release of Diedrich as a guarantor of certain Company obligations under the guaranty agreements set forth on Schedule 4(k) hereto. 5. Restrictions on Transfer. None of the shares of the Series B Preferred Stock purchased hereunder or the Conversion Shares shall be sold, transferred, assigned, pledged, hypothecated or otherwise disposed of unless and until one of the following events shall have occurred: (a) Such securities are disposed of pursuant to and in conformity with an effective registration statement filed with the Securities and Exchange Commission pursuant to the Securities Act or pursuant to Rule 144 promulgated thereunder; or (b) The seller shall have delivered to the Company a written opinion by counsel which is reasonably acceptable to the Company to the effect that the proposed transfer is exempt from the registration and prospectus delivery requirements of the Securities Act; or (c) The seller shall have transferred such securities to an Affiliate (as defined in Section 10(h) below) of the seller and such Affiliate has delivered to the Company a written agreement making the representations set forth in Section 3 and agreeing to be bound by the restrictions of this Section 5 with respect to the shares so transferred. For purposes of this Agreement, the definition of "Purchaser" as used herein shall be deemed to include any such Affiliate of Purchaser. 12 13 The parties hereto further agree that any certificate evidencing the Series B Preferred Stock or the Conversion Shares shall bear the following legend: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, HAVE BEEN TAKEN FOR INVESTMENT, AND MAY NOT BE SOLD, TRANSFERRED, ASSIGNED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF EXCEPT IN ACCORDANCE WITH THE TERMS OF AN AGREEMENT BETWEEN THE COMPANY AND THE REGISTERED HOLDER HEREOF, A COPY OF WHICH AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICES OF THE COMPANY. The Company shall, within 10 days of the request of any holder of a certificate bearing the foregoing legend and the surrender of such certificate, issue a new stock certificate without the foregoing legend if any of the events set forth in Sections 5(a) or (b) above have occurred. 6. The Closing; Delivery. The closing of the transactions contemplated by this Agreement (the "Closing") shall take place on June 26, 1995, at the offices of Gibson, Dunn & Crutcher, 4 Park Plaza, Irvine, California, or at such other place and at such time and date as Purchasers, Company and Management Shareholders shall mutually agree. At the Closing, the Company shall deliver to each Purchaser a certificate or certificates evidencing the Series B Preferred Stock being purchased by such Purchaser against delivery to the Company of the purchase price therefor, by a check payable to the order of the Company. 7. Conditions to Obligations of Purchasers. The obligations of Purchasers to purchase the Series B Preferred Stock at the Closing and the other obligations of Purchasers under this Agreement are subject to the fulfillment at or prior to the Closing of the following conditions, any of which may be waived in writing in whole or in part by Purchasers: (a) Representations and Warranties. On the date of the Closing, the representations and warranties of Company and Management Shareholders set forth in this Agreement shall be true and correct in all respects with the same effect as though such representations and warranties had been made at and as of such time, except to the extent that any changes therein are specifically contemplated by this Agreement. (b) Performance. The Company and Management Shareholders shall have performed and complied in all respects with all agreements and conditions contained herein required to be performed or complied with by them prior to or at the Closing. (c) Absence of Litigation. No suit, action, proceeding or investigation shall have occurred, be pending or threatened which would or seeks to prevent or delay beyond the date of the Closing the consummation of the transactions contemplated by this Agreement. (d) Opinion of Counsel to the Company and Management Shareholders. Purchasers shall have received from Allen, Matkins, Leck, Gamble & Mallory, counsel for the Company and Management Shareholders, a written opinion, substantially identical in form and substance to that attached hereto as Exhibit 7(d). 13 14 (e) Consents and Waivers. The Company shall have obtained any and all consents, permits and waivers, and made any and all filings, necessary or appropriate for the consummation of the transactions contemplated by this Agreement. (f) Contemporaneous Transactions. Prior to or contemporaneously with the Closing, the Company and Management Shareholders shall have executed and delivered to Purchasers the Other Agreements contemplated by this Agreement. (g) Closing Papers. The Company and Management Shareholders shall have delivered to Purchasers all of the following: (i) a certificate signed by the President and Secretary of the Company, dated the date of the Closing, stating that (A) the persons signing such certificate have made or have caused to be made such investigations as are necessary to permit them to certify the accuracy of the information set forth therein, (B) such certificate does not misstate any material fact and does not omit to state any fact necessary to make the certificate not misleading and (C) the conditions specified in Sections 7(a), 7(b), 7(c), 7(e) and 7(i) of this Agreement have been satisfied; (ii) copies (certified by the President, Secretary or Assistant Secretary of the Company) of the resolutions duly adopted by the board of directors and shareholders of the Company authorizing, as appropriate, the execution, delivery and performance of this Agreement and the Other Agreements referred to in this Agreement as being executed at or prior to the Closing; (iii) copies (certified by the President, Secretary or Assistant Secretary of the Company) of the Company's Articles of Incorporation and Bylaws as amended through the date of the Closing; and (iv) such other documents relating to the transactions contemplated by this Agreement as Purchasers may reasonably request. (h) Proceedings. All corporate and other proceedings taken or to be taken by the Company in connection with the transactions contemplated hereby to be consummated at the Closing and all documents incident thereto shall be reasonably satisfactory in form and substance to Purchaser. (i) Redemption. The Company shall have entered into the Redemption Agreement pursuant to the terms of which the Company shall be permitted to redeem, following the Closing, all of the shares of the Company's capital stock owned directly or indirectly by Donald M. Holly. 8. Conditions to Obligations of the Company and Management Shareholders. The obligations of the Company and Management Shareholders under this Agreement are subject to the fulfillment at or prior to the date of the Closing of the following conditions, any of which may be waived in writing, in whole or in part, by the Company and Management Shareholders: (a) Representations and Warranties. On the date of the Closing, the representations and warranties of Purchasers set forth in this Agreement shall be true and correct in all respects with the same effect as though such representations and warranties were made at and as of such time. 14 15 (b) Performance. Purchasers shall have performed and complied in all respects with all agreements and conditions contained herein required to be performed by or complied with by it prior to the Closing. (c) Contemporaneous Transaction. Prior to or contemporaneously with the Closing, the Purchasers shall have executed and delivered to the Company and Management Shareholders the Other Agreements contemplated by this Agreement. (d) Employment Agreement. The Company and Martin R. Diedrich shall have entered into the Employment Agreement in the form attached hereto as Exhibit 8(d). (e) Absence of Litigation. No suit, action, proceeding or investigation shall have occurred, be pending or threatened which would or seeks to prevent or delay beyond the date of the Closing the consummation of the transactions contemplated by this Agreement. (f) Closing Papers. The Purchasers shall have delivered to Company and Management Shareholders a certificate signed by each such Purchaser, dated the date of the Closing, stating that (A) the persons signing such certificate have made or have caused to be made such investigations as are necessary to permit them to certify the accuracy of the information set forth therein, (B) such certificate does not misstate any material fact and does not omit to state any fact necessary to make the certificate not misleading and (C) the conditions specified in Sections 8(a), 8(b) and 8(e) of this Agreement have been satisfied. (g) Consents and Waivers. The Purchasers shall have obtained any and all consents, permits and waivers, and made any and all filings, necessary or appropriate for the consummation of the transactions contemplated by this Agreement. 9. Indemnity. (a) The Company agrees to indemnify and hold harmless the Purchasers, and each of them, and any of their affiliates harmless from and against any and all losses, claims, damages or liabilities (or actions in respect thereof) ("Losses") to which the Purchasers, or either of them, or any of their affiliates may become subject under any statute or at common law, or otherwise to the extent that such Losses arise out of or are based upon (i) any inaccuracy in any representation or warranty made by the Company or the Management Shareholders in this Agreement, or (ii) any breach by the Company or the Management Shareholders of any of the terms or provisions of this Agreement or the Other Agreements, and in each case the Company further agrees to reimburse the Purchasers or any of their affiliates for any legal or other expenses reasonably incurred in connection with investigating, prosecuting or defending any such Loss. (b) The Company agrees to indemnify and hold harmless Diedrich from and against any and all Losses to which Diedrich may become subject to the extent that such Losses arise out of or are based upon his guaranty of certain Company obligations under the guaranty agreements set forth on Schedule 4(k) to this Agreement. 10. Miscellaneous Provisions. (a) Notices. All notices, demands or other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered in person, by reputable overnight commercial delivery service or by United States mail, certified or registered, with return receipt requested, or otherwise actually delivered: 15 16 If to Redwood: Redwood Enterprises VII, L.P. 450 Newport Center Drive, Suite 570 Newport Beach, CA 92660 With Copies to: E. Michael Greaney, Esq. Gibson, Dunn & Crutcher 4 Park Plaza Irvine, CA 92714 If to DPL: Diedrich Partners I, L.P. 3 Civic Plaza, Suite 170 Newport Beach, CA 92660 If to the Company: Diedrich Coffee 350 Clinton Street, Suite A Costa Mesa, CA 92626 If to Management Shareholders: Martin R. Diedrich 350 Clinton Street, Suite A Costa Mesa, CA 92626 Steven A. Lupinacci 350 Clinton Street, Suite A Costa Mesa, CA 92626 With Copies to: Jeremy D. Glaser, Esq. Allen, Matkins, Leck, Gamble & Mallory 18400 Von Karman Avenue, 4th Floor Irvine, California 92715 or at such other address as may have been furnished by such person in writing to the other parties. Any such notice, demand or other communication shall be deemed to have been given on the date actually delivered or as of the date mailed, as the case may be. (b) Severability and Governing Law. Should any Section or any part of a Section within this Agreement be rendered void, invalid or unenforceable by any court of law for any reason, such invalidity or unenforceability shall not void or render invalid or unenforceable any other Section or part of a Section in this Agreement. This Agreement and the rights and obligations of the parties under this Agreement shall be governed by and construed in accordance with the laws of the State of California, excluding its rules of conflicts of law. (c) Amendments and Waivers. The provisions of this Agreement may not be changed, waived, discharged or terminated orally or in writing, except with (but only with) the written consent of the Company, the Management Shareholders and the holders of at least 66-2/3% of the Series B Preferred Stock then outstanding; provided, however, that no such amendment or waiver shall affect the provisions of this Section 10(c) and no such waiver shall extend to or affect any obligation not expressly waived or impair any right consequent therein. No failure to exercise and no delay in exercising, on the part of any party, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The rights, remedies, powers and privileges herein provided are 16 17 cumulative and not exclusive of any rights, remedies, powers and privileges provided by law. The failure of any party to insist upon a strict performance of any of the terms or provisions of this Agreement, or to exercise any option, right or remedy herein contained, shall not be construed as a waiver or as a relinquishment for the future of such term, provision, option, right or remedy, but the same shall continue and remain in full force and effect. (d) Survival of Representations and Warranties. All agreements, representations and warranties contained herein shall survive the execution and delivery of this Agreement, any investigation at any time made, the sale and purchase of the Series B Preferred Stock and payment therefor, the conversion or redemption of the Series B Preferred Stock as provided for in the Articles of Incorporation, and, as to the Purchasers as defined herein, any disposition of the Series B Preferred Stock or the Conversion Shares and (i) the representations and warranties set forth in Sections 2(c), 2(g), 2(i), 2(k) and 2(q) shall survive until the expiration of the respective statute of limitations with respect to such matters and (ii) all other representations and warranties set forth herein will expire on the third anniversary of the date hereof; unless prior to the stated time of expiration, a claim specifying a breach of any of the representations or warranties described above is submitted in writing to the indemnifying party. All statements contained in any certificate or other instrument executed and delivered by the Company or its duly authorized officers pursuant to this Agreement in connection with the transactions contemplated hereby shall constitute additional representations and warranties by the Company hereunder. (e) Expenses. The Company agrees to pay, and save either Purchaser (or any subsequent holder of Series B Preferred Stock or Conversion Shares) harmless against liability for the payment of, (i) fees and expenses not to exceed $20,000 of the Purchasers' special counsel, Gibson, Dunn & Crutcher, arising in connection with the negotiation, execution and consummation of the transactions contemplated by this Agreement, (ii) reasonable fees and expenses of counsel incurred with respect to any amendments or waivers (whether or not they become effective) under or in respect of the Articles of Incorporation, Bylaws, this Agreement or any of the Other Agreements, and (iii) in the event of breach or default of the Company's obligations to the Purchasers under the Articles of Incorporation, the Bylaws, this Agreement or any of the Other Agreements, fees and expenses of the Purchasers or such holders incurred in respect of the enforcement of the rights granted under any of the foregoing whether or not suit is brought; provided, however, that the Company shall not pay such fees and expenses if such Purchasers or holders are not "prevailing parties" as defined in Section 10(k) of this Agreement. The Company agrees to pay fees and expenses not to exceed $1,000 of Diedrich's special counsel, Allen, Matkins, Leck, Gamble & Mallory, arising in connection with the negotiation and execution of Diedrich's Employment Agreement with the Company. (f) Exercise of Contractual Rights. Each of the Company and the Management Shareholders recognize, acknowledge and agree that the Purchasers have a major financial interest in the Company to preserve and that the exercise by Purchasers of any of their contractual rights under this Agreement or any of the Other Agreements contemplated hereby shall not be deemed to constitute a lack of good faith or unfair dealing. (g) Entire Agreement. This Agreement, the attached Schedules and Exhibits and the Other Agreements contain the entire understanding of the parties and there are no further or other agreements or understandings, written or oral, in effect between the parties relating to the subject matter hereof unless expressly referred to herein. 17 18 (h) Assignment. No party hereto shall assign or transfer or permit the assignment or transfer of this Agreement without the prior written consent of the other parties. Notwithstanding the foregoing, nothing contained herein shall prevent the transfer of this Agreement or any portion hereof by a Purchaser to any entity or person that, directly or indirectly, through one or more intermediaries, controls, or is controlled by, or is under common control with such Purchaser (an "Affiliate"), but no such assignment shall operate to relieve Purchaser from any obligation, liability, indemnity, warranty, covenant, promise or agreement hereunder. (i) Counterparts. This Agreement may be executed by one or more of the parties hereto on any number of separate counterparts and all of said counterparts taken together shall be deemed to constitute one and the same instrument. (j) Further Assurances. Each party hereto agrees to execute any and all documents and to perform such other acts as may be necessary or expedient to further the purposes of this Agreement and the transactions contemplated hereby. (k) Attorneys' Fees. If either party to this Agreement shall bring any action, suit, counterclaim or appeal for any relief against the other, declaratory or otherwise, to enforce the terms hereof or to declare rights hereunder (collectively, an "Action"), the prevailing party shall be entitled to recover as part of any such Action its reasonable attorneys' fees and costs, including any fees and costs incurred in bringing and prosecuting such Action and/or enforcing any order, judgment, ruling or award granted as part of such Action. "Prevailing party" within the meaning of this section includes, without limitation, a party who agrees to dismiss an Action upon the other party's payment of all or a portion of the sums allegedly due or performance of the covenants allegedly breached, or who obtains substantially the relief sought by it. (l) Captions. The captions of the Sections of this Agreement are for convenience only and shall not be considered or referred to in resolving questions of construction. (m) Acknowledgment. Each Purchaser acknowledges and agrees that it has, independently and without reliance upon any other Purchaser, made its own evaluation and decision to purchase the Series B Preferred Stock purchased by it pursuant to this Agreement. Each Purchaser further acknowledges that no other Purchaser has acted as an agent for such Purchaser in connection with the purchase of the Series B Preferred Stock hereunder and will not be acting as an agent for such Purchaser in connection with monitoring its investment hereunder. 18 19 IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the date first above written. "MANAGEMENT SHAREHOLDERS" "COMPANY" MARTIN R. DIEDRICH DIEDRICH COFFEE - ---------------------------- ------------------------------ Martin R. Diedrich Steven A. Lupinacci President, Chief Executive Officer and Chief Financial Officer STEVEN A. LUPINACCI ------------------------------ Martin R. Diedrich - ---------------------------- Chairman of the Board and Steven A. Lupinacci Secretary "PURCHASERS" REDWOOD ENTERPRISES VII, L.P. ------------------------------- Paul C. Heeschen General Partner DIEDRICH PARTNERS I, L.P. ------------------------------- Name: ------------------------- General Partner 19 EX-10.1 4 MARTIN R. DIEDRICH EMPLOYMENT AGREEMENT 6-29-95 1 EXHIBIT 10.1 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into as of June 29, 1995, by and between DIEDRICH COFFEE, a California corporation ("Employer"), and MARTIN R. DIEDRICH ("Employee"). R E C I T A L S : Employer and Employee desire to enter into this Agreement to establish the terms and conditions of Employee's employment by Employer during the term hereof. A G R E E M E N T : NOW, THEREFORE, in consideration of the foregoing recital, and subject to the conditions and covenants set forth herein, the parties agree as follows: 1. Employment and Term. (a) Employer hereby employs Employee as its Vice President, Quality Control, and Corporate Spokesperson and Employee hereby accepts such employment upon the terms and subject to the conditions set forth in this Agreement. Unless earlier terminated as provided in this Agreement, the term of Employee's employment under this Agreement shall commence on the date hereof and shall continue for a period of three (3) years from the date hereof (the "Term"). (b) Employee shall perform such duties and functions consistent with his role as Vice President, Quality Control, and Corporate Spokesperson of Employer as may from time to time be assigned to him by the Chief Executive Officer or the Board of Directors of the Employer (the "Board") which duties and functions are intended to include oversight of all material aspects of the following matters as they relate to the Employer's business and products sold or otherwise distributed by Employer: (i) product quality control, (ii) new product development, (iii) logos, trade names and imagery, and (iv) selection of additional spokespersons for Employer. Employee agrees that during the course of the Employer's business hours throughout the Term, he will devote the whole of his time, attention and efforts to the performance of his duties and obligations hereunder. Employee shall not, during the Term, without the written approval of the Board first had and obtained in each instance, directly or indirectly (A) accept employment or receive any compensation for the performance of services from any business enterprise other than Employer or (B) enter into or be concerned or interested in any trade or business or public or private work (whether for profit or otherwise and whether as partner, principal, shareholder or otherwise), which may, in the absolute discretion of the Board, hinder or otherwise interfere with the performance by the Employee of his duties and obligations hereunder, except as a holder of not more than five percent (5%) of any class of stock or other securities in any company which is listed and/or traded on any securities market. 2 2. Compensation. Employee shall be paid a salary (the "Base Salary") in an amount that initially shall be equal to One Hundred Thousand Dollars ($100,000) per year, payable in semi-monthly installments, less all amounts required by law to be withheld or deducted. During the Term of this Agreement, the Board shall review Employee's Base Salary on or about each anniversary date of the date of this Agreement. The Board, in its sole and absolute discretion from time to time, may increase (but not decrease without Employee's written consent) Employee's Base Salary. The Board, in its sole and absolute discretion, also may pay Employee performance bonuses based on Employer's performance and Employee's contribution thereto in such amounts and at such times as the Board may determine. 3. Employee Benefits. During the Term of Employee's employment hereunder: (a) Employee shall be entitled to vacation leave consistent with Employer's policies for other senior executives of Employer. (b) Employer shall pay or reimburse Employee for all reasonable and necessary travel and other business expenses incurred or paid by Employee in connection with the performance of his services under this Agreement consistent with Employer's policies for other senior executives of Employer. (c) Employer shall provide and pay for the annual cost of premiums for health, dental and medical insurance coverage for Employee and Employee's dependents consistent with the coverage generally made available by Employer to senior executives of Employer and providing benefits at least as favorable to Employee as the coverage that is in effect at the date of this Agreement. (d) In addition to the benefits set forth above, Employee shall be entitled to participate in any other policies, programs and benefits which Employer may, in its sole and absolute discretion, make generally available to its other senior executives from time to time including, but not limited to, life insurance, disability insurance, pension and retirement plans, stock plans and other similar programs. 4. Termination of Employment. (a) Notwithstanding any other provision of this Agreement, Employee's employment under this Agreement may be terminated as follows: (i) Upon the death of Employee, this Agreement and Employee's employment hereunder shall terminate immediately and without notice by Employer; or (ii) In the event of the inability of Employee to perform his duties or responsibilities hereunder, as a result of mental or physical ailment or incapacity, for an aggregate of ninety (90) calendar days during any calendar year (whether or not consecutive) (a "Disability") during which period of Disability the Employee shall be entitled to his compensation pursuant to this Agreement, this Agreement 3 and Employee's employment hereunder shall terminate upon delivery of written notice to Employee or (iii) By Employer for Cause (as defined below) in accordance with the provisions of Section 4(b) hereof. (b) The parties agree that for purposes of this Agreement, the term "Cause" shall mean the following: (i) Employee's willful and repeated failure to satisfactorily perform his job duties under this Agreement; (ii) Failure by the Employee to comply with all material applicable laws in performing his job duties or in directing the conduct of Employer's business; and (iii) Commission by the Employee of any felony or intentionally fraudulent or other act against Employer, or its employees, agents or customers which demonstrates Employee's untrustworthiness or lack of integrity. With respect to events described in subparagraph 4(b)(i) and (ii) above, Employer shall give written notice to Employee of any such event and Employee shall have thirty (30) days beginning on the date of delivery of such written notice to cure same, or if such event cannot be cured within said thirty (30) day period, Employee shall commence his efforts to cure the event within the thirty (30) day period and diligently work to cure such event within a reasonable time period. If Employee within said thirty (30) day period or within a reasonable time period, as applicable, does not cure the event for which notice has been provided under subparagraphs 4(b)(i) or (ii) above, then Employee's employment under this Agreement may be terminated by Employer by delivery to Employee of written notice of termination and such termination will be effective as of the date of delivery of such written notice. With respect to events described in subparagraph 4(b)(iii) above, Employee's employment under this Agreement may be terminated by Employer by delivery to Employee of written notice of termination and such termination will be effective as of the date of delivery of such written notice. 