-----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, GT3aAHTNuT7Yjc9rSaIyCBIFspErXk9ZK9IagCvt8XSBLF9UgCP9H18ylfgj1LkU sUZIvXPKNXyyVQnh1PUY+w== 0000892569-96-001727.txt : 19960829 0000892569-96-001727.hdr.sgml : 19960829 ACCESSION NUMBER: 0000892569-96-001727 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 19960828 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: 96622477 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 FORM S-1/A AMENDMENT #3 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 28, 1996 REGISTRATION NO. 333-08633 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 3 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 AUGUST 28, 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 7. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- -------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------- UNDERWRITING PROCEEDS TO PRICE TO DISCOUNTS AND PROCEEDS TO SELLING PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDERS - -------------------------------------------------------------------------------------------------- Per Share..................... $ $ $ $ - -------------------------------------------------------------------------------------------------- Total(3)...................... $ $ $ $ - -------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------
(1) Does not include (a) a non-accountable expense allowance payable to the Representative, and (b) the value of the three-year warrants granted to the Representative to purchase up to 160,000 shares of Common Stock at an exercise price per share equal to 120% of the greater of: (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 $900,000, including the Representative's non-accountable expense allowance. See "Underwriting." (3) The Selling Stockholders have granted the Underwriters a 30-day option to purchase up to 330,000 additional shares of Common Stock, solely to cover over-allotments, if any. See "Underwriting." If all such shares of Common Stock are purchased, the total Price to Public, Underwriting Discounts and Commissions and Proceeds to Selling Stockholders will be $ , $ and $ , respectively. The Common Stock is offered by the Underwriters, when, as and if delivered to and accepted by them, and subject to their right to withdraw, cancel or modify the Offering and reject any order in whole or in part. It is expected that delivery of the certificates for the shares of Common Stock will be made on or about , 1996. ------------------------ THE BOSTON GROUP, L.P. The date of this Prospectus is , 1996. 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 $15.6 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 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 7 10 results of operations. In addition, the success of any expansion plans will depend in part upon the Company's ability to continue to improve and expand its management and financial control systems, to attract, retain and motivate key employees and to raise additional capital. There can be no assurance the Company will be 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." 8 11 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 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 9 12 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 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. 10 13 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 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, 11 14 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." USE OF PROCEEDS The net proceeds to the Company from the Offering, at an assumed initial public offering price of $11.00, after deducting underwriting discounts and commissions and estimated offering expenses, are estimated to be approximately $15,644,000. The Company will not receive any proceeds from the sale of shares of Common Stock by the Selling Stockholders, including any shares 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 $438,000 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 $8.7 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. 12 15 CAPITALIZATION The following table sets forth the capitalization of the Company as of May 1, 1996 (i) on an actual basis, (ii) on a pro forma basis giving effect to (a) the conversion of Series A and Series B Preferred Stock into Common Stock upon the closing of this Offering and (b) the reincorporation of the Company in the State of Delaware 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 ========== ========== ==========
13 16 DILUTION The pro forma net tangible book value of the Company as of May 1, 1996 was $2,569,814, or $0.68 per share of Common Stock, based upon 3,791,650 shares of Common Stock outstanding. Pro forma net tangible book value per share represents the amount of total tangible assets of the Company less total liabilities, divided by the number of shares of Common Stock outstanding, after giving effect to the conversion of all outstanding shares of Preferred Stock into Common Stock upon the consummation of this Offering. The 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 ========= ===== =========== =====
14 17 SELECTED FINANCIAL DATA The following selected financial data as of and for the years ended January 31, 1994, 1995 and 1996 were derived from the Company's financial statements, which have been audited by BDO Seidman, LLP, independent certified public accountants. The financial data as of and for the years ended January 31, 1992 and 1993 were derived from unaudited financial statements. The financial data with respect to the statement of operations for the twelve weeks ended April 25, 1995 and the thirteen weeks ended May 1, 1996 and with respect to the balance sheet as of May 1, 1996 were derived from unaudited financial statements appearing herein. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, which the Company considers necessary for a fair presentation of the financial position and results of operations for these periods. The operating results for the thirteen weeks ended May 1, 1996 are not necessarily indicative of the results that may be achieved for the fiscal year ending on January 29, 1997. The financial data set forth below should be read in conjunction with the audited financial statements and accompanying notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein.
YEARS ENDED JANUARY 31, TWELVE THIRTEEN -------------------------------------------------------- WEEKS WEEKS PRO ENDED ENDED MAY FORMA APRIL 25, 1, 1992 1993 1994 1995 1996 1996(1) 1995(2) 1996(2)(3) ------ ------ ------ ------ ------ ------- --------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net sales: Retail...................... $2,382 $2,906 $3,912 $6,673 $8,879 $11,236 $ 1,757 $3,902 Wholesale and other......... -- 33 502 918 1,365 1,365 301 373 ------ ------ ------ ------ ------ ------- ------ ------ Total.................. 2,382 2,939 4,414 7,591 10,244 12,601 2,058 4,275 ------ ------ ------ ------ ------ ------- ------ ------ Costs and expenses: Cost of sales and related occupancy costs........... 883 1,140 1,796 3,164 4,409 5,932 872 1,773 Store operating expenses.... 770 1,064 1,594 2,584 3,520 4,686 669 1,735 Other operating expenses.... -- 6 146 282 277 277 64 60 Depreciation and amortization.............. 71 143 102 255 354 498 62 154 General and administrative expenses.................. 624 762 809 851 1,335 1,782(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 ========= ========= =========
15 18
JANUARY 31, -------------------------------------------------------- PRO FORMA MAY 1, 1996 1992 1993 1994 1995 1996 1996(1) (2)(3) ------ ------ ------ ------ ------ ------- ------------ BALANCE SHEET DATA: Working capital (deficiency)......... $ (387) $ 470 $ (364) $ (218) $ (53) $(1,436) $ (3,819) Total assets......................... 866 1,790 2,163 2,503 5,316 6,699 8,915 Long-term obligations, less current portion............................ 239 453 544 471 829 829 304 Total stockholders' equity........... 126 938 849 1,173 3,304 3,304 3,412
- --------------- (1) The pro forma condensed financial statement information assumes the Company's acquisition of the 12 Brothers Stores occurred on February 1, 1995 for the statement of operations data and on January 31, 1996 for the balance sheet data. Pro forma statement of operations and balance sheet data excludes the acquisition of the Acquired Cafes as the acquisition does not require pro forma presentation. See Note 9 of Notes to Financial Statements and the Unaudited Pro Forma Condensed Financial Statements. (2) Effective February 1, 1996, the Company changed its 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. 16 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following should be read in conjunction with the financial statements of the Company and notes thereto and other financial information appearing elsewhere in this Prospectus. GENERAL The first retail store operating under the name Diedrich Coffee commenced operations in 1972. At the conclusion of 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 17 20 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. 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. 18 21 YEAR ENDED JANUARY 31, 1996 COMPARED TO YEAR ENDED JANUARY 31, 1995 Net sales. Net sales for the year ended January 31, 1996 were $10,244,000, an increase of $2,653,000, or 35.0% over net sales for fiscal 1995 which were $7,591,000. Retail sales increased 33.1% to $8,879,000 in fiscal 1996 from $6,673,000 in fiscal 1995. The increase resulted from a combination of sales growth at existing locations and sales from new locations. Comparable fiscal 1996 over fiscal 1995 store sales for the seven stores opened prior to fiscal 1995 showed an increase of 10.2% primarily due to 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 19 22 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. 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. 20 23 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. 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. 21 24 General and administrative expenses. General and administrative expenses increased to $337,000 for the first quarter of fiscal 1997 from $277,000 for the first quarter of fiscal 1996. As a percentage of net sales, general and administrative expenses decreased to 7.9% from 13.4% due to the addition of the acquired stores sales in the revenue base. Management is currently adding selected resources and personnel to aid in the conversion and control of the new markets according to the integration plan established prior to the acquisitions. General and administrative expenses are not directly attributable to specific stores. Accordingly, no separate analysis of the general and administrative expenses excluding the Brothers Stores and Acquired Cafes is included here. Interest expense. Interest expense increased to $39,000 for the thirteen weeks ended May 1, 1996 from $15,000 for the twelve weeks ended April 25, 1995. The $24,000 increase was due primarily to higher average debt outstanding as a result of the acquisition of the Brothers Stores and Acquired Cafes. 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 22 25 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. 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." 23 26 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. 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. 24 27 Cost of sales and related occupancy costs. The historical Brothers Stores' cost of sales and related occupancy costs (64.6% of Brothers Stores' net sales) were combined with the Company's (43.0% of the Company's net sales) for a total of 47.1% of combined pro forma net sales. Store operating expenses. Store operating expenses were combined on a historical basis which blends the Company's expenses at 34.4% of its net sales with the Brothers Stores' expenses at 49.5% of its net sales for a total of 37.2% of combined pro forma net sales. Other operating expenses. Other operating expenses consist solely of the Company's expenses of operating the wholesale division for the year. Depreciation and amortization. Depreciation and amortization combines the historical expenses of the two operations with a net pro forma adjustment of $483,000 for a pro forma combined total of $498,000, or 4.0% of pro forma combined net sales. The net adjustment gives effect to (i) the difference in depreciation for the historical cost basis of the property and equipment for the Brothers Stores and the fair value of such assets, and (ii) the amortization of the cost in excess of net assets acquired. General and administrative expenses. General and administrative expenses comprise the combination of the historical amounts for the Company and Brothers Stores (13.0% and 19.0%, respectively, 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. 25 28 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. 26 29 Until the conversion of an acquired store is completed, it continues to operate under the predecessor company's name. The Company is in the process of converting each of the acquired stores to the Diedrich coffeehouse format. As of July 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. 27 30 BUSINESS STRATEGY The Company's objective is to become the leading high quality specialty coffee retailer in each market in which it operates. Each element of the Company's strategy is designed to differentiate and reinforce Diedrich Coffee's brand identity, to engender a high degree of customer loyalty and to position the Company as a leading specialty coffee retailer. The key elements of this strategy include: - High Quality, Guaranteed Fresh Roasted Coffee. The Company strives to deliver only high quality, freshly roasted coffee to its customers. Diedrich Coffee purchases premium grade arabica beans from throughout the world which are then roasted by the Company in accordance with the Company's standards and 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. 28 31 GROWTH STRATEGY The Company's growth strategy centers around its objective to sustain its high-growth rate through a strategy of internal growth, growth through acquisitions, strategic alliances and sales through other selected distribution channels. - Internal Growth. The Company will continue to seek new locations to build additional coffeehouses. In the current fiscal year, in addition to the nineteen stores recently acquired, the Company has opened 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 29 32 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. 30 33 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. 31 34 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 $275,000 per store or 26.4% 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. 32 35 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) 33 36 - --------------- (1) Does not include one of the Brothers Stores that, in accordance with management's initial evaluation at the time of the acquisition, was closed in July 1996. (2) Conversion to Diedrich coffeehouse format pending. (3) Conversion to Diedrich coffeehouse format completed. (4) The lease for this coffeehouse is presently under negotiation and the premises are not subject to a binding lease. International Development In July 1996, the Company entered into a Development Agreement (the "Development Agreement") with a Singapore company that specializes in assisting U.S. companies to establish a presence in Asia (the "Developer"). The Development Agreement grants the Developer the exclusive right to open and operate Diedrich coffeehouses in the countries of Singapore, Indonesia and Malaysia pursuant to a pre-negotiated form of franchise agreement. In return, the Developer agrees to develop at least thirty stores in these countries according to the following schedule: two stores by May 1, 1997, six stores by May 1, 1998, eleven stores by May 1, 1999, twenty-one stores by May 1, 2000 and thirty stores by May 1, 2001. The Company 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 34 37 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 35 38 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. 36 39 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. 37 40 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES The directors, executive officers and other key employees of the Company, and their ages as of July 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, 38 41 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. 39 42 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. 40 43 EXECUTIVE COMPENSATION Summary Compensation The following table sets forth all compensation awarded or paid by the Company during the fiscal year ended January 31, 1996 to its Chief Executive Officer and the Company's other executive officer (collectively, the "Named Executive Officers").
