-----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, BWZjgIbonQAUqtNs1vBufFjjPijQmMngbM3XbTFHNFMWRHy1OIBkjwSIuAjk90F4 UEF0JT5pd2K3X03GJLlLxw== 0000892569-96-001793.txt : 19960910 0000892569-96-001793.hdr.sgml : 19960910 ACCESSION NUMBER: 0000892569-96-001793 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 19960909 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIEDRICH COFFEE INC 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: 96627110 BUSINESS ADDRESS: STREET 1: 2144 MICHELSON DRIVE STREET 2: STE A CITY: IRVINE STATE: CA ZIP: 9262682612 BUSINESS PHONE: 7142601600 MAIL ADDRESS: STREET 1: 2144 MICHELSON DRIVE CITY: IRVINE STATE: CA ZIP: 92612 S-1/A 1 AMENDMENT NO. 5 TO THE FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 9, 1996 REGISTRATION NO. 333-08633 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 5 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ DIEDRICH COFFEE, INC. (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) DELAWARE 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, INC. 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 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 SEPTEMBER 9, 1996 2,200,000 SHARES LOGO DIEDRICH COFFEE, INC. COMMON STOCK ------------------------ Of the 2,200,000 shares of common stock, par value $.01 per share (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 among 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." The Common Stock has been approved for quotation on the Nasdaq National Market under the symbol "DDRX," subject to notice of issuance. THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" ON PAGE 8. 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: (i) the Price to Public per share or (ii) $11.50 (the "Representative's Warrants"). For indemnification and contribution arrangements with the Underwriters, see "Underwriting." (2) Before deducting expenses payable by the Company estimated at $1,400,000, 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. 3 [Photo of the Company's logo surrounded by twelve labels with a background of roasted coffee beans] 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. 4 With a coffee growing heritage spanning three [PHOTO (i)] generations, Diedrich Coffee selects only the Martin Diedrich finest arabica beans from each of the world's major growing regions. Diedrich's proprietary formula custom roasts [PHOTO (ii)] individual coffees from each specific region. Regional Roasting Facility This custom roasting process highlights flavor characteristics unique to each coffee. Based on the European coffeehouse concept, [PHOTO (iii)] each of Diedrich's Coffeehouses serve as a Diedrich Coffee House, Denver, Colorado community meeting place, designed to be interesting and inviting and tailored to reflect the unique character of each neighborhood. [PHOTO (iv)] Mission San Juan Capistrano, California Store [PHOTO (v)] Irvine Entertainment Center, Irvine, California
Five photos comprised of (i) one photo of the Company's Chairman of the Board with a coffee plant; (ii) one photo of the Company's Chairman of the Board with a coffee roasting machine; (iii) one photo of exterior of a Company coffeehouse; (iv) one photo of interior of Company's Mission San Juan Capistrano coffeehouse; and (v) one photo of interior of Company's Irvine Entertainment Center coffeehouse. 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 into 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 prior to the consummation of this Offering. Prospective investors should carefully consider the information discussed under "Risk Factors." References to "fiscal" years refer to the fiscal year ending on January 31 of the indicated calendar year for fiscal 1996 and prior years and to the fiscal year ending on the Wednesday nearest January 31 of the indicated calendar year for all years subsequent to 1996. THE COMPANY Diedrich Coffee is a rapidly growing specialty coffee roaster/retailer that currently operates thirty-seven coffeehouses located in Southern California, Colorado and Texas. Diedrich Coffee sells high quality coffee beverages made with its own freshly roasted coffee. In addition to brewed coffee, the Company offers a broad range of Italian-style beverages such as espresso, cappuccino, caffe latte, caffe mocha and espresso machiato. See "Business -- Diedrich's Coffee." 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-seven coffeehouses as of July 31, 1996 through the construction of new coffeehouses and recent acquisitions. In addition, the Company has entered into leases that will permit the opening of five 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. See "Business -- Growth Strategy." 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, sourcing 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. These beans are then custom roasted in carefully controlled batches according to the Company's standards and proprietary recipes 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. See "Business -- Diedrich's Coffee." 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 1,500 square feet, ranging in size from 725 to 2,654 square feet. 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 31, 1996, the conversion of twelve stores had been completed. Management believes that the addition of the Denver stores 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. See "Business -- Recent Acquisitions." 3 6 Diedrich Coffee, the predecessor of the Company, was incorporated in California in March 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................... The net proceeds to the Company, estimated to be approximately $15.1 million, will be used for funding the opening of additional coffeehouses (through new store construction and acquisitions), repayment of the amounts outstanding under the Company's short-term revolving credit facility, a revolving promissory note and certain other indebtedness, funding for infrastructure enhancements and working capital for other general corporate purposes. See "Use of Proceeds." 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 at an exercise price of $1.45 per share, 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's Common Stock has been approved for quotation on the Nasdaq National Market, there can be no assurance 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 AND OTHER 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 1,782(4) 277 337 Operating income (loss)... (33) 455 349 (574) 114 216 Net income (loss)......... $ (89) $ 324 $ 186 $ (396) $ 59 $ 107 ======== ======== ========== ========== ======== ========== Pro forma net income (loss) per share(5)..... $ 0.06 $ (0.13) $ 0.03 ========== ========== ========== Shares used in pro forma per share calculation(5).......... 3,153,000 3,087,000 3,906,000 ========== ========== ========== OTHER DATA: Average sales per store(6)................ $883,000 $946,000 $1,002,000 $ 216,000 $ 223,000(7) Average sales per square foot(6)................. $ 653 $ 678 $ 706 $ 153 $ 148(7) Percentage change in comparable store sales(8)................ 8.0% 17.0% 10.2% 19.8% 8.5%(9) Number of stores open for full period............. 4 7 8(10) 8(10) 12 Number of stores open at end of period........... 7 7 12 8 33(11) Pre-opening expenses...... $ 68,000 $ -- $ 87,000 $ 15,000 $ 44,000
JANUARY 31, MAY 1, -------------------- -------------------------- PRO FORMA AS ADJUSTED 1996 1996(1) 1996(2) 1996(12) ------ --------- ---------- ----------- 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. 5 8 (2) Effective February 1, 1996, the Company changed its fiscal 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 dates that the acquisitions from unrelated sellers 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) The pro forma general and administrative expenses include a proportional allocation to the 12 Brothers Stores of the corporate and administrative salaries and related employee benefit costs, and other corporate overhead expenses, which were allocated to all stores operated by Brothers Gourmet Coffees, Inc. Although no adjustment has been made, the Company believes that a substantial portion of such allocated expenses are redundant as a result of its overhead infrastructure and, accordingly, does not believe the pro forma general and administrative expenses are indicative of the actual general and administrative expenses that would have been incurred had the Company owned and operated the Brothers Stores for the year ended January 31, 1996. See the Unaudited Pro Forma Condensed Financial Statements. (5) 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. (6) Includes only stores open for the entire period indicated. (7) 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 $5,017 while average weekly per store sales for the Company, excluding such stores, were $17,191. (8) Includes only stores open one year or more at the beginning of the period. (9) The percentage change in comparable store sales has been adjusted for the additional week in the quarterly period ended May 1, 1996. (10) Includes one store opened on the second day of the period and considered to have been open for the entire period. (11) 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. (12) 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 RECENT OPERATING RESULTS (UNAUDITED) For the thirteen weeks ended July 31, 1996, the Company had net sales of approximately $4,667,000 and net income of approximately $6,000 as compared to net sales of approximately $2,166,000 and net income of approximately $60,000 for the twelve week period ended July 18, 1995. The decrease in net income for the second quarter in fiscal 1997 was consistent with the Company's growth strategy as the Company scheduled most of the budgeted conversion expenses for the Company's acquisitions in Denver and Houston to take place during this quarter and also opened five new stores in California. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- General." The noncapitalized conversion costs of approximately $76,000, plus pre-opening costs of approximately $60,000 in connection with the new stores opened in California, during the quarter were significantly in excess of the comparable expenses during the second quarter in fiscal 1996 of $18,000 for pre-opening expenses. In addition, as part of the conversion process, fifteen of the acquired stores were temporarily closed for periods varying from five days to twenty-three days which resulted in a reduction in net sales despite the fact that certain operating expenses, such as occupancy costs and management salaries, continued to be incurred. The percentage increase in comparable store sales comparing net sales for stores open during the full period in the second quarter in fiscal 1996 to net sales for the same stores in the second quarter of fiscal 1997 was 0.7% versus 8.5% for the first quarter in fiscal 1996 compared to the first quarter in fiscal 1997. Only eight of the Company's thirty-seven coffeehouses were open for the full period in the second quarter of fiscal 1996 and are therefore included in the base for comparable store sales. On average these stores have been open for five years and had sales of approximately $1,021,000 per store for the twelve months ended July 31, 1996. The Company believes that the variation in comparable store sales results in part from the over-representation of mature, revenue-stable stores in the computation base. Furthermore, given the small number of stores included in the base for comparable store sales, management believes that this percentage will remain volatile until the base contains a more statistically meaningful number of stores that more accurately reflects the overall composition of the Company. 7 10 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. The Company had a net loss of $89,000 in fiscal 1994 and net income of $324,000 and $186,000 in fiscal 1995 and 1996, respectively. 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. At January 31, 1996, the Company had an accumulated deficit of $52,000. The Company's working capital deficiency at the end of fiscal years 1994, 1995 and 1996 was $364,000, $218,000 and $53,000, respectively. Management anticipates that profitability may be adversely affected during 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." Reliance on Growth Strategy; Recent Acquisitions and Rapid Expansion. 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 31, 1996, the Company expanded the number of coffeehouses from three to forty-two, of which five are not yet open but are subject to binding leases. 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 31, 1996, the Company had completed twelve 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 in the future, 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 8 11 motivate key employees and to raise additional capital. There can be no assurance the Company will be 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. The proceeds of this Offering, borrowings under the Company's credit facility and cash flow from operations are expected to be sufficient to fund the Company's capital expenditures, estimated to be $5.3 million, for the last three quarters of fiscal 1997. In order to achieve and maintain the Company's anticipated growth rate thereafter, 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 coffee, or the unavailability of adequate supplies of unroasted coffee 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 coffee, 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 9 12 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 supply of coffee than would have been required absent such activities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Coffee Prices and Availability." 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, consumers 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; Fluctuations in Regional Economic Conditions. 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; Uncertainty of Renewal Terms. The Company's thirty-seven 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 these 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 10 13 substantial rent increases, or are subject to renewal with a scheduled rent increase, which could result in rents being above fair market value. 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 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 the products available at a 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, which include, among other things, provisions restricting them from competing with the Company during the terms of their respective employment agreements. The Company has also entered into 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 "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." 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." 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 11 14 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 -- Seasonality and Quarterly Results." 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 among 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. See "Description of Capital Stock -- Registration Rights." 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, Senior Vice President of Trading and 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 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." 12 15 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 $15,144,000. The Company will not receive any proceeds from the sale of shares of Common Stock by the Selling Stockholders, including any shares sold 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 $3,599,000 with a weighted average interest rate of 7.8% as of August 2, 1996). The funds borrowed under this facility, which matures on November 1, 1996 (extended to October 1, 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 August 2, 1996). See "Certain Transactions." 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 August 2, 1996, amounted to an aggregate of approximately $444,000 which bore interest at a weighted average interest rate of 13.5%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Of the remaining net proceeds, approximately $8.2 million will be used to fund the opening of additional coffeehouses (through new store construction and acquisitions), as well as providing working capital for general corporate purposes and approximately $1.5 million will be used to fund 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. Although the Company from time to time evaluates potential acquisitions of other existing specialty coffee retail businesses, as of July 31, 1996, it had no understandings, commitments or agreements with respect to any acquisition. 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, 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. 13 16 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 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 at an exercise price of $1.45 per share, 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 (actual); no shares authorized (pro forma and as adjusted); 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 (actual); no shares authorized (pro forma and as adjusted); 1,608,568 shares outstanding (actual); no shares outstanding (pro forma and as adjusted).......... 2,225,813 -- -- Preferred stock, no par value (actual); par value $.01 per share (pro forma and as adjusted); no shares authorized (actual); 3,000,000 shares authorized (pro forma and as adjusted); no shares outstanding...................................... -- -- -- Common stock, no par value (actual); par value $.01 per share (pro forma and as adjusted); 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 37,917 53,917 Additional paid-in capital.......................... -- 3,318,594 18,946,594 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 ========== ========== ==========
14 17 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 number of 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 at an exercise price of $1.45 per share, 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 ========= ===== =========== =====
15 18 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 1,782(4) 277 337 ------ ------ ------ ------ ------ ------- ------ ------ Total.................. 2,348 3,115 4,447 7,136 9,895 13,175 1,944 4,059 ------ ------ ------ ------ ------ ------- ------ ------ Operating income (loss)......... 34 (176) (33) 455 349 (574) 114 216 Interest expense and other...... 80 72 55 78 34 97 13 37 ------ ------ ------ ------ ------ ------- ------ ------ Income (loss) before income taxes......................... (46) (248) (88) 377 315 (671) 101 179 Provision (benefit) for income taxes......................... 1 (15) 1 53 129 (275) 42 72 ------ ------ ------ ------ ------ ------- ------ ------ Net income (loss)............... $ (47) $ (233) $ (89) $ 324 $ 186 $ (396) $ 59 $ 107 ====== ====== ====== ====== ====== ======= ====== ====== Pro forma net income (loss) per share(5)...................... $ 0.06 $ (0.13) $ 0.03 ====== ======= ====== Shares used in pro forma per share calculation(5).......... 3,153,000 3,087,000 3,906,000 ========= ========= =========
16 19
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 fiscal 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 dates that the acquisitions from unrelated sellers 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) The pro forma general and administrative expenses include a proportional allocation to the 12 Brothers Stores of the corporate and administrative salaries and related employee benefit costs, and other corporate overhead expenses, which were allocated to all stores operated by Brothers Gourmet Coffees, Inc. Although no adjustment has been made, the Company believes that a substantial portion of such allocated expenses are redundant as a result of its overhead infrastructure and, accordingly, does not believe the pro forma general and administrative expenses are indicative of the actual general and administrative expenses that would have been incurred had the Company owned and operated the Brothers Stores for the year ended January 31, 1996. See the Unaudited Pro Forma Condensed Financial Statements. (5) 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 into 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. 17 20 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 fiscal 1996, there were twelve coffeehouses in operation, all of which were located in Southern California, and as of July 31, 1996, the Company operated a total of thirty-seven coffeehouses located in California, Colorado and Texas, with five additional locations subject to binding leases. At the end of fiscal 1996, ten coffeehouses were located in suburban sites such as neighborhood shopping centers, one coffeehouse was located in a regional shopping mall and one coffeehouse 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. On February 15, 1996, the Company acquired seven retail locations in Denver, Colorado that were former bakery-espresso cafes (the "Acquired Cafes") for cash consideration of $450,000. 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") for cash consideration of $1,350,000. 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 format. As of July 31, 1996, twelve of the eighteen remaining acquired stores had been converted to Diedrich coffeehouses which included new signage, decor, recipes, products and service standards. The Company has budgeted approximately $1,080,000 for the conversion costs in connection with the Acquired Cafes and the Brothers Stores. On a per store basis, the average cost of acquiring and converting such stores is anticipated to be $160,000. This contrasts with the Company's average cost to open a new coffeehouse in fiscal 1996 of approximately $320,000. 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 format 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. During the current fiscal year, however, management anticipates that profitability may be adversely affected as a result of the conversion process. Effective February 1, 1996, the Company changed its fiscal 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. 18 21 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain information from the Company's Statements of Operations (dollars in thousands).
THIRTEEN WEEKS ENDED TWELVE 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.................. $3,912 $6,673 $ 8,879 $11,236 $ 1,757 $2,907 $ 995 $3,902 Wholesale Net Sales............... 502 918 1,365 1,365 301 373 -- 373 ------ ------ ------ ------- ------ ------ ----- ------ Net Sales......................... 4,414 7,591 10,244 12,601 2,058 3,280 995 4,275 ------ ------ ------ ------- ------ ------ ----- ------ Cost of Sales and Related Occupancy Costs........................... 1,796 3,164 4,409 5,932 872 1,362 411 1,773 Store Operating Expenses.......... 1,594 2,584 3,520 4,686 669 1,207 528 1,735 Other Operating Expenses.......... 146 282 277 277 64 60 -- 60 Depreciation and Amortization..... 102 255 354 498 62 119 35 154 General and Administrative Expenses........................ 809 851 1,335 1,782 277 337 N/A 337 Operating Income (Loss)........... (33) 455 349 (574) 114 195 21 216 Net Income (Loss)................. $ (89) $ 324 $ 186 $ (396) $ 59 $ 113 $ (6) $ 107 ====== ====== ====== ======= ====== ====== ===== ======
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.
THIRTEEN WEEKS ENDED TWELVE 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 -- 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 15.9 -- 15.9 Depreciation and Amortization.... 2.3 3.4 3.5 4.0 3.0 3.6 3.5 3.6 General and Administrative Expenses....................... 18.3 11.2 13.0 14.1 13.4 10.3 N/A 7.9 Operating Income (Loss).......... (0.7) 6.0 3.4 (4.6) 5.5 6.0 2.1 5.1 Net Income (Loss)................ (2.0)% 4.3% 1.8% (3.1)% 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 19 22 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 an increased number of sale transactions. 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 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. Net income. Net income decreased to $186,000 for fiscal 1996 from $324,000 in the comparable period in fiscal 1995, a decrease of $138,000 or 42.7%. As a percentage of net sales, net income decreased to 1.8% for fiscal 1996 from 4.3% for fiscal 1995. The decrease in net income is primarily attributable to increased general and administrative expenses resulting from the Company's move to a larger principal executive office and the addition of corporate office personnel in anticipation of the Company's expansion plans. 20 23 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 an increased number of sale transactions 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 an increased number of sale transactions. 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. 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. Net income. Net income increased to $324,000 for fiscal 1995 from a loss of $89,000 in the comparable period in fiscal 1994, an increase of $413,000. The increase resulted primarily from the reduction, as a percentage of net sales, of general and administrative expenses. 21 24 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 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 $60,000 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 sales management personnel. Depreciation and amortization. Depreciation and amortization excluding the acquired stores increased by 91.5% to $119,000 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 $35,000, or 3.5% 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 22 25 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. Net income Net income of the Company excluding the Brothers Stores and Acquired Cafes increased to $113,000 for the thirteen weeks ended May 1, 1996 from $59,000 for the twelve weeks ended April 25, 1995, an increase of $54,000 or 92%. As a percentage of net sales, net income for the thirteen weeks ended May 1, 1996 increased to 3.4% from 2.9% for the twelve weeks ended April 25, 1995. The percentage increase was primarily due to the reduction in general and administrative expenses as a percentage of net sales. Net loss for the Brothers Stores and Acquired Cafes for the thirteen weeks ended May 1, 1996 was $6,000 or 0.6% of net sales for the period. 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 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 and, on average, these stores began to show a return on the initial investment within three to four months. Infrastructure additions consist principally of additional roasting and packaging capacity as well as development of enhancements to the management information system 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 long-term capital assets. From time to time, the Company's financing of long-term assets with short-term indebtedness results in a temporary imbalance in working capital. It has been the Company's practice to minimize the time period during which a working capital deficiency exists either through refinancing the indebtedness or an equity infusion. 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. The Company believes that the proceeds from this Offering, borrowings under the Company's credit facility and cash flow from operations will be sufficient to fund these expenditures. 23 26 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 31, 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 mature 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 August 2, 1996, borrowings under this facility were approximately $3,599,000 with a weighted average interest rate of 7.8% and $501,000 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 matures 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 1, 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, require the delivery of regular financial information and the 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 matures on September 30, 1996. The outstanding balance on the note as of August 2, 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, 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. 24 27 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. 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. 25 28 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, of historical net sales), for a total of $1,782,000, or 14.1% of pro forma combined net sales. The pro forma general and administrative expenses include a proportional allocation to the twelve Brothers Stores of the corporate and administrative salaries and related employee benefit costs, and other corporate overhead expenses, which were allocated to all stores operated by Brothers Gourmet Coffees, Inc. The Company believes that a substantial portion of such allocated expenses are redundant as a result of its overhead infrastructure and, accordingly, does not believe the pro forma general and administrative expenses are indicative of the actual general and administrative expenses that would have been incurred had the Company owned and operated the Brothers Stores for the year ended January 31, 1996. 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 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. 26 29 BUSINESS GENERAL Diedrich Coffee is a rapidly growing specialty coffee roaster/retailer that currently operates thirty-seven coffeehouses located in Southern California, Denver, Colorado and Houston, Texas. Diedrich Coffee sells high quality coffee beverages made with its own freshly roasted coffee. In addition to brewed coffee, the Company 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-seven coffeehouses as of July 31, 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 five 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 1,500 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. 27 30 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 31, 1996, the conversion of twelve 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 twelve 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. See "Business -- Diedrich's Coffee," "Business -- Coffeehouses" and "Business -- Customer Service and Training." 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, a report published by the Specialty Coffee Association of America in January 1993, 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. This 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. 28 31 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 proprietary 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 freshly roasted coffee beans are delivered promptly after roasting 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 31, 1996, the Company had executed leases for five additional coffeehouses which are not yet open for business. 29 32 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 seven newly constructed coffeehouses as of July 31, 1996. Five 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 evaluate potential acquisitions that can accelerate critical mass in 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 any acquisitions. - 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 to be operated by franchisees. 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 is exploring 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 purchase only the finest qualities and varieties of coffee generally available to this industry by sampling the 30 33 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 characteristics of the coffee during the roasting process and develop the optimal flavor conditions that a coffee has to offer. 31 34 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 establishes operations. 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 coffeehouses feature varying amenities to promote this environment, such as live music or outdoor patios where customers can enjoy their coffee. 32 35 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 retail sales of $7,292,000 or an average of $729 per square foot. These stores earned an average operating profit after depreciation of approximately $245,000 per store or 23.5% of average net retail sales. For the twelve-month period ended May 1, 1996, the Company's net retail sales were $11,024,000, with an operating profit after depreciation of $1,762,000 or 16% of net retail sales. During fiscal 1996, 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 coffeehouses 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 enhance its selection of food items to complement beverage sales. Three of the Company's coffeehouses operate as Diedrich Espresso Cafes. These coffeehouses 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. 33 36 Diedrich Coffeehouse Locations Set forth below is a list of each of the Company's coffeehouse locations as of July 31, 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 31, 1996, the Company was operating thirty-seven coffeehouses and had entered into leases that will permit the opening of five additional coffeehouses in the next four months.
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 Entertainment Center................................................ 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 Mission San Juan Capistrano................................................ February 1996 Open Trabuco Hills.............................................................. August 1992 Open Tustin..................................................................... August 1986 Open Irvine-Park Place.......................................................... July 1996 Open 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 (3) 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) 34 37 - --------------- (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 may terminate the agreement if the Developer fails to meet this schedule, unless the Developer chooses to make certain payments to the Company. 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 the Company 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 (the "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 operating a coffeehouse. These improvements have enabled continued daily managerial supervision and control with minimal 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 and requests and problem solving forums. The Company intends to utilize a portion of the net proceeds of this 35 38 Offering to complete this phase of the MIS upgrades and to continue to explore 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 and regional 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 distinctions between Diedrich Coffee and prepackaged ground coffee. In markets that are more knowledgeable 36 39 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 31, 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, 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. 37 40 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 affecting its business and operations. Each of the Company's coffeehouses and roasting facilities is and shall be subject to licensing and reporting requirements by a number of governmental authorities, which may include building, land use, environmental protection, health and safety and fire agencies in the state or municipality in which the coffeehouse or facility is located. Difficulties in obtaining or failure to obtain the required licenses or approvals could delay or prevent the development or operation of a given coffeehouse in a particular area, the conversion of the remaining Acquired Cafes and Brothers Stores or limit the products available at a 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 material adverse effect upon the operations of the Company. EMPLOYEES As of July 31, 1996, the Company employed a work force of 668 persons, 91 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. 38 41 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 31, 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 Kerry W. Coin......................... 48 Executive Vice President and Chief Operating Officer 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 Peter Churm*.......................... 70 Director Lawrence Goelman*..................... 55 Director
- --------------- * Mr. Churm and Mr. Goelman are expected to be nominated by the Board of Directors of the Company to become directors after the closing of the Offering. 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. Kerry W. Coin became the Executive Vice President and Chief Operating Officer of the Company in August 1996. From May 1996 until joining the Company, he was President and General Manager of the restaurant subsidiary of Synerdyne Corporation. From January 1994 to February 1996, he was President and Chief Executive Officer of Boston West, L.L.C., a franchisee of Boston Chicken, Inc. From February 1993 to January 1994, Mr. Coin served as Vice President of Strategic Development for CKE Restaurants, Inc., a Southern California-based chain of quick-service restaurants, and from June 1987 until February 1993, he was a principal at A.T. Kearney, Inc., a private management consulting firm. 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 as a Promotions Accountant for Taco Bell (a division of PepsiCo), Accounting Manager/Financial Analyst for the Sizzler Restaurant Division of Collins Foodservice International, Financial Analyst for El Torito Restaurants (a division of W.R. Grace) and the Controller for 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, 39 42 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." Peter Churm is expected to be nominated by the Board of Directors of the Company to become a director of the Company after the closing of the Offering. He is Chairman Emeritus of Furon Company, a publicly-held diversified manufacturing company headquartered in Laguna Niguel, California. Mr. Churm served as Chairman of the Board of Furon Company from May 1980 through February 1992 and was President of that company for more than sixteen years prior to that time. He is presently a member of the boards of directors of Furon Company and CKE Restaurants, Inc. Lawrence Goelman is expected to be nominated by the Board of Directors of the Company to become a director of the Company after the closing of the Offering. Since May 1996, Mr. Goelman has served as President and Chief Executive Officer of Pinnacle Micro, Inc. From June 1995 to May 1996, he was a managing partner of Tremont Partners, Inc., and from April 1981 to June 1995, he served as Chairman, President and Chief Executive Officer of CostCare, Inc. Presently, Mr. Goelman is a director of Pinnacle Micro, Inc. and Urohealth, Inc. 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. BOARD COMMITTEES Upon the consummation of the Offering, the Board of Directors intends to establish an Audit Committee and a Compensation Committee composed of Messrs. Heeschen, Churm and Goelman. 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, Mr. Churm and Mr. Goelman. No member of the Compensation Committee was, 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. 40 43 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 10,000 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. 41 44 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").
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................................ $ 116,638 131,350 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 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 Agreements 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 $3,557,111, respectively. The actual value realized may be greater or less than the potential realizable values set forth in the table. 42 45 Aggregated Stock Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table sets forth the number and value of the exercisable and unexercisable options held by each of the Named Executive Officers at January 31, 1996. None of the Named Executive Officers exercised any options during the fiscal year ended January 31, 1996.