5. Relocation; Travel. In connection with the performance of his employment duties under the terms of this Agreement, Employee shall not be required to relocate to an office of Employer outside of the Orange County, California area. 6. Arbitration. Any controversy, dispute or claim arising out of, in connection with, or in relation to the interpretation, performance or breach of this Agreement or otherwise arising out of the execution hereof, including any claim based on contract, tort or statute, shall be resolved, at the request of any party, by submission to binding arbitration at the Orange County, California offices of Judicial Arbitration & Mediation Services, Inc. ("JAMS"), and any judgment or award rendered by JAMS shall be final, binding and unappealable, and judgment may be entered by any state or federal court having jurisdiction thereof. Any party can initiate 3 4 arbitration by sending written notice of intention to arbitrate (the "Demand") by registered or certified mail to all parties and to JAMS. The Demand shall contain a description of the dispute, the amount involved, and the remedy sought. The arbitrator shall be a retired or former judge agreed to between the parties from the JAMS' panel. If the parties are unable to agree, JAMS shall provide a list of three available judges and each party may strike one. The remaining judge shall serve as the arbitrator. Each party hereto intends that the provisions to arbitrate set forth herein be valid, enforceable and irrevocable. In his award, the arbitrator shall allocate, in his discretion, among the parties to the arbitration all costs of the arbitration, including the fees of the arbitrator and reasonable attorneys' fees, costs and expert witness expenses of the parties. The parties hereto agree to comply with any award made in any such arbitration proceedings that has become final and agree to the entry of a judgment in any jurisdiction upon any award rendered in such proceeding becoming final. 7. Notices. All notices, requests, demands and other communications under this Agreement must be in writing and shall be deemed to have been duly given on the date of service if served personally on the party to whom notice is to be given, or on the date indicated on the return receipt as the date of receipt or refusal if mailed to the party to whom notice is to be given by first class mail, registered or certified, postage prepaid, return receipt requested, and properly addressed as follows: To the Employer: Diedrich Coffee 350 Clinton Street, Suite A Costa Mesa, California 92626 Attention: President To the Employee: Martin R. Diedrich (at the Employer's address) Any party may change its address for the purpose of this Paragraph 7 by giving the other party written notice of the new address in the manner set forth above. 8. Enforceability. If any of the covenants contained in this Agreement, for any reason and to any extent, are construed to be invalid or unenforceable, the remainder of this Agreement, and the application of the remaining covenants to other persons or circumstances shall not be affected hereby, but rather shall be enforced to the greatest extent permitted by law. 9. Assignment; Binding Effect. This Agreement shall inure to the benefit of, and be enforceable by, the Employer and its successors and assigns; however, this Agreement is personal to Employee and may not be assigned by Employee in whole or in part. In the event of the sale of all or substantially all of the assets of Employer or other transaction in which Employer will not continue as a surviving corporate entity engaged in a substantially similar business as it is engaged in prior to such transaction, Employer will use commercially reasonable efforts to obtain from the acquiring person or entity, before the succession takes place, an agreement to assume and perform all of the terms and conditions of this Agreement. 4 5 10. Entire Agreement; Amendment. This Agreement contains the entire agreement between Employer and Employee with respect to the subject matters hereof and supersedes all prior or contemporaneous agreements, arrangements or understandings written or oral, with respect to the subject matters hereof. This Agreement may not be amended, waived, changed, modified or discharged except by an instrument in writing executed by or on behalf of the party or parties against whom any amendment, waiver, change, modification or discharge is sought to be enforced. 11. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 12. Counterparts. This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. "EMPLOYER" DIEDRICH COFFEE, a California corporation By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- "EMPLOYEE" /s/ Martin R. Diedrich ---------------------------------------- MARTIN R. DIEDRICH 5 EX-10.4 5 FORM OF INDEMNIFICATION AGREEMENT 1 Exhibit 10.4 INDEMNIFICATION AGREEMENT This Indemnification Agreement ("Agreement") is made as of this ______ day of _______, 1996 by and between DIEDRICH COFFEE, a California corporation (the "Company") and __________________________ ("Indemnitee"), with reference to the following: RECITALS A. The Indemnitee is currently serving as a Director and/or Officer of the Company and the Company wishes the Indemnitee to continue in such capacity. The Indemnitee is willing, under certain circumstances, to continue in such capacity. B. The Indemnitee has indicated his concern that the indemnities available under the Company's bylaws and available insurance, if any, may not be adequate to protect him against the risks associated with his service to the Company. The Indemnitee may not be willing to continue in office in the absence of the benefits accorded to Indemnitee under this Agreement. AGREEMENT In order to induce the Indemnitee to continue to serve as Director and/or Officer for the Company and in consideration for his continued service, the Company hereby agrees to indemnify the Indemnitee as follows: 1. The Company shall indemnify, and advance expenses to, Indemnitee as provided in this Agreement and to the fullest extent permitted by applicable law in effect on the date hereof and to such greater extent as applicable law may thereafter from time to time permit. The rights of Indemnitee provided under the preceding sentence shall include, but shall not be limited to, the rights set forth in the other Sections of this Agreement. The indemnification and advancement of expenses contemplated by this Agreement are intended to be provided in accordance with the terms and conditions of this Agreement regardless of whether any of the events underlying the indemnified claims or actions or advanced expenses occurred before or after the date of this Agreement. The rights of Indemnitee under this Agreement shall survive termination of his status as a director, officer, employee or agent of the Company. 2. Indemnitee shall be entitled to the rights of indemnification provided in this Section 2 if, by reason of the fact that he is or was a director, officer, employee or agent of the Company, he is, or is threatened to be made, a party to any threatened, pending, or completed action, suit or proceeding, other than an action by or in the right of the Company. Pursuant to this Section 2, Indemnitee shall be indemnified against expenses (including attorneys' fees), judgments, damages, penalties, fines and amounts paid in settlement actually and reasonably incurred by him or on his behalf in connection with such proceeding or any claim, issue or matter therein, if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal proceeding, had no reasonable cause to believe his conduct was unlawful. 2 3. Indemnitee shall be entitled to the rights of indemnification provided in this Section 3 if, by reason of the fact that he is or was a director, officer, employee or agent of the Company, he is, or is threatened to be made, a party to any threatened, pending or completed action, suit or proceeding brought by or in the right of the Company to procure a judgment in its favor. Pursuant to this Section, Indemnitee shall be indemnified against expenses actually and reasonably incurred by him or on his behalf in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and its shareholders. Notwithstanding the foregoing, no indemnification against such expenses shall be made in respect of any claim, issue or matter in such proceeding as to which Indemnitee shall have been adjudged to be liable to the Company in the performance of his duty to the Company and its shareholders if applicable law prohibits such indemnification; provided, however, that, if applicable law so permits, indemnification against expenses shall nevertheless be made by the Company in such event if and only to the extent that the court in which such proceeding shall have been brought or is pending, shall determine. 4. Any indemnification under Sections 2 and 3 of this Agreement, unless ordered by a court, shall be made by the corporation only as authorized by the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 2 and 3 of this agreement. Such determination shall be made (1) by a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum, or (2) if there are no such directors, or if such directors so direct, by independent legal counsel, in a written opinion, or (3) by the stockholders. 5. If the Company does not respond to a written claim for payment under this Agreement within sixty (60) days of having received a claim under this Agreement, it shall be deemed to have waived any right to refuse to pay such claim under this Agreement. If a claim under this Agreement is not paid by the Company, or on its behalf, within ninety (90) days after a written claim has been received by the Company, the claimant may at any time thereafter bring suit against the Company to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall be entitled to be paid also the expense of prosecuting such claim. 6. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of the Indemnitee, who shall execute all papers required and shall do everything that may be necessary to secure such rights, including the execution of such documents necessary to enable the Company effectively to bring suit to enforce such rights. 7. Notwithstanding anything to the contrary herein, the Company shall not be liable under this Agreement to make any payment in connection with any claim made against the Indemnitee: 2 3 (a) for which payment is actually made to the Indemnitee under a valid and collectible insurance policy, except in respect of any excess beyond the amount of payment under such insurance; (b) for which the Indemnitee is indemnified by the Company otherwise than pursuant to this Agreement; (c) based upon or attributable to the Indemnitee or any member of his immediate family gaining in fact any personal profit or advantage to which he was not legally entitled; (d) for an accounting of profits made from the purchase or sale by the Indemnitee of securities of the Corporation within the meaning of Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or similar provisions of any state statutory law or common law; or (e) brought about or contributed to by the dishonesty of the Indemnitee seeking payment hereunder; however, notwithstanding the foregoing, the Indemnitee shall be protected under this Agreement as to any claims upon which suit may be brought against him by reason of any alleged dishonesty on his part, unless a judgment or other final adjudication thereof adverse to the Indemnitee shall establish that he committed (i) acts of active and deliberate dishonesty or (ii) acts with actual dishonest purpose and intent, which acts were material to the cause of action so adjudicated. 8. No costs, charges or expenses for which indemnity shall be sought hereunder shall be incurred without the Company's consent, which consent shall not be unreasonably withheld. 9. The Indemnitee, as a condition precedent to his right to be indemnified under this Agreement, shall give to the Company notice in writing as soon as practicable of any claim made against him for which indemnity will or could be sought under this Agreement. Notice to the Company shall be directed to Diedrich Coffee, 2144 Michelson Drive, Irvine, CA 92715, Attention: Corporate Secretary (or such other addresses as the Company shall designate in writing to the Indemnitee); notice shall be deemed received if sent by prepaid mail properly addressed, the date of such notice being the date postmarked. In addition, the Indemnitee shall give the Company such information and cooperation as it may reasonably require and as shall be within the Indemnitee's power. 10. Costs and expenses (including attorneys' fees) incurred by the Indemnitee in defending or investigating any action, suit, proceeding or investigation shall be paid by the Company in advance of the final disposition of such matter, if the Indemnitee shall undertake in writing to repay any such advances in the event that it is ultimately determined that the Indemnitee is not entitled to indemnification under the terms of this Agreement. Notwithstanding the foregoing or any other provision of this Agreement, no advance shall be made by the Company if a determination is reasonably promptly made (1) by a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum, or (2) if there are no 3 4 such directors, or if such directors so direct, by independent legal counsel in a written opinion that, based upon the facts known to the board or counsel at the time such determination is made, (a) the Indemnitee acted in bad faith or deliberately breached his duty to the Company or its stockholders, and (b) as a result of such actions by the Indemnitee, it is more likely than not that it will ultimately be determined that the Indemnitee is not entitled to indemnification under the terms of this Agreement. 11. Nothing herein shall be deemed to diminish or otherwise restrict the Indemnitee's right to indemnification under any provision of the certificate of incorporation or bylaws of the Company or under Delaware law. 12. This Agreement shall be governed by and construed in accordance with Delaware law, but without reference to the conflicts of law's principles of that jurisdiction. 13. This Agreement shall be binding upon all successors and assigns of the Corporation (including any transferee of all or substantially all of its assets and any successor by merger or operation or law) and shall inure to the benefit of the heirs, personal representatives and estates of Indemnitee. 14. If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever (a) the validity, legality and enforceability of the remaining provisions of this Agreement (including, without limitation, all portions of any paragraphs of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby, and (b) to the fullest extent possible, the remaining provisions of this Agreement (including, without limitation, all portions of any paragraphs of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall be construed so as to give effect to the intent of the parties that the Company provide protection to Indemnitee to the fullest enforceable extent. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and signed as of the day and year first above written. DIEDRICH COFFEE 2144 Michelson Drive Irvine, CA 92712 --------------------------------------- Martin R. Diedrich, Corporate Secretary 4 5 AGREED TO AND ACCEPTED: INDEMNITEE Signed: ---------------------------- Name: ------------------------------ - ----------------------------------- - ----------------------------------- (address) 5 EX-10.5 6 DEIDRICH COFFEE 1996 STOCK INCENTIVE PLAN 1 EXHIBIT 10.5 DIEDRICH COFFEE, INC. 1996 STOCK INCENTIVE PLAN ARTICLE I PURPOSE OF PLAN The Company has adopted this Plan to promote the interests of the Company and its stockholders by using investment interests in the Company to attract, retain and motivate its management and other persons, to encourage and reward their contributions to the performance of the Company, and to align their interests with the interests of the Company's stockholders. ARTICLE II EFFECTIVE DATE AND TERM OF PLAN 2.1 TERM OF PLAN. This Plan became effective as of the Effective Date and shall continue in effect until the Expiration Date, at which time this Plan shall automatically terminate. 2.2 EFFECT ON AWARDS. Awards may be granted during the Plan Term, but no Awards may be granted after the Plan Term. Notwithstanding the foregoing, each Award properly granted under this Plan during the Plan Term shall remain in effect after termination of this Plan until such Award has been exercised, terminated, or expired in accordance with its terms and the terms of this Plan. 2.3 STOCKHOLDER APPROVAL. This Plan shall be approved by the Company's stockholders within 12 months after the Effective Date. The effectiveness of any Awards granted prior to such stockholder approval shall be subject to such stockholder approval. ARTICLE III SHARES SUBJECT TO PLAN 3.1 NUMBER OF SHARES. The maximum number of shares of Common Stock that may be issued pursuant to Awards granted under this Plan shall be 475,000, subject to adjustment as set forth in Section 3.4. 3.2 SOURCE OF SHARES. The Common Stock to be issued under this Plan will be made available, at the discretion of the Board, either from authorized but unissued shares of Common Stock or from previously issued shares of Common Stock reacquired by the Company, including without limitation shares purchased on the open market. 3.3 AVAILABILITY OF UNUSED SHARES. Shares of Common Stock subject to unexercised portions of any Award granted under this Plan that expire, terminate or are cancelled, and shares of Common Stock issued pursuant to an Award under this Plan that are reacquired by the Company pursuant to the terms of the Award under which such shares were issued, will again become available for the grant of further Awards under this Plan. 2 3.4 ADJUSTMENT PROVISIONS. (a) If (i) the outstanding shares of Common Stock of the Company are increased, decreased or exchanged for a different number or kind of shares or other securities, or if additional shares or new or different shares or other securities are distributed in respect of such shares of Common Stock (or any stock or securities received with respect to such Common Stock), through merger, consolidation, sale or exchange of all or substantially all of the properties of the Company, reorganization, recapitalization, reclassification, stock dividend, stock split, reverse stock split, spin-off or other distribution with respect to such shares of Common Stock (or any stock or securities received with respect to such Common Stock), or (ii) the value of the outstanding shares of Common Stock of the Company is reduced by reason of an extraordinary cash dividend, an appropriate and proportionate adjustment may be made in (1) the maximum number and kind of shares subject to this Plan as provided in Section 3.1, (2) the number and kind of shares or other securities subject to then outstanding Awards, and/or (3) the price for each share or other unit of any other securities subject to then outstanding Awards. (b) No fractional interests will be issued under the Plan resulting from any adjustments. (c) To the extent any adjustments relate to stock or securities of the Company, such adjustments shall be made by the Administering Body, whose determination in that respect shall be final, binding and conclusive. (d) The grant of an Award pursuant to this Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure or to merge or to consolidate or to dissolve, liquidate or sell, or transfer all or any part of its business or assets. (e) No adjustment to the terms of an Incentive Stock Option shall be made unless such adjustment either (i) would not cause the Option to lose its status as an Incentive Stock Option or (ii) is agreed to in writing by the Administering Body and the Recipient. 3.5 RESERVATION OF SHARES. The Company will at all times reserve and keep available such number of shares of Common Stock as shall equal at least the number of shares of Common Stock subject to then outstanding Awards issuable in shares of Common Stock under this Plan. ARTICLE IV ADMINISTRATION OF PLAN 4.1 ADMINISTERING BODY. (a) Subject to the provisions of Section 4.1(b)(ii), this Plan shall be administered by the Board or by a Committee of the Board appointed pursuant to Section 4.1(b). (b) (i) The Board in its sole discretion may from time to time appoint a Committee of not less than two Board members to administer this Plan and, subject to applicable law, to exercise all of the powers, authority and discretion of the Board under this Plan. The Board may from time to time increase or decrease (but not below two) the number of members of the Committee, remove from membership on the Committee all or any portion of its members, and/or appoint such person or persons as it desires to fill any vacancy existing 2 3 on the Committee, whether caused by removal, resignation or otherwise. The Board may disband the Committee at any time and revest in the Board the administration of this Plan. (ii) Notwithstanding the foregoing provisions of this Section 4.1(b) to the contrary, as long as the Company is an Exchange Act Registered Company, (1) the Board shall appoint the Committee, (2) this Plan shall be administered by the Committee, and (3) each of the Committee's members shall be Disinterested Directors, and in addition, if Awards are to be made to persons subject to Section 162(m) of the IRC and such Awards are intended to constitute Performance Based Compensation, then each of the Committee's members shall, in addition to being a Disinterested Director, also be an Outside Director. (iii) The Committee shall report to the Board the names of Eligible Persons granted Awards, the number of shares of Common Stock covered by each Award, and the terms and conditions of each such Award. 4.2 AUTHORITY OF ADMINISTERING BODY. (a) Subject to the express provisions of this Plan, the Administering Body shall have the power to interpret and construe this Plan and any Award Documents or other documents defining the rights and obligations of the Company and Recipients hereunder and thereunder, to determine all questions arising hereunder and thereunder, to adopt and amend such rules and regulations for the administration hereof and thereof as it may deem desirable, and otherwise to carry out the terms of this Plan and such Award Documents and other documents. The interpretation and construction by the Administering Body of any provisions of this Plan or of any Award shall be conclusive and binding. Any action taken by, or inaction of, the Administering Body relating to this Plan or any Awards shall be within the absolute discretion of the Administering Body and shall be conclusive and binding upon all persons. Subject only to compliance with the express provisions hereof, the Administering Body may act in its absolute discretion in matters related to this Plan and any and all Awards. (b) Subject to the express provisions of this Plan, the Administering Body may from time to time in its discretion select the Eligible Persons to whom, and the time or times at which, Incentive Awards shall be granted or sold, the nature of each Incentive Award, the number of shares of Common Stock or the number of rights that make up or underlie each Incentive Award, the period for the exercise of each Incentive Award, and such other terms and conditions applicable to each individual Incentive Award as the Administering Body shall determine. The Administering Body may grant at any time new Incentive Awards to an Eligible Person who has previously received Incentive Awards or other grants (including other stock options) whether such prior Incentive Awards or such other grants are still outstanding, have previously been exercised as a whole or in part, or are cancelled in connection with the issuance of new Incentive Awards. The Administering Body may grant Incentive Awards singly or in combination or in tandem with other Incentive Awards as it determines in its discretion. The purchase price, exercise price, initial value and any and all other terms and conditions of the Incentive Awards may be established by the Administering Body without regard to existing Incentive Awards or other grants. (c) Any action of the Administering Body with respect to the administration of this Plan shall be taken pursuant to a majority vote of the authorized number of members of the Administering Body or by the unanimous written consent of its members; provided, however, that (i) if the Administering Body is the Committee and consists of two members, then actions of the Administering Body must be unanimous, and (ii) if the Administering Body is the Board, actions taken at a meeting of the Board shall be valid if approved by directors constituting a majority of the required quorum for such meeting. 3 4 4.3 NO LIABILITY. No member of the Board or the Committee or any designee thereof will be liable for any action or inaction with respect to this Plan or any Award or any transaction arising under this Plan or any Award except in circumstances constituting bad faith of such member. 4.4 AMENDMENTS. (a) The Administering Body may, insofar as permitted by applicable law, rule or regulation, from time to time suspend or discontinue this Plan or revise or amend it in any respect whatsoever, and this Plan as so revised or amended will govern all Awards hereunder, including those granted before such revision or amendment; provided, however, that no such revision or amendment shall alter, impair or diminish any rights or obligations under any Award theretofore granted under this Plan without the written consent of the Recipient to whom such Award was granted. Without limiting the generality of the foregoing, the Administering Body is authorized to amend this Plan to comply with or take advantage of amendments to applicable laws, rules or regulations, including amendments to the Securities Act, Exchange Act or the IRC or any rules or regulations promulgated thereunder. No stockholder approval of any amendment or revision shall be required unless (i) such approval is required by applicable law, rule or regulation or (ii) an amendment or revision to this Plan would materially increase the number of shares subject to this Plan (as adjusted under Section 3.4), materially modify the requirements as to eligibility for participation in this Plan, extend the final date upon which Awards may be granted under this Plan, or otherwise materially increase the benefits accruing to Recipients in a manner not specifically contemplated herein, or affect this Plan's compliance with Rule 16b-3 or applicable provisions of or regulations under the IRC, and stockholder approval of the amendment or revision is required to comply with Rule 16b-3 or applicable provisions of or rules under the IRC. (b) The Administering Body may, with the written consent of a Recipient, make such modifications in the terms and conditions of an Incentive Award as it deems advisable. Without limiting the generality of the foregoing, the Administering Body may, in its discretion with the written consent of the Recipient, at any time and from time to time after the grant of any Incentive Award accelerate or extend the vesting or exercise period of any Incentive Award as a whole or in part, and adjust or reduce the purchase or exercise price of Incentive Awards held by such Recipient by cancellation of such Incentive Awards and granting of Incentive Awards at lower purchase or exercise prices or by modification, extension or renewal of such Incentive Awards. In the case of Incentive Stock Options, Recipients acknowledge that extensions of the exercise period may result in the loss of the favorable tax treatment afforded incentive stock options under Section 422 of the IRC. (c) Except as otherwise provided in this Plan or in the applicable Award Document, no amendment, revision, suspension or termination of this Plan will, without the written consent of the Recipient, alter, terminate, impair or adversely affect any right or obligation under any Award previously granted under this Plan. 4.5 OTHER COMPENSATION PLANS. The adoption of this Plan shall not affect any other stock option, incentive or other compensation plans in effect for the Company, and this Plan shall not preclude the Company from establishing any other forms of incentive or other compensation for employees, directors, advisors or consultants of the Company, whether or not approved by stockholders. 4.6 PLAN BINDING ON SUCCESSORS. This Plan shall be binding upon the successors and assigns of the Company. 4.7 REFERENCES TO SUCCESSOR STATUTES, REGULATIONS AND RULES. Any 4 5 reference in this Plan to a particular statute, regulation or rule shall also refer to any successor provision of such statute, regulation or rule. 4.8 ISSUANCES FOR COMPENSATION PURPOSES ONLY. This Plan constitutes an "employee benefit plan" as defined in Rule 405 promulgated under the Securities Act. Awards to eligible employees or directors shall be made for any lawful consideration, including compensation for services rendered, promissory notes or otherwise. Awards to consultants and advisors shall be made only in exchange for bona fide services rendered by such consultants or advisors and such services must not be in connection with the offer and sale of securities in a capital-raising transaction. 4.9 INVALID PROVISIONS. In the event that any provision of this Plan is found to be invalid or otherwise unenforceable under any applicable law, such invalidity or unenforceability shall not be construed as rendering any other provisions contained herein invalid or unenforceable, and all such other provisions shall be given full force and effect to the same extent as though the invalid and unenforceable provision were not contained herein. 4.10 GOVERNING LAW. This Agreement shall be governed by and interpreted in accordance with the internal laws of the State of Delaware, without giving effect to the principles of the conflicts of laws thereof. ARTICLE V GENERAL AWARD PROVISIONS 5.1 PARTICIPATION IN PLAN. (a) A person shall be eligible to receive grants of Incentive Awards under this Plan if, at the time of the grant of the Incentive Award, such person is an Eligible Person. (b) Incentive Stock Options may be granted only to Eligible Persons meeting the employment requirements of Section 422 of the IRC. (c) Notwithstanding anything to the contrary herein, the Administering Body may, in order to fulfill the purposes of this Plan, modify grants of Incentive Awards to Recipients who are foreign nationals or employed outside of the United States to recognize differences in applicable law, tax policy or local custom. 5.2 AWARD DOCUMENTS. (a) Each Award granted under this Plan shall be evidenced by an agreement duly executed on behalf of the Company and by the Recipient or, in the Committee's discretion, a confirming memorandum issued by the Company to the Recipient, setting forth such terms and conditions applicable to the Award as the Committee may in its discretion determine. Award Documents may but need not be identical and shall comply with and be subject to the terms and conditions of this Plan, a copy of which shall be provided to each Recipient and incorporated by reference into each Award Document. Any Award Document may contain such other terms, provisions and conditions not inconsistent with this Plan as may be determined by the Committee. (b) In case of any conflict between this Plan and any Award Document, this Plan shall control. 5.3 EXERCISE OF STOCK OPTIONS. No Stock Option shall be exercisable except in respect of whole shares, and fractional share interests shall be disregarded. Not less 5 6 than 100 shares of Common Stock (or such other amount as is set forth in the applicable Award Documents) may be purchased at one time and Stock Options must be exercised in multiples of 100 unless the number purchased is the total number at the time available for purchase under the terms of the Stock Option. A Stock Option shall be deemed to be exercised when the Secretary or other designated official of the Company receives written notice of such exercise from the Recipient, together with payment of the exercise price made in accordance with Section 5.4 and any amounts required under Section 5.11. Notwithstanding any other provision of this Plan, the Administering Body may impose, by rule and/or in Award Documents, such conditions upon the exercise of Stock Options (including without limitation conditions limiting the time of exercise to specified periods) as may be required to satisfy applicable regulatory requirements, including without limitation Rule 16b-3 and Rule 10b-5 under the Exchange Act, or as required under Section 5.12 hereof or other applicable section of or regulation under the IRC. 5.4 PAYMENT FOR AWARDS. (a) Payment of Exercise Price. The exercise price or other payment for an Award shall be payable upon the exercise of a Stock Option or upon other purchase of shares pursuant to an Award granted hereunder by delivery of legal tender of the United States or payment of such other consideration as the Administering Body may from time to time deem acceptable in any particular instance. (b) The Company may assist any person to whom an Award is granted hereunder (including without limitation any officer or eligible director of the Company) in the payment of the purchase price or other amounts payable in connection with the receipt or exercise of that Award, by lending such amounts to such person on such terms and at such rates of interest and upon such security (if any) as shall be approved by the Administering Body. (c) In the discretion of the Administering Body, Awards may be exercised by capital stock of the Company delivered in transfer to the Company by or on behalf of the person exercising the Award and duly endorsed in blank or accompanied by stock powers duly endorsed in blank, with signatures guaranteed in accordance with the Exchange Act if required by the Administering Body, or retained by the Company from the stock otherwise issuable upon exercise or surrender of vested and/or exercisable Awards or other equity incentive awards previously granted to the Recipient and being exercised (if applicable) (in either case valued at Fair Market Value as of the exercise date); or such other consideration as the Administering Body may from time to time in the exercise of its discretion deem acceptable in any particular instance; provided, however, that the Administering Body may, in the exercise of its discretion, (i) allow exercise of an Award in a broker-assisted or similar transaction in which the exercise price is not received by the Company until promptly after exercise, and/or (ii) allow the Company to loan the exercise price to the person entitled to exercise the Award, if the exercise will be followed by a prompt sale of some or all of the underlying shares and a portion of the sale proceeds is dedicated to full payment of the exercise price and amounts required pursuant to Section 5.11. 5.5 NO EMPLOYMENT RIGHTS. Nothing contained in this Plan (or in Award Documents or in any other documents related to this Plan or to Awards granted hereunder) shall confer upon any Eligible Person or Recipient any right to continue in the employ of the Company or any Affiliated Entity or constitute any contract or agreement of employment or engagement, or interfere in any way with the right of the Company or any Affiliated Entity to reduce such person's compensation or other benefits or to terminate the employment or engagement of such Eligible Person or Recipient, with or without cause. Except as expressly provided in this Plan or in any statement evidencing the grant of an Award pursuant to this 6 7 Plan, the Company shall have the right to deal with each Recipient in the same manner as if this Plan and any such statement evidencing the grant of an Award pursuant to this Plan did not exist, including without limitation with respect to all matters related to the hiring, discharge, compensation and conditions of the employment or engagement of the Recipient. Any question(s) as to whether and when there has been a termination of a Recipient's employment or engagement, the reason (if any) for such termination, and/or the consequences thereof under the terms of this Plan or any statement evidencing the grant of an Award pursuant to this Plan shall be determined by the Administering Body and the Administering Body's determination thereof shall be final and binding. 5.6 RESTRICTIONS UNDER APPLICABLE LAWS AND REGULATIONS. (a) All Awards granted under this Plan shall be subject to the requirement that, if at any time the Company shall determine, in its discretion, that the listing, registration or qualification of the shares subject to Awards granted under this Plan upon any securities exchange or under any federal, state or foreign law, or the consent or approval of any government regulatory body, is necessary or desirable as a condition of, or in connection with, the granting of such an Award or the issuance, if any, or purchase of shares in connection therewith, such Award may not be exercised as a whole or in part unless and until such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company. During the term of this Plan, the Company will use its reasonable efforts to seek to obtain from the appropriate regulatory agencies any requisite qualifications, consents, approvals or authorizations in order to issue and sell such number of shares of its Common Stock as shall be sufficient to satisfy the requirements of this Plan. The inability of the Company to obtain from any such regulatory agency having jurisdiction thereof the qualifications, consents, approvals or authorizations deemed by the Company to be necessary for the lawful issuance and sale of any shares of its Common Stock hereunder shall relieve the Company of any liability in respect of the nonissuance or sale of such stock as to which such requisite authorization shall not have been obtained. (b) The Company shall be under no obligation to register or qualify the issuance of Awards or underlying shares under the Securities Act or applicable state securities laws. Unless the issuance of Awards and underlying shares have been registered under the Securities Act and qualified or registered under applicable state securities laws, the Company shall be under no obligation to issue any Awards or underlying shares of Common Stock covered by any Award unless the Awards and underlying shares may be issued pursuant to applicable exemptions from such registration or qualification requirements. In connection with any such exempt issuance, the Administering Body may require the Recipient to provide a written representation and undertaking to the Company, satisfactory in form and scope to the Company and upon which the Company may reasonably rely, that such Recipient is acquiring such Awards and underlying shares for such Recipient's own account as an investment and not with a view to, or for sale in connection with, the distribution of any such shares of stock, and that such person will make no transfer of the same except in compliance with any rules and regulations in force at the time of such transfer under the Securities Act and other applicable law, and that if shares of stock are issued without such registration, a legend to this effect (together with any other legends deemed appropriate by the Administering Body) may be endorsed upon the securities so issued. The Company may also order its transfer agent to stop transfers of such shares. The Administering Body may also require the Recipient to provide the Company such information and other documents as the Administering Body may request in order to satisfy the Administering Body as to the investment sophistication and experience of the Recipient and as to any other conditions for compliance with any such exemptions from registration or qualification. 7 8 5.7 ADDITIONAL CONDITIONS. Any Incentive Award may also be subject to such other provisions (whether or not applicable to any other Award or Recipient) as the Administering Body determines appropriate including without limitation provisions to assist the Recipient in financing the purchase of Common Stock through the exercise of Stock Options, provisions for the forfeiture of or restrictions on resale or other disposition of shares of Common Stock acquired under any form of benefit, provisions giving the Company the right to repurchase shares of Common Stock acquired under any form of benefit in the event the Recipient elects to dispose of such shares, and provisions to comply with federal and state securities laws and federal and state income tax withholding requirements. 5.8 NO PRIVILEGES OF STOCK OWNERSHIP. Except as otherwise set forth herein, a Recipient or a permitted transferee of an Award shall have no rights as a stockholder with respect to any shares issuable or issued in connection with the Award until the date of the receipt by the Company of all amounts payable in connection with exercise of the Award and performance by the Recipient of all obligations thereunder. Status as an Eligible Person shall not be construed as a commitment that any Award will be granted under this Plan to an Eligible Person or to Eligible Persons generally. No person shall have any right, title or interest in any fund or in any specific asset (including shares of capital stock) of the Company by reason of any Award granted hereunder. Neither this Plan (or any documents related hereto) nor any action taken pursuant hereto shall be construed to create a trust of any kind or a fiduciary relationship between the Company and any person. To the extent that any person acquires a right to receive an Award hereunder, such right shall be no greater than the right of any unsecured general creditor of the Company. 5.9 NONASSIGNABILITY. No Award granted under this Plan shall be assignable or transferable except (i) by will or by the laws of descent and distribution, or (ii) subject to the final sentence of this Section 5.9, upon dissolution of marriage pursuant to a qualified domestic relations order or, in the discretion of the Administering Body and under circumstances that would not adversely affect the interests of the Company, pursuant to a nominal transfer that does not result in a change in beneficial ownership. During the lifetime of a Recipient, an Award granted to such person shall be exercisable only by the Recipient (or the Recipient's permitted transferee) or such person's guardian or legal representative. Notwithstanding the foregoing, (i) no Award owned by a Recipient subject to Section 16 of the Exchange Act may be assigned or transferred in any manner inconsistent with Rule 16b-3, and (ii) Incentive Stock Options (or other Awards subject to transfer restrictions under the IRC) may not be assigned or transferred in violation of Section 422(b)(5) of the IRC (or any comparable or successor provision) or the regulations thereunder, and nothing herein is intended to allow such assignment or transfer. 5.10 INFORMATION TO RECIPIENTS. (a) The Administering Body in its sole discretion shall determine what, if any, financial and other information shall be provided to Recipients and when such financial and other information shall be provided after giving consideration to applicable federal and state laws, rules and regulations, including without limitation applicable federal and state securities laws, rules and regulations. (b) The furnishing of financial and other information that is confidential to the Company shall be subject to the Recipient's agreement that the Recipient shall maintain the confidentiality of such financial and other information, shall not disclose such information to third parties, and shall not use the information for any purpose other than evaluating an investment in the Company's securities under this Plan. The Administering Body may impose other restrictions on the access to and use of such confidential information and may require a 8 9 Recipient to acknowledge the Recipient's obligations under this Section 5.10(b) (which acknowledgment shall not be a condition to Recipient's obligations under this Section 5.10(b)). 5.11 WITHHOLDING TAXES. Whenever the granting, vesting or exercise of any Award granted under this Plan, or the transfer of any shares issued upon exercise of any Award, gives rise to tax or tax withholding liabilities or obligations, the Administering Body shall have the right to require the Recipient to remit to the Company an amount sufficient to satisfy any federal, state and local withholding tax requirements prior to issuance of such shares. The Administering Body may, in the exercise of its discretion, allow satisfaction of tax withholding requirements by accepting delivery of stock of the Company or by withholding a portion of the stock otherwise issuable in connection with an Award. 5.12 LEGENDS ON AWARDS AND STOCK CERTIFICATES. Each Award Document and each certificate representing shares acquired upon vesting or exercise of an Award shall be endorsed with all legends, if any, required by applicable federal and state securities and other laws to be placed on the Award Document and/or the certificate. The determination of which legends, if any, shall be placed upon Award Documents or the certificates shall be made by the Administering Body in its sole discretion and such decision shall be final and binding. 5.13 EFFECT OF TERMINATION OF EMPLOYMENT ON INCENTIVE AWARDS. (i) Termination for Just Cause. Subject to subsection (iii) below, and except as otherwise provided in a written agreement between the Company and the Recipient, which may be entered into at any time before or after termination of employment, in the event of a Just Cause Dismissal of a Recipient all of the Recipient's unexercised Stock Options, whether or not vested, shall expire and become unexercisable as of the date of such Just Cause Dismissal. (ii) Termination other than for Just Cause. Subject to subsection (iii) below, and except as otherwise provided in a written agreement between the Company and the Recipient, which may be entered into at any time before or after termination of employment, in the event of a Recipient's termination of employment for: (A) death, Permanent Disability or normal retirement, the Recipient's unexercised Options shall, whether or not vested, expire and become unexercisable as of the earlier of (1) the date such Stock Options would expire in accordance with their terms had the Recipient remained employed and (2) six months after the date of employment termination. (B) any reason other than for Just Cause Dismissal, death, Permanent Disability or normal retirement, the Recipient's Stock Options, whether or not vested, shall expire and become unexercisable as of the earlier of (1) the date such Stock Options would expire in accordance with their terms had the Recipient remained employed and (2) thirty days after the date of employment termination. (iii) Alteration of Vesting and Exercise Periods. Notwithstanding anything to the contrary in subsections (i) or (ii) above, the Administering Body may in its discretion designate shorter or longer periods to exercise Stock Options following a Recipient's termination of employment; provided, however, that any shorter periods determined by the Administering Body shall be effective only if provided for in the instrument that evidences the grant to the Recipient of such Stock Options or if such shorter period is agreed to in writing by the Recipient. Notwithstanding anything to the contrary herein, Stock Options shall be exercisable by a Recipient (or the Recipient's successor in interest) following such Recipient's termination of employment only to the extent that installments thereof had become exercisable 9 10 on or prior to the date of such termination; provided, however, that the Administering Body may, in its discretion, elect to accelerate the vesting of all or any portion of any Stock Options that had not become exercisable on or prior to the date of such termination. (iv) Leave of Absence. In the case of any employee on an approved leave of absence, the Administering Body may make such provision respecting continuance of a Stock Option as the Administering Body in its discretion deems appropriate, except that in no event shall a Stock Option be exercisable after the date such Stock Options would expire in accordance with its terms had the Recipient remained continuously employed. 5.15 LIMITS ON AWARDS TO CERTAIN ELIGIBLE PERSONS. Notwithstanding any other provision of this Plan, no one Eligible Person shall be granted any Awards with respect to more than 200,000 shares of Common Stock in any one calendar year; provided, however, that this limitation shall not apply if it is not required in order for the compensation attributable to Awards hereunder to qualify as Performance-Based Compensation. The limitation set forth in this Section 5.15 shall be subject to adjustment as provided in Section 3.4 or under Article VII, but only to the extent such adjustment would not affect the status of compensation attributable to Awards hereunder as Performance-Based Compensation. 5.16 SPECIAL PROVISIONS REGARDING CALIFORNIA PERMITTED PLAN. Notwithstanding any provisions of this Plan to the contrary, during any period that this Plan constitutes a California Permitted Plan, the terms of any Awards granted during such period shall comply with the California Commissioner's guidelines for options granted to and share purchases by employees, directors and consultants as set forth in the California Securities Rules Sections 260.140.41 and 260.140.42 in effect at the time the California Commissioner issues the qualification permit for this Plan, unless and to the extent any such compliance is waived by the California Commissioner. As of the Effective Date, such guidelines require, among other matters (i) that the option exercise price of Stock Options be not less than 85% of the fair value of the underlying shares as of the grant date of the Stock Option, with the exercise price to be not less than 110% of the fair value as of such date in the case of Stock Options granted to Significant Shareholders; (ii) the right to exercise a Stock Option at a rate of at least 20% per year over a five-year period commencing with the option grant date; (iii) in the case of stock purchases, a purchase price of at least 85% of the fair value of the shares at the time the stock purchase right is granted or consummated, with the price to be 100% of the fair value of the shares at such dates in the case of stock purchases by Significant Stockholders; and (iv) that Recipients receive financial statements of the Company at least annually. ARTICLE VI INCENTIVE AWARDS 6.1 STOCK OPTIONS. (a) Nature of Stock Options. Stock Options may be Incentive Stock Options or Nonqualified Stock Options. (b) Option Exercise Price. The exercise price for each Stock Option shall be determined by the Administering Body as of the date such Stock Option is granted. The exercise price may be greater than or less than the Fair Market Value of the Common Stock subject to the Option, provided that in no event shall the exercise price be less than the par value of the shares of Common Stock subject to the Stock Option. The Administering Body may, with the consent of the Recipient and subject to compliance with statutory or administrative requirements applicable to Incentive Stock Options, amend the terms of any Stock Option to provide that the exercise price of the shares remaining subject to the Stock Option shall be reestablished at a price not less than 100% of the Fair Market Value of the 10 11 Common Stock on the effective date of the amendment. No modification of any other term or provision of any Stock Option which is amended in accordance with the foregoing shall be required, although the Administering Body may, in its discretion, make such further modifications of any such Stock Option as are not inconsistent with this Plan. (c) Option Period and Vesting. Stock Options granted hereunder shall vest and may be exercised as determined by the Administering Body, except that exercise of such Stock Options after termination of the Recipient's employment shall be subject to Section 5.13. Each Stock Option granted hereunder and all rights or obligations thereunder shall expire on such date as shall be determined by the Administering Body, but not later than l0 years after the date the Stock Option is granted and shall be subject to earlier termination as provided herein or in the Award Document. The Administering Body may in its discretion at any time and from time to time after the grant of a Stock Option accelerate vesting of such Option as a whole or in part by increasing the number of shares then purchasable, provided that the total number of shares subject to such Stock Option may not be increased. Except as otherwise provided herein, a Stock Option shall become exercisable, as a whole or in part, on the date or dates specified by the Administering Body and thereafter shall remain exercisable until the expiration or earlier termination of the Stock Option. (d) Special Provisions Regarding Incentive Stock Options. (i) Notwithstanding anything in this Section 6.1 to the contrary, the exercise price and vesting period of any Stock Option intended to qualify as an Incentive Stock Option shall comply with the provisions of Section 422 of the IRC and the regulations thereunder. As of the Effective Date, such provisions require, among other matters, that (A) the exercise price must not be less than the Fair Market Value of the underlying stock as of the date the Incentive Stock Option is granted, and not less than 110% of the Fair Market Value as of such date in the case of a grant to a Significant Stockholder; and (B) that the Incentive Stock Option not be exercisable after the expiration of five years from the date of grant in the case of an Incentive Stock Option granted to a Significant Stockholder. (ii) The aggregate Fair Market Value (determined as of the respective date or dates of grant) of the Common Stock for which one or more Options granted to any Recipient under this Plan (or any other option plan of the Company or any of its subsidiaries or affiliates) may for the first time become exercisable as Incentive Stock Options under the federal tax laws during any one calendar year shall not exceed $100,000. (iii) Any Options granted as Incentive Stock Options pursuant to this Plan that for any reason fail or cease to qualify as such shall be treated as Nonqualified Stock Options. 6.2 RESTRICTED STOCK. (a) Award of Restricted Stock. The Administering Body shall determine the Purchase Price (if any), the terms of payment of the Purchase Price, the restrictions upon the Restricted Stock, and when such restrictions shall lapse. (b) Requirements of Restricted Stock. All shares of Restricted Stock granted or sold pursuant to this Plan will be subject to the following conditions: (i) No Transfer. The shares may not be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of, alienated or encumbered until the restrictions are removed or expire; 11 12 (ii) Certificates. The Administering Body may require that the certificates representing Restricted Stock granted or sold to a Recipient pursuant to this Plan remain in the physical custody of an escrow holder or the Company until all restrictions are removed or expire; (iii) Restrictive Legends. Each certificate representing Restricted Stock granted or sold to a Recipient pursuant to this Plan will bear such legend or legends making reference to the restrictions imposed upon such Restricted Stock as the Administering Body in its discretion deems necessary or appropriate to enforce such restrictions; and (iv) Other Restrictions. The Administering Body may impose such other conditions on Restricted Stock as the Administering Body may deem advisable including without limitation restrictions under the Securities Act, under the Exchange Act, under the requirements of any stock exchange upon which such Restricted Stock or shares of the same class are then listed and under any blue sky or other securities laws applicable to such shares. (c) Lapse of Restrictions. The restrictions imposed upon Restricted Stock will lapse in accordance with such terms or other conditions as are determined by the Administering Body. (d) Rights of Recipient. Subject to the provisions of Section 6.2(b) and any restrictions imposed upon the Restricted Stock, the Recipient will have all rights of a stockholder with respect to the Restricted Stock granted or sold to such Recipient under this Plan, including without limitation the right to vote the shares and receive all dividends and other distributions paid or made with respect thereto. (e) Termination of Employment. Unless the Administering Body in its discretion determines otherwise, upon a Recipient's termination of employment for any reason, all of the Recipient's Restricted Stock remaining subject to restrictions imposed pursuant to this Plan on the date of such termination of employment shall be repurchased by the Company at the Purchase Price (if any). 6.3 STOCK APPRECIATION RIGHTS. (a) Granting of Stock Appreciation Rights. The Administering Body may at any time and from time to time approve the grant to Eligible Persons of Stock Appreciation Rights, related or unrelated to Stock Options. (b) SARs Related to Options. (i) A Stock Appreciation Right granted in connection with a Stock Option granted under this Plan will entitle the holder of the related Stock Option, upon exercise of the Stock Appreciation Right, to surrender such Stock Option, or any portion thereof to the extent previously vested but unexercised, with respect to the number of shares as to which such Stock Appreciation Right is exercised, and to receive payment of an amount computed pursuant to Section 6.3(b)(iii). Such Stock Option will, to the extent surrendered, then cease to be exercisable. (ii) A Stock Appreciation Right granted in connection with a Stock Option hereunder will be exercisable at such time or times, and only to the extent that, the related Stock Option is exercisable, and will not be transferable except to the extent that such related Stock Option may be transferable. 12 13 (iii) Upon the exercise of a Stock Appreciation Right related to a Stock Option, the Recipient will be entitled to receive payment of an amount determined by multiplying: (i) the difference obtained by subtracting the exercise price of a share of Common Stock specified in the related Stock Option from the Fair Market Value of a share of Common Stock on the date of exercise of such Stock Appreciation Right (or as of such other date or as of the occurrence of such event as may have been specified in the instrument evidencing the grant of the Stock Appreciation Right), by (ii) the number of shares as to which such Stock Appreciation Right is exercised. (c) SARs Unrelated to Options. The Administering Body may grant Stock Appreciation Rights unrelated to Stock Options to Eligible Persons. Section 6.3(b)(iii) shall be used to determine the amount payable at exercise under such Stock Appreciation Right, except that in lieu of the Option exercise price specified in the related Stock Option the initial base amount specified in the Incentive Award shall be used. (d) Limits. Notwithstanding the foregoing, the Administering Body, in its discretion, may place a dollar limitation on the maximum amount that will be payable upon the exercise of a Stock Appreciation Right under this Plan. (e) Payments. Payment of the amount determined under the foregoing provisions may be made solely in whole shares of Common Stock valued at their Fair Market Value on the date of exercise of the Stock Appreciation Right or, alternatively, at the sole discretion of the Administering Body, in cash or in a combination of cash and shares of Common Stock as the Administering Body deems advisable. The Administering Body has full discretion to determine the form in which payment of a Stock Appreciation Right will be made and to consent to or disapprove the election of a Recipient to receive cash in full or partial settlement of a Stock Appreciation Right. If the Administering Body decides to make full payment in shares of Common Stock, and the amount payable results in a fractional share, payment for the fractional share will be made in cash. (f) Rule 16b-3. The Administering Body may, at the time a Stock Appreciation Right is granted, impose such conditions on the exercise of the Stock Appreciation Right as may be required to satisfy the requirements of Rule 16b-3 (or any other comparable provisions in effect at the time or times in question). 6.4 STOCK PAYMENTS. The Administering Body may approve Stock Payments of the Company's Common Stock to any Eligible Person for all or any portion of the compensation (other than base salary) or other payment that would otherwise become payable by the Company to the Eligible Person in cash. 6.5 DIVIDEND EQUIVALENTS. The Administering Body may grant Dividend Equivalents to any Recipient who has received a Stock Option, SAR or other Incentive Award denominated in shares of Common Stock. Such Dividend Equivalents shall be effective and shall entitle the recipients thereof to payments during the Applicable Dividend Period. Dividend Equivalents may be paid in cash, Common Stock or other Incentive Awards; the amount of Dividend Equivalents paid other than in cash shall be determined by the Administering Body by application of such formula as the Administering Body may deem appropriate to translate the cash value of dividends paid to the alternative form of payment of the Dividend Equivalent. Dividend Equivalents shall be computed as of each dividend record date and shall be payable to recipients thereof at such time as the Administering Body may determine. 13 14 6.6 STOCK BONUSES. The Administering Body may issue shares of Common Stock to Eligible Persons as bonuses for services rendered or for any other valid consideration on such terms and conditions as the Administering Body may determine. 6.7 STOCK SALES. The Administering Body may sell to Eligible Persons shares of Common Stock on such terms and conditions as the Administering Body may determine. 6.8 PHANTOM STOCK. The Administering Body is authorized to grant Awards of Phantom Stock. Phantom Stock is a cash bonus granted under this Plan measured by the Fair Market Value of a specified number of shares of Common Stock on a specified date, or measured by the excess of such Fair Market Value over a specified minimum, which may but need not include a Dividend Equivalent. 6.9 OTHER STOCK-BASED BENEFITS. The Administering Body is authorized to grant Other Stock-Based Benefits. Other Stock-Based Benefits are any arrangements granted under this Plan not otherwise described above which (i) by their terms might involve the issuance or sale of Common Stock or (ii) involve a benefit that is measured, as a whole or in part, by the value, appreciation, dividend yield or other features attributable to a specified number of shares of Common Stock. ARTICLE VII REORGANIZATIONS 7.1 CORPORATE TRANSACTIONS NOT INVOLVING A CHANGE IN CONTROL. If the Company shall consummate any Reorganization not involving a Change of Control in which holders of shares of Common Stock are entitled to receive in respect of such shares any securities, cash or other consideration (including without limitation a different number of shares of Common Stock), each Award outstanding under this Plan shall thereafter be exercisable, in accordance with this Plan, only for the kind and amount of securities, cash and/or other consideration receivable upon such Reorganization by a holder of the same number of shares of Common Stock as are subject to that Award immediately prior to such Reorganization, and any adjustments will be made in the sole discretion of the Administering Body to the terms of the Award as the Administering Body may deem appropriate to give effect to the Reorganization. 7.2 CORPORATE TRANSACTIONS INVOLVING A CHANGE IN CONTROL. As of the effective time and date of any Change in Control this Plan and any then outstanding Awards (whether or not vested) shall automatically terminate unless (i) provision is made in writing in connection with such transaction for the continuance of this Plan and for the assumption of such Awards, or for the substitution for such Awards of new awards covering the securities of a successor entity or an affiliate thereof, with appropriate adjustments as to the number and kind of securities and exercise prices, in which event this Plan and such outstanding Awards shall continue or be replaced, as the case may be, in the manner and under the terms so provided; or (ii) the Board otherwise shall provide in writing for such adjustments as it deems appropriate in the terms and conditions of the then-outstanding Awards (whether or not vested), including without limitation (A) accelerating the vesting of outstanding Awards, and/or (B) providing for the cancellation of Awards and their automatic conversion into the right to receive the securities, cash or other consideration that a holder of the shares underlying such Awards would have been entitled to receive upon consummation of such Change in Control had such shares been issued and outstanding immediately prior to the effective date and time of the Change in Control (net of the appropriate option exercise prices). If, pursuant to the foregoing provisions of this Section 7.2, this Plan and the Awards shall terminate by reason of the occurrence of a Change in Control without provision for any of the action(s) 14 15 described in clause (i) or (ii) hereof, then any Recipient holding outstanding Awards shall have the right, at such time immediately prior to the consummation of the Change in Control as the Board shall designate, to exercise the Recipient's Awards to the full extent not theretofore exercised, including any installments which have not yet become vested. ARTICLE VIII DEFINITIONS Capitalized terms used in this Plan and not otherwise defined shall have the meanings set forth below: "ADMINISTERING BODY" shall mean, subject to the provisions of Section 4.1(b)(ii) hereof, the Board as long as no Committee has been appointed and is in effect and shall mean the Committee once the Committee has been appointed and is in effect. "AFFILIATED ENTITY" means any Parent Corporation or Subsidiary Corporation. "APPLICABLE DIVIDEND PERIOD" means (i) the period between the date a Dividend Equivalent is granted and the date the related Stock Option, SAR, or other Incentive Award is exercised, terminates, or is converted to Common Stock, or (ii) such other time as the Administering Body may specify in the written instrument evidencing the grant of the Dividend Equivalent. "AWARD" means any Incentive Award. "AWARD DOCUMENT" means the agreement or confirming memorandum setting forth the terms and conditions of an Award. "BOARD" means the Board of Directors of the Company. "CALIFORNIA COMMISSIONER" means the Commissioner of Corporations of the State of California. "CALIFORNIA PERMITTED PLAN" means this Plan when at any time the issuance of securities under this Plan is not exempt from qualification under the California Securities Law and the issuance of securities under this Plan is subject to a qualification permit issued by the California Commissioner. "CALIFORNIA SECURITIES LAW" means the California Corporate Securities Law of 1968, as amended. "CALIFORNIA SECURITIES RULES" means the Rules of the California Commissioner adopted under the California Securities Law. "CHANGE IN CONTROL" means the following and shall be deemed to occur if any of the following events occur: (i) Any Person becomes the beneficial owner (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 50% or more of either the then outstanding shares of Common Stock or the combined voting power of the Company's then outstanding securities entitled to vote generally in the election of directors; or (ii) Individuals who, as of the effective date hereof, constitute the Board of Directors of the Company ("Incumbent Board") cease for any reason to 15 16 constitute at least a majority of the Board of Directors of the Company, provided that any individual who becomes a director after the effective date hereof whose election, or nomination for election by the Company's stockholders, is approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered to be a member of the Incumbent Board unless that individual was nominated or elected by any Person having the power to exercise, through beneficial ownership, voting agreement and/or proxy, 20% or more of either the then outstanding shares of Common Stock or the combined voting power of the Company's then outstanding voting securities entitled to vote generally in the election of directors, in which case that individual shall not be considered to be a member of the Incumbent Board unless such individual's election or nomination for election by the Company's stockholders is approved by a vote of at least two-thirds of the directors then comprising the Incumbent Board; or (iii) Consummation by the Company of the sale or other disposition by the Company of all or substantially all of the Company's assets or a Reorganization of the Company with any other person, corporation or other entity, other than: (A) a Reorganization that would result in the voting securities of the Company outstanding immediately prior thereto (or, in the case of a reorganization or merger or consolidation that is preceded or accomplished by an acquisition or series of related acquisitions by any Person, by tender or exchange offer or otherwise, of voting securities representing 5% or more of the combined voting power of all securities of the Company, immediately prior to such acquisition or the first acquisition in such series of acquisitions) continuing to represent, either by remaining outstanding or by being converted into voting securities of another entity, more than 50% of the combined voting power of the voting securities of the Company or such other entity outstanding immediately after such reorganization or merger or consolidation (or series of related transactions involving such a reorganization or merger or consolidation), or (B) a Reorganization effected to implement a recapitalization or reincorporation of the Company (or similar transaction) that does not result in a material change in beneficial ownership of the voting securities of the Company or its successor; or (iv) Approval by the stockholders of the Company or an order by a court of competent jurisdiction of a plan of liquidation of the Company. "COMMISSION" means the Securities and Exchange Commission. "COMMITTEE" means the committee appointed by the Board to administer this Plan pursuant to Section 4.1. "COMMON STOCK" means the common stock of the Company, $.01 par value per share, as constituted on the Effective Date of this Plan, and as thereafter adjusted as a result of any one or more events requiring adjustment of outstanding Awards under Section 3.4 above. "COMPANY" means Diedrich Coffee, Inc., a Delaware corporation. "DISINTERESTED DIRECTOR" means any non-employee director of the Company who qualifies as "disinterested" within the meaning of Rule 16b-3. 16 17 "DIVIDEND EQUIVALENT" means a right granted by the Company under Section 6.5 to a holder of a Stock Option, Stock Appreciation Right or other Incentive Award denominated in shares of Common Stock to receive from the Company during the Applicable Dividend Period payments equivalent to the amount of dividends payable to holders of the number of shares of Common Stock underlying such Stock Option, Stock Appreciation Right, or other Incentive Award. "EFFECTIVE DATE" means July 16, 1996, which is the date this Plan was adopted by the Board. "ELIGIBLE PERSON" shall include directors, officers, employees, consultants and advisors of the Company or of any Affiliated Entity; provided, however, that Disinterested Directors shall not be Eligible Persons at any time the Company is an Exchange Act Registered Company. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "EXCHANGE ACT REGISTERED COMPANY" means that the Company has any class of any equity security registered pursuant to Section 12 of the Exchange Act. "EXPIRATION DATE" means the tenth anniversary of the Effective Date. "FAIR MARKET VALUE" of a share of the Company's capital stock as of a particular date shall be: (i) if the stock is listed on an established stock exchange or exchanges (including for this purpose, the Nasdaq National Market), the mean between the highest and lowest sale prices of the stock quoted for such date in the Transactions Index of each such exchange as averaged with such mean price as reported on any and all other exchanges, as published in The Wall Street Journal and determined by the Administering Body, or, if no sale price was quoted in any such Index for such date, then as of the next preceding date on which such a sale price was quoted; or (ii) if the stock is not then listed on an exchange or the Nasdaq National Market, the average of the closing bid and asked prices per share for the stock in the over-the-counter market as quoted on The Nasdaq Small Cap Market on such date (in the case of (i) or (ii), subject to adjustment as and if necessary and appropriate to set an exercise price not less than 100% of the fair market value of the stock on the date an option is granted); or (iii) if the stock is not then listed on an exchange or quoted in the over-the-counter market, an amount determined in good faith by the Administering Body; provided, however, that (A) when appropriate, the Administering Body in determining Fair Market Value of capital stock of the Company may take into account such other factors as it may deem appropriate under the circumstances and (B) if the stock is traded on the Nasdaq Small Cap Market and both sales prices and bid and asked prices are quoted or available, the Administering Body may elect to determine Fair Market Value under either clause (i) or (ii) above. Notwithstanding the foregoing, the Fair Market Value of capital stock for purposes of grants of Incentive Stock Options shall be determined in compliance with applicable provisions of the IRC. The Fair Market Value of rights or property other than capital stock of the Company means the fair market value thereof as determined by the Committee on the basis of such factors as it may deem appropriate. "INCENTIVE AWARD" means any Stock Option, Restricted Stock, Stock Appreciation Right, Stock Payment, Stock Bonus, Stock Sale, Phantom Stock, Dividend Equivalent, or Other Stock-Based Benefit granted or sold to an Eligible Person under this Plan. 17 18 "INCENTIVE STOCK OPTION" means a Stock Option that qualifies as an incentive stock option under Section 422 of the IRC. "IRC" means the Internal Revenue Code of 1986, as amended. "JUST CAUSE DISMISSAL" shall mean a termination of a Recipient's employment for any of the following reasons: (i) the Recipient violates any reasonable rule or regulation of the Board, the Company's Chief Executive Officer or the Recipient's superiors that results in damage to the Company or which, after written notice to do so, the Recipient fails to correct within a reasonable time; (ii) any willful misconduct or gross negligence by the Recipient in the responsibilities assigned to the Recipient; (iii) any willful failure to perform the Recipient's job as required to meet Company objectives; (iv) any wrongful conduct of a Recipient which has an adverse impact on the Company or which constitutes a misappropriation of Company assets; (v) the Recipient's performing services for any other person or entity which competes with the Company while the Recipient is employed by the Company, without the written approval of the Chief Executive Officer of the Company; or (vi) any other conduct that the Administering Body determines constitutes Just Cause for Dismissal; provided, however, that if a Recipient is party to an employment agreement with the Company providing for just cause dismissal (or some comparable notion) of Recipient from Recipient's employment with the Company, "Just Cause Dismissal" for purposes of this Plan shall have the same meaning as ascribed thereto or to such comparable notion in such employment agreement. "NONQUALIFIED STOCK OPTION" means a Stock Option that is not an Incentive Stock Option. "OTHER STOCK-BASED BENEFITS" means an Incentive Award granted under Section 6.9 of this Plan. "OUTSIDE DIRECTOR" means an "outside director" as defined in the regulations adopted under Section 162(m) of the IRC. "PARENT CORPORATION" means any Parent Corporation as defined in Section 424(e) of the IRC. "PAYMENT EVENT" means the event or events giving rise to the right to payment of a Performance Award. "PERFORMANCE-BASED COMPENSATION" means performance-based compensation as described in Section 162(m) of the IRC. If the amount of compensation an Eligible Person will receive under any Award is not based solely on an increase in the value of Common Stock after the date of grant or award, the Committee, in order to qualify an Award as performance-based compensation under Section 162(m) of the IRC, can condition the grant, award, vesting, or exercisability of such an Award on the attainment of a preestablished, objective performance goal. For this purpose, a preestablished, objective performance goal may include one or more of the following performance criteria: (a) cash flow, (b) earnings per share (including earnings before interest, taxes, and amortization), (c) return on equity, (d) total stockholder return, (e) return on capital, (f) return on assets or net assets, (g) income or net income, (h) operating income or net operating income, (i) operating margin, (j) return on operating revenue, and (k) any other similar performance criteria. "PERSON" means any person, entity or group, within the meaning of Section 13(d) or 14(d) of the Exchange Act, but excluding (i) the Company and its subsidiaries, (ii) any employee stock ownership or other employee benefit plan maintained by 18 19 the Company that is qualified under ERISA and (iii) an underwriter or underwriting syndicate that has acquired the Company's securities solely in connection with a public offering thereof. "PERMANENT DISABILITY" shall mean that the Recipient becomes physically or mentally incapacitated or disabled so that the Recipient is unable to perform substantially the same services as the Recipient performed prior to incurring such incapacity or disability (the Company, at its option and expense, being entitled to retain a physician to confirm the existence of such incapacity or disability, and the determination of such physician to be binding upon the Company and the Recipient), and such incapacity or disability continues for a period of three consecutive months or six months in any 12-month period or such other period(s) as may be determined by the Committee with respect to any Award, provided that for purposes of determining the period during which an Incentive Stock Option may be exercised pursuant to Section 5.13(ii) hereof, Permanent Disability shall mean "permanent and total disability" as defined in Section 22(e) of the IRC. "PHANTOM STOCK" means an Incentive Award granted under Section 6.8 of this Plan. "PLAN" means this 1996 Stock Incentive Plan of the Company. "PLAN TERM" means the period during which this Plan remains in effect (commencing the Effective Date and ending on the Expiration Date). "PURCHASE PRICE" means the purchase price (if any) to be paid by a Recipient for Restricted Stock as determined by the Committee (which price shall be at least equal to the minimum price required under applicable laws and regulations for the issuance of Common Stock which is nontransferable and subject to a substantial risk of forfeiture until specific conditions are met). "RECIPIENT" means a person who has received an Award under this Plan. "REORGANIZATION" means any merger, consolidation or other reorganization. "RESTRICTED STOCK" means Common Stock that is the subject of an Award made under Section 6.2 and which is nontransferable and subject to a substantial risk of forfeiture until specific conditions are met as set forth in this Plan and in any statement evidencing the grant of such Incentive Award. "RULE 16B-3" means Rule 16b-3 promulgated under the Exchange Act. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SIGNIFICANT STOCKHOLDER" is an individual who, at the time a Stock Option is granted to such individual under this Plan, owns more than ten percent (10%) of the combined voting power of all classes of stock of the Company or of any Parent Corporation or Subsidiary Corporation (after application of the attribution rules set forth in Section 424(d) of the IRC). "STOCK APPRECIATION RIGHT" or "SAR" means a right granted under Section 6.3 to receive a payment that is measured with reference to the amount by which the Fair Market Value of a specified number of shares of Common Stock appreciates from a specified date, such as the date of grant of the SAR, to the date of exercise. 