10-K

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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended July 3, 2002

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                      to                                     

Commission File No. 0-21203

DIEDRICH COFFEE, INC.
(Exact name of registrant as specified in its charter)

Delaware	33-0086628
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2144 Michelson Drive
Irvine, California 92612
(949) 260-1600
(Address of principal executive offices, including zip code
and telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of Class)

        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 ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o

        The aggregate market value of the registrant's common stock held by non-affiliates, based upon the closing sale price of the registrant's common stock on September 27, 2002 as reported on the Nasdaq National Market, was $9,698,000

        The number of shares of the registrant's common stock outstanding, as of September 27, 2002 was 5,161,267.

DOCUMENTS INCORPORATED BY REFERENCE

        Part III incorporates certain information by reference from registrant's definitive proxy statement pursuant to Schedule 14A for its 2002 annual meeting of stockholders, which proxy statement will be filed not later than 120 days after the close of the registrant's fiscal year ended July 3, 2002.

TABLE OF CONTENTS

		Page
A Warning About Forward-Looking Statements		3
	PART I
Item 1.	Business	4
Item 2.	Properties	20
Item 3.	Legal Proceedings	21
Item 4.	Submission of Matters to a Vote of Security Holders	21
	PART II
Item 5.	Market for Registrant's Common Equity and Related Stockholder Matters	22
Item 6.	Selected Financial Data	23
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 8.	Financial Statements and Supplementary Data	40
Item 9.	Changes in and Discussions With Accountants on Accounting and Financial Disclosures	40
	PART III
Item 10.	Directors and Officers of the Corporation	40
Item 11.	Executive Compensation	40
Item 12.	Security Ownership of Certain Beneficial Owners and Management	40
Item 13.	Certain Relationships and Related Transactions	40
Item 14.	Controls and Procedures	40
	PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	40
	Signatures	41
	Financial Statements	F-1
	Index to Exhibits	S-1

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A WARNING ABOUT FORWARD-LOOKING STATEMENTS

        We make forward-looking statements in this annual report that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our financial condition, operations, plans, objectives and performance. Additionally, when we use the words "believe," "expect," "anticipate," "estimate" or similar expressions, we are making forward-looking statements. Many possible events or factors could affect our future financial results and performance. This could cause our results or performance to differ materially from those expressed in our forward-looking statements. You should consider these risks when you review this document, along with the following possible events or factors:

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the financial and operating performance of our retail operations;



•

our ability to maintain profitability over time;



•

our ability to perform within the terms of our credit agreement;



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the successful execution of our growth strategies;



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franchisees' adherence to our practices, policies and procedures;



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the impact of competition; and



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the availability of working capital.

        Foreseeable risks and uncertainties are described elsewhere in this report and in detail under "Item 1. Business—Risk Factors and Trends Affecting Diedrich Coffee and Its Business." You are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this annual report. We undertake no obligation to publicly release the results of any revision of the forward-looking statements. Unless otherwise indicated, "we", "us", "our", and similar terms refer to Diedrich Coffee, Inc.

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PART I

Item 1. Business.

Overview

        Diedrich Coffee, Inc. is a specialty coffee roaster, wholesaler and retailer. We sell brewed, espresso-based and various blended beverages primarily made from our own fresh roasted premium coffee beans, as well as light food items, whole bean coffee, and accessories, through our Company operated and franchised retail locations. We also sell whole bean and ground coffees on a wholesale basis through a network of distributors in the Office Coffee Service ("OCS") market, and to other wholesale customers including restaurant chains and other retailers. Our brands include Diedrich Coffee, Gloria Jean's Coffees, and Coffee People. We operate a limited number of kiosks under the Coffee Plantation brand name. As of July 3, 2002, we owned and operated 70 retail locations and franchised 307 other retail locations under these brands, for a total of 377 retail coffee outlets. Although the specialty coffee industry is presently dominated by a single company, which operates or licenses over ten times the number of retail outlets we do, we are one of the nation's largest specialty coffee retailers with annual system-wide revenues in excess of $150 million. Our retail units are located in 37 states and 10 foreign countries. As of July 3, 2002, we also have over 426 wholesale accounts with OCS distributors, chain and independent restaurants, and others. In addition, we operate a large coffee roasting facility in central California that supplies freshly roasted coffee to our retail locations and wholesale accounts.

        Our Gloria Jean's mall based coffee stores offer an extensive variety of the finest quality flavored whole bean coffees, as well as an assortment of coffee related merchandise, accessories, porcelain novelties and gift items, in addition to coffee-based beverages. The critical components for each of our retail locations include high quality, fresh roasted coffee and superior customer service by knowledgeable employees.

        Our Diedrich Coffee brand is differentiated from other specialty coffee companies by roasting our coffee beans with experience gained over three generations by the Diedrich family. Our roasting recipes take into account the specific variety, origin and physical characteristics of each coffee bean to maximize its unique flavor. In addition, we seek to differentiate our coffeehouses by offering our customers a broad line of superior tasting coffee products and a high level of personalized customer service. Our coffeehouses offer a warm, friendly environment specifically designed to encourage guests to enjoy their favorite beverages while lingering with friends and business associates, or relaxing alone in comfort. Ample seating is augmented by sofas and comfortable chairs to create intimate nooks for meeting and relