-----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, AkhwT7GKhrmmuvSDePZHtTW9opgNaa7PLBxRHHq8Ge9c9RB4CU9AMcP7qL0ewBJS Zh1zrDl+cjzFUSQHDoYC1w== 0000892569-97-002539.txt : 19970918 0000892569-97-002539.hdr.sgml : 19970918 ACCESSION NUMBER: 0000892569-97-002539 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19970730 FILED AS OF DATE: 19970912 SROS: NASD 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: 0129 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21203 FILM NUMBER: 97679479 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 10-Q 1 FORM 10-Q FOR PERIOD ENDED JULY 30, 1997 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q ---------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ COMMISSION FILE NUMBER 0-21203 DIEDRICH COFFEE, INC. (Exact name of registrant as specified in its charter) DELAWARE 33-0086628 (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 2144 MICHELSON DRIVE IRVINE, CALIFORNIA 92612 (Address of Principal Executive Offices including Zip Code) (714) 260-1600 (Registrant's Telephone Number including Area Code) ---------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] As of September 10, 1997, there were 5,391,650 shares of common stock of the registrant outstanding. ================================================================================ 1 2 DIEDRICH COFFEE, INC. INDEX
PAGE NO. PART I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Balance Sheets.............................................................3 Condensed Statements of Operations...................................................4 Condensed Statements of Cash Flows...................................................5 Notes to Condensed Financial Statements..............................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................9 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders............................14 Item 6. Exhibits and Reports on Form 8-K...............................................15 Signatures.............................................................................15
2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DIEDRICH COFFEE, INC. CONDENSED BALANCE SHEETS (UNAUDITED)
JULY 30, 1997 JANUARY 29, 1997 ------------- ---------------- ASSETS Current Assets: Cash $ 571,752 $ 2,071,904 Accounts receivable 178,256 210,363 Inventories (Note 2) 1,572,795 1,615,145 Prepaid expenses 340,195 185,063 Other current assets 202,419 285,072 ------------ ------------ Total current assets 2,865,417 4,367,547 Property and equipment, net 10,323,525 11,962,752 Costs in excess of net assets acquired, net 403,350 796,178 Other assets 351,370 344,942 ------------ ------------ Total assets $ 13,943,662 $ 17,471,419 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 1,498,357 $ 1,800,292 Accrued compensation 418,640 417,028 Accrued expenses 316,397 201,487 Note Payable 1,250,000 Restructuring liabilities 1,483,073 -- ------------ ------------ Total current liabilities 4,966,467 2,418,807 Deferred rent 160,238 154,384 ------------ ------------ Total liabilities 5,126,705 2,573,191 ------------ ------------ Stockholders' Equity: Preferred stock -- -- Common stock 53,917 53,917 Additional paid-in capital 15,882,046 15,882,046 Accumulated deficit (7,119,006) (1,037,735) ------------ ------------ Total stockholders' equity 8,816,957 14,898,228 ------------ ------------ Commitments and contingencies Total liabilities and stockholders' equity $ 13,943,662 $ 17,471,419 ============ ============
See accompanying Notes to condensed financial statements. 3 4 DIEDRICH COFFEE, INC. CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
THIRTEEN THIRTEEN TWENTY-SIX TWENTY-SIX WEEKS ENDED WEEKS ENDED WEEKS ENDED WEEKS ENDED JULY 30, 1997 JULY 31, 1996 JULY 30, 1997 JULY 31, 1996 ------------- ------------- -------------- ------------- Net Sales: Retail $ 5,258,780 $ 4,269,206 $ 10,643,405 $ 8,171,203 Wholesale and other 551,742 398,155 1,034,837 770,888 ----------- ----------- ------------ ----------- Total 5,810,522 4,667,361 11,678,242 8,942,091 ----------- ----------- ------------ ----------- Cost and Expenses: Cost of sales and related occupancy costs 2,860,893 2,135,990 5,902,708 3,908,882 Store operating expenses 2,126,728 1,872,544 4,506,955 3,607,423 Other operating expenses 75,764 63,265 140,089 122,585 Depreciation and amortization 439,077 210,626 886,516 364,551 Provision for store closings and restructuring costs -- -- 4,550,068 -- General and administrative expenses 969,554 310,085 1,743,879 647,460 ----------- ----------- ------------ ----------- Total 6,472,016 4,592,510 17,730,215 8,650,901 ----------- ----------- ------------ ----------- Operating income (loss) (661,494) 74,851 (6,051,973) 291,190 Interest expense (21,651) (69,891) (21,651) (108,732) Interest and other income (expense) (12,417) 742 (4,757) 2,006 ----------- ----------- ------------ ----------- Income (loss) before income taxes (695,562) 5,702 (6,078,381) 184,464 Provision for income taxes 2,890 -- 2,890 71,649 ----------- ----------- ------------ ----------- Net income (loss) $ (698,452) $ 5,702 $ (6,081,271) $ 112,815 =========== =========== ============ =========== Per share information: Net income (loss) per share $ (.13) $ .00 $ (1.13) $ .03 =========== =========== ============ =========== Weighted average shares outstanding 5,391,650 3,903,000 5,391,650 3,903,000 =========== =========== ============ ===========
See accompanying Notes to condensed financial statements. 4 5 DIEDRICH COFFEE, INC. CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
TWENTY-SIX TWENTY-SIX WEEKS ENDED WEEKS ENDED JULY 30, 1997 JULY 31, 1996 ------------- ------------- Cash flows from operating activities: Net income (loss) $(6,081,271) $ 112,815 Adjustments to reconcile net income (loss) to cash (used in) provided by operating activities: Depreciation and amortization 886,516 364,551 Restructuring charge 2,329,113 -- Impairment on long-lived assets 2,220,955 -- Increase (decrease) from changes in: Accounts receivable 32,107 (16,580) Inventories (27,043) (307,143) Prepaid expenses (155,132) (64,634) Other current assets 82,653 (118,387) Other assets (6,428) (316,668) Accounts payable (301,935) 1,059,666 Accrued compensation (96,183) 100,990 Accrued expenses 114,910 99,422 Income taxes payable -- (24,916) Deferred rent 5,854 6,546 ----------- ----------- Net cash provided by (used in) operating activities (995,884) 895,662 ----------- ----------- Cash flows from investing activities: Capital expenditures for property and equipment (1,150,095) (3,609,893) Property disposition (604,173) -- Acquisition of coffeehouses -- (1,800,000) ----------- ----------- Net cash provided by (used in) investing activities (1,754,268) (5,409,893) ----------- ----------- Cash flows from financing activities: Checks issued against future deposits -- 204,145 Proceeds from notes payable -- 10,000 Proceeds from line of credit -- 3,386,530 Proceeds from long-term debt 1,250,000 1,422,520 Principal payments on long-term debt -- (546,565) ----------- ----------- Net cash provided by financing activities 1,250,000 4,476,630 ----------- ----------- Net decrease in cash (1,500,152) (37,601) Cash at beginning of period 2,071,904 94,659 ----------- ----------- Cash at end of period $ 571,752 $ 57,058 =========== =========== Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest $ -- $ 86,021 Income taxes $ 2,890 $ 62,500
See accompanying Notes to condensed financial statements. 5 6 DIEDRICH COFFEE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS JULY 30, 1997 (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The unaudited condensed financial statements of Diedrich Coffee, Inc. (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information. In the opinion of management, all adjustments (consisting of normal, recurring adjustments and accruals) considered necessary for a fair presentation of the Company's financial position at July 30, 1997 and the results of operations and cash flows for the twenty-six weeks ended July 30, 1997 and July 31, 1996 have been included. Results for the interim periods are not necessarily indicative of the results for an entire year. This information should be read in conjunction with the financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended January 29, 1997. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, which establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS No. 130 is effective for financial statements issued for periods beginning after December 15, 1997. The Company has not determined the impact of SFAS No. 130 on its consolidated financial statements. In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. SFAS No. 131 is effective for financial statements issued for periods beginning after December 15, 1997. The Company has not determined the impact of SFAS No. 131 on its consolidated financial statements. Net Income (Loss) per Common Share The calculation of net income (loss) per share was determined by dividing the net income (loss) by the weighted average common and common equivalent shares outstanding when dilutive. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 83, shares issued and share options granted within one year of the Company's initial public offering ("IPO") have been included in the calculation of common share equivalents, using the treasury stock method to determine the dilutive effect of the issuance's, as if they were outstanding for all periods presented even if they were antidilutive. The calculation of common share equivalents assumes that the proceeds of common shares and share options issued within one year of the IPO were used to repurchase common shares at the IPO price of $9.50 per share. Primary earnings (loss) per share approximate fully diluted earnings (loss) per share for all periods presented. 6 7 DIEDRICH COFFEE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) JULY 30, 1997 (UNAUDITED) In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS No. 128 specifies new standards designed to improve the earnings per share ("EPS") information provided in financial statements by simplifying the existing computational guidelines, revising the disclosure requirements and increasing the comparability of EPS data on an international basis. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. The Company does not believe the implementation of SFAS No. 128 will have a material effect on net income (loss) per share. 2. INVENTORIES Inventories consist of the following:
JULY 30, JANUARY 29, 1997 1997 ---------- ----------- Green coffee $ 528,573 $ 357,255 Roasted coffee 72,413 90,536 Accessory and specialty items 446,859 454,946 Other food, beverage and supplies 524,950 712,408 ---------- ---------- $1,572,795 $1,615,145 ========== ==========
3. DEBT On May 27, 1997, the Company made a promissory note (the "Note") for the benefit of The Palm Trust of which Paul Heeschen, a director, is a trustee. Mr. Heeschen has no beneficial interest in the Palm Trust. The Note provides for borrowings by the Company up to $1,500,000 with interest accruing at the prime rate plus 3-1/2%. All outstanding principal and accrued interest is due and payable on January 27, 1998 or promptly after the closing of any new debt or equity financing in an amount exceeding $1,500,000. The amount outstanding as of July 30, 1997 was $1,250,000. On August 19, 1997 the Company borrowed an additional $250,000 under the facility. The Company is presently negotiating a possible debt facility with unrelated parties that will replace the Note. The Company is also exploring possible private placements of convertible debt or equity. 4. RESTRUCTURING CHARGE On March 12, 1997, the Company announced that it was reviewing the performance of all of the Company's coffeehouses to determine which units were meeting or not meeting management's long-term operational expectations. As a result of this review, twelve stores were identified to be closed. In connection with the store closures, the Company recorded an impairment provision and a restructuring charge totaling approximately $4,600,000 in the first quarter of fiscal 1998. The store closures, which were undertaken to streamline operations and improve profitability, began in late March 1997 and are expected to be completed during fiscal 1998. As of July 30, 1997, the Company had closed nine of the twelve stores and had a remaining reserve of $1,483,073. 7 8 DIEDRICH COFFEE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) JULY 30, 1997 (UNAUDITED) 5. SUBSEQUENT EVENTS On August 19, 1997, the Company entered into a promissory note, term loan agreement, and security agreement with the Virginia R. Cirica Trust (the "Cirica Trust Loan Documents"). That trust is controlled by Ms. Cirica, who is the spouse of Lawrence Goelman, Chairman. The loan is secured and provides for borrowings up to $500,000 with interest accruing at the prime rate plus 3 1/2 %. All outstanding principal and accrued interest is due and payable on August 19, 2002. In connection with the Cirica Trust Loan Documents, the Company issued a warrant to the Cirica Trust to purchase up to 170,000 shares of the Company's common stock at a price of $2.25 a share. The Company closed the tenth store under its restructuring plan and opened a new store, as planned, in Houston, Texas. 8 9 PART I - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS In addition to historical information, management's discussion and analysis includes certain forward-looking statements, including those related to the Company's growth and strategies, that involve risks and uncertainties. These projections or forward looking statements fall under the safe harbors of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company's actual results and financial position could differ materially from those anticipated in the forward-looking statements as a result of a number of factors, such as unexpected delays in implementing the new systems or in obtaining additional working capital, failure of the wholesale business to meet targets and volatile world coffee prices. The need for additional financing and other risks and uncertainties are described elsewhere in this report and in detail under "Certain Factors and Trends Affecting Diedrich Coffee and Its Business" in the Company's annual report on Form 10-K for the fiscal year ended January 29, 1997 and in reports filed by the Company with the Securities and Exchange Commission. GENERAL The Company commenced operations in 1972 as a private company. The Company went public in September 1996. The Company sells high quality coffee beverages made with its own freshly roasted coffee. In addition to brewed coffee, the Company offers a broad range of espresso drinks. To complement beverage sales, the Company sells light food items and whole bean coffee through its coffeehouses. At the conclusion of fiscal 1997 (January 29, 1997), the Company operated forty-seven coffeehouses or carts in operation, located in California, Colorado and Texas. As of July 30, 1997, the Company operated a total of thirty-nine coffeehouses as a result of the closure of nine of the twelve locations identified for closure under the previously announced restructuring plan (see Note 4 of Notes to Condensed Financial Statements) and the opening of one new coffeehouse in Houston, Texas in July, 1997. In the first two quarters of the current fiscal year the Company experienced losses related to underperforming stores and a $4,600,000 restructuring charge. The Company is executing a new business plan designed to return the Company to profitability by the end of fiscal 1998 (January 28, 1998). The business plan targets significant growth in several markets or channels of distribution. Achieving these goals depends upon, among other things, obtaining sufficient working capital, successful implementation of new systems and of the new store management approach and team. New management team. A new management team took over following the resignation of Steven A. Lupinacci, the Company's Chief Executive Officer ("CEO") in March, 1997. In addition to Lawrence Goelman, Chairman and Interim CEO, Kerry W. Coin, President and Chief Operating Officer, and John Bayley, Vice President of Finance and Controller, the Company hired in the second quarter Michael P. Reeves, Vice President of Human Resources and Marketing, Jonathan B. Eddison, Vice President and General Counsel, Edward A. Apffel, Director of the Wholesale Division, and Philip R. Williams, Director of Purchasing. The Company believes that its new senior management team has the skills, experience and ability to execute the business plan. New business plan. At the direction of the Board of Directors, the Company's new management developed and is implementing a new business plan for renewing and strengthening the Company while attempting to return it to profitability. As previously announced, the new business plan includes: (1) closing stores which do not meet the Company's performance standards; (2) developing new channels of distribution such as "co-branding", franchising, carts, kiosks, and office coffee service; (3) accelerating growth in wholesale sales; (4) improved cost controls through installing upgraded software and new management information and point-of-sale systems; (5) rolling out an enhanced training and human resources systems so as to strengthen and build the Company's operating management and staff; and (6) concentrating on building brand awareness and brand equity. Progress against the plan. Nine of the twelve stores targeted for closure were closed by July 30, 1997. Management remains confident that the remaining stores to be closed will be closed before the end of the fiscal year. On a period-to-period comparative basis the Company is operating according to the new business plan since the plan was put into place. The Company's plan projects operating losses to steadily diminish and end in the fourth quarter if all targets are met and sufficient working capital is obtained. Retail revenues are ramping up while controllable operating expenses at the store level are decreasing. Wholesale sales are increasing. The new business plan emphasizes growth in wholesale sales. 9 10 Green coffee prices. In the second quarter of fiscal 1998, worldwide coffee commodity prices were at the highest levels since 1992. The Company usually pays a premium over the commodity price for the select and high quality coffee beans that it purchases. As worldwide demand for coffee of all types remains strong, the Company expects the prices that it pays to remain comparatively high into the foreseeable future. The Company has so far mitigated the effect of the green coffee price increases by increasing the wholesale and retail sales prices of its roasted coffee beans, brewed coffee and related products in the second quarter. Demand for the Company's coffee was not adversely affected by the price increase. Roast capacity and packaging. The Company is actively seeking cost effective ways to expand its coffee roasting capacity and upgrade its packaging capabilities. These improvements are needed to enable the Company to expand and diversify its wholesale business. These steps are to take place following management's review of the costs and benefits of purchasing or contracting for these added capabilities. RESULTS OF OPERATIONS Thirteen Weeks Ended July 30, 1997 Compared with the Thirteen Weeks Ended July 31, 1996 Net sales. Net sales for the thirteen weeks ended July 30, 1997, increased 24.5% to $5,811,000 from $4,667,000 for the thirteen weeks ended July 31, 1996. During this most recent quarter, the Company derived 90.5% of net sales from its retail coffeehouse operations. The Company's wholesale and mail order sales accounted for the remainder of net sales. Net retail sales for the thirteen weeks ended July 30, 1997 increased 23.2% to $5,259,000 from $4,269,000 in the thirteen weeks ended July 31, 1996 primarily due to the increase in the number of coffeehouses as well as replacing the closed coffeehouses with higher volume coffeehouses. The Company's ability to continue to increase net sales depends upon many factors, including existing and emerging competition. There can be no assurance that the Company's net sales will continue to increase. Wholesale and mail order sales combined increased 38.7% to $552,000 in the thirteen weeks ended July 30, 1997 from $398,000 in the thirteen weeks ended July 31, 1996. The increase was due to a more active sales effort, the hiring of a director of wholesale and continued favorable customer response from new and existing wholesale accounts. A moderate price increase on roasted whole bean coffee was implemented during the quarter in response to industry wide cost pressures resulting from increases in the price of green coffee. The percentage increase in second quarter of fiscal 1998 comparable store sales was 0.8%. Due to the remodeling of stores in Denver, only 22 of the Company's 38 coffeehouses were open for the full period in the second quarter in fiscal 1997. On average these comparable stores have been open for more than 3.5 years and had sales of approximately $170,000 per store for the thirteen weeks ended July 30, 1997. 10 11 Net sales for the twenty-six weeks ended July 30, 1997 increased 30.6% to $11,678,000 from $8,942,000 for the twenty-six weeks ended July 31, 1996. Net retail sales for the twenty-six weeks ended July 30, 1997 increased 30.3% to $10,643,000 from $8,171,000 for the twenty-six weeks ended July 31, 1996 due to an increase in the number of coffeehouses and in coffeehouse sales. Wholesale and mail order sales for the twenty-six weeks ended July 30, 1997 increased 34.2% to $1,035,000 from $771,000 for the twenty-six weeks ended July 31, 1996. 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 thirteen weeks ended July 30, 1997 increased to $2,861,000 from $2,136,000 for the thirteen weeks ended July 31, 1996. As a percentage of retail net sales, cost of sales and related occupancy costs increased to 54.4% in the second quarter of fiscal 1998 from 50.0% for the second quarter of fiscal 1997. These figures include non-recurring expenses of closing stores, such as continuing lease payments. Cost of sales and related occupancy costs for the twenty-six weeks ended July 30, 1997 increased to $5,903,000 from $3,909,000 for the twenty-six weeks ended July 31, 1996. As a percentage of retail net sales, cost of sales and related occupancy costs increased to 55.5% for the first two quarters in fiscal 1998 from 47.8% for the first two fiscal quarters in fiscal 1997. This increase stems from the result of higher green coffee costs that were not entirely offset by the menu price increase implemented in the second quarter of fiscal 1998. Additionally, the increase was also attributable to some increases in related occupancy costs. Store operating expenses. Store operating expenses increased to $2,127,000 for the thirteen weeks ended July 30, 1997 from $1,873,000 for the thirteen weeks ended July 31, 1996. As a percentage of retail net sales, store operating expenses decreased to 40.4% in the second quarter of fiscal 1998 from 43.9% in the prior fiscal year's second quarter. For the twenty-six weeks ended July 31, 1997, store operating expenses, as a percentage of retail net sales, similarly decreased to 42.3% from 44.1% for the twenty-six weeks ended July 31, 1996. These decreases were due to improved sales projection methods and labor scheduling techniques. Other operating expenses. Other operating expenses (those associated with wholesale and mail order sales) increased to $76,000 for the second quarter of fiscal 1998 from $63,000 in the second quarter of fiscal 1997. These expenses, as a percentage of the net sales from the wholesale division, decreased to 13.8% from 15.8%. These decreases are due to an increase in wholesale sales. For the twenty-six weeks ended July 30, 1997, other operating expenses, as a percentage of wholesale net sales, decreased to 13.5% from 16.0% for the twenty-six weeks ended July 31, 1996. These decreases are a result of an increased in volume and prices, as well as an increase in equipment sales. Depreciation and Amortization. Depreciation and amortization increased to $439,000 for the thirteen weeks ended July 30, 1997 from $211,000 for the thirteen weeks ended July 31, 1996. As a percentage of net sales, depreciation and amortization increased to 7.6% from 4.5% for the same period in the prior year, principally due to depreciable assets related to the addition of the conversion costs for the acquired locations. Depreciation and amortization increased to $887,000 for the twenty-six weeks ended July 30, 1997 from $365,000 for the twenty-six weeks ended July 31, 1996. General and administrative expenses. General and administrative expenses increased to $970,000 for the second quarter of fiscal 1998 from $310,000 for the second quarter of fiscal 1997. As a percentage of net sales, general and administrative expenses increased to 16.7% from 6.6% due to the adding of selected resources and personnel in order to implement the policies and procedures necessary for the effective control of multi-state operations and new points of distribution operating at various volume levels. Similarly, as a percentage of net sales, general and administrative expenses increased to 14.9% in the twenty-six weeks ended July 30, 1997 from 7.2% for the twenty-six weeks ended July 31, 1996. The Company expects to see a reduction in general and administrative expenses relative to sales over the next several quarters as revenue flows increase assuming continued successful execution of the new business plan. 11 12 Provision for store closings and restructuring costs. In response to lower than expected profitability in certain of its operations the Company commenced a restructuring program which includes store closures, lease terminations and the write off of fixed assets. The $4.6 million, or $.84 per share provision for store closings and restructuring costs reflects anticipated expenses related to the program. The restructuring charge primarily includes lease termination and other costs associated with store closures as well as a provision for the impairment of long-lived assets in accordance with SFAS No. 121. Interest expense. Interest expense decreased to $22,000 for the thirteen weeks ended July 30, 1997 from $70,000 for the thirteen weeks ended July 31, 1996. Operating (loss) income. Operating loss for the thirteen weeks ended July 30, 1997 was $698,000 compared to operating income of $6,000 for the thirteen weeks ended July 31, 1996. This change was primarily the result of increases in cost of sales and related occupancy, depreciation and amortization, and general and administrative costs as a percentage of sales. Operating loss for the twenty-six ended July 30, 1997 was $6,081,000 compared to operating income of $113,000 for the twenty-six weeks ended July 31, 1996. This change was principally the result of the restructuring provision discussed above as well as increases in cost of sales and related occupancy, depreciation and amortization, and general and administrative costs as a percentage of sales. LIQUIDITY AND CAPITAL RESOURCES The Company had a working capital deficiency of $2,101,000 as of July 30, 1997 compared to working capital of $1,949,000 as of January 29, 1997. The current period working capital deficiency includes remaining restructuring liabilities of $1,483,000. Cash used by operating activities for the twenty-six weeks ended July 30, 1997 totaled $996,000. On May 27, 1997, the Company made a promissory note to The Palm Trust. The Note provides for borrowings up to $1,500,000 with interest accruing at the prime rate plus 3 1/2%. All outstanding principal and accrued interest is due and payable on January 27, 1998 or promptly after the closing of any new financing, debt or equity, in an amount exceeding $1,500,000. The amount outstanding as of July 30, 1997 was $1,250,000. On August 19, 1997 the Company borrowed an additional $250,000 under the facility. On August 19, 1997, the Company entered into a promissory note, term loan agreement, and a security agreement with the Virginia R. Cirica Trust. The loan provides for borrowings up to $500,000 with interest accruing at the prime rate plus 3-1/2%. All outstanding principal and accrued interest is due and payable on August 19, 2002. In connection with the loan, the Company issued a warrant to the Cirica Trust to purchase up to 170,000 shares of the Company's common stock at a price of $2.25 a share. The Company borrowed the full amount of the loan. The Company is actively pursuing additional working capital, which may include additional loans on similar terms, convertible debt or private placement of securities pursuant to Regulation D of the Securities Act of 1933. The Company expects this financing to be completed before the end of this year. The Company believes that cash from operations and these financing activities, if and when completed, will be sufficient to satisfy the Company's working capital needs for the remainder of the fiscal year. The Company anticipates that it will need to seek additional debt or equity financing to fund new retail locations and additional capital expenditures currently projected for fiscal 1999. 12 13 GREEN COFFEE AVAILABILITY The Company believes that it has adequate sources of supply of high quality green arabica coffee to meet its projected needs for the foreseeable future. While the Company seeks to carefully anticipate its green coffee needs, there can be no assurance that supplies and prices will not be affected by weather in coffee growing regions of the world, unexpected demand or incorrect forecasts. 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 have not been realized proportionately in each quarter, with net sales being the highest during the last fiscal quarter which includes the December holiday season. Hot weather tends to reduce sales. 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, the financial results for any individual quarter may not be indicative of the results that may be achieved for a full fiscal year. 13 14 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company's Annual Meeting of Stockholders was held on June 26, 1997 at the Disneyland Hotel in Anaheim, California. Lawrence Goelman, Martin Diedrich, Paul Heeschen, and Peter Churm were elected to the Board of Directors to serve until the next Annual Meeting. In addition to the election of directors, the stockholders voted upon the following propositions: Voting was as follows, as recorded and reported by the inspector of elections: For the Board of Directors
ABSTAIN OR BROKER NAME FOR WITHHELD NON-VOTES ---- --- -------- --------- Peter Churm 4,498,355 36,505 -- Martin R. Diedrich 4,499,105 35,755 -- Lawrence Goelman 4,500,105 34,755 -- Paul C. Heeschen 4,501,555 33,305 --
Approval of an Amendment to the Diedrich Coffee, Inc. 1996 Stock Incentive Plan to increase by 300,000 shares the total number of shares of the Company's Common Stock that may be issued pursuant to such a plan.
AGAINST OR FOR WITHHELD ABSTAIN BROKER NON-VOTES --- -------- ------- ---------------- 2,847,799 156,561 19,677 1,510,823
Ratification of the Selection of KPMG Peat Marwick LLP as independent accountants for the company for the fiscal year ending January 28, 1998.
AGAINST OR FOR WITHHELD ABSTAIN BROKER NON-VOTES --- -------- ------- ---------------- 4,510,150 16,060 8,650 --
14 15 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Set forth below is a list of the exhibits included as part of this Quarterly Report:
EXHIBIT NO. DESCRIPTION ----------- ----------- 3.1 Certificate of Incorporation of the Company(1) 3.2 Bylaws of the Company(1) 10.13 Employment Letter to Jonathan B. Eddison dated June 4, 1997 10.14 Employment Letter to John Bayley dated July 21, 1997 10.15 Employment Letter to Michael Reeves dated May 5, 1997 10.16 Form of Promissory Note made in favor of the Palm Trust 10.17 Form of Term Loan Agreement made to the Virginia R. Cirica Trust 10.18 Form of Security Agreement made to the Virginia R. Cirica Trust 10.19 Form of Warrant Agreement made to the Virginia R. Cirica Trust 10.20 Form of Promissory Note made in favor of the Virginia R. Cirica Trust 27 Financial data schedule
(1) Incorporated by reference to the exhibit of the same number to the Company's Registration Statement on Form S-1 ( No. 333-08633), as amended, as declared effective by the Securities and Exchange Commission on September 11, 1996. (b) REPORTS ON FORM 8-K None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: September 11, 1997 DIEDRICH COFFEE, INC. /s/ Lawrence Goelman ---------------------------------------- Lawrence Goelman, Chairman of the Board and Interim Chief Executive Officer /s/ John Bayley ---------------------------------------- John Bayley, Vice President of Finance and Controller (principal financial officer) 15 EX-10.13 2 EMPLOYMENT LETTER TO JONATHAN B. EDDISON 1 EXHIBIT 10.13 [DIEDRICH COFFEE LETTERHEAD] June 4, 1997 Mr. Jonathan Eddison 227 S. Norton Avenue Los Angeles, CA 90004 Dear Jonathan: On behalf of Diedrich Coffee (Company), it is with great pleasure that we offer you the position as Vice President and General Counsel. In this role, you will have responsibility for legal guidance in areas such as contract development, trademark infringement, labor law compliance, and various other legal applications. Your cash compensation in this position will consist of a base of $100,000 per annum earned and paid ratably on a biweekly basis, and an annual incentive component of up to $20,000 or 20% of your base pay. Payment of the incentive component of your compensation will be based upon financial performance of the Company and the Company's assessment of your performance versus specific objectives set for your areas of responsibility. In addition to the cash compensation defined above, you will be granted stock options under the Company's 1996 Stock Incentive Plan. Your initial grant is for 35,000 shares at market closing price on the date that you accept this offer is subject to approval of the Compensation Committee of the Board of Directors. These options will vest 33 1/3% annually over the next three years. During subsequent years, you will qualify for an additional annual stock option grant for 5,000 shares at the then current price. Subsequent option awards will likewise vest over a 3 years period at 33 1/3% per year. The award of these subsequent year options will be based upon the Company's assessment of your performance versus specific objectives set for your areas of responsibility. As part of your employment, the Company will provide for accelerated vesting of your stock options in the event of a change of control. Furthermore, you will be entitled to standard insurance coverages equal to those provided to other members of senior management. If Diedrich Coffee terminates your employment for any reason other than fraud or other illegal acts, you will be eligible for a severance package equivalent to three months of your annual salary. This will be paid in a lump sum at the time of separation. 2 Jonathan Eddison Page 2 Jonathan, you know that I am personally excited about the prospects of you joining the Diedrich Coffee team. I truly feel that you can make a material difference in taking our Diedrich Coffee to the next level. Further, I trust that you would grow personally and professionally with these responsibilities. It would be a pleasure to have the opportunity to work with you. Please sign this letter and mail it back to me at your earliest convenience. Congratulations and welcome aboard! Sincerely, Kerry Coin President, Chief Operating Officer - ---------------------------------- ------------------------- Jonathan Eddison Date EX-10.14 3 EMPLOYMENT LETTER TO JOHN BAYLEY 1 EXHIBIT 10.14 [DIEDRICH COFFEE LETTERHEAD] July 21, 1997 Mr. John B. Bayley 2144 Michelson Drive Irvine, CA 92612 Dear John: On April 25, 1997, the Compensation Committee of the Board of Directors of Diedrich Coffee, Inc. (the "Company") approved certain changes to your compensation and employment status with the Company. If you are in agreement with the changes set forth below, please sign a copy of this letter (the "Letter") and return it to me. 1. Effective April 28, 1997, you shall assume the position of Acting Vice President of Finance and Controller of the Company. 2. Effective May 1, 1997, your annual base salary shall be adjusted from $75,000 to $85,000. 3. Upon the specific achievement of criteria to be developed between you and the Company, you shall be entitled to a "success bonus" in an amount up to 20% of your annual base salary. These criteria are to be developed in connection with the rebudgeting process for fiscal 1998 that is currently underway. You shall not be entitled to any bonus hereunder unless you and the Company's Chief Executive Officer have agreed upon specific criteria that are set forth in writing and you fulfill the requirements set forth in such document for receiving the success bonus. 4. Effective April 25, 1997, the Compensation Committee of the Board of Directors of the Company granted stock options to you pursuant to the terms and conditions of the Diedrich Coffee, Inc. 1996 Stock Incentive Plan and upon the following additional terms and conditions. You are granted options to purchase 20,000 shares of the Company's common stock at an exercise price of $3.17 (the average closing price of the Company's common stock reported on the NASDAQ National Market for the period beginning 15 trading days prior to April 25, 1997 and ending 15 trading days after April 25, 1997) with the following vesting schedule: 30% of the option shares vest on the first anniversary of the date of grant, 30% of the option shares vest on the second anniversary of the date of grant and 40% of the option shares vest on the third anniversary of the date of grant. These options shall expire on April 24, 2007. Congratulations and I look forward to working with you to build Diedrich Coffee into a thriving and profitable company. Sincerely, /s/ LAWRENCE GOELMAN -------------------------------------------- Lawrence Goelman Chairman and Interim Chief Executive Officer I have reviewed the foregoing and agree to be bound by the terms hereof: /s/ JOHN B. BAYLEY 2/23/97 - -------------------------------- ------------------------ John B. Bayley Date EX-10.15 4 EMPLOYMENT LETTER TO MICHAEL REEVES 1 EXHIBIT 10.15 [DIEDRICH COFFEE LETTERHEAD] May 5, 1997 Mr. Michael Reeves Platinum Rotisserie 100 Cambridge Plaza Drive Winston Salem, NC 27104 Dear Mike: On behalf of Diedrich Coffee (Company), it is with great pleasure that we offer you the position as Vice President of Marketing and Human Resources. In this role, you will have responsibility for development and implementation of brand development initiatives in marketing, merchandising, and public relations. In addition, you will have responsibility for development and implementation of human resources initiatives in such areas as recruitment and selection, compensation and benefits, labor law compliance, and employee welfare. Your cash compensation in this position will consist of a base of $120,000 per annum earned and paid ratably on a biweekly basis, and an annual incentive component of up to $24,000 or 20% of your base pay. Payment of the incentive component of your compensation will be based upon financial performance of the Company and the Company's assessment of your performance versus specific objectives set for your areas of responsibility. In addition to the cash compensation defined above, you will be granted stock options under the Company's 1996 Stock Incentive Plan. Your initial grant is for 50,000 shares at market closing price on the date that you accept this offer. These options will vest 33 1/3% annually over the next three years. During subsequent years, you will qualify for an additional annual stock option grant for 10,000 shares at the then current price. Subsequent option awards will likewise vest over a 3 years period at 33 1/3% per year. The award of these subsequent year options will be based upon the Company's assessment of your performance versus specific objectives set for your areas of responsibility. As part of your employment, the Company will provide for accelerated vesting of your stock options in the event of a change of control. Furthermore, you will be entitled to 2 Michael Reeves Page 2 standard insurance coverages equal to those provided to other members of senior management. If Diedrich Coffee terminates your employment for any reason other than fraud or other illegal acts, you will be eligible for a severance package equivalent to four months of your annual salary. This will be paid in a lump sum at the time of separation. Mike, you know that I am personally excited about the prospects of you joining the Diedrich Coffee team. I truly feel that you can make a material difference in taking our Marketing, Human Resources, and Training Departments to the next level. Further, I trust that you would grow personally and professionally with these responsibilities. It would be a pleasure to have the opportunity to work with you. Please sign this letter and mail it back to me at your earliest convenience. Congratulations and welcome aboard! Sincerely, /s/ KERRY COIN - ---------------------------------- Kerry Coin President, Chief Operating Officer - ------------------------------- ------------------------ Michael Reeves Date EX-10.16 5 FORM OF PROMISSORY NOTE IN FAVOR OF PALM TRUST 1 EXHIBIT 10.16 PROMISSORY NOTE MADE BY DIEDRICH COFFEE, INC. IN FAVOR OF THE PALM TRUST $1,500,000 Maximum Principal Amount May 27, 1997 Irvine, California 1. OBLIGATION. FOR VALUE RECEIVED, the undersigned Borrower hereby promises to pay to the order of The Palm Trust ("Holder") or their successors or assigns, the principal sum of up to One Million Five Hundred Thousand Dollars ($1,500,000) or such lesser amount as may be borrowed under the terms of this Note, together with interest on the unpaid principal amount from time to time outstanding from the date hereof until the principal amount of this Note is paid in full, in accordance with the terms of this Note, at the Note Rate (as defined below). The principal of this Note, together with all accrued and unpaid interest, shall become due and payable on January 27, 1998 or promptly after closing of new financing, debt or equity, in an amount exceeding $1,500,000 (excluding lease financing). Interest shall become due and payable monthly as it is accrued, beginning May 27, 1997. 2. INTEREST. The principal amount of this Note shall bear interest at the Note Rate. The "Note Rate" shall be the prime rate plus three and one-half percent or the maximum rate allowable by law. The prime rate as of any date shall be determined by reference to the prime rate as published in the Wall Street Journal (the base rate on corporate loans posted by at least 75% of the thirty largest U.S. banks). Interest shall be computed daily at the Note Rate on the basis of the actual number of days in which all or any portion of the principal amount hereof is outstanding computed on the basis of a 360 day year. 3. DISBURSEMENTS. Borrower may borrow any amount up to an aggregate amount of $1,500,000 by providing notice to Holder prior to the date of the borrowing, which notice shall include the amount of such borrowing and the date of such borrowing; provided that each such borrowing shall be in a minimum principal amount of $25,000 or any larger multiple of $5,000. Within the limits set forth in this Note, Borrower may borrow amounts under this Note, provided that the aggregate principal balance outstanding under this Note at any given time shall not exceed $1,500,000. All loans made by Holder and all repayments of the principal thereof shall be recorded by the Holder and endorsed by an officer of the Borrower on the Schedule attached hereto, or on a continuation of such schedule 2 attached to and made a part hereof; provided that the failure of Holder to make any such recordation or of Borrower to make any such endorsement shall not affect the obligations of Borrower hereunder. 4. EFFECT OF NON-PAYMENT OF PRINCIPAL AND INTEREST. In the event that any principal and/or interest is not paid when due, without affecting any of Holder's other rights and remedies, the unpaid principal amount and, to the extent permitted by applicable law, interest, shall bear interest at the Note Rate and shall be payable on demand of Holder until such unpaid amount is paid in full. 5. PAYMENT OF PRINCIPAL AND INTEREST. Principal and interest shall be payable in lawful money of the United States at Holder's offices located at 450 Newport Center Drive, #450, Newport Beach, California 92660. 6. PREPAYMENT. This Note may be prepaid at any time without penalty. 7. DEFAULT. Borrower will be deemed to be in default under this Note upon the occurrence of any event of default as defined below: (a) Borrower shall fail to pay when due (whether by acceleration or otherwise) principal or interest on this Note, and such default unless otherwise cured shall have continued for a period of fifteen (15) calendar days; or (b) Any representation or warranty made by or on behalf of Borrower in the Note or in any statement or certificate given in writing pursuant thereto or in connection therewith is false, misleading or incomplete in any material respect when made (or deemed to have been made); or (c) Borrower breaches or fails, or neglects to perform, keep or observe any covenant set forth in the Note and the same has not been cured within ten (10) calendar days after Borrower receives notice thereof from Lender; or (d) Borrower shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general 2 3 assignment for the benefit of creditors, or shall fail to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing; or (e) An involuntary case or other proceeding shall be commenced against Borrower seeking liquidation, reorganization or other relief with respect to its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against Borrower under the federal bankruptcy laws as now or hereafter in effect; or (f) The Note for any reason (other than the satisfaction in full of all amounts owing in connection with the Note) ceases to be, or is asserted by Borrower not to be, a legal, valid and binding obligation of Borrower, enforceable in accordance with its terms; of (g) Borrower has fraudulently conveyed or concealed any material property to prevent attachment or execution by its creditors; or (h) Borrower is insolvent and fails to satisfy or obtain the release of any judicial lien within 30 days of such lien coming into existence; or (i) Borrower has admitted to any person in writing that it is unable to pay its debts and that it is willing to be adjudged a bankrupt. 8. REMEDIES OF LENDER. If an Event of Default shall occur and be continuing or shall exist, the principal amount of the Note and interest accrued thereon shall be immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived, and an action therefor shall immediately accrue. 9. GOVERNING LAW. This Note shall be governed by, and construed and enforced in accordance wit, the internal laws (excluding the laws of conflict and choice of law) of the State of California. 3 4 11. WAIVER. No failure to exercise and no delay in exercising any right, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein provided are cumulative and not exclusive of any rights or remedies provided by law. 12. AMENDMENT. This Note may be amended or modified only upon the written consent of both Borrower and Holder. Any amendment must specifically state the provision or provisions to be amended and the manner in which such provisions(s) are to be amended. [Signature Page Follows] 4 5 [SIGNATURE PAGE TO PROMISSORY NOTE] IN WITNESS WHEREOF, Borrower has executed this Note in favor of The Palm Trust as of the date and year first above written. BORROWER: DIEDRICH COFFEE, INC., a Delaware corporation By: /s/ KERRY W. COIN ----------------------------------------- Name: Kerry W. Coin --------------------------------------- Title: President and Chief Operating Officer ------------------------------------- 5 6 PROMISSORY NOTE MADE BY DIEDRICH COFFEE, INC. IN FAVOR OF THE PALM TRUST MAY 27, 1997 LOANS OF PRINCIPAL