19 20 "STOCK BONUS" means an issuance or delivery of unrestricted or restricted shares of Common Stock under Section 6.6 of this Plan as a bonus for services rendered or for any other valid consideration under applicable law. "STOCK PAYMENT" means a payment in shares of the Company's Common Stock to replace all or any portion of the compensation (other than base salary) that would otherwise become payable to a Recipient. "STOCK OPTION" means a right to purchase stock of the Company granted under Section 6.1 of this Plan. "STOCK SALE" means a sale of Common Stock to an Eligible Person under Section 6.7 of this Plan. "SUBSIDIARY CORPORATION" means any Subsidiary Corporation as defined in Section 425(f) of the IRC. 20 EX-10.6 7 DEIDRICH COFFE 1996 NON-EMPLOYEE STOCK PLAN 1 EXHIBIT 10.6 DIEDRICH COFFEE, INC. 1996 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN ARTICLE I GENERAL 1.01 ADOPTION. This 1996 Non-Employee Directors Stock Option Plan (the "PLAN") has been adopted by the Board of Directors and approved by the stockholders of Diedrich Coffee, Inc., a Delaware corporation (the "COMPANY"), effective as of July 16, 1996, to promote the interests of the Company and its stockholders by using investment interests in the Company to attract and retain highly qualified independent directors. 1.02 ADMINISTRATION. The Plan shall be administered by the Company, which, subject to the express provisions of the Plan, shall have the power to construe the Plan and any agreements or memoranda defining the rights and obligations of the Company and option recipients, to determine all questions arising thereunder, to adopt and amend such rules and regulations for the administration thereof as it may deem desirable, and otherwise to carry out the terms of the Plan and such agreements or memoranda. The interpretation and construction by the administrator of any provisions of the Plan or of any option granted under the Plan shall be final. Notwithstanding the foregoing, the administrator shall have no authority or discretion as to the selection of persons eligible to receive options granted under the Plan, the number of shares covered by options granted under the Plan, the timing of such grants, or the exercise price of options granted under the Plan, which matters are specifically governed by the provisions of the Plan. 1.03 ELIGIBLE DIRECTORS. A person shall be eligible to receive grants of options under the Plan (an "ELIGIBLE DIRECTOR") if, at the time of the option's grant, he or she is a duly elected or appointed member of the Company's Board of Directors, but is not and has not since the beginning of the Company's most recently completed fiscal year been (a) granted or awarded any equity securities of the Company (including, without limitation, stock options and stock appreciation rights) except pursuant to the Plan or a similar plan for directors of the Company, or (b) an employee of the Company or any of its affiliates or otherwise eligible for selection as a person to whom equity securities of the Company (including, without limitation, stock options and stock appreciation rights) may be allocated or granted pursuant to any plan of the Company or any of its affiliates (other than the Plan or a similar plan for directors of the Company) entitling participants therein to acquire stock, stock options, or stock appreciation rights of the Company or any of its affiliates. 1.04 SHARES OF COMMON STOCK SUBJECT TO THE PLAN AND GRANT LIMIT. The shares that may be issued upon exercise of options granted under the Plan shall be authorized and unissued shares of the Company's Common Stock, previously issued shares of the Company's Common Stock reacquired by the Company and unused option shares pursuant to Section 2.06. The aggregate number of shares that may be issued upon exercise of options granted under the Plan shall not exceed 125,000 shares of Common Stock, subject to adjustment in accordance with Article III. 1.05 AMENDMENTS. The Company's Board of Directors may, insofar as permitted by law, from time to time suspend or discontinue the Plan or revise or amend it in any respect whatsoever, and the Plan as so revised or amended will govern all options thereunder, including those granted before such revision or amendment, except that no such 2 amendment shall alter or impair or diminish in any material respect any rights or obligations under any option theretofore granted under the Plan without the consent of the person to whom such option was granted. In addition, if an amendment to the Plan would increase the number of shares subject to the Plan (as adjusted under Article III), increase the number of shares for which an option or options may be granted to any optionee (as adjusted under Article III), change the class of persons eligible to receive options under the Plan, provide for the grant of options having an exercise price per option share less than the exercise price specified in the Plan, extend the final date upon which options may be granted under the Plan, or otherwise materially increase the benefits accruing to participants in a manner not specifically contemplated herein or affect the Plan's compliance with Rule 16b-3 promulgated under Section 16 of the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), and the rules promulgated thereunder, the amendment shall be approved by the Company's stockholders to the extent required to comply with Rule 16b-3 under the Exchange Act ("RULE 16b-3"). Under no circumstances may the provisions of the Plan that provide for the amounts, price, and timing of option grants be amended more than once every six months, other than to comport with changes in the Internal Revenue Code, the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or the rules thereunder. The Plan is intended to qualify as a formula plan under Rule 16b-3, but not to impose restrictions included in the Plan for purposes of compliance with Rule 16b-3 if those restrictions become unnecessary to compliance with Rule 16b-3. Accordingly, notwithstanding the foregoing, the administrator may administer and amend the Plan to comply with or take advantage of changes in the rules (or interpretations thereof) promulgated by the Securities and Exchange Commission or its staff under Section 16 of the Exchange Act, subject to the stockholder approval requirement described above. 1.06 TERM OF PLAN. Options may be granted under the Plan until the earlier to occur of the tenth anniversary of the effective date of the Plan or the date of a Change in Control, as defined in Section 3.02. In addition, no options may be granted during any suspension of the Plan or after its termination for any reason. Notwithstanding the foregoing, each option properly granted under the Plan shall remain in effect until such option has been exercised or terminated in accordance with its terms and the terms of the Plan. 1.07 RESTRICTIONS. All options granted under the Plan shall be subject to the requirement that, if at any time the Company shall determine, in its discretion, that the listing, registration or qualification of the shares subject to options granted under the Plan upon any securities exchange or under any state or federal law, or the consent or approval of any government or regulatory body or authority, is necessary or desirable as a condition of, or in connection with, the granting of such an option or the issuance, if any, or purchase of shares in connection therewith, such option may not be exercised in whole or in part unless such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company. Unless the shares of stock to be issued upon exercise of an option granted under the Plan have been effectively registered under the Securities Act of 1933, as amended (the "SECURITIES ACT") as now in force or hereafter amended, the Company shall be under no obligation to issue any shares of stock covered by any option unless the person who exercises such option, in whole or in part, shall give a written representation and undertaking to the Company satisfactory in form and scope to counsel to the Company and upon which, in the opinion of such counsel, the Company may reasonably rely, that he or she is acquiring the shares of stock issued to him or her pursuant to such exercise of the option for his or her own account as an investment and not with a view to, or for sale in connection with, the distribution of any such shares of stock, and that he or she will make no transfer of the same except in compliance with any rules and regulations in force at the time of such transfer under the Securities Act, or any other applicable law or regulation, 2 3 and that if shares of stock are issued without such registration, a legend to this effect may be endorsed upon the securities so issued and the Company may order its transfer agent to stop transfer of such shares. 1.08 NONASSIGNABILITY. No option granted under the Plan shall be assignable or transferable by the grantee except by will or by the laws of descent and distribution or pursuant to a qualified domestic relations order or, in the discretion of the administrator and under circumstances that would not adversely affect the interests of the Company, pursuant to a nominal transfer that does not result in a change in beneficial ownership or as otherwise permitted by rule or interpretation of the Securities and Exchange Commission or its staff as an exception to the general proscription on transfer of derivative securities set forth in Rule 16b-3 (or any successor rule) under the Exchange Act or interpretation thereof. During the lifetime of the optionee, the option shall be exercisable only by the optionee (or the optionee's permitted transferee) or his or her guardian or legal representative. 1.09 WITHHOLDING TAXES. Whenever shares of stock are to be issued upon exercise of an option granted under the Plan, the administrator shall have the right to require the optionee to remit to the Company an amount sufficient to satisfy any federal, state and local withholding tax requirements prior to such issuance. The administrator may, in the exercise of its discretion, allow satisfaction of tax withholding requirements by accepting delivery of stock of the Company or by withholding a portion of the stock otherwise issuable upon exercise of an option. 1.10 DEFINITION OF "FAIR MARKET VALUE." For purposes of the Plan, the "FAIR MARKET VALUE" of a share of stock as of a particular date shall be: (a) if the stock is listed on an established stock exchange or exchanges (including for this purpose, The Nasdaq Stock Market), the mean between the highest and lowest sale prices of the stock quoted for such date in the Transactions Index of each such exchange as averaged with such mean price as reported on any and all other exchanges, as published in The Wall Street Journal and determined by the administrator, or, if no sale price was quoted in any such Index for such date, then as of the next preceding date on which such a sale price was quoted; or (b) if the stock is not then listed on an exchange, the average of the closing bid and asked prices per share for the stock in the over-the-counter market as quoted on the NASDAQ system on such date (in the case of (a) or (b), subject to adjustment as and if necessary and appropriate to set an exercise price not less than 100% of the fair market value of the stock on the date an option is granted); or (c) if the stock is not then listed on an exchange or quoted in the over-the-counter market, an amount determined in good faith by the administrator. The Fair Market Value of rights or property other than stock shall be determined by the administrator on the basis of such factors as it may deem appropriate. 1.11 RIGHTS AS A STOCKHOLDER. An optionee or a permitted transferee of an option shall have no rights as a stockholder with respect to any shares issuable or issued upon exercise of the option until the date of the receipt by the Company of all amounts payable in connection with exercise of the option, including the exercise price and any amounts required pursuant to Section 1.09. ARTICLE II STOCK OPTIONS 2.01 GRANTS OF INITIAL OPTIONS. Each Eligible Director shall, upon first becoming an Eligible Director, receive a one-time grant of an option to purchase up to 5,000 shares of the Company's Common Stock at an exercise price per share equal to the Fair 3 4 Market Value of the Company's Common Stock on the date of grant, subject to (a) vesting as set forth in Section 2.03, and (b) adjustment as set forth in Article III. Options granted under this Section 2.01 are "INITIAL OPTIONS" for purposes hereof. 2.02 GRANTS OF ADDITIONAL OPTIONS. Immediately after the annual meeting of stockholders of the Company next following an Eligible Director's becoming an Eligible Director, and immediately following each subsequent annual meeting of stockholders of the Company, in each case if the Eligible Director has served as a director since his or her election or appointment and has been re-elected as a director at such annual meeting, such Eligible Director shall automatically receive an option to purchase up to 5,000 shares of the Company's Common Stock (an "ADDITIONAL OPTION"). In addition to the Additional Options described above, an individual who was previously an Eligible Director and received an initial grant of stock options under the Plan or pursuant to a prior option plan for the Company's directors, who then ceased to be a director for any reason, and who then again becomes an Eligible Director, shall upon again becoming an Eligible Director automatically receive an Additional Option. The exercise price per share for all Additional Options shall be equal to the Fair Market Value of the Company's Common Stock on the date of grant, subject to (a) vesting as set forth in Section 2.03, and (b) adjustment as set forth in Article III. 2.03 VESTING. Initial Options shall vest and become exercisable (a) 50% upon the earlier of (i) the first anniversary of the grant date or (ii) immediately prior to the first annual meeting of stockholders of the Company following the grant date, if the optionee has remained an Eligible Director for the entire period from the date of grant to such earlier date; and (b) 50% upon the earlier of (i) the second anniversary of the grant date or (ii) immediately prior to the second annual meeting of stockholders of the Company following the grant date, if the optionee has remained an Eligible Director for the entire period from the date of grant to such earlier date. Additional Options shall vest and become exercisable upon the earlier of (y) the first anniversary of the grant date or (z) immediately prior to the annual meeting of stockholders of the Company next following the grant date, if the optionee has remained an Eligible Director for the entire period from the date of grant to such earlier date. Notwithstanding the foregoing, Initial Options and Additional Options that have not vested and become exercisable at the time the optionee ceases to be a director shall terminate. 2.04 EXERCISE. No option shall be exercisable except in respect of whole shares, and fractional share interests shall be disregarded. Not less than 100 shares of stock (or such other amount as is set forth in the applicable option agreement or confirming memorandum) may be purchased at one time and options must be exercised in multiples of 100 unless the number purchased upon exercise is the total number at the time available for purchase under the terms of the option. An option shall be deemed to be exercised when the Secretary or other designated official of the Company receives written notice of such exercise from or on behalf of the optionee, together with payment of the exercise price and any amounts required under Section 1.09. The option exercise price shall be payable upon the exercise of an option in legal tender of the United States or capital stock of the Company delivered in transfer to the Company by or on behalf of the person exercising the option duly endorsed in blank or accompanied by stock powers duly endorsed in blank, with signatures guaranteed in accordance with the Exchange Act if required by the administrator or retained by the Company from the stock otherwise issuable upon exercise or surrender of vested and exercisable options previously granted to the recipient and being exercised (in either case valued at Fair Market Value as of the exercise date) or such other consideration as the administrator may from time to time in the exercise of its discretion deem acceptable in any particular instance, provided, however, that the administrator may, in the exercise of its discretion, (a) allow exercise of an option in a broker-assisted or similar transaction in which 4 5 the exercise price is not received by the Company until promptly after exercise, and/or (b) allow the Company to loan the exercise price to the person entitled to exercise the option, if the exercise will be followed by a prompt sale of some or all of the underlying shares and a portion of the sales proceeds is dedicated to full payment of the exercise price and amounts required pursuant to Section 1.09. 2.05 OPTION AGREEMENTS OR MEMORANDA. Each option granted under the Plan shall be evidenced by an option agreement duly executed on behalf of the Company and by the Eligible Director to whom such option is granted or, in the administrator's discretion, a confirming memorandum issued by the Company to the recipient, stating the number of shares of stock issuable upon exercise of the option and the exercise price, and setting forth explicitly or by reference to the Plan the time during which the option is exercisable and the times at which the options vest and become exercisable. Such option agreements or confirming memoranda may but need not be identical and shall comply with and be subject to the terms and conditions of the Plan, a copy of which shall be provided to each option recipient and incorporated by reference into each option agreement or confirming memorandum. Any option agreement or confirming memorandum may contain such other terms, provisions and conditions not inconsistent with the Plan as may be determined by the administrator. 2.06 TERM OF OPTIONS AND EFFECT OF TERMINATION. Notwithstanding any other provision of the Plan, no option granted under the Plan shall be exercisable after the expiration of ten years from the effective date of its grant. In the event that any outstanding option under the Plan expires by reason of lapse of time or is otherwise terminated without exercise for any reason, then the shares of Common Stock subject to such option that have not been issued upon exercise of the option shall again become available in the pool of shares of Common Stock for which options may be granted under the Plan. In the event that the recipient of any options granted under the Plan shall cease to be a director of the Company, and subject to Section 3.02, (a) all Initial Options granted under this plan to such recipient shall be exercisable, to the extent already exercisable at the date such recipient ceases to be a director and regardless of the reason the recipient ceases to be a director, for a period of 365 days after that date (or, if sooner, until the expiration of the option according to its terms), and shall then terminate; and (b) all Additional Options granted under this Plan to such recipient shall be exercisable, to the extent already exercisable at the date such recipient ceases to be a director, for a period of 365 days after that date (or, if sooner, until the expiration of the option according to its terms) if he or she ceases to be a director because of death or permanent disability, or for a period of 90 days after that date (or, if sooner, until the expiration of the option according to its terms) if he or she ceases to be a director for any other reason, and shall then terminate. In the event of the death of an optionee while such optionee is a director of the Company or within the period after termination of such status during which he or she is permitted to exercise an option, such option may be exercised by any person or persons designated by the optionee on a beneficiary designation form adopted by the administrator for such purpose or, if there is no effective beneficiary designation form on file with the Company, by the executors or administrators of the optionee's estate or by any person or persons who shall have acquired the option directly from the optionee by his or her will or the applicable laws of descent and distribution. ARTICLE III CORPORATE TRANSACTIONS 3.01 ANTI-DILUTION ADJUSTMENTS. The number of shares of Common Stock available for issuance upon exercise of options granted under the Plan, the number of shares for which each option can be exercised, and the exercise price per share of options shall be 5 6 appropriately and proportionately adjusted for any increase or decrease in the number of issued and outstanding shares of Common Stock resulting from a subdivision or consolidation of shares or the payment of a stock dividend or any other increase or decrease in the number of issued and outstanding shares of capital stock of the Company effected without receipt of consideration by the Company. No fractional interests will be issued under the Plan resulting from any such adjustments. 3.02 REORGANIZATIONS; MERGERS; CHANGES IN CONTROL. Subject to the other provisions of this Section 3.02, if the Company shall consummate any reorganization or merger or consolidation in which holders of shares of the Company's Common Stock are entitled to receive in respect of such shares any other consideration (including, without limitation, a different number of such shares), each option outstanding under the Plan shall thereafter be exercisable, in accordance with the Plan, only for the kind and amount of securities, cash and/or other property receivable upon such reorganization or merger or consolidation by a holder of the same number of shares of Common Stock as are subject to that option immediately prior to such reorganization or merger or consolidation, and any appropriate adjustments will be made to the exercise price thereof. In addition, if a Change in Control occurs and in connection with such Change in Control any recipient of an option granted under the Plan ceases to be a director of the Company, then such recipient shall have the right to exercise his or her options granted under the Plan in whole or in part during the applicable time period provided in Section 2.06 without regard to any vesting requirements. For purposes hereof, but without limitation, a director will be deemed to have ceased to be a director of the Company in connection with a Change in Control if such director (i) is removed by or resigns upon request of a Person (as defined in paragraph (a) below) exercising practical voting control over the Company following the Change in Control or a person acting upon authority or at the instruction of such Person, or (ii) is willing and able to continue as a director of the Company but is not re-elected to or retained on the Company's Board of Directors by the Company's stockholders through the stockholder vote or consent action for election of directors that precedes and is taken in connection with, or next follows, the Change in Control. For purposes hereof, a "CHANGE IN CONTROL" means the following and shall be deemed to occur if any of the following events occur: (a) Any person, entity or group, within the meaning of Section 13(d) or 14(d) of the Exchange Act, but excluding the Company and its subsidiaries and any employee benefit or stock ownership plan of the Company or its subsidiaries and also excluding an underwriter or underwriting syndicate that has acquired the Company's securities solely in connection with a public offering thereof (such person, entity or group being referred to herein as a "PERSON"), becomes the beneficial owner (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 50% or more of either the then outstanding shares of Common Stock or the combined voting power of the Company's then outstanding securities entitled to vote generally in the election of directors; or (b) Individuals who, as of the effective date hereof, constitute the Board of Directors of the Company (the "INCUMBENT BOARD") cease for any reason to constitute at least a majority of the Board of Directors of the Company, provided that any individual who becomes a director after the effective date hereof whose election, or nomination for election by the Company's stockholders, is approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered to be a member of the Incumbent Board unless that individual was nominated or elected by any Person having the power to exercise, through beneficial ownership, voting agreement and/or proxy, 20% or more of either the then outstanding shares of Common Stock or the combined voting power of the Company's then 6 7 outstanding voting securities entitled to vote generally in the election of directors, in which case that individual shall not be considered to be a member of the Incumbent Board unless such individual's election or nomination for election by the Company's stockholders is approved by a vote of at least two-thirds of the directors then comprising the Incumbent Board; or (c) Consummation by the Company of the sale or other disposition by the Company of all or substantially all of the Company's assets or a reorganization or merger or consolidation of the Company with any other person, entity or corporation, other than (i) a reorganization or merger or consolidation that would result in the voting securities of the Company outstanding immediately prior thereto (or, in the case of a reorganization or merger or consolidation that is preceded or accomplished by an acquisition or series of related acquisitions by any Person, by tender or exchange offer or otherwise, of voting securities representing 5% or more of the combined voting power of all securities of the Company, immediately prior to such acquisition or the first acquisition in such series of acquisitions) continuing to represent, either by remaining outstanding or by being converted into voting securities of another entity, more than 50% of the combined voting power of the voting securities of the Company or such other entity outstanding immediately after such reorganization or merger or consolidation (or series of related transactions involving such a reorganization or merger or consolidation), or (ii) a reorganization or merger or consolidation effected to implement a recapitalization or reincorporation of the Company (or similar transaction) that does not result in a material change in beneficial ownership of the voting securities of the Company or its successor; or (d) Approval by the stockholders of the Company or an order by a court of competent jurisdiction of a plan of liquidation of the Company. 3.03 DETERMINATION BY THE COMPANY. To the extent that the foregoing adjustments relate to stock or securities of the Company, such adjustments shall be made by the administrator, whose determination in that respect shall be final, binding and conclusive. The grant of an option pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure or to merge, consolidate, dissolve, or liquidate or to sell or transfer all or any part of its business or assets. 7 EX-10.8 8 REVOLVING PROMISSORY NOTE DATED 5-20-96 1 EXHIBIT 10.8 REVOLVING PROMISSORY NOTE $2,000,000 Maximum Principal Amount May 20, 1996 Non-negotiable Irvine, California FOR VALUE RECEIVED, the undersigned, Diedrich Coffee, a California corporation ("Borrower"), hereby promises to pay to the order of Redwood Enterprises VII, L.P., a California limited partnership with offices at 450 Newport Center Drive, Suite 450, Newport Beach, California 92660 or its successors or assigns ("Lender"), the principal sum of Two Million Dollars ($2,000,000) or such lesser amount as may be borrowed under the terms of this Note, together with interest on the unpaid principal amount from time to time outstanding from the date hereof until the principal amount of this Note is paid in full, in accordance with the terms of this Note, at the Note Rate (as defined below). The principal of this Note, together with all accrued interest, shall become due and payable on September 30, 1996. The "Note Rate" shall be the lesser of the prime rate plus three percent or the maximum rate allowable by law. The prime rate as of any date shall be determined by reference to the prime rate as published in the Wall Street Journal (the base rate on corporate loans posted by at least 75% of the thirty largest U.S. banks). Interest shall be computed daily at the Note Rate on the basis of the actual number of days in which all or any portion of the principal amount hereof is outstanding computed on the basis of a 360 day year. Borrower may borrow any amount up to an aggregate amount of $2,000,000 by providing notice to Lender no less than three (3) business days prior to the date of the borrowing, which notice shall include the amount of such borrowing and the date of such borrowing; provided that each such borrowing shall be in a minimum principal amount of $50,000 or any larger multiple of $10,000. Within the limits set forth in this Note, Borrower may borrow, repay and reborrow amounts under this Note, provided that the aggregate principal balance outstanding under this Note at any given time shall not exceed $2,000,000. All loans made by Lender and all repayments of the principal thereof shall be recorded by the Lender and endorsed by an officer of the Borrower on the schedule attached hereto, or on a continuation of such schedule attached to and made a part hereof; provided that the failure of Lender to make any such recordation or of Borrower to make any such endorsement shall not affect the obligations of Borrower hereunder. In the event that any principal and/or interest is not paid when due, without affecting any of Lender's other rights and remedies, the unpaid principal amount and, to the extent permitted by applicable law, interest, shall bear interest at the Note Rate and shall be payable on demand of Lender until such unpaid amount is paid in full. Principal and interest shall be payable in lawful money of the United States at Lender's offices located at the address set forth above. This Note may be prepaid in full at any time by the Borrower without penalty. 2 Each of the following shall constitute an event of default ("Event of Default") under this Note: (a) Borrower shall fail to pay when due (whether by acceleration or otherwise) principal or interest on this Note, and such default unless otherwise cured shall have continued for a period of fifteen (15) days; or (b) Borrower shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing; or (c) an involuntary case or other proceeding shall be commenced against the Borrower seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against the Borrower under the federal bankruptcy laws as now or hereafter in effect. If an Event of Default shall occur and be continuing or shall exist, the principal amount of the Promissory Note and interest accrued thereon shall be immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived, and an action therefor shall immediately accrue. This Note shall be governed by, and construed and enforced in accordance with, the internal laws (excluding the laws of conflict) of the State of California. All agreements between the undersigned and the holder hereof are expressly limited so that in no contingency or event whatsoever, whether by reason of advancement of the proceeds hereof, acceleration of maturity of the unpaid principal balance hereof, or otherwise, shall the amount paid or agreed to be paid to the holder hereof for the use, forbearance or detention of the money to be advanced hereunder exceed the highest lawful rate permissible under applicable usury laws. If, from any circumstances whatsoever, fulfillment of any provision hereof, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by law which a court of competent jurisdiction may deem applicable hereto, then ipso facto, the obligations to be fulfilled shall be reduced to the limit of such validity, and if from any circumstances the holder hereof shall ever receive as interest an amount which would exceed the highest lawful rate, such amount which would be excessive interest shall be applied to the reduction of the unpaid principal balance due hereunder and not to the payment of interest. No failure to exercise and no delay in exercising any right, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein provided are cumulative and not exclusive of any rights or remedies provided by law. This Note may be amended or modified only upon the written consent of both Borrower and Lender. Any amendment must specifically state the provision or provisions to be amended and the manner in which such provision(s) are to be amended. 2 3 Borrower promises to pay all the cost and expenses, including reasonable attorneys' fees, incurred in the collection and enforcement of this Note. Borrower and each surety, endorser, guarantor, and other party ever liable for payment of any sums of money payable under this Note, hereby, jointly and severally, consent to renewal and extension of time at or after the maturity hereof, without notice, and hereby, jointly and severally waive diligence, presentment, protest, demand and notice of every kind and, to the full extent permitted by law, the right to plead any statute of limitations as a defense to any demand hereunder. Borrower: Diedrich Coffee By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- 3 4 REVOLVING PROMISSORY NOTE LOANS AND PAYMENTS OF PRINCIPAL
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EX-10.9 9 AGREEMENT OF SALE DATED 2-23-96 1 EXHIBIT 10.9 AGREEMENT OF SALE THIS AGREEMENT OF SALE (this "Agreement") is made this 23rd day of February, 1996 by and among Brothers Coffee Bars, Inc. ("Bars"), and Brothers Gourmet Coffees, Inc. ("Brothers"), each of which are Delaware corporations whose principal places of business are located at 2255 Glades Road, Boca Raton, Florida 33431 (each of Bars and Brothers is sometimes individually referred to herein as a "Seller," and both of them are sometimes collectively referred to herein as the "Sellers"), and Diedrich Coffee, a California corporation having its principal place of business at 2144 Michelson Drive, Irvine, California 92715 (referred to herein as "Purchaser"). Each of the Sellers and the Purchaser is sometimes referred to herein as a "Party," and all of them are sometimes collectively referred to herein as the "Parties." RECITALS WHEREAS, Sellers are engaged through the "Brothers" tradename in the business of retail sales of coffee and other food, beverage, accessory and specialty items, as conducted through twelve store locations (as more specifically described in the leases set forth in Schedule 1(a)(i)) (individually, a "Store" and collectively, the "Stores") (collectively, the "Business"); WHEREAS, Sellers desire (1) to sell to Purchaser certain of their assets as more fully described in Paragraph 1(a) below, which assets include, without limitation, real property leasehold interests for the twelve (12) Stores, and (2) that Purchaser assume certain of the Sellers' liabilities under the terms and conditions as hereinafter set forth; and WHEREAS, Purchaser desires to purchase said assets, and is willing to assume said liabilities, all under the terms and conditions as hereinafter set forth. NOW, THEREFORE, in consideration of the mutual promises, covenants and representations of the Parties contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, it is hereby agreed by the Parties as follows: 1. SALE OF ASSETS. a. Transferred Assets. On the Closing Date (as defined in Paragraph 5(c) below), Sellers shall sell, transfer, assign, convey and deliver to Purchaser, for the consideration hereinafter provided, all right, title and interest in and to all of the assets used in or useful to the Business, as such assets are enumerated in Schedule 1(a) (the "Assets"), which Assets specifically include: (i) All of Sellers' right, title and interest under the real property leases for the Store locations described in Schedule 1(a)(i), true and complete copies of which leases have been delivered by Sellers to Purchaser prior to the date hereof and true and complete copies of which leases are attached to Schedule 1(a)(i) (the "Leases"), and the related security deposits. (ii) All the stock-in-trade, retail inventory, supplies, furniture, fixtures and equipment, leasehold improvements, telephone equipment, telephone numbers (if assignable), rights in and to personal property and other property used in the Business, as described in Schedule 1(a)(ii) (the "FF&E"). 2 (iii) All licenses and permits issued for use by Sellers at the Stores, if and to the extent so assignable, as described in Schedule 1(a)(iii) (the "Licenses"). (iv) All customer address cards, profiles, mailing lists and all other information regarding Sellers' current and potential customers at the Stores. (v) All hiring, training, operations, personnel, quality control, marketing and other manuals or systems owned by Sellers, including any computer-based or on-line systems, that are used in or were developed for the operation of the Stores. (vi) All existing plans or designs for the Stores and for capital and cost reduction projects in process at or currently planned in connection with the Stores (collectively, the "Blueprints"), as described in Schedule 1(a)(vi). (vii) All cash registers and polling systems used in or for the Stores, as described in Schedule 1(a)(vii) (the "POS Equipment"). (viii) The personal computers used at the Store locations, including, to the extent assignable, all related packaged and developed software, analysis sheets and business forms (i.e., time sheets, inventory control, etc.) used in Sellers' day-to-day operation of the Stores, Lotus Notes and the specialized programming developed to download and process Store operations data, as described in Schedule 1(a)(viii) (the "Computer Equipment"). (ix) Subject to Paragraph 4(d) below, all Brothers Keeper/Sleeper bean storage equipment. (x) All training, operations, personnel, quality control and marketing manuals and/or systems, including those which are computer based. (xi) All rights of Sellers under any and all express or implied warranties from Sellers' suppliers with respect to the Assets, if and to the extent assignable. b. Excluded Assets. This sale does not include any assets of Sellers other than those specifically described in Schedule 1(a). c. Amendments to Schedule 1(a). Sellers shall have the right to amend and update Schedule 1(a) through the Closing Date. No such amendment to Schedule 1(a) shall reduce the number of Stores and related Leases that are the subject of this Agreement, nor shall any such amendment have the effect of reducing by more than $ 2,500 the value of the Assets or of any particular Store, or adversely affecting by more than $ 2,500 the potential future operations of any particular Store. 2. PURCHASE PRICE. a. Calculation; Timing of Payment. The total purchase price for the Assets payable by Purchaser shall be $1,350,000 (the "Purchase Price") or $112,500 per Store (the "Store Price"). The Purchaser shall pay the Purchase Price at the following times in the following manner and subject to the following conditions: (i) Subject to repayment by Sellers to Purchaser pursuant to Paragraph 2(a)(iv), fifty percent (50%) of the Purchase Price (the "Downpayment") shall be paid by Purchaser to Sellers at Closing in cash by federal funds wire transfer pursuant to 2 3 written wire instructions provided by Sellers to Purchaser at least three (3) business days prior to Closing. (ii) In addition to the Downpayment, Purchaser shall pay to Sellers at Closing in cash, by federal funds wire transfer pursuant to written wire instructions provided by Sellers to Purchaser at least three (3) business days prior to Closing, the amount, if any, by which the Assigned Lease Amount as of the Closing Date exceeds the Downpayment. The "Assigned Lease Amount" shall be equal to the product of the Store Price multiplied by the number of Leases for which the Parties shall have received and executed a lease assignment and landlord consent to assignment in form satisfactory to Purchaser and Sellers ("Lease Assignment") executed by the landlord thereof. (iii) The balance of the Purchase Price (the "Purchase Reserve") shall be paid in cash by federal funds wire transfer to Norwest Bank of Colorado, N.A. (the "Escrow Agent"), pursuant to written wire instructions provided by Escrow Agent to Purchaser at least three business days prior to Closing which amount shall be held in an interest bearing account established for the benefit of Sellers and Purchaser, subject to the terms of that certain escrow agreement by and among Sellers, Purchaser and Escrow Agent, in the form and substance of Exhibit A hereto (the "Escrow Agreement"). The Purchase Reserve shall be held in escrow to secure Sellers' obligations under Paragraphs 3(a), 4(b), 4(k), 7(b), 9(b)(i) and 14(b) of this Agreement ("Sellers' Indemnification Obligations") and Sellers' obligations to obtain any Lease Assignments which are not obtained prior to the Closing Date. At such time as the Assigned Lease Amount equals or exceeds the Downpayment, then, within five (5) business days after Purchaser receives a Lease Assignment signed by the respective landlord with respect to any Lease that was not assigned on or prior to the Closing Date, an amount equal to the Store Price shall be transferred from the Purchase Reserve to Sellers pursuant to the terms of the Escrow Agreement; provided, however, that no such transfer to Sellers shall be permitted if such transfer shall result in the balance of funds held in the Purchase Reserve being less than twenty percent (20%) of the Purchase Reserve balance as of the day immediately following the Closing Date. After the close of the period ending September 30, 1996 (the "Deadline"), if all twelve (12) of the Leases have not been assigned as provided herein, the balance of the Purchase Reserve shall be paid by the Escrow Agent pursuant to the terms of the Escrow Agreement to Purchaser. In the event that all twelve (12) of the Leases have been assigned prior to the Deadline as provided herein, on the date that is six (6) months after the Closing Date, all amounts remaining in the Purchase Reserve on such date shall be paid by Escrow Agent to Sellers pursuant to the terms of the Escrow Agreement. (iv) Notwithstanding the foregoing, in the event that all twelve (12) of the Leases have not been assigned by the Deadline as provided herein and the amount of the Downpayment exceeds the Assigned Lease Amount as of the Deadline, then Sellers shall immediately pay the amount of such excess to Purchaser. b. Allocation of Purchase Price. Sellers and Purchaser shall allocate the Purchase Price among the Assets as set forth on Schedule 2(b) hereto, using the allocation method required by Section 1060 of the Internal Revenue Code of 1986, as amended (the "Code"), and the regulations thereunder. Sellers and Purchaser each agree to report the federal, state and local income and other tax consequences of the transactions contemplated herein, and in particular to report the information required by Code Section 1060(b), in a manner consistent with such allocation and will not take any position inconsistent therewith. c. Working Capital Adjustment. On or before the date which is twenty (20) business days following the Closing Date, (i) Purchaser shall pay to Sellers an amount equal to the aggregate amount of the prepaid rents made by Sellers as of the Closing 3 4 Date, with respect to the Leases for periods beyond the end of the month in which the Closing occurs, and (ii) Purchaser shall pay to Sellers (or Sellers shall pay to Purchaser) the increase (or decrease) in Sellers' retail inventory at the Stores (valued at Sellers' invoice cost) at the Closing Date as compared to Sellers' retail inventory at the Stores (valued at Sellers' invoice cost) as of December 29, 1995, and as set forth on Schedule 2(c). 3. ASSUMPTION OF CERTAIN LIABILITIES. a. Nonassumed Liabilities. Except as specifically provided in Paragraph 3(b) below, Purchaser shall not assume and shall not acquire, take over, or be responsible for any liabilities or obligations of the Sellers presently in existence, including, without limitation, all liabilities and obligations relating to the Business, Lease related commitments to contractors and landlords for Store build-outs, deferred rents or any other ongoing non-lease related items (such liabilities or obligations not assumed by Purchaser hereunder being herein referred to as the "Nonassumed Liabilities") and Sellers shall indemnify, defend and hold harmless Purchaser from all loss, cost, damage or expense related to the Nonassumed Liabilities. The parties intend for Purchaser to acquire ownership of the Assets free and clear of all claims, liens or encumbrances, except those claims, liens or encumbrances which the Purchaser has agreed to assume or take subject to as provided in Paragraph 3(b) below. The Sellers shall prior to Closing fulfill all construction, consulting and similar commitments (other than the payment of rent for periods after the month in which the Closing occurs) to landlords under the Leases. b. Assumed Liabilities. At Closing, Purchaser shall, pursuant to the terms of an Assumption Agreement in the form and substance of Exhibit B hereto, (i) with respect to Leases that have been assigned to Purchaser, assume and agree to perform the obligations set forth in the applicable Lease Assignment arising after the date of effectiveness of such Lease Assignment, (ii) assume and agree to perform obligations of Sellers arising after the Closing Date under all personal property leases set forth on Schedule 1(a)(ii) and (iii) satisfy all costs arising after the Closing Date under service agreements set forth on Schedule 1(a)(ii) (collectively referred to herein as the "Assumed Liabilities"), and shall indemnify, defend and hold harmless Sellers from all loss, cost, damage or expense related to the Assumed Liabilities, except as provided for in Paragraph 10(a) below. 4. OTHER AGREEMENTS. a. Employee Matters. Purchaser shall not assume, acquire, take over or be responsible for any liabilities or obligations of Sellers pursuant to any contract between Sellers and any of their employees. After the date hereof, Purchaser may interview any or all of Sellers' employees involved in the day-to-day operations of the Stores; provided, that, if the transaction contemplated by this Agreement does not close as provided herein, Purchaser shall not initiate contact with any of such employees for the purpose of inducing such employee to leave the employ of the Sellers until the date that is eighteen (18) months after the date hereof. b. Bulk Transfers. Purchaser and Sellers agree to waive the Uniform Commercial Code provisions relating to bulk transfers ("Bulk Sales Laws") with respect to the transactions contemplated by this Agreement. Sellers shall indemnify and hold Purchaser, its directors, officers, employees and agents harmless from and against all damages, costs and expenses arising out of the noncompliance with the Bulk Sales Laws. c. License to Use Name. Sellers shall permit Purchaser to use the "Brothers" trade name and trademark for a period not to exceed six (6) months following the 4 5 date that Purchaser has received all Lease Assignments executed by the respective landlords, in displays, signage and postings and on cups, stationary, packaging materials, supplies or inventory, and Purchaser shall discontinue any use thereof upon the expiration of such six-month period. Purchaser acknowledges that the failure to discontinue the use of the "Brothers" trade name and trademark at such time will cause irreparable damage to Sellers and that Sellers will be entitled to seek all available remedies at law and in equity against Purchaser. d. Brothers Keeper and Brothers Sleeper. Purchaser shall have the royalty-free right and perpetual, worldwide license to use the Brothers Keeper and Brothers Sleeper technology and equipment (as described on Schedule 4(d) hereto) in all of Purchaser's retail stores, existing and future (the "License"); provided, however, that Sellers shall retain any and all patent and other intellectual property rights in such equipment other than the License and, except as provided elsewhere herein, shall not be responsible following the Closing for (i) any warranties with respect to such technology and equipment, except as provided in this Agreement, (ii) any enhancements or modifications to such technology and equipment following the Closing or (iii) providing to Purchaser any additional technology or equipment other than the technology and equipment in Sellers' retail stores on the Closing Date as set forth on Schedule 4(d) hereto. e. Access to Books and Records. Purchaser may, prior to the Closing Date, through its representatives, review the properties, books and records of Sellers as they relate to the Assets and the Stores to inspect such Assets and Stores and familiarize itself with the Assets, the Leases and other matters related to the Assets and the Stores. Sellers shall, at Purchaser's expense, permit Purchaser and its representatives to have, from time to time after the Closing Date, full access to the premises and to all the books and records of Sellers related to the Assets and the Stores and to cause the officers of Sellers to (i) cooperate with and to furnish Purchaser with such financial and operating data and other information with respect to the Financial Statements, Assets and the Stores as Purchaser shall from time to time reasonably request for the purpose of conducting an audit or such other purposes related to the Business and (ii) provide management representations to Purchaser's auditors with respect to the Financial Statements provided that such auditors apply generally accepted accounting principles on a basis consistent with Seller's practice for the period preceding the Closing Date. f. Preservation of Goodwill. After the date hereof and through the Closing Date, Sellers shall use reasonable efforts to preserve for Purchaser the goodwill the Sellers have developed with their suppliers, customers and other persons having business relations with the Sellers with respect to the Stores. g. Non-Compete. Except as set forth in Schedule 4(g), Sellers shall not own, operate, license or franchise any retail locations in the United States that sell prepared coffee beverages and/or food items (whole beans only and the existing locations and licensing agreements listed in Schedule 4(g) excepted) for a period of five (5) years from Closing. Notwithstanding, Sellers may prepare or license the preparation and distribution of coffee beverages with the Sellers' names and/or marks within the indoor premises of its current and future wholesale customers whose principal business is not the retail sale and/or preparation of coffee beans and/or prepared coffee beverages nor the operation of a retail coffee establishment, provided that such preparation and distribution is not towards the effort of creating a retail presence so as to avoid the aforesaid restriction. However, Sellers shall not sell to nor license a wholesale customer which purchases whole beans for the purpose of obtaining the right to sell coffee beverages in order to avoid the restriction contained herein. 5 6 Sellers acknowledge that Purchaser is relying on this non-compete clause as a material inducement to consummate this transaction. h. Confidentiality. Purchaser and Sellers shall hold in strict confidence (i) all documents and information obtained from the other Parties hereto, their employees, agents and/or independent contractors, (ii) the nature and content of this Agreement and all discussions between Purchaser and Sellers regarding the transaction contemplated herein, whether prior to or after the execution of this Agreement and (iii) the fact that Sellers and Purchaser have entered into this Agreement (all of the above shall collectively be referred to herein as "Confidential Information"), and shall not disclose or convey any of such Confidential Information to any other person, provided that Purchaser and Sellers may disclose Confidential Information (x) to such of their employees, attorneys, accountants and financial advisors as is reasonable to facilitate consummation of the transactions contemplated by this Agreement, (y) to the extent any such disclosure is required by law and (z) to landlords and other third parties as necessary to facilitate obtaining such parties' consent to the transfer of Assets hereunder. i. Sellers to Operate in Ordinary Course of Business. During the period from the date of this Agreement to the Closing Date, Sellers shall (i) carry on the Business and conduct their operations of the Assets and the Stores only in the ordinary and usual course of business consistent with past practices, (ii) use their best efforts to (A) preserve intact the Assets and the Stores, (B) keep available the services of their officers and employees and (C) preserve existing relationships with licensors, suppliers, distributors, customers, landlords and others having business relationships with Sellers with respect to the Business, (iii) not waive any right of substantial value related to the Business, and (iv) communicate on a regular and frequent basis with one or more designated representatives of Purchaser to report material operational matters and to report the general status of ongoing operations of the Business. Prior to the Closing Date and except as may be first approved by the Purchaser or as is otherwise permitted or required by this Agreement, Sellers shall refrain from entering into or amending or terminating any material contract or commitment with respect to the Business, except in the ordinary course of business. j. Operation of Stores Following the Closing for Which No Lease Assignment Has Been Received. (i) In connection with each Store as to which the Seller does not deliver a Lease Assignment to Purchaser on the Closing Date, commencing on the Closing Date and ending on the earlier of the date that such Lease Assignment is delivered to the Purchaser or the Deadline, Purchaser shall (A) assume the operation of each such Store, (B) reasonably cooperate with Sellers in their efforts to obtain such Lease Assignment, (C) not knowingly or intentionally take any actions that would impair Sellers' ability to obtain such Lease Assignment and (D) use commercially reasonable efforts to maintain the goodwill and going concern value of the Store. During this period in which Purchaser is operating such Store, Purchaser shall have sole discretion in all operations and management of such Store as though there had been an assignment and (X) Sellers relinquish and Purchaser shall retain all rights to any revenues and/or income from the sale of goods and services from such Store and (Y) Purchaser shall be responsible for payment of all costs and expenses incurred in the operation of such Store (except for rental payments for the month in which the Closing occurs). (ii) On the first day following the date of the Deadline, Sellers shall resume operation of and responsibility for any Store for which no Lease Assignment has been received. As a result, notwithstanding anything in this Agreement to the 6 7 contrary, Sellers shall assume all risk and obligation under the Leases for such Stores on the first day following the date of the Deadline. (iii) In the event that Purchaser occupies any Store premises pursuant to this Paragraph 4(j), Sellers shall jointly and severally indemnify, defend, protect and hold Purchaser, its directors, officers, employees, agents and affiliates harmless from and against any and all Damages (as defined in Paragraph 9(b)(i)) arising out of, resulting from or in any way related to the non- assignment of any Lease on the Closing Date and/or Purchaser's occupancy of such Store premises on or after the Closing Date in violation of any Lease, including, but not limited to, Damages resulting from a landlord's failure to perform any of its obligations under any Lease. The foregoing indemnification is in addition to the indemnification provided by Paragraph 9. Purchaser shall reimburse Sellers for any regularly scheduled rental payments required to be made by Sellers to the landlord under the terms of a Lease after the month in which the Closing occurs and during Purchaser's occupancy of the related Store premises hereunder until such time as such Lease is validly assigned to Purchaser. (iv) The occupancy by Purchaser of any Store premises pursuant hereto shall not be deemed an implied assumption of the Lease. Sellers shall use their best efforts and shall take all necessary actions to obtain the valid assignment of each Lease to Purchaser effective as of the Closing Date or as soon thereafter as possible. Sellers shall bear all costs, expenses and risks relating to obtaining the valid assignment to Purchaser of each Lease. k. Certain Defaults. Sellers will give prompt notice to Purchaser of: (i) any notice of default received subsequent to the date of this Agreement (and prior to the Closing Date) under any lease, instrument or agreement to which it is a party or by which it is bound, which default would, if not remedied, result in a material adverse effect on the Business, Assets or operation of any particular Store or which would render materially incomplete or untrue any representation made herein; and (ii) any suit, action or proceeding instituted or, to the knowledge of Sellers, threatened against or affecting Sellers, the Business or the Assets subsequent to the date of this Agreement (and prior to the Closing Date) which, if adversely determined, would result in a material adverse effect on the Business, Assets or operation of any particular Store or which would render materially incorrect any representation made herein. l. Additional Actions. Subject to the terms and conditions of this Agreement, the parties hereto agree to use all reasonable efforts to take, or cause to be taken, all reasonable action and to do, or cause to be done, all things reasonably necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by this Agreement as promptly as reasonably practicable. Such obligation shall include without limitation such efforts of each of the parties, prior to the Closing Date, to obtain, to be effective either at the Closing Date or as soon as practicable thereafter, any required consents with respect to, or novations of, any contracts, agreements, plans, leases, instruments, licenses, arrangements or commitments of Sellers in effect prior to the Closing Date. In case at any time after the Closing Date any further action is necessary or desirable to carry out the purposes of this Agreement or to vest Purchaser with full title to all properties, assets, rights, approvals, immunities and franchises of Sellers, the proper officers, directors or employees of each party to this Agreement shall take all such necessary action. 7 8 5. CONDITIONS TO CLOSING, CLOSING AND DELIVERIES AT CLOSING. a. Conditions to Purchaser's Obligations. Subject to the terms of Paragraph 5(c) below, the obligation of Purchaser to consummate the transactions contemplated hereunder is expressly contingent upon the satisfaction, or written waiver by Purchaser in its sole discretion, of the following conditions precedent: (i) Purchaser shall have received duly executed originals of the following documents: (A) the opinion of Sellers' counsel, Ballard Spahr Andrews & Ingersoll, dated as of the Closing Date, in the form and substance of Exhibit C hereto, (B) Bills of Sale for the Assets in the form and substance of Exhibit D hereto, and (C) the Escrow Agreement. (ii) Sellers shall have performed in all material respects the obligations required under this Agreement to be performed by them at or prior to the Closing, and Sellers shall have provided Purchaser an Officer's Certificate to such effect at Closing. (iii) The representations and warranties of the Sellers contained herein shall be true and correct in all material respects at and as of the Closing Date as if made at and as of such time, except to the extent that a different time is specifically stated in such representations and warranties, and Sellers shall have provided to Purchaser an Officer's Certificate to such effect at Closing. (iv) No temporary restraining order, preliminary injunction or permanent injunction or other order preventing the consummation of the transactions contemplated by this Agreement shall have been issued by any federal, state or foreign court or other governmental or regulatory authority and remain in effect, and no litigation seeking the issuance of such an order or injunction, or seeking substantial damages against Purchaser or Sellers if the transactions contemplated by this Agreement are consummated, shall be pending which, in the good faith judgment of Sellers and Purchaser, has a reasonable probability of resulting in such order, injunction or substantial damages. In the event any such order or injunction shall have been issued, each party agrees to use its reasonable efforts to have any such injunction lifted. (v) No federal, state, local or foreign statute, rule or regulation shall have been enacted which would make the consummation of the transactions contemplated by this Agreement illegal. (vi) Since the date hereof, there shall not have been instituted and be continuing or threatened against any Seller, any claim, action or proceeding related to the Business or the Assets, which if determined adversely to such Seller could reasonably result in a material adverse effect on the Business, the Assets or the operation of any particular Store. (vii) No material adverse change shall have occurred related to the Business or the Assets or the operation of any particular Store. (viii) Except for Lease Assignments not obtained from landlords on or before the Closing Date, any and all other consents, assignments and releases required from third parties relating to contracts, licenses and other agreements and instruments that are part of the Assets shall have been obtained in form and substance satisfactory to Purchaser. 8 9 (ix) Sellers shall have delivered a final version of Schedule 1(a) which shall set forth the Assets to be transferred pursuant to this Agreement and such final version of Schedule 1(a) shall not differ from the version of Schedule 1(a) delivered on the date hereof if such difference results in a reduction in the value of the Assets being transferred hereunder by more than $ 2,500 or adversely affects the potential future operations of any Store by more than $ 2,500. (x) Purchaser shall have received a duly executed Officer's Certificate certifying that the conditions set forth in Paragraphs 5(a)(iv), (v), (vi), (vii), (viii) and (ix) have been satisfied. b. Conditions to Sellers' Obligations. Subject to the terms of Paragraph 5(c) below, the obligations of Sellers to consummate the transactions contemplated hereunder are expressly contingent upon the satisfaction, or written waiver by Sellers in their sole discretion, of the following conditions precedent: (i) Sellers shall have received duly executed originals of the following documents: (A) the Assumption Agreement, (B) the Escrow Agreement and (C) the opinion of Purchaser's counsel dated as of the Closing Date in substantially the form of Exhibit E. (ii) Purchaser shall have performed in all material respects its obligations required under this Agreement to be performed by it at or prior to the Closing, and Purchaser shall have provided to Sellers an Officer's Certificate to such effect at Closing. (iii) The representations and warranties of Purchaser contained herein shall be true and correct in all material respects at and as of the Closing Date as if made at and as of such time, except to the extent that a different time is specifically stated in such representations and warranties, and Purchaser shall have provided to Sellers an Officer's Certificate to such effect at Closing. c. Location of Closing and Closing Date. Unless otherwise agreed to by the Parties, the consummation of the transactions contemplated by this Agreement (the "Closing") shall take place at on February __, 1996, or such later date as is agreed to by the Parties in writing (the "Closing Date"), at the offices of Ballard Spahr Andrews & Ingersoll, 1225 17th Street, Suite 2300, Denver, Colorado. d. Deliveries at Closing. (i) Sellers shall execute and deliver or cause to be executed and delivered, as the case may be, to Purchaser (or the Escrow Agent) at Closing the following, each of which must be reasonably satisfactory in form and substance to Purchaser and its legal counsel (A) the Escrow Agreement, (B) the Bills of Sale for the Assets, (C) the Lease Assignments, (D) the opinion of Sellers' counsel, dated as of the Closing Date, (E) the Officer's Certificate described in Paragraphs 5(a)(iii) and (iv) above, (F) certified copies of resolutions of the Board of Directors of each Seller approving the execution and delivery of this Agreement and consummation of all of the transactions contemplated hereby, duly certified by an officer of each Seller and (G) all other documents or certificates required to be delivered to Purchaser under the provisions of this Agreement. (ii) Purchaser shall execute and deliver or cause to be executed and delivered, as the case may be, to Sellers (or the Escrow Agent) at Closing the following, each of which must be reasonably satisfactory in form and substance to Sellers and 9 10 their legal counsel (A) the Escrow Agreement, (B) the Assumption Agreement, (C) the Lease Assignments, (D) the Officer's Certificate described in Paragraphs 5(b)(iii) and (iv) above, (E) a certified copy of resolutions of the Board of Directors of Purchaser approving the execution and delivery of this Agreement and consummation of all of the transactions contemplated hereby, duly certified by an officer of Purchaser, (F) the opinion of Purchaser's counsel dated as of the Closing Date and (G) all other documents or certificates required to be delivered to Sellers under the provisions of this Agreement. 6. REPRESENTATIONS AND WARRANTIES OF SELLERS. Brothers, jointly and severally, and Bars, severally, make the following representations and warranties to Purchaser, with the knowledge that all such representations and warranties made by Sellers shall, subject to Paragraph 9(a) below, survive execution of this Agreement, and with the full knowledge that Purchaser is entering into and consummating this Agreement in full reliance thereon. a. Due Incorporation and Authorization. Each of the Sellers (i) has been duly incorporated, is validly existing and is in good standing under the laws of the State of Delaware, (ii) is in good standing in every jurisdiction in which the nature of the business conducted by it or the character of the properties owned or leased by it makes such qualification necessary, except where the failure to be in good standing does not have a material adverse effect on the operation of any particular Store or on each Seller's Business taken as a whole, and (iii) has the full power and authority to enter into this Agreement and the documents referenced herein and to consummate the transactions contemplated herein and otherwise to perform its obligations hereunder. This Agreement has been duly authorized and executed by each of the Sellers and constitutes the legal, valid and binding obligation of each of the Sellers, enforceable against each Seller in accordance with its terms. b. Violation. The execution and delivery of this Agreement by each of the Sellers, the assignment of the Leases and the consummation of the sale of the Assets contemplated hereby do not and will not (i) violate any provision of the Certificate of Incorporation or by-laws of any of the Sellers, (ii) violate any material court or administrative order, process, judgment or decree to which any of the Sellers is a party or by which any of them (or any of their respective properties or assets) is bound or (iii) except as disclosed on Schedule 6(b), violate any provision of, or result in the acceleration of or entitle any party to accelerate (whether after notice or lapse of time or both) any obligation under, or result in the creation or imposition of any material lien, charge, pledge, security interest or other encumbrance upon the property of any of the Sellers pursuant to any provision of, any mortgage, lien, lease, agreement, license, or instrument to which any of the Sellers is a party. c. Consents. Except as disclosed on Schedule 6(c) hereto, no consent or approval by or of, or any notification or filing with, any person (governmental or private) is required in connection with the execution, delivery and performance by Sellers of this Agreement or the consummation of the transactions contemplated hereby. d. Schedule of Assets. Schedule 1(a) is true, complete and correct in all material respects. All of the Assets are in satisfactory condition and repair for the requirements of the Business as now being conducted ordinary wear and tear excepted. There are no proceedings affecting any of the Assets pending or, to the knowledge of Sellers, threatened which may reasonably be expected to adversely curtail the use of the Assets for the purpose for which they were acquired or the purpose for which they are now used. The Assets constitute all of the assets and interests in assets that are necessary in the conduct of the 10 11 Business as currently being conducted, other than the Excluded Assets. Sellers are in possession of all Assets leased to them by others. e. Encumbrances. Except as disclosed on Schedule 6(e) hereto, at Closing, each Seller shall have good and marketable title to (or a valid leasehold or contractual interest in) its Assets, free and clear of any and all liens, claims, encumbrances, debts or other adverse claims or rights of any kind. f. Misstatements and Omissions. No representation or warranty by Sellers in this Agreement and/or any Exhibit, addendum or attachment hereto contains any untrue statement of a material fact, or omits any material fact necessary to make the statements contained therein not misleading. g. Litigation. Except as disclosed on Schedule 6(g), there is no action, suit or proceeding pending or, to Sellers' knowledge, contemplated in or before any licensing, taxing or other governmental body or any court of law or arbitrator which could result in the avoidance of any term or condition hereunder, or create any liability on the part of Purchaser for the actions or operations of the Assets or Stores either on or before or following the Closing Date, or which challenges the right or ability of Sellers to enter into this Agreement and perform their obligations hereunder, or which relates in any manner to the Assets or the Business. Except as disclosed as Schedule 6(g), to the knowledge of Sellers, there is no reasonable basis for a claim, action or proceeding against or relating to Sellers, the Assets or the Business which, if adversely determined, could, individually or in the aggregate, reasonably be expected to result in a material adverse effect on the Business, Assets or the operation of any particular Store. There is not in existence any order, judgment or decree of any court or other tribunal or other agency enjoining or requiring Sellers to take any action of any kind with respect to the Business or the Assets. h. Financial Information. Sellers have previously delivered to Purchaser the financial information set forth on Schedule 6(h) hereto with respect to the Assets and the Stores (the "Financial Statements"). The Financial Statements are true, correct and complete and have been prepared in conformity with generally accepted accounting principles applied on a consistent basis throughout the periods involved, except as otherwise noted therein and subject (in the case of interim financial statements referred to above) to year-end audit adjustments. i. Ordinary Course of Business. Except as set forth in Schedule 6(i) hereto, since January 1, 1995, (i) each Seller has operated its Assets and its Stores in the ordinary course, consistent with past practice, (ii) there has not been any change in the operations or condition, financial or otherwise, of the Business, including the Assets and the Stores, other than changes, none of which, individually or in the aggregate, has been materially adverse to each Seller's Assets or the operation of any particular Store, and (iii) there has not been any material Asset sold or disposed of (except inventory sold in the ordinary course of business), any material Asset mortgaged, pledged or subjected to any lien, charge or other encumbrance. j. Compliance with Laws. (i) Except as disclosed on Schedule 6(j), each Seller has complied and the Business has been operated in compliance with all applicable federal, state and local laws and regulations, including, without limitation, Environmental Laws and the Americans with Disabilities Act of 1990, and all applicable foreign laws and regulations relating to the operation of the Business, its Assets and its Stores, except where failure to 11 12 comply with such laws and regulations would not have a material adverse effect on the Business or each Seller's operation of its Assets and its Stores, taken as a whole, or a material adverse effect as to the continued operation of any particular Store by Purchaser from and after the Closing Date. For purposes of this Agreement, the term "Environmental Laws" shall mean any federal, state or local statute, ordinance, rule, regulation, order, consent decree, judgment or common-law doctrine, and provisions and conditions of permits, licenses and other operating authorizations relating to (i) pollution or protection of the environment, (ii) exposure of persons, including employees, to toxic or hazardous substances or other products, raw materials, chemicals or other substances, (iii) protection of the public health or welfare from the effects of by-products, wastes, emissions, discharges or releases of chemical substances from industrial or commercial activities or (iv) regulation of the manufacture, use or introduction into commerce of chemical substances, including, without limitation, their manufacture, formulation, labeling, distribution, transportation, handling, storage and disposal. (ii) Each Seller, its employees or agents have not caused or, to such Seller's knowledge, allowed the generation, treatment, storage, release or disposal of hazardous substances except in compliance with all Environmental Laws. Each Seller, its employees or agents have not received any written notice or, to the knowledge of such Seller, any other communication, from any governmental authority alleging or concerning any violation by such Seller of, or responsibility or liability of such Seller under, any Environmental Law. There are no pending, or to the knowledge of each Seller, threatened, claims, suits, proceedings or investigations with respect to the Business or the Assets alleging or concerning any violation of or responsibility or liability under any Environmental Law, nor does any Seller have any knowledge of any fact or condition which might reasonably be expected to give rise to such a claim, suit, proceeding or investigation. Each Seller is in possession of all material approvals, permits and licenses from all governmental authorities under statutes and regulations relating to the environment and to workplace health and safety with respect to the operation of the Business; there are no pending or, to the knowledge of each Seller, threatened, actions, proceedings or investigations seeking to revoke or deny renewal of any of such approvals, permits and licenses; and each Seller has no knowledge of any fact or condition which would reasonably be expected to give rise to any action, proceeding or investigation to revoke or deny renewal of such approvals, permits or licenses. (iii) Schedule 6(j) sets forth a true and complete list of each health authority (including, without limitation, the Department of Health) pending or actual review of or visitation to a Store on or after January 1, 1995, and the date of such pending or actual review or visitation and, in the case of a completed review or visitation, a summary of the health authority's findings resulting therefrom. Except as set forth on Schedule 6(j), there are not existing, nor to the knowledge of each Seller threatened, any orders or requests by any health authority requiring or requesting any action by such Seller relating in any manner to the Business or the Assets. Prior to the Closing Date, the Sellers have provided Purchaser with true and complete copies of all correspondence since January 1, 1995 with any health authority relating in any manner to the Business or the Assets. k. Inventories. All of the inventories included in the Financial Statements are usable and salable in the ordinary course of business, except for items of obsolete materials and materials of below-standard quality, all of which have been written off or written down to fair market value on the Financial Statements and in accordance with generally accepted accounting principles and except for such lack of usability and salability as would not have a material adverse affect on the value of the inventory. No inventory has been pledged as collateral. 12 13 l. Permits and Licenses. Except as disclosed on Schedule 6(l), each Seller has all permits, governmental licenses, registrations and approvals (collectively, "Approvals") necessary to carry on the Business as operated at its Stores (as presently conducted) as required by law or the rules and regulations of any federal, state, county or local association, corporation or governmental agency, body, instrumentality or commission having jurisdiction over them, except where the failure to have any such Approvals would not have a material adverse affect on each Seller's operation of its Stores, taken as a whole, or a material adverse effect as to the continued operation of any particular Store by Purchaser from and after the Closing Date. m. Material Contracts. Schedule 6(m) hereto sets forth a list of all material contracts and agreements, whether oral or written, to which each of the Sellers is a party with respect to the Business. With respect to such contracts, except as set forth in Schedule 6(m), Sellers (with respect to the contracts to which each is a party) are not in breach thereof or default thereunder and, to the best knowledge of Sellers, there does not exist under any such contract any event which, with the giving of notice or the lapse of time, would constitute such a breach or default, except for such breaches, defaults and events as to which requisite waivers or consents have been obtained or as to which do not or would not have a material adverse affect on the Business or the operation of any particular Store. n. Labor Matters. Schedule 6(n) hereto sets forth all labor union and collective bargaining agreements and all employment or consulting contracts to which any Seller is a party and which are related to the Business. o. Taxes. Each Seller has paid or accrued for all applicable income, social security, withholding, sales, unemployment insurance, and other taxes of any kind relating to the Business due through the Closing Date, and each Seller has properly filed all required tax returns and applicable regulatory filings as provided by law which are due to be filed as of the Closing Date and shall file on a timely basis all such returns and filings, and shall make all related payments, required to be filed or made by such Seller with respect to the Assets and the Stores following the Closing Date. All such filings were true, correct and complete when made. p. Other Transactions. Sellers, individually and in the aggregate, have not entered into any unterminated contract to sell (other than this Agreement) the Assets or the Stores, or any portion thereof. q. Leases and Real Property. Except as disclosed on Schedule 6(q), the Leases are in full force and effect as written and, at Closing, the Sellers will be in full compliance therewith. Schedule 6(q) lists each lease of real property related to the Business (including, without limitation, the Leases) under which any Seller is a lessee, lessor, sublessee or sublessor, as so designated therein. All leases, easements and other real property interests held by each Seller are valid and subsisting and, except as disclosed on Schedule 6(q), each Seller is not in default thereunder. No Seller owns any real property used in the Business. r. Absence of Undisclosed Liabilities. Except as disclosed in the Financial Statements, no Seller has any material liabilities or obligations (contingent or otherwise) relating to the Business or the Assets. s. Full Disclosure. All instruments, agreements and other documents delivered or to be delivered, or made available, to Purchaser pursuant to this Agreement are complete and correct in all material respects. No representation or warranty made by Sellers in this Paragraph 6 or the Schedules to this Agreement contains or will 13 14 contain any untrue statement of a material fact or omits or will omit to state a material fact required to be stated herein or therein necessary to make the statements on behalf of Sellers in this Paragraph 6. and the Schedules to this Agreement, in light of the circumstances in which they are made, not misleading. 7. EXCLUSION OF WARRANTIES. a. No Warranties. Provided that nothing in this Paragraph 7(a) shall be deemed to limit the effect of the other covenants, representations and warranties made by Sellers in Paragraph 6, Paragraph 7(b) or elsewhere herein, the Parties agree that all FF&E shall be in good operating condition on the Closing Date, and are otherwise sold pursuant to this Agreement "AS IS." EXCEPT AS TO THE OPERATING CONDITION ON THE DAY OF CLOSING, THERE ARE NO WARRANTIES WITH RESPECT TO THE FF&E WHICH EXTEND BEYOND THE DESCRIPTION UPON THE FACE HEREOF. EXCEPT AS PROVIDED ELSEWHERE IN THIS AGREEMENT, SELLERS MAKE NO REPRESENTATIONS OR WARRANTIES OF ANY KIND, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THOSE WITH RESPECT TO THE CONDITION OF THE ASSETS, THEIR MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR WITH RESPECT TO PATIENT INFRINGEMENT OR THE LIKE. Except as provided in this Agreement, there shall be no abatement of the Purchase Price and Sellers shall have no liability to Purchaser for any claim, loss or damage as a result of (i) any non-operating deficiency or defect in the FF&E, (ii) the use or performance of the FF&E or (iii) any interruption or loss of service or of use of the FF&E; and b. Limited Warranty. The Sellers hereby warrant that all Assets, including, without limitation, all FF&E and buildouts in the Stores, are in good operating condition as of the Closing Date, and Purchaser shall have a period of six (6) months from the Closing Date to notify Seller of any nonconforming Assets pursuant to this warranty. In the event that Purchaser determines and establishes that any of such Assets were not in good operating condition as of the Closing Date, Sellers shall reimburse Purchaser within five (5) business days of Sellers' receipt of the reimbursement request for any of Purchaser's reasonable costs related to repairing or replacing such defective items. Sellers shall not be obligated to reimburse Purchaser for any repairs and/or replacements of such items if such repair and/or replacement shall cost less than one hundred dollars ($100) per item, except that the Sellers shall reimburse Purchaser for any such repairs and/or replacements which aggregate in excess of five hundred dollars ($500) in any one Store. All equipment and construction warranties applicable to the Assets shall, to the extent assignable, be assigned by the Sellers at Closing to Purchaser. 8. REPRESENTATIONS AND WARRANTIES OF PURCHASER. Purchaser makes the following representations and warranties to Sellers, with the knowledge that all such representations and warranties made by Purchaser shall, subject to Paragraph 9(a) below, survive execution of this Agreement, and with full knowledge that Sellers are entering into and consummating this Agreement in full reliance thereon. a. Due Incorporation and Authorization. Purchaser (i) has been duly incorporated, is validly existing and is in good standing under the laws of the State of California, (ii) is in good standing in every jurisdiction in which the nature of the business conducted by it or the character of the properties owned or leased by it makes such 14 15 qualification necessary, except where the failure to be in good standing does not have a material adverse effect on Purchaser's business taken as a whole, and (iii) has the full power and authority to enter into this Agreement and to consummate the transactions contemplated herein and otherwise to perform its obligations hereunder. This Agreement has been duly authorized and executed by the Purchaser and constitutes the legal, valid and binding obligation of Purchaser enforceable against it in accordance with its terms. b. Violation. The execution and delivery of this Agreement by the Purchaser, the acceptance of the valid assignment of the Leases, the consummation of the purchase of the Assets and the assumption of the Assumed Liabilities contemplated hereby will not (i) violate any provision of the articles of incorporation or by-laws of the Purchaser or (ii) violate any material court or administrative order, process, judgment or decree to which either Purchaser is a party or by which Purchaser is bound. c. Consents. No consent or approval by, or any notification of or filing with, any person (governmental or private) is required in connection with the execution, delivery and performance by Purchaser of this Agreement or the consummation of the transactions contemplated hereby, other than those consents which have been obtained. d. Misstatements and Omissions. No representation or warranty of Purchaser in this Agreement and/or any Exhibit, addendum or attachment hereto, contains any untrue statement of a material fact, or omits any material fact necessary to make the statements contained therein not misleading. e. Litigation. Purchaser is not aware of any action, suit or proceeding pending or contemplated in or before any licensing, taxing or other governmental body or any court of law which could result in the avoidance of any term or condition hereunder or which challenges the right or ability of Purchaser to enter into this Agreement and perform its obligations hereunder. f. Financing. There is no financing contingency which may prohibit or delay Purchaser's ability to close the transactions contemplated hereby. 9. INDEMNIFICATION. a. Survival of Representations and Warranties. Regardless of any investigations of any Party made prior to the Closing, all representations and warranties made by Sellers and Purchaser herein shall survive the Closing hereunder for a period of one (1) year following the Closing Date, and any claim with respect to the inaccuracy of any such representation or warranty must be made during such one-year period; provided, however, that the representations and warranties contained in Paragraphs 6(d), 6(e), 6(j) and 6(o) hereof shall survive the closing until expiration of applicable statutes of limitation. b. Agreement to Indemnify. (i) Subject to the limitations set forth in this Paragraph 9, from and after the Closing, Brothers, jointly and severally, and Bars, severally, agree to indemnify, defend and hold Purchaser and its directors, officers, employees and agents harmless from and against any and all demands, claims, losses, damages, costs and expenses of any kind, including without limitation interest, costs, penalties and reasonable attorneys' fees (collectively, "Damages"), asserted against, resulting from, imposed upon or incurred or suffered by Purchaser and its directors, officers, employees and agents as a result of or arising from (A) the Nonassumed Liabilities, (B) the Assumed Liabilities on or prior to the Closing 15 16 Date, (C) any inaccuracy in or breach or nonfulfillment in any material respect of any representation, warranty, covenant or agreement of Sellers contained in this Agreement, (D) the payment of any Taxes (including interest and penalties) of any kind or nature imposed, whether before or after the Closing, by any government or subdivision thereof upon the business, assets or employees or independent contractors of Sellers or otherwise resulting from or relating to the Business or the Assets prior to or on the Closing, (E) the death of or injury to any person or damage to property that occurred prior to the Closing and arose out of or in connection with the Business or the Assets (whether asserted, discovered or established before or after the Closing, and whether or not such claim or action is disclosed in the Schedules to this Agreement), (F) all employment-related claims and causes of action, and all other claims and causes of action, that have arisen or arise out of or in connection with the Business or the Assets prior to the Closing (whether asserted, discovered or established before or after the Closing, and whether or not such claim or action is disclosed in the Schedules to this Agreement), (G) all intellectual property-related claims and causes of action, and all other claims and causes of action, that arise out of or in connection with the use by Purchaser of the rights granted to it pursuant to Paragraphs 4(c) and 4(d), including, without limitation, any claims and causes of action that the "Brothers", "Brothers Keeper" or "Brothers Sleeper" name and related trademarks, tradenames and/or logos infringe any United States or foreign trademark or other proprietary right, and (H) the existence prior to the Closing Date of any hazardous or toxic substances, wastes or materials, defined as such or governed by any applicable Environmental Law ("Hazardous Materials") upon, about or beneath any property of any Seller or migrating or threatening to migrate from any such properties, or the existence of a violation of Environmental Laws pertaining to such properties or the Business or the Assets, regardless of whether the existence of such Hazardous Materials or the violation of Environmental Laws arose prior to the present ownership or operation of such properties by Sellers or was disclosed to Purchaser by any Seller. Subject to the provisions of this Paragraph 9, Purchaser shall have the right to offset any amount due hereunder by withdrawing such amount from the Purchase Reserve. (ii) Subject to the limitations set forth in this Paragraph 9, Purchaser agrees to indemnify, defend and hold Sellers harmless from and against any and all Damages, asserted against, resulting from, imposed upon or incurred or suffered by Sellers as a result of or arising from (A) the Assumed Liabilities after the Closing Date and (B) any inaccuracy in or breach or nonfulfillment in any material respect of any representation, warranty, covenant or agreement of Purchaser contained in this Agreement. (iii) For purposes of this Paragraph 9, all Damages shall be computed net of (A) any insurance proceeds actually received by the indemnified party with respect thereto and (B) any amounts recovered from any third parties based on claims the indemnified party has against such third parties which reduce the Damages that would otherwise be sustained. Each indemnified party agrees to use reasonable efforts to pursue any claims or rights it may have against any third party, or otherwise cooperate with the indemnifying party, so as to reduce the amount of Damages otherwise incurred by such indemnified party. c. Procedure for Indemnification. (i) In the event that any indemnified party receives written notice of the commencement of any action or proceeding, the assertion of any claim by a third party or the imposition of any penalty or assessment for which indemnity may be sought pursuant to this Paragraph 9 (a "Third Party Claim"), and such indemnified party intends to seek indemnity pursuant to this Paragraph 9, such indemnified party shall promptly provide the indemnifying party with written notice of such Third Party Claim (provided that failure to 16 17 provide such notice shall not effect the indemnified party's right to indemnity hereunder), and such indemnifying party shall, upon receipt of such notice, be entitled to participate in or, at the indemnifying party's option, assume the defense, appeal or settlement of such Third Party Claim with respect to which such indemnity has been invoked with counsel of its choosing, subject to the consent of the indemnified party, which consent shall not be unreasonably withheld, and such indemnified party shall fully cooperate with the indemnifying party in connection therewith; provided that such indemnified party shall be entitled to employ counsel to represent such indemnified party if, in such indemnified party's reasonable judgment, a conflict of interest between the indemnifying party and the indemnified party exists in respect of such Third Party Claim and in that event the fees and expenses of such separate counsel after the date on which the indemnifying party assumes the defense shall be paid by the indemnified party. In the event that the indemnifying party fails to assume the defense, appeal or settlement of such Third Party Claim within twenty (20) days after receipt of written notice thereof from such indemnified party, such indemnified party shall have the right to undertake the defense or appeal of or settle or compromise such Third Party Claim on behalf of, at the expense of, and for the account and risk of the indemnifying party. The indemnifying party shall not settle or compromise any Third Party Claim without such indemnified party's prior written consent, which shall not be unreasonably withheld, unless the terms of such settlement or compromise release such indemnified party from any and all liability with respect to such Third Party Claim. (ii) Any indemnifiable claim that is not a Third Party Claim shall be asserted by the party entitled to indemnification hereunder by written notice to the indemnifying party in compliance with the terms of this Agreement. If the indemnifying party does not respond to such notice within sixty (60) days, it shall have no further right to contest the validity of such claim. d. Limitations on Indemnification. Sellers shall not be liable for Damages under Paragraph 9(b)(i), and Purchaser shall not be liable for Damages under Paragraph 9(b)(ii), unless the aggregate amount of Damages for which Sellers or Purchaser, as the case may be, would, but for the provisions of this Paragraph 9(d), be liable exceeds, on an aggregate basis, $20,000 and then only to the extent of any such excess; provided, that such limitation shall not be applicable to Seller's limited warranty, set forth in Paragraph 7(b), as to the good operating condition of the Assets as of the Closing Date, nor shall such limitation restrict amounts paid to Purchaser following the Closing Date from the Purchase Reserve under the Escrow Agreement in satisfaction of Sellers' obligations under Paragraph 9(b)(i) or to Disputed Amounts of the Purchase Reserve under the Escrow Agreement. The aggregate liability of Sellers, on the one hand, and Purchaser, on the other hand, under this Paragraph 9 shall in no event exceed the Purchase Price. e. Remedies Exclusive. The remedies provided in this Paragraph 9 shall be exclusive and shall preclude assertion by an indemnified party of any other rights or the seeking of any and all other remedies against an indemnifying party for claims based on this Agreement. f. Payments. Payments of all amounts owing by any indemnifying party pursuant to this Paragraph 9 relating to a Third Party Claim shall be made within fifteen (15) days after the latest of (i) the settlement of such Third Party Claim, (ii) the expiration of the period for appeal of a final adjudication of such Third Party Claim or (iii) the expiration of the period for appeal of a final adjudication of the indemnifying party's liability to the indemnified party under this Agreement. Payments of all amounts owing by any indemnifying party other than for a Third Party Claim shall be made within fifteen (15) days after the later of (i) the expiration of the 60- day indemnity notice period set forth in Paragraph 9(c)(ii) or (ii) 17 18 the expiration of the period for appeal of a final adjudication of the indemnifying party's liability to the indemnified party under this Agreement. 10. TRANSFER; RISK OF LOSS. a. Transfer of Assets and Assumption of Assumed Liabilities. Purchaser shall take over and assume management and operational control of the Stores, shall acquire legal and beneficial ownership of the Assets related to such Stores, and shall assume, acquire, take over and become responsible for the Assumed Liabilities related thereto as of the end of the day on the Closing Date. If Lease Assignments are not received with respect to a particular Store or Stores on or before the Deadline (following which the balance of the Purchase Reserve is disbursed to Purchaser), management, operational control, ownership of the Assets and responsibility for the Assumed Liabilities as to such Store or Stores shall revert to Sellers as of the first day following the close of such period. b. Risk of Loss. Sellers shall retain all risk of destruction, loss or damage due to fire or other casualty with respect to each Store and its related Assets through the Closing Date. Such risks shall revert to Sellers as to any Store or Stores for which Lease Assignments are not received on or before the Deadline, (following which the balance of the Purchase Reserve is disbursed to Purchaser), as of the first day following the close of such period. 11. CERTAIN TRANSITION PROVISIONS. a. Taxes and Rents. Taxes, rent and all other charges due under the Leases shall be paid by Sellers through the last day of the month in which the Closing occurs, without reimbursement by Purchaser. All utility and telephone service to the Stores premises shall be discontinued in Sellers' names within a reasonable period following the Closing and Sellers shall no longer be responsible for payment of the related charges effective, in each case, on and as of the close of business on the last day of the month in which the Closing occurs. b. Pre-Closing Credits. Purchaser shall reimburse Sellers within ten (10) business days of receipt of any retroactive credits or other amounts (excluding security deposits) which all or partially relate to any period prior to Closing (for example, a real estate tax credit arising after the Closing that relates to the period nine (9) months before and three (3) months after Closing will be reimbursed by Purchaser to Sellers to the extent of seventy-five percent (75%) of such credit received by Purchaser). c. Post-Closing Charges. Sellers shall reimburse Purchaser within ten (10) business days after receiving written notice from Purchaser of any charges which all or partially relate to any period prior to Closing and which are not Assumed Liabilities (for example, a real estate tax charge received from a landlord after the Closing that relates to the period nine (9) months before and three (3) months after Closing will be reimbursed by Sellers to the extent of seventy-five percent (75%) of the bill). d. Supply Agreement. Commencing on the Closing Date and continuing for a period of fourteen (14) days thereafter, Sellers hereby agree to supply to the Purchaser and the Stores whole coffee beans on substantially the same terms and conditions (i.e., quantity of beans, quality of beans, type of beans and delivery terms) as Seller provided such whole coffee beans to the Stores immediately prior to the Closing; provided, however, that the price of such whole coffee beans to the Purchaser and/or the Stores shall be Seller's cost for such beans plus ten percent (10%) (F.O.B. the Seller's shipping dock or any third 18 19 party coffee supplier's shipping dock, as the case may be). Seller shall not be responsible or liable to the Purchaser and/or the Stores for any damages suffered by the Purchaser and/or the Stores for late delivery or non-delivery of such beans if such damages are attributable solely to the actions or inactions of third parties unrelated to the Sellers. e. Personnel Support. For a period of up to two (2) months following the Closing, Sellers shall make the personnel listed on Schedule 11(e), who are involved in the day-to-day operation of the Stores, available to Purchaser during normal business hours upon reasonable notice, at Purchaser's option and at Purchaser's sole cost and expense, for not in excess of an aggregate of fifteen (15) hours per week, to answer questions and otherwise assist in the transition. 12. TAXES AND EXPENSES. All sales, transfer, use and similar taxes and recording and similar fees incurred in connection with the sale, conveyance or transfer of the Assets to Purchaser, to the extent required by the respective governmental authorities, shall be paid in full by Sellers. Sellers shall also be responsible for any and all fees charged by the landlords in their review and/or processing of the Leases and the Lease Assignments. 13. PUBLIC ANNOUNCEMENTS. Sellers and Purchaser shall consult with each other before issuing any press releases or otherwise making any public statements with respect to this Agreement or the transactions contemplated hereby and shall not issue any such press release or make any such public statement prior to such consultation, except to the extent required by law. 19 20 14. MISCELLANEOUS. a. Waiver. Failure of a Party to insist upon the strict performance of any covenant, term, condition, warranty, guarantee or indemnification of this Agreement or to exercise any right or remedy accruing therefrom, shall not constitute a waiver by such Party of any unremedied breach or the performance of any such covenant, term, condition, warranty, guarantee or indemnification. A waiver shall be effective only upon a written instrument executed by all of the Parties. Any waiver of any breach shall not affect or alter this Agreement, but rather each and every covenant, term, condition, warranty, guarantee and indemnification shall continue in full force and effect with respect to any other then existing or subsequent breach thereof. b. Expenses and Absence of Commissions. Purchaser and Sellers each agree to bear their own legal, accounting, and other expenses in connection with the preparation of this Agreement and the consummation of the transactions contemplated hereby. Purchaser and Sellers also acknowledge and warrant to each other that none of them has incurred any liability for commissions, finder's fees, or similar claims in connection with this transaction, except that Sellers shall be responsible for and hereby indemnify Purchaser against all of the fees of Donaldson, Lufkin & Jenrette in connection herewith. c. Notices. All notices, demands, or other communications given under this Agreement shall be in writing, and shall be effective either when hand-delivered, or one (1) day after sent by Federal Express or such comparable overnight delivery service, or three (3) days after mailed postage prepaid, certified or registered mail, return receipt requested, to Purchaser at 2144 Michelson Drive, Irvine, California 92715, Attention: Steven A. Lupinacci, President, with a copy to John M. Williams, III, Esq., Gibson, Dunn & Crutcher, 4 Park Plaza, Irvine, California 92714; and to the Sellers at 2255 Glades Road, Boca Raton, Florida 33431, Attention: Donald D. Breen, with a copy to John L. Ruppert, Esq., Ballard Spahr Andrews & Ingersoll, 1225 17th Street, Suite 2300, Denver, Colorado 80202. d. Assignability and Benefit. All of the terms of this Agreement shall be binding upon and inure to the benefit of, and be enforceable by, the respective legal representatives, and the successors and permitted assigns of the Sellers and Purchaser. Notwithstanding the above, this Agreement shall not be assignable by any Party without the prior written consent of all of the other Parties, which consent may be withheld by a Party in its sole discretion; provided, however, that Sellers may assign their rights, but not their obligations, under this Agreement to First Union National Bank of North Carolina, N.A. and; provided that a reincorporation by any party shall not be deemed an assignment. e. Construction. This Agreement is being delivered and is intended to be performed in the State of Colorado, and shall be construed and enforced in accordance with the laws of such jurisdiction. Captions used in this Agreement are for convenience of reference only, do not constitute a part of this Agreement and will not be deemed to limit, characterize or any way affect any provision of this Agreement. All provisions of this Agreement will be enforced and construed as if no caption had been used in this Agreement. f. Entire Agreement. This Agreement, together with all Schedules and Exhibits hereto which are incorporated herein by this reference, contains all of the agreements and understandings between the parties hereto, and no oral agreements or written correspondence shall be held to affect the provisions hereof. All subsequent changes and modifications to be valid shall be by written instrument executed by each of the Sellers and Purchaser. If for any reason any provision of this Agreement should be declared void, illegal 20 21 or invalid, such declaration shall not affect the validity of the remainder of this Agreement, which shall continue in force as if executed with the void, illegal or invalid provision eliminated. The Parties agree to accept and be bound by facsimile signatures, with originals to follow by overnight mail. g. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original and all of which counterparts taken together shall constitute one and the same agreement. h. Attorneys' Fees. If any Party shall bring any action, suit, counterclaim or appeal for any relief against any other Party, declaratory or otherwise, to enforce the terms hereof or to declare rights hereunder (collectively, an "Action"), the prevailing party shall be entitled to recover as part of any such Action its reasonable attorneys' fees and costs, including any fees and costs incurred in bringing and prosecuting such Action and/or enforcing any order, judgment, ruling or award granted as part of such Action. "Prevailing party" within the meaning of this Paragraph includes, without limitation, a party who agrees to dismiss an Action upon the other party's payment of all or a portion of the sums allegedly due or performance of the covenants allegedly breached, or who obtains substantially the relief sought by it. 21 22 IN WITNESS WHEREOF, Sellers and Purchaser have caused this Agreement to be signed as of the date first set forth above. BROTHERS COFFEE BARS, INC. By: -------------------------------------- Name (Print): ---------------------------- Title: ----------------------------------- BROTHERS GOURMET COFFEES, INC. By: -------------------------------------- Name (Print): ---------------------------- Title: ----------------------------------- DIEDRICH COFFEE By: -------------------------------------- Name (Print): ---------------------------- Title: ----------------------------------- 22 EX-23.1 10 CONSENT OF BDO SEIDMAN, LLP RE: DIEDRICH COFFEE 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Diedrich Coffee Irvine, California We hereby consent to the use in the Prospectus constituting a part of this Registration Statement of our report dated March 11, 1996, except as to Note 9, which is as of July 19, 1996, relating to the financial statements of Diedrich Coffee, which is contained in that Prospectus. We also consent to the reference to us under the caption "Experts" in the Prospectus. BDO SEIDMAN, LLP Costa Mesa, California July 22, 1996 EX-23.2 11 CONSENT OF BDO SEIDMAN, LLP RE: BROTHERS COFFEE 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Diedrich Coffee Irvine, California We hereby consent to the use in the Prospectus constituting a part of this Registration Statement of our report dated April 19, 1996, relating to the financial statements of the Acquired Stores of Brothers Gourmet Coffees, Inc., which is contained in that Prospectus. We also consent to the reference to us under the caption "Experts" in the Prospectus. BDO SEIDMAN, LLP Costa Mesa, California July 22, 1996 -----END PRIVACY-ENHANCED MESSAGE-----