NUMBER OF SECURITIES VALUES OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT FISCAL YEAR-END (#) FISCAL YEAR-END ($)(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. Other than options to purchase 120,000 shares of the Company's Common Stock at an exercise price equal to the initial public offering price per share that were granted to the Company's Chief Operating Officer in August 1996, 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, the Company's Chairman of the Board and Director of Coffee, 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 43 46 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 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, the Company's President, Chief Executive Officer and Chief Financial Officer, 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 Mr. Lupinacci. 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. Employment Agreement with Kerry W. Coin In August 1996, Kerry W. Coin, the Company's Executive Vice President and Chief Operating Officer, entered into a three-year employment agreement with the Company. The agreement provided for an annual base salary of $120,000 per year, subject to periodic adjustment by the Board of Directors. Mr. Coin is also entitled to receive employee benefits consistent with the Company's policies for other senior executives and may be eligible for performance bonuses based upon the Company's performance and Mr. Coin's contributions thereto. The agreement also provided for the grant of options to purchase 120,000 shares of the Company's Common Stock at an exercise price equal to the initial public offering price per share. 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 indemnifi- 44 47 cation 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 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 sole 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, $17,000 and $16,000 in fiscal years 1996, 1995 and 1994, respectively. As of July 31, 1996, the Company had purchased approximately $33,000 worth of goods from Diedrich Coffee Roasters in fiscal 1997. Management believes that the prices paid to Diedrich Coffee Roasters are at least as favorable to the Company as those which would have been available from unrelated third parties at the times the purchases were made. 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 becomes due and payable on September 30, 1996. The outstanding balance on the note as of July 31, 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 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. 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 45 48 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 with D.C.H., L.P. ("D.C.H.") which acknowledged a purchase price overpayment of $200,000 for the 1,000,000 shares of Series A Preferred Stock purchased on December 11, 1992 for an aggregate consideration of $1,000,000. This purchase price overpayment led to the negotiation of a post-closing adjustment. The post-closing adjustment arose as a result of the fact that certain liabilities of the Company were estimated for purposes of the Company's valuation in connection with the sale of the Series A Preferred Stock and subsequent to the sale of such shares it was determined that the actual liabilities exceeded the estimated liabilities. The Company issued to D.C.H. 268,097 shares of Common Stock in exchange for the $200,000 post-closing adjustment. 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 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. This agreement in connection with his resignation from the Company included a release of any and all claims against the Company arising from his employment, the sale of his shares or any other matter. Mr. Holly was formerly a director and Chief Financial Officer of the Company. Shortly following the Company's initial filing of the registration statement in connection with this Offering which was available to the public, Mr. Holly contacted the Company alleging that the per share price paid to him in 1995 was insufficient in light of the estimated initial public offering price disclosed in such registration statement. The Company believes that Mr. Holly's allegation is without merit. 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 31, 1996 was $36,231. 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." 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." 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. 46 49 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of July 31, 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 director designates, and (iv) by all directors, director designates 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. The information contained in this table assumes that the Series A and Series B Preferred Stock of the Company has been converted into Common Stock.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED OWNED PRIOR TO THE OFFERING NUMBER OF AFTER OFFERING --------------------- SHARES BEING --------------------- NAME AND ADDRESS OF BENEFICIAL 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.(3) .......... 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.................... 236,991(4) 6.2 -- 236,991(4) 4.4 Kerry W. Coin.......................... 11,667(5) * -- 11,667(5) * Paul C. Heeschen....................... 2,072,381(6) 54.7 432,247 1,640,134(6) 30.4 Peter Churm............................ -- -- -- -- -- Lawrence Goelman....................... -- -- -- -- -- All directors, director designates and executive officers as a group (6 persons)............................. 3,006,146 78.9 432,247 2,573,899 47.6
- --------------- * Less than 1%. (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) Amre A. Youness is the sole general partner of this limited partnership with voting and investment power as to all of the shares beneficially owned by the limited partnership. Neither Mr. Diedrich nor any member of his family owns any interest in this limited partnership. (4) Includes 7,113 shares that Mr. Lupinacci has the right to acquire upon exercise of stock options within 60 days of July 31, 1996, assuming consummation of the Offering. These options were granted to Mr. Lupinacci on June 29, 1995 pursuant to a stock option plan and agreement at an exercise price of $1.45 per share. (5) Includes 11,667 shares that Mr. Coin has the right to acquire upon exercise of stock options within 60 days of July 31, 1996. These options were granted to Mr. Coin on August 26, 1996 pursuant to the Incentive Plan at an exercise price equal to the initial public offering price per share. (6) Includes shares beneficially owned by D.C.H., L.P. and 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. 47 50 DESCRIPTION OF CAPITAL STOCK GENERAL Prior to 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, par value $.01 per share, and 3,000,000 shares of preferred stock, par value $.01 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 31, 1996, there were 1,183,082 shares of Common Stock outstanding held of record by three stockholders and 2,608,568 shares of Common Stock reserved for issuance upon the conversion of preferred stock to three stockholders. 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, of such shares. The issuance of preferred stock could adversely affect, among other things, the rights of 48 51 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 the consummation of 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. 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 49 52 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 Incentive Plan and Non-Employee Directors 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 31, 1996, other than options to purchase 120,000 shares of the Company's Common Stock at an exercise price equal to the initial public offering price per share that were granted to the Company's Chief Operating Officer in August 1996, there were no shares subject to options which had been granted under either of these plans. 50 53 UNDERWRITING The Underwriters named below, represented by The Boston Group, L.P., 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. However, the Chairman, Vice Chairman, Senior Vice President of Trading and 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 assurance that the Offering will be completed or, if completed, that an active trading market for the Common Stock will develop. 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, 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. 51 54 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 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 among 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: (i) the actual public offering price per share or (ii) $11.50. The Representative's Warrants are exercisable for a period of two years beginning one year from the completion of this Offering. The Representative's Warrants are not transferable except to the officers or partners of the Representative or, beginning one year after completion of the Offering, to the 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 52 55 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. 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. 53 56 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, the 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-23 Pro Forma Condensed Balance Sheet as of January 31, 1996.............................. F-24 Pro Forma Condensed Statement of Operations for the year ended January 31, 1996....... F-25 Notes to Pro Forma Condensed Financial Statements..................................... F-26
F-1 57 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 58 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 59 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 60 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 61 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 62 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 63 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. Historical net income per share has not been presented as such amount is based on a calculation that is not reflective of the Company's ongoing capital structure. 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 64 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 2. INVENTORIES Inventories consist of the following:
MAY 1, JANUARY 31, 1996 ------------------------- ---------- 1995 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:
MAY 1, JANUARY 31, 1996 ------------------------- ---------- 1995 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 65 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 66 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 67 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. Contingencies The Company is subject to certain legal proceedings and claims arising in connection with its business. In the opinion of management, there are currently no claims that will have a material adverse effect on the Company's financial position or results of operations. 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 F-12 68 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 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. (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") acknowledged a purchase price overpayment and agreed to a post-closing 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 options 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 options become exercisable upon the occurrence of certain events, including an initial public offering and a change in control (as defined). If not exercisable earlier, the options become exercisable in June 2003, and expire 10 years from the date of grant. F-13 69 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 70 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................................................... $ (395,886) Net loss per share......................................... $ (.13) Shares used in per share calculation....................... 3,087,000
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 71 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. Initial Public Offering In July 1996, the Company agreed to sell 2,200,000 shares (subject to an over-allotment option) of the Company's common stock in an initial public offering. Such offering is to consist of (a) 1,600,000 shares of common stock on behalf of the Company and (b) 600,000 shares of common stock on behalf of certain selling stockholders. Pursuant to this proposed public offering, the managing underwriter is entitled to receive warrants exercisable for 160,000 shares of the Company's common stock. The warrants are exercisable for a period of two years commencing one year after the effective date of the definitive prospectus and are exercisable at a price per share equal to 120% of the greater of the actual public offering price or $11.50. F-16 72 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 73 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 74 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 75 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. STATEMENTS OF CASH FLOWS
INCEPTION YEAR ENDED FOUR WEEKS (JUNE 1, 1994) DECEMBER ENDED TO DECEMBER 30, 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 76 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 operating entities, on a company-wide basis. Brothers also paid for the build-out of the Acquired Stores as well as operating equipment. F-21 77 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 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. 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-22 78 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 property and equipment for twelve coffeehouse stores (the "Acquired Stores"), and assumed certain lease obligations 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-23 79 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-24 80 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(5)....................... 1,334,694 447,306 1,782,000 ----------- ----------- ----------- Operating income (loss)............. 349,228 (1,406,068) (574,182) Interest expense.................... (50,187) -- (62,438)(3) (112,625) Interest and other income........... 15,814 -- 15,814 ----------- ----------- ----------- Income (loss) before income taxes... 314,855 (1,406,068) (670,993) Provision (benefit) for income taxes............................. 129,211 -- (404,318)(4) (275,107) ----------- ----------- ----------- Net income (loss)................... $ 185,644 $(1,406,068) $ (395,886) =========== =========== =========== Pro forma information(6): Net income (loss) per share................... $ .06 $ (.13) =========== =========== Shares used in per share calculation............. 3,153,000 3,087,000 =========== ===========
See accompanying notes to pro forma condensed financial statements. F-25 81 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 for additional interest expense resulting from borrowings under the Company's credit facility used to purchase the Acquired Stores. 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 of 41%. 5. The pro forma general and administrative expenses include a proportional allocation to the 12 Brothers Stores of the corporate and administrative salaries and related employee benefit costs, and other corporate overhead expenses, which were allocated to all stores operated by Brothers Gourmet Coffees, Inc. Although no adjustment has been made, the Company believes that a substantial portion of such allocated expenses are redundant as a result of its overhead infrastructure and, accordingly, does not believe the pro forma general and administrative expenses are indicative of the actual general and administrative expenses that would have been incurred had the Company owned and operated the Brothers Stores for the year ended January 31, 1996. 6. 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. Pro forma net loss per share excludes stock options granted during the period as their effect would be antidilutive.
F-26 82 [Photo of four packages of the Company's coffee, three Company beverage products and roasted coffee beans.] 83 - ------------------------------------------------------ - ------------------------------------------------------ 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.......................... 8 Use of Proceeds....................... 13 Dividend Policy....................... 13 Capitalization........................ 14 Dilution.............................. 15 Selected Financial Data............... 16 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 18 Business.............................. 27 Management............................ 39 Certain Transactions.................. 45 Principal and Selling Stockholders.... 47 Description of Capital Stock.......... 48 Shares Eligible for Future Sale....... 49 Underwriting.......................... 51 Legal Matters......................... 53 Experts............................... 53 Additional Information................ 53 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 - ------------------------------------------------------ - ------------------------------------------------------ 84 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................................ 30,979.13 Blue Sky fees and expenses........................................ 7,500.00 Accounting fees and expenses...................................... 225,000.00 Legal fees and expenses........................................... 275,000.00 Transfer Agent and registrar fees................................. 10,000.00 Printing and engraving expenses................................... 200,000.00 Officers and directors insurance.................................. 120,000.00 Representative's nonaccountable expense allowance................. 500,000.00 Miscellaneous..................................................... 18,078.11 ---------- Total................................................... $1,400,000.00 ==========
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 85 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 VIII 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 December 11, 1992, the Company issued 1,000,000 shares of Series A Preferred Stock to D.C.H., L.P. for an aggregate consideration of $1 million. With respect to the issuance of these securities, the Company relied upon the provisions of Section 4(2) of 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 issued with an investment legend thereon. Prior to the consummation of the Offering, the shares of Series A Preferred Stock shall be converted into an equivalent number of shares of the Company's Common Stock. 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. Prior to the consummation of the Offering, the shares of Series B Preferred Stock shall be converted into an equivalent number of shares of the Company's Common Stock. II-2 86 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. 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 (4) 3.1 Certificate of Incorporation of the Company (4) 3.2 Bylaws of the Company (4) 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.(3) 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.(3) 4.3 Representative's Warrant Agreement 4.4 Specimen Stock Certificate 4.5 Form of Conversion Agreement in connection with the conversion of Series A and Series B Preferred Stock into Common Stock (4) 5.1 Opinion of Gibson, Dunn & Crutcher LLP 10.1 Martin R. Diedrich Employment Agreement, dated June 29, 1995 (1) 10.2 Steven A. Lupinacci Employment Agreement, dated June 29, 1995(4) 10.3 Stock Option Plan and Agreement of Steven A. Lupinacci, dated June 29, 1995(3) 10.4 Form of Indemnification Agreement (1) 10.5 Diedrich Coffee 1996 Stock Incentive Plan (1) 10.6 Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan(3) 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(3)
II-3 87
EXHIBIT NUMBER DESCRIPTION ------ ---------------------------------------------------------------------------------- 10.8 Revolving Promissory Note dated May 20, 1996 by Diedrich Coffee in favor of Redwood Enterprises VII, L.P. (1) 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(3) 10.10 Kerry W. Coin Employment Agreement, dated August 26, 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 (2) 27.1 Financial Data Schedule (4) 99.1 Consent of Peter Churm(3) 99.2 Consent of Lawrence Goelman(3)
- --------------- * To be filed by amendment. (1) Previously filed with this Registration Statement on July 23, 1996. (2) Previously filed with Amendment No. 1 to this Registration Statement on July 24, 1996. (3) Previously filed with Amendment No. 2 to this Registration Statement on August 12, 1996. (4) Previously filed with Amendment No. 3 to this Registration Statement on August 28, 1996. (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 88 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Amendment No. 5 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 September 9, 1996. DIEDRICH COFFEE, INC. By: /s/ STEVEN A. LUPINACCI ------------------------------------ Steven A. Lupinacci Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 5 to the Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
NAME TITLE DATE - ----------------------------------- ------------------------------------- ------------------- * Chairman of the Board, Secretary and September 9, 1996 - ----------------------------------- Director of Coffee Martin R. Diedrich /s/ STEVEN A. LUPINACCI President, Chief Executive Officer, September 9, 1996 - ----------------------------------- Chief Financial Officer and Director Steven A. Lupinacci (Principal Executive Officer and Principal Financial Officer) * Controller (Principal Accounting September 9, 1996 - ----------------------------------- Officer) Edwin P. Ott * Director September 9, 1996 - ----------------------------------- Paul C. Heeschen *By: /s/ STEVEN A. LUPINACCI - ----------------------------------- Steven A. Lupinacci Attorney-in-Fact
II-5 89 EXHIBIT INDEX
SEQUENTIALLY EXHIBIT NUMBERED NO. DESCRIPTION PAGES - ------------ -------------------------------------------------------------------- ------------- 1.1 Form of Underwriting Agreement 2.1 Form of Agreement and Plan of Merger(4) 3.1 Certificate of Incorporation of the Company(4) 3.2 Bylaws of the Company(4) 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.(3) 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.(3) 4.3 Representative's Warrant Agreement 4.4 Specimen Stock Certificate 4.5 Form of Conversion Agreement in connection with the conversion of Series A and Series B Preferred Stock into Common Stock(4) 5.1 Opinion of Gibson, Dunn & Crutcher LLP 10.1 Martin R. Diedrich Employment Agreement, dated June 29, 1995 (1) 10.2 Steven A. Lupinacci Employment Agreement, dated June 29, 1995(4) 10.3 Stock Option Plan and Agreement of Steven A. Lupinacci, dated June 29, 1995(3) 10.4 Form of Indemnification Agreement (1) 10.5 Diedrich Coffee 1996 Stock Incentive Plan (1) 10.6 Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan(3) 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(3) 10.8 Revolving Promissory Note dated May 20, 1996 by Diedrich Coffee in favor of Redwood Enterprises VII, L.P. (1) 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(3) 10.10 Kerry W. Coin Employment Agreement, dated August 26, 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 (2) 27.1 Financial Data Schedule(4) 99.1 Consent of Peter Churm(3) 99.2 Consent of Lawrence Goelman(3)
- --------------- * To be filed by amendment. (1) Previously filed with this Registration Statement on July 23, 1996. (2) Previously filed with Amendment No. 1 to this Registration Statement on July 24, 1996. (3) Previously filed with Amendment No. 2 to this Registration Statement on August 12, 1996. (4) Previously filed with Amendment No. 3 to this Registration Statement on August 28, 1996. EX-1.1 2 FORM OF UNDERWRITING AGREEMENT 1 EXHIBIT 1.1 2,200,000 Shares of Common Stock DIEDRICH COFFEE, INC. UNDERWRITING AGREEMENT Los Angeles, California September ___, 1996 THE BOSTON GROUP, L.P. As Representative of the Several Underwriters Named in Schedule I Hereto 2049 Century Park East, 30th Floor Los Angeles, California 90067 Ladies and Gentlemen: Diedrich Coffee, Inc., a Delaware corporation (the "Company") and successor to Diedrich Coffee, a California corporation ("Diedrich California"), and D.C.H, L.P., a California limited partnership, Redwood Enterprises VII, L.P., a California limited partnership ("Redwood"), and Diedrich Partners I, L.P., a California limited partnership ("Diedrich Partners") (collectively, the "Selling Stockholders"), confirm their agreement with the several Underwriters named in Schedule I attached hereto and incorporated herein by this reference (the "Underwriters") with respect to the sale by the Company and the purchase by the Underwriters, severally and not jointly, of the number of shares of Common Stock set forth opposite each person's name under the column "Number of Selling Shares" in Schedule I, for an aggregate of one million six hundred thousand (1,600,000) shares (the "Company Shares") of the Company's common stock, $0.01 par value (the "Common Stock"), and the sale by the Selling Stockholders, severally and not jointly, and the purchase by the Underwriters, severally and not jointly, of the number of shares of Common Stock set forth opposite each person's name under the column "Number of Selling Shares" in Schedule I, for an aggregate of six hundred thousand (600,000) shares (the "Selling Shares") of Common Stock from the Selling Stockholders (the Company Shares and the Selling Shares collectively shall herein be called the "Firm Shares"). Redwood, Diedrich Partners and Martin R. Diedrich (collectively, the "Overallotment Sellers") further, severally and not jointly, confirm their agreement to sell to the Underwriters the number of shares of Common Stock set forth opposite each person's name under the column "Number of Option Shares" in Schedule II -1- 2 attached hereto for an aggregate of up to three hundred thirty thousand (330,000) shares of Common Stock for the purpose of covering over-allotments, if any (the "Option Shares"), in accordance with the provisions of Section 4(b) hereof. The Firm Shares and the Option Shares are hereinafter referred to collectively as the "Securities" and are more fully described in the Registration Statement and the Prospectus referred to below. The Company also proposes to issue and sell to you or your designees, individually and not in your capacity as Representative, warrants (the "Representative's Warrants") pursuant to the Representative's Warrant Agreement substantially in the form filed as Exhibit 4.3 to the Registration Statement (the "Representative's Warrant Agreement"), for the purchase of an additional one hundred sixty thousand (160,000) shares of Common Stock (the "Representative's Shares"), in accordance with the provisions of Section 4(d) hereof. The shares of Common Stock issuable upon exercise of the Representative's Warrants are hereinafter referred to as the "Warrant Shares." 1. Representations and Warranties of the Company. The Company represents and warrants to each of the Underwriters as of the date hereof, and as of the Closing Date and each Option Closing Date (as such terms are defined below), if any, as follows: (a) The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") a registration statement, and amendments thereto, on Form S-1 (Registration No. 333-08633), including any related Preliminary Prospectus (as defined below), for the registration of the offer and sale of the Securities under the Securities Act of 1933, as amended (the "Act"). The Company will next file with the Commission either (A) prior to effectiveness of such registration statement, a further amendment to such registration statement, including the form of final prospectus or (B) after effectiveness of such registration statement, a final prospectus in accordance with Rules 430A and 424(b)(1) or (4). In the case of clause (B), the Company will include in such registration statement, as amended at the Effective Date (as defined below), all material information (other than Rule 430A Information (as defined below)) required by the Act and the rules thereunder to be included in the Prospectus with respect to the Securities and the offering thereof. As filed, such amendment and form of final prospectus, or such final prospectus, shall include all Rule 430A Information, together with all other such required information, with respect to the Securities and the offering thereof and, except to the extent the Representative shall agree in writing to a modification, shall be in all substantive respects in the form furnished to you prior to the Execution Time (as defined below) or, to the extent not completed at the Execution Time, shall contain only such specific additional information and other changes (beyond that contained in the latest Preliminary Prospectus, as defined below) as the Company has advised you, prior to the Execution Time, will be included or made therein. "Rule 430A Information" means information with respect to the Securities and the offering thereof permitted to be omitted from the Registration Statement when it becomes effective pursuant to Rule 430A. As used in this Agreement, the term "Registration Statement" means such registration statement, as amended at the time when it was or is declared effective, including all financial statements and exhibits thereto and, in the event of any post-effective amendment thereto or a registration statement filed with respect to the Securities pursuant to Rule 462(b) (or post-effective amendment thereto), becomes effective prior to the Closing Date (as hereinafter defined), shall also mean such registration statement as so amended or registration statement (or amendment thereto) pursuant to Rule 462(b), respectively. Such -2- 3 term shall include any information deemed to be included therein at the Effective Date pursuant to Rule 430A under the Act or any Term Sheet (as defined below) filed pursuant to Rule 434 under the Act. The term "Preliminary Prospectus" means each prospectus subject to completion filed with such Registration Statement or any amendments thereto (including the prospectus subject to completion, if any, included in the Registration Statement or any amendment thereto at the time it was or is declared effective); the term "Prospectus" means: (i) if the Company relies on Rule 434 under the Act, the Term Sheet relating to the Securities that is first filed pursuant to Rule 424(b)(7) under the Act, together with the Preliminary Prospectus identified therein that such Term Sheet supplements, (ii) if the Company does not rely on Rule 434 under the Act, the prospectus first filed with the Commission pursuant to Rule 424(b) under the Act, or (iii) if the Company does not rely on Rule 434 under the Act and if no prospectus is required to be filed pursuant to Rule 424(b) under the Act, the prospectus included in the Registration Statement; and the term "Term Sheet" means any term sheet that satisfies the requirements of Rule 434 under the Act. Any reference hereto to the "date" of a Prospectus that includes a Term Sheet shall mean the date of such Term Sheet. For purposes hereof, "Rules and Regulations" means the rules and regulations adopted by the Commission under the Act or the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as applicable. The term "Effective Date" shall mean each date that the Registration Statement and any post-effective amendment or amendments thereto become effective. "Execution Time" shall mean the date and time that this Agreement is executed and delivered by the parties hereto. (b) Neither the Commission nor any state regulatory authority has issued any order preventing or suspending the use of any Preliminary Prospectus, the Registration Statement or the Prospectus or any part of any of the foregoing, and no proceedings for a stop order suspending the effectiveness of the Registration Statement or any part thereof have been initiated or, to the Company's knowledge, are pending, contemplated or threatened. Each Preliminary Prospectus and the Registration Statement (including each amendment thereto), at the time of filing thereof and on the Effective Date, complied or will comply with the requirements of the Act and the Rules and Regulations, and neither any Preliminary Prospectus nor the Registration Statement, at the time of filing thereof and on the Effective Date, contained or will contain an untrue statement of a material fact or omitted or will omit to state a material fact required to be stated therein or necessary to make the statements therein, not misleading; provided that, the foregoing shall not apply to statements made or statements omitted in reliance upon information furnished to the Company by you or on your behalf in writing expressly for use in any Preliminary Prospectus or in the Registration Statement. (c) The Company has filed a Form 8-A with the Commission providing for the registration under the Exchange Act of its Common Stock, which registration shall become effective concurrently with the effectiveness of the Registration Statement. (d) The Company has been duly organized and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation. The Company is duly qualified and licensed and in good standing as a foreign corporation in each jurisdiction in which it owns or leases property or in which the conduct of its business, as currently being conducted, requires such qualification or licensing, except where the failure -3- 4 to be so qualified, licensed or in good standing, singularly or in the aggregate, would not have a material adverse effect on the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, properties, businesses or results of operations of the Company taken as a whole ("Material Adverse Effect"). The Company has all requisite power and authority (corporate, if applicable, and other), and has obtained any and all authorizations, approvals, orders, licenses, certificates, franchises and permits of and from all governmental or regulatory officials, agencies, authorities and bodies (including, without limitation, those having jurisdiction over environmental, health or similar matters) ("Permits") necessary to own or lease its properties and conduct its business as described in the Prospectus other than those which, singularly or in the aggregate, the failure to obtain would not have a Material Adverse Effect. The Company has fulfilled and performed all of its material obligations with respect to such Permits, and all federal, state and local laws, regulations and orders; and the Company has not received any notice of proceedings relating to the revocation or modification of any such Permits which, singularly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would have a Material Adverse Effect. None of such Permits contains any restriction that is materially burdensome to the Company in conducting its business as described in the Prospectus except as may be set forth therein. The disclosure in the Registration Statement concerning the effects of federal, state and local laws, rules, regulations and orders on the Company's business as currently conducted and as contemplated is correct in all material respects and does not omit to state a material fact required to be stated therein or necessary to make the statements contained therein, in light of the circumstances in which they were made, not misleading. The Company does not own an interest in any corporation, partnership, trust, joint venture or other entity. (e) The Company has the duly authorized, issued and outstanding capitalization as set forth in the Prospectus, and any amendment or supplement thereto under "Capitalization" and "Description of Capital Stock," and will have the adjusted capitalization set forth therein on the Closing Date and each Option Closing Date, if any, based upon the assumptions set forth therein. The Company is not a party to or bound by any instrument, agreement or other arrangement or understanding providing for or requiring it to issue any capital stock, rights, warrants, options or other securities, except for this Agreement, the Representative's Warrant Agreement, the Company's Non-Employee Directors Stock Plan (the "Non-Employee Directors Plan"), the Company's 1996 Stock Incentive Plan (the "Incentive Plan"), and the Stock Option Plan and Agreement of Mr. Lupinacci as in effect as of the date of this Agreement and as described in the Registration Statement (collectively, the "Incentive Plans"). The Securities and all other securities issued or issuable by the Company conform or, when issued and paid for, will conform, in all material respects to the description thereof contained in the Registration Statement and the Prospectus. All issued and outstanding securities of the Company (including the Selling Shares) have been duly authorized and validly issued and are fully paid and non- assessable; the holders thereof have no rights of rescission with respect thereto, and the holders of ownership interests in the Company are not subject to personal liability solely by reason of being such holders; and none of such securities were issued in violation of the preemptive rights, co-sale right, right of first refusal or other similar rights of any holders of any security of the Company. The Securities have been duly authorized and, when issued, paid for and delivered in accordance with the terms hereof, will be validly issued, fully paid and non-assessable and issued in full -4- 5 compliance with all applicable federal and state securities laws; the holders thereof will not be subject to any liability solely by reason of being such holders; all corporate action required to be taken for the authorization, issue and sale of the Securities has been duly and validly taken; and the certificates representing the Securities, when delivered by the Company, will be in due and proper form. Upon the issuance and delivery of the Securities pursuant to the terms hereof and the Representative's Warrant Agreement and Representative's Warrants and Representative's Shares to be sold by the Company hereunder and thereunder, respectively, the Underwriters and the Representative, respectively, will acquire good and marketable title to such Securities and Representative's Warrants and Representative's Shares, free and clear of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction of any kind whatsoever other than those arising from acts of any Underwriter or their affiliates. (f) The financial statements of the Company and the notes thereto included in the Registration Statement and the Prospectus fairly present the financial position, results of operations and cash flow and changes in financial position and stockholders' equity of the Company at the respective dates and for the respective periods to which they apply, and such financial statements and related notes thereto have been prepared in conformity with generally accepted accounting principles and the Rules and Regulations, consistently applied throughout the periods involved. The as adjusted and/or pro forma combined financial information included in the Registration Statement and the Prospectus present fairly the information shown therein, have been prepared in conformity with the Rules and Regulations and have been properly compiled on the basis described therein consistent with the historical financial statements included in the Registration Statement and the Prospectus. The assumptions underlying such as adjusted and/or pro forma financial information are reasonable, and the adjustments made therein are appropriate to give effect to the transactions or circumstances referred to therein. There has been no material adverse change, or known development involving a material prospective change, in the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, obligations, properties, businesses or results of operations of the Company, whether or not arising in the ordinary course of business, since the date of the financial statements included in the Registration Statement and the Prospectus, except as described therein. The outstanding debt, property and assets (both tangible and intangible) and the businesses of the Company conform in all material respects to the descriptions thereof contained in the Registration Statement and the Prospectus. The financial information set forth in the Prospectus fairly presents the information set forth therein and such financial information has been derived from or compiled on a basis consistent with that of the audited financial statements included in the Registration Statement and the Prospectus as described above. (g) The Company (i) has filed all federal, state, local and foreign tax returns required to be filed, which returns are true and correct in all material respects, (ii) has paid all federal, state, local and foreign taxes for which it is liable, including, but not limited to, withholding taxes and amounts payable under Chapters 21 through 24 of the Internal Revenue Code of 1986, as amended (the "Code"), and any other assessments, fines or penalties leveled against it and has furnished all information returns it is required to furnish pursuant to the Code or otherwise, (iii) has established adequate reserves for such -5- 6 taxes, assessments, fines or penalties which are not due and payable and (iv) does not have any tax deficiency or claims outstanding, proposed or assessed against it. (h) No transfer tax, stamp, duty or other similar tax, fee or duty is payable by or on behalf of the Underwriters or the Representative, as applicable, in connection with (i) the issuance by the Company of the Securities, (ii) the purchase by the Underwriters of the Securities or (iii) the consummation of any of the transactions contemplated by this Agreement, the Representative's Warrant Agreement, the Registration Statement or the Prospectus. (i) The Company maintains insurance policies, including, without limitation, general liability, property and personal liability insurance, and surety bonds which insure the Company, its employees and such other persons to whom such entities may become liable against such losses and risks generally insured against by comparable businesses, all of which insurance is in full force and effect. (j) There is no action, suit, proceeding, inquiry, arbitration, investigation, litigation or governmental or other proceeding (including, without limitation, those pertaining to environmental, health or similar matters) pending, contemplated or threatened (or circumstances that may give rise to the same), to which the Company is subject or to which any property or assets (tangible or intangible) of the Company is subject (or circumstances that may give rise to the same) which (i) questions the validity of the capital stock of the Company, of this Agreement, of the Representative's Warrant Agreement or of any action or transaction contemplated by this Agreement, the Representative's Warrant Agreement, the Registration Statement or the Prospectus, (ii) is required to be disclosed in the Prospectus which is not so disclosed (and such proceedings as are summarized in the Prospectus are accurately summarized in all respects) or (iii) might, if adversely determined, have a Material Adverse Effect, except as disclosed in the Prospectus. (k) The Company has full legal right, power and authority to authorize, issue, deliver and sell the Securities, to enter into this Agreement and the Representative's Warrant Agreement and to consummate the transactions contemplated in such agreements, the Registration Statement and the Prospectus; and this Agreement has been duly and properly authorized, executed and delivered by the Company. This Agreement constitutes a legal, valid and binding agreement of the Company enforceable against the Company in accordance with its terms except to the extent that indemnity and/or contribution may be limited by federal securities law or the public policy of a state with respect to such matters. (l) Neither the issuance, delivery and sale of the Securities, the execution, delivery or performance of this Agreement or Representative's Warrant Agreement, the consummation of the transactions contemplated herein, therein, in the Registration Statement or the consummation of the Merger (as hereinafter defined), nor the conduct of the Company's business as described in the Registration Statement, the Prospectus and any amendments thereof or supplements thereto, conflicts or will conflict with, or results or will result in any breach or violation of any of the terms, covenants, conditions or provisions of, or constitutes or will constitute (with notice, the lapse of time or both) a default under, or results or will result in the creation or imposition of any lien, charge, claim, encumbrance, -6- 7 pledge, security interest, defect or other restriction or equity of any kind whatsoever upon any property or assets (tangible or intangible) of the Company (except as described in the Prospectus) pursuant to the terms of, (i) the Certificate of Incorporation or bylaws of the Company, (ii) any license, contract, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, stockholders agreement, purchase order, note, loan or credit agreement or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which the Company is a party or by which it is or may be bound or to which any of its properties or assets (tangible or intangible) is or may be subject except where such conflict, breach, violation, lien or other restriction would not have a Material Adverse Effect or (iii) any law, statute, judgment, decree, order, rule or regulation applicable to the Company of any arbitrator, court, administrative agency or other governmental or regulatory official, agency authority or body (including, without limitation, those having jurisdiction over environmental, health or similar matters) having jurisdiction over the Company or any of its activities or properties. (m) No consent, approval, authorization, registration, qualification, or order of, and no filing with, any court, administrative agency or other government or regulatory official, agency, authority or body is required for the issuance, delivery and sale of the Securities pursuant to this Agreement, the Prospectus and the Registration Statement, the performance of this Agreement and the Representative's Warrant Agreement and the consummation of the transactions contemplated hereby, thereby, by the Registration Statement and by the Prospectus, except such as have been or may be obtained under the Act, state securities or "blue sky" laws and the rules of the National Association of Securities Dealers, Inc. (the "NASD") in connection with the Underwriters' purchase and distribution of the Securities. (n) All agreements, contracts or other documents or copies of executed agreements, contracts or other documents filed or required to be filed as exhibits to the Registration Statement to which the Company therein is a party or by which it may be bound are accurately described and fairly present the information required to be shown with respect thereto by Form S-1 or the Rules and Regulations; there are no agreements, contracts or other documents which are required by the Act to be described in the Registration Statement or filed as exhibits to the Registration Statement which are not described or filed as required; and the exhibits which have been filed are complete and correct copies of the agreements, contracts or other documents of which they purport to be copies. (o) Subsequent to the respective dates as of which information is set forth in the Registration Statement and the Prospectus, and except as may otherwise be indicated or contemplated herein or therein, the Company has not done, or agreed to do, any of the following, (i) issued any securities or incurred any liability or obligation, direct, indirect or contingent, for borrowed money, (ii) entered into any transaction other than in the ordinary course of business or (iii) declared or paid any dividend or made any other distribution on or in respect of any class of its capital stock; and, subsequent to such dates and except as may otherwise be indicated or contemplated herein or therein, there has not been any change in the capital stock or any change in the debt (long- or short-term) or liabilities or obligations or any material change in the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, properties, businesses or results of -7- 8 operations of the Company except for debt, liabilities and obligations incurred in the normal course of business consistent with past practices. (p) No material default exists, and no event has occurred which, with notice, lapse of time or both, would constitute a default in the due performance and observance of any term, covenant, condition or provision of any license, contract, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, stockholders' agreement, purchase order, note, loan or credit agreement or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which the Company is a party or by which it is or may be bound or its properties or assets (tangible or intangible) are or may be subject, except where such default would not have a Material Adverse Effect. The Company is not in violation of its Certificate of Incorporation or bylaws, or other organizational documents, or in violation in any material respect of any law, ordinance, administrative or governmental rule or regulation applicable to the Company or its subsidiaries. (q) The Company has generally enjoyed a satisfactory employer-employee relationship with its employees and it is in substantial compliance with all federal, state and local laws, rules, regulations and orders respecting employment and employment practices, including, without limitation, terms and conditions of employment and wages and hours. There are no pending investigations involving the Company by the U.S. Department of Labor, the Department of Justice - Immigration and Naturalization Service or any other governmental or regulatory official, agency, authority or body responsible for the enforcement of such federal, state or local laws, rules, regulations and orders, except where such investigation could not be expected to have a Material Adverse Effect. There is no unfair labor practice charge or complaint pending, threatened or contemplated against the Company before the National Labor Relations Board or any strike, picketing, boycott, dispute, slowdown or stoppage pending, threatened or contemplated against or involving the Company and none has ever occurred. There are no existing collective bargaining agreements with the Company. No representation question exists respecting the employees of the Company and no collective bargaining agreement or modification thereof is currently being negotiated by or on behalf of the Company. No grievance or arbitration proceeding is pending, threatened or contemplated under any expired collective bargaining agreements of the Company. No labor dispute with the employees of the Company is pending, threatened or contemplated. (r) Except as disclosed in the Registration Statement or Prospectus, the Company does not maintain, sponsor, contribute, have any obligation to contribute or have any obligation with respect to, or at any time previously maintained, sponsored, contributed, had any obligation to contribute or had any obligation with respect to, any program or arrangement that is an "employee pension benefit plan," an "employee welfare benefit plan" or a "multi-employer plan" (each an "ERISA Plan"), as such terms are defined in Sections 3(2), 3(l) and 3(37), respectively, of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Except as disclosed in the Registration Statement or Prospectus, the Company does not maintain, sponsor, contribute, have any obligation to contribute or have any obligation with respect to or has it at any time previously maintained, sponsored, contributed, had any obligation to contribute or had any obligation with respect to, a "defined -8- 9 benefit plan," as defined in section 3(35) of ERISA. No ERISA Plan (or any trust created thereunder) has engaged in a "prohibited transaction" within the meaning of Section 406 of ERISA or Section 4975 of the Code which could subject the Company to any tax penalty on prohibited transactions and which has not adequately been corrected. Each ERISA Plan is in compliance with all material reporting, disclosure and other requirements of the Code and ERISA as they relate to any such ERISA Plan. Determination letters have been received from the Internal Revenue Service with respect to each ERISA Plan which is intended to comply with Code Section 401(a), stating that such ERISA Plan and the attendant trust are qualified thereunder. The Company is not in any way liable in connection with a "multiemployer plan" from which it has ever completely or partially withdrawn. (s) Neither the Company nor any of its employees, directors, stockholders or affiliates (within the meaning of the Rules and Regulations) of any of the foregoing, has taken, directly or indirectly, any action designed to or which has constituted or which might be expected to cause or result in, under the Exchange Act or otherwise, the illegal stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities or otherwise. (t) The Company and its subsidiaries own or possess adequate licenses or other rights to use all patents, trademarks, trademark registrations, service marks, service mark registrations, trade names, copyrights, licenses, inventions, trade secrets, and knowhow or other similar rights ("Intellectual Property") described in the Prospectus as being owned or possessed by them, or necessary for the conduct of its business as described in the Prospectus, the Company has not infringed, is not now infringing, and its business as presently conducted and as proposed to be conducted will not cause it to infringe, any Intellectual Property belonging to any other person, which infringement or infringements, either individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect; the Company has not received any claim or notice of infringement or potential infringement of any Intellectual Property of any other person which could reasonably be expected to have a Material Adverse Effect; and neither the Company nor any of its subsidiaries has any claim against a third party with respect to the infringement by such third party of Intellectual Property of the Company or any such subsidiary material to the business or prospects of the Company and its subsidiaries considered as a whole. (u) The Company has the unrestricted right to use all trade secrets, knowhow (including, without limitation, all unpatented and/or unpatentable proprietary or confidential information, systems or procedures), inventions, technology, designs, processes, works of authorship, computer programs and technical data and information that are material to the development, manufacture, operation and sale of all products and services sold or proposed to be sold by the Company, free and clear of and without violating any right, lien or claim of others, including, without limitation, former employers of their employees. (v) The Company has good and marketable title to, or valid and enforceable leasehold estates in, all items of real and personal property described in the Registration Statement and Prospectus as owned or leased by it and such property is owned by it free and clear of all liens, charges, claims, encumbrances, pledges, security interests, -9- 10 defects, or other restrictions or equities of any kind whatsoever, other than those referred to in the Prospectus and liens for taxes not yet payable. (w) BDO Seidman, LLP whose report is filed with the Commission as a part of the Registration Statement, each Preliminary Prospectus and the Prospectus, is an accounting firm of independent certified public accountants as required by the Act and the Rules and Regulations. (x) The Company has caused to be executed agreements pursuant to which the Company, the Selling Stockholders, Martin R. Diedrich and Steven A. Lupinacci, who, prior to the execution of this Agreement, collectively own all of the issued and outstanding shares of Common Stock have agreed, for a period of one hundred eighty (180) days following the effective date of the Registration Statement, not to, directly or indirectly, offer, offer to sell, sell, grant an option for the purchase or sale of, transfer, assign, pledge, exercise any registration rights or deliver any notice regarding registration, hypothecate or otherwise encumber or enter into any agreement to do any of the foregoing with respect to any securities issued or issuable by the Company, whether or not owned by or registered in the name of such person, or dispose of any interest therein (whether pursuant to Rule 144 under the Act or otherwise), without the prior written consent of the Representative (collectively, the "Lock-Up Agreements"). (y) There are no claims, payments, issuances, agreements, arrangements or understandings, whether oral or written, for services in the nature of a finder's fee, brokerage fee, origination fee or otherwise with respect to the offerings contemplated by this Agreement, the Representative's Warrant Agreement, the Registration Statement and the Prospectus or any other arrangements, agreements, understandings, payments or issuances that may affect the Underwriters' compensation as determined by the NASD other than as disclosed in the Registration Statement and Prospectus and other than as the Representative may itself have agreed to with third parties. (z) The Securities have been approved for quotation, subject to official notice of issuance, on the Nasdaq National Market (the "NNM") and the Company has obtained CUSIP numbers for the Securities. The Certificates for the Securities conform to the requirement of the Delaware General Corporation Law and the NNM. (aa) Neither the Company nor any officer, stockholder, employee, agent nor any other person acting on behalf of the Company has, directly or indirectly, given or agreed to give any money, gift or similar benefit (other than legal price concessions to customers in the ordinary course of business) to any customer, supplier, employee or agent of a customer or supplier, or any official or employee of any governmental agency or instrumentality of any government or any political party or candidate for office or any other person who was, is or may be in a position to help or hinder the business of the Company (or assist them in connection with any actual or proposed transactions) which might subject the Company or any other such person to any damage or penalty in any civil, criminal or governmental action, suit, inquiry, investigation, litigation or proceeding. -10- 11 (ab) Except as set forth in the Prospectus under "Certain Transactions" and "Management - Compensation Committee Interlocks and Insider Participation," and except for transaction(s) that would not be required to be disclosed in the Registration Statement pursuant to the Rules and Regulations, no officer, director or stockholder of the Company, and no affiliate or associate (as those terms are defined in the Rules and Regulations) of any of the foregoing persons or entity, has or has had, either directly or indirectly, (i) an interest in any person or entity which (A) furnishes or sells services or products which are furnished or sold or are proposed to be furnished or sold by the Company or (B) purchases from or sells or furnishes to the Company any products or services or (ii) a beneficial interest in any contract, arrangement, understanding or agreement to which the Company is a party or by which the Company or any of its property or assets (tangible or intangible) may be bound or affected. Except as set forth in the Prospectus under "Certain Transactions" and "Management - Compensation Committee Interlocks and Insider Participation," there are no existing agreements, arrangements, understandings or transactions, or proposed agreements, arrangements, understandings or transactions, between or among the Company and any officer or director of the Company or any person listed in the "Principal and Selling Stockholders" section of the Prospectus, or any affiliate or associate of any of the foregoing persons or entity. (ac) The minute books of the Company have been made available to the Representative and contain a complete summary of all meetings and actions of the directors, including any committee thereof, and stockholders of the Company since the time of its incorporation, and reflect all transactions referred to in such minutes accurately in all material respects. (ad) Except as described in the Registration Statement, no person, corporation, trust, partnership, association or other entity has the right to include or register any securities of the Company in the Registration Statement or to require that any registration statement be filed by the Company or, if filed, to include any security in such registration statement. Except as described in the Registration Statement, no person, corporation, trust, partnership, association or other entity holds any antidilution rights with respect to any securities of the Company. (ae) Any certificate signed by any officer of the Company, and delivered to the Representative or to the Underwriters' Counsel shall be deemed a representation and warranty by the Company to the Underwriters as to the matters covered thereby. (af) The Company has (i) entered into an employment agreement with each of Martin R. Diedrich and Steven A. Lupinacci in substantially the same forms filed as Exhibits 10.1 and 10.2, respectively, to the Registration Statement, and (ii) purchased key-man life insurance on the life of Martin R. Diedrich in the amount of one million dollars ($1,000,000) which policy names the Company as the sole beneficiary thereof. (ag) The Representative's Warrant Agreement has been duly and validly authorized by the Company and, assuming due execution by the Representative, constitutes or will constitute a valid and legally binding agreement of the Company, enforceable against the Company in accordance with its terms (except as such enforceability may be limited by -11- 12 applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law). The Company has reserved and available for issuance a sufficient number of shares of Common Stock to be issued upon exercise of the Representative's Warrants. (ah) The Company is familiar with the Investment Company Act of 1940, as amended (the "1940 Act"), and the rules and regulations thereunder, and has in the past conducted, and intends in the future to conduct, its affairs in such a manner as to ensure that it will not become an "investment company" within the meaning of the 1940 Act and such rules and regulations. (ai) The books, records and accounts of the Company accurately and fairly reflect, in reasonable detail, the transactions and dispositions of the assets of the Company. The system of internal accounting controls maintained by the Company is sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary (A) to permit preparation of financial statements in accordance with generally accepted accounting principles and (B) to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any difference. (aj) All transactions necessary to complete the merger (the "Merger") of Diedrich California with and into the Company in accordance with the terms of that certain Agreement and Plan of Reorganization, dated August 29, 1996 (the "Merger Agreement"), between the Company and Diedrich California have been consummated and the Merger was effectuated on September 6, 1996 (the "Merger Date"). Each of the Company and Diedrich California had all requisite corporate power and authority to execute, deliver and perform the Merger Agreement. All necessary corporate proceedings of the Company and Diedrich California had been duly taken to authorize the execution, delivery and performance of the Merger Agreement. The Merger Agreement had been duly authorized, executed and delivered by the Company and/or Diedrich California, as the case may be, is the legal, valid and binding obligation of the Company and/or Diedrich California, as the case may be, and is enforceable as to the Company and/or Diedrich California, as the case may be, in accordance with its terms. The Company has obtained all consents, authorizations, approvals, orders, licenses, certificates or permits of or from, or declaration or filing with, any federal, state, local or other governmental authority or any court of other tribunal which is required by the Company or Diedrich California for the execution, delivery, or performance of any Merger Agreement. The Company has obtained all consents, approvals or authorizations of any party to any material license, contract, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, stockholders agreement, purchase order, note, loan or credit agreement or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which the Company or Diedrich California is a party or by which either of them is or may be bound or to which either of their properties or assets (tangible or -12- 13 intangible) are or may be subject, necessary for the execution, delivery or performance by the Company or Diedrich California of the Merger Agreement. The execution, delivery and performance of the Merger Agreement by the Company and Diedrich California did not conflict with and did not result in any breach or violation of any of the terms, covenants, conditions or provisions of, did not constitute (with notice, the lapse of time or both) a default under, result in the creation or imposition of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever upon any property or assets (tangible or intangible) of the Company or Diedrich California pursuant to the terms of, (i) the Certificate or Articles of Incorporation or bylaws of the Company or Diedrich California, (ii) any material contract, license, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, stockholders' agreement, purchase order, note, loan or credit agreement or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which the Company or Diedrich California was a party at the Merger Date or by which they were bound at the Merger Date or to which any of their properties or assets (tangible or intangible) were subject at the Merger Date or (iii) any law, statute, judgment, decree, order, rule or regulation applicable to the Company or Diedrich California at the Merger Date of any arbitrator, court, administrative agency or other governmental or regulatory official, agency authority or body (including, without limitation, those having jurisdiction over environmental, health or similar matters) having jurisdiction over the Company, Diedrich California or either of their activities or properties. (ak) The Company has all manufacturer, vendor and distributor authorizations, permits, licenses and other approvals necessary for the Company to conduct its business as described in the Prospectus other than those authorizations, approvals, licenses and permits of and from manufacturers, vendors and distributors which, singularly or in the aggregate, the failure to obtain would not have a Material Adverse Effect. The Company is and has been doing business in substantial compliance with all such authorizations, approvals, licenses, and permits; and the Company has not received any notice of violation, revocation or modification of any such authorizations, approvals, licenses or permits which, singularly or in the aggregate, would materially and adversely affect the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, properties, businesses or results of operations of the Company. 2. Representations and Warranties of the Selling Stockholders. Each Selling Stockholder, severally and not jointly, represents and warrants to, and covenants and agrees with, each of the Underwriters as of the date hereof and as of the Closing Date, with respect to such portion of the Selling Shares being sold by such Selling Stockholder, as follows: (a) All authorizations, orders, consents and other approvals necessary for the execution and delivery of this Agreement and the sale and delivery of the Selling Shares by such Selling Stockholder, including, but not limited to, approvals under relevant partnership agreements and partnership law, have been duly and validly given, and such Selling Stockholder has full legal right, power and authority to enter into this Agreement and to sell and deliver the Selling Shares to the Underwriters. This Agreement constitutes a legal, valid and binding agreement of such Selling Stockholder enforceable against such Selling Stockholder in accordance with its terms (except as such enforceability may be -13- 14 limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law). (b) Such Selling Stockholder has and on the Closing Date will have, good, valid and marketable title to the Selling Shares. The Selling Shares, as of the date of this Agreement and as of the Closing Date, have not previously been sold except pursuant to and as contemplated by this Agreement; and upon the delivery of and payment for the Selling Shares, good, valid and marketable title thereto, free and clear of all liens, charges, claims, encumbrances, pledges, security interests, defects or other restrictions or equities of any kind whatsoever, will pass to the Underwriters. (c) Neither the execution, delivery or performance of this Agreement, any Power of Attorney and Custody Agreement to be executed by such Selling Stockholder in connection with the transactions contemplated by this Agreement (the "Power-of-Attorney" and the "Custody Agreement," respectively), the delivery and sale of the Selling Shares nor the consummation of the transactions contemplated by this Agreement, the Registration Statement and the Prospectus conflicts or will conflict with or results or will result in any breach or violation of any of the terms, covenants, conditions or provisions of, or constitutes or will constitute (with notice, the lapse of time or both) a default under, or results or will result in the creation or imposition of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever upon any property or assets (tangible or intangible) of such Selling Stockholder pursuant to the terms of (i) any material license, contract, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, purchase order, note, loan or credit agreement or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which such Selling Stockholder is a party or by which he, she or it is or may be bound or to which any of its properties or assets (tangible or intangible) is or may be subject or (ii) any law, statute, judgment, decree, order, rule or regulation applicable to such Selling Stockholder of any arbitrator, court, administrative agency or other governmental official, agency, authority or body (including, without limitation, those having jurisdiction over environmental, health or similar matters) having jurisdiction over the Selling Stockholder or any of his, her or its activities or properties. (d) Such Selling Stockholder has not taken, and will not take, directly or indirectly, any action designed to or which has constituted or which might be expected to cause or result in, under the Exchange Act or otherwise, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities or otherwise and has not effected any sales of shares of Common Stock which, if effected by the issuer, would be required to be disclosed in response to Item 701 of Regulation S-K. (e) Certificates in negotiable form for such Selling Shareholder's Securities have been placed in custody, for delivery pursuant to the terms of this Agreement, under a Power of Attorney and Custody Agreement executed and delivered by such Selling Shareholder, in the form heretofore furnished to you (the "Custody Agreement"), with Steven A. Lupinacci, as Custodian (the "Custodian"); the Securities represented by the -14- 15 certificates so held in custody for each Selling Shareholder are subject to the interests hereunder of the Underwriters, the Company, and the other Selling Shareholders; the arrangements for custody and delivery of such certificates, made by such Selling Shareholder hereunder and under the Custody Agreement, are not subject to termination by any acts of such Selling Shareholder, or by operation of law, whether by the death or incapacity of such Selling Shareholder or the occurrence of any other event; and if any such death, incapacity or any other such event shall occur before the delivery of such Securities hereunder, certificates for the Securities will be delivered by the Custodian in accordance with the terms and conditions of this Agreement and the Custody Agreement as if such death, incapacity or other event had not occurred, regardless of whether or not the Custodian shall have received notice of such death, incapacity or other event. (f) There is no action, suit, proceeding, inquiry, arbitration, investigation, litigation or governmental or other proceeding pending, contemplated or threatened (or circumstances that may give rise to the same), to which such Selling Stockholder is subject or to which any property or assets (tangible or intangible) of such Selling Stockholder is subject (or circumstances that may give rise to the same) which questions the validity of this Agreement or of any action or transaction contemplated by this Agreement, the Registration Statement or the Prospectus. (g) Such Selling Stockholder represents and warrants to, and agrees with, the Underwriters to the same effect as the representation and warranties of the Company set forth in Section 1 of this Agreement; provided, however, that such Selling Stockholder shall be liable for breach of the representations and warranties in this Section 2(g) only for an amount not exceeding the proceeds received by such Selling Stockholder from the sale of the Selling Shares hereunder. (h) Such Selling Stockholder has reviewed the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) and the Registration Statement, and the information regarding such Selling Stockholder set forth therein under the caption "Principal and Selling Stockholders" is complete and accurate. (i) In order to document the Underwriters' compliance with the reporting and withholding provisions of the Internal Revenue Code of 1986, as amended, with respect to the transactions herein contemplated, such Selling Stockholder shall deliver to the Representative prior to or on the Closing Date, a properly completed and executed United States Treasury Department Form W-8 or W-9 (or other applicable form of statement specified by Treasury Department regulations in lieu thereof). 3. Representations and Warranties of the Overallotment Sellers. Each Overallotment Seller, severally and not jointly, represents and warrants to, and covenants and agrees with, each of the Underwriters as of the date hereof and as of each Option Closing Date, with respect to such portion of the Option Shares being sold by such Overallotment Seller, as follows: (a) All authorizations, orders, consents and other approvals necessary for the execution and delivery of this Agreement and the sale and delivery of the Option Shares -15- 16 by such Overallotment Seller, including, but not limited to, approvals under relevant partnership agreements and partnership law, have been duly and validly given, and such Overallotment Seller has full legal right, power and authority to enter into this Agreement and to sell and deliver the Option Shares to the Underwriters. This Agreement constitutes a legal, valid and binding agreement of such Overallotment Seller enforceable against such Overallotment Seller in accordance with its terms (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law). (b) Such Overallotment Seller has and on each Option Closing Date will have, good, valid and marketable title to the Option Shares. The Option Shares, as of the date of this Agreement and as of each Option Closing Date, have not previously been sold except pursuant to and as contemplated by this Agreement; and upon the delivery of and payment for the Option Shares, good, valid and marketable title thereto, free and clear of all liens, charges, claims, encumbrances, pledges, security interests, defects or other restrictions or equities of any kind whatsoever, will pass to the Underwriters. (c) Neither the execution, delivery or performance of this Agreement, any Power of Attorney and Custody Agreement to be executed by such Overallotment Seller in connection with the transactions contemplated by this Agreement (the "Power-of-Attorney" and the "Custody Agreement," respectively), the delivery and sale of the Option Shares nor the consummation of the transactions contemplated by this Agreement, the Registration Statement and the Prospectus conflicts or will conflict with or results or will result in any breach or violation of any of the terms, covenants, conditions or provisions of, or constitutes or will constitute (with notice, the lapse of time or both) a default under, or results or will result in the creation or imposition of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever upon any property or assets (tangible or intangible) of such Overallotment Seller pursuant to the terms of (i) any material license, contract, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, purchase order, note, loan or credit agreement or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which such Overallotment Seller is a party or by which he, she or it is or may be bound or to which any of its properties or assets (tangible or intangible) is or may be subject or (ii) any law, statute, judgment, decree, order, rule or regulation applicable to such Overallotment Seller of any arbitrator, court, administrative agency or other governmental official, agency, authority or body (including, without limitation, those having jurisdiction over environmental, health or similar matters) having jurisdiction over the Overallotment Seller or any of his, her or its activities or properties. (d) Such Overallotment Seller has not taken, and will not take, directly or indirectly, any action designed to or which has constituted or which might be expected to cause or result in, under the Exchange Act or otherwise, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities or otherwise and has not effected any sales of shares of Common Stock which, if effected by the issuer, would be required to be disclosed in response to Item 701 of Regulation S-K. -16- 17 (e) Certificates in negotiable form for such Overallotment Seller's Securities have been placed in custody, for delivery pursuant to the terms of this Agreement, under a Power of Attorney and Custody Agreement executed and delivered by such Overallotment Seller, in the form heretofore furnished to you (the "Custody Agreement"), with Steven A. Lupinacci, as Custodian (the "Custodian"); the Securities represented by the certificates so held in custody for each Overallotment Seller are subject to the interests hereunder of the Underwriters, the Company, the Selling Shareholders and the other Overallotment Sellers; the arrangements for custody and delivery of such certificates, made by such Overallotment Seller hereunder and under the Custody Agreement, are not subject to termination by any acts of such Overallotment Seller, or by operation of law, whether by the death or incapacity of such Overallotment Seller or the occurrence of any other event; and if any such death, incapacity or any other such event shall occur before the delivery of such Securities hereunder, certificates for the Securities will be delivered by the Custodian in accordance with the terms and conditions of this Agreement and the Custody Agreement as if such death, incapacity or other event had not occurred, regardless of whether or not the Custodian shall have received notice of such death, incapacity or other event. (f) There is no action, suit, proceeding, inquiry, arbitration, investigation, litigation or governmental or other proceeding pending, contemplated or threatened (or circumstances that may give rise to the same), to which such Overallotment Seller is subject or to which any property or assets (tangible or intangible) of such Overallotment Seller is subject (or circumstances that may give rise to the same) which questions the validity of this Agreement or of any action or transaction contemplated by this Agreement, the Registration Statement or the Prospectus. (g) Such Overallotment Seller represents and warrants to, and agrees with, the Underwriters to the same effect as the representation and warranties of the Company set forth in Section 1 of this Agreement; provided, however, that such Overallotment Seller shall be liable for breach of the representations and warranties in this Section 3(g) only for an amount not exceeding the proceeds received by such Overallotment Seller from the sale of the Option Shares hereunder. (h) Such Overallotment Seller has reviewed the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) and the Registration Statement, and the information regarding such Overallotment Seller set forth therein under the caption "Principal and Selling Stockholders" is complete and accurate. (i) In order to document the Underwriters' compliance with the reporting and withholding provisions of the Internal Revenue Code of 1986, as amended, with respect to the transactions herein contemplated, such Overallotment Seller shall deliver to the Representative prior to or on the Option Closing Date, a properly completed and executed United States Treasury Department Form W-8 or W-9 (or other applicable form of statement specified by Treasury Department regulations in lieu thereof). -17- 18 4. Purchase, Sale and Delivery of the Securities. (a) On the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, the Company and the Selling Stockholders agree, severally and not jointly, to sell to the Underwriters the Firm Shares, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company and the Selling Stockholders that number of the Firm Shares set forth opposite such Underwriter's and Selling Stockholders name, in Schedule I to this Agreement at a price equal to $_____ per Share. (b) In addition, on the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, the Overallotment Sellers hereby grant an option to the Underwriters to purchase all or any part of the Option Shares at a price equal to $____ per share. The Option Shares shall be purchased, if the option is exercised as provided herein, from the Overallotment Sellers, as set forth in Schedule II hereto, for the accounts of the several Underwriters, severally and not jointly, in proportion to the aggregate number of Firm Shares set forth opposite such Underwriter's name in Schedule I to this Agreement, except that the respective purchase obligations of each Underwriter may be adjusted by the Representative so that no Underwriter shall be obligated to purchase fractional Option Shares. The option granted hereby will expire, to the extent unexercised, thirty (30) days after the date hereof, and may be exercised, in the Representative's sole discretion, in whole or in part from time to time, but only for the purpose of covering over-allotments which may be made in connection with the offering and distribution of the Firm Shares, upon notice by the Representative to the Company setting forth the number of Option Shares as to which the Underwriters are then exercising the option and the time and date of payment for and delivery of any such Option Shares. Any such time and date of delivery (an "Option Closing Date") shall be determined by the Representative, but shall not be later than five (5) full business days after the exercise of said option, or in any event prior to the Closing Date, unless otherwise agreed upon by the Representative and the Company. Nothing herein contained shall in any way obligate the Underwriters to exercise the option granted hereby. No Option Shares shall be delivered unless the Firm Shares shall be simultaneously delivered or shall theretofore have been delivered as herein provided. (c) Payment of the purchase price for, and delivery of certificates evidencing, the Firm Shares shall be made at the offices of Munger, Tolles & Olson, 355 South Grand Avenue, Los Angeles, California or at such other place as shall be agreed upon by the Representative and the Company. Such delivery and payment shall be made at 6:30 a.m. (Los Angeles time) on September ___, 1996 or at such other time and date as shall be agreed upon by the Representative, the Company and the Selling Stockholders (such time and date of payment and delivery being herein called the "Closing Date"). In addition, in the event that any or all of the Option Shares are purchased by the Underwriters, payment of the purchase price for, and delivery of certificates for, such Option Shares shall be made at the above-mentioned office of the counsel to the Underwriters or at such other place as shall be agreed upon by the Representative and the Company with respect to each applicable Option Closing Date as specified in the relevant notice from the Representative to the Company and the Overallotment Sellers. Delivery of the certificates representing the Firm -18- 19 Shares and the Option Shares, if any, shall be made to the Representative against payment by the Underwriters of the purchase price for the Firm Shares and the Option Shares, if any, respectively, to the order of the Company, the Selling Stockholders and/or the Overallotment Sellers, as applicable, by certified or official bank checks payable in Los Angeles Clearing House funds (next day funds). Certificates representing the Firm Shares and the Option Shares, if any, respectively, shall be in definitive, fully registered form, shall bear no restrictive legends and shall be in such denominations and registered in such names as the Representative may request in writing at least two (2) business days prior to the Closing Date or the relevant Option Closing Date, as the case may be. The certificates representing the Firm Shares and the Option Shares, if any, shall be made available to the Representative at such offices or such other place as the Representative may designate for inspection, checking and packaging no later than 9:30 a.m. Los Angeles time on the last business day prior to the Closing Date or the relevant Option Closing Date, as the case may be. If settlement for the Option Shares occurs after the Closing Date, the obligation of the Underwriters to purchase the Option Shares shall be conditioned upon receipt of, supplemental opinions, certificates and letters confirming as of such date, the opinions, certificates and letters delivered on the Closing Date pursuant to Section 8. (d) On the Closing Date, the Company shall issue and sell to The Boston Group L.P., individually and not in its capacity as the Representative, or to its designees, the Representative's Warrants for an aggregate purchase price of fifty dollars ($50), which warrant shall entitle the holders thereof to purchase an aggregate of an additional one hundred sixty thousand (160,000) shares of Common Stock. The Representative's Warrants shall be issued pursuant to the Representative's Warrant Agreement. Payment for the Representative's Warrants shall be made on the Closing Date. 5. Public Offering of the Securities. As soon after the Registration Statement becomes effective as the Representative deems advisable, the Underwriters shall make a public offering of the Firm Shares and such of the Option Shares as the Representative may determine at the initial price and upon the other terms set forth in the Prospectus. The Underwriters may from time to time increase or decrease the public offering price of the Securities to such extent as the Representative, in its sole discretion, deems advisable. The Underwriters may enter into one or more agreements as they, in their sole discretion, deem advisable with one or more broker-dealers who shall act as dealers in connection with such public offering. 6. Covenants and Agreements of the Company. The Company covenants and agrees with each of the Underwriters as follows: (a) The Company shall use all reasonable efforts to cause the Registration Statement and any amendments thereto to become effective simultaneously with or as promptly as practicable after the date of this Agreement and will not at any time after the earlier of the date of this Agreement or the effective date of the Registration Statement, file any amendment to the Registration Statement or Term Sheet or supplement to the Prospectus or file any document under the Act or the Exchange Act before termination of the offering of the Securities to the public by the Underwriters of which the Representative shall not previously have been advised and furnished with a copy or to which the Representative shall -19- 20 have reasonably objected (unless the Company's outside counsel reasonably determines in a written opinion that such amendment or supplement is required to be filed pursuant to applicable law) or which is not in compliance with the Act, the Exchange Act or the Rules and Regulations. (b) As soon as the Company is advised or obtains knowledge thereof, the Company will advise the Representative and confirm the same in writing (i) when the Registration Statement, as amended, becomes effective, when any post-effective amendment to the Registration Statement becomes effective and, if the provisions of Rule 430A promulgated under the Act will be relied upon, when the Prospectus has been filed in accordance with said Rule 430A, (ii) of the issuance by the Commission or any State or other regulatory body of any stop order or other order, or of the initiation or the threat or contemplation of any proceeding, the outcome of which may result in the suspension of the effectiveness of the Registration Statement or any order preventing or suspending the use of the Preliminary Prospectus or the Prospectus, or any amendment or supplement or Term Sheet thereto, or the institution of any proceedings for that purpose, (iii) of the issuance by the Commission or any State or other regulatory body of any proceedings for the suspension of the qualification of any of the Securities for offering or sale in any jurisdiction or of the initiation or the threat or contemplation of any proceeding for that purpose, (iv) of the receipt of any comments from the Commission and (v) of any request by the Commission for any amendment to the Registration Statement or any amendment or supplement to the Prospectus or for additional information. If the Commission or any state or other regulatory body shall enter a stop order or other order suspending the effectiveness of the Registration Statement or preventing or suspending the use of the Preliminary Prospectus or the Prospectus, or any amendment or supplement thereto, or suspend such qualification at any time, the Company will make every effort to obtain promptly the lifting of such order or suspension. (c) The Company shall file the Prospectus (in form and substance satisfactory to the Representative) with the Commission, or transmit the Prospectus by a means reasonably calculated to result in filing the same with the Commission, pursuant to Rule 424(b)(1) under the Act (or, if applicable and if consented to by the Representative, pursuant to Rule 424(b)(4)) within the time period specified in Rule 424(b)(1) (or if applicable, Rule 424(b)(4)) or shall deliver and shall file with the Commission a Term Sheet (in form and substance satisfactory to the Representative) in accordance with Rule 434 under the Act. (d) The Company will give the Representative notice of its intention to file or prepare any amendment to the Registration Statement (including any post-effective amendments) or any amendment or supplement or Term Sheet to the Prospectus (including any revised prospectus which the Company proposes for use in connection with the offering of any of the Securities which differs from the corresponding prospectus on file at the Commission at the time the Registration Statement becomes effective, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) under the Act), and will furnish the Representative with copies of any such amendment or supplement or Term Sheet a reasonable amount of time prior to such proposed filing or use, as the case may be, and will not file any such amendment or supplement to which the Representative or Munger, Tolles & Olson, the Underwriters' counsel (the "Underwriters' Counsel"), shall reasonably -20- 21 object unless the Company's outside counsel reasonably determines in a written opinion that such amendment or supplement or Term Sheet is required to be filed pursuant to applicable law. (e) The Company shall cooperate with the Representative and its counsel in any efforts to qualify the Securities for offering and sale under the securities or "blue sky" laws of such jurisdictions as the Representative may reasonably designate to permit the continuance of sales and dealings therein for as long as may be necessary to complete the distribution, and shall make such applications, file such documents and furnish such information as may be required for such purpose; provided, however, the Company shall not be required to qualify as a foreign corporation or to execute a general consent to service of process in any such jurisdiction. In each jurisdiction where such qualification shall be effected, the Company will use all reasonable efforts to file and make such statements or reports at such times as are or may be required by the laws of such jurisdiction to continue such qualification. (f) During the time when a prospectus is required to be delivered under the Act, the Company shall comply with all requirements imposed upon it by the Act and the Exchange Act, as now and hereafter amended, and by the Rules and Regulations, as from time to time in force, so far as necessary to permit the continuance of sales of or dealings in the Securities in accordance with the provisions hereof and the Prospectus, or any amendments or supplements thereto. If at any time when a prospectus relating to the Securities is required to be delivered under the Act, any event shall have occurred as a result of which, in the opinion of the Company or counsel for the Company or the Representative or the Underwriters' Counsel, the Prospectus, as then amended or supplemented, would include an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances in which they were made, not misleading, or if it is necessary at any time to amend or supplement the Prospectus to comply with the Act, the Company will promptly notify the Representative and prepare and file, at the Company's expense, with the Commission an appropriate amendment or supplement to the Registration Statement or an amendment or supplement to the Prospectus which will correct such statement or omission, or effect such compliance, each such amendment or supplement to be reasonably satisfactory to the Representative and the Underwriters' Counsel, and the Company will furnish to the Underwriters copies of such amendment or supplement as soon as available and in such quantities as the Underwriters may request. (g) As soon as practicable, but in any event not later than forty-five (45) days after the end of the twelve (12) month period beginning after the effective date of the Registration Statement, the Company shall make generally available to its security holders, in the manner specified in Rule 158(b) under the Act, and to the Representative, an earnings statement which will comply with the provisions of Section 11(a) of the Act and Rule 158(a) promulgated under the Act. (h) During the five (5) year period commencing on the date hereof, so long as the Company has securities which are registered under the Act or the Exchange Act or otherwise publicly tradeable and Common Stock continues to be outstanding, the Company, -21- 22 at its expense, will furnish to its stockholders, as soon as practicable, annual reports (including financial statements audited by independent certified public accountants) and unaudited quarterly reports for each of the first three (3) fiscal quarters of the Company (such reports, whether or not the Company is then subject to the periodic reporting requirements of the Exchange Act, are to be in conformity with the requirements of the Exchange Act) and will deliver to the Representative: (i) concurrently with furnishing such quarterly reports to its stockholders, balance sheets, statements of operations and cash flow of the Company for such quarter and any year to date period in the form furnished to the Company's stockholders and certified by the Company's principal financial or accounting officer; (ii) concurrently with furnishing such annual reports to its stockholders, a balance sheet of the Company as at the end of the preceding fiscal year, together with statements of operations, stockholders' equity and cash flows of the Company for such fiscal year, accompanied by a copy of the report thereon of independent certified public accountants; (iii) as soon as they are available, copies of all reports (financial or other) mailed to stockholders; (iv) as soon as they are available, copies of all reports and financial statements furnished to or filed with the Commission, the NASD, the NMS or any securities exchange; (v) as soon as they are available, all press releases, material news items or articles of interest to the financial community in respect of the Company or its affairs which are released or prepared by or on behalf of the Company; and (vi) any additional information of a public nature concerning the Company or its businesses which the Representative may request. During such five (5) year period, if the Company has active subsidiaries or is a partner or member in any venture or limited liability company, the foregoing financial statements will be on a consolidated basis to the extent that the accounts of the Company and its subsidiaries (including any venture or company of which it is a partner or member) are consolidated, and will be accompanied by similar financial statements for any significant subsidiary (as defined in the Rules and Regulations) which is not so consolidated. (i) The Company will maintain a transfer agent and, if necessary under the jurisdiction of incorporation of the Company, a registrar (which may be the same entity as the transfer agent) for the Common Stock. (j) The Company will furnish to the Representative and the Underwriters, without charge and at such place as the Representative may designate, copies of each Preliminary Prospectus, the Registration Statement and any pre-effective or post-effective amendments thereto (two of which will be signed and will include all financial statements and -22- 23 exhibits), the Prospectus, and all amendments and supplements thereto, including any prospectus prepared after the effective date of the Registration Statement and any Term Sheet, in each case as soon as available and in such quantities as the Representative may request. (k) The Company agrees that, for a period of one hundred eighty (180) days commencing with the effective date of the Registration Statement, except as contemplated hereby, it shall not, without the prior written consent of the Representative, issue, sell, grant an option for the sale of, assign, transfer, pledge, distribute or otherwise dispose of, directly or indirectly, or agree or offer to do any of the foregoing, any shares of Common Stock or any option, warrant or other contract right or security convertible, directly or indirectly, into shares of Common Stock, except for shares issuable upon the exercise of issued and outstanding options and the issuance of options to any newly hired officer, director or employee. (l) Neither the Company nor any of its officers, directors, stockholders or affiliates (within the meaning of the Rules and Regulations) will take, directly or indirectly, any action designed to illegally stabilize or manipulate the price of any securities of the Company or which might be expected to cause or result in, under the Exchange Act or otherwise, the illegal stabilization or manipulation of the price of any security of the Company. (m) The Company shall apply the net proceeds from the sale of the Securities offered to the public substantially in the manner set forth under the caption "Use of Proceeds" in the Prospectus and will file any and all required Form SRs in a timely manner. No portion of the net proceeds will be used, directly or indirectly, to acquire any securities issued by the Company. (n) The Company shall timely file all registrations, reports, forms or other documents as may be required (including, without limitation, any Form SR required by Rule 463 under the Act) from time to time under the Act, the Exchange Act and the Rules and Regulations, all such registrations, reports, forms and other documents shall comply as to form and substance with the applicable requirements under the Act, the Exchange Act and the Rules and Regulations. The Company shall promptly provide to the Representative and, upon request, the Underwriters copies of such registrations, regulations, reports, forms or other documents. (o) The Company shall furnish to the Representative as early as practicable but in no event later than two (2) full business days prior to the Closing Date and each Option Closing Date, a copy of the latest available preliminary unaudited interim financial statements of the Company (which in no event shall be as of a date more than forty-five (45) days prior to the date hereof, the Closing Date or the relevant Option Closing Date, as the case may be) which have been read by the Company's independent certified public accountants, as stated in their letters to be furnished pursuant to Sections 8(i) and 8(j) hereof. (p) The Company shall cause the Securities to be quoted on the NNM and for a period of five (5) years from the date hereof, the Company shall maintain the -23- 24 appropriate NNM or stock exchange listing of the Securities so long as the Company continues to have securities registered under the Act or the Exchange Act or otherwise publicly tradeable and such securities continue to be outstanding and shall comply with all registration, filing, reporting and other requirements of the NNM, which may from time to time be applicable to the Company. (q) For a period of five (5) years from the Closing Date, the Company shall furnish or cause to be furnished to the Representative, upon any and all reasonable requests of the Representative and at the Company's sole expense, (i) daily consolidated transfer sheets relating to the Common Stock and (ii) a list of holders of all of the Company's securities. (r) For a period of five (5) years from the Closing Date, so long as the Company continues to have securities registered under the Act or the Exchange Act or otherwise publicly tradeable and Common Stock continues to be outstanding, the Company shall, at the Company's sole expense, (i) provide the Representative, upon any and all reasonable requests of the Representative, with a "blue sky trading survey" for secondary sales of the Company's securities prepared by counsel to the Company, and (ii) take all necessary and appropriate actions to further qualify the Company's securities in all jurisdictions of the United States in order to permit secondary sales of such securities pursuant to the securities or "blue sky" laws of those jurisdictions, provided, however, that the Company shall not be required to qualify as a foreign corporation or to execute a general consent to service of process in any jurisdiction. In the event that the Company does not comply with the provisions of this Section 6(r), the Company authorizes the Underwriters' Counsel to take all necessary and appropriate actions to comply with the provisions of this Section 6(r), at the Company's sole expense payable in advance, provided that in no event shall the Company be obligated for expenses in excess of Ten Thousand Dollars ($10,000) per year. (s) As soon as practicable, but in no event more than one hundred twenty (120) days after the effective date of the Registration Statement, the Company shall take all necessary and appropriate actions to be included in Standard & Poor's Corporation Manual and Moody's Investors Services, Inc. Manual and to continue such inclusion for a period of not less than seven (7) years or so long as the Company has securities which are registered under the Act or the Exchange Act or otherwise publicly tradeable and Common Stock continues to be outstanding. (t) The Company hereby agrees that it will not, for a period of twenty-four (24) months commencing with the effective date of the Registration Statement, without the Representative's written approval, provided, that no written approval shall be required for any of the following matters as provided in and pursuant to the Incentive Plans as in effect as of the date of this Agreement and as described in the Registration Statement or if approval of a majority of the independent members of the Board of Directors has been obtained, (i) adopt, propose to adopt or otherwise permit to exist any employee, officer, director, consultant or compensation plan, agreement, understanding or arrangement permitting the grant, issue, sale or entry into any agreement, understanding or arrangement to grant, issue or sell any option, warrant or other contract right (x) at an exercise price that is less than the -24- 25 greater of the initial public offering price of the Securities as set forth herein or the fair market value per share of Common Stock on the date of grant or sale or (y) to any of its executive officers or directors or to any holder of five percent (5%) or more of the Common Stock or any holder of five percent (5%) or more of the Common Stock as the result of the exercise or conversion of equivalent securities, including, without limitation, options, warrants or other contract rights or securities convertible, directly or indirectly, into shares of Common Stock; (ii) permit the maximum number of shares of Common Stock or other securities of the Company purchasable at any time pursuant to options, warrants or other contract rights or securities convertible, directly or indirectly, into shares of Common Stock to exceed fifteen percent (15%) of the outstanding shares of Common Stock; (iii) permit the payment for such securities, including, without limitation, upon the exercise of any option, warrant or other contract right upon the conversion of any security convertible, directly or indirectly, into shares of Common Stock, with any form of consideration other than cash ; or (iv) permit the existence of stock appreciation rights, phantom options or similar arrangements. The provisions of this Section 6(t) shall not apply to grants, issuances or sales to, or agreements with, the Underwriters or you, individually and not in your capacity as the Representative. (u) Until the completion of the distribution (as such term would be applied under Rule 10b-6 promulgated under the Exchange Act) of the Firm Shares and, if applicable, the Option Shares, to the public, the Company shall not, without the prior written consent of the Representative, issue, directly or indirectly, any press release or other communication or hold any press conference with respect to the Company or its activities or the offering contemplated hereby, other than trade releases issued in the ordinary course of the Company's business consistent with past practices with respect to the Company's operations or except as specifically required by law as advised to the Company by its outside counsel. (v) Prior to the earlier of (i) the date which is seven (7) years from the date hereof and (ii) the date of the completion of the sale to the public of all of the Representative's Shares, the Company will not take any action or actions which may prevent or disqualify the Company's use of Form S-1 or, commencing one year from the date hereof, Form S-3 (or other appropriate form) for the registration under the Act of the Representative's Shares. (w) For a period of twenty-four (24) months after the effective date of the Registration Statement, the Company shall not, without the written consent of the Representative, restate, amend, modify or otherwise alter any term of any written employment, consulting or similar agreement entered into between the Company and any officer, director or key employee as of the effective date of the Registration Statement in a manner which is more favorable to such officer, director or key employee, provided, that no written approval shall be required for any of the foregoing matters if approval of a majority of the independent members of the Board of Directors has been obtained. For a period of twenty-four (24) months from the effective date of the Registration Statement, the Company shall not enter into a written employment, consulting or similar agreement with any officer, director or key employee with whom the Company has entered into a written employment, consulting or similar agreement as of the effective date of the Registration Statement other -25- 26 than the renewal of such agreement on terms which are no more favorable to such officer, director or key employee unless agreed upon in writing by the Representative, provided, that no written approval shall be required for any of the foregoing matters if approval of a majority of the independent members of the Board of Directors has been obtained.. (x) For a period of seven (7) years from the effective date of the Registration Statement, the Company and all of its subsidiaries shall obtain and maintain insurance policies, including, without limitation, general liability, property, and personal liability insurance, and surety bonds which insure such entities, their employees and such other persons to whom such entities may become liable against such losses and risks generally insured against by comparable businesses. (y) For a period of five (5) years from the date hereof, the Company will retain BDO Seidman, LLP (or such other nationally-recognized accounting firm qualified to practice in front of the Commission) as its independent certified public accountants and, during such period, the Company will promptly submit to the Representative copies of all accountant's management reports, Company representation letters and similar correspondence between the Company's accountants and the Company. (z) For a period of two (2) years after the effective date of the Registration Statement, the Company shall provide you with copies of the minutes of each meeting of its board of directors and any committees thereof or any written consents signed by the board of directors or any committee thereof along with any attachments thereto within a reasonable time of the holding of any meeting or the entering into of such consent. (aa) The Company will cause its transfer agent to mark an appropriate legend on the face of the stock certificates representing all of the securities subject to Lock-Up Agreements and to place "stop transfer" orders on the Company's stock ledgers. (ab) The Company shall at all times following the Closing Date have reserved and available for issuance a sufficient number of shares of Common Stock to be issued upon exercise of the Representative's Warrants. (ac) When the Registration Statement becomes effective and at all times subsequent thereto up to and including the Closing Date and each Option Closing Date, if any, and during such other periods as a prospectus may be required to be delivered in connection with sales by any Underwriter or a dealer, the Registration Statement and the Prospectus will contain all statements which are required to be stated therein in accordance with the Act and the Rules and Regulations, and will comply with the requirements of the Act and the Rules and Regulations, and at and through such dates, neither the Registration Statement, the Prospectus nor any amendment thereof or supplement thereto will contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading. The Company confirms as of the date hereof that it is in compliance with all provisions of Section 1 of Laws of Florida, Chapter 92-198, An Act Relating to Disclosure -26- 27 of Doing Business with Cuba, and the Company further agrees that if it commences engaging in business with the government of Cuba or with any person or affiliate located in Cuba after the date the Registration Statement becomes or has become effective with the Securities and Exchange Commission or with the Florida Department of Banking and Finance (the "Department"), whichever date is later, or if the information reported in the Prospectus, if any, concerning the Company's business with Cuba or with any person or affiliate located in Cuba changes in any material way, the Company will provide the Department notice of such business or change, as appropriate, in a form acceptable to the Department. 7. Payment of Expenses. (a) The Company hereby agrees to pay (such payment to be made on the Closing Date as part of the closing on such date and on each Option Closing Date as part of the closing on such date (to the extent not paid on the Closing Date or a previous Option Closing Date)) all out-of-pocket expenses and fees (other than fees of the Underwriters' Counsel not specifically provided for in this Section 7) incident to the issuance, offer, sale and delivery of the Securities and the performance of the obligations of the Company under this Agreement and the Representative's Warrant Agreement, including, without limitation, (i) the fees and expenses of accountants and counsel for the Company, (ii) all costs and expenses incurred in connection with the preparation, duplication, printing (including mailing and handling charges), filing, delivery and mailing (including the payment of postage with respect thereto) of each Preliminary Prospectus, the Registration Statement and the Prospectus and any amendments and supplements or Term Sheets thereto and the printing, mailing (including the payment of postage with respect thereto) and delivery of this Agreement, all other underwriting documents (including Agreements Among Underwriters, Underwriter's Questionnaires, Underwriter's Powers of Attorneys and Selected Dealer Agreements), the Representative's Warrant Agreement and agreements with selected dealers, and related documents, including the cost of all copies thereof and of each Preliminary Prospectus and of the Prospectus and any amendments thereof or supplements thereto supplied to each of the Underwriters and such dealers as the Underwriters may request, in such quantities as the Underwriters may reasonably request, (iii) all costs and expenses (including issue and transfer taxes) incurred in connection with the printing, engraving, issuance, sale and delivery of the Securities, including (x) the purchase by each of the Underwriters, severally and not jointly, of the number of the Securities from the Company and the Selling Stockholders set forth opposite its name on Schedules I and II to this Agreement, (y) the consummation by the Company of any of its obligations under this Agreement and the Representative's Warrant Agreement and (z) the resale of the Securities by each of the Underwriters in connection with the distribution contemplated hereby, (iv) all costs and expenses incurred in connection with the qualification of the Securities under state securities or "blue sky" laws and the determination of the status of such securities under legal investment laws, including the costs of printing and mailing the "Preliminary Blue Sky Memorandum," the "Supplemental Blue Sky Memorandum" and the "Legal Investments Survey," if any, and fees of Munger, Tolles & Olson in connection with such -27- 28 determinations, filings, documents and qualifications of the Securities, (v) the fees, costs and expenses incurred in connection with any required filing with the NASD and obtaining a determination from the NASD with respect to the fairness and reasonableness of the underwriting terms and arrangements and disbursements and fees of Munger, Tolles & Olson in connection with such determinations, filings, documents and qualifications of the Securities, (vi) all advertising costs and expenses, including costs and expenses in connection with "road shows," information meetings and presentations, bound volumes and prospectus memorabilia and "tombstone" advertisements, (vii) all costs and expenses incurred in connection with due diligence investigations by an independent third party, subject to the Company's prior approval which shall not be unreasonably withheld, including the fees of any independent counsel (other than Munger, Tolles & Olson) or consultants, (viii) the fees and expenses of a transfer agent and registrar for the Securities, (ix) the fees payable to the Commission and (x) the fees and expenses incurred in connection with the listing of the Securities on the NNM and any other exchange. (b) If this Agreement is terminated by the Underwriters in accordance with the provisions of Section 8 hereof or if the transactions contemplated hereby are not consummated by the Company for any reason, the Company shall reimburse and indemnify the Underwriters for all of their accountable expenses, including, without limitation, all of the fees and disbursements of Underwriters' Counsel (including, without limitation, the fees of the Underwriters' Counsel specifically provided for herein). (c) The Company and the Selling Shareholders further agree that, in addition to the expenses payable pursuant to Section 7(a) hereof, they will pay to you, individually and not in your capacity as the Representative, on the Closing Date by certified or bank cashier's check, or, at your election, by deduction from the proceeds of the offering of the Firm Shares, a non-accountable expense allowance (the "Firm Share Allowance") equal to the lesser of (i) two (2%) of the aggregate offering proceeds from the sale of the Firm Shares and (ii) five hundred thousand dollars ($500,000). In the event the Underwriters elect to exercise all or any part of the over-allotment option described in Section 4(b) hereof and so long as the Firm Share Allowance plus any additional Option Share Allowance (as defined herein) previously paid for the prior sale of any Option Shares is less than five hundred thousand dollars ($500,000), the Company agrees to pay to you, individually and not in your capacity as the Representative, on each Option Closing Date, by certified or bank cashier's check, a non-accountable expense allowance (the "Option Share Allowance") equal to the lesser of (x) two percent (2%) of the aggregate offering proceeds from the sale of such Option Shares and (y) five hundred thousand dollars ($500,000) minus the Firm Share Allowance and any Option Share Allowance previously paid for the prior sale of any Option Shares. 8. Conditions of the Underwriters' Obligations. The obligations of each of the Underwriters hereunder shall be subject to the continuing accuracy of the representations and warranties of the Company, the Selling Stockholders and the Overallotment Sellers herein as of the date hereof and as of the Closing Date and each Option Closing Date, if any, as if they had been made on and as of the Closing Date, except with respect to the Overallotment Sellers, or each Option Closing Date, except with respect to the Selling Stockholders, as the case may be; the accuracy on and as of the Closing Date and each Option Closing Date, if any, of the statements of officers of the Company made and certificates of officers of the Company and/or the Selling Stockholders and/or the Overallotment Sellers delivered pursuant to the provisions hereof; and the performance by the Company, the Selling Stockholders and the Overallotment Sellers on and as of the Closing Date and each Option Closing Date, if -28- 29 any, of all of its covenants and obligations hereunder which are possible to perform on and as of such date and to the following further conditions: (a) The Registration Statement shall have become effective not later than 5:00 p.m., New York time, on the date of this Agreement or such later date and time as shall be consented to in writing by the Representative, and, at the Closing Date and each Option Closing Date, if any, no stop order suspending the effectiveness of the Registration Statement or any part thereof shall have been issued and no proceedings for that purpose shall have been initiated or shall be pending, threatened or contemplated by the Commission or any State or other regulatory body and any request on the part of the Commission or any State or other regulatory body for additional information shall have been complied with to the reasonable satisfaction of the Representative and the Underwriters' Counsel. If the Company has elected to rely upon Rule 430A under the Act, the price of the Securities and any price-related information previously omitted from the effective Registration Statement pursuant to such Rule 430A shall have been transmitted to the Commission for filing pursuant to Rule 424(b) under the Act within the prescribed time period or shall have been delivered and shall have been filed with the Commission as required by Rule 434 under the Act, as applicable, and, prior to the Closing Date, the Company shall have provided evidence satisfactory to the Representative of such timely filing, or a post-effective amendment providing such information shall have been promptly filed and declared effective in accordance with the requirements of Rule 430A under the Act. Neither the Registration Statement nor the Prospectus nor any amendment thereto or supplement thereof (including a Term Sheet) shall have been filed to which the Representative shall have reasonably objected after it shall have had the chance to review such amendment or supplement unless the Company's outside counsel reasonably determines in a written opinion that such amendment or supplement is required to be filed pursuant to applicable law. (b) No Underwriter shall have advised the Company that the Registration Statement, or any amendment thereto, contains an untrue statement of fact which, in the Representative's opinion, is material, or omits to state a fact which, in the Representative's opinion, is material and is required to be stated therein or is necessary to make the statements therein, in light of the circumstances in which they were made, not misleading, or that the Prospectus, or any amendment or supplement (including any Term Sheet) thereto, contains an untrue statement of fact which, in the Representative's opinion, is material, or omits to state a fact which, in the Representative's opinion, is material and is required to be stated therein or is necessary to make the statements therein, in light of the circumstances in which they were made, not misleading. (c) On or prior to the Closing Date, the Representative shall have received from the Underwriters' Counsel such opinion or opinions with respect to the issuance and sale of the Securities, the Registration Statement, the Prospectus and such other related matters as the Representative may reasonably request and the Underwriters' Counsel shall have received such papers and information as it may request in order to enable it to pass upon such matters. (d) At the Closing Date, the Representative shall have received the favorable opinion of Gibson, Dunn & Crutcher LLP, counsel to the Company, dated the -29- 30 Closing Date, addressed to the Representative, in form and substance satisfactory to the Underwriters' Counsel and subject to customary qualifications and conditions, with respect to the matters set forth in Schedule III attached hereto and incorporated herein by this reference. In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws other than the laws of the United States and jurisdictions in which it is admitted, to the extent such counsel deems proper and to the extent specified in such opinion, if at all, upon an opinion or opinions (in form and substance satisfactory to the Underwriters' Counsel) of other counsel, acceptable to the Underwriters' Counsel, familiar with the applicable laws; and (B) as to matters of fact, to the extent it deems proper, on certificates and written statements of responsible officers of the Company and certificates or other written statement of officers of departments of various jurisdictions having custody of documents respecting the corporate existence or good standing of the Company, provided that copies of any such opinions, statements or certificates shall be delivered to the Representative and the Underwriters' Counsel. The opinion of such counsel for the Company shall state that the opinion of any such other counsel is in form satisfactory to such counsel and that the Underwriters and the Underwriters' Counsel are justified in relying thereon. At each Option Closing Date, if any, the Representative shall have received the favorable opinion of Gibson, Dunn & Crutcher LLP, counsel to the Company, dated such Option Closing Date, addressed to the Representative and in form and substance satisfactory to Underwriters' Counsel confirming as of such Option Closing Date the statements made by Gibson, Dunn & Crutcher LLP in its opinion delivered on the Closing Date. (e) On or prior to the Closing Date and each Option Closing Date, if any, the Underwriters' Counsel shall have been furnished with such documents, certificates and opinions as it may reasonably require for the purpose of enabling it to review or pass upon the matters referred to in Section 8(c) hereof, or in order to evidence the accuracy, completeness or satisfaction of any of the representations, warranties or conditions of the Company herein contained. (f) Prior to the Closing Date and each Option Closing Date, if any, (i) there shall have been no material adverse change or development involving a prospective material adverse change in the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, properties, businesses or results of operations of the Company from the latest dates as of which such matters are set forth in the Registration Statement and the Prospectus; (ii) there shall have been no transaction, not in the ordinary course of business and consistent with past practices, entered into by the Company, from the latest date as of which the financial condition of the Company is set forth in the Registration Statement and the Prospectus, which may in any way be materially adverse to the Company; (iii) the Company shall not be in default, and no event shall have occurred which, with notice, lapse of time or both, would constitute a default, under any provision of any agreement, instrument or other document relating to any outstanding material indebtedness; (iv) the Company shall not have issued any securities (other than the Securities or pursuant to the Incentive Plans) or declared or paid any dividend or made any distribution in respect of its capital stock of any class, and there shall not have been any -30- 31 change in the capital stock except as described in the Prospectus, or any change in the debt (long- or short-term) or liabilities or obligations (contingent or otherwise), of the Company except as incurred in the ordinary course of business; (v) no material amount of the property or assets (tangible or intangible) of the Company shall have been pledged, mortgaged or otherwise encumbered; and (vi) no action, suit, proceeding, inquiry, arbitration, investigation, litigation or governmental or other proceeding (including, without limitation, those pertaining to environmental, health or similar matters) shall be pending, contemplated or threatened (or circumstances giving rise to same) to which the Company is subject or to which any property or assets (tangible or intangible) of the Company are subject wherein an unfavorable decision, ruling or finding may be reasonably expected to have a material adverse effect on the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, properties, businesses or results of operations of the Company taken as a whole, except as set forth in the Registration Statement and Prospectus and except for debts, liabilities and obligations incurred in the normal course of business consistent with past practices. (g) At the Closing Date the Representative shall have received (i) a certificate of the Company, signed by the principal executive officer, the chief financial or chief accounting officer of the Company, and (ii) a certificate of the Selling Stockholders. At each Option Closing Date, if any, the Representative shall have received (i) a certificate of the Company, signed by the principal executive officer, the chief financial or chief accounting officer of the Company, and (ii) a certificate of each Overallotment Seller. Each such certificate shall be dated the Closing Date or the such Option Closing Date, as the case may be, to the effect that the person(s) executing the certificate has carefully examined the Registration Statement, the Prospectus and this Agreement, and that: (A) the representations and warranties of the Company, the Selling Stockholders or the Overallotment Sellers, as the case may be, in this Agreement are true and correct, as if made on and as of the Closing Date or such Option Closing Date, and that the Company, the Selling Stockholders or the Overallotment Sellers, as the case may be, has complied with all agreements and covenants and satisfied all conditions contained in this Agreement on its, their or his part to be performed or satisfied at or prior to the Closing Date or such Option Closing Date, as the case may be; (B) no stop order suspending the effectiveness of the Registration Statement or any part thereof has been issued, and no proceedings for that purpose have been initiated or are pending, contemplated or threatened; (C) the Registration Statement, the Prospectus and each amendment and supplement thereto, if any, contain all statements and information required to be included therein, and neither the Registration Statement nor any amendment thereto, at the time such Registration Statement or amendment became effective and as of the date of such certificate included any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading and neither any Prospectus nor any supplement thereto, at the date of such Prospectus or supplement thereto and at the date of such certificate, included any untrue statement of a material fact or -31- 32 omitted to state any material fact necessary to make the statements therein, in light of the circumstances in which they were made, not misleading; and (D) subsequent to the latest respective dates as of which information is given in the Registration Statement and the Prospectus, (A) the Company has not incurred any liabilities or obligations, direct, indirect or contingent, other than in the ordinary course of business; (B) the Company has not paid or declared any dividends or other distributions on its capital stock or other ownership interests; (C) the Company has not entered into any transactions not in the ordinary course of business; (D) there has not been any change in the capital stock, long-term debt or short-term debt (other than any increase in short-term debt in the ordinary course of business) of the Company; (E) other than ordinary wear and tear, the Company has not sustained any material loss or damage to its property or assets (tangible and intangible), whether or not insured; (F) there is no litigation which is pending, threatened or contemplated (or circumstances giving rise to same) against the Company which is required to be set forth in an amended or supplemented Prospectus which has not been so set forth; and (G) there has occurred no event required to be set forth in an amended or supplemented Prospectus which has not been so set forth. References to the Registration Statement and the Prospectus in this Section 8(g) are to such documents as amended and supplemented at the date of such certificate. (h) By the effective date of the Registration Statement, the Representative shall have received clearance from the NASD as to the amount of compensation allowable or payable to the Underwriters, in the amount as described in the Registration Statement. (i) At or prior to the time this Agreement is executed, the Representative shall have received a letter, dated such date, addressed to the Representative and in form and substance satisfactory in all respects to the Representative from BDO Seidman, LLP: (i) confirming that it is an accounting firm of independent certified public accountants with respect to the Company within the meaning of the Act and the Rules and Regulations; (ii) stating its opinion that the financial statements and schedules of the Company included in the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Act and the Rules and Regulations and that each of the Underwriters may rely upon the opinion of BDO Seidman, LLP with respect to such financial statements and schedules included in the Registration Statement; (iii) stating that, on the basis of a limited review which included a reading of the latest available unaudited interim financial statements of the Company (with an indication of the date of the latest available unaudited interim financial statements), a reading of the latest available minutes of the stockholders and the board of directors, including any committees of the board of directors, of the Company, consultations with officers and other employees of the Company responsible for financial and accounting matters and other specified procedures and inquiries, nothing has come to its attention which would lead it to -32- 33 believe that (A) the unaudited financial statements and schedules of the Company included in the Registration Statement do not comply as to form in all material respects with the applicable accounting requirements of the Act and the Rules and Regulations or are not fairly presented in conformity with generally accepted accounting principles applied on a basis substantially consistent with that of the audited financial statements of the Company included in the Registration Statement or (B) at a specified date not more than five (5) days prior to the effective date of the Registration Statement, there has been any change in the capital stock, short-term debt or long-term debt of the Company, or any decrease in the stockholders' equity or net current assets or net assets of the Company as compared with amounts shown in the January 31, 1996 balance sheet included in the Registration Statement or, if there was any change or decrease, setting forth the amount of such change or decrease, or (C) during the period from February 1, 1996 to a specified date not more than five (5) days prior to the effective date of the Registration Statement, there was any decrease in revenues, net income or net earnings per share of Common Stock, in each case as compared with the corresponding period beginning February 1, 1996, or, if there was any such decrease, setting forth the amount of such decrease; (iv) stating that it has compared specific dollar amounts, numbers of shares, percentages, statements and other financial information pertaining to the Company set forth in the Registration Statement, in each case to the extent that such amounts, numbers, percentages, statements and information may be derived from the general accounting records, including work sheets or analysis, of the Company with the results obtained from the application of specific readings, inquiries and other appropriate procedures (which procedures do not constitute an examination in accordance with generally accepted auditing standards) set forth in the letter and found them to be in agreement; (v) stating it has read the unaudited financial statements referred to in Section 6(o) hereof; and (vi) statements as to such other matters as the Representative may reasonably request. (j) At the Closing Date and each Option Closing Date, if any, the Representative shall have received from BDO Seidman, LLP a letter, dated as of the Closing Date or such Option Closing Date, as the case may be, to the effect that (i) it reaffirms that statements made in the letter furnished pursuant to Section 8(i) hereof, (ii) if the Company has elected to rely on Rule 430A under the Act or a Term Sheet under Rule 434, to the further effect that it has carried out procedures as specified in clause (iv) of such Section 8(i) with respect to certain amounts, numbers, percentages, statements and other financial information as specified by the Representative and deemed to be a part of the Registration Statement pursuant to Rule 430A(b) or 434 and has found such amounts, numbers, percentages, statements and other financial information to be in agreement with the documents specified in such clause (iv); and (iii) it has read the unaudited financial statements referred to in Section 6(o) hereof. (k) On the Closing Date and each Option Closing Date, if any, there shall have been duly tendered to the Representative the appropriate number of Securities. -33- 34 (l) No order suspending the sale of the shares in any jurisdiction designated by the Representative pursuant to Section 6(e) hereof shall have been issued on either the Closing Date or any Option Closing Date, and no proceedings for that purpose shall have been initiated or shall be pending, contemplated or threatened. (m) On or before the Closing Date, the Company shall have executed and delivered to you, individually and not in your capacity as the Representative, the Representative's Warrant Agreement, substantially in the form filed as Exhibit 4.3 to the Registration Statement. The executed version of the Representative's Warrant Agreement shall be satisfactory to you. (n) On or before the effective date of the Registration Statement, the Securities shall have been duly approved for quotation on the NNM. (o) On or before the effective date of the Registration Statement, the Company shall provide the Representative with true copies of valid, duly executed, legally binding and enforceable Lock-Up Agreements. On or before the Closing Date, the Company shall deliver instructions to its transfer agent authorizing such transfer agent to place appropriate legends on the certificates representing the securities subject to the Lock-Up Agreements and to place appropriate stop transfer orders on the Company's ledgers. (p) The Company shall provide the Representative with such additional documents and certificates as the Representative may reasonably request. If any condition to the Underwriters' obligations hereunder to be fulfilled prior to or at the Closing Date or at any Option Closing Date, as the case may be, is not so fulfilled, the Underwriters may terminate this Agreement, without liability to any of the Underwriters, or, if the Representative so elects in its sole discretion, it may waive any such conditions which have not been fulfilled or extend the time for their fulfillment. 9. Indemnification and Contribution. (a) The Company, the Selling Stockholders and the Overallotment Sellers jointly and severally agree to indemnify and hold harmless each Underwriter (for purposes of this Section 9, "Underwriters" shall include the officers, directors, partners, employees, agents and counsel of each Underwriter), and each person, if any, who controls any of the Underwriters, as applicable ("controlling person"), within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, from and against any and all losses, claims, damages, expenses (including, without limitation, reasonable attorneys, fees and expenses) or liabilities and all actions, suits, proceedings, inquiries, arbitrations, investigations, litigation or governmental or other proceedings (in this Section 9, collectively, "actions") in respect thereof, whatsoever (including, without limitation, any and all expenses whatsoever reasonably incurred in investigating, preparing or defending against any action, commenced or threatened, or any claim whatsoever), as such are incurred, to which any Underwriter or such controlling person may become subject under the Act, the Exchange Act or any other statute or at common law or otherwise, arising out of or based upon any untrue statement or alleged untrue statement of a material fact contained (i) in any Preliminary Prospectus, the -34- 35 Registration Statement or the Prospectus (as from time to time amended and supplemented); (ii) in any post-effective amendment or amendments or any new registration statement and prospectus in which is included securities of the Company issued or issuable upon exercise of the Securities; (iii) in any application or other document or written communication (in this Section 9, collectively, "application") executed by the Company or based upon written information furnished by the Company in any jurisdiction in order to qualify the Securities under the securities or "blue sky" laws thereof or filed with the Commission, any state securities commission or agency, the NASD or the NNM or any other securities exchange; or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading (in light of the circumstances in which they were made), unless such statement or omission was made in reliance upon and in conformity with written information furnished to the Company by the Representative with respect to an Underwriter expressly for use in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment thereof or supplement (including any Term Sheet) thereto, or in any application, as the case may be. In addition to its other obligations under this Section 9(a), the Company agrees that, as an interim measure during the pendency of any action arising out of or based upon any untrue statement or omission, or alleged untrue statement or alleged omission as described in this Section 9(a), it will reimburse each Underwriter (and, to the extent applicable, each controlling person), on a monthly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such action, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's obligations to reimburse each Underwriter and (and, to the extent applicable, each controlling person), for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement is so held to have been improper as to the Company, each Underwriter (and, to the extent applicable, each controlling person), shall promptly return it to the Company together with interest compounded daily, based on the "reference rate" announced from time to time by Bank of America NTSA (the "Prime Rate"), but in no case more than is allowed by applicable law. Any such interim reimbursement payments which are not made to an Underwriter, or a controlling person, as applicable, within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. In no event, however, shall the liability of the Selling Stockholders or Overallotment Sellers for indemnification under this Section 9(a), when added to any amounts paid by the Selling Stockholder or Overallotment Seller under Section 9(d), exceed the lesser of (i) that proportion of the total of such losses, claims, damages or liabilities indemnified against equal to the proportion of the total Securities sold hereunder which is being sold by the Selling Stockholder or Overallotment Seller, or (ii) the proceeds received by the Selling Stockholders or Overallotment Sellers from the Underwriters in the offering. The indemnity agreement in this Section 9(a) shall be in addition to any liability which the Company, the Selling Stockholders and the Overallotment Sellers, jointly and severally, may have at common law or otherwise. (b) Each Underwriter severally, but not jointly, agrees to indemnify and hold harmless the Company (for purposes of this Section 9(b), "Company" shall include the officers, directors, partners, employees, agents and counsel of the Company), the Selling -35- 36 Stockholders, the Overallotment Sellers and each other person, if any, who control the Company, a Selling Stockholder or an Overallotment Seller ("controlling person") within the meaning of the Act, to the same extent as the foregoing indemnity from the Company to each Underwriter, but only with respect to statements or omissions, if any, made in any Preliminary Prospectus, the Registration Statement or the Prospectus or any amendment thereof or supplement (including any Term Sheet) thereto or in any application made in reliance upon, and in strict conformity with, written information furnished to the Company by the Representative with respect to such Underwriter expressly for use in any Preliminary Prospectus, the Registration Statement or the Prospectus or any amendment thereof or supplement (including any Term Sheet) thereto or in any application. The Company acknowledges that the statements with respect to the Underwriters and the public offering of the Securities set forth under the headings "Underwriting" and "Risks Factors - Recently Formed Representative May Be Unable to Complete Offering or Make a Market," and the stabilization legend in the Prospectus have been furnished by the Representative with respect to the Underwriters expressly for use therein and constitute the only information furnished in writing by the Representative with respect to the Underwriters for inclusion in any Preliminary Prospectus, the Registration Statement or the Prospectus. In addition to its other obligations under this Section 9(b), each Underwriter severally, but not jointly, agrees that, as an interim measure during the pendency of any action arising out of or based upon any untrue statement or omission, or alleged untrue statement or alleged omission as described in this Section 9(b), it will reimburse Company and (and, to the extent applicable, each controlling person) on a monthly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such action, notwithstanding the absence of a judicial determination as to the propriety and enforceability of such Underwriter's obligations to reimburse the Company (and, to the extent applicable, each controlling person) for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement is so held to have been improper as to such Underwriter, the Company (and, to the extent applicable, each controlling person) shall promptly return it to such Underwriter, together with interest compounded daily, based on the Prime Rate announced from time to time by Bank of American NTSA, but in no case more than is allowed by applicable law. Any such interim reimbursement payments which are not made to the Company within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. Notwithstanding the provisions of this Section 9(b), no Underwriter shall be required to indemnify or hold harmless the Company, or any controlling person for, in the aggregate, any amounts in excess of the underwriting discount applicable to the Securities purchased by such Underwriter hereunder. The indemnity agreement in this Section 9(b) shall be in addition to any liability which each Underwriter severally, but not jointly, may have at common law or otherwise. (c) Promptly after receipt by an indemnified party under this Section 9 of notice of the commencement of any action, such indemnified party shall notify each party against whom indemnification is to be sought in writing of the commencement thereof (but the failure to so notify an indemnifying party shall not relieve it from any liability which it may have under this Section 9 except to the extent that it has been materially prejudiced by such failure). In case any such action is brought against any indemnified party, and it -36- 37 notifies an indemnifying party or parties of the commencement thereof, the indemnifying party or parties shall be entitled to participate therein, and to the extent it or they may elect by written notice delivered to the indemnified party or parties promptly after receiving the aforesaid notice from such indemnified party or parties, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party. Notwithstanding the foregoing, an indemnified party shall have the right to employ its own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of such counsel shall have been authorized in writing by the indemnifying party or parties in connection with the defense of such action at the expense of the indemnifying party or parties, (ii) the indemnifying party or parties shall not have employed counsel reasonably satisfactory to such indemnified party to have charge of the defense of such action within a reasonable time after notice of commencement of the action or (iii) such indemnified party shall have reasonably concluded that there may be one or more defenses available to it which are different from or additional to those available to one or all of the indemnifying parties (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party or parties), in any of which events such fees and expenses of one additional counsel (in addition to appropriate local counsel) shall be borne by the indemnifying parties. In no event shall the indemnifying parties be liable for fees and expenses of more than one counsel (in addition to appropriate local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. Anything in this Section 9 to the contrary notwithstanding, an indemnifying party shall not be liable for any settlement of any claim or action effected without its written consent; provided, however, that such consent may not be unreasonably withheld or delayed. (d) In order to provide for just and equitable contribution in any case in which (i) an indemnified party makes a claim for indemnification pursuant to this Section 9, but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that the express provisions of this Section 9 provide for indemnification in such case or (ii) contribution under the Act may be required on the part of any indemnified party, then each indemnifying party shall contribute to the amount paid as a result of such losses, claims, damages, expenses or liabilities (or actions in respect thereof) (A) in such proportion as is appropriate to reflect the relative benefits received by each of the contributing parties, on the one hand, and the party to be indemnified, on the other hand, from the offering of the Securities or (B) if the allocation provided by clause (A) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (A) above but also the relative fault of each of the contributing parties, on the one hand, and the party to be indemnified, on the other hand, in connection with the statements or omissions that resulted in such losses, claims, damages, expenses or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company, the Selling Stockholders and the Overallotment Sellers, on the one hand, and the Underwriters, on the other hand, shall be deemed to be in the same proportion as the total net proceeds from the offering of the Securities (before deducting expenses) bear to the total underwriting discounts received by the Underwriters hereunder, in -37- 38 each case as set forth in the table on the cover page of the Prospectus. Relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, the Selling Stockholders, the Overallotment Sellers or by the Representative with respect to an Underwriter, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The amount paid by an indemnified party as a result of the losses, claims, damages, expenses or liabilities (or actions in respect thereof) referred to in the first sentence of this Section 9(d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 9(d), no Underwriter shall be required to contribute any amount in excess of the underwriting discount applicable to the Securities purchased by such Underwriter hereunder. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act and the cases and promulgations thereunder) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 9(d), each person, if any, who controls the Company, a Selling Stockholder, an Overallotment Seller or an Underwriter within the meaning of the Act, each officer of the Company who has signed the Registration Statement and each director of the Company shall have the same rights to contribution as the Underwriters, or the Company, as the case may be, subject in each case to the provisions of this Section 9(d). Any party entitled to contribution will, promptly after receipt of notice of commencement of any action against such party in respect to which a claim for contribution may be made against another party or parties under this Section 9(d), notify such party or parties from whom contribution may be sought, but the omission to so notify such party or parties shall not relieve the party or parties from whom contribution may be sought from any obligation it or they may have hereunder or otherwise than under this Section 9(d) except to the extent it has been materially prejudiced by such failure. The contribution agreement set forth above shall be in addition to any liabilities which any indemnifying party may have at common law or otherwise. Notwithstanding anything to the contrary contained in this Agreement, a Selling Stockholder and/or Overallotment Seller shall not be required to contribute any amount which when added to any amounts paid by the Selling Stockholder and/or Overallotment Seller under Section 9(a), would be in excess of the lesser of (i) that proportion of the total of such losses, claims, damages or liabilities indemnified or contributed against equal to the proportion of the total Securities sold hereunder which is being sold by it, him or her (as the case may be), or (ii) the proceeds received by it, him, or her (as the case may be) from the Underwriters in the offering. The Underwriters' obligations in this Section 9(d) to contribute are several in proportion to their respective underwriting obligations and not joint. (e) The indemnity and contribution agreements contained in this Section 9 and the representations and warranties of the Company and the Selling Stockholders set forth in this Agreement shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of any Underwriter or any person controlling any Underwriter, the Company, its directors or officers or the Selling Stockholders or any person controlling the Company, (ii) acceptance of any Securities and payment therefor hereunder, and (iii) any termination of this Agreement. A successor to any Underwriter or any person controlling any Underwriter, or to the Company, its directors or officers, the Selling -38- 39 Stockholders, the Overallotment Sellers or any person controlling the Company, the Selling Stockholders or the Overallotment Sellers, shall be entitled to the benefits of the indemnity, contribution and reimbursement agreements contained in this Section 9. (f) In any proceeding relating to the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement (including any Term Sheet) thereto, each party against whom contribution may be sought under this Section 9 hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon him or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join him or it as an additional defendant in any such proceeding in which such other contributing party is a party. 10. Representations, Warranties and Agreements to Survive Delivery. All representations, warranties, covenants and agreements contained in this Agreement, or contained in certificates of officers of the Company, the Selling Stockholders or the Overallotment Sellers delivered pursuant hereto, shall be deemed to be representations, warranties, covenants and agreements at the Closing Date and at each Option Closing Date, as the case may be, and such representations, warranties, covenants and agreements of the Company, the Selling Stockholders and the Overallotment Sellers and the respective indemnity and contribution agreements contained in Section 9 hereof, shall remain operative and in full force and effect regardless of any investigation made by or on behalf of the Representative, any of the Underwriters or the Company, the Selling Stockholders or the Overallotment Sellers, and shall survive the termination of this Agreement and the issuance, sale and delivery of the Securities to the Underwriters. 11. Effective Date. This Agreement shall become effective at 10:00 a.m., New York City time, on the date hereof, or at such earlier time after the Registration Statement becomes effective as the Representative, in its sole discretion, shall release the Securities for sale to the public; provided, however, that the provisions of Sections 7, 9 and 12 hereof shall at all times be effective. For purposes of this Section 11, the Securities to be purchased hereunder shall be deemed to have been so released upon the earlier of dispatch by the Representative of telegrams or facsimile transmissions to securities dealers releasing such Securities for offering or the release by the Representative for publication of the first newspaper advertisement which is subsequently published relating to the Securities. 12. Termination. (a) The Representative shall have the right to terminate this Agreement after it becomes effective, the exercise of which shall be determined in the Representative's sole discretion, if: (i) any domestic or international event or act or occurrence has, as determined in the Representative's sole judgment, disrupted, or in the Representative's sole judgment will in the immediate future materially disrupt, the financial markets; or (ii) any material adverse change, as determined in the Representative's sole judgment, in the financial markets shall have occurred; or (iii) trading on the New York Stock Exchange, the American Stock Exchange, the NNM or the over-the-counter market shall have been suspended, or minimum or maximum prices for trading shall have been fixed, or maximum ranges for -39- 40 prices for securities shall have been required on the over-the-counter market by the NASD or the Commission or any other governmental authority having jurisdiction; or (iv) the United States shall have become involved in a war or in hostilities, or there shall have been an escalation in an existing war or hostilities or a national emergency shall have been declared in the United States; or (v) a banking moratorium shall have been declared by any state or federal authority or body; or (vi) a moratorium in foreign exchange trading shall have been declared; or (vii) the Company shall have sustained a material or substantial loss by fire, flood, accident, hurricane, earthquake, theft, sabotage or other calamity or malicious act which, whether or not such loss shall have been insured, will, in the Representative's sole judgment, make it inadvisable to proceed with the offering, sale or delivery of the Securities; or (viii) there shall have been a material adverse change or development involving a material prospective change, in the condition (financial or otherwise), earnings, business affairs, position, prospects, stockholders' equity, operations, obligations, properties, businesses, management or results of operations of the Company taken as a whole, whether or not arising in the ordinary course of business, or (ix) if there shall have been a material adverse change in the general market, political or economic conditions, whether in the United States or elsewhere, as in the Representative's sole judgment would make it inadvisable to proceed with the offering, sale or delivery of the Securities. (b) Notwithstanding any contrary provision contained in this Agreement, in the event of any termination of this Agreement (including, without limitation, pursuant to Sections 8, 12(a) or 13 hereof), and whether or not this Agreement is otherwise carried out, the provisions of Sections 7 and 9 hereof shall remain effective and shall not in any way be affected by such termination or failure to carry out the terms of this Agreement or any part hereof. 13. Default by the Company. If the Company, any Selling Stockholders or any Overallotment Sellers shall fail at the Closing Date or any Option Closing Date, as applicable, to sell and deliver the number of Securities which it or he or she is obligated to sell and deliver hereunder on such date, then this Agreement shall terminate (or, if such default shall occur with respect to any Option Shares to be purchased on an Option Closing Date, the Underwriters may, in the Representative's sole discretion, by notice from the Representative to the Company and Overallotment Seller, terminate the Underwriters' obligation to purchase such Option Shares from the Overallotment Seller on such date) with no liability whatsoever on the part of any non-defaulting party other than pursuant to Sections 7, 9 and 12 hereof. No action taken pursuant to this Section 13 shall relieve the Company, the Selling Stockholders or the Overallotment Sellers from liability, if any, in respect of such default. 14. Substitution of Underwriters. If any Underwriter defaults in its obligation to purchase the number of Securities which it has agreed to purchase under this Agreement, the non-defaulting Underwriters shall be obligated to purchase (in the respective proportions which the number of Securities set forth opposite the name of each non-defaulting Underwriter in Schedule I to this Agreement bears to the total number of Securities set forth opposite the names of all the non-defaulting Underwriters in Schedule I to this Agreement) the Securities which the defaulting Underwriter agreed but failed to purchase; except that the non-defaulting Underwriters shall not be obligated to purchase any of the Securities if the -40- 41 total number of Securities which the defaulting Underwriter or Underwriters agreed but failed to purchase exceeds 10% of the total number of Securities, and any non-defaulting Underwriter shall not be obligated to purchase more than 110% of the number of Securities set forth opposite its name in Schedule I to this Agreement plus the total number of Option Shares purchasable by it pursuant to the terms of Section 4(b) hereof. If the foregoing maximums are exceeded, the non-defaulting Underwriters, and any other underwriters satisfactory to you who so agree, shall have the right, but shall not be obligated, to purchase (in such proportions as may be agreed upon among them) all the Securities. If the non- defaulting Underwriters or the other underwriters satisfactory to you do not elect to purchase the Securities which the defaulting Underwriter or Underwriters agreed but failed to purchase, this Agreement shall terminate without liability on the part of any non-defaulting Underwriter, the Company except for the payment of expenses to be borne by the Company as provided in Section 7(a) hereof and the indemnify and contribution agreements of the Company and the Underwriters contained in Section 9 hereof; provided, however, that this provision shall not affect any Closing which at the time of such termination already shall have taken place. Nothing contained herein shall relieve a defaulting Underwriter of any liability it may have for damages caused by its default. If the other underwriters satisfactory to you are obligated or agreed to purchase the Securities of a defaulting Underwriter, either you or the Company may postpone the Closing Date for up to seven full Business Days in order to effect any changes that may be necessary in the Registration Statement, the Prospectus or in any other document or agreement, and to file promptly any amendments or any supplements to the Registration Statement or the Prospectus which in your opinion may thereby be made necessary. 15. Notices. All notices and communications hereunder, except as herein otherwise specifically provided, shall be in writing and shall be deemed to have been duly given if mailed, delivered by hand or transmitted by any standard form of telecommunication. Notices to the Underwriters shall be directed to the Representative at 1999 Avenue of the Stars, Suite 2800, Los Angeles, California 90067, Attention: Anthony K. Soich, with a copy to Munger, Tolles & Olson, 355 South Grand Avenue, Los Angeles, California 90071, Attention: Sandra A. Seville-Jones, Esq. Notices to the Company shall be directed to the Company at 2144 Michelson Drive, Irvine, California 92175, Attention: Steven A. Lupinacci, with a copy to Gibson, Dunn & Crutcher LLP, 4 Park Plaza, Irvine, California 92614, Attention: John M. Williams, Esq. 16. Parties. This Agreement shall inure solely to the benefit of and shall be binding upon, the Underwriters, the Company, the Selling Stockholders and the Overallotment Sellers and the controlling persons, officers, directors and others referred to in Section 9 hereof, and their respective successors, legal representatives and assigns, and no other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of or by virtue of this Agreement or any provisions herein contained. No purchaser of Securities from an Underwriter shall be deemed to be a successor merely by reason of such purchase. -41- 42 17. Construction. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of California, without giving effect to conflict of laws principles thereof. 18. Counterparts; Facsimile Signatures. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, and all of which taken together shall be deemed to be one and the same instrument. Delivery of executed copies of this Agreement by facsimile transmission shall be deemed to be delivery of an original, executed copy of this Agreement by the transmitting party. 19. Entire Agreement; Amendments. This Agreement and the Representative's Warrant Agreement constitute the entire agreement of the parties hereto concerning the subject matter hereof and supersede all prior written or oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may not be amended, modified or altered except in a writing signed by the Representative and the Company. If the foregoing correctly sets forth the understanding among the parties hereto, please so indicate in the space provided below for that purpose, whereupon this letter shall constitute a binding agreement among us. Very truly yours, DIEDRICH COFFEE, INC. a Delaware corporation By:_______________________________________ Name: Steve Lupinacci Title: Chief Executive Officer D.C.H., L.P. a California limited partnership By:_______________________________________ Name: Paul C. Heeschen Title: General Partner REDWOOD ENTERPRISES VII, L.P. a California limited partnership By:_______________________________________ Name: Paul C. Heeschen Title: General Partner -42- 43 DIEDRICH PARTNERS I, L.P. a California limited partnership By:_______________________________________ Name: Title: General Partner __________________________________________ Martin R. Diedrich Confirmed and accepted as of the date first above written. THE BOSTON GROUP, L.P. AS REPRESENTATIVE FOR THE SEVERAL UNDERWRITERS NAMED IN SCHEDULE I ATTACHED HERETO By:____________________________________ Anthony K. Soich, Director of Corporate Finance -43- 44 SCHEDULE I
Underwriter Number of Selling Shares - ----------- ------------------------ The Boston Group, L.P. [List others] ========= TOTAL 2,200,000 Shares To Be Sold Company Shares Number of Selling Shares - -------------- ------------------------ Diedrich Coffee, Inc. 1,600,000 Selling Shares - -------------- D.C.H., L.P. 100,000 Redwood Enterprises VII, L.P. 332,247 Diedrich Partners I, L.P. 167,753 --------- 2,200,000 SCHEDULE II Overallotment Sellers Number of Option Shares - --------------------- ----------------------- Redwood Enterprises VII, L.P. 216,123 Diedrich Partners I, L.P. 83,877 Martin R. Diedrich 30,000 ------- TOTAL 330,000 =======
45 SCHEDULE III Opinion to Underwriters -45- EX-4.3 3 RESPRESENTATIVE'S WARRANT AGREEMENT 1 DIEDRICH COFFEE, INC. and THE BOSTON GROUP, L.P. ____________________ REPRESENTATIVE'S WARRANT AGREEMENT Dated as of September ___, 1996 ____________________ 2 REPRESENTATIVE'S WARRANT AGREEMENT THIS REPRESENTATIVE'S WARRANT AGREEMENT (the "Agreement"), dated as of September ___, 1996, is made and entered into by and between DIEDRICH COFFEE, INC., a Delaware corporation (the "Company"), and THE BOSTON GROUP, L.P. (the "Representative"). The Company agrees to issue and sell to the Representative and the Representative agrees to purchase from the Company, for the price of $50, a warrant, as hereinafter described (the "Warrant" and together with any warrants subsequently issued hereunder, the "Warrants"), to purchase up to 160,000 shares, as may be adjusted from time to time as set forth herein, of the Company's common stock, $0.01 par value (the "Common Stock"), in connection with a public offering (the "Offering") by the Company and certain stockholders of the Company of 2,200,000 shares of Common Stock (plus 330,000 shares subject to an over-allotment option of the Underwriters named therein) pursuant to an underwriting agreement (the "Underwriting Agreement"), dated as of September ___, 1996, by and among the Company, certain stockholders of the Company and the Representative, as one of the representatives of the several Underwriters named therein. The shares of Common Stock purchasable upon exercise of the Warrants, as may be adjusted from time to time as set forth herein, are hereinafter referred to as the "Warrant Stock." The Warrant shall be issued pursuant to this Agreement on the closing date of the Offering (the "Closing Date"). In consideration of the foregoing and for the purpose of defining the terms and provisions of the Warrants, the Warrant Stock and the respective rights and obligations thereunder, the Company and the Representative, for value received, hereby agree as follows: SECTION 1. TRANSFERABILITY AND FORM OF WARRANTS. 1.1 Registration. All Warrants shall be numbered and shall be registered on the books of the Company when issued. 1.2 Transfer. The Warrants shall be transferable only on the books of the Company maintained at its principal office, wherever its principal office may then be located, upon delivery thereof duly endorsed by a Warrant holder (a "Warrantholder") or by its duly authorized attorney or representative and with the signatures properly guaranteed, accompanied by proper evidence of succession, assignment or authority to transfer. Upon any registration of transfer, the Company shall execute and deliver a new certificate evidencing each such Warrant to each person entitled thereto. 1.3 Limitations on Transfer of the Warrants. Warrants shall not be sold, transferred, assigned or hypothecated by the Representative, except that Warrants may be transferred (i) to one or more officers or partners of the Representative, and after 9:00 a.m. Pacific time on September ___, 1997 to employees of the Representative; (ii) to a purchaser of all or substantially all of the assets of a Warrantholder; or (iii) by will, pursuant to the laws of descent or distribution or by operation of law. The Warrants may be divided or combined, upon request to the Company by a Warrantholder, into a certificate or certificates 3 representing the right to purchase the same aggregate number of Warrant Stock. Unless the context indicates otherwise, the term "Warrantholder" shall include the Representative and any transferee or transferees of the Warrants pursuant to this subsection 1.3 and as otherwise permitted by this Agreement, and the term "Warrants" shall include any and all Warrants outstanding pursuant to this Agreement, including those evidenced by a certificate or certificates issued upon division, exchange, substitution or transfer pursuant to this Agreement. 1.4 Form of Warrants. The text of the Warrants and of the form of election to purchase Warrant Stock shall be substantially as set forth in Exhibit A attached hereto. The aggregate number of shares of Common Stock issuable upon exercise of the Warrants is subject to adjustment upon the occurrence of certain events, all as hereinafter provided. The Warrants shall be executed on behalf of the Company by its Chief Executive Officer or its President and attested to by its Secretary. A Warrant bearing the signature of an individual who was at any time the proper officer of the Company shall bind the Company, notwithstanding that such individual shall have ceased to hold such office prior to the delivery of such Warrant or did not hold such office on the date of this Agreement or at any time thereafter. The Warrants shall be dated as of the date of signature thereof by the Company either upon initial issuance or upon division, exchange, substitution or transfer. 1.5 Legend on Warrants and Warrant Stock. Each certificate evidencing a Warrant (or Warrant Stock issued upon exercise of a Warrant) initially issued upon exercise of a Warrant shall bear the following legend, unless, at the time of exercise, such Warrant Stock is subject to a currently effective Registration Statement under the Securities Act of 1933, as amended (the "Act"): "'THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE SOLD, EXCHANGED, HYPOTHECATED OR TRANSFERRED IN ANY MANNER EXCEPT IN COMPLIANCE WITH SECTION 11 OF THE REPRESENTATIVE'S WARRANT AGREEMENT PURSUANT TO WHICH THEY WERE ISSUED." Any certificate issued at any time in exchange or substitution for any certificate bearing such legend (except a new certificate issued upon completion of a public distribution pursuant to an effective registration statement under the Act of the securities represented thereby) shall also bear the above legend unless, in the opinion of the Company's counsel, the securities represented thereby need no longer be subject to such restrictions. SECTION 2. EXCHANGE OF WARRANT CERTIFICATE. Any Warrant certificate may be exchanged for another certificate or certificates entitling the Warrantholder to purchase a like aggregate number of shares of Warrant Stock as the certificate or certificates surrendered then entitled such Warrantholder to purchase. Any Warrantholder desiring to exchange a -2- 4 Warrant certificate shall make such request in writing delivered to the Company, and shall surrender, properly endorsed, the certificate evidencing the Warrant to be so exchanged. Thereupon, the Company shall execute and deliver to the person entitled thereto a new Warrant certificate or certificates as so requested. SECTION 3. TERM OF WARRANTS; EXERCISE OF WARRANTS. (a) Subject to the terms of this Agreement, the Warrantholder shall have the right, at any time during the period commencing at 6:30 a.m., Pacific Time, on September ___, 1997 (the "Commencement Date") and ending at 5:00 p.m., Pacific Time, on September ___, 1999 (the "Termination Date"), to purchase from the Company up to the number of fully paid and nonassessable shares of Warrant Stock to which the Warrantholder may at the time be entitled to purchase pursuant to this Agreement, upon surrender to the Company, at its principal office, of the certificate evidencing the Warrants to be exercised, together with the purchase form on the reverse thereof duly completed and executed, and upon payment to the Company of the Warrant Price (as defined in and determined in accordance with the provisions of this Section 3 and Sections 7 and 8 hereof) for the number of shares of Warrant Stock in respect of which such Warrants are then exercised, but in no event for less than 100 shares of Warrant Stock (unless less than an aggregate of 100 shares of Warrant Stock are then purchasable under all outstanding Warrants held by such Warrantholder). This Warrant, when exercisable, may be exercised from time to time in whole or in part. (b) Payment of the Warrant Price shall be made in cash, by certified or official bank check in Los Angeles Clearing House funds (next day funds), or any combination thereof. (c) In addition to the method of payment set forth in Section 3(b) above and in lieu of any cash payment required thereunder, unless otherwise prohibited by law, the Warrantholders shall have the right at any time, when exercisable, and from time to time to exercise the Warrants in full or in part (i) by receiving from the Company the number of shares of Warrant Stock equal to the number of shares of Warrant Stock otherwise issuable upon such exercise less the number of shares of Warrant Stock having an aggregate value on the date of exercise equal to the Warrant Price multiplied by the number of shares of Warrant Stock for which this Warrant is being exercised and/or (ii) by delivering to the Company the number of shares of Common Stock having an aggregate value on the date of exercise equal to the Warrant Price multiplied by the number of shares of Warrant Stock for which this Warrant is being exercised. For purposes hereof, the "value" of a share of Common Stock on a given date shall be equal to the Current Market Price on such date as defined in Section 9 of this Agreement. (d) Upon surrender of the Warrants and payment of the Warrant Price as aforesaid, the Company shall issue and cause to be delivered with all reasonable dispatch to or upon the written order of the Warrantholder, and in such name or names as the Warrantholder may designate, a certificate or certificates for the number of full shares of Warrant Stock so purchased upon such exercise of the Warrant, together with cash, as provided in Section 9 hereof, in respect of any fractional shares otherwise issuable upon such -3- 5 surrender. Such certificate or certificates, to the extent permitted by law, shall be deemed to have been issued and any person so designated to be named therein shall be defined to have become a holder of record of such securities as of the date of surrender of the Warrants and payment of the Warrant Price, as aforesaid, notwithstanding that the certificate or certificates representing such securities shall not actually have been delivered or that the stock transfer books of the Company shall then be closed. The Warrants shall be exercisable, at the election of the Warrantholder, either in full or from time to time in part and, in the event that a Warrant is exercised in respect of less than all of the shares of Warrant Stock specified therein at any time prior to the Termination Date, a new Warrant evidencing the remaining shares of the Warrant Stock purchasable by such Warrantholders hereunder shall be issued by the Company to such Warrantholders. SECTION 4. VALIDITY; PAYMENT OF TAXES. All securities delivered upon exercise of a Warrant shall be duly and validly issued and non- assessable. The Company shall pay all documentary stamp taxes, if any, attributable to the initial issuance of the Warrants and the shares of Warrant Stock issuable upon the exercise of the Warrants; provided, however, the Company shall not be required to pay any tax which may be payable in respect of any secondary transfer of the Warrants or the Warrant Stock. SECTION 5. MUTILATED OR MISSING WARRANTS. In case the certificate or certificates evidencing the Warrants shall be mutilated, lost, stolen or destroyed, the Company shall, at the request of the Warrantholder, issue and deliver in exchange and substitution for and upon cancellation of the mutilated certificate or certificates, or in lieu of and substitution for the certificate or certificates lost, stolen or destroyed, a new Warrant certificate or certificates of like tenor and representing an equivalent right or interest, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction of such Warrant and a reasonable indemnification undertaking. SECTION 6. RESERVATION OF SHARES; NO CONTRARY ACTION. The Company represents and warrants to the Warrantholder that there has been reserved, and the Company shall at all times keep reserved so long as and to the extent the Warrants remain outstanding, out of its authorized Common Stock, such number of shares of Common Stock as shall be or remain subject to purchase under the outstanding Warrants. Every transfer agent for the Common Stock and other securities of the Company issuable upon the exercise of the Warrants shall be irrevocably authorized and directed at all times to reserve such number of authorized shares and other securities as shall be requisite for such purpose. The Company shall keep a copy of this Agreement on file with every transfer agent for the Common Stock and other securities of the Company issuable upon the exercise of the Warrants. The Company shall supply every such transfer agent with duly executed stock and other certificates, as appropriate, for such purpose and shall provide or otherwise make available any cash which may be payable in lieu of the issuance of fractional shares, as provided in Section 9 hereof. SECTION 7. WARRANT PRICE. The price per share at which shares of Warrant Stock shall be purchasable upon the exercise of the Warrants shall be $ [GREATER OF: (I) 120% OF IPO PRICE OR (II) 120% OF 12.50], subject to adjustment pursuant to Section 8 hereof (as so adjusted from time to time, the "Warrant Price"). -4- 6 SECTION 8. ADJUSTMENTS OF NUMBER OF SHARES OF WARRANT STOCK AND WARRANT PRICE. The number and kind of securities purchasable upon the exercise of the Warrants and the Warrant Price shall be subject to adjustment from time to time upon the happening of certain events, as follows: 8.1 Adjustments. The number of shares of Warrant Stock purchasable upon the exercise of each Warrant and the Warrant Price shall be subject to adjustment as follows: (a) In case the Company shall (i) pay a dividend or make a distribution on its Common Stock in shares of its capital stock or other securities, (ii) subdivide its outstanding shares of Common Stock into a greater number of shares, (iii) combine its outstanding Common Stock into a smaller number of shares or (iv) issue, by reclassification of its Common Stock, shares of its capital stock or other securities of the Company (including any such reclassification in connection with a consolidation or merger in which the Company is the continuing corporation), the number of shares of Warrant Stock purchasable upon exercise of a Warrant immediately prior thereto shall be adjusted so that the Warrantholder shall be entitled to receive the kind and number of shares of Warrant Stock, shares of its capital stock and other securities of the Company which such holder would have owned or would have been entitled to receive immediately after the happening of any of the events described above, had the Warrant been exercised immediately prior to the happening of such event or any record date with respect thereto. Any adjustment made pursuant to this subsection 8.1(a) shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) In case the Company shall issue rights, options (other than options issued under, and pursuant to, the Company's Stock Incentive Option Plan (the "Incentive Plan") or the Company's 1996 Non-Employee Directors Stock Option Plan (the "Non-Employee Directors Plan" and together with the Incentive Plan, the "Option Plans"), both as in effect as of the date of this Agreement), warrants or convertible securities to holders of its Common Stock, without any charge to such holders, containing the right to subscribe for or purchase Common Stock, the number of shares of Warrant Stock thereafter purchasable upon the exercise of each Warrant shall be determined by multiplying the number of shares of Warrant Stock theretofore purchasable upon exercise of a Warrant by a fraction, of which the numerator shall be the number of shares of Common Stock outstanding immediately prior to the issuance of such rights, options, warrants or convertible securities plus the number of additional shares of Common Stock offered for subscription or purchase, and of which the denominator shall be the number of shares of Common Stock outstanding immediately prior to the issuance of such rights, options, warrants or convertible securities. Such adjustment shall be made whenever such rights, options, warrants or convertible securities are issued, and shall become effective immediately upon issuance of such rights, options, warrants or convertible securities. (c) In case the Company shall distribute to holders of its Common Stock evidences of its indebtedness or assets (excluding cash dividends or distributions out of current earnings made in the ordinary course of business consistent with past practices), then in each case the number of shares of Warrant Stock thereafter purchasable upon the exercise -5- 7 of each Warrant shall be determined by multiplying the number of shares of Warrant Stock theretofore purchasable upon exercise of such Warrant by a fraction, of which the numerator shall be the then Current Market Price (as defined below) on the date of such distribution, and of which the denominator shall be such Current Market Price on such date minus the then fair value (determined as provided in subsection 8(f) below) of the portion of the assets or evidences of indebtedness so distributed applicable to one share of Common Stock. Such adjustment shall be made whenever any such distribution is made and shall become effective on the date of distribution. (d) No adjustment in the number of shares of Warrant Stock purchasable pursuant to subsections 8.1(b) or (c) hereof shall be required unless such adjustment would require an increase or decrease of at least one percent in the number of shares of Warrant Stock then purchasable upon the exercise of the Warrants or, if the Warrants are not then exercisable, the number of shares of Warrant Stock purchasable upon the exercise of the Warrants on the first date thereafter that the Warrants would become exercisable; provided, however, that any adjustments which by reason of this subsection 8.1(d) are not required to be made immediately shall be carried forward and taken into account in any subsequent adjustment. (e) Whenever the number of shares of Warrant Stock purchasable upon the exercise of a Warrant is adjusted as herein provided, the Warrant Price payable upon exercise of the Warrant shall be adjusted by multiplying such Warrant Price immediately prior to such adjustment by a fraction, of which the numerator shall be the number of shares of Warrant Stock purchasable upon the exercise of such Warrant immediately prior to such adjustment, and of which the denominator shall be the number of shares of Warrant Stock purchasable immediately thereafter. (f) To the extent not covered by subsections 8.1(b) or (c) hereof, in case the Company shall sell or issue Common Stock or rights, options (other than Common Stock or options issued under and pursuant to the Option Plans), warrants or convertible securities containing the right to subscribe for, purchase or exchange into shares of Common Stock at a price per share (determined, in the case of such rights, options, warrants or convertible securities, by dividing (i) the total amount received or receivable by the Company in consideration of the sale or issuance of such rights, options, warrants or convertible securities, plus the total consideration payable to the Company upon exercise, conversion or exchange thereof, by (ii) the total number of shares of Common Stock covered by such rights, options, warrants or convertible securities) lower than the greater of the then Current Market Price or the Warrant Price in effect immediately prior to such sale or issuance, then the Warrant Price shall be reduced to a price (calculated to the nearest cent) determined by dividing (I) an amount equal to the sum of (A) the number of shares of Common Stock outstanding immediately prior to such sale or issuance multiplied by the then existing Warrant Price, plus (B) the consideration received or receivable by the Company upon such sale or issuance, by (II) the total number of shares of Common Stock outstanding immediately after such sale or issuance. The number of shares of Warrant Stock purchasable upon the exercise of a Warrant shall thereafter be that number determined by multiplying the number of shares of Warrant Stock purchasable upon exercise immediately prior to such adjustment by a fraction, of which the numerator shall be the Warrant Price in effect -6- 8 immediately prior to such adjustment and the denominator shall be the Warrant Price as so adjusted. For the purposes of such adjustments, the Common Stock which the holders of any such rights, options, warrants or convertible securities shall be entitled to subscribe for, purchase or exchange into shall be deemed issued and outstanding as of the date of such sale or issuance and the consideration received by the Company therefor shall be deemed to be the consideration received by the Company for such rights, options, warrants or convertible securities, plus the consideration or premiums stated in such rights, options, warrants or convertible securities to be payable for the Common Stock covered thereby. In case the Company shall sell or issue Common Stock or rights, options, warrants or convertible securities containing the right to subscribe for, purchase or exchange into Common Stock for a consideration consisting, in whole or in part, of property other than cash or its equivalent, then, in determining the "price per share" of Common Stock and the "consideration received by the Company" for purposes of the first sentence of this subsection 8.1(f), the Board of Directors shall determine the fair value of said property, and such determination, if based upon the Board of Directors' good faith business judgment, shall be binding upon the Warrantholders. In determining the "price per share" of Common Stock, any underwriting discounts or commissions paid to brokers, dealers or other selling agents shall not be deducted from the price received by the Company for sales of securities registered under the Act or issued in a private placement. There shall be no adjustment of the Warrant Price pursuant to this subsection 8.1(f) if the amount of such adjustment would be less than $.05 per share of Common Stock; provided, however, that any adjustment which by reason of this provision is not required to be made immediately shall be carried forward and taken into account in any subsequent adjustment. (g) For the purpose of this Section 8, the term "Common Stock" shall mean (i) the class of stock designated as the Common Stock of the Company at the date of this Agreement or (ii) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. In the event that at any time, as a result of an adjustment made pursuant to this Section 8, a Warrantholder shall become entitled to purchase any securities of the Company other than Common Stock, (i) if the Warrantholder's right to purchase is on any other basis than that available to all holders of the Company's Common Stock, the Company shall obtain an opinion of a reputable investment banking firm valuing such other securities and (ii) thereafter the number of such other securities so purchasable upon exercise of a Warrant and the Warrant Price of such securities shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in this Section 8. (h) Upon the expiration of any rights, options, warrants or conversion privileges, if such shall not have been exercised, the number of shares of Warrant Stock purchasable upon exercise of a Warrant and the Warrant Price, to the extent a Warrant has not then been exercised, shall, upon such expiration, be readjusted and shall thereafter be such number and such price as they would have been had they been originally adjusted (or had the original adjustment not been required, as the case may be) on the basis of (A) the fact that the only shares of Common Stock issued in respect of such rights, options, warrants or conversion privileges were the shares of Common Stock, if any, actually issued or sold -7- 9 upon the exercise of such rights, options, warrants or conversion privileges, and (B) the fact that such shares of Common Stock, if any, were issued or sold for the consideration actually received by the Company upon such exercise plus the consideration, if any, actually received by the Company for the issuance, sale or grant of all such rights, options, warrants or conversion privileges whether or not exercised; provided, however, that no such readjustment shall have the effect of decreasing the numbers of shares of Warrant Stock purchasable upon exercise of a Warrant or increasing the Warrant Price by an amount in excess of the amount of the adjustment made in respect of the issuance, sale or grant of such rights, options, warrants or conversion privileges. (i) Whenever the number of shares of Warrant Stock purchasable upon the exercise of a Warrant or the Warrant Price is adjusted pursuant to this Section 8, the Company shall cause to be promptly mailed to each Warrantholder by first class mail, postage prepaid, notice of such adjustment or adjustments and a certificate of the chief financial officer of the Company setting forth the number of shares of Common Stock, capital stock and other securities purchasable upon the exercise of such Warrantholder's Warrant and the applicable Warrant Price after such adjustment, a brief statement of the facts requiring such adjustment and the computation by which such adjustment was made. 8.2 No Adjustment for Dividends, Incentive Plan, Non-Employee Directors Plan. Except as specifically provided in subsection 8.1, no adjustment in respect of any cash dividends or distributions on the Company's Common Stock out of current earnings made in the ordinary course of business consistent with past practices shall be made during the term of the Warrants or upon the exercise of the Warrants. No adjustment in respect to options issued under, and pursuant to, the Option Plans, both as in effect as of the date of this Agreement, shall be made during the term of the Warrants or upon the exercise of the Warrants. 8.3 Preservation of Purchase Rights upon Reclassification, Consolidation, etc. At any time following the date of this Agreement, in case of any consolidation of the Company with or merger of the Company into another corporation or other entity or in case of any sale, lease, conveyance or other transfer to another corporation, person or other entity of the property, assets or business of the Company as an entirety or substantially as an entirety, the Company or such successor or purchasing corporation, person or other entity, as the case may be, shall execute with the Warrantholder, and the agreements governing such consolidation, merger, sale, lease, conveyance or other transfer shall require such execution of, an agreement that the Warrantholder shall have the right thereafter upon payment of the Warrant Price in effect immediately prior to such event, upon exercise of the Warrants, to receive the kind and amount of shares and other securities and property which it would have owned or have been entitled to receive after the happening of such consolidation, merger, sale, lease, conveyance or other transfer had the Warrants (and each underlying security) been exercised immediately prior to such action. The Company shall promptly mail to each Warrantholder by first class mail, postage prepaid, notice of the execution of any such agreement. In the event of a merger described in Section 368(a)(2)(E) of the Internal Revenue Code of 1986, in which the Company is the surviving corporation, the right to purchase shares of Warrant Stock under the Warrants shall terminate on the date of such merger and thereupon the Warrants shall become null and void, but only if the controlling -8- 10 corporation shall agree to substitute for the Warrants its warrant which entitles the holder thereof to purchase upon its exercise the kind and amount of shares and other securities and property which it would have owned or been entitled to receive had the Warrants been exercised immediately prior to such merger. Any such agreements referred to in this subsection 8.3 shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 8 hereof, and shall provide for terms and provisions at least as favorable to the Warrantholder as those contained in this Agreement. The provisions of this subsection 8.3 shall similarly apply to successive consolidations, mergers, sales, leases, conveyances or other transfers. 8.4 Par Value of Shares of Common Stock. Before taking any action which would cause an adjustment effectively reducing the portion of the Warrant Price allocable to each share of Warrant Stock below the then par value per share, if any, of the Warrant Stock issuable upon exercise of the Warrants, the Company shall take any corporate action which may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable Warrant Stock upon exercise of the Warrants. 8.5 Independent Public Accountants. The Company may retain BDO Seidman, LLP (or such other accounting firm qualified to practice in front of the Securities and Exchange Commission (the "Commission") as is reasonably acceptable to the Representative) to make any computation required under this Section 8, and a certificate signed by such firm shall be conclusive evidence of the correctness of any computation made under this Section 8. 8.6 Statement on Warrant Certificates. Irrespective of any adjustments in the number of securities issuable upon exercise of Warrants, Warrant certificates theretofore or thereafter issued may continue to express the same number of securities as are stated in the similar Warrant certificates initially issuable pursuant to this Agreement, provided that such expression shall in no way affect the number of shares of Warrant Stock actually purchasable upon the exercise of such Warrants. SECTION 9. FRACTIONAL SHARES; CURRENT MARKET PRICE. The Company shall not be required to issue fractional shares of Common Stock on the exercise of a Warrant. If any fraction of a share of Common Stock would, except for the provisions of this Section 9, be issuable upon the exercise of a Warrant (or specified portion thereof), the Company shall in lieu thereof pay an amount in cash equal to the then Current Market Price multiplied by such fraction. For purposes of this Agreement, the term "Current Market Price" shall mean (i) if the Common Stock is traded on the Nasdaq National Market ("NNM") or on a national securities exchange, the per share closing price of the Common Stock in the NNM or on the principal stock exchange on which it is listed, as the case may be, on the date of exercise of the Warrant or, with respect to any adjustment pursuant to Section 8.1 hereof, on the date immediately preceding the announcement of the event causing such adjustment or (ii) if the Common Stock is traded in the over-the-counter market and not in the NNM or on any national securities exchange, the average of the per share closing bid prices of the Common Stock on the thirty (30) consecutive trading days immediately preceding the date in question, as reported by The Nasdaq Small Cap Market (or an equivalent generally accepted reporting -9- 11 service if quotations are not reported on The Nasdaq Small Cap Market). The closing price referred to in clause (i) above shall be the last reported sale price or, in the case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case in the NNM or on the principal stock exchange on which the Common Stock is then listed. For purposes of clause (ii) above, if trading in the Common Stock is not reported by The Nasdaq Small Cap Market, the bid price referred to in said clause shall be the lowest bid price as reported in the Nasdaq Electronic Bulletin Board or, if not reported thereon, as reported in the "pink sheets" published by National Quotation Bureau, Incorporated, and, if such Common Stock is not so reported, shall be the price of a share of Common Stock determined by the Company's Board of Directors in good faith. SECTION 10. NO RIGHTS AS STOCKHOLDER; NOTICES TO WARRANTHOLDER. Except as expressly provided herein, nothing contained in this Agreement or in the Warrants shall be construed as conferring upon the Warrantholder or its transferees any rights as a stockholder of the Company, including the right to vote, receive dividends, consent or receive notices as a stockholder in respect of any meeting of stockholders for the election of directors of the Company or any other matter. If, however, at any time prior to the expiration of the Warrants and prior to their exercise, any one or more of the following events shall occur: (a) any action which would require an adjustment pursuant to Section 8 hereof; (b) an issuance by the Company of rights, options, warrants or convertible securities to all or substantially all holders of its Common Stock, without any charge to such holders, containing the right to subscribe for or purchase Common Stock; or (c) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger or sale of its property, assets and business as an entirety or substantially as an entirety) shall be proposed; then the Company shall give notice in writing of such event to the Warrantholder, as provided in Section 13 hereof, at least 20 days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to any relevant dividend, distribution or other rights or for the determination of stockholders entitled to vote on such proposed dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing of the transfer books, as the case may be. SECTION 11. RESTRICTIONS ON TRANSFER; REGISTRATION RIGHTS; OBLIGATIONS IN REGISTRATION. (a) The Warrantholder agrees that prior to making any disposition of the Warrants or the Warrant Stock, other than to persons or entities identified in the first sentence of Section 1.3, the Warrantholder shall give written notice to the Company describing briefly the manner in which any such proposed disposition is to be made; and no such disposition shall be made unless the Warrantholder has notified, or currently with such disposition notifies, the Company that in the opinion of counsel reasonably satisfactory to the Company a registration statement, application or other notification, filing or post-effective -10- 12 amendment or supplement thereto (hereinafter collectively a "Registration Statement") under the Act or the state securities or "blue sky" laws of any applicable jurisdiction is not required with respect to such disposition and no such Registration Statement has been filed by the Company with, and declared effective, if necessary, by, the Commission or state securities commission or agency. The Warrantholder agrees that it shall obtain from any transferee who acquires any Warrants in a private transaction with the Warrantholder an agreement by such transferee that it agrees to be bound by any transfer restrictions set forth in this subsection 11(a) then applicable to such transferees. (b) The Company shall be obligated to the registered holders of the Warrants and the Warrant Stock as follows: (i) During the period beginning on the Commencement Date and ending four years following the Commencement Date, the Company will, as promptly as practicable (but in any event within sixty (60) days), after written request (the "Request") by a person or persons holding (or having the right to acquire by virtue of holding the warrants) more than sixty percent (60%) of the shares of Warrant Stock which have been (or may be) issued upon exercise of the Warrants, prepare and file at the expense of the holder(s) making the Request a Registration Statement with the Commission and such applications or other filings as required under applicable state securities or blue sky laws sufficient to permit the public offering of the Warrants and the Warrant Stock, and shall use its reasonable best efforts (at the expense of the holder making the Request) through its officers, directors, auditors and counsel, in all matters necessary or advisable, to cause such Registration Statement to become effective as promptly as practicable and to maintain such effectiveness so as to permit resale of the securities covered by the Request until the earlier of the time that all such Warrant Stock has been sold or the expiration of twelve (12) months from the effective date of the Registration Statement; provided, however, that the Company shall only be obligated to file one such Registration Statement under this Section 11(b)(i). Notwithstanding the foregoing, once and only once during the period the Company would have an obligation to register the Warrants and the Warrant Stock pursuant to this Section 11(b)(i), the Company shall not be obligated to effect a registration pursuant to this Section 11(b)(i) during the three (3) month period starting with the date thirty (30) days prior to the Company's estimated date of filing of an underwritten public offering of securities for the account of the Company; provided that the Company is actively employing in good faith all reasonable efforts to cause such registration statement to become effective and that the Company's estimate of the date of filing such registration statement is made in good faith; provided further, that the Company shall furnish to the Warrantholder and each holder of Warrant Stock a certificate signed by the managing underwriter stating that it would be seriously detrimental to the Company or its stockholders for the registration statement to be filed in the near future. (ii) In addition to any Registration Statement pursuant to subparagraph (i) above, whenever during the period beginning on the Commencement Date and ending four years following the commencement date, the Company proposes to file with the Commission a Registration Statement under the Act (other than as to securities issued pursuant to an employee benefit plan or as to a transaction subject to Rule 145 promulgated under the Act), it shall, regardless of whether a Request has been made pursuant to section -11- 13 II(a)(i) hereof, at least thirty (30) days prior to each such filing, give written notice of such proposed filing to each Warrantholder and each holder of the Warrant Stock at their respective addresses as they appear on the records of the Company, and shall offer to include and shall include in such filing any proposed disposition of the Warrants and Warrant Stock upon receipt by the Company, not more than twenty (20) days following the receipt of such notice, of a request therefor setting forth the facts with respect to such proposed disposition and all other information with respect to such person reasonably necessary to be included in such Registration Statement. In the event that such registration statement relates to an underwritten offering on a "firm commitment" basis and the managing underwriter for said offering advises the Company in writing that the inclusion of such securities in the offering would be materially and substantially detrimental to the completion of the offering, such securities shall nevertheless be included in the Registration Statement, provided that the Warrantholder and each holder of Warrant Stock desiring to have such securities included in the Registration Statement agrees in writing for a period of ninety (90) days following such offering not to sell or otherwise dispose of such securities pursuant to such Registration Statement, which Registration Statement the Company shall keep effective for a period of at least twelve (12) months following the expiration of such ninety (90) day period. In the event that the total size of any offering contemplated by the Company is reduced by the managing underwriter, the number of Warrants or Warrant Stock eligible to be included in such registration or offering shall be reduced in the same proportion and in pari passu with the reduction in the number of shares being offered by any other entity or person offering shares in the offering. Notwithstanding the foregoing, in the event that an offering is made pursuant to Regulation A promulgated under the Act, the Company shall be obligated to offer only those Warrants which, in conjunction with the proposed offering by the Company, would allow the Company to remain within the restrictions contained in Regulation A, including but not limited limitations as to the number of shares and dollar amount to be offered. (c) With respect to any registration described in Section 11(b)(i) hereof, all fees, disbursements and out-of- pocket expenses in connection with the filing of any Registration Statement or maintaining the currency and effectiveness of the Registration Statement (or obtaining the opinion of counsel and any no-action position of the commission with respect to sales under Rule 144) and in complying with applicable federal securities and state securities and blue sky laws shall be borne by the Warrantholder. With respect to any registration, offering or notification described in Section 11(b)(ii) hereof, all fees, disbursements and out-of-pocket expenses (other than the Warrantholder's brokerage fees and commissions and legal fees of counsel to the Warrantholder, if any) in connection with the filing of any Registration Statement or maintaining the currency and effectiveness of the Registration Statement and in complying with applicable federal securities and state securities and blue sky laws shall be borne by the Company, and the Company at its expense shall supply any Warrantholder and any holder of Warrant Stock with copies of such Registration Statement and the prospectus included therein and other related documents and any opinions and no-action letters in such quantities as may be reasonably requested by such Warrantholder or holder of Warrant Stock. (d) The Company shall not be required by this Section 11 to file such Registration Statement if, in the opinion of counsel for the Warrantholders, which -12- 14 counsel shall be reasonably satisfactory to the Company, or in the opinion of another counsel experienced in securities law matters acceptable to counsel for such Warrantholders and the Company, the proposed public offering or other transfer as to which such Registration Statement is requested is exempt, or without adverse economic effect could be structured to be exempt, from applicable federal securities and state securities and blue sky laws and would result in all proposed sales being made under Rule 144 under the Act. (e) The provisions of this Section 11 and of Section 12 hereof shall apply to the extent provided herein if the Company chooses to file an Offering Statement under Regulation A promulgated under the Act. (f) The Company agrees that until all the Warrants and Warrant Stock have been sold under a Registration Statement or pursuant to Rule 144 under the Act, it shall keep current in filing all materials required to be filed with the Commission in order to permit the holders of such securities to sell the same under Rule 144. (g) In the event any Warrantholder timely elects to make a Request for registration or include Warrant Stock in a Registration Statement pursuant to subsection 11(b) above, the Company shall use its reasonable best efforts to effect such registration to permit the sale of Warrant Stock in accordance with the intended method or methods of disposition thereof, and pursuant thereto, the Company shall, as expeditiously as possible: (i) Prepare and file with the Commission a Registration Statement or Registration Statements on a form available for the sale of the Warrant Stock, and to cause any such Registration Statement filed under the Act pursuant to subsection 11(b) above to become effective at the earliest possible date after the filing thereof and remain effective as provided herein and to comply with all applicable rules and regulations of the Commission (the "Rules and Regulations") in connection therewith, provided, however, that before filing a Registration Statement or prospectus or any amendments or supplements thereto, including documents which would be incorporated or deemed to be incorporated by reference in the Registration Statement after the initial filing of any Registration Statement, the Company will furnish to the Warrantholders, their respective counsel, and the underwriters, if any, to be engaged in connection with the offering and sale by the Company (for purposes of this subsection 11(g), the "Public Underwriter"), copies of all such documents proposed to be filed, which documents will be subject to the review of the Warrantholders, their respective counsel and the Public Underwriter, if any, and the Company will not file any Registration Statement, amendment thereto, any prospectus or any supplement thereto (including such documents incorporated or deemed to be incorporated by reference) to which the Public Underwriter, if any, shall reasonably object; (ii) Prepare and promptly file with the Commission such amendments and post-effective amendments to a Registration Statement as may be necessary to keep such Registration Statement continuously effective for a period of twelve (12) months or, if earlier, until all the Warrant Stock has been sold; cause the related prospectus to be supplemented, by any required prospectus supplement, and as so supplemented, to be filed pursuant to Rule 424 under the Act; and comply with the provisions of the Act with respect to the disposition of all Warrant Stock covered by such Registration Statement during the -13- 15 applicable period in accordance with the intended methods of disposition as set forth in such Registration Statement or supplement to such prospectus. The Company shall not be deemed to have used its reasonable best efforts to keep a Registration Statement effective during the applicable period if it intentionally or voluntarily takes any action that would result in such Warrantholders not being able to sell such Warrant Stock; (iii) As soon as the Company is advised or obtains knowledge thereof, advise the Warrantholders and confirm the same in writing (A) when the Registration Statement, as amended, becomes effective and when any post-effective amendment to the Registration Statement becomes effective, (B) of the issuance by the Commission or any State or other regulatory body of any stop order or other order, or of the initiation or the threat or contemplation of any proceeding, the outcome of which may result in the suspension of the effectiveness of the Registration Statement or the issuance of any order preventing or suspending the use of any preliminary prospectus or the prospectus, or any amendment or supplement thereto, or the institution of any proceedings for that purpose, (C) of the issuance by the Commission or any State or other regulatory body of any proceedings for the suspension of the qualification of any of the Warrant Stock for offering or sale in any jurisdiction or of the initiation or the threat or contemplation of any proceeding for that purpose, (D) of the receipt of any comments from the Commission and (E) of any request by the Commission for any amendment to the Registration Statement or any amendment or supplement to the prospectus related thereto or for additional information; if the commission or any State or other regulatory body shall enter a stop order or other order suspending the effectiveness of the Registration Statement or preventing or suspending the use of any preliminary prospectus or the prospectus, or any amendment or supplement thereto, or suspend such qualification at any time, make every effort to obtain promptly the lifting of such order or suspension; (iv) If requested by the Public Underwriter, if any, or any Warrantholder (1) immediately incorporate in a prospectus supplement or post-effective amendment such information as such Warrantholder and the Public Underwriter, if any, agree should be included therein relating to such sale and distribution of the Warrant Stock, including, without limitation, information with respect to the number of shares of Warrant Stock being sold to such Public Underwriter, the purchase price being paid therefor by such Public Underwriter and with respect to any other terms of the underwritten offering of the Warrant Stock to be sold in such offering; (2) make all required filings of such prospectus supplement or post-effective amendment as soon as notified of the matters to be so incorporated in such prospectus supplement or post-effective amendment; and (3) supplement or amend any Registration Statement if requested by the Warrantholders or any Public Underwriter; (v) Furnish to each of the Warrantholders and their respective counsel, without charge in the case of a Registration Statement under Section 11(b)(ii) hereof, and at such place as such Warrantholders may designate, copies of each preliminary prospectus, the Registration Statement (and any pre-effective or post-effective amendments thereto), the Prospectus, and all amendments and supplements thereto, including any prospectus prepared after the effective date of the Registration Statement and any term -14- 16 sheet, in each case as soon as available and in such quantities as each Warrantholder may request; (vi) During the time when a prospectus is required to be delivered under the Act, the Company shall comply with all requirements imposed upon it by the Act and the Securities Exchange Act, 1934, as amended (the "Exchange Act"), as now and hereafter amended, and by the Rules and Regulations, as from time to time in force, so far as necessary to permit the continuance of sales of or dealings in the Warrant Stock in accordance with the provisions hereof and the prospectus, or any amendments or supplements thereto; if at any time when a prospectus relating to the Warrant Stock is required to be delivered under the Act, any event shall have occurred as a result of which, in the opinion of the Company or counsel for the Company or counsel for the Warrantholders, the prospectus, as then amended or supplemented, would include an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances in which they were made, not misleading, or if it is necessary at any time to amend or supplement the prospectus to comply with the Act, notify the Public Underwriter and prepare and file, at the Company's expense, with the Commission an appropriate amendment or supplement to the Registration Statement or an amendment or supplement to the prospectus which will correct such statement or omission, or effect such compliance, each such amendment or supplement to be reasonably satisfactory to the Warrantholders and the counsel for the Warrantholders; and furnish to the Warrantholders copies of such amendment or supplement as soon as available and in such quantities as the Warrantholders may request; (vii) As soon as practicable, but in any event not later than forty-five (45) days after the end of the twelve (12) month period beginning after the effective date of the Registration Statement occurs, make generally available to its security holders, in the manner specified in Rule 158(b) promulgated under the Act, and to the Representative, an earnings statement which will comply with the provisions of Section 11(a) of the Act and Rule 158(a) promulgated under the Act; (viii) Deliver to each of the Warrantholders, their respective counsel and the Public Underwriter, if any, without charge in the case of a Registration Statement under Section 11(b)(ii) hereof, as many copies of the prospectus or prospectuses (including each preliminary prospectus) and any amendment or supplement thereto as such persons may reasonably request; the Company consents to the use of any such prospectus or any amendment or supplement thereto by the Warrantholders and the Public Underwriter, if any, in connection with the offering and sale of the Warrant Stock covered by such prospectus or any amendment or supplement thereto; (ix) Prior to any public offering of Warrant Stock, use its reasonable best efforts, at or prior to the time the Registration Statement becomes effective, to qualify the Warrant Stock for offering and sale under the securities or "blue sky" laws of such jurisdictions as the Warrantholders may reasonably designate to permit the continuance of sales and dealings therein for as long as may be necessary to complete the distribution, and make such applications, file such documents and furnish such information as may be required for such purpose; provided, however, the Company shall not be required to qualify -15- 17 as a foreign corporation or to execute a general consent to service of process in any such jurisdiction; in each jurisdiction where such qualification shall be effected, use its reasonable best efforts to file and make such statements or reports at such times as are or may be required by the laws of such jurisdiction to continue such qualification; (x) Cooperate with the Warrantholders and the Public Underwriter, if any, to facilitate the timely preparation and delivery of certificates representing Warrant Stock to be sold, which certificates shall not bear any restrictive legends; and enable such Warrant Stock to be in such denominations and registered in such names as the Public Underwriter, if any, may request at least two (2) business days prior to any sale of Warrant Stock; (xi) Use its reasonable best efforts to cause the Warrant Stock covered by the Registration Statement to be registered with or approved by such other governmental bodies, agencies or authorities as may be necessary to enable the Warrantholders or the Public Underwriter, if any, to consummate the disposition of such Warrant Stock; (xii) Make every reasonable effort to cause all Warrant Stock covered by such Registration Statement to be (1) listed on each securities exchange, if any, in which equity securities issued by the Company are then listed or (2) authorized to be quoted on the NNM or Nasdaq Small Cap Market or any exchange if the Company's Common Stock is then authorized to be quoted on the NNM or Nasdaq Small Cap Market or any exchange; (xiii) Enter into such agreements (including, without limitation, if applicable, an underwriting agreement, in form, scope and substance as is customary in underwritten offerings) and take all such other actions in connection therewith in order to expedite or facilitate the disposition of such Warrant Stock and, in such connection, whether or not an underwriting agreement is entered into and whether or not the registration is an underwritten registration, (1) make such representations and warranties to the Warrantholders and the Public Underwriter, if any, with respect to the business of the Company and its subsidiaries and the Registration Statement, the prospectus, the prospectus supplement (if any) and documents, if any, incorporated or deemed to be incorporated by reference in the Registration Statement, in each case in such form, substance and scope as are customarily made by issuers to underwriters in underwritten offerings and confirm the same if and when requested; (2) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to the Warrantholders), addressed to the Warrantholders with respect to the matters referred to in the preceding clause in such form, scope and substance as are customarily rendered to underwriters in underwritten offerings and such other matters as may be reasonably requested by counsel to the Warrantholders or the Public Underwriter, if any; (3) obtain "cold comfort" letters and updates thereof from the independent certified public accountants of the Company (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements and financial data is, or is required to be, included in or incorporated by reference into the Registration Statement) addressed to the Warrantholders and each of the Public -16- 18 Underwriters, if any, such letters to be in customary form and covering matters of the type customarily covered in "cold comfort" letters to underwriters in connection with underwritten offerings; (4) if an underwriting agreement is entered into, the same shall set forth in full the indemnification and contribution provisions and procedures of Section 12 hereof (or such other provisions and procedures as shall be acceptable to the Warrantholders and to the Public Underwriter of such underwritten offering) with respect to all parties to be indemnified pursuant to said section; and (5) deliver such documents and certificates as may be reasonably requested by the Warrantholders and the Public Underwriter, if any, to evidence the continued validity of the representations and warranties made pursuant to clause (1) above and to evidence compliance with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company; the above shall be done at each closing under such underwriting or similar agreement or as and to the extent required thereunder; (xiv) Make available for inspection by a representative of the Warrantholders or any Public Underwriter participating in any disposition pursuant to such Registration Statement, and any attorney or accountant retained by the Warrantholders or such Public Underwriter, all financial and other records, pertinent corporate documents and properties and assets of the Company and its subsidiaries and cause the officers, directors, agents and employees of the Company and its subsidiaries to supply all information reasonably requested by any such representative, Public Underwriter, attorney or accountant in connection with any registration of Warrant Stock; provided, however, that any records, information or documents that are designated by, the Company in writing at the time of delivery of such records, information or documents as confidential shall be kept confidential by such persons unless (1) disclosure of such records, information or documents is required by court or administrative order or is necessary to respond to inquiries of governmental or regulatory bodies, agencies or authorities, (2) disclosure of such records, information or documents is, in the opinion of counsel to the Warrantholders or to any Public Underwriter, required by law regulations or legal process, (3) such records, information or documents are otherwise publicly available or (4) such records, information or documents become available to such person from a source other than the Company, and such source is not bound by a confidentiality agreement or law prohibiting such disclosure; and (xv) If the Company, in the exercise of its reasonable judgment, objects to any change reasonably requested by the Warrantholders or the Public Underwriter, if any, to any Registration Statement or prospectus or any amendments or supplements thereto (including documents incorporated or deemed to be incorporated therein by reference) as provided for in this Subsection 11(g), the Company shall not be obligated to make any such change and the Warrantholders may withdraw the Warrants and Warrant Stock from such registration, in which event the Company shall pay all registration expenses (including, without limitation, attorneys' fees and expenses) incurred by the Warrantholders in connection with such Registration Statement or prospectus or any amendment thereto or supplement thereof; provided, that if the Company provides the Warrantholders, as applicable, with a written opinion of independent counsel (which counsel may be the Company's regular outside counsel), upon which such Warrantholders may rely, that the change so requested is not required in order that the Registration Statement comply with all applicable securities laws (including any rules and regulations promulgated thereunder), such -17- 19 Warrantholders may withdraw the Warrants and the Warrant Stock from such registration but the Company shall not be obligated to pay any registration expenses incurred by the Warrantholders; and (xvi) Pay all costs and expenses incident to the performance of or compliance with the Company's obligations under the second sentence of subsection 11(c) above and under this subsection 11(g) (collectively, "Registration Expenses") whether or not any Registration Statement is filed or becomes effective, including, without limitation, the fees and disbursements of the Company's auditors, legal counsel, special legal counsel, legal counsel responsible for qualifying the Warrants and the Warrant Stock under blue sky laws and with the NASD, all filing fees (including, without limitation, the Commission, states, NASD, the Nasdaq Stock Market or any exchange) and printing expenses, all expenses in connection with the transfer and delivery of the Warrant Stock, and all expenses in connection with the qualification of the Warrants and the Warrant Stock under applicable blue sky laws and with the NASD; provided, however, that the Company shall not bear the Public Underwriter's discount or commission with respect to, or any transfer taxes imposed on, the Warrant Stock or the fees and expenses of counsel to the Warrantholders; provided, further, however, that the Company shall not be responsible in any way for any fees or expenses of counsel to the Warrantholders or any Public Underwriter, except, in each case, as provided in Subsection 11(g)(xv) above. SECTION 12. INDEMNIFICATION AND CONTRIBUTION. (a) The Company agrees to indemnify and hold harmless the Representative, the Warrantholder, and any Holder of Warrant Stock (for purposes of this Section 12, "Holder" shall include the officers, directors, partners, employees, agents and counsel of a Warrantholder or a holder of Warrant Stock), and each person, if any, who controls a Holder ("controlling person") within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, from and against any and all losses, claims, damages, expenses (including, without limitation, reasonable attorneys' fees and expenses) or liabilities and all actions, suits, proceedings, injuries, arbitrations, investigations, litigation or governmental or other proceedings (in this Section 12, collectively, "actions") in respect thereof, whatsoever (including, without limitation, any and all expenses whatsoever reasonably incurred in investigating preparing or defending against any action, commenced or threatened, or any claim whatsoever), as such are incurred, to which a Holder or such controlling person may become subject under the Act, the Exchange Act or any other statute or at common law or otherwise, arising out of or based upon any untrue statement or alleged untrue statement of a material fact contained (i) in any preliminary prospectus, any Registration Statement, the Registration Statement or any prospectus (as from time to time amended and supplemented); (ii) in any post-effective amendment or amendments or any new registration statement and prospectus in which is included securities of the Company issued or issuable upon exercise of the Warrants; or (iii) in any application or other document or written communication (in this Section 12, collectively, "application") executed by the Company or based upon written information furnished by the Company in any jurisdiction in order to qualify the Warrants or the Warrant Stock under the securities or blue sky laws thereof or filed with the Commission, any state securities commission or agency, the -18- 20 National Association of Securities Dealers, Inc. (the "NASD") or the NNM, Nasdaq Small Cap Market or any other securities exchange; or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading (in light of the circumstances in which they were made), unless such statement or omission was made in reliance upon and in conformity with written information furnished to the Company with respect to a Holder by or on behalf of such Holder expressly for use in any preliminary prospectus, the registration statement or any prospectus, or any amendment thereof or supplement thereto, or in any application, as the case may be. In addition to its other obligations under this subsection 12(a), the Company agrees that, as an interim measure during the pendency of any action arising out of or based upon any untrue statement or omission, or alleged untrue statement or alleged omission as described in this subsection 12(a), it shall reimburse the Holders (and, to the extent applicable, each controlling person) on a monthly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such action notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's obligations to reimburse the Holders (and, to the extent applicable, each controlling person) for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement is so held to have been improper as to the Company, the Holders (and, to the extent applicable, each controlling person) shall promptly return it to the Company, together with interest compounded daily, based on the "reference rate" announced from time to time by Bank of America NTSA (the "Prime Rate"). Any such interim reimbursement payments which are not made to the applicable Holder within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. In no case shall any interest be in excess of that permitted by law. The indemnity agreement in this subsection 12(a) shall be in addition to any liability which the Company may have at common law or otherwise. (b) Each Holder severally agrees to indemnify and hold harmless the Company (for purposes of this Section 12, "Company" shall include the officers, directors, partners, employees, agents and counsel of the Company) and each other person, if any, who controls the Company ("controlling person") within the meaning of the Act, to the same extent as the foregoing indemnity from the Company to the Holders, but only with respect to statements or omissions, if any, made in any preliminary prospectus, any Registration Statement, or any prospectus or any amendment thereof or supplement thereto or in any application made in reliance upon, and in strict conformity with, written information furnished to the Company with respect to such Holder by or on behalf of such Holder expressly for use in any preliminary prospectus, any Registration Statement or any prospectus or any amendment thereof or supplement thereto or in any application, provided that such written information or omissions only pertain to disclosures in any preliminary prospectus, any Registration Statement or any prospectus directly relating to the transactions in connection with the offering contemplated hereby. In addition to its other obligations under this subsection 12(b), each Holder severally agrees that, as an interim measure during the pendency of any action arising out of or based upon any untrue statement or omission, or alleged untrue statement or alleged omission as described in this subsection 12(b), it shall reimburse the Company (and, to the extent applicable, each controlling person) on a monthly -19- 21 basis for all reasonable legal or other expenses incurred in connection with investigating or defending any action with respect to such Holder notwithstanding the absence of a judicial determination as to the propriety and enforceability of such Holder's obligations to reimburse the Company (and, to the extent applicable, each controlling person) for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement is so held to have been improper as to such Holder, the Company (and, to the extent applicable, each controlling person) shall promptly return it to such Holder, together with interest compounded daily, based on the Prime Rate. Any such interim reimbursement payments which are not made to the company within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. In no case shall any interest be in excess of that permitted by law. Notwithstanding the provisions of this subsection 12(b), in connection with a registration which includes the Warrants or Warrant Stock pursuant to Subsection 11(b)(i) hereof, no such Holder shall be required to indemnify or hold harmless the Company or any controlling person for any amounts in excess of the net proceeds (before deducting expenses) applicable to the Warrants or Warrant Stock sold by such Holder pursuant to the Registration Statement. Notwithstanding the provisions of this subsection 12(b), in connection with a registration that includes a Holder's Warrants or Warrant Stock pursuant to subsection 11(b)(ii) hereof, no such Holder shall be required to indemnify and hold harmless the Company or any controlling person for any amounts in excess of that portion of all expenses as to which indemnification is properly claimed under this Agreement equal to such Holder's relevant proportion of all net proceeds (before deduction of expenses) applicable to all securities sold pursuant to any Registration Statement or the Registration Statement, as applicable. (c) Promptly after receipt by an indemnified party under this Section 12 of notice of the commencement of any action, such indemnified party shall notify each party against whom indemnification is to be sought in writing of the commencement thereof (but the failure to so notify an indemnifying party shall not relieve it from any liability which it may have under this Section 12 except to the extent that it has been materially prejudiced by such failure). In case any such action is brought against any indemnified party, and it notifies an indemnifying party or parties of the commencement thereof, the indemnifying party or parties shall be entitled to participate therein, and to the extent it or they may elect by written notice delivered to the indemnified party or parties promptly after receiving the aforesaid notice from such indemnified party or parties, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party. Notwithstanding the foregoing, an indemnified party shall have the right to employ its own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of such counsel shall have been authorized in writing by the indemnifying party or parties in connection with the defense of such action at the expense of the indemnifying party or parties, (ii) the indemnifying party or parties shall not have employed counsel reasonably satisfactory to such indemnified party to have charge of the defense of such action within a reasonable time after notice of commencement of the action or (iii) such indemnified party shall have reasonably concluded that there may be one or more defenses available to it which are different from or additional to those available to one or all of the indemnifying parties (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party -20- 22 or parties), in any of which events such fees and expenses of one additional counsel (in addition to appropriate local counsel) shall be borne by the indemnifying parties. In no event shall the indemnifying parties be liable for fees and expenses of more than one counsel (in addition to appropriate local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. Anything in this Section 12 to the contrary notwithstanding, an indemnifying party shall not be liable for any settlement of any claim or action effected without its written consent; provided, however, that such consent may not be unreasonably withheld or delayed. (d) In order to provide for just and equitable contribution in any case in which (i) an indemnified party makes a claim for indemnification pursuant to this Section 12, but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that the express provisions of this Section 12 provide for indemnification in such case or (ii) contribution under the Act may be required on the part of any indemnified party, then each indemnifying party shall contribute to the amount paid as a result of such losses, claims, damages, expenses or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative fault of each of the contributing parties, on the one hand, and the party to be indemnified, on the other hand, in connection with the statements or omissions that resulted in such losses, claims, damages, expenses or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. Relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or by such Holder, and the parties' relative intent, knowledge, state of mind and access to information and opportunity to correct or prevent such untrue statement or omission. The amount paid by an indemnified party as a result of the losses, claims, damages, expenses or liabilities (or actions in respect thereof) referred to in the first sentence of this subsection 12(d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subsection 12(d), in a registration that includes a Holder's Warrants or Warrant Stock pursuant to subsection 11(b)(i) hereof, no Holder shall be required to contribute any amount in excess of the net proceeds (before deducting expenses) applicable to the shares of Warrants and Warrant Stock sold by such Holder pursuant to such registration statement and prospectus. Notwithstanding the provisions of this subsection 12(d), in a registration that includes a Holder's Warrant Stock pursuant subsection 11(b)(ii) hereof, no such Holder shall be required to contribute any amount in excess of that portion of all expenses as to which contribution is properly claimed under this Agreement equal to such Holder's relevant portion of all net proceeds (before deducting expenses) applicable to all securities sold pursuant to the Registration Statement, as applicable. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act and the cases and promulgations thereunder) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Any party entitled to contribution will, promptly after receipt of notice of commencement of any action against such party in respect to which a claim for contribution may be made against another party or parties under this subsection 12(d), notify such party or parties from whom contribution may -21- 23 be sought, but the omission to so notify such party or parties shall not relieve the party or parties from whom contribution may be sought from any obligation it or they may have hereunder or otherwise than under this subsection 12(d) except to the extent it has been materially prejudiced by such failure. The contribution agreement set forth above shall be in addition to any liabilities which any indemnifying party may have at common law or otherwise. Notwithstanding anything to the contrary contained in this Agreement, no Holder shall be required to contribute any amount in excess of the lesser of (i) that proportion of the total of such losses, claims, damages or liabilities indemnified or contributed against equal to the proportion of the total securities sold pursuant to the Registration Statement, as the case may be, which is being sold by it, or (ii) the proceeds received by it in any such offering. The Holders' obligations in this Section 12(d) to contribute are several in proportion to the number of Warrants or Warrant Shares registered on their behalf and not joint. (e) The indemnity and contribution agreements contained in this Section 12 and the representations shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of any Holder or any person controlling any Holder, the Company, its directors or officers or any Public Underwriter or any person controlling such Public Underwriter, (ii) acceptance of any Warrants or Warrant Shares and payment therefor hereunder, and (iii) any termination of this Agreement. A successor to any Holder or any person controlling any Holder, or to the Company, its directors or officers, or any person controlling the Company, shall be entitled to the benefits of the indemnity, contribution and reimbursement agreements contained in this Section 12. (f) In any proceeding relating to any Registration Statement or any prospectus or any amendment or supplement thereto, each party against whom contribution may be sought under this Section 12 hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon him or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join him or it as an additional defendant in any such proceeding in which such other contributing party is a party. SECTION 13. NOTICES. All notices and communications hereunder, except as herein otherwise specifically provided, shall be in writing and shall be deemed to have been duly given if mailed, delivered by hand or transmitted by any standard form of telecommunication. Notices to the Warrantholders or a holder of Warrant Stock shall be directed to The Boston Group, L.P. at 1999 Avenue of the Stars, Suite 2550, Los Angeles, California 90067, Attention: Mr. Robert A. DiMinico, with a copy to Munger, Tolles & Olson, 355 South Grand Avenue, 35th Floor, Los Angeles, California 90071, Attention: Sandra A. Seville-Jones, Esq. Notices to the Company shall be directed to the Company at 2144 Michelson Drive, Irvine, California 92612, Attention: Mr. Steven A. Lupinacci, with a copy to Gibson, Dunn & Crutcher LLP, 4 Park Plaza, Irvine, California 92614, Attention: John M. Williams, Esq. SECTION 14. PARTIES. This Agreement shall inure solely to the benefit of and shall be binding upon, the Representative, the Company and the Warrantholders and the holders of Warrant Stock and the controlling persons, officers, directors and others referred to in Section 12 hereof, and their respective successors, legal representatives and assigns, and no -22- 24 other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of or by virtue of this Agreement or any provisions herein contained. SECTION 15. MERGER OR CONSOLIDATION OF THE COMPANY. The Company shall not merge or consolidate with or into any other corporation or sell all or substantially all of its property to another corporation, unless the provisions of Section 8.3 hereof are complied with. SECTION 16. SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All statements contained in the Underwriting Agreement, any schedule, exhibit, certificate or other instrument delivered by or on behalf of the parties hereto, or in connection with the transactions contemplated by this Agreement, shall be deemed to be representations and warranties hereunder. Notwithstanding any investigations made by or on behalf of the parties to this Agreement, all representations, warranties and agreements made by the parties to this Agreement or pursuant hereto shall survive the termination of this Agreement and the issuance, sale and delivery of the Warrant and the Warrant Stock. SECTION 17. CONSTRUCTION. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of California, without giving effect to conflict of laws principles thereof. SECTION 18. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, and all of which taken together shall be deemed to be one and the same instrument. SECTION 19. ENTIRE AGREEMENT, AMENDMENTS. This Agreement and the Underwriting Agreement constitute the entire agreement of the parties hereto concerning the subject matter hereof and supersede all prior written or oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may not be amended, modified or altered except in a writing signed by the Representative and the Company. -23- 25 IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed, all as of the day and year first above written. DIEDRICH COFFEE, INC. By: ____________________________ Steven A. Lupinacci President and CEO THE BOSTON GROUP, L.P. By: ____________________________ Name: Title: 26 THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE SOLD, EXCHANGED, HYPOTHECATED OR TRANSFERRED IN ANY MANNER EXCEPT IN COMPLIANCE WITH SECTIONS 1.3 AND 11(a) OF THE REPRESENTATIVE'S WARRANT AGREEMENT PURSUANT TO WHICH THEY WERE ISSUED. WARRANT CERTIFICATE NO. 1 WARRANT TO PURCHASE 160,000 SHARES OF COMMON STOCK VOID AFTER 5:00 P.M. PACIFIC TIME, ON SEPTEMBER ___, 1999 DIEDRICH COFFEE, INC. INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE This certifies that, for value received, THE BOSTON GROUP, L.P., the registered holder hereof or assigns (the "Warrantholder"), is entitled to purchase from DIEDRICH COFFEE, INC. (the "Company"), at any time during the period commencing at 6:30 am., Pacific time, on September ___, 1997, and before 5:00 p.m., Pacific time, on September ___, 1999, at the purchase price per share of Common Stock of $_____ (the "Warrant Price"), 160,000 shares of Common Stock of the Company (the "Warrant Stock "). The number of shares of Common Stock of the Company purchasable upon exercise of each Warrant evidenced hereby shall be subject to adjustment from time to time as set forth in the Representative's Warrant Agreement, dated as of September ___, 1996, by and between the Company and the Representative (the "Representative's Warrant Agreement"). The Warrants evidenced hereby represent the right to purchase an aggregate of up to 160,000 shares of Warrant Stock (subject to adjustment as provided in the Representative's Warrant Agreement) and are issued under and in accordance with the Representative's Warrant Agreement, and are subject to the terms and provisions contained in the Representative's Warrant Agreement, to all of which the Warrantholder by acceptance hereof consents. The Warrants evidenced hereby may be exercised in whole or in part by presentation of this Warrant Certificate with the Purchase Form attached hereto duly executed (with a signature guarantee as provided hereon) and simultaneous payment of the Warrant Price at the principal office of the Company. Payment of such price shall be made at the option of the Warrantholder in any manner allowed in the Representative's Warrant Agreement. Upon any partial exercise of the Warrants evidenced hereby, there shall be signed and issued to the Warrantholder a new Warrant Certificate in respect of the shares of Warrant Stock as to which the Warrants evidenced hereby shall not have been exercised. These Warrants may be exchanged at the office of the Company by surrender of this Warrant Certificate properly endorsed for one or more new Warrants of the same aggregate number 27 of shares of Warrant Stock as evidenced by the Warrant or Warrants exchanged. No fractional securities shall be issued upon the exercise of rights to purchase hereunder, but the Company shall pay the cash value of any fraction upon the exercise of one or more Warrants. These Warrants are transferable at the office of the Company in the manner and subject to the limitations set forth in the Warrant Agreement. This Warrant Certificate does not entitle any Warrantholder to any of the rights of a stockholder of the Company. DIEDRICH COFFEE, INC. By: ________________________________ Steven A. Lupinacci President and CEO Dated: September ___, 1996 ATTEST: [Seal] ____________________________________ Martin R. Diedrich Secretary 28 DIEDRICH COFFEE, INC. PURCHASE FORM DIEDRICH COFFEE, INC. (the "Company") ___________________________________ ___________________________________ Attention: President The undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant Certificate for, and to purchase thereunder, _____ shares of common stock of the Company (the "Warrant Stock") provided for therein, and requests that certificates for the Warrant Stock be issued in the name of: __________________________________________ (Please print or Type Name, Address and Social Security Number) __________________________________________ __________________________________________ and, if said number of shares of Warrant Stock shall not be all the Warrant Stock purchasable hereunder, that a new Warrant Certificate for the balance of the Warrant Stock purchasable under the within Warrant Certificate be registered in the name of the undersigned Warrantholder or his Assignee as below indicated and delivered to the address stated below. Dated:_________________ Name of Warrantholder or Assignee: _________________________ (Please Print) Address: _________________________ _________________________ Signature: _________________________ Note: The above signature must correspond with the name as it appears upon the face of this Warrant Certificate in every particular, without alteration or enlargement or any change whatever, unless these Warrants have been assigned. Signature Guaranteed:_____________________________ (Signature must be guaranteed by a bank or trust company having an office or correspondent in the United States or by a member firm of a registered securities exchange of the National Association of Securities Dealers, Inc.) 29 ASSIGNMENT (To be signed only upon assignment of Warrants) FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers the right to purchase _____ shares of Warrant Stock represented by the within Warrant Certificate unto, and requests that a certificate for such Warrant be issued in the name of: _____________________________________ (Name and Address of Assignee Must be Printed or Typewritten) _____________________________________ _____________________________________ hereby irrevocably constituting and appointing _______________ Attorney to transfer said Warrants on the books of the Company, with full power of substitution in the premises and, if said number of Warrant Stock shall not bear all of the Warrant Stock purchasable under the within Warrant Certificate, that a new Warrant Certificate for the balance of the Warrant Stock purchasable under the within Warrant Certificate be registered in the name of the undersigned Warrantholder and delivered to such Warrantholder's address as then set forth on the Company's books. Dated:________________________ _____________________________________ Signature of Registered Holder Note: The above signature must correspond with the name as it appears upon the face of this Warrant Certificate in every particular, without alteration or enlargement or any change whatever. Signature Guaranteed:_____________________________ (Signature must be guaranteed by a bank or trust company having an office or correspondent in the United States or by a member firm of a registered securities exchange or the National Association of Securities Dealers, Inc.) EX-4.4 4 SPECIMEN STOCK CERTIFICATE 1 EXHIBIT 4.4 [SPECIMEN COMMON STOCK CERTIFICATE] COMMON STOCK [LOGO] DIEDRICH COFFEE, INC. COMMON STOCK SHARES SHARES [RT ] [ ] SEE REVERSE FOR CERTAIN DEFINITIONS INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE CUSIP 253675 10 2
THIS CERTIFIES THAT IS THE RECORD HOLDER OF FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $0.01 VALUE OF DIEDRICH COFFEE, INC. transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this certificate properly endorsed. This certificate is not valid until countersigned by the Transfer Agent and registered by the Registrar. WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. Dated: /s/ Martin Diedrich [SEAL] /s/ Steven A. Lupinacci - ---------------------- ----------------------- SECRETARY AND CHAIRMAN PRESIDENT AND CHIEF OF THE BOARD EXECUTIVE OFFICER COUNTERSIGNED AND REGISTERED: U.S. STOCK TRANSFER CORPORATION TRANSFER AGENT AND REGISTRAR BY /s/ ----------------------------------- AUTHORIZED SIGNATURE 2 The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM -- as tenants in common TEN ENT -- as tenants by the entireties JT TEN -- as joint tenants with right of survivorship and not as tenants in common UNIF GIFT MIN ACT -- _________________ Custodian _________________ (Cust) (Minor) under Uniform Gifts to Minors Act__________________________________________ (State) UNIF TRF MIN ACT -- _________________ Custodian (until age______) (Cust) ______________________under Uniform Transfers (Minor) to Minors Act________________________________ (State) Additional abbreviations may also be used though not in the above list. FOR VALUE RECEIVED, ____________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE [ ] ________________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE) ________________________________________________________________________________ ________________________________________________________________________________ __________________________________________________________________________Shares of the common stock represented by the within Certificate, and do hereby irrevocably constitute and appoint ________________________________________________________________________Attorney to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises. Dated________________________________ X_______________________________________________ X_______________________________________________ THE SIGNATURE(S) TO THIS ASSIGNMENT MUST NOTICE: CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER. Signature(s) Guaranteed By_________________________________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. EX-5.1 5 OPINION OF GIBSON, DUNN & CRUTCHER LLP 1 EXHIBIT 5.1 Gibson, Dunn & Crutcher LLP 4 Park Plaza, Suite 1700 Irvine, California 92614 September 9, 1996 Telephone Our File Number (714) 451-3800 22453-00004 Diedrich Coffee, Inc. 2144 Michelson Drive Irvine, CA 92612 Re: Registration Statement on Form S-1 (Registration No. 333-08633) Ladies and Gentlemen: We have examined the Registration Statement on Form S-1 (the "Registration Statement") filed by Diedrich Coffee, Inc., a Delaware corporation (the "Company") with the Securities and Exchange Commission on July 23, 1996 (Registration No. 333-08633), as amended to the date hereof, in connection with the registration under the Securities Act of 1933, as amended, of up to an aggregate of 2,530,000 shares of the Company's Common Stock, par value $0.01 per share (the "Common Stock"), to be sold in a proposed public offering (the "Offering"), consisting of (i) up to 1,600,000 shares of Common Stock to be issued and sold by the Company, and (ii) up to 930,000 shares of Common Stock to be sold by selling stockholders (such shares, together with the shares to be issued and sold by the Company, being referred to herein as the "Shares"), all as set forth in the Registration Statement. As your counsel, we have examined the Company's Certificate of Incorporation and Bylaws, each as amended to the date hereof, and the records of corporate proceedings and other actions taken by the Company in connection with the authorization and issuance of the Common 2 Diedrich Coffee, Inc. September 9, 1996 Page 2 Stock being sold by the Company and the sale of the Shares by the Company and the selling stockholders. Based upon the foregoing and in reliance thereon, and subject to (i) compliance with applicable state securities laws and (ii) receipt from the Securities and Exchange Commission of an order declaring the Registration Statement effective, it is our opinion that the Shares, when issued, delivered and paid for pursuant to and in accordance with the Registration Statement (and pertinent exhibits thereto), will be validly issued, fully paid and non-assessable. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement, and we further consent to the use of our name under the caption "Legal Matters" in the Prospectus forming a part of said Registration Statement. In giving this consent, we do not thereby admit that we are within the category of persons whose consent is required under Section 7 of the Securities Act or the Rules and Regulations of the Commission. Very truly yours, /s/ Gibson Dunn & Crutcher GIBSON, DUNN & CRUTCHER LLP MWS/JMW/AEM EX-10.10 6 K. COIN EMPLOYMENT AGREEMENT DATED AUG. 26, 1996 1 EXHIBIT 10.10 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into as of August 26, 1996, by and between DIEDRICH COFFEE, a California corporation (the "Company"), and KERRY W. COIN (the "Employee"). R E C I T A L S : The Company and the Employee desire to enter into this Agreement to establish the terms and conditions of the Employee's employment by the Company 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) The Company hereby employs the Employee as its Chief Operating Officer and the 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 the 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) The Employee shall perform such duties and functions consistent with his role as Chief Operating Officer as assigned to him by the Board of Directors of the Company (the "Board"). 2. Compensation. 2.1 Salary. For all services to be rendered by the Employee under this Agreement, the Company agrees to pay the Employee a salary (the "Base Salary") equal to One Hundred Twenty Thousand Dollars ($120,000) 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 the 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 the Company's performance and Employee's contribution thereto in such amounts and at such times as the Board may determine. 2.2 Stock Options. The Company shall grant options to the Employee pursuant to the Company's 1996 Stock Incentive Plan in accordance with the following terms and conditions: (a) The Company shall grant to the Employee an option to purchase Twenty Thousand (20,000) shares of the Company's common stock as a signing bonus. Five Thousand (5,000) of these Twenty Thousand (20,000) option shares shall become exercisable immediately upon grant, Ten Thousand (10,000) of these Twenty Thousand (20,000) option shares shall become exercisable sixty-five (65) days after the commencement of the Employee's employment and the remaining Five Thousand (5,000) option shares shall become exercisable ratably on the last day of each of the six months following the Employee's 2 commencement of employment. The option exercise price with respect to these option shares shall be the per share offering price of the Company's common stock in its initial public offering (the "IPO price"). (b) The Company shall grant to the Employee an option to purchase an additional One Hundred Thousand (100,000) shares of the Company's common stock, such option shares to become exercisable in accordance with the following schedule: Sixty Thousand (60,000) option shares shall become exercisable ratably on the last day of each of the twenty-four months following the Employee's commencement of employment and Forty Thousand (40,000) option shares shall become exercisable ratably on the last day of each of the twenty-fifth through thirty-sixth months following the Employee's commencement of employment. The option exercise price with respect to these option shares shall also be the IPO price. (c) Notwithstanding the foregoing, the option shares referred to in subparagraphs 2.2(a) and (b) shall become exercisable immediately upon the occurrence of a "Change in Control." For purposes hereof, a "Change in Control" shall be deemed to mean (i) the acquisition, in a transaction other than the initial public offering of the Company's common stock, by any person, entity or "group" (within the meaning of section 13(d)(3) of the Securities Exchange Act of 1934, as amended), of securities of the Company representing 60% or more of the combined voting power of the then outstanding securities of the Company, (ii) the merger or other business combination of the Company with or into another corporation, a majority of the directors of which were not directors of the Company immediately prior to the merger and in which stockholders of the Company immediately prior to the effective date of such merger directly or indirectly own less than 60% of the voting power in such corporation, or (iii) the sale or other disposition of all or substantially all of the assets of the Company. (d) Unless terminated earlier pursuant to this subparagraph 2.2(d), the option shares shall terminate on the tenth anniversary of the date hereof. If the Employee's employment with the Company is terminated prior to the expiration of the Term for any reason other than a reason set forth in subparagraph 4(a), any option shares that have not yet become exercisable shall not become exercisable after the effective date of Employee's termination of employment and such option shares shall terminate on such date and any option shares exercisable as of the effective date of Employee's termination of employment shall terminate and not be exercisable on the date two years following the effective date of such termination of employment. If the Employee's employment is terminated by the Company for a reason set forth in subparagraph 4(a), any option shares that are not yet exercisable shall not become exercisable after the effective date of Employee's termination of employment and such option shares shall terminate on such date and any option shares exercisable as of the effective date of Employee's termination of employment shall terminate and not be exercisable on the date sixty (60) days following the effective date of such termination of employment. 2.3 Employee Benefits. During the Term of the Employee's employment hereunder: (a) The Employee shall be entitled to vacation leave consistent with the Company's policies for other senior executives of the Company. (b) The Company shall pay or reimburse the Employee for all reasonable and necessary travel and other business expenses incurred or paid by the Employee in connection with the performance of his services under this Agreement consistent with the Company's policies for other senior executives of the Company. 2 3 (c) The Company shall provide and pay for the annual cost of premiums for health, dental and medical insurance coverage for the Employee and the Employee's dependents consistent with the coverage generally made available by the Company to senior executives of the Company and providing benefits at least as favorable to the Employee as the coverage that is in effect at the date of this Agreement. (d) In addition to the benefits set forth above, the Employee shall be entitled to participate in any other policies, programs and benefits which the Company 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. 3. Confidential Information and Nonsolicitation. (a) The Employee acknowledges and agrees that the Company has developed and uses certain proprietary and confidential information, data, processes, business methods, computer software, data bases, customer lists and know-how ("Confidential Information"). The Employee agrees that the Confidential Information is a trade secret of the Company which shall remain the sole property of the Company notwithstanding that the Employee, as an employee of the Company, may participate in the development of the Confidential Information. During the term of this Agreement and at all times thereafter the Employee shall not disclose any Confidential Information to any person or entity for any reason or purpose whatsoever, nor shall the Employee make use of any Confidential Information for the Employee's own benefit or for the benefit of any other person or entity. Upon termination of this Agreement for any reason, the Employee will promptly surrender to the Company all Confidential Information in the Employee's possession or under the Employee's control, whether prepared by the Employee or by others. (b) The Employee agrees that for a period of three (3) years following the termination of the Employee's employment hereunder, the Employee will not directly or indirectly solicit or attempt to solicit any of the employees of or consultants to the Company to leave the Company or to become employees of or consultants to any other person or entity. 4. Termination of Employment. (a) Notwithstanding any other provision of this Agreement, the Employee's employment under this Agreement may be terminated as follows: (i) Upon the death of the Employee, this Agreement and the Employee's employment hereunder shall terminate immediately and without notice by the Company; or (ii) In the event of the inability of the 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 and the Employee's employment hereunder shall terminate upon delivery of written notice to the Employee; or (iii) By the Company for Cause (as defined below) in accordance with the provisions of Section 4(b) hereof. 3 4 (b) The parties agree that for purposes of this Agreement, the term "Cause" shall mean the following: (i) The 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 the Company's business; and (iii) Commission by the Employee of any felony or intentionally fraudulent act against the Company, or its employees, agents or customers. (c) With respect to events described in subparagraph 4(b)(i) and (ii) above, the Company shall give written notice to the Employee of any such event and the 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, the 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 the 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 the Employee's employment under this Agreement may be terminated by the Company by delivery to the 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, the Employee's employment under this Agreement may be terminated by the Company by delivery to the Employee of written notice of termination and such termination will be effective as of the date of delivery of such written notice. Upon the effectiveness of termination as set forth in this subparagraph 4(c), the Employee shall not be entitled to receive any further compensation or benefits pursuant to this Agreement except for payment within ten days after his termination date of all accrued but unpaid Base Salary. (d) In addition to its rights to terminate the Employee's employment under this Agreement pursuant to subparagraph 4(a), the Company may also terminate the Employee's employment under this Agreement for any other reason, provided that, in such event, the Employee shall be entitled to receive an amount equal to seventy-five percent of the Employee's Base Salary on the termination date and the Employee shall not be entitled to receive any other compensation or benefits hereunder. The Employee acknowledges and agrees that the provisions of this paragraph 4 state his entire and exclusive rights, entitlements, and remedies against the Company, its successors, assigns, affiliates, officers, directors, employees and representatives for termination without any cause shown by the Company. (e) The Employee may terminate his employment for good cause or without any cause. In the event the Employee terminates his employment for "good cause" (as defined below), he shall be entitled to receive the severance benefits described in subparagraph 4(d) above. If he terminates his employment for any other reason, he shall not be entitled to receive any compensation except for payment within ten days after his termination date of all accrued but unpaid Base Salary. For purposes of this Agreement, "good cause" for termination of employment by the Employee shall mean: failure to maintain the Employee in the position of an officer of the Company or a material breach of the provisions of this Agreement by the Company. The Employee acknowledges and agrees that the provisions of this subparagraph 4(e) state his entire and exclusive rights and remedies under this Agreement against the Company, its successors, assigns, affiliates, officers, directors, employees and representatives if he terminates this Agreement. 4 5 5. Assignment of Rights and Duties. Neither the Employee nor the Company may assign their rights or duties under this Agreement without prior written consent of both parties, which consent may be withheld for any reason. Any attempted assignment, transfer, conveyance, or other disposition of any interest of either party in this Agreement shall be void. Notwithstanding the foregoing, the Company may make such assignment to any affiliated company, but its assignment of this Agreement to an affiliate does not relieve it of its obligations under this Agreement if that affiliate fails to perform the Company's obligations under this Agreement. 6. Miscellaneous. 6.1 Modification and Waiver of Breach. No waiver or modification of this Agreement or any term hereof shall be binding unless it is in writing signed by the parties hereto. No failure to insist upon compliance with any term, provision or condition to this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a waiver of any such term, provision or condition or as a waiver of any other term, provision or condition of this Agreement. 6.2 Notices. All notices and other communications required or permitted under this Agreement shall be in writing and shall be deemed given upon personal delivery, facsimile transmission (with confirmation of receipt), delivery by a reputable overnight courier service or five (5) days following deposit in the United States mail (if sent by certified or registered mail, postage prepaid, return receipt requested), in each case duly addressed to the party to whom such notice or communication is to be given as follows: (a) If to the Company: Diedrich Coffee 2144 Michelson Drive Irvine, CA 92612 Attn: President Telecopy Number: (714) 260-1610 (b) If to the Employee: Kerry W. Coin -------------------------- -------------------------- -------------------------- Either the Employee or the Company may change the address for purposes of this Paragraph by giving to the other intended to be bound thereby, in the manner provided herein, a written notice of such change. 6.3 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same Agreement. 6.4 Complete Agreement. This Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated by this Agreement and supersedes all previous and all contemporaneous negotiations, commitments, writings, and understandings. 5 6 6.5 Legal Fees; Arbitration. The parties hereto expressly agree that in the event of any dispute, controversy or claim by any party regarding this Agreement, the prevailing party shall be entitled to reimbursement by the other party to the proceeding of reasonable attorneys' fees, expenses and costs incurred by the prevailing party. 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 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, expenses, 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. 6.6 Severability. In the event any provision or provisions of this Agreement is or are to be held invalid, the remaining provisions of this Agreement shall not be affected thereby. 6.7 Governing Law. This Agreement shall be governed by the laws of the State of California. IN WITNESS WHEREOF, the undersigned have executed this Agreement on the day and year first above written. THE EMPLOYEE ------------------------------ Kerry W. Coin DIEDRICH COFFEE By: --------------------------- Steven A. Lupinacci President and Chief Executive Officer 6 EX-23.1 7 CONSENT OF BDO SEIDMAN 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. /s/ BDO SEIDMAN, LLP BDO SEIDMAN, LLP Costa Mesa, California September 9, 1996 EX-23.2 8 CONSENT OF BDO SEIDMAN, RE:ACQUIRED STORES.. 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. /s/ BDO SEIDMAN, LLP BDO SEIDMAN, LLP Costa Mesa, California September 9, 1996 -----END PRIVACY-ENHANCED MESSAGE-----