LONG TERM COMPENSATION AWARDS ANNUAL COMPENSATION ($) --------------------- ----------------------- SECURITIES UNDERLYING NAME AND PRINCIPAL POSITION SALARY OPTIONS(#) - --------------------------------------------------- ----------------------- --------------------- Martin R. Diedrich................................. $ 87,500 -- Chairman of the Board, Secretary and Director of Coffee Steven A. Lupinacci................................ $ 113,720 131,350 President, Chief Executive Officer, Chief Financial Officer and Director
Stock Option Grants in Last Fiscal Year The following table sets forth information regarding each grant of stock options made during the fiscal year ended January 31, 1996 to each of the Named Executive Officers. No stock appreciation rights 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 $3,557,111, respectively. The actual value realized may be greater or less than the potential realizable values set forth in the table. 41 44 Aggregated Stock Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table sets forth the number and value of the exercisable and unexercisable options held by each of the Named Executive Officers at January 31, 1996. None of the Named Executive Officers exercised any options during the fiscal year ended January 31, 1996.
NUMBER OF SECURITIES VALUES OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT FISCAL YEAR-END (#) FISCAL YEAR-END ($)(1) ------------------------------ ------------------------------ NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ------------------------------- ----------- ------------- ----------- ------------- Martin R. Diedrich............. -- -- -- -- Steven A. Lupinacci............ -- 131,350 -- $ 1,254,393
- --------------- (1) These values are calculated using the assumed initial public offering price of $11.00 per share, less the exercise price of the options. 1996 Stock Incentive Plan The Board of Directors has adopted the 1996 Stock Incentive Plan (the "Incentive Plan"). The purpose of the Incentive Plan is to promote the interests of the Company and its stockholders by using investment interests in the Company to attract, retain and motivate its management and other persons, to encourage and reward their contributions to the performance of the Company and to align their interests with the interests of the Company's stockholders. The Incentive Plan enables the Company to grant a variety of stock-based incentive awards, including incentive and nonstatutory stock options, restricted stock, stock appreciation rights, stock payments, dividend equivalents, stock bonuses, stock sales, phantom stock and other stock-based benefits. An award may consist of one such arrangement or benefit or two or more of them in tandem or in the alternative. A total of 475,000 shares have been reserved for issuance under the Incentive Plan. 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 42 45 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- 43 46 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, $3,000 and $16,000 in fiscal years 1996, 1995 and 1994, respectively. As of July 31, 1996, the Company had purchased approximately $30,000 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 44 47 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. 45 48 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. 46 49 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 47 50 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 48 51 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. 49 52 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. 50 53 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 51 54 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. 52 55 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 56 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 57 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 58 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 59 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 60 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 61 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 62 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 63 DIEDRICH COFFEE NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 2. INVENTORIES Inventories consist of the following:
JANUARY 31, ------------------------- MAY 1, 1995 1996 1996 ---------- ---------- ---------- (UNAUDITED) Unroasted coffee............................... $ 47,679 $ 128,369 $ 159,451 Roasted coffee................................. 20,214 24,274 69,939 Accessory and specialty items.................. 105,091 74,299 119,684 Other food, beverage and supplies.............. 127,119 418,551 500,557 ---------- ---------- ---------- $ 300,103 $ 645,493 $ 849,631 ========== ========== ==========
3. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
JANUARY 31, ------------------------- MAY 1, 1995 1996 1996 ---------- ---------- ---------- (UNAUDITED) Leasehold improvements......................... $1,017,649 $2,107,408 $3,072,007 Equipment...................................... 833,882 1,542,436 2,246,945 Furniture and fixtures......................... 414,174 772,936 1,242,390 Construction in progress....................... 96,382 609,305 1,102,603 ---------- ---------- ---------- 2,362,087 5,032,085 7,663,945 Accumulated depreciation and amortization...... (601,215) (931,187) (1,083,532) ---------- ---------- ---------- $1,760,872 $4,100,898 $6,580,413 ========== ========== ==========
F-9 64 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 65 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 66 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 67 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 68 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 69 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 70 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 On July 8, 1996, the Company entered into a letter of intent 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 71 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 72 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 73 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 74 ACQUIRED STORES OF BROTHERS GOURMET COFFEES, INC. STATEMENTS OF CASH FLOWS
INCEPTION FOUR WEEKS (JUNE 1, 1994) YEAR ENDED ENDED TO DECEMBER 30, DECEMBER 29, JANUARY 26, 1994 1995 1996 --------------- ----------- ----------- Cash flows from operating activities: Net loss.......................................... $ (111,009) $(1,406,068) $(103,853) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization.................. 40,770 626,758 56,174 Increase (decrease) from changes in: Accounts receivable.......................... (3,453) 2,127 (295) Inventories.................................. (76,703) 8,591 (4,122) Accrued compensation......................... 12,689 19,540 (1,514) Accrued expenses............................. 8,919 7,940 (14,334) Deferred rent................................ 12,342 34,058 1,982 ----------- ----------- --------- Cash used in operating activities................... (116,445) (707,054) (65,962) ----------- ----------- --------- Cash flows from investing activities: Capital expenditures for property and equipment... (2,278,266) (1,970,512) -- Other assets...................................... (38,483) (119,801) -- ----------- ----------- --------- Cash used in investing activities................... (2,316,749) (2,090,313) -- ----------- ----------- --------- Cash flows from financing activities: Increase in parent company investment............. 2,456,468 2,814,519 76,199 ----------- ----------- --------- Net increase in cash................................ 23,274 17,152 10,237 Cash at beginning of period......................... -- 23,274 40,426 ----------- ----------- --------- Cash at end of period............................... $ 23,274 $ 40,426 $ 50,663 =========== =========== =========
See accompanying notes to financial statements. F-20 75 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 76 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 77 DIEDRICH COFFEE PRO FORMA CONDENSED FINANCIAL STATEMENTS (UNAUDITED) On February 23, 1996, the Company acquired certain assets from Brothers Gourmet Coffees, Inc. ("Brothers"), which assets included 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 78 DIEDRICH COFFEE PRO FORMA CONDENSED BALANCE SHEET JANUARY 31, 1996 (UNAUDITED)
DIEDRICH ACQUIRED STORES COFFEE OF BROTHERS ADJUSTMENTS PRO FORMA ---------- --------------- ----------- ---------- ASSETS Current Assets: Cash................................ $ 94,659 $ 40,426 (40,426)(1) $ 94,659 Accounts receivable................. 134,573 1,326 (1,326)(1) 134,573 Inventories......................... 645,493 68,112 (68,112)(1) 645,493 Prepaid expenses and other current assets........................... 133,336 -- 133,336 ---------- ---------- ---------- Total current assets........ 1,008,061 109,864 1,008,061 Property and equipment, net........... 4,100,898 3,712,316 (2,887,316)(1) 4,925,898 Cost in excess of net assets acquired............................ -- -- 548,000(1) 548,000 Other assets.......................... 206,713 27,218 (27,218)(1) 216,713 10,000(1) ---------- ---------- ---------- $5,315,672 $3,849,398 $6,698,672 ========== ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt... $ 117,538 $ -- $ 117,538 Notes payable....................... 39,398 -- 675,000(1) 714,398 Obligation to seller for acquisition...................... -- -- 675,000(1) 675,000 Accounts payable.................... 635,428 -- 635,428 Accrued compensation................ 184,891 32,229 (32,229)(1) 184,891 Accrued expenses.................... 83,472 16,859 (16,859)(1) 116,472 33,000(1) ---------- ---------- ---------- Total current liabilities... 1,060,727 49,088 2,443,727 Long-term debt, less current portion............................. 829,320 -- 829,320 Deferred rent......................... 121,144 46,400 (46,400)(1) 121,144 ---------- ---------- ---------- Total liabilities........... 2,011,191 95,488 3,394,191 Stockholders' equity.................. 3,304,481 3,753,910 (3,753,910)(1) 3,304,481 ---------- ---------- ---------- $5,315,672 $3,849,398 $6,698,672 ========== ========== ==========
See accompanying notes to pro forma condensed financial statements. F-24 79 DIEDRICH COFFEE PRO FORMA CONDENSED STATEMENT OF OPERATIONS YEAR ENDED JANUARY 31, 1996 (UNAUDITED)
DIEDRICH ACQUIRED STORES COFFEE OF BROTHERS ADJUSTMENTS PRO FORMA ----------- --------------- ----------- ----------- Net sales........................... $10,244,175 $ 2,356,397 $12,600,572 Cost of sales and related occupancy costs............................. 4,409,485 1,522,674 5,932,159 Store operating expenses............ 3,520,140 1,165,727 4,685,867 Other operating expenses............ 276,788 -- 276,788 Depreciation and amortization....... 353,840 626,758 (482,658)(2) 497,940 General and administrative expenses(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: 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 80 DIEDRICH COFFEE NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. Pro forma adjustments to record the purchase of the Acquired Stores: Components of purchase price: Cash from borrowings under the Company's credit facility.................... $ 675,000 Obligation to seller upon satisfaction of certain conditions................ 675,000 ---------- Total purchase price.................................................. 1,350,000 Allocation of purchase price: Equity of the Acquired Stores............................................... (3,753,910) Elimination of assets and liabilities not acquired or assumed as part of the acquisition: Cash..................................................................... 40,426 Accounts receivable...................................................... 1,326 Inventories.............................................................. 68,112 Accrued compensation..................................................... (32,229) Accrued expenses......................................................... (16,859) Deferred rent............................................................ (46,400) Write-down of property and equipment to fair value.......................... 2,887,316 Write-off of capitalized pre-opening costs.................................. 27,218 Accrual for store to be closed.............................................. 33,000 Covenant not to compete..................................................... (10,000) ---------- Cost in excess of net assets acquired......................................... $ 548,000 ========= 2. Pro forma adjustment to adjust depreciation and amortization: Elimination of depreciation and amortization expense on assets of the Acquired Stores...................................................................... $ (626,758) Depreciation and amortization on new cost basis of property and equipment of the Acquired Stores......................................................... 107,600 Amortization of cost in excess of net assets acquired over 15 years........... 36,500 ---------- $ (482,658) ========= 3. Pro forma adjustment 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. 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.