Holder of Borrower Date Amount of Loan Principal Balance Recordation Endorsement By - --------------------------------------------------------------------------------------------- 5/27/97 $350,000 $350,000 The Palm Trust - --------------------------------------------------------------------------------------------- 6/11/97 $600,000 $950,000 The Palm Trust - --------------------------------------------------------------------------------------------- 6/26/97 $300,000 $1,250,000 The Palm Trust - --------------------------------------------------------------------------------------------- 8/19/97 $250,000 $1,500,000 The Palm Trust - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------
6 EX-10.17 6 FORM OF TERM LOAN AGREEMENT 1 EXHIBIT 10.17 TERM LOAN AGREEMENT THIS TERM LOAN AGREEMENT (the "Agreement") is made and entered into as of the 29th day of August, 1997, by and between DIEDRICH COFFEE, INC., a Delaware corporation (the "Borrower"), and THE VIRGINIA R. CIRICA TRUST, a trust organized under the laws of the State of California (the "Lender"). RECITALS A. WHEREAS, Borrower desires to borrow Five Hundred Thousand Dollars ($500,000) for working capital purposes from Lender. B. WHEREAS, Lender advanced Two Hundred Fifty Thousand Dollars ($250,000) to the Borrower pursuant to the Secured Promissory Note dated August 19, 1997 (the "Note"), a copy of which is attached hereto as Exhibit A, and has agreed to advance an additional Two Hundred Fifty Thousand Dollars ($250,000) to Borrower in accordance with the terms and conditions provided herein. AGREEMENT NOW, THEREFORE, in consideration of the foregoing premises and the mutual covenants, agreements, representations and warranties hereinafter set forth, the parties hereto agree as follows: 1. Definitions. 1.1 Action. The term "Action" has the meaning given in Section 11.11. 1.2 Business Day. The term "Business Day" means a day other than a Saturday, Sunday or other day on which commercial banks in the State of California are required by law to close. 1.3 Closing Date. The term "Closing Date" has the meaning given in Section 3.1. 1.4 Closing. The term "Closing" has the meaning given in Section 3.1. 1.5 Common Stock. The term "Common Stock" means the Common Stock, $0.01 par value per share, of Borrower as hereafter modified and any other class of stock of Borrower or of any other entity into which such stock shall be converted or for which it shall be exchanged. 1.6 Event of Default. The term "Event of Default" has the meaning given in Section 10.1. 2 1.7 Final Advance. The term "Final Advance" has the meaning given in Section 2.1. 1.8 GAAP. The term "GAAP" means Generally Accepted Account- ing Principles. 1.9 Intellectual Property. The term "Intellectual Property" has the meaning given in Section 4.25. 1.10 Intercreditor Agreement. The term "Intercreditor Agreement" means the Intercreditor Agreement to be entered into between Lender and the Other Lenders. 1.11 Initial Advance. The term "Initial Advance" has the meaning given in Section 2.1. 1.12 Loan. The term "Loan" means Lender's $500,000 loan to Borrower subject to and upon the terms and conditions set forth herein. 1.13 Loan Documents. The term "Loan Documents" means this Agreement, the Note, the Warrant Agreement, the Warrants and the Security Agreement. 1.14 Maturity Date. The term "Maturity Date" means August 19, 2002. 1.15 Note. The term "Note" has the meaning given in the recitals. 1.16 Note Rate. The term "Note Rate" has the meaning given in Section 2.3. 1.17 Other Agreements. The term "Other Agreements" means two or more term loan agreements, on substantially the same terms as this Agreement except for amounts, between Borrower and the Other Lenders. 1.18 Other Lenders. The term "Other Lenders" means the lenders identified on Schedule 1.18 that may loan up to $2,500,000 to the Company on terms substantially similar to those contained in this Agreement. 1.19 Security Agreement. The term "Security Agreement" means the Security Agreement dated as of August 19, 1997, entered into and between Lender and Borrower, a copy of which is attached hereto as Exhibit B. 1.20 Warrant Agreement. The term "Warrant" means the Warrant issued to Lender by Borrower of even date, in the form of Exhibit C attached hereto. 1.21 Warrant Stock. The term "Warrant Stock" means Borrower's authorized and unissued Common Stock reserved for issuance upon exercise of the Warrant, subject to the terms and conditions of this Agreement. -2- 3 2. Amount and Basic Terms of the Loan. 2.1 Basic Loan Terms. The terms of the Loan shall be as set forth in this Agreement and in the Note. As more fully described below and in the Note, Lender advanced to Borrower Two Hundred Fifty Thousand Dollars ($250,000) on August 19, 1997 pursuant to the Note (the "Initial Advance") and shall advance to Borrower an additional Two Hundred Fifty Thousand Dollars ($250,000) at the Closing (the "Final Advance") and Borrower shall repay that aggregate amount, together with interest from the date of each such advance until fully paid. 2.2 Payments. The entire principal of the Loan, together with all accrued and unpaid interest, shall be due and payable on August 19, 2002. Interest shall be due and payable on the first day of each month as it is accrued, beginning September 1, 1997; provided, however, that if any interest payment is due on a day which is not a Business Day, such payment shall be considered timely if paid on the next Business Day. 2.3 Rate of Interest. The principal balance of the Loan shall bear interest at the "Note Rate," which shall be the "Prime Rate" (as defined below) plus three and one-half percent (3.5%) or the maximum rate allowable by law, whichever is less. The Prime Rate as of any date shall be the base rate on corporate loans posted by at least 75% of the thirty largest U.S. banks as reported by The Wall Street Journal. Interest shall be computed daily at the Note Rate on the basis of the actual number of days in which all or any portion of the principal advanced to Borrower is unpaid, computed on the basis of a 360-day year. 2.4 Security Agreement. The Loan shall be secured by the Security Agreement executed by Borrower as debtor to Lender as a secured party, granting Lender a first-priority security interest (subject to certain limitations contained in the Security Agreement), to the extent of the amount of the indebtedness, in the collateral described in the Security Agreement. 2.5 Warrants. Concurrently with the execution of this Agreement, Borrower will issue the Warrant to purchase 170,000 shares of Warrant Stock of Borrower to Lender pursuant to the terms of the Warrant. 3. Closing Date Delivery. 3.1 Closing Date. The consummation of the transactions contemplated by this Agreement (the "Closing") shall take place at the time and place mutually agreed upon by the parties hereto on September __, 1997 (the "Closing Date"). 3.2 Delivery. At the Closing, each party will deliver the Loan Documents (other than the Note and the Security Agreement which have previously been delivered) for which it is a party, and Lender will make the Final Advance under the Loan by check payable to Borrower or by wire transfer to an account designated by Borrower and acceptable to Lender. Borrower shall endorse the schedule attached to the Note to record the amount of the Final Advance. -3- 4 4. Representations and Warranties of Borrower. Borrower represents and warrants to Lender that: 4.1 Organization and Standing; Charter Documents. Borrower is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite corporate power and authority to own, lease and operate its property and to conduct its business as such is presently conducted and as proposed to be conducted. Borrower is duly qualified to do business as a foreign corporation in any state or jurisdiction in the United States in which such qualification is required by the nature of Borrower's business. True and accurate copies of the Certificate of Incorporation and Bylaws of Borrower, each as currently in effect, have been made available to Lender and its Counsel. 4.2 Capitalization. Immediately prior to the Closing, the authorized capital of Borrower will consist only of 25,000,000 shares of Common Stock and 3,000,000 shares of Preferred Stock. 4.3 Authorization. All corporate action on the part of Borrower and its officers, directors and shareholders that is necessary for the authorization, execution, delivery and performance of the Loan Documents by Borrower has been taken; and the Loan Documents, when executed and delivered, will constitute valid and legally binding obligations of Borrower, enforceable in accordance with their terms. The Warrant Stock of Borrower issuable upon exercise of the Warrant has been duly authorized and reserved and, when and if delivered, will be duly and validly issued and outstanding, fully paid and non-assessable, subject to the rights and restrictions described in the Warrant. 4.4 Validity of the Note. The Note, when endorsed by Borrower in accordance with the terms of this Agreement, will be duly and validly issued for the full amount of the Loan. 4.5 Consents. All consents, approvals, orders, waivers of authoriza- tions of, or registrations, qualifications, designations, declarations or filings with, any court or any federal or state governmental authority or third party required on the part of Borrower or any of its subsidiaries in connection with the consummation of the transactions contemplated by this Agreement and the other Loan Documents will have been obtained prior to and be effective as of the Closing Date. 4.6 Compliance with Other Instruments. Borrower is not in viola- tion of or default under any provision of its Certificate of Incorporation or Bylaws, each as amended. Borrower is not in material violation of or default under any provision of any instrument or contract to which it is a party or by which it is bound, or, to Borrower's knowledge, of any provision of any federal or state statute, rule, governmental regulation, order or decree, applicable to it. 4.7 Litigation. There is no material claim, action, suit, proceeding, arbitration or investigation pending or to the knowledge of Borrower currently threatened by or against Borrower or any of its affiliates which, if adversely determined, is likely to have an adverse effect upon Borrower. Borrower is not a party to or subject to the provisions of any order, writ, injunction, judgment or decree of any court or government -4- 5 agency or instrumentality which may have a material effect upon the Loan or Borrower's ability to enter into and perform its obligations under the Loan Documents. 4.8 Conduct of Business. The conduct of Borrower's business, as now conducted and as proposed to be conducted, and the closing of the transactions completed hereby, will not conflict with or result in a breach of the terms, conditions or provisions of, or constitute a default under, any contract, covenant or instrument under which Borrower is now obligated. 4.9 Title to Property and Assets. Except as described in Schedule 4.9 attached hereto, Borrower owns all its property and assets in its own name free and clear of all mortgages, liens, claims, loans and encumbrances, except for liens for taxes not yet due and payable which are contested in good faith and mechanics liens, materialmen's liens and dairyman's liens for amounts incurred in the ordinary course of business, and for amounts that either are not delinquent or will be repaid with proceeds of the Loan promptly following the Closing. All material contracts of Borrower containing obligations in excess of $50,000 are listed on Schedule 4.9 hereto. Each of the outstanding liens or claims in excess of $50,000, which have been or may be asserted against Borrower or its assets is listed on Schedule 4.9. 4.10 Information; Misleading Statements. No representation, warranty or statement by Borrower in this Agreement or the other Loan Documents, or in any written statement or certificate furnished or to be furnished to Lender pursuant thereto contains or will contain any untrue statement of a material fact or, when taken together, omits or will omit to state a material fact necessary to make the statements made herein or therein, in light of the circumstances in which made, not misleading. 4.11 Offering. Subject to the accuracy of Lender's representations in Section 5 of this Agreement, the offer, issuance and sale of the Note, and the Warrant constitutes, and will constitute, transactions exempt from the registration and prospectus delivery requirement of Section 5 of the Securities Act of 1933, as amended, and Borrower has obtained (or is exempt from the requirement to obtain) all qualifications, permits, and other consents required by all applicable state laws governing the offer, sale or issuance of securities. 4.12 Accuracy of Financial Records. Each of (a) the financial state- ments of Borrower attached to Schedule 4.12 hereto, (b) the financial statements of Borrower provided to Lender prior to the date hereof, and (c) the financial statements of Borrower to be provided to Lender under this Agreement, shall have been prepared in accordance with GAAP (except as disclosed therein and except that interim financial statements do not and will not contain footnotes and are subject to year-end adjustments) and fairly in all material respects (or, as to financial statements to be provided in the future, will fairly in all material respects) represent the financial condition of Borrower as at the dates thereof and the results of operations for the periods then ended. Borrower is not aware of any fact or claim that when reasonably applied would render the information contained in any of the financial statements delivered to Lender on or prior to the date hereof materially false or misleading. 4.13 No Material Adverse Change. Except as disclosed in any of Borrower's financial statements delivered to Lender prior to the date hereof, Borrower has -5- 6 no actual knowledge of any fact or claim that has occurred that will cause a material change in Borrower's business, or its ability to operate. 4.14 Lender to Have First-Priority Lien; No Junior Liens. Except as disclosed on Schedule 4.9 and subject to the terms of the Intercreditor Agreement, this Agreement and the other Loan Documents give Lender a first-priority security interest in all of the collateral identified in the Security Agreement, and there are no junior liens presently existing with respect to such collateral. 4.15 No Other Encumbrances on Borrowers Leases. Except as described in Schedule 4.15, none of Borrower's rights under any of its leases are or will be subject to a sublease, assignment or agreement, or have otherwise been or will be otherwise transferred or encumbered, except to Lender (or to the Other Lenders pursuant to the Other Agreements). 4.16 No Outstanding Warrants or Options. Except for the Warrant granted to Lender (and the similar warrants granted to the Other Lenders in connection with the Other Agreements), options issued to underwriters, and the rights of Borrower's employees as set forth in various stock option plans and agreements, there are no outstanding warrants, stock options, or other similar rights outstanding as of the date of this Agreement with respect to any securities of Borrower. 4.17 Outstanding Obligations. Except for (a) this Agreement and the other Loan documents, (b) the Other Agreements, (c) the leases identified in Schedule 4.9, (d) the co-branding relationships described on Schedule 4.15, (e) contracts for the purchase of inventory in the ordinary course of business, and (f) such other obligations as are identified on Schedule 4.17, Borrower has not entered into any contract, agreement or commitment which obligates or may obligate borrower to pay, now or in the future, a total of $100,000 or more to any person or entity or which would require Borrower to pay, now or in the future, a total of $100,000 or more to any group of persons or entities for the same or related goods and/or services. 4.18 Financial Information. Borrower shall make all of its books and financial records available for inspection by Lender or its authorized agents and representatives within seven days following a written request by Lender. Promptly upon its receipt of a written request from Lender therefor, Borrower shall provide Lender with copies of final and interim balance sheets, final and interim profit and loss statements (broken down on a month-by-month and/or a store-by-store basis if so requested); final and interim budgets; narrative explanations by a senior executive of Borrower setting forth why Borrower's budgets and projections are believed to be accurate and Borrower's plans for expansion of its business or the closing of any of its stores, leases, contracts, agreements or other commitments (including "soft commitments") which obligate or might obligate Borrower to pay, during the term of such lease, contract, agreement or other commitment, a total of $100,000 or more to any person or entity (or which would require Borrower to pay a total of $100,000 or more to any group of persons or entities for the same or related goods and/or services); explanations of any fact, claim or circumstance which could have a material adverse effect on Lender, its business or its ability to satisfy its obligations under this Agreement, the Note, or any of the other Loan Documents, and all such similar financial records and information as Lender may reasonably request. Borrower shall promptly furnish Lender with the information identified in this Section -6- 7 upon Lender's agreement that, with respect to any material inside information which Lender may receive pursuant to this section, Lender will retain such information in confidence and use it solely in connection with the enforcement of Lender's rights under this Agreement and the other Loan Documents. 4.19 Inspections. Borrower shall grant Lender reasonable access to all of Borrower's places of business to inspect the premises and the collateral described in the Security Agreement. 4.20 Notice of Certain Events. Borrower shall promptly notify Lender of any fact, occurrence or event which (a) constitutes (or which would, with the passage of time, constitute) an Event of Default under this Agreement or a breach of or default under any of the other Loan documents, (b) results in a fire or other casualty of any of its assets which caused or is expected to cause damages of $100,000 or more to Borrower, or (c) would render any fact, representation or warranty contained in any of the Loan documents or otherwise conveyed to Lender false or misleading. Borrower shall also promptly notify Lender of each fire, casualty or accident which has caused or is expected to cause damages or liabilities of $100,000 or more. 4.21 Notification of Governmental Claims; Compliance with Govern- mental Directives. Lender shall promptly notify Lender of any eminent domain or similar proceedings which are brought or threatened against any of its properties or assets and of each other court or governmental notice, order, ruling or directive which would prevent or have a material adverse effect on Borrower's ability to carry on its business at any of its stores or otherwise conducts its affairs. Except as Borrower may contest in good faith, Borrower shall comply with all notices, orders, rulings and directives made by any court or governmental authority relating to the conduct of its business or the maintenance of any license, permit or authorization which Borrower is or may be required to maintain. 4.22 Payment of Taxes and Assessments. Borrower has filed all necessary federal, state and local tax returns and similar filings within the times and in the manner prescribed by law and has paid all taxes and assessments (including without limitation, all payroll and income taxes and all taxes on sales, inventory and fixtures) and any penalties and interest relating thereto, that are or were due and payable. 4.23 Provisions for Obligations. Borrower has made and shall con- tinue to make adequate provisions for the payment of all tax obligations which are not yet due and payable. Borrower has made and shall continue to make adequate provisions for the payment or other full satisfaction of all mechanics' liens, landlord liens, dairymen's liens and similar obligations which it has incurred or will incur in the future. 4.24 Names; Subsidiaries. Borrower has not, does not and will not do business under any name or trade name other than its own. Borrower does not own, directly or indirectly, any interest or investment (whether equity or debt) in any corporation, partnership, business, trust, joint venture or any other entity or subsidiary. 4.25 Intellectual Property. Borrower owns, and/or has applied for, the trademarks, service marks, copyrights, patents, inventions and processes which are listed on Schedule 4.25 (collectively, "Intellectual Property"). Except with respect to -7- 8 certain co-branding relationships described on Schedule 4.15, no person other than Borrower owns any trademark, service mark, copyright, patent, invention or process the use of which is necessary or contemplated in connection with the operation of Borrower's business or in connection with the performance of any contract to which Borrower is a party. Borrower has not infringed, and is not now infringing, on any trademark, service mark, copyright, patent, invention or process which is protected by federal trademark, copyright or patent protection; and there are no pending or threatened actions against Borrower relating to any alleged infringement. 4.26 No Guarantees. Borrower is not a guarantor, surety, co-obligor or otherwise responsible, directly or indirectly, primarily or secondarily, for the obligation, debt or liability of any other person or entity. 4.27 Insurance. As set forth in greater detail in the Security Agree- ment, Borrower: (a) maintains and shall continue to maintain adequate insurance protection against all damages, losses, liabilities, claims and risks against which it is customary to insure, all in amounts as are adequate given the nature and size of Borrower's business and its foreseeable risks and (b) shall cause Lender and its successors and assigns to be named as additional insureds on all of Borrower's insurance policies. 5. Representations, Warranties and Covenants of Lender. Lender repre- sents and warrants to Borrower that: 5.1 Organization. Lender is a trust duly formed under the laws of the State of California and has the requisite power and authority to own, lease and operate its property and to conduct its business as such is presently conducted and is proposed to be conducted. 5.2 Authorization. All action on the part of Lender and its representatives necessary for the authorization, execution, delivery and performance of the Loan Documents by Lender has been taken; and the Loan Documents, when executed and delivered, will constitute valid and legally binding obligations of Lender, enforceable in accordance with their terms. 5.3 Consents. All consents, approvals, orders or authorizations of, or registrations, qualifications, designations, declarations or filings with, any court or any federal or state governmental authority required on the part of Lender in connection with the consummation of the transactions contemplated by this Agreement and the other Loan Documents will have been obtained prior to and be effective as of the Closings. 5.4 Investment Intent. The Note has been and the Warrant to be issued to Lender pursuant to this Agreement and the Warrant Stock issuable upon exercise of the Warrant are being acquired by Lender solely for its own account, for investment purposes only, and with no present intention of distributing, selling or otherwise disposing of the Note, the Warrant or the Warrant Stock issuable upon exercise of the Warrant. 5.5 Sophistication. Lender is able to bear the economic risk of the investment required pursuant to this Agreement and can afford to sustain a total loss on such investment, and has such knowledge and experience in financial and business matters -8- 9 that it is capable of evaluating the merits and risks of the proposed investment and therefore has the capacity to protect its own interests in connection with the Loan. 6. Conditions Precedent to Lender's Obligations at Closing. The obliga- tion of Lender to make the Final Advance under the Loan is subject to the satisfaction (or written waiver by Lender) of all the following conditions precedent: 6.1 Representations True. All representations and warranties of Bor- rower contained in this Agreement and all other Loan Documents will be true, correct and complete in all respects with the same effect as though such representations and warranties had been made on and as of the Closing and Lender will have received a certificate from the President or Chief Executive Officer of Borrower certifying the foregoing. 6.2 Note. A duly-authorized officer of Borrower will have endorsed the schedule attached to the Note to record the amount of the Final Advance. 6.3 Corporate Documents. Lender will have received, in form and substance satisfactory to Lender and its counsel, a copy of the records of all actions taken by Borrower, including corporate resolutions of Borrower authorizing or relating to the execution, delivery and performance of the Loan Documents and the consummation of the transactions contemplated thereby, and a certified copy of the Certificate of Incorporation and Bylaws of Borrower. 6.4 Qualifications and Consents. All authorizations, approvals, permits, consents or waivers if any, of (i) governmental authority or regulatory body of the United States or of any state or (ii) any third party that are required on the part of Borrower in connection with the receipt of the Loan or the issuance of the Note and the Warrant will have been duly obtained and will be effective on and as of the Closing Date. 6.5 Proceedings and Documents. All corporate and other proceed- ings in connection with the transaction contemplated by this Agreement and all documents incident to such transaction, including but not limited to the Note and the Security Agreement are and the Warrant will be in form and substance satisfactory to Lender and its counsel, and Lender will have received all counterpart originals or certified or other copies of such documents as it may reasonably request. 6.6 Performance. Borrower shall have performed and complied with all terms and conditions required to be performed or complied with by it prior to or at the Closing, and no Event of Default shall exist. 6.7 Absence of Litigation. No suit, action, proceeding, court order, administrative order or investigation shall have occurred, be pending or threatened which would or seeks to prevent or delay beyond the date of the Closing, the consummation of the transactions contemplated by this Agreement or the operation of Borrower's business. 6.8 Opinion of Borrower's General Counsel. Borrower's General Counsel shall deliver to Lender a legal opinion substantially in the form of Exhibit D hereto. -9- 10 6.9 No Material Changes. No fact or event has occurred or been discovered which would have a material adverse effect on the accuracy of the financial information provided by Borrower to Lender or which would have a material adverse effect on the liability or conduct of Borrower's business. 7. Conditions Precedent to Borrower's Obligation at the Closing. The obligation of Borrower at the Closing is subject to fulfillment, at or before the Closing, of each of the following conditions: 7.1 Representations and Warranties True. The representations and warranties of Lender contained in Section 5 hereof will be true and correct at and as of the Closing Date. 7.2 Funds Disbursed. Borrower will receive from Lender the principal sum of the Final Advance at the Closing. 7.3 Performance. Lender shall have performed and complied in all respects with all agreements and conditions contained herein required to be performed by or complied with by it prior to the Closing. 8. Covenants of Borrower. Borrower hereby covenants and agrees with Lender as follows: 8.1 Corporate Rights; Facilities; Conduct of Business. Borrower shall: (a) Maintain and preserve in full force and effect its corporate existence and all rights, licenses, leases qualifications, privileges, franchises and other authority necessary or appropriate for the conduct of its business; (b) Subject to Borrower's reasonable business judgment as to opening new business sites and closing those that do not meet Borrower's financial requirements, Borrower will maintain, preserve and protect all its properties, assets, equipment and facilities in good order and working repair and condition (taking into consideration ordinary wear and tear) and from time to time make, or cause to be made, all needful and proper repairs, renewals and replacements thereto; (c) Maintain, preserve and protect its goodwill and all of its rights to enjoy and use patents, copyrights, trademarks, trade names, service marks, licenses, leases, and franchises; (d) Promptly pay and discharge all taxes, including taxes on inventories and fixtures, when due and payable, except such as may be contested in good faith by appropriate proceedings and for which an adequate reserve has been established and is maintained in accordance with GAAP. Borrower will promptly notify Lender of any challenge, contest or proceeding pending by or against Borrower before any taxing authority; (e) Maintain all banking accounts at FDIC- or FSLIC-insured banks or other financial institutions; -10- 11 (f) From time to time as may be necessary, disclose to Lender in writing any material matter hereafter arising which, if existing or occurring at the date of this Agreement, would have been required to be set forth or described by Borrower in this Agreement or any of the other Loan Documents (including all schedules and exhibits hereto or thereto) or which is necessary to correct any information set forth or described by Borrower hereunder or thereunder which has been rendered inaccurate thereby. 8.2 Expenses. Borrower shall immediately pay Lender upon demand all costs and expenses incurred by Lender in connection with: (a) the preparation of this Agreement and all other Loan Documents contemplated hereby; and (b) the administration of this Agreement and the other Loan Documents for the term of the Loan. For all purposes of this Agreement, Lender's costs and expenses shall include, without limitation, all legal fees and expenses, accounting fees and auditor fees. In no event shall such expenses to Borrower exceed Five Thousand Dollars ($5,000). 8.3 Reservation of Warrant Stock. Borrower, during the period within which the Warrant may be exercised, shall at all times have authorized and reserved, for the purpose of issuance upon the exercise of the Warrant, a sufficient number of shares of Common Stock to provide for such exercise. 8.4 Negative Covenants. So long as any portion of the Loan remains outstanding, Borrower will not, without first obtaining Lender's prior written consent, which consent will not be unreasonably withheld: (a) declare or pay any dividend on or declare or make any distribution on account of, any shares of any class of stock now or hereafter outstanding, or set apart any sum for such purpose, except for shares of Common Stock issued by Borrower to its employees or other participants pursuant to Borrower's existing stock option plans; or (b) issue or enter into any agreement that restricts its ability to repay the Loan. 8.5 Further Assurances. In addition to the obligations and documents which this Agreement expressly requires Borrower to execute, deliver and perform, Borrower will execute, deliver and perform, and will cause its subsidiaries to execute, deliver and perform, any and all further acts or documents which Lender may reasonably require to effectuate the purposes of this Agreement or any of the other Loan Documents. 9. Prepayment of the Note. 9.1 Mandatory Prepayments. Borrower shall prepay up to the $500,000 aggregate principal amount (or such lesser principal amount as shall then be outstanding) of the Note immediately upon the issuance, offer or sale of any shares of its capital stock pursuant to a secondary offering to the public with net proceeds of greater than Ten Million Dollars ($10,000,000); excluding, however, any offering of Common Stock of Borrower pursuant to stock option, bonus, award or other employee benefit plan and existing options to purchase the Common Stock of Borrower held by officers, directors or employees of Borrower. -11- 12 9.2 Optional Prepayment. Borrower may prepay the Loan in any amount which is an integral multiple of $10,000 at any time without penalty. 10. Events of Default of Borrower. 10.1 Events of Default. Each of the following shall constitute an event of default ("Event of Default") under this Agreement: (a) Borrower shall fail to pay when due (whether by acceleration or otherwise) principal or interest on this Note, and such default shall have continued for a period of fifteen (15) days; or (b) Any representation or warranty made by or on behalf of Bor- rower in this Agreement, the Note or in any other Loan Document or in any statement or certificate given in writing pursuant thereto or in connection therewith is false, misleading or incomplete in any material respect when made (or deemed to have been made); or (c) Borrower breaches or fails or neglects to perform, keep or observe any covenant set forth in this Agreement, the Note, or any other Loan Document other than Borrower's obligation to make all payments due under the Note when due and the same has not been cured within ten (10) calendar days after Borrower receives notice thereof from Lender; or (d) Borrower shall commence a voluntary case or other proceed- ing seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing; or (e) An involuntary case or other proceeding shall be commenced against Borrower seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against Borrower under the federal bankruptcy laws as now or hereafter in effect; or (f) This Agreement, the Note or any other Loan Document for any reason (other than the satisfaction in full of all amounts owing in connection with the Loan) ceases to be, or is asserted by Borrower not to be, a legal, valid and binding obligation of Borrower, enforceable in accordance with its terms, and such occurrence has not been cured to Lender's satisfaction within five (5) calendar days after Borrower receives notice thereof from Lender; or -12- 13 (g) Borrower has fraudulently conveyed or concealed its property to prevent attachment or execution by its creditors; or (h) Borrower is insolvent and fails to satisfy or obtain the release of any judicial lien within 30 days of such lien coming into existence; or (i) Borrower has admitted to any person in writing that it is unable to pay its debts and that it is willing to be adjudged a bankrupt. 10.2 Remedies of Lender. If an Event of Default shall occur and be continuing or shall exist, the principal amount of the Note and interest accrued thereon shall be immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived, and an action therefor shall immediately accrue. 10.3 Indemnification. Borrower hereby agrees to defend, indemnify and hold harmless Lender, its officers, employees, agents, successors and assigns from and against any and all losses, damages, liabilities, claims, actions, judgments, court costs and legal or other expenses (including, without limitation, attorneys' fees and expenses) which Lender may incur as a direct or indirect consequence of: (a) the purpose to which Borrower applies proceeds of the Loans; (b) the material failure of Borrower to perform any obligations as and when required by this Agreement, the Note or any of the other Loan Documents; (c) any failure at any time of any of Borrower's representations or warranties to be materially true and correct; or (d) any act or omission by Borrower. Borrower shall immediately pay to Lender upon demand any amounts owing under this indemnity, together with interest from the date the indebtedness arises until paid at the rate of interest applicable to the principal balance of the Note. 11. Miscellaneous. 11.1 Survival of Representations and Warranties. The representations and warranties contained herein or made pursuant to this Agreement and all other Loan Documents shall survive the Closing. 11.2 Notices. All notices and other communications hereunder shall be in writing and shall be deemed given upon personal delivery, facsimile transmission (with written or facsimile confirmation of receipt), telex or delivery by a reputable overnight commercial delivery service (delivery, postage or freight charges prepaid), or on the fourth day following deposit in the United States mail (if sent by registered or certified mail, return receipt requested, delivery, postage or freight charges prepaid), addressed to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (a) if to Lender, to: The Virginia R. Cirica Trust Attention: Virginia R. Cirica ___________________________________ ___________________________________ ___________________________________ Fax: (714) ___-____ -13- 14 with a copy to: __________________________________ __________________________________ __________________________________ (b) if to Borrower, to: Diedrich Coffee, Inc. Attention: President 2144 Michelson Drive Irvine, California 92612 Fax: (714) 756-1144 with a copy to: Paul, Hastings, Janofsky & Walker LLP Attention: Peter J. Tennyson, Esq. 695 Town Center Drive, 17th Floor Costa Mesa, CA 92626-1924 Fax: (714) 979-1921 11.3 Interpretation. When a reference is made in this Agreement to an Article, Section, Exhibit or Schedule, such reference shall be to an Article, Section, Exhibit or Schedule to this Agreement unless otherwise indicated. The words "include," "includes" and "including" when used herein shall be deemed in each case to be followed by the words "without limitation." 11.4 Counterparts; Faxes. This Agreement may be executed on any number of separate counterparts and all of said counterparts taken together shall be deemed to constitute one and the same document and shall become effective when each party has delivered to the other party a counterpart duly executed by it, it being understood that all parties need not sign the same counterpart. An executed signature page of this Agreement which is transmitted by fax shall be treated for all purposes as containing an original signature of the party whose signature appears thereon; as a courtesy, however, when a signature is initially provided by fax, an original, hand-signed signature page shall also be provided. 11.5 Integration. This Agreement, the Note, the Security Agreement and the Warrant and the exhibits and schedules attached hereto and thereto constitute the entire agreement among the parties with respect to the subject matter set forth herein or therein and supersede all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof or thereof. 11.6 Amendment. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. 11.7 Governing Law. This Agreement and the rights and obligations of the parties hereunder shall be governed in all respects, including validity, interpretation and effect, by the laws of the State of California, including its rules of conflicts of law or choice of law. 11.8 Assignment. No party hereto shall assign or transfer or permit the assignment or transfer of this Agreement without the prior written consent of the other party. -14- 15 11.9 Severability. Any portion or provision of this Agreement which is invalid, illegal or unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity, illegality or unenforceability, without affecting in any way the remaining portions or provisions hereof in such jurisdiction or, to the extent permitted by law, rendering that or any other portion or provision of this Agreement invalid, illegal or unenforceable in any other jurisdiction. 11.10 Brokers. No finder, broker, agent, financial advisor or other intermediary has acted on behalf of Lender in connection with the transactions contemplated by this Agreement. Borrower and Lender acknowledge that Gregg Rondinelli and Gregg Rondinelli & Associates (collectively, "Rondinelli") has provided services to Borrower in connection with the negotiations and transactions which led to the execution of this Agreement and the other Loan documents, and agree that Borrower shall be solely responsible for the payment of all sums, if any, which are due to Rondinelli in this regard. Borrower and Lender further agree that, at all times, Rondinelli was acting exclusively for Borrower and not at the request of or for the benefit of Lender. 11.11 Attorneys' Fees. If any party to this Agreement shall bring any action, suit, counterclaim or appeal for any relief against any other party, declaratory or otherwise, to enforce the terms hereof or to declare rights hereunder (collectively, an "Action"), the prevailing party shall be entitled to recover as part of any such Action its reasonable attorney's fees and costs, including any fees and costs incurred in bringing and prosecuting such Action and/or enforcing any order, judgment, ruling or award granted as part of such Action. "Prevailing party" within the meaning of this section includes, without limitation, a party who agrees to dismiss an Action upon the other party's payment of all or a portion of the sums allegedly due or performance of the covenants allegedly breached, or who obtains substantially the relief sought by it. (Signature Page Follows) -15- 16 [SIGNATURE PAGE - TERM LOAN AGREEMENT] IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. BORROWER: LENDER: DIEDRICH COFFEE, INC., THE VIRGINIA R. CIRICA TRUST a Delaware corporation By:______________________________ By: ______________________________ Name: ___________________________ Virginia R. Cirica, Trustee Title: __________________________ -16- 17 EXHIBIT TO TERM LOAN AGREEMENT FORM OF OPINION OF DIEDRICH COFFEE, INC. This opinion is delivered in connection with that certain Loan and Security Agreement, dated as of August , 1997 (the "Loan Agreement") between Diedrich Coffee, Inc., a Delaware corporation (the "Borrower"), and Newco, LP (the "Lender"). Initially capitalized terms used herein shall have the meaning given such terms in the Loan Agreement, unless specifically defined herein. I have acted as General Counsel to the Borrower in connection with the negotiation, execution and delivery of the following documents: The Loan Agreement; the Note, of even date therewith, in the original principal amount of One Million Five Hundred Thousand Dollars ($1,500,000), executed by Borrower in favor of Lender, the Security Agreement executed by Borrower in favor of Lender, the financing statement(s) executed by the Borrower (collectively, the "Financing Statements"), and the Warrant Agreement and Warrant in favor of the Lender of even date herewith. The Loan Agreement, the Note, the Security Agreement, the Financing Statements, the Warrant Agreement, and the Warrant are referred to herein collectively as the "Loan Documents." This opinion is furnished to you as required by Section 7.1(h) of the Loan Agreement. The documents I examined in rendering this opinion, and upon which I relied, are the following: (i) the Loan Documents; (ii) the Articles of Incorporation of the Company certified by the Delaware Secretary of State on ___________________________; (iii) the Bylaws of the Company as of this date; (iv) certificate from the Delaware Secretary of State indicating that the Company is in good standing as of ____________; certificate from California Secretary of State indicating that the Company is in good standing as of ____________; certificate from the Colorado Secretary of State indicating that the Company is in good standing as of ____________; and certificate from the 18 EXHIBIT TO TERM LOAN AGREEMENT Texas Secretary of State indicating that the Company is in good standing as of ____________. (v) certificate dated ________________ of the Franchise Tax Board attesting to the current payment by the Company of all franchise and similar state taxes of the State of California; (vi) minutes of meetings of the Board of Directors and Shareholders of the Company at which actions were taken with respect to the Loan Documents; (vii) certificates of responsible officers of the Company as to factual matters; and (vii) UCC Search Report on Diedrich Coffee as debtor by CSC Networks dated __________________ (financing statements, financing statements change documents, federal or state tax liens, certain judgment liens, and attachment liens). Insofar as this opinion relates to the absence of actions, liabilities, mortgages, security interests, chattel mortgages, conditional sales agreements, pledges, liens, leases, agreements or encumbrances (the foregoing types of claims are collectively referred to as the "Enumerated Interests"), I have relied upon, and assumed the accuracy of, the Reports and Certificates of responsible officers of the Company. I searched only under those corporate names of the Company shown in its Articles of Incorporation as certified by the office of the Secretary of State of California. Information regarding the Enumerated Interests does not include any filings filed, indexed or terminated in the State of California after the effective dates indicated for each of the Reports, and accordingly, I express no opinion relating to the existence or absence of any Enumerated Interests filed, indexed or recorded after the effective dates. I assumed that the following facts are true in rendering this opinion: (i) the Borrower owns the assets to be subject to Lender's security interests (as described in the Loan Documents) free and clear of any liens, encumbrances, or claims, except as shown in the Reports; (b) the Company has good and sufficient title to these assets; and (c) these assets exist. (ii) Lender has no notice of any security interest in the Collateral in favor of any third person; 19 EXHIBIT TO TERM LOAN AGREEMENT (iii) Lender has taken possession of the Notes for new value and in good faith; (iv) the due authorization, execution, and delivery of, and the validity and binding effect of, the Loan Documents with regard to Lender; (v) the delivery to, or for the benefit of the Borrower at the closing of the funds to be loaned pursuant to the Loan Documents; (vi) the filing of the Financing Statements with the California, Colorado and Texas Secretaries of State and the proper indexing of the Financing Statements by that office; (vii) the representations contained in the Loan Documents; (viii) the genuineness of all signatures of parties on all documents (other than the Loan Documents to the extent signed); (ix) the authenticity of all documents submitted to me as originals (other than the Loan Documents); (x) the conformity to the originals of all documents submitted to me as copies; (xi) the correctness and accuracy of all facts set forth in all certificates and reports identified in this opinion; (xii) regarding documents executed by parties other than the Borrower, that those parties had the individual capacity and corporate power to enter into and perform all obligations under those documents, the due authorization by all requisite corporate action of the execution and delivery of those documents, and the validity and bindings effect of those documents on those persons; (xiii) that except as stated in the Loan Documents, there are no other documents or agreements between Borrower and Lender which would have an effect on the opinions expressed in this opinion; and (xiv) that Lender is _________________________________________________, a ___________________________ Ltd. Partnership and has qualified to do business in the state of California, has obtained all necessary permits in that state to make the Loan, and has paid all taxes due and owing on its activities in California. 20 EXHIBIT TO TERM LOAN AGREEMENT On the basis of the foregoing, and in reliance thereon, and subject to the assumptions qualifications, exceptions and limitations set forth in this opinion, I am of the opinion that: 1. The Borrower is a corporation which has been duly incorporated and organized as validly existing, and in good standing under the laws of the State of Delaware and has the corporate power and authority to enter into and perform under the Loan Documents, to the extent it is a party thereto. 2. The Borrower is duly qualified to own and operate its properties and assets and to carry on its business as they are currently being conducted (as described in the Company's Annual Report on Form 10-K) and as they are contemplated to be conducted pursuant to the terms of the Loan Documents, and is in good standing in the States of California, Colorado, and Texas. 3. The Loan Documents, to the extent the Borrower is a party thereto, have been duly authorized by all necessary corporate action on the part of the Borrower, under the laws of Delaware, and have been duly executed and delivered by the Borrower. 4. The Loan Documents, to the extent the Borrower is a party thereto, constitute the legal, valid, and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms. 5. The execution, delivery, and performance of the Loan Documents by the Borrower, to the extent it is a party thereto, the compliance with the terms and conditions thereof, and the consummation of the transactions contemplated thereby, do not and will not conflict with, result in a breach of, or constitute a default under (i) any existing statute, rule, or regulation applicable to the Borrower; (ii) the certificate or articles of incorporation or bylaws of the Borrower; or (iii) to the best of my knowledge, after reasonable inquiry, any agreement or instrument to which the Borrower is a party or by which it or its assets are bound, or any order, judgment, or decree which is binding on the Borrower. 6. Subject to the exceptions and facts acknowledged below, the Loan Documents create a valid, perfected security interest in and to the personal property described. 21 EXHIBIT TO TERM LOAN AGREEMENT 7. No governmental consents, approvals, authorization, registrations, declarations, or filings are required by the Borrower in connection with the extensions of credit under the Loan Documents or the consummation of the transactions contemplated by the Loan Documents, except for filings required for the perfection of Lender's liens and security interests. 8. To the best of my knowledge, after due inquiry, there are no material actions, suits, proceedings, or investigations pending or threatened against the Borrower except: Qualifications and Exceptions (i) The opinions expressed herein are qualified to the extent that the validity, binding nature, and enforceability of any of the terms of the Loan Documents may be limited or otherwise affected by: (a) general principles of equity (regardless of whether enforceability is considered in a proceeding in equity or at law); (b) bankruptcy, insolvency, reorganization, arrangement, moratorium, fraudulent transfer or other similar laws generally affecting creditors' rights at the time in effect; and (ii) Except as expressly stated in this opinion, I neither express nor imply any opinion as to the creation, perfection or priority of any purported security interest in any property. (iii) Insofar as they relate to the creation, perfection and effect of perfection or non-perfection of a security interest, the opinions set forth are limited to Collateral consisting of personal property which is subject to California law on the creation, perfection and effect of perfection or non-perfection of a security interest in personal property, as set forth in Article 9 of the California Uniform Commercial Code ("CUCC"). (iv) Expect as specifically stated in this opinion, the opinions given above as to the perfection and priority of security interests apply only to property in which a security interest may be perfected by the filing of a financing statement pursuant to Section 9-302, and I call to your attention that the Collateral is defined to include items in which a security interest may not be perfected by such a filing. 22 EXHIBIT TO TERM LOAN AGREEMENT (v) The opinions expressed herein are further qualified by limitations imposed by California law on a secured lender's right to enforce collection of, or collect, any deficiency remaining after a foreclosure sale or the conclusions of any action to enforce an obligation if there has not been compliance with the procedural requirements of state law. (vi) I express no opinion as to the laws of any other state or the perfection and effect of perfection or non-perfection of a security interest in Collateral subject to the laws of another state; and (a) Uniform Commercial Code 9-501 et seq. relating to the exercise of remedies by a lender; the possible application of requirements to marshall its claim; and (b) the possible subordination of lender's claims or security interest based on its future conduct; (vii) I express no opinion on: limitations based on statutes or on public policy limiting a person's right to waive the benefits of statutory provisions or common law rights; nor on (a) Limitations on the right of Lender to exercise rights and remedies under the Loan Documents for defaults by Borrower if it is determined that the defaults are not material; (b) Limitations on Lender's right to exercise rights and remedies under the Loan Documents for defaults by the Borrower if it is determined that any late charges or penalties bear no reasonable relation to the damage suffered by the lender as a result of delinquencies or defaults; (c) Limitations on Lender's right to exercise rights and remedies under the Loan Documents for defaults by Borrower if it is determined that the performance or enforcement of the covenants or provisions would violate Lender's implied covenant of good faith and fair dealing; (d) The unenforceability under certain circumstances of provisions releasing a party from, or indemnifying a party against, liability for its own wrongful or negligent acts or where such release or indemnification is contrary to public policy; and In rendering this opinion, I assumed Lender is an sophisticated investor represented by counsel experienced in secured lending, and thus have not attempted to call to your attention particularly to the limits imposed by California law on the exercise of a secured lender's rights, including requirements of notice and commercially reasonable 23 EXHIBIT TO TERM LOAN AGREEMENT conduct. Such limitations do not render the Loan Documents invalid as a whole and, in the event of a material breach of a material covenant in the Loan Documents, Lender may exercise remedies that would be normally available to a secured lender. The opinions expressed herein are solely for the benefit of, and may not be relied on in any manner or for any purpose by any person other than Lender, its counsel, and its participants, successors and assigns. The opinions expressed herein relate only to the laws of the State of California, the General Corporation Law of the State of Delaware, and the federal laws of the United States of America. By: -------------------------------------- Jonathan B. Eddison Its: Vice President and General Counsel Date: ------------------------------------ EX-10.18 7 FORM OF SECURITY AGREEMENT 1 EXHIBIT 10.18 SECURITY AGREEMENT The parties to this Security Agreement ("Agreement") are: SECURED PARTY: The Virginia Cirica Trust DEBTOR: Diedrich Coffee, Inc., a Delaware Corporation TERMS 1. Definitions. (a) "Collateral" refers to all of Debtor's assets, both tangible and intangible, whether on Debtor's premises or elsewhere, including, without limitation: (i) all of Debtor's present and future accounts receivable, including accounts, instruments, documents, chattel paper, and general intangibles in which Debtor, has or later acquires rights (collectively, "Accounts"); (ii) all present and future proceeds of all Accounts; (iii) all of Debtor's present and future contract rights, including, without limitation, all rights under any insurance policy; (iv) all of Debtor's present and future rights as lessee under any lease, including furnishings, fixtures, improvements, and personal property; (v) all of Debtor's present and future rights as lessor under any lease, including furnishings, fixtures, improvements, and personal property; (vi) all of Debtor's present and future equipment, fixtures, and trade fixtures; (vii) all of Debtor's present and future inventory; 2 (viii) all of Debtor's present and future bank accounts, deposits, and certificates of any kind; (ix) all of Debtor's present and future brokerage accounts of any kind; (x) all shares, bonds, securities, or other indicia of ownership in or rights with respect to any corporation or business entity owned by Debtor, now or in the future; (xi) all interests which Debtor has or may acquire in any real property, wherever located; (xii) all books, records, ledger cards, computer programs, and other property and general intangibles evidencing or relating to the Accounts, any account debtor, or any form of Collateral, including all file cabinets or containers in which they are stored (collectively, "Records"); (xiii) all of Debtor's present and future rights with respect to intellectual property, including, without limitation, all trade names and trademarks (and the goodwill of the business they symbolize), patents, copyrights, and licenses, as well as all applications for any of the above; (xiv) all of Debtor's present and future Federal, State and local tax refund claims of all kinds, insurance claims; and condemnation awards; (xv) all of Debtor's other present and future property rights and general intangibles of every kind, including without limitation, goodwill, judgments and choses in action, whether tangible or intangible, vested or contingent; (xvi) all of Debtor's present and future rights of stoppage in transit, replevin, repossession and reclamation and other rights and remedies of an unpaid vendor, lienor or secured party, guaranties or other contracts of suretyship with respect to the Accounts, deposits or other security for the obligation of any account debtor, and credit and other insurance; (xvii) all proceeds of any of the Collateral, including sale proceeds, claims against third parties for loss or damage to or destruction of Collateral, and insurance proceeds; -2- 3 (xviii) to the extent permitted by law, all of Debtor's licenses, permits, qualifications, privileges, rights, franchises, authority, and authorizations which are adequate, necessary or appropriate for the conduct of Debtor's business; (xix) to the extent permitted by applicable leases, all of Debtor's present and future rights to possess, occupy, or conduct business on the real property owned, leased, or occupied by Debtor for use in the continued operation of any or all of Secured Party's stores or in connection with the operation of any other lawful business thereon; and (xx) all of Debtor's present and future rights to possess and use the personal property and fixtures owned, leased, or possessed by the Company for use in connection with the continued operation of any or all of Secured Party's stores or in connection with the operation of any other lawful business. (b) "Indebtedness" means all of the Obligations (as defined below) of Debtor to Secured Party under the Secured Promissory Note between the parties of even date (the "Promissory Note") and the Term Loan Agreement to be entered into between Debtor and Secured Party (the "Term Loan Agreement") (including, without limitation, attorneys' fees and out-of-pocket costs and interest on those fees and costs at annual rate of 10% from the date incurred), or any other agreement between the parties, including future agreements by which Debtor becomes indebted or otherwise obligated to Secured Party. (c) "Obligations" means existing and future Indebtedness, including any non-monetary liabilities of Debtor to Secured Party, and obligations under the Term Loan Agreement and the Promissory Note, including attorneys' fees and costs incurred in enforcing this Agreement or collecting payment under it. (d) Terms defined in the California Commercial Code not otherwise defined in this Agreement are used in this Agreement as defined in that Code on the date of this Agreement. 2. Security Interest. In consideration for Secured Party's commitment to loan Debtor monies under the Promissory Note and under the Term Loan Agreement, Debtor grants Secured Party a first-priority security interest in the Collateral to secure payment of the Obligations. The first-priority security interest is subject to the following: (a) Debtor represents that, with the exception of UCC filings of record, liens for taxes not yet due and payable, and mechanics' liens, it is the sole -3- 4 legal and equitable owner of 100% of the Collateral and has not previously transferred, assigned, pledged, or hypothecated any interest in any of the Collateral. (b) Except for (i) the property to be disposed of as set forth in Schedule A attached hereto, (ii) sales of inventory in the ordinary course of business, and (iii) sales of used equipment or furnishings in the ordinary course of business (and not in full or partial liquidation of Borrower's business), Debtor will not, without the written consent of Secured Party, transfer, assign, pledge or hypothecate any interest in the Collateral until it satisfies the Indebtedness owed to Secured Party, except that: (i) Borrower may grant or suffer the existence of mechanics' liens and landlord liens in the ordinary course of its business, provided that Borrower makes adequate provisions for the payment or other satisfaction of such liens; (ii) Borrower may grant purchase money liens in the ordinary course of its business, provided that such purchase money liens shall have priority over the rights of Secured Creditor only to the extent of the portion of the purchase price which was advanced to Borrower by the purchase money lender and if such purchase money lender shall require Borrower to convey security other than the goods sold to Borrower, the agreement between Borrower and the purchase money lender shall expressly acknowledge that the Borrower money lender's rights with respect to any such additional security shall be junior to the rights of Secured Party; and (iii) Borrower may enter into certain sale and leaseback agreements with respect to equipment as set forth in Schedule B attached hereto. (c) If any of the Collateral, or any interest in it, is conveyed, pledged or alienated by the Debtor, by operation of law or otherwise, except as set forth above, the Indebtedness shall immediately become due at the option of Secured Party, and without demand or notice. (d) In the event of a default (as defined in Section 8 below) Secured Party shall have the right to occupy, possess, use, or sublet any or all of Debtor's present or future real or personal property (whether owned or leased) as Secured Party, in its sole an absolute discretion, as Secured Party deems appropriate or desirable (provided such action is not prohibited by any underlying lease) and such right is a material part of the consideration for Secured Party's loan to Debtor. This is because Secured Party's ability to operate some or all of Debtor's stores (or to sublet the premises or use such property as may be permitted by any underlying lease) -4- 5 may, under certain circumstances, be the best or only way that Secured Party can protect its rights as a practical matter. 3. Covenants of Debtor. Debtor promises: (a) To pay the Indebtedness to Secured Party when it is due, time being of the essence. (b) To pay all expenses, including attorneys' fees, incurred by Secured Party in the perfection, preservation, realization, enforcement, and exercise of its rights under this Agreement. (c) To indemnify Secured Party against actual loss of any kind, including reasonable attorneys' fees, caused to Secured Party by reason of its interest in the Collateral. (d) Not to sell, lease, transfer, or otherwise dispose of any Collateral except for (i) the property to be disposed of as set forth in Schedule A, (ii) sales of inventory in the ordinary course of business, (iii) sales of used equipment or furnishings in the ordinary course of business (and not in full or partial liquidation of Borrower's business), and (iv) the sale and leaseback agreements as set forth in Schedule B. (e) Not to permit liens on the Collateral, except existing liens, liens for taxes not yet due and payable, mechanics' liens, landlord liens, and purchase- money liens. (f) To execute and deliver to Secured Party all financing statements and other documents that Secured Party requests, in order to maintain a first-perfected security interest in the Collateral in all appropriate jurisdictions. (g) To maintain, satisfactory and complete books and records of all Accounts, and to make all records available as Lender may reasonably request; provided, however, that Lender may only use the information contained in such records for purposes consistent with this Agreement. (h) That it has made adequate provisions to pay or otherwise fully satisfy all tax obligations, mechanics' liens, and landlord liens. 4. Insurance. Debtor represents, warrants, and covenants that, at present and for so long as any of the Indebtedness remains unsatisfied: -5- 6 (a) Debtor maintains and shall continue to maintain adequate insurance protection against all damages, losses, liabilities, claims, and risks against which it is customary to insure, all in amounts as is adequate given the nature and size of Debtor's business and its foreseeable risks. In this regard, Debtor shall, at a minimum, carry (i) fire, casualty, and loss of income insurance on all its business and assets, including all items of Collateral as is customary for Debtor's business and all of Debtor's insurable interests in its real and personal property (whether owned or leased), in amounts which are customary and (ii) general liability insurance against all liabilities to insure, in amounts which are customary. (b) Debtor is not in default with respect to payment of premiums on any insurance policy held by Debtor. (c) Debtor shall cause Secured Party and its successors and assigns to be named as additional insureds on each of the insurance policies described above. Debtor shall likewise cause Secured Party and its successors and assigns to be named as additional insureds on each subsequent, replacement, or additional insurance policies which it may later acquire. 5. Appointment of Attorney in Fact. In the event of a default (as defined in Section 8 below), and subject to the terms of the Intercreditor Agreement between Secured Party and the other parties thereto to be entered into as of a later date ("the Intercreditor Agreement"), Debtor appoints Secured Party as Debtor's attorney in fact, with the following powers: (a) To perform any of the Obligations of Debtor under the Agreement, the Term Loan Agreement, or the Promissory Note in Debtor's name or otherwise; (b) To collect any payments due to and to enforce all of the rights of Creditor with respect to any of the Collateral; (c) To give notice of Secured Creditor's right to payment, to enforce that right, and to make extension agreements with respect to it; (d) To prepare and file financing statements, continuation statements, statements of assignment, termination statements, and the like as necessary, appropriate, or helpful to perfect, protect, preserve, or release Secured Party's interest in the Collateral; (e) To endorse Debtor's name on instruments, documents, or other forms of payment or security that come into Secured Party's possession; and -6- 7 (f) To accept cash in payment of Obligations. 6. Termination. This Agreement and the Secured Party's security interest hereunder shall be extinguished when Debtor satisfies the Indebtedness in full and completes performance of all Obligations to Secured Party. 7. Documents to Perfect. Debtor shall execute all documents, including UCC-1 form financing statements, requested by Secured Party to effectuate and perfect the security interest, as may be necessary, appropriate, or helpful to secure the benefits to be provided to Secured Party under this Agreement, the Term Loan Agreement, or the Promissory Note. 8. Default. Debtor will be in default under this Agreement if: (a) Debtor fails to satisfy any Obligation on or before the required date of performance thereof and such default remains uncured for a period of at least 15 days; (b) There shall occur any event which constitutes an "Event of Default" under the Promissory Note; or (c) There shall occur any event which constitutes an "Event of Default" under the Term Loan Agreement. 9. Remedies for Default. Upon the occurrence of any default, and subject to the Intercreditor Agreement: (a) Secured Party shall have all rights of a secured creditor under the California Commercial Code and under the Uniform Commercial Code of any other jurisdiction as may be necessary, appropriate, or helpful to enforce this Agreement. These rights include, but are not limited to, the right to take possession, appropriate or sell any of the Collateral and apply proceeds of the Collateral toward payment of the underlying obligation; the right to settle and compromise any claims of the Debtor regarding the Collateral; the right to prosecute any action, suite or proceeding with respect to the Collateral; and the right to sell the Collateral at a public or private sale and to purchase Collateral at such a sale. (b) Debtor waives any bond that might be required if Secured Party seeks to take possession of Collateral through judicial process. (c) All rights, powers and remedies shall be cumulative and may be exercised successively or concurrently in Secured Party's sole discretion without impairing its security interest, rights or available remedies. Secured Party's -7- 8 forbearance, failure or delay in exercising any right, power, or remedy shall not preclude further exercise of that or any other right, power, or remedy, which shall continue in effect until Secured Party specifically waives it in writing. Secured Party has the right to decide, in its sole discretion, which remedies it will pursue and when. Debtor will remain liable for any deficiency after disposition of the Collateral. (d) Debtor agrees that each of the following procedures will be considered "commercially reasonable" within the meaning of the California Commercial Code, the Uniform Commercial Code of any other state or jurisdiction, and any similar statutes, rules, or regulations which may be applicable: (i) The giving of notice of any sale of any of the Collateral by Secured Party to Debtor, in the manner set forth in Paragraph 16 of this Agreement, which is at least 5 days before the date of any public sale (or 5 days before the time after which a private sale will be made); or (ii) The sale of any Collateral to a supplier, including sale in bulk or in parcels, as may be provided in any agreement between Secured Party and the supplier. If Secured Party disposes of any Collateral other than as set out in this subparagraph, the commercial reasonableness of the disposition will be determined under California law. 10. Assignment of Rights of Secured Party. Secured Party may, at any time, sell, assign, convey, alienate, pledge, hypothecate, borrow against, or otherwise transfer or encumber any or all of the interests, rights, and powers granted to Secured Party by this Agreement without any need to obtain Debtor's consent or approval to such transfer or encumbrance and regardless of whether Secured Party has provided Debtor with prior notice of that or any transfer or encumbrance. 11. Transfers Requiring Consent, Approval, or Waiver. Notwithstanding any other provision of this Agreement to the contrary, if it should be determined that any right of Debtor lessee under any lease of Debtor ("Leasehold Right") is not assignable or transferable pursuant to the terms of such lease without the consent, approval, or waiver of a third party, or if an assignment or other transfer ("Transfer") of, or an agreement to Transfer, any Leasehold Right would constitute a breach thereof or a violation of law, nothing in this Agreement will constitute a Transfer of, or an agreement to Transfer, such Leasehold Right. 12. Defenses. In the event of any default, Debtor will fulfill all of Obligations and commitments to Secured Party regardless of whether any Collateral is defective or worth less than believed or anticipated and will indemnify and hold -8- 9 Secured Party harmless against any claims or defenses asserted by any buyer of the Collateral relating to the condition of, or representations made by Debtor about, any Collateral. Debtor waives all rights of offset against Secured Party and agrees that it will not assert against Secured Party any claim or defense Debtor has or may have against any third party. 13. Further Acts; Cooperation. The parties will execute all further documents reasonable, convenient, necessary, or desirable to carry out this Agreement. The parties shall cooperate to effectuate the intent of this Agreement and the mutual benefits intended to be conferred under it. 14. Successors and Assigns. This Agreement shall be binding upon and insure to the benefit of the parties and their respective heirs, successors, and assigns. 15. Jurisdiction and Venue for Disputes. Any action relating to any dispute under this Agreement shall be litigated solely in the courts located in Orange County, California. All parties consent to the jurisdiction in the State of California over all disputes and consent that venue is proper in Los Angeles County, California. 16. Notices. All notices and other communications hereunder shall be in writing and shall be deemed given upon personal delivery, facsimile transmission (with written or facsimile confirmation of receipt), telex or delivery by a reputable overnight commercial delivery service (delivery, postage or freight charges prepaid), or on the fourth day following deposit in the United States mail (if sent by registered or certified mail, return receipt requested, delivery, postage or freight charges prepaid), addressed to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): IF TO SECURED PARTY: ______________________________ ______________________________ ______________________________ ______________________________ -9- 10 IF TO DEBTOR: Diedrich Coffee, Inc. 2144 Michelson Drive Irvine, California 92612 Attention: President Fax: (714) 756-1144 WITH A COPY TO: Peter J. Tennyson, Esq. Paul, Hastings, Janofsky & Walker LLP 695 Town Center Drive, 17th Floor Costa Mesa, California 92626 Fax: (714) 979-1921 17. Headings. Headings in this Agreement are for convenience only and shall not be deemed a part of this Agreement. 18. Governing Law. This Agreement shall be interpreted and enforced in accordance with the laws of California. 19. Construction. All parties have cooperated in the drafting and preparation of this Agreement. Accordingly, no provision of this Agreement shall be construed for or against either party by virtue of its having drafted a specific provision. 20. Attorneys' Fees. Debtor promises to pay all of the costs and expense, including reasonable attorneys's fees, incurred in connection with the perfection and enforcement of this Agreement or in connection with the collection or enforcement of the Promissory Note. The obligation to pay attorneys; fees as set forth herein shall not be construed as an agreement authorizing an award of attorneys' fees incurred in connection with any controversy or dispute concerning the interpretation, breach, or enforceability of the Term Loan Agreement even if such fees are incurred in connection with proceedings seeking the perfection or enforcement of this Agreement or the collection or enforcement of the Note. 21. No Waiver. Secured Party's waiver, forbearance, failure, or delay in exercising any right, power, or remedy shall not preclude further exercise of that or any other right, power, or remedy, which shall continue in effect until Secured Party specifically waives it in writing. Secured Party has the right to decide, in its sole discretion, which remedies it will pursue and when. -10- 11 22. Survival of Representations and Warranties. Debtor's representations and warranties in this Agreement, the Term Loan Agreement, and the Promissory Note will survive the execution, delivery, and termination of this Agreement. 23. Integration. This Agreement all prior agreement or understandings between Secured Party and Debtor relating to its subject matter, except for those agreements contained in the Term Loan Agreement or the Promissory Note. There are no oral agreements pertaining to the subject matter of this Agreement, and this Agreement shall supersede all oral representations and statements by the parties. This Agreement may be modified only by a writing signed by the party to be charged. Dated: August 19, 1997 DIEDRICH COFFEE INC. (DEBTOR) By: /s/ KERRY W. COIN ----------------------------------- Kerry Coin, its President and Chief Operating Officer THE VIRGINIA R. CIRICA TRUST (SECURED PARTY) By: /s/ VIRGINIA R. CIRICA ----------------------------------- Trustee for Virginia R. Cirica Trust -11- 12 FORM OF SCHEDULE A TO SECURITY AGREEMENT: PROPERTY TO BE DISPOSED 13 PLANNED CLOSURES RESTRUCTURING COSTS DEL MAR 1555 Camino Del Mar, Del Mar, CA 92014 - ------- Equipment Furn/Fixtures Leasehold ADDISON 5100 Beltline Road, Addison, TX 75240 - ------- Equipment Furn/Fixtures Leasehold GREEN MOUNTAIN 12095 West Alameda Pkwy, Lakewood, CO 80228 - -------------- Equipment Furn/Fixtures Leasehold CHERRY CREEK 2626 East Third Avenue, Denver, CO 80206 - ------------ Equipment Furn/Fixtures Leasehold LARIMER SQUARE 1224 15th Street, Denver, CO 80202 - -------------- Equipment Furn/Fixtures Leasehold
Page 1 14 PLANNED CLOSURES RESTRUCTURING COSTS EQUITABLE BLDG 724 17th Street, Denver, CO 80202 - -------------- Equipment Furn/Fixtures Leasehold COLORADO BLVD 700 Colorado Blvd., Denver, CO 80206 - ------------- Equipment Furn/Fixtures Leasehold JEWEL & SHERIDAN 1945 So Sheridan Blvd, Unit 105-A, Denver, Co - ---------------- (Location closed in fiscal 1997) Equipment Furn/Fixtures Leasehold MISSION PLAZA 15473-I East Hampden, Aurora, CO 80013 - ------------- Equipment Furn/Fixtures Leasehold
Page 2 15 PLANNED CLOSURES RESTRUCTURING COSTS BLVD CENTER 1685 South Colorado Blvd., Denver, CO 80222 - ----------- Equipment Furn/Fixtures Leasehold TIFFANY PLAZA 7400 East Hampden Avenue, Denver, CO 80231 - ------------- Equipment Furn/Fixtures Leasehold
Page 3 16 WATCH LIST LOCATION A - ---------- Equipment Furn/Fixtures Leasehold LOCATION B - ---------- Equipment Furn/Fixtures Leasehold Page 4 17 SCHEDULE B TO SECURITY AGREEMENT: PROPOSED EQUIPMENT FINANCING 18 FORM OF SCHEDULE B(1) COFFEEHOUSE FF&E TO BE LEASED -- FISCAL 1998
Item Vendor Invoice(s) Description ---- ------ ---------- ----------- 1 Raygal Package 1 Clearlake* Package 1 Irvine (Jitters)** Package 1 Santa Monica (Home Savings)*** Pkg 2 Diedrich Package 1 Clearlake* Package 1 Irvine (Jitters) Package 1 Santa Monica (Home Savings) Pkg 3 Sign Vendors 1 Clearlake Package 1 Irvine (Jitters) Package 1 Santa Monica (Home Savings) Pkg
- --------------------- * Clearlake refers to the Diedrich coffeehouse located on Bay Area Blvd. in Houston, Texas which opened in July 1997 ** Jitters refers to a Diedrich coffeehouse to be established in the University Center in Irvine, CA in the fall of 1997 *** Santa Monica (Home Savings) refers to a Diedrich coffeehouse to be established at 26th & Wilshire Blvd. in Santa Monica in the fall or winter of 1997/8 Page 1 of 3 19 FORM OF SCHEDULE B(2) HOME OFFICE DATA PROCESSING HARDWARE & SOFTWARE TO BE LEASED - FISCAL 1998
Item Vendor Invoice(s) Description ---- ------ ---------- ----------- 1 Data Enhancement International, Inc. Xcellenet & Related Software* (Vendor not yet selected - may vary) Implementation** Hardware*** 2 Lotus Development 15 Organizer GS* 75 Notes 4.5 client* (includes software for coffeehouses) 3 Microsoft 35 Office 97* 1 SQL Server*
- -------------------- * Software to be purchased from third parties ** Third party time to install, test and debug software and hardware *** PC based server, modem pool and telecommunications equipment Page 2 of 3 20 FORM OF SCHEDULE B(3) COFFEE CARTS TO BE LEASED - FISCAL 1998
Item Vendor Invoice(s) Description ---- ------ ---------- ----------- 1 VanSan 6 8' Carts 2 Various 6 Cart Equipment Packages Rio or La Mazzorco Espresso Machines Bunn-O-Matic Grinder Curtis Brewer Vita Mix Blender Mazer Grinder Other Water Conditioner & Other 3 Microsoft 6 Javelin Terminals 6 Modem 6 Cash drawers
Page 3 of 3 EX-10.19 8 FORM OF WARRANT AGREEMENT 1 EXHIBIT 10.19 EXHIBIT C THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS AND THUS MAY NOT BE TRANSFERRED UNLESS REGISTERED UNDER THAT ACT OR SUCH LAWS OR UNLESS AN EXEMPTION FROM REGISTRATION OR QUALIFICATION IS AVAILABLE. - -------------------------------------------------------------------------------- WARRANT - -------------------------------------------------------------------------------- August 29, 1997 Diedrich Coffee, Inc., a Delaware corporation ("Company"), hereby grants to The Virginia R. Cirica Trust, a trust organized under the laws of the State of California ("Holder" or the "Trust"), or its registered assigns the right to acquire the shares of Common Stock issuable upon exercise hereof, subject to the terms and conditions set forth below: 1. Definitions. As used in this Warrant, the following terms shall mean: 1.1 "Agreement" -- shall mean the Term Loan Agreement dated as the date hereof, between Company and the Trust. 1.2 "Common Stock" -- shall mean the Common Stock, $0.01 par value issued by Company issuable on exercise of this Warrant. 1.3 "Company" shall include Diedrich Coffee, Inc. and each successor corporation or Diedrich Coffee, Inc. under this Warrant, whether such assumption is express, implied, or by operation of law. 1.4 "Determination Date" -- shall mean the date on which Company receives Holder's written notice of an exercise of the stock purchase right pursuant to Section 2.1 hereof. 1.5 "Indemnified Person" -- shall have the meanings given in Section 3.7(a) and Section 3.7(b). 1.6 "Issuance Date" -- shall mean the date of this Warrant. 2 1.7 "Note" -- shall mean the Secured Promissory Note issued by Company to the Trust as further described in the Agreement. 1.8 "Liability" -- shall have the meaning given in Section 3.7. 1.9 "Purchase Price" -- shall mean initially $2.25 per share, as adjusted in accordance with Section 5, depending upon the context. 1.10 "Registration Expenses" -- shall have the meaning given in Section 3.6. 1.11 "SEC" -- shall mean the Securities Exchange Commission. 1.12 "Securities Act" -- shall mean the Securities Act of 1933, as amended. 1.13 "Shares" -- shall mean the shares of Warrant Stock for which this Warrant may be exercised pursuant to Section 2.1 hereof. 1.14 "Subsidiary" -- shall mean any corporation, association or other business entity at least fifty percent (50%) of the outstanding voting stock of which is at the time owned or controlled directly or indirectly by Company or by one or more of such subsidiary entities or both. 1.15 "Warrant Amount" -- shall mean an amount equal to the initial Purchase Price times 170,000 shares, as reduced by the exercise of rights hereunder; provided however that if Company repays the Trust all amounts due under the Note within 120 days of the date hereof, thereafter the term "Warrant Amount" shall mean an amount equal to the initial Purchase price times 85,000 shares, as reduced by the exercise of rights hereunder. 1.16 "Warrant Stock" -- shall mean the authorized and unissued Common Stock reserved for issuance upon exercise of the Warrant. 2. Right to Purchase. 2.1 Exercise. Holder shall have the right to purchase for all or any portion of the Warrant Amount that number of shares of fully paid and nonassessable Warrant Stock of Company which is determined by dividing the Warrant Amount by the Purchase Price. Such right shall be exercisable at any time through and including August 19, 2003, or, if later, one year after the final payment of all principal and accrued interest on the Secured Promissory Note issued to the Trust pursuant to the Agreement (the "Note"). Upon the surrender of this Warrant -2- 3 to Company, accompanied by Holder's written notice of exercise and a payment of the Purchase Price for the Shares identified in the notice, Company shall, within ten (10) days from the date of Company's receipt of such notice (a) issue and deliver to Holder certificates evidencing the Shares (as hereinafter set forth) and (b) if any or all of rights to purchase evidenced by this Warrant remain unexercised, return this Warrant or a substitute Warrant to Holder with such notation thereon as appropriate to indicate that partial exercise has occurred and to purchase rights. For the purpose of this Section 2, the purchase shall be deemed to occur at the close of business on the Determination Date. In the event that Holder shall elect to exercise its right with respect to less than the entire number of shares covered by this Warrant, such partial exercise shall not be interpreted to prevent Holder or its transferees, successors or assignees from asserting the then unexercised rights or constitute a waiver of such unexercised rights. 2.2 Form of Payment: "Cashless" Exercise. Payment on exercise of this Warrant may be in cash, by check payable to the order of the Company, by surrender of one or more of the Company's promissory notes (or portion thereof), securities, or other obligations (or portion thereof), or any combination of the above. At Purchaser's option, exercisable in the notice delivered pursuant to Section 2.1, all or a portion of the Purchase Price may be paid by surrendering a portion of the Shares. The value attributed to any Shares so surrendered shall be the closing bid price on the date of the notice. 2.3 Fractional Shares. No fractional shares of Warrant Stock, or other class of capital stock, will be issued in connection with any exercise hereunder, but in lieu of such fractional shares, Company shall make a cash payment therefor upon the basis of the fair market value of each Share as of the Determination Date, as determined in good faith by the Board of Directors of Company less the Purchase Price. 2.4 Interest Adjustment. The parties agree that if the Note was not accompanied by this Warrant, the interest rate would be not more than one percent (1%) higher. 2.5 Surrender Warrant Following Kickout. If Company repays the Trust all amounts due under the Note within 120 days of the date hereof, the Trust shall immediately surrender this Warrant to Company and Company shall reissue to the Trust a replacement Warrant reflecting the change in the Warrant Amount. 3. Registration Rights; Transfer of Securities. This Warrant and the Warrant Stock to be issued pursuant to exercise of this Warrant is not transferable except, to the extent such transfers would not violate the provisions of the Securities Act or any applicable state securities laws, (a) to affiliates (as such term is defined -3- 4 in Rule 144 of the Securities Act) of the Holder who are accredited investors within the meaning of Regulation D of the Securities Act, (b) such other persons upon the prior written consent of Company, which consent shall not be unreasonably be withheld, or (c) upon the conditions specified in this Section 3, which conditions are intended to assure compliance with the provisions of the Securities Act and state securities laws in respect of the transfer of any such Warrants or Warrant Stock. 3.1 Restrictive Legends. Unless and until they are registered under the Securities Act, this Warrant (and any replacement therefor) and the Shares issued upon the exercise of this Warrant shall be stamped or otherwise imprinted with legends in substantially the following form: THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS AND THUS MAY NOT BE TRANSFERRED UNLESS REGISTERED OR QUALIFIED UNDER THAT ACT OR SUCH LAWS OR UNLESS AN EXEMPTION FROM REGISTRATION OR QUALIFICATION IS AVAILABLE. Company may cause its transfer agent to stop the transfer of such Warrants or Warrant Stock if Holder or the owner of Warrant Stock wishing to make the transfer fails to provide the Company with such a written opinion of counsel. 3.2 Notice of Proposed Transfers. Subject to Section 3.1, prior to any transfer or attempted transfer of this Warrant (or any Warrant Stock) bearing the legend described in Section 3.1, Holder (or the owner of Warrant Stock) shall give the Company written notice of its intention so to do, describing briefly the nature of any such proposed transfer. If, in the written opinion of counsel for Holder (or the owner of Warrant Stock), in form and substance reasonably satisfactory to the Company or its counsel, addressed to the Company or Holder (or the owner of Warrant Stock), the proposed transfer may be effected without registration of this Warrant (or such Warrant Stock), this Warrant (or the Warrant Stock proposed to be transferred) may be transferred in accordance with the terms of said notice and in compliance with applicable state securities laws and regulations. Company shall not be required to effect any such transfer prior to the receipt of such favorable opinion; provided that if the proposed transfer is governed by Rule 144 promulgated by the SEC, or any successor rule, such opinion shall not be required, but Company may prevent such transfer until it receives evidence satisfactory to it and its counsel that the transfer complies with Rule 144. Each transfer shall comply with all applicable state securities laws and regulations. -4- 5 3.3 Piggyback Registration. If Company at any time prior to August 19, 2003 proposes to register any of its securities under the Securities Act (other than a registration effected solely to implement an employee benefit plan, a transaction to which Rule 145 of the SEC is applicable or any other form or type of registration in which the Warrant Stock cannot be included pursuant to SEC rule or practice), it will give a written notice to Holder and the registered owners of Warrant Stock of its intention to do so. If such registration is proposed on a form which permits inclusion of the Warrant Stock, upon the written request of Holder or any owner of Warrant Stock given within 30 days after the transmittal by Company to such Holder or owner of such notice, the Company will, subject to the limits contained in this Section 3.3, use its best efforts to cause all Warrant Stock which said requesting Holder or owner identifies in its request (including Warrant Stock to be issued upon exercise of this Warrant) to be registered under the Securities Act and qualified for sale under any state blue sky law, all to the extent requisite to permit such sale or other disposition by such Holder or owner. Notwithstanding the above, however, if the underwriter managing such registration gives a written notice to the person requesting registration pursuant to this Section 3.3 that market or economic conditions limit the amount of securities of the Company which may reasonably be expected to be sold, the underwriter shall first exclude from the proposed registration the shares of Common Stock which persons other than (a) such requesting Holder or owners of Warrant Stock, (b) the holders of the warrants issued pursuant to the Other Agreements (as that term is defined in the Agreement) or (c) Company have requested to be registered. If, after such exclusion, the total number of shares of Common Stock to be registered still exceeds the number of shares of Common Stock which the underwriter will permit to be registered, each requesting Holder or owner will be allowed to register Warrant Stock pro rata according to the proportion which the number of shares of Warrant Stock held (including shares issuable upon exercise of this Warrant) by such requesting Holder or owner bears to the total number of shares of Common Stock which were proposed to be sold by the underwriter. Company may for any reason determine not to proceed with a proposed registration of its securities even though Holder or one or more owners of Warrant Stock has requested the inclusion of Warrant Stock in such proposed registration. However, if Company determines not to proceed and withdraws the Company's registration statement, Company shall pay all fees and expenses reasonably incurred by the requesting Holder or owner(s) in connection with the proposed registration. 3.4 Demand Registration. Company shall use its best efforts to qualify and remain qualified for registration of the Warrant Stock on Form S-3 (or a similar short-form registration statement). If singly or in combination, the Holder, holders of any other warrant issued pursuant to the Agreement or the Other Agreements, or owners of Common Stock issued pursuant to this Warrant or any other warrant issued pursuant to the Agreement or the Other Agreements request -5- 6 to have 255,000 or more of their shares of Common Stock (or shares of Warrant Stock which they are entitled to acquire under this or such other warrants) registered, Company will use its best efforts to promptly register such shares on Form S-3 (or a similar short-form registration statement). Such request(s) shall be in writing and shall state the number of shares of Warrant Stock to be registered and the intended method of disposition of such Warrant Stock in sufficient detail to permit a description in a registration statement and shall contain a statement of a good-faith intention to sell the Warrant Stock proposed to be registered. The Company may delay registration pursuant to this Section 3.4 if, in the good-faith judgment of the Company, such registration will hinder or interfere with a concurrent or proposed security issuance of, or acquisition by, the Company; provided that the Company shall use its best efforts to effect the registration following the completion of the transaction or transactions involving such issuance or acquisition. The Company shall give notice to Holder and all registered owners of Warrant Stock of the receipt of a request for registration pursuant to this Section 3.4 and shall provide a reasonable opportunity for such persons to participate in the registration. If any requesting Holder or owner of Warrant Stock determines not to proceed with a registration requested pursuant to this Section 3.4 and the registration is not completed (or is completed but less than 255,000 shares of Warrant Stock are registered), such withdrawing Holder or owner shall pay its proportionate share of the expenses reasonably incurred by Company pursuant to the registration request, unless the decision not to proceed is: (a) based upon a material adverse fact or condition relating to Company which was not disclosed to such Holder or owner of Warrant Stock prior to the request for registration; (b) based upon a written opinion of such Holder or owner's counsel that one or more specific statements or omissions in the proposed registration statement are materially misleading without changes which Company declines to make after written request therefor; or (c) followed by a decision by Company or other holders of Company's Common Stock (or holders of rights to such stock) to proceed with the registration in question, which results in the proposed registration statement becoming effective with respect to shares of Common Stock to be issued by the Company or held by others. 3.5 Registration Procedures. If and whenever Company proposes the registration of any of its securities under the Securities Act, or is in receipt of a request pursuant to Section 3.3 or 3.4, Company will, as expeditiously as possible, subject in all cases to the right of Company to withdraw a proposed registration as described in Section 3.3 or delay the registration as described in Section 3.4. -6- 7 (a) prepare and file with the SEC a registration statement with respect to such securities and use its best efforts to cause such registration statement to become and remain effective for the period provided for in Section 3.5(g); (b) prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for the period provided for in Section 3.5(g) and to otherwise comply with the provisions of the Securities Act with respect to the sale or other disposition of the securities covered by such registration statement; (c) furnish to Holder and the owners of Warrant Stock whose securities are to be included in the registration such number of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents, as Holder or such owners may reasonably request to facilitate the sale or other disposition of the Warrant Stock to be covered by such registration statement; (d) use every reasonable effort to register or qualify the securities covered by such registration statement under such other securities or state blue sky laws of such jurisdictions as Holder or the owners of Warrant Stock participating in such registration shall reasonably request and do any and all other acts and things which may be necessary under such securities or blue sky laws to enable such Holder or owners to consummate the sale or other disposition in such jurisdictions of the securities owned by them which are covered by the registration statement in question, except that the Company shall not for any such purpose be required to qualify to do business as a foreign corporation in any jurisdiction wherein it is not so qualified; (e) before filing the registration statement or prospectus or amendments or supplements thereto, furnish to one counsel selected by Holder and the owners of Warrant Stock who have requested registration copies of such documents proposed to be filed which shall be subject to the reasonable approval of such counsel; and (f) furnish to Holder and each requesting owner of Warrant Stock a signed counterpart, addressed to such Holder or owner, of (i) an opinion of counsel for Company, dated the effective date of the registration statement, and (ii) a "comfort" letter signed by the independent public accountants who have certified Company's financial statements included in the registration statement, covering substantially the same matters with respect to the registration statement (and the prospectus included therein) and (in case of the accountants' -7- 8 letter with respect to events subsequent to the date of the financial statements, as are customarily covered (at the time of such registration) in opinions of Company's counsel and in accountants' letters delivered to the underwriters in underwritten public offerings of securities; and (g) notwithstanding any other provision of this Section 3, Company shall not in any event be required to us its best efforts to maintain the effectiveness of any such registration statement for a period in excess of 90 days (or at the request of Holder or any owner of Warrant Stock who so requests, an additional 90 days). 3.6 Expenses. All expenses incurred in effecting all registrations provided for above, including without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel for Company, expenses of any audits incident to or required by any such registration and expenses of complying with the securities or blue sky laws of any jurisdictions relating to a registration pursuant to Section 3.3 or 3.4 hereof (all of such expenses referred to as "Registration Expenses") shall be paid by Company; provided, however, that Company shall bear the Registration Expenses for no more than two registrations pursuant to Section 3.4 for all holders of this Warrant and the warrants issued in connection with the Other Agreements. The Company shall not pay any fees or expenses of counsel for Holder or the owners of Warrant Stock or any counsel for underwriters or any fees or commissions due to any underwriter with respect to any Warrant Stock. 3.7 Indemnification. (a) In the event of any registration of any of its securities under the Securities Act pursuant to Section 5, Company shall indemnify and hold harmless the seller of such securities, each underwriter (as defined in the Securities Act), and each other person, if any, who controls (within the meaning of the Securities Act) such seller, underwriter or participating seller (individually and collectively the "Indemnified Person") against any losses, claims, damages or liabilities (collectively the "liability"), joint or several, to which such Indemnified Person may become subject under the Securities Act or any other statute or at common law, insofar as such liability (or action in respect thereof) is caused by (i) any untrue statement of material fact contained on the effective date thereof, in any registration statement under which such securities were registered under the Securities Act, any preliminary prospectus or final prospectus contained therein or any amendment or supplement thereto, or (ii) any omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading. Except as otherwise provided in Section 3.7(d), Company shall reimburse each such Indemnified Person in connection with investigating or -8- 9 defending any such liability, provided, however, that Company shall not be liable to any Indemnified Person in any such case to the extent that any such liability is caused by any untrue statements or omissions made in such registration statement, preliminary or final prospectus, or amendment or supplement thereto in reliance upon and in conformity with information furnished to Company by such Indemnified Person specifically for use therein; and provided further, that Company shall not be required to indemnify any Indemnified Person against any liability caused by any untrue or misleading statement or omission contained in any preliminary prospectus if such deficiency is corrected in the final prospectus or for any lability which is caused by the failure of any person other than Company to deliver a prospectus as required by the Securities Act. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of such Indemnified Person and shall survive transfer of such securities by such seller. (b) If, at the request of Holder or any owner of Warrant Stock, Company shall register any of the Warrant Stock of such requesting Holder or owner, that requesting Holder or owner shall indemnify and hold harmless Company, Company's directors and officers, each underwriter and each other person, if any,who controls (within the meaning of the Securities Act) Company or such underwriter (individually and collectively also the "Indemnified Person") against any liability (or actions in respect thereof) was caused by (i) the disposition of this Warrant or Warrant Stock by such Holder or owner in violation of the provisions of Section 3.2; (ii) an untrue statement of material fact contained in, on the effective date thereof, any registration statement of material fact contained in, on the effective date thereof, any registration statement under which such securities were registered, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereto, which untrue statement was included therein in good faith reliance on and in conformity with information furnished to Company in writing by such Holder or owner specifically for use in such registration statement, preliminary or final prospectus, or amendment or supplement thereto, or (iii) an omission of material fact required to be stated in any registration statement under which such securities were registered, an preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereto, which omission was the result of the Indemnified Person's good-faith reliance on and in conformity with information furnished to Company in writing by such Holder or owner specifically for use in such registration statement, preliminary or final prospectus, or amendment or supplement thereto. Notwithstanding the above, however, no Holder or owner of Warrant Stock shall be required to indemnify any Indemnified Person if any untrue statement or omission of material fact was made in reliance on the advise, conclusions, calculations, determinations, or authority of an expert so long as Holder or such owner of Warrant Stock had no reasonable ground to disbelieve, and did not in fact disbelieve, the accuracy or completeness of the information provided by the Holder or owner in reliance on such expert. A -9- 10 Holder or owner of Warrant Stock otherwise required to provide indemnification pursuant to this Section 3.7(b) shall reimburse any Indemnified Person for any legal fees incurred in investigating or defending any such liability, provided,however, that no such Holder or owner of Warrant Stock shall be required to indemnify any person against any liability arising form any untrue or misleading statement or omission contained in any preliminary prospectus if such deficiency is corrected in the final prospectus or for any liability which arises out of thee failure of any person other than Holder (or the indemnity obligation shall apply to the benefit of the Company, the Company's directors and officers, each underwriter and each other person, if any, who controls the Company or such underwriter and to no other persons or entities. (c) Subject to such modifications as the context may require, indemnification similar to that specified in Section 3.7(a) above shall be given by Holder and owners of Warrant Stock who have indemnity obligations (but only to the extent of such Holder or owner's obligations thereunder) with respect to any required registration or other qualification of Warrant Stock under any federal or state law or regulation of governmental authority other than the Securities Act. (d) If Company, Holder, or any owner of Warrant Stock receives a complaint, claim or other notice of any liability or action, giving rise to a claim for indemnification under Section 3.7(a), 3.7(b), or 3.7(c), the person claiming indemnification under such sections shall promptly notify the person against whom indemnification is sought of such complaint, notice, claim or action and such indemnifying person shall have the right to investigate and defend any such loss, claim, damage, liability, or action. The person claiming indemnification shall have the right to employ separate counsel in any such action and to participate in the defense thereof, but the fees and expenses sought unless the indemnifying party fails to promptly defend (in which case the fees and expenses of such separate counsel shall be borne by the person against whom indemnification is sought). In no even shall a person against whom indemnification is sought be obligated to indemnify any person for any settlement of any claim or action effecting without indemnifying person's prior written consent. 3.8 Contribution. If the indemnification by Company as provided for in Sections 3.7(a) or 3.7(c) is unavailable or insufficient to hold harmless the Indemnified Persons in respect of any liability, then Company shall contribute to the amount paid or payable by such Indemnified Persons as a result of such liability in such proportion as is appropriate to reflect the relative fault of Company on the one hand and the Indemnified Person(s) on the other, in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities, expenses or actions as well as any other relevant equitable considerations, including the failure -10- 11 to file the notice required hereunder. The relative fault of Company and the Indemnified Person(s) shall be determined by reference to, among other things, whether the untrue statement of material fact relates to the information supplied by Company or the Indemnified Person(s) and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. Company agrees that it would not be just and equitable if contributions pursuant to this Section 3.8 were determined by pro rata allocation or by any other method of allocation which did not take account of the equitable considerations referred to above. 3.9 Registration Rights Do not Necessarily Follow the Warrant Stock. Notwithstanding the provisions of this Section 3, if Holder causes Company to issue any Warrant Stock to a third party, or if Holder transfers any Warrant Stock issued to it to a third party, Holder shall retain the right to have those shares registered as set forth in this Section 3, and the third-party owner of such Warrant Stock shall not have any registration rights under this Warrant, unless the Company shall give its written consent to the transfer of such registration rights. 3.10 Termination of Registration Rights. Notwithstanding the provisions of this Section 3, the rights to registration of the Warrant Stock shall terminate, as to any particular Warrant Stock, when such Warrant Stock shall have been lawfully sold by the holder pursuant to a registration statement or Rule 144 or may be sold pursuant to Rule 144 during any three month period or, if earlier, the later of August 19, 2003 and one year after the final payment of all principal and accrued interest on the Note. 3.11 Compliance with Rule 144. At the request of Holder or any owner of Warrant Stock who proposes to sell Warrant Stock in compliance with Rule 144 of the SEC, Company shall forthwith furnish to Holder or such owner a written statement of compliance with the filing requirements of the SEC as set forth in such Rule, as such Rule may be amended from time to time and make available to the public and Holder or such owner such information as will enable holder of the owner to make sales of Warrant Stock pursuant to Rule 144. 3.12 Consent to Be Bound. Each subsequent Holder and each transferee of any Warrant Stock must consent in writing to be bound by the terms and conditions of this Section 3 in order to acquire the registration rights granted pursuant to this Section. 3.13 Investment Intent. Holder represents and warrants that this Warrant and the Warrant Stock issuable upon exercise of the Warrant are being acquired by Holder solely for Holder's own account, for investment purposes only, -11- 12 and with no present intention of distributing, selling or otherwise disposing of the Warrant or the Warrant Stock issuable upon exercise of the Warrant. 3.14 Sophistication. Holder represents and warrants that Holder is able to bear the economic risk of the investment required pursuant to this Warrant and the Warrant Stock issuable upon exercise of the Warrant and can afford to sustain a total loss on such investment, and has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the proposed investment and therefore has the capacity to protect its own interests in connection with the Warrant. 4. Replacement of Warrant. Upon receipt of evidence reasonably satisfactory to Company of the ownership of and the loss, theft, destruction or mutilation of this Warrant and (in the case of loss, theft or destruction) upon delivery of an indemnity agreement in an amount reasonably satisfactory to Company, or (in the case of mutilation) upon surrender and cancellation of the mutilated Warrant, Company will execute and deliver, in lieu thereof, a new Warrant of like tenor. 5. Protection Against Dilution. 5.1 Adjustment for Stock Splits and Combinations. If Company at any time or from time to time after the Issuance Date effects a subdivision of the outstanding Warrant Stock, the Purchase Price then in effect immediately before the subdivision shall be proportionately decreased, and conversely, if Company at any time or from time to time after the Issuance Date combines the outstanding shares of Warrant Stock, the Purchase Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 5.1 shall become effective as of the date and time the subdivision or combination becomes effective. 5.2 Adjustment for Certain Dividends and Distributions. If Company at any time or from time to time after the Issuance Date makes, or fixes a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Purchase Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date is fixed, as of the close of business on such record date, by multiplying the Purchase Price then in effect by a fraction (1) the numerator of which is the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and (2) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number -12- 13 of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, that if such record date is fixed and such dividend is not fully paid, or if such distribution is not fully made on the date fixed therefor, the Purchase Price shall be recomputed to reflect that such dividend was not fully paid or that such distribution was not fully made as of the close of business on such record date and thereafter the Purchase Price shall be adjusted pursuant to this Section 5.2 as of the time of actual payment of such dividends or distributions. 5.3 Adjustments for Other Dividends and Distributions. In the event Company at any time or from time to time after the Issuance Date makes, or fixes a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in securities of Company other than shares of Common Stock, then and in each such event provision shall be made so that Holder shall receive upon exercise of this Warrant, in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of Company which Holder would have received had the Warrant been fully exercised for Common Stock on the date of such event and had Holder thereafter, during the period from the date of such event to and including the date of exercise, retained such securities receivable by it as aforesaid during such period, subject to all other adjustments called for during such period under this Section 5 with respect to the rights of Holder. 5.4 Adjustment for Reclassification, Exchange and Substitution. If the Warrant Stock issuable upon the exercise of this Warrant is changed into the same or a different number of shares of any class or classes of stock, whether by recapitalization, reclassification or otherwise (other than a subdivision or combination of shares or stock dividend or a reorganization, merger, consolidation or sale of assets, provided for elsewhere in this Section 5), then, and in any such event, Holder shall have the right thereafter, upon exercise of this Warrant to receive the kind and amount of stock and other securities and property receivable upon such reorganization, reclassification or other change, in an amount equal to the amount that Holder would have been entitled to had it immediately prior to such reorganization, reclassification or change exercised Holder's rights to purchase under this Warrant, but only at such time and to the extent this Warrant is actually exercised, all subject to further adjustment as provided herein. 5.5 Reorganizations, Mergers, Consolidations or Sales of Assets. If at any time or from time to time there is a capital reorganization of the Warrant Stock (other than a recapitalization, subdivision, combination, reclassification or exchange of the Warrant Stock provided for elsewhere in this Section 5) or merger or consolidation of Company with or into another entity, or the sale of all or substantially all of Company's properties and assets to any other person then, as a part of such reorganization, merger, consolidation or sale, provision shall be made -13- 14 so that Holder shall thereafter be entitled to receive, upon exercise of rights to purchase under this Warrant (but only to the extent such rights are exercised), the number of shares of stock or other securities or property of Company, or of the successor entity resulting from such merger or consolidation or sale, to which a holder of Warrant Stock, or other securities, deliverable upon the exercise of purchase rights under this Warrant would otherwise have been entitled on such capital reorganization, merger, consolidation, or sale. In any such case, appropriate adjustments shall be made in the application of the provisions of this Section 5 (including adjustment of the Purchase Price then in effect and number of shares purchasable) which shall be applicable after such events; provided, however, that any such adjustments shall be made so as to ensure that the provisions of this Section 5 applicable after such events shall be as equivalent as may be practicable to the provisions of this Section 5 applicable before such events. 5.6 Officer's Certificate of Adjustment. In any case of an adjustment or readjustment of the Purchase Price, the number of shares of Warrant Stock or other securities issuable upon exercise of this Warrant, the Company's chief financial officer at its expense shall compute such adjustment or readjustment in accordance with the provisions hereof and shall prepare a certificate showing such adjustment or readjustment, and shall mail such certificate, by first class mail, postage prepaid, to Holder at Holder's address as shown in Company's books. The certificate shall set forth such adjustment or readjustment, showing in detail the facts upon which such adjustment or readjustment is based including a statement of (a) the consideration received or deemed to be received by Company for any Warrant Stock issued or sold or deemed to have been issued or sold, (b) the Purchase Price at the time in effect, and (c) the type and amount, if any, of other property which at the time would be received upon exercise of this Warrant. Notwithstanding the above, the Holder may select and cause independent public accountants of recognized standing also to compute such adjustment or readjustment in accordance with the provisions hereof and to prepare a certificate showing such adjustment or readjustment. If, by such computation, the Holder shall determine that the computation performed by the Company's chief financial officer was incorrect by five percent (5%) and such inaccuracy was prejudicial to the Holder, then, at the option of Holder, the cost of Holder's computation and certificate preparation shall be borne by Company and shall be due and owing upon demand. 5.7 No Change in Warrant Required. The form of this Warrant need not be changed because of any adjustment in the Purchase Price or in the number of shares of Warrant Stock purchasable on its exercise. A Warrant issued after any such adjustment on any partial exercise or in replacement may continue to express the same Purchase Price and the same number of shares of Warrant Stock (appropriately reduced in the case of partial exercise) as are stated on the face of -14- 15 this Warrant as initially issued, and that Purchase Price and number of shares shall be considered to have been so changed as of the close of business on the date of adjustment. 5.8 Reservation of Shares. Company recognizes that since the Warrant Amount is a fixed number, the adjustments provided in this Section will alter the number of shares subject to purchase rights and agrees to adjust the appropriate number(s) of shares reserved pursuant to Section 7.1 for issuance upon exercise of purchase rights. 6. Transfer of Securities. 6.1 Transfer. Subject to the restrictions on transfer contained in the Agreement, this Warrant and all rights hereunder are transferable on the books of Company maintained for such purpose at its principal office referred to above by Holder in person or by duly authorized attorney, upon surrender of this Warrant properly endorsed and upon payment of any necessary transfer tax or other governmental charge imposed upon such transfer. Each taker and holder of this Warrant, by taking or holding the same, consents and agrees that this Warrant when endorsed in blank shall be deemed negotiable and that when this Warrant shall have been so endorsed, Holder hereof may be treated by Company and all other persons dealing with this Warrant, as the absolute owner hereof for any purpose and as the person entitled to exercise the rights represented hereby, or to the transfer hereof on the books of Company, any notice to the contrary notwithstanding; but until such transfer on such books, Company may treat the registered Holder hereof as the owner for all purposes. 6.2 Rights Under Agreement. The Shares issuable upon the exercise of this Warrant are subject to the terms, conditions and limitations set forth in the Agreement. 6.3 Payment of Taxes. All Shares issued upon the exercise of rights under this Warrant shall be validly issued, fully paid and nonassessable, and Company shall pay all taxes and other governmental charges that may be imposed in respect of the issue or delivery thereof. Company shall not be required, however, to pay any tax or other charge imposed in connection with any transfer involved in the issuance of any certificate for Shares in any name other than that of Holder surrendered in connection with the purchase of such Shares, and in such case Company shall not be required to issue or deliver any stock certificate until such tax or other charge has been paid or it has been established to Company's satisfaction that no tax or other charge is due. -15- 16 7. Affirmative Duties of Company. 7.1 Reservation of Warrant Stock. Company shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of issuance upon the exercise of the purchase rights under this Warrant, such number of shares of Warrant Stock as shall be issuable upon the exercise hereof. Company covenants and agrees that, upon such exercise all Shares issuable upon such exercise shall be duly and validly issued, fully paid and nonassessable. 7.2 No Dilution or Impairment. Company will not, by amendment of its certificate of incorporation or through reorganization, consolidation, merger, dissolution, sale of assets or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant. Without limiting the generality of the foregoing, Company will take all such action as may be necessary or appropriate in order that Company may validly and legally issue fully paid and nonassessable Warrant Stock upon the exercise of the purchase rights in this Warrant. 8. Notices to Warrant Holder. 8.1 Notices to be Given. Nothing contained in this Warrant shall be construed as conferring upon Holder hereof the right to vote or to consent or to receive notice as a shareholder in respect of any meetings of shareholders for the election of directors or any other matter or as having any rights whatsoever as a shareholder of Company. If, however, at any time prior to the expiration (by lapse of time or complete exercise) of the purchase right under this Warrant, any of the following events shall occur: (a) Company shall take a record of the holders of its shares of Warrant Stock for the purpose of entitling them to receive a dividend or distribution; or (b) Company shall offer to the holders of its Common Stock generally any additional shares of capital stock of Company or securities convertible into or exchangeable for shares of capital stock of Company, or any option, right or warrant to subscribe therefor; or (c) Company shall reclassify its Common Stock; or (d) Company shall engage in or enter into any capital reorganization, consolidation or merger; or -16- 17 (e) A dissolution, liquidation or winding up of Company (other than in connection with a consolidation or merger) or a sale of all or substantially all of its property, assets and business as an entirety shall be proposed; then Company shall give written notice of such event to Holder at least fifteen (15) days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the shareholders entitled to receive such dividend, distribution, convertible or exchangeable securities or subscription rights, or entitled to vote on such proposed dissolution, liquidation, winding up or sale. Such notice shall specify such record date or the date of closing the transfer books, as the case may be. Failure to give such notice or any defect therein shall not affect the validity of any action taken in connection with the declaration or payment of any such dividend, or the issuance of any convertible or exchangeable securities, or subscription rights, options or warrants, or any proposed dissolution, liquidation, winding up or sale. 8.2 Listing on Stock Exchange. The Common Stock is currently listed on NASDAQ. If the Company at any time lists any Common Stock or other securities of the same class as those issuable on exercise of this Warrant on any national securities (other than NASDAQ), the Company will, at its sole expense, simultaneously list on that exchange, an official notice of issuance on exercise of this Warrant and maintain such listing or inclusion of all shares of Warrant Stock or other securities from time to time issuable on exercise of this Warrant. 8.3 Methods; Addresses. Except as otherwise provided herein, any notice or demand which, by the provisions hereof, is required or which may be given to or served upon the parties hereto shall be in writing and, if by telegram, telecopy or telex, shall be deemed to have been validly served, given or delivered when delivery is confirmed electronically, if by personal delivery, shall be deemed to have been validly served, given or delivered upon actual delivery and, if mailed, shall be deemed to have been validly served, given or delivered three (3) business days after deposit in the United States mails, as registered or certified mail, with proper postage prepaid and addressed to the party or parties to be notified, at the following addresses (or such other address(es) as a party may designate for itself by like notice): (a) If to Holder: Virginia R. Cirica Trust c/o Virginia R. Cirica ------------------------------ ------------------------------ Facsimile: (714) ------------- -17- 18 With copy to: _________________________ _________________________ _________________________ _________________________ _________________________ (b) If to Company: Diedrich Coffee, Inc. Attention: President 2144 Michelson Drive Irvine, California 92612 Facsimile: (714) 756-1144 With copy to: Paul, Hastings, Janofsky & Walker LLP Attention: Peter J. Tennyson Seventeenth Floor 695 Town Center Drive Costa Mesa, California 92626 Facsimile: (714) 979-1921 8.4 Warrant Agent. The Company may, on written notice to the Holder, appoint an agent for the purposes of issuing Warrant Stock or other securities on the exercise of this Warrant and/or replacing or exchanging this Warrant. If any such appointment is made, any issuance, replacement, or exchange shall be made at that office by that agent. 8.5 No Right as Shareholder. No Holder of this Warrant, as such, shall be entitled to vote or receive dividends or be considered a shareholder of the Company for the purposes, nor shall anything in this Warrant be construed to confer on any Holder of this Warrant, as such, any rights of a shareholder of the Company or any right to vote, to give or withhold consent to corporate action, to receive notice of meetings of shareholders, or to receive dividends or subscription rights or otherwise. 9. Miscellaneous. 9.1 Survival of Covenants. All agreements and covenants made herein shall survive the execution and delivery hereof. 9.2 Failure or Indulgence Not Waiver. No failure or delay on the part of Holder in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor shall any one or more of such failures or delays -18- 19 constitute a course of performance or dealing on which Company is entitled to rely, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercises thereof or of any other right, power or privilege. All rights and remedies existing hereunder are cumulative to, and not exclusive of, any rights or remedies otherwise available. 9.3 Cost of Enforcement. If any default is made in the fulfillment of Company's duties under this Warrant, Company shall pay Holder all costs of enforcement, including, without limitation, reasonable attorneys' and accountants' fees and costs of appeals and interest on any sums actually disbursed at the rate set forth herein. 9.4 Governing Law. This Warrant has been executed in and shall be governed by the laws of the State of California. As part of the consideration for Holder's investment herein, Company and Holder hereby agree that all actions or proceedings arising directly or indirectly hereunder, whether instituted by Holder or Company, may, at the option of Holder, be litigated in courts having situs within the State of California, County of Orange and Company hereby expressly consents to the jurisdiction of any local, state or federal court located within said state and county, and consents that any service of process in such action or proceeding may be made by personal service upon Company wherever Company may be located, or by certified or registered mail directed to Company at its last known address. Company and Holder waive trial by jury, any objection based on forum non conveniens, and any objection to venue of any action instituted hereunder. 9.5 Modification. Neither this Warrant nor any provision hereof may be amended, modified, waived, discharged or terminated with respect to Holder unless agreed to by the Holder. 9.6 Severability. Whenever possible, each provision of this Warrant will be interpreted in such manner as to be effective and valid under applicable law, but, if any provision of this Warrant is held to be prohibited by or invalid under applicable law, such provision will be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of this Warrant. 9.7 Further Assurance. At any time or from time to time upon the request of Holder, Company will execute and deliver such further documents and do such other acts and things as Holder may reasonably request in order fully to effectuate the purposes of this Warrant, the exercise of Holder's purchase right. 9.8 Successors. All the covenants, agreements, representations and warranties contained in this Note shall bind the parties hereto and their respective heirs, executors, administrators, distributees, successors and assigns. -19- 20 9.9 Headings. The section headings in this Warrant are inserted for purposes of convenience only and shall have no substantive effect. 9.10 Construction. Both of the parties have participated in the drafting of this Warrant. Consequently, no provision of this Warrant shall be construed in favor of or against any party by reason of his or its attorney having drafting it. [Signature Page Follows] -20- 21 [SIGNATURE PAGE - WARRANT] IN WITNESS WHEREOF, the parties hereto have caused this Warrant to be executed as of the day and year first written above. DIEDRICH COFFEE, INC. By: ____________________________ Name: __________________________ Its: ___________________________ THE VIRGINIA R. CIRICA TRUST By: ____________________________ Virginia R. Cirica, Trustee -21- EX-10.20 9 FORM OF PROMISSORY NOTE 1 EXHIBIT 10.20 SECURED PROMISSORY NOTE $500,000 Maximum Principal Amount August 19, 1997 Irvine, California FOR VALUE RECEIVED, the undersigned, Diedrich Coffee, Inc., a Delaware corporation ("Borrower") hereby promises to pay to the order of The Virginia R. Cirica Trust ("Holder") or its successors or assigns, the principal sum of up to Five Hundred Thousand Dollars ($500,000) or such lesser amount as may be borrowed under the terms of this Note, together with interest on the unpaid principal amount from time to time outstanding from the date hereof until the principal amount of this Note is paid in full, in accordance with the terms of this Note, at the Note Rate (as defined below). The principal of this Note, together with all accrued and unpaid interest, shall become due and payable on August 19, 2002. Interest shall become due and payable monthly as it is accrued, beginning September 1, 1997. 1. LOAN AGREEMENT. Borrower and Holder intend to enter into a Term Loan Agreement (the "Agreement") and this Note shall be entitled to all of rights and benefits under such Agreement. Reference is made to the Agreement for a more complete statement of the terms and conditions under which the loan evidenced hereby is made and is to be repaid. 2. INTEREST. The principal amount of this Note shall bear interest at the Note Rate. The "Note Rate" shall be the prime rate plus three and one-half percent or the maximum rate allowed by law, whichever is less. The prime rate as of any date shall be determined by reference to the prime rate as published in the Wall Street Journal (the base rate on corporate loans posted by at least 75% of the thirty largest U.S. banks). Interest shall be computed daily at the Note Rate on the basis of the actual number of days in which all or any portion of the principal amount hereof is outstanding computed on the basis of a 360 day year. 3. DISBURSEMENTS. Holder shall advance $250,000 to Borrower upon the execution by Borrower hereof. Holder shall advance Borrower up to the remaining $250,000, upon Borrower's request, upon the execution by both Holder and Borrower of the Agreement and the issuance of the Warrants thereunder. All loans made by Holder and all repayments of the principal thereof shall be recorded by the Holder and endorsed by an officer of the Borrower on the schedule attached hereto, or on a continuation of such schedule attached to and made a part hereof; provided that the failure of Holder to make any such recordation or of 2 Borrower to make any such endorsement shall not affect the obligations of Borrower hereunder. 4. EFFECT OF NON-PAYMENT OF PRINCIPAL AND INTEREST. In the event that any principal and/or interest is not paid when due, without affecting any of Holder's other rights and remedies, the unpaid principal amount and, to the extent permitted by applicable law, interest, shall bear interest at the Note Rate and shall be payable on demand of Holder until such unpaid amount is paid in full. 5. PAYMENT OF PRINCIPAL AND INTEREST. Principal and interest shall be payable in lawful money of the United States at Holder's address located at ________________________________, _______, California _______ or at such other place as is directed by Holder in writing. 6. PREPAYMENT. (a) MANDATORY PREPAYMENTS. Borrower shall prepay the entire principal balance of this Note (plus all interest then due hereunder) immediately upon the issuance, offer or sale of any shares of Borrower's capital stock pursuant to a secondary offering to the public with net proceeds of greater than Ten Million Dollars ($10,000,000); excluding, however, any offering of Borrower's common stock pursuant to a stock option, bonus, award or other employee benefit plan and existing options to purchase any of Borrower's common stock which are presently held by officers, directors or employees of Borrower. (b) OPTIONAL PREPAYMENT. Borrower may prepay any portion of the principal balance of this Note in any amount which is an integral multiple of $10,000 at any time without penalty. 7. SECURITY. This Note and all of Borrower's obligations hereunder are secured by the security interest granted by Borrower to Holder by that certain Security Agreement dated August 19, 1997 in which Borrower is the Debtor and Holder is the Secured Party(the "Security Agreement"). 8. DEFAULT. Each of the following shall constitute an event of default ("Event of Default") under this Note: (a) Borrower shall fail to pay when due (whether by acceleration or otherwise) principal or interest on this Note, and such default shall have continued for a period of fifteen (15) days; or (b) Any representation or warranty made by or on behalf of Borrower in this Note, the Agreement, the Security Agreement or in any other Loan -2- 3 Document (as defined in the Agreement) or in any statement or certificate given in writing pursuant thereto or in connection therewith is false, misleading or incomplete in any material respect when made (or deemed to have been made); or (c) Borrower breaches or fails or neglects to perform, keep or observe any covenant set forth in this Note, the Agreement, the Security Agreement, or any other Loan Document (other than Borrower's obligation to make all payments due under this Note which is governed by subparagraph (a) above) and the same has not been cured within ten (10) calendar days after Borrower receives notice thereof from Holder; or (d) Borrower shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing; or (e) An involuntary case or other proceeding shall be commenced against Borrower seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against Borrower under the federal bankruptcy laws as now or hereafter in effect; or (f) This Note, the Agreement, the Security Agreement or any other Loan Document for any reason (other than the satisfaction in full of all amounts owing in connection with the Loan) ceases to be, or is asserted by Borrower not to be, a legal, valid and binding obligation of Borrower, enforceable in accordance with its terms, and such occurrence has not been cured to Holder's satisfaction within five (5) calendar days after Borrower receives notice thereof from Holder; or (g) Borrower has fraudulently conveyed or concealed its property to prevent attachment or execution by its creditors; or (h) Borrower is insolvent and fails to satisfy or obtain the release of any judicial lien within 30 days of such lien coming into existence; or -3- 4 (i) Borrower has admitted to any person in writing that it is unable to pay its debts and that it is willing to be adjudged a bankrupt. If an Event of Default shall occur and be continuing or shall exist, the principal amount of this Note and interest accrued hereon shall be immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived, and an action therefor shall immediately accrue. 9. GOVERNING LAW. This Note shall be governed by, and construed and enforced in accordance with, the internal laws (including the laws of conflict and choice of law) of the State of California. 10. WAIVER. No failure to exercise and no delay in exercising any right, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein provided are cumulative and not exclusive of any rights or remedies provided by law. 11. AMENDMENT. This Note may be amended or modified only upon the written consent of both Borrower and Holder. Any amendment must specifically state the provision or provisions to be amended and the manner in which such provision(s) are to be amended. 12. FEES AND EXPENSES. Borrower promises to pay all the cost and expenses, including reasonable attorneys' fees, incurred in the collection and enforcement of this Note. Borrower and each surety, endorser, guarantor, and other party ever liable for payment of any sums of money payable under this Note, hereby, jointly and severally, consent to renewal and extension of time at or after the maturity hereof, without notice, and hereby, jointly and severally waive diligence, presentment, protest, demand and notice of every kind and, to the full extent permitted by law, the right to plead any statute of limitations as a defense to any demand hereunder. 13. AGREEMENT. This Note incorporates by reference all the provisions of the Agreement, including but not limited to all provisions contained therein with respect to Events of Default, waivers, remedies and covenants, and the description of the benefits, rights and obligation of each of the Borrower and Holder under the Agreement. [Signature Page Follows] -4- 5 [SIGNATURE PAGE TO PROMISSORY NOTE] IN WITNESS WHEREOF, Borrower has executed this Note as of the date and year first above written. BORROWER: DIEDRICH COFFEE, INC., a Delaware corporation By: /s/ KERRY W. COIN ------------------------------- Name: Kerry W. Coin Title: President and Chief Operating Officer -5- 6 PROMISSORY NOTE LOANS OF PRINCIPAL
- ------------------------------------------------------------------------------------------------------------------------ Holder Borrower Date Amount of Loan Principal Balance Recordation By Endorsement By - ------------------------------------------------------------------------------------------------------------------------ August 19, 1997 $250,000 $250,000 /s/ V.R. Cirica /s/ K. Coin - ------------------------------------------------------------------------------------------------------------------------ August __, 1997 $250,000 $500,000 /s/ V.R. Cirica /s/ K. Coin - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------
-6- EX-27 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DIEDRICH COFFEE, INC. UNAUDITED FINANCIAL STATEMENTS FOR THE TWENTY-SIX WEEKS ENDED AND AS OF JULY 30, 1997 CONTAINED IN COMPANY'S 2ND QUARTER AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 6-MOS JAN-28-1998 JAN-30-1997 JUL-30-1997 571,752 0 178,256 0 1,572,795 2,865,417 12,936,700 2,613,175 13,943,662 4,966,467 0 0 0 53,917 0 13,943,662 11,678,242 11,678,242 5,902,708 5,902,708 11,827,507 0 21,651 (6,078,381) 2,890 (6,081,271) 0 0 0 (6,081,271) (1.13) 0
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