F-26 81 [Photo of four packages of the Company's coffee, three Company beverage products and roasted coffee beans.] 82 - ------------------------------------------------------ - ------------------------------------------------------ NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER CONTAINED HEREIN, AND IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SHARES OF COMMON STOCK IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE ANY SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary.................... 3 Risk Factors.......................... 7 Use of Proceeds....................... 12 Dividend Policy....................... 12 Capitalization........................ 13 Dilution.............................. 14 Selected Financial Data............... 15 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 17 Business.............................. 26 Management............................ 38 Certain Transactions.................. 44 Principal and Selling Stockholders.... 46 Description of Capital Stock.......... 47 Shares Eligible for Future Sale....... 48 Underwriting.......................... 50 Legal Matters......................... 52 Experts............................... 52 Additional Information................ 52 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 - ------------------------------------------------------ - ------------------------------------------------------ 83 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...................................... * Legal fees and expenses........................................... * Transfer Agent and registrar fees................................. * Printing and engraving expenses................................... * Officers and directors insurance.................................. * Representative's nonaccountable expense allowance................. * Miscellaneous..................................................... * ---------- Total................................................... $ * ==========
- --------------- * To be provided by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS As of the consummation of this Offering, Diedrich Coffee, Inc. (the "Company") shall be a Delaware corporation. Article VII of the Company's Bylaws provides that the Company may indemnify its officers and directors to the full extent permitted by law. Section 145 of the General Corporation Law of the State of Delaware (the "GCL") provides that a Delaware corporation has the power to indemnify its officers and directors in certain circumstances. Subsection (a) of Section 145 of the GCL empowers a corporation to indemnify any director or officer, or former director or officer, who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation), against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred in connection with such action, suit or proceeding provided that such director or officer acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, provided that such director or officer had no cause to believe his or her conduct was unlawful. Subsection (b) of Section 145 of the GCL empowers a corporation to indemnify any director or officer, or former director or officer, who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person acted in any of the capacities set forth above, against expenses actually and reasonably incurred in connection with the defense or settlement of such action or suit provided that such director or officer acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the corporation, except that no indemnification may be made in respect of any claim, issue or matter as to which such director or officer shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action was brought shall determine II-1 84 that despite the adjudication of liability such director or officer is fairly and reasonably entitled to indemnity for such expenses which the court shall deem proper. Section 145 of the GCL further provides that to the extent a director or officer of a corporation has been successful in the defense of any action, suit or proceeding referred to in subsections (a) and (b) or in the defense of any claim, issue or matter therein, he or she shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him or her in connection therewith; that indemnification provided for in Section 145 shall not be deemed exclusive of any other rights to which the indemnified party may be entitled; and that the corporation shall have power to purchase and maintain insurance on behalf of a director or officer of the corporation against any liability asserted against him or her or incurred by him or her in any such capacity or arising out of his or her status as such whether or not the corporation would have the power to indemnify him or her against such liabilities under Section 145. Article VII of the Company's Certificate of Incorporation currently provides that each Director shall not be personally liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Directors' duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the GCL, or (iv) for any transaction from which the Director derived an improper benefit. Reference is made to the Form of Underwriting Agreement (which will be filed as Exhibit 1.1 to this Registration Statement) which provides for indemnification by the Underwriters under certain circumstances of the directors and officers of the Company signing the Registration Statement and certain controlling persons of the Company against certain liabilities, including those arising under the Securities Act. The Company intends to carry directors' and officers' liability insurance covering its directors and officers. Insofar as indemnification for liabilities under the Securities Act may be permitted to directors, officers or persons controlling the Registrant pursuant to the foregoing provisions, the Registrant has been informed that, in the opinion of the Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES On 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 85 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 3.1 Certificate of Incorporation of the Company 3.2 Bylaws of the Company 4.1 Purchase Agreement for Series A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee, Martin R. Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P.(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 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 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 86
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* 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 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. (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 87 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Amendment No. 3 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 August 28, 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. 3 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 August 28, 1996 - ----------------------------------- Director of Coffee Martin R. Diedrich /s/ STEVEN A. LUPINACCI President, Chief Executive Officer, August 28, 1996 - ----------------------------------- Chief Financial Officer and Director Steven A. Lupinacci (Principal Executive Officer and Principal Financial Officer) * Controller (Principal Accounting August 28, 1996 - ----------------------------------- Officer) Edwin P. Ott * Director August 28, 1996 - ----------------------------------- Paul C. Heeschen *By: /s/ STEVEN A. LUPINACCI - ----------------------------------- Steven A. Lupinacci Attorney-in-Fact
II-5 88 EXHIBIT INDEX
SEQUENTIALLY EXHIBIT NUMBERED NO. DESCRIPTION PAGES - ------------ -------------------------------------------------------------------- ------------- 1.1 Form of Underwriting Agreement* 2.1 Form of Agreement and Plan of Merger 3.1 Certificate of Incorporation of the Company 3.2 Bylaws of the Company 4.1 Purchase Agreement for Series A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee, Martin R. Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P.(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 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 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* 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 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. EX-2.1 2 FORM OF AGREEMENT AND PLAN OF MERGER 1 EXHIBIT 2.1 AGREEMENT AND PLAN OF MERGER This AGREEMENT AND PLAN OF MERGER (hereinafter called the "Merger Agreement") is made as of ___________ ___, 1996, by and between Diedrich Coffee, a California corporation ("Diedrich California"), and Diedrich Coffee, Inc., a Delaware corporation ("Diedrich Delaware"). Diedrich California and Diedrich Delaware are sometimes referred to as the "Constituent Corporations." The authorized capital stock of Diedrich California consists of four million twenty one thousand four hundred thirty-seven (4,021,437) shares of Common Stock, no par value and two million six hundred eight thousand five hundred sixty-eight (2,608,568) shares of Preferred Stock, no par value. The authorized capital stock of Diedrich Delaware consists of twenty-eight million (28,000,000) shares of Common Stock, $.01 par value per share, and three million (3,000,000) shares of Preferred Stock, $.01 par value per share. The directors of the Constituent Corporations deem it advisable and to the advantage of said corporations that Diedrich California merge with and into Diedrich Delaware upon the terms and conditions herein provided. NOW, THEREFORE, the parties do hereby adopt the plan of reorganization encompassed by this Merger Agreement and do hereby agree that Diedrich California shall merge with and into Diedrich Delaware on the following terms, conditions and other provisions: 1. TERMS AND CONDITIONS 1.1 MERGER. Diedrich California shall be merged with and into Diedrich Delaware (the "Merger"), and Diedrich Delaware shall be the surviving corporation (the "Surviving Corporation") effective at _____ p.m. (Eastern Time) on ____________ ___,1996 (the "Effective Time"). 1.2 SUCCESSION. At the Effective Time, Diedrich Delaware shall continue its corporate existence under the laws of the State of Delaware, and the separate existence and corporate organization of Diedrich California, except insofar as it may be continued by operation of law, shall be terminated and cease. 1.3 TRANSFER OF ASSETS AND LIABILITIES. At the Effective Time, the rights, privileges, powers and franchises, both of a public as well as of a private nature, of each of the Constituent Corporations shall be vested in and possessed by the Surviving Corporation, subject to all of the disabilities, duties and restrictions of or upon each of the Constituent Corporations; and all and singular rights, privileges, powers and franchises of each of the Constituent Corporations, and all property, real, personal and mixed, of each of the Constituent Corporations, and all debts due to each of the Constituent Corporations on whatever account, and all things in action or belonging to each of the Constituent Corporations shall be transferred to and vested in the Surviving Corporation; and all property, rights, privileges, powers and franchises, and all and every other interest, shall be thereafter the property of the Surviving Corporation as they were of the 2 Constituent Corporations, and the title to any real estate vested by deed or otherwise in either of the Constituent Corporations shall not revert or be in any way impaired by reason of the Merger; provided, however, that the liabilities of the Constituent Corporations and of their shareholders, directors and officers shall not be affected and all rights of creditors and all liens upon any property of either of the Constituent Corporations shall be preserved unimpaired, and any claim existing or action or proceeding pending by or against either of the Constituent Corporations may be prosecuted to judgment as if the Merger had not taken place except as they may be modified with the consent of such creditors and all debts, liabilities and duties of or upon each of the Constituent Corporations shall attach to the Surviving Corporation, and may be enforced against it to the same extent as if such debts, liabilities and duties had been incurred or contracted by it. 1.4 COMMON STOCK OF DIEDRICH CALIFORNIA AND DIEDRICH DELAWARE. At the Effective Time, by virtue of the Merger and without any further action on the part of the Constituent Corporations or their shareholders, (i) each share of Common Stock of Diedrich California issued and outstanding immediately prior thereto shall be changed and converted into one fully paid and nonassessable share of Common Stock of Diedrich Delaware; and (ii) each share of Common Stock of Diedrich Delaware issued and outstanding immediately prior thereto shall be canceled and returned to the status of authorized but unissued shares. 1.5 STOCK CERTIFICATES. At and after the Effective Time, all of the outstanding certificates which prior to that time represented shares of the Common Stock of Diedrich California shall be deemed for all purposes to evidence ownership of and to represent the shares of Diedrich Delaware into which the shares of Diedrich California represented by such certificates have been converted as herein provided and shall be so registered on the books and records of the Surviving Corporation or its transfer agents. The registered owner of any such outstanding stock certificate shall, until such certificate shall have been surrendered for transfer or conversion or otherwise accounted for to the Surviving Corporation or its transfer agent, have and be entitled to exercise any voting and other rights with respect to and to receive any dividend and other distributions upon the shares of Diedrich Delaware evidenced by such outstanding certificate as above provided. 1.6 OPTIONS OF DIEDRICH CALIFORNIA. At the Effective Time, the Surviving Corporation will assume and continue all of Diedrich California's stock option plans in existence at the Effective Time, including but not limited to the 1996 Stock Incentive Plan, the 1996 Non-Employee Directors Stock Option Plan, the Stock Option Plan and Agreement of Steven A. Lupinacci and the outstanding and unexercised portions of all options to purchase Common Stock of Diedrich California, including without limitation all options outstanding under such stock option plans and any other outstanding options, shall become options to purchase the same number of shares of Common Stock of Diedrich Delaware, with no other changes in the terms and conditions of such options. Effective at the Effective Time, Diedrich Delaware hereby assumes the outstanding and unexercised portions of such options and the obligations of Diedrich California with respect thereto. 1.7 EMPLOYEE BENEFIT PLANS. At the Effective Time, the Surviving Corporation shall assume all obligations of Diedrich California under any and all employee benefit plans in effect as of the Effective Time with respect to which employee rights or accrued benefits are outstanding 2 3 as of such time, provided, however, that one share of Common Stock of Diedrich Delaware shall be substituted for each share of Common Stock of Diedrich California (if any) thereunder. At the Effective Time, the Surviving Corporation shall adopt and continue in effect all such employee benefit plans upon the same terms and conditions as were in effect immediately prior to the Merger and shall reserve that number of shares of Diedrich Delaware Common Stock with respect to each such employee benefit plan as is equal to the number of shares of Diedrich California Common Stock (if any) so reserved at the Effective Time. 2. CHARTER DOCUMENTS, DIRECTORS AND OFFICERS 2.1 CERTIFICATE OF INCORPORATION AND BYLAWS. The Certificate of Incorporation and Bylaws of Diedrich Delaware in effect at the Effective Time shall continue to be the Certificate of Incorporation and Bylaws of the Surviving Corporation. 2.2 DIRECTORS. The directors of Diedrich Delaware elected by the sole incorporator shall become the directors of the Surviving Corporation at and after the Effective Time to serve until the expiration of their terms and until their successors are elected and qualified. 2.3 OFFICERS. The officers elected by the directors of Diedrich Delaware shall become the officers of the Surviving Corporation at and after the Effective Time to serve at the pleasure of its Board of Directors. 3. MISCELLANEOUS 3.1 FURTHER ASSURANCES. From time to time, and when required by the Surviving Corporation or by its successors and assigns, there shall be executed and delivered on behalf of Diedrich California such deeds and other instruments, and there shall be taken or caused to be taken by it such further and other action, as shall be appropriate or necessary in order to vest or perfect in or to conform of record or otherwise, in the Surviving Corporation the title to and possession of all the property, interests, assets, rights, privileges, immunities, powers, franchises and authority of Diedrich California and otherwise to carry out the purposes of this Merger Agreement, and the officers and directors of the Surviving Corporation are fully authorized in the name and on behalf of Diedrich California or otherwise to take any and all such action and to execute and deliver any and all such deeds and other instruments. 3.2 AMENDMENT. At any time before or after approval by the shareholders of Diedrich California, this Merger Agreement may be amended in any manner (except that, after the approval of the Merger Agreement by the shareholders of Diedrich California, the principal terms may not be amended without the further approval of the shareholders of Diedrich California) as may be determined in the judgment of the respective Board of Directors of Diedrich Delaware and Diedrich California to be necessary, desirable, or expedient in order to clarify the intention of the parties hereto or to effect or facilitate the purpose and intent of this Merger Agreement. 3.3 CONDITIONS TO MERGER. The obligation of the Constituent Corporations to effect the transactions contemplated hereby is subject to satisfaction of the following conditions (any or 3 4 all of which may be waived by either of the Constituent Corporations in its sole discretion to the extent permitted by law): (a) the Merger shall have been approved by the shareholders of Diedrich California in accordance with applicable provisions of the General Corporation Law of the State of California; and (b) Diedrich California, as sole stockholder of Diedrich Delaware, shall have approved the Merger in accordance with the General Corporation Law of the State of Delaware; and (c) any and all consents, permits, authorizations, approvals, and orders deemed in the sole discretion of Diedrich California to be material to the consummation of the Merger shall have been obtained. 3.4 ABANDONMENT OR DEFERRAL. At any time before the Effective Time, this Merger Agreement may be terminated and the Merger may be abandoned by the Board of Directors of either Diedrich California or Diedrich Delaware or both, notwithstanding the approval of this Merger Agreement by the shareholders of Diedrich California or Diedrich Delaware or the prior filing of this Merger Agreement with the Secretary of State of the State of Delaware, or the consummation of the Merger may be deferred for a reasonable period of time if, in the opinion of the Boards of Directors of Diedrich California and Diedrich Delaware, such action would be in the best interest of such corporations. In the event of termination of this Merger Agreement, this Merger Agreement shall become void and of no effect and there shall be no liability on the part of either Constituent Corporation or its Board of Directors or shareholders with respect thereto, except that Diedrich California shall pay all expenses incurred in connection with the Merger or in respect of this Merger Agreement or relating thereto. 3.5 COUNTERPARTS. In order to facilitate the filing and recording of this Merger Agreement, the same may be executed in any number of counterparts, each of which shall be deemed to be an original. 4 5 IN WITNESS WHEREOF, this Merger Agreement, having first been fully approved by the Board of Directors of Diedrich California and Diedrich Delaware, is hereby executed on behalf of each said corporation and attested by their respective officers thereunto duly authorized. DIEDRICH COFFEE, a California corporation By: --------------------------------------- Its: -------------------------------------- ATTEST: - ------------------------------- - ------------------------------- Secretary DIEDRICH COFFEE, INC. a Delaware corporation By: --------------------------------------- Its: -------------------------------------- ATTEST: - ------------------------------- - ------------------------------- Secretary 5 EX-3.1 3 CERIFICATE OF INCORPORATION OF THE COMPANY 1 EXHIBIT 3.1 CERTIFICATE OF INCORPORATION OF DIEDRICH COFFEE, INC. ARTICLE I NAME OF CORPORATION The name of this corporation is DIEDRICH COFFEE, INC. ARTICLE II REGISTERED OFFICE The address of the registered office of the corporation in the State of Delaware is 9 East Loockerman Street, in the City of Dover, County of Kent, and the name of its registered agent at that address is National Registered Agents, Inc. ARTICLE III PURPOSE The purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. ARTICLE IV AUTHORIZED CAPITAL STOCK The corporation is authorized to issue two classes of shares of stock to be designated, respectively, "Common" and "Preferred"; the total number of such shares shall be twenty eight million (28,000,000); the total number of Common shares shall be twenty five million (25,000,000), each having a par value of one cent ($.01); and the total number of Preferred shares shall be three million (3,000,000), each having a par value of one cent ($.01). The Preferred shares may be issued from time to time in one or more series. The Board of Directors is hereby vested with authority to fix by resolution or resolutions the designations and the powers, preferences and 2 relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, including without limitation, the dividend rate, conversion rights, redemption price and liquidation preference, of any series of Preferred shares, and to fix the number of shares constituting any such series, and to increase or decrease the number of shares of any such series (but not below the number of shares thereof then outstanding). In case the number of shares of any such series shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution or resolutions originally fixing the number of shares of such series. ARTICLE V INCORPORATOR The name and mailing address of the incorporator of the corporation is: Steven A. Lupinacci 2144 Michelson Drive Irvine, California 92612 ARTICLE VI BOARD POWER REGARDING BYLAWS In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to make, repeal, alter, amend and rescind the bylaws of the corporation. ARTICLE VII ELECTION OF DIRECTORS Elections of directors need not be by written ballot unless the bylaws of the corporation shall so provide. ARTICLE VIII LIMITATION OF DIRECTOR LIABILITY To the fullest extent permitted by the Delaware General Corporation Law as the same exists or may hereafter be amended, a director of the corporation shall not be liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. If the Delaware General Corporation Law is amended after the date of the filing of this Certificate of Incorporation to authorize corporate action further eliminating or limiting 2 3 the personal liability of directors, then the liability of a director of the corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended from time to time. No repeal or modification of this Article VIII by the stockholders shall adversely affect any right or protection of a director of the corporation existing by virtue of this Article VIII at the time of such repeal or modification. ARTICLE IX CORPORATE POWER The corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred on stockholders herein are granted subject to this reservation. ARTICLE X CREDITOR COMPROMISE OR ARRANGEMENT Whenever a compromise or arrangement is proposed between this corporation and its creditors or any class of them and/or between this corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for this corporation under the provisions of Section 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for this corporation under the provisions of Section 279 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this corporation as a consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of this corporation, as the case may be, and also on this corporation. 3 4 THE UNDERSIGNED, being the incorporator hereinbefore named, for the purpose of forming a corporation to do business both within and without the State of Delaware, and in pursuance of the Delaware General Corporation Law, does make and file this Certificate. ------------------------------------ Steven A. Lupinacci 4 EX-3.2 4 BYLAWS OF THE COMPANY 1 EXHIBIT 3.2 DIEDRICH COFFEE, INC. (a Delaware corporation) BYLAWS ARTICLE I Offices SECTION 1.01 Registered Office. The registered office of Diedrich Coffee, Inc. (the "Corporation") in the State of Delaware shall be 9 East Loockerman Street, City of Dover, County of Kent, and the name of the registered agent in charge thereof shall be National Registered Agents, Inc. SECTION 1.02 Other Offices. The Corporation may also have an office or offices at such other place or places, either within or without the State of Delaware, as the Board of Directors (the "Board") may from time to time determine or as the business of the Corporation may require. ARTICLE II Meetings of Stockholders SECTION 2.01 Annual Meetings. Annual meetings of the stockholders of the Corporation for the purpose of electing directors and for the transaction of such other proper business as may come before such meetings may be held at such time, date and place as the Board shall determine by resolution. SECTION 2.02 Special Meetings. A special meeting of the stockholders for the transaction of any proper business may be called at any time by the Board or by the President. SECTION 2.03 Place of Meetings. All meetings of the stockholders shall be held at such places, within or without the State of Delaware, as may from time to time be designated by the person or persons calling the respective meeting and specified in the respective notices or waivers of notice thereof. SECTION 2.04 Notice of Meetings. Except as otherwise required by law, notice of each meeting of the stockholders, whether annual or special, shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder of record entitled to vote at such meeting by delivering a typewritten or printed notice thereof to him personally, or by depositing such notice in the United States mail, in a postage prepaid envelope, directed to him at his post office address furnished by him to the Secretary of the Corporation for such purpose or, if he shall not have furnished to the Secretary his address for such purpose, then at his post office address last known to the Secretary, or by transmitting a notice thereof to him at such address by telegraph, cable or wireless. Except as otherwise 2 expressly required by law, no publication of any notice of a meeting of the stockholders shall be required. Every notice of a meeting of the stockholders shall state the place, date and hour of the meeting, and, in the case of a special meeting, shall also state the purpose or purposes for which the meeting is called. Notice of any meeting of stockholders shall not be required to be given to any stockholder who shall have waived such notice and such notice shall be deemed waived by any stockholder who shall attend such meeting in person or by proxy, except as a stockholder who shall attend such meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Except as otherwise expressly required by law, notice of any adjourned meeting of the stockholders need not be given if the time and place thereof are announced at the meeting at which the adjournment is taken. SECTION 2.05 Quorum. Except in the case of any meeting for the election of directors summarily ordered as provided by law, the holders of record of a majority in voting interest of the shares of stock of the Corporation entitled to be voted thereat, present in person or by proxy, shall constitute a quorum for the transaction of business at any meeting of the stockholders of the Corporation or any adjournment thereof. In the absence of a quorum at any meeting or any adjournment thereof, a majority in voting interest of the stockholders present in person or by proxy and entitled to vote thereat or, in the absence therefrom of all the stockholders, any officer entitled to preside at, or to act as secretary of, such meeting may adjourn such meeting from time to time. At any such adjourned meeting at which a quorum is present any business may be transacted which might have been transacted at the meeting as originally called. SECTION 2.06 Voting. (a) Each stockholder shall, at each meeting of the stockholders, be entitled to vote in person or by proxy each share or fractional share of the stock of the Corporation having voting rights on the matter in question and which shall have been held by him and registered in his name on the books of the Corporation: (i) on the date fixed pursuant to Section 6.05 of these Bylaws as the record date for the determination of stockholders entitled to notice of and to vote at such meeting, or (ii) if no such record date shall have been so fixed, then (a) at the close of business on the day next preceding the day on which notice of the meeting shall be given or (b) if notice of the meeting shall be waived, at the close of business on the day next preceding the day on which the meeting shall be held. (b) Shares of its own stock belonging to the Corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors in such other corporation is held, directly or indirectly, by the Corporation, shall neither be entitled to vote nor be counted for quorum purposes. Persons holding stock of the Corporation in a fiduciary capacity shall be entitled to vote such stock. Persons whose stock is pledged shall be entitled 2 3 to vote, unless in the transfer by the pledgor on the books of the Corporation he shall have expressly empowered the pledgee to vote thereon, in which case only the pledgee, or his proxy, may represent such stock and vote thereon. Stock having voting power standing of record in the names of two or more persons, whether fiduciaries, members of a partnership, joint tenants in common, tenants by entirety or otherwise, or with respect to which two or more persons have the same fiduciary relationship, shall be voted in accordance with the provisions of the General Corporation Law of the State of Delaware. (c) Any such voting rights may be exercised by the stockholder entitled thereto in person or by his proxy appointed by an instrument in writing, subscribed by such stockholder or by his attorney thereunto authorized and delivered to the secretary of the meeting; provided, however, that no proxy shall be voted or acted upon after three years from its date unless said proxy shall provide for a longer period. The attendance at any meeting of a stockholder who may theretofore have given a proxy shall not have the effect of revoking the same unless he shall in writing so notify the secretary of the meeting prior to the voting of the proxy. At any meeting of the stockholders all matters, except as otherwise provided in the Certificate of Incorporation, in these Bylaws or by law, shall be decided by the vote of a majority in voting interest of the stockholders present in person or by proxy and entitled to vote thereat and thereon, a quorum being present. The vote at any meeting of the stockholders on any question need not be by ballot, unless so directed by the chairman of the meeting. On a vote by ballot each ballot shall be signed by the stockholder voting, or by his proxy, if there be such proxy, and it shall state the number of shares voted. SECTION 2.07 List of Stockholders. The Secretary of the Corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. SECTION 2.08 Judges. If at any meeting of the stockholders a vote by written ballot shall be taken on any question, the chairman of such meeting may appoint a judge or judges to act with respect to such vote. Each judge so appointed shall first subscribe an oath faithfully to execute the duties of a judge at such meeting with strict impartiality and according to the best of his ability. Such judges shall decide upon the qualification of the voters and shall report the number of shares represented at the meeting and entitled to vote on such question, shall conduct and accept the votes, and, when the voting is completed, shall ascertain and report the number of shares voted respectively for and against the question. Reports of judges shall be in writing and subscribed and delivered by them to the Secretary of the Corporation. The judges need not be stockholders of the Corporation, and any officer 3 4 of the Corporation may be a judge on any question other than a vote for or against a proposal in which he shall have a material interest. SECTION 2.09 Action Without Meeting. Any action required to be taken at any annual or special meeting of stockholders of the Corporation, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. ARTICLE III Board of Directors SECTION 3.01 General Powers. The property, business and affairs of the Corporation shall be managed by the Board. SECTION 3.02 Number and Term of Office. The number of directors of the Corporation shall be not less than three (3) nor more than seven (7), until changed in accordance with applicable law. The exact number of directors shall be fixed from time to time, within the limits specified, by resolution of the board of directors or stockholders. Subject to the foregoing provisions for changing the exact number of directors, the number of directors of this Corporation shall initially be five (5). Directors need not be stockholders. Each of the directors of the Corporation shall hold office until his successor shall have been duly elected and shall qualify or until he shall resign or shall have been removed in the manner hereinafter provided. SECTION 3.03 Election of Directors. The directors shall be elected annually by the stockholders of the Corporation and the persons receiving the greatest number of votes, up to the number of directors to be elected, shall be the directors. SECTION 3.04 Resignations. Any director of the Corporation may resign at any time by giving written notice to the Board or to the Secretary of the Corporation. Any such resignation shall take effect at the time specified therein, or, if the time be not specified, it shall take effect immediately upon its receipt; and unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. SECTION 3.05 Vacancies. Except as otherwise provided in the Certificate of Incorporation, any vacancy in the Board, whether because of death, resignation, disqualification, an increase in the number of directors, or any other cause, may be filled by vote of the majority of the remaining directors, although less than a quorum. Each director so chosen to fill a vacancy shall hold office until his successor shall have been elected and shall qualify or until he shall resign or shall have been removed in the manner hereinafter provided. 4 5 SECTION 3.06 Place of Meeting, Etc. The Board may hold any of its meetings at such place or places within or without the State of Delaware as the Board may from time to time by resolution designate or as shall be designated by the person or persons calling the meeting or in the notice or a waiver of notice of any such meeting. Directors may participate in any regular or special meeting of the Board by means of conference telephone or similar communications equipment pursuant to which all persons participating in the meeting of the Board can hear each other, and such participation shall constitute presence in person at such meeting. SECTION 3.07 First Meeting. The Board shall meet as soon as practicable after each annual election of directors and notice of such first meeting shall not be required. SECTION 3.08 Regular Meetings. Regular meetings of the Board may be held at such times as the Board shall from time to time by resolution determine. If any day fixed for a regular meeting shall be a legal holiday at the place where the meeting is to be held, then the meeting shall be held at the same hour and place on the next succeeding business day not a legal holiday. Except as provided by law, notice of regular meetings need not be given. SECTION 3.09 Special Meetings. Special meetings of the Board shall be held whenever called by the President or a majority of the authorized number of directors. Except as otherwise provided by law or by these Bylaws, notice of the time and place of each such special meeting shall be mailed to each director, addressed to him at his residence or usual place of business, at least five (5) days before the day on which the meeting is to be held, or shall be sent to him at such place by telegraph or cable or be delivered personally not less than forty-eight (48) hours before the time at which the meeting is to be held. Except where otherwise required by law or by these Bylaws, notice of the purpose of a special meeting need not be given. Notice of any meeting of the Board shall not be required to be given to any director who is present at such meeting, except a director who shall attend such meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. SECTION 3.10 Quorum and Manner of Acting. Except as otherwise provided in these Bylaws or by law, the presence of a majority of the authorized number of directors shall be required to constitute a quorum for the transaction of business at any meeting of the Board, and all matters shall be decided at any such meeting, a quorum being present, by the affirmative votes of a majority of the directors present. In the absence of a quorum, a majority of directors present at any meeting may adjourn the same from time to time until a quorum shall be present. Notice of any adjourned meeting need not be given. The directors shall act only as a Board, and the individual directors shall have no power as such. SECTION 3.11 Action by Consent. Any action required or permitted to be taken at any meeting of the Board or of any committee thereof may be taken without a meeting if a written consent thereto is signed by all members of the Board or of such 5 6 committee, as the case may be, and such written consent is filed with the minutes of proceedings of the Board or committee. SECTION 3.12 Removal of Directors. Subject to the provisions of the Certificate of Incorporation, any director may be removed at any time, either with or without cause, by the affirmative vote of the stockholders having a majority of the voting power of the Corporation given at a special meeting of the stockholders called for such purpose. SECTION 3.13 Compensation. The directors shall receive only such compensation for their services as directors as may be allowed by resolution of the Board. The Board may also provide that the Corporation shall reimburse each such director for any expense incurred by him on account of his attendance at any meetings of the Board or Committees of the Board. Neither the payment of such compensation nor the reimbursement of such expenses shall be construed to preclude any director from serving the Corporation or its subsidiaries in any other capacity and receiving compensation therefor. SECTION 3.14 Committees. The Board may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of one or more of the directors of the Corporation. Any such committee, to the extent provided in the resolution of the Board and except as otherwise limited by law, shall have and may exercise all the powers and authority of the Board in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it. Any such committee shall keep written minutes of its meetings and report the same to the Board at the next regular meeting of the Board. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board to act at the meeting in the place of any such absent or disqualified member. ARTICLE IV Officers SECTION 4.01 Number. The officers of the Corporation shall be a President, one or more Vice Presidents (the number thereof and their respective titles to be determined by the Board), a Secretary and a Chief Financial Officer. SECTION 4.02 Election, Term of Office and Qualifications. The officers of the Corporation, except such officers as may be appointed in accordance with Section 4.03, shall be elected annually by the Board at the first meeting thereof held after the election thereof. Each officer shall hold office until his successor shall have been duly chosen and shall qualify or until his resignation or removal in the manner hereinafter provided. SECTION 4.03 Assistants, Agents and Employees, Etc. In addition to the officers specified in Section 4.01, the Board may appoint other assistants, agents and employees as it may deem necessary or advisable, each of whom shall hold office for such 6 7 period, have such authority, and perform such duties as the Board may from time to time determine. The Board may delegate to any officer of the Corporation or any committee of the Board the power to appoint, remove and prescribe the duties of any such assistants, agents or employees. SECTION 4.04 Removal. Any officer, assistant, agent or employee of the Corporation may be removed, with or without cause, at any time: (i) in the case of an officer, assistant, agent or employee appointed by the Board, only by resolution of the Board; and (ii) in the case of an officer, assistant, agent or employee, by any officer of the Corporation or committee of the Board upon whom or which such power of removal may be conferred by the Board. SECTION 4.05 Resignations. Any officer or assistant may resign at any time by giving written notice of his resignation to the Board or the Secretary of the Corporation. Any such resignation shall take effect at the time specified therein, or, if the time be not specified, upon receipt thereof by the Board or the Secretary, as the case may be; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. SECTION 4.06 Vacancies. A vacancy in any office because of death, resignation, removal, disqualification, or other cause, may be filled for the unexpired portion of the term thereof in the manner prescribed in these Bylaws for regular appointments or elections to such office. SECTION 4.07 The President. The President of the Corporation shall be the chief executive officer of the Corporation and shall have, subject to the control of the Board, general and active supervision and management over the business of the Corporation and over its several officers, assistants, agents and employees. SECTION 4.08 The Vice Presidents. Each Vice President shall have such powers and perform such duties as the Board may from time to time prescribe. At the request of the President, or in case of the President's absence or inability to act upon the request of the Board, a Vice President shall perform the duties of the President and when so acting, shall have all the powers of, and be subject to all the restrictions upon, the President. SECTION 4.09 The Secretary. The Secretary shall, if present, record the proceedings of all meetings of the Board, of the stockholders, and of all committees of which a secretary shall not have been appointed in one or more books provided for that purpose; he shall see that all notices are duly given in accordance with these Bylaws and as required by law; he shall be custodian of the seal of the Corporation and shall affix and attest the seal to all documents to be executed on behalf of the Corporation under its seal; and, in general, he shall perform all the duties incident to the office of Secretary and such other duties as may from time to time be assigned to him by the Board. SECTION 4.10 The Chief Financial Officer. The Chief Financial Officer shall have the general care and custody of the funds and securities of the Corporation, and 7 8 shall deposit all such funds in the name of the Corporation in such banks, trust companies or other depositories as shall be selected by the Board. He shall receive, and give receipts for, moneys due and payable to the Corporation from any source whatsoever. He shall exercise general supervision over expenditures and disbursements made by officers, agents and employees of the Corporation and the preparation of such records and reports in connection therewith as may be necessary or desirable. He shall, in general, perform all other duties incident to the office of Chief Financial Officer and such other duties as from time to time may be assigned to him by the Board. SECTION 4.11 Compensation. The compensation of the officers of the Corporation shall be fixed from time to time by the Board. None of such officers shall be prevented from receiving such compensation by reason of the fact that he is also a director of the Corporation. Nothing contained herein shall preclude any officer from serving the Corporation, or any subsidiary corporation, in any other capacity and receiving such compensation by reason of the fact that he is also a director of the Corporation. Nothing contained herein shall preclude any officer from serving the Corporation, or any subsidiary corporation, in any other capacity and receiving proper compensation therefor. ARTICLE V Contracts, Checks, Drafts, Bank Accounts, Etc. SECTION 5.01 Execution of Contracts. The Board, except as in these Bylaws otherwise provided, may authorize any officer or officers, agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances; and unless so authorized by the Board or by these Bylaws, no officer, agent or employee shall have any power or authority to bind the Corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or in any amount. SECTION 5.02 Checks, Drafts, Etc. All checks, drafts or other orders for payment of money, notes or other evidence of indebtedness, issued in the name of or payable to the Corporation, shall be signed or endorsed by such person or persons and in such manner as, from time to time, shall be determined by resolution of the Board. Each such officer, assistant, agent or attorney shall give such bond, if any, as the Board may require. SECTION 5.03 Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board may select, or as may be selected by any officer or officers, assistant or assistants, agent or agents, or attorney or attorneys of the Corporation to whom such power shall have been delegated by the Board. For the purpose of deposit and for the purpose of collection for the account of the Corporation, the President, any Vice President or the Chief Financial Officer (or any other officer or officers, assistant or assistants, agent or agents, or attorney or attorneys of the Corporation who shall from time to time be determined by the Board) may endorse, assign and deliver checks, drafts and other orders for the payment of money which are payable to the order of the Corporation. 8 9 SECTION 5.04 General and Special Bank Accounts. The Board may from time to time authorize the opening and keeping of general and special bank accounts with such banks, trust companies or other depositories as the Board may select or as may be selected by any officer or officers, assistant or assistants, agent or agents, or attorney or attorneys of the Corporation to whom such power shall have been delegated by the Board. The Board may make such special rules and regulations with respect to such bank accounts, not inconsistent with the provisions of these Bylaws, as it may deem expedient. ARTICLE VI Shares and Their Transfer SECTION 6.01 Certificates for Stock. Every owner of stock of the Corporation shall be entitled to have a certificate or certificates, to be in such form as the Board shall prescribe, certifying the number and class of shares of the stock of the Corporation owned by him. The certificates representing shares of such stock shall be numbered in the order in which they shall be issued and shall be signed in the name of the Corporation by the President or a Vice President, and by the Secretary or an Assistant Secretary or by the Chief Financial Officer. Any of or all of the signatures on the certificates may be a facsimile. In case any officer, transfer agent or registrar who has signed, or whose facsimile signature has been placed upon, any such certificate, shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, such certificate may nevertheless be issued by the Corporation with the same effect as though the person who signed such certificate, or whose facsimile signature shall have been placed thereupon, were such officer, transfer agent or registrar at the date of issue. A record shall be kept of the respective names of the persons, firms or corporations owning the stock represented by such certificates, the number and class of shares represented by such certificates, respectively, and the respective dates thereof, and in case of cancellation, the respective dates of cancellation. Every certificate surrendered to the Corporation for exchange or transfer shall be cancelled, and no new certificate or certificates shall be issued in exchange for any existing certificate until such existing certificate shall have been so cancelled, except in cases provided for in Section 6.04. SECTION 6.02 Transfers of Stock. Transfers of shares of stock of the Corporation shall be made only on the books of the Corporation by the registered holder thereof, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary, or with a transfer clerk or a transfer agent appointed as provided in Section 6.03, and upon surrender of the certificate or certificates for such shares properly endorsed and the payment of all taxes thereon. The person in whose name shares of stock stand on the books of the Corporation shall be deemed the owner thereof for all purposes as regards the Corporation. Whenever any transfer of shares shall be made for collateral security, and not absolutely, such fact shall be so expressed in the entry of transfer if, when the certificate or certificates shall be presented to the Corporation for transfer, both the transferor and the transferee request the Corporation to do so. SECTION 6.03 Regulations. The Board may make such rules and regulations as it may deem expedient, not inconsistent with these Bylaws, concerning the issue, 9 10 transfer and registration of certificates for shares of the stock of the Corporation. It may appoint, or authorize any officer or officers to appoint, one or more transfer clerks or one or more transfer agents and one or more registrars, and may require all certificates for stock to bear the signature or signatures of any of them. SECTION 6.04 Lost, Stolen, Destroyed, and Mutilated Certificates. In any case of loss, theft, destruction, or mutilation of any certificate of stock, another may be issued in its place upon proof of such loss, theft, destruction, or mutilation and upon the giving of a bond of indemnity to the Corporation in such form and in such sum as the Board may direct; provided, however, that a new certificate may be issued without requiring any bond when, in the judgment of the Board, it is proper so to do. SECTION 6.05 Fixing Date for Determination of Stockholders of Record. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any other change, conversion or exchange of stock or for the purpose of any other lawful action, the Board may fix, in advance, a record date, which shall not be more than 60 nor less than 10 days before the date of such meeting, nor more than 60 days prior to any other action. If in any case involving the determination of stockholders for any purpose other than notice of or voting at a meeting of stockholders or expressing consent to corporate action without a meeting the Board shall not fix such a record date, the record date for determining stockholders for such purpose shall be the close of business on the day on which the Board shall adopt the resolution relating thereto. A determination of stockholders entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of such meeting; provided, however, that the Board may fix a new record date for the adjourned meeting. ARTICLE VII Indemnification SECTION 7.01 Action, Etc. Other Than by or in the Right of the Corporation. The Corporation shall indemnify any person 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) by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did 10 11 not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, that he had reasonable cause to believe that his conduct was unlawful. SECTION 7.02 Actions, Etc., by or in the Right of the Corporation. The Corporation shall indemnify any person 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 he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. SECTION 7.03 Determination of Right of Indemnification. Any indemnification under Section 7.01 or 7.02 (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Section 7.01 and 7.02. Such determination shall be made (i) by the Board by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (ii) if such a quorum is not obtainable, or, even if obtainable a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (iii) by the stockholders. SECTION 7.04 Indemnification Against Expenses of Successful Party. Notwithstanding the other provisions of this Article, to the extent that a director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 7.01 or 7.02, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. SECTION 7.05 Prepaid Expenses. Expenses incurred by an officer or director in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized by the Board in the specific case upon receipt of an undertaking by or on behalf of the director or officer to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation as authorized in this Article. Such expenses incurred by other 11 12 employees and agents may be so paid upon such terms and conditions, if any, as the Board deems appropriate. SECTION 7.06 Other Rights and Remedies. The indemnification provided by this Article shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any Bylaws, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. SECTION 7.07 Insurance. Upon resolution passed by the Board, the Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Article. SECTION 7.08 Constituent Corporations. For the purposes of this Article, references to "the Corporation" include all constituent corporations absorbed in a consolidation or merger as well as the resulting or surviving corporation, so that any person who is or was a director, officer, employee or agent of such a constituent corporation or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise shall stand in the same position under the provisions of this Article with respect to the resulting or surviving corporation as he would if he had served the resulting or surviving corporation in the same capacity. SECTION 7.09 Other Enterprises, Fines, and Serving at Corporation's Request. For purposes of this Article, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to any employee benefit plan; and references to "serving at the request of the Corporation" shall include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Article. 12 13 ARTICLE VIII Miscellaneous SECTION 8.01 Seal. The Board shall provide a corporate seal, which shall be in the form of a circle and shall bear the name of the Corporation and words and figures showing that the Corporation was incorporated in the State of Delaware and the year of incorporation. SECTION 8.02 Waiver of Notices. Whenever notice is required to be given by these Bylaws or the Certificate of Incorporation or by law, the person entitled to said notice may waive such notice in writing, either before or after the time stated therein, and such waiver shall be deemed equivalent to notice. SECTION 8.03 Amendments. These Bylaws, or any of them, may be altered, amended or repealed, and new Bylaws may be made, (i) by the Board, by vote of a majority of the number of directors then in office as directors, acting at any meeting of the Board, or (ii) by the stockholders, at any annual meeting of stockholders, without previous notice, or at any special meeting of stockholders, provided that notice of such proposed amendment, modification, repeal or adoption is given in the notice of special meeting. Any Bylaws made or altered by the stockholders may be altered or repealed by either the Board or the stockholders. 13 14 CERTIFICATE OF SECRETARY The undersigned, being the duly elected Secretary of Diedrich Coffee, Inc., a Delaware corporation, hereby certifies that the Bylaws to which this Certificate is attached were duly adopted by the Board of Directors of said Corporation as of ______ __, l996. ------------------------------ Martin R. Diedrich EX-4.5 5 CONVERSION AGREEMENT 1 EXHIBIT 4.5 CONVERSION AGREEMENT THIS CONVERSION AGREEMENT (the "Agreement") is made and entered into as of the ___ day of ______________, 1996, by and among DIEDRICH COFFEE, a California corporation (the "Company") and D.C.H., L.P., a California limited partnership ("DCH"), REDWOOD ENTERPRISES VII, L.P., a California limited partnership ("Redwood") and DIEDRICH PARTNERS I, L.P., a Delaware limited partnership ("DPL") (DCH, Redwood and DPL are collectively referred to herein as the "Preferred Shareholders"). R E C I T A L S : A. DCH owns 1,000,000 shares of the Company's Series A Preferred Stock (the "Series A Preferred Stock"), such shares having been purchased pursuant to that certain Purchase Agreement, dated as of December 11, 1992 (the "Series A Purchase Agreement"). B. Redwood and DPL each own 804,284 shares of the Company's Series B Preferred Stock (the "Series B Preferred Stock"), such shares having been purchased pursuant to that certain Series B Preferred Stock Purchase Agreement, dated as of June 29, 1995 (the "Series B Purchase Agreement"). C. This Agreement shall serve to amend the Series A Purchase Agreement and the Series B Purchase Agreement with respect to the Company and the Preferred Shareholders. A G R E E M E N T : NOW, THEREFORE, in consideration of the foregoing recitals, and subject to the conditions and covenants set forth herein, the parties agree as follows: 1. Conversion of Preferred Stock to Common Stock. In anticipation of the Company's initial public offering (the "Initial Public Offering") of shares of its common stock (the "Common Stock"), the parties hereby agree that all shares of Series A Preferred Stock and Series B Preferred Stock owned by the Preferred Shareholders shall be converted into the equivalent number of shares of Common Stock, such conversion to be effective on the date hereof. Upon the surrender of the certificates representing shares of Series A Preferred Stock or Series B Preferred Stock, such shares shall be appropriately canceled on the books of the Company and new certificates representing shares of Common Stock shall be issued. 2. No Right to Receive Dividends. The Preferred Shareholders hereby acknowledge and agree that they are not entitled to receive any accrued or unpaid dividends on the Series A Preferred Stock or Series B Preferred Stock in connection with the conversion to Common Stock contemplated under this Agreement, since, pursuant to the terms of the Company's Articles of Incorporation, such dividends are payable only upon the liquidation and winding up of the Company. 3. Registration Rights. The Preferred Shareholders hereby acknowledge and agree that, although the Initial Public Offering includes the offering of some of their newly converted 2 shares of Common Stock, they shall not be entitled to the registration of any additional shares in the Initial Public Offering; provided, however, that the Initial Public Offering shall not count against the limit of three public offerings available to the Preferred Shareholders pursuant to Sections 4(g) and 4(e) of the Series A Purchase Agreement and the Series B Purchase Agreement, respectively, and that such registration rights shall not be hindered, waived or terminated in respect to any other offerings by the Company or in any other manner. 4. Termination of Other Rights. The Preferred Shareholders hereby agree to terminate certain other rights that they have with respect to the Company pursuant to the Series A Purchase Agreement and the Series B Purchase Agreement. Specifically, DCH's rights regarding Right of First Refusal, Key Man Life Insurance, Actions Requiring Notice and Approval and the Chief Executive Officer, as set forth in Sections 4(e), 4(i), 4(j) and 4(k) of the Series A Purchase Agreement, shall be terminated, as shall Redwood's and DPL's rights regarding Key Man Life Insurance, Employee Stock Arrangements, Actions Requiring Notice and Approval and Other Affirmative Covenants, as set forth in Sections 4(g) through 4(j) of the Series B Purchase Agreement. 5. Miscellaneous Provisions. (a) Severability and Governing Law. Should any Section or any part of a Section within this Agreement be rendered void, invalid or unenforceable by any court of law for any reason, such invalidity or unenforceability shall not void or render invalid or unenforceable any other Section or part of a Section in this Agreement. This Agreement and the rights and obligations of the parties under this Agreement shall be governed by and construed in accordance with the laws of the State of California, excluding its rules of conflicts of law. (b) Amendments and Waiver. Any term of this Agreement may be amended and the observance of any term of this Agreement may be waived (either generally or in a particular instance, either retroactively or prospectively, and either for a specified period of time or indefinitely), only in writing signed by all parties. (c) Entire 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. (d) Counterparts. This Agreement may be executed by one or more of the parties hereto on any number of separate counterparts and all of said counterparts taken together shall be deemed to constitute one and the same instrument. (e) Further Assurances. Each party hereto agrees to execute any and all documents and to perform such other acts as may be necessary or expedient to further the purposes of this Agreement and the transactions contemplated hereby. (f) Captions. The captions of the Sections of this Agreement are for convenience only and shall not be considered or referred to in resolving questions of construction. 2 3 IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the date first above written. "COMPANY" DIEDRICH COFFEE -------------------------------------------- Steven A. Lupinacci President, Chief Executive Officer and Chief Financial Officer -------------------------------------------- Martin R. Diedrich Chairman of the Board and Secretary "PREFERRED SHAREHOLDERS" D.C.H., L.P. -------------------------------------------- Paul C. Heeschen General Partner REDWOOD ENTERPRISES VII, L.P. -------------------------------------------- Paul C. Heeschen General Partner DIEDRICH PARTNERS I, L.P. -------------------------------------------- Amre A. Youness General Partner 3 EX-10.2 6 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.2 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into as of June 29, 1995, by and between DIEDRICH COFFEE, a California corporation ("Employer"), and STEVEN A. LUPINACCI ("Employee"). R E C I T A L S : Employer and Employee desire to enter into this Agreement to establish the terms and conditions of Employee's employment by Employer during the term hereof. A G R E E M E N T : NOW, THEREFORE, in consideration of the foregoing recital, and subject to the conditions and covenants set forth herein, the parties agree as follows: 1. Employment and Term. (a) Employer hereby employs Employee as its President and Chief Executive Officer and Employee hereby accepts such employment upon the terms and subject to the conditions set forth in this Agreement. Unless earlier terminated as provided in this Agreement, the term of Employee's employment under this Agreement shall commence on the date hereof and shall continue for a period of three (3) years from the date hereof (the "Term"). (b) Employee shall perform such duties and functions consistent with his role as President and Chief Executive Officer as assigned to him by the Board of Directors of the Employer (the "Board"). Employee agrees that during the course of the Employer's business hours throughout the Term, he will devote the whole of his time, attention and efforts to the performance of his duties and obligations hereunder. Employee shall not, during the Term, without the written approval of the Board first had and obtained in each instance, directly or indirectly (a) accept employment or receive any compensation for the performance of services from any business enterprise other than Employer or (B) enter into or be concerned or interested in any trade or business or public or private work (whether for profit or otherwise and whether as partner, principal, shareholder or otherwise), which may, in the absolute discretion of the Board, hinder or otherwise interfere with the performance by the Employee of his duties and obligations hereunder, except as a holder of not more than five percent (5%) of any class of stock or other securities in any company which is listed and/or traded on any securities market. 2. Compensation. Employee shall be paid a salary (the "Base Salary") in an amount that initially shall be equal to One Hundred Twenty-Five Thousand Dollars ($125,000) per year, payable in semi-monthly installments, less all amounts required by law to be withheld or deducted. During the Term of this Agreement, the Board shall review Employee's Base Salary on or about each anniversary date of the date of this Agreement. The Board, in its sole and absolute discretion from time to time, may increase (but not decrease without Employee's written consent) Employee's Base Salary. The Board, in its sole and absolute discretion, also may pay Employee performance bonuses based on Employer's performance and Employee's contribution thereto in such amounts and at such times as the Board may determine. 3. Employee Benefits. During the Term of Employee's employment hereunder: (a) Employee shall be entitled to vacation leave consistent with Employer's policies for other senior executives of Employer. (b) Employer shall pay or reimburse Employee for all reasonable and necessary travel and other business expenses incurred or paid by Employee in connection 2 with the performance of his services under this Agreement consistent with Employer's policies for other senior executives of Employer. (c) Employer shall provide and pay for the annual cost of premiums for health, dental and medical insurance coverage for Employee and Employee's dependents consistent with the coverage generally made available by Employer to senior executives of Employer and providing benefits at least as favorable to Employee as the coverage that is in effect at the date of this Agreement. (d) In addition to the benefits set forth above, Employee shall be entitled to participate in any other policies, programs and benefits which Employer may, in its sole and absolute discretion, make generally available to its other senior executives from time to time including, but not limited to, life insurance, disability insurance, pension and retirement plans, stock plans and other similar programs. 4. Termination of Employment. (a) Notwithstanding any other provision of this Agreement, Employee's employment under this Agreement may be terminated as follows: (i) Upon the death of Employee, this Agreement and Employee's employment hereunder shall terminate immediately and without notice by Employer; or (ii) In the event of the inability of Employee to perform his duties or responsibilities hereunder, as a result of mental or physical ailment or incapacity, for an aggregate of ninety (90) calendar days during any calendar year (whether or not consecutive) (a "Disability") during which period of Disability the Employee shall be entitled to his compensation pursuant to this Agreement, this Agreement and Employee's employment hereunder shall terminate upon delivery of written notice to Employee; or (iii) By Employer for Cause (as defined below) in accordance with the provisions of Section 4(b) hereof. (b) The parties agree that for purposes of this Agreement, the term "Cause" shall mean the following: (i) Employee's willful and repeated failure to satisfactorily perform his job duties under this Agreement; (ii) Failure by the Employee to comply with all material applicable laws in performing his job duties or in directing the conduct of Employer's business; and 2 3 (iii) Commission by the Employee of any felony or intentionally fraudulent act against Employer, or its employees, agents or customers. (c) With respect to events described in subparagraph 4(b)(i) and (ii) above, Employer shall give written notice to Employee of any such event and Employee shall have thirty (30) days beginning on the date of delivery of such written notice to cure same, or if such event cannot be cured within said thirty (30) day period, Employee shall commence his efforts to cure the event within the thirty (30) day period and diligently work to cure such event within a reasonable time period. If Employee within said thirty (30) day period or within a reasonable time period, as applicable, does not cure the event for which notice has been provided under subparagraphs 4(b)(i) or (ii) above, then Employee's employment under this Agreement may be terminated by Employer by delivery to Employee of written notice of termination and such termination will be effective as of the date of delivery of such written notice. With respect to events described in subparagraph 4(b)(iii) above, Employee's employment under this Agreement may be terminated by Employer by delivery to Employee of written notice of termination and such termination will be effective as of the date of delivery of such written notice. 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 Employer 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 the product of Employee's Base Salary on the termination date times a fraction, the numerator of which shall be the total number of days left in the Term and the denominator of which shall be 365 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 Employer, its successors, assigns, affiliates, officers, directors, employees and representatives for termination without any cause shown by the Employer. (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 Employer or a material breach of the provisions of this Agreement by the Employer. 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 Employer, its 3 4 successors, assigns, affiliates, officers, directors, employees and representatives if he terminates this Agreement. 5. Arbitration. Any controversy, dispute or claim arising out of, in connection with, or in relation to the interpretation, performance or breach of this Agreement or otherwise arising out of the execution hereof, including any claim based on contract, tort or statute, shall be resolved, at the request of any party, by submission to binding arbitration at the Orange County, California offices of Judicial Arbitration & Mediation Services, Inc. ("JAMS"), and any judgment or award rendered by JAMS shall be final, binding and unappealable, and judgment may be entered by any state or federal court having jurisdiction thereof. Any party can initiate arbitration by sending written notice of intention to arbitrate (the "Demand) by registered or certified mail to all parties and to JAMS. The Demand shall contain a description of the dispute, the amount involved, and the remedy sought. The arbitrator shall be a retired or former judge agreed to between the parties from the JAMS' panel. If the parties are unable to agree, JAMS shall provide a list of three available judges and each party may strike one. The remaining judge shall serve as the arbitrator. Each party hereto intends that the provisions to arbitrate set forth herein be valid, enforceable and irrevocable. In his award, the arbitrator shall allocate, in his discretion, among the parties to the arbitration all costs of the arbitration, including the fees of the arbitrator and reasonable attorneys' fees, costs and expert witness expenses of the parties. The parties hereto agree to comply with any award made in any such arbitration proceedings that has become final and agree to the entry of a judgment in any jurisdiction upon any award rendered in such proceeding becoming final. 6. Notices. All notices, requests, demands and other communications under this Agreement must be in writing and shall be deemed to have been duly given on the date of service if served personally on the party to whom notice is to be given, or on the date indicated on the return receipt as the date of receipt or refusal if mailed to the party to whom notice is to be given by first class mail, registered or certified, postage prepaid, return receipt requested, and properly addressed as follows: To the Employer: Diedrich Coffee 2144 Michelson Drive Irvine, California 92612 Attention: Chairman of the Board To the Employee: Steven A. Lupinacci 2144 Michelson Drive Irvine, California 92612 Any party may change its address for the purpose of this Paragraph 6 by giving the other party written notice of the new address in the manner set forth above. 7. Enforceability. If any of the covenants contained in this Agreement, for any reason and to any extent, are construed to be invalid or unenforceable, the remainder of this Agreement, and the application of the remaining covenants to other persons or circumstances shall not be affected hereby, but rather shall be enforced to the greatest extent permitted by law. 4 5 8. Assignment; Binding Effect. This Agreement shall inure to the benefit of, and be enforceable by, the Employer and its successors and assigns; however, this Agreement is personal to Employee and may not be assigned by Employee in whole or in part. In the event of the sale of all or substantially all of the assets of Employer or other transaction in which Employer will not continue as a surviving corporate entity engaged in a substantially similar business as it is engaged in prior to such transaction, Employer will use commercially reasonable efforts to obtain from the acquiring person or entity, before the succession takes place, an agreement to assume and perform all of the terms and conditions of this Agreement. 9. Entire Agreement; Amendment. This Agreement contains the entire agreement between Employer and Employee with respect to the subject matters hereof and supersedes all prior or contemporaneous agreements, arrangements or understandings, written or oral, with respect to the subject matters hereof. This Agreement may not be amended, waived, changed, modified or discharged except by an instrument in writing executed by or on behalf of the party or parties against whom any amendment, waiver, change, modification or discharge is sought to be enforced. 10. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 11. Counterparts. This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. "EMPLOYER" DIEDRICH COFFEE, a California corporation By:____________________________________ Name:______________________________ Title______________________________ "EMPLOYEE" ______________________________________ STEVEN A. LUPINACCI 5 EX-23.1 7 CONSENT OF BDO, SEIDMAN, LLP, 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 August 28, 1996 EX-23.2 8 CONSENT OF BDO, SEIDMAN, LLP, 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 August 28, 1996 EX-27.1 9 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEETS AS OF JANUARY 31, 1996 AND MAY 1, 1996 AND THE STATEMENTS OF OPERATIONS FOR THE YEAR ENDED JANUARY 31, 1996 AND THE THIRTEEN WEEKS ENDED MAY 1, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS INCLUDED IN AMENDMENT NO. 3 TO FORM S-1. YEAR 3-MOS JAN-31-1996 JAN-29-1997 FEB-01-1995 FEB-01-1996 JAN-31-1996 MAY-01-1996 94,659 79,222 0 0 134,573 159,049 0 0 645,493 849,631 1,008,061 1,255,332 5,032,085 7,663,945 931,187 1,083,532 5,315,672 8,914,706 1,060,727 5,074,344 829,320 304,345 0 0 3,025,813 3,025,813 330,698 330,698 (52,030) 55,083 5,315,672 8,914,706 10,244,175 4,274,730 10,244,175 4,274,730 4,409,485 1,772,892 8,206,413 3,567,091 353,840 153,925 0 0 50,187 38,841 314,855 178,762 129,211 71,649 185,644 107,113 0 0 0 0 0 0 185,644 107,113 .06 .03 .06 .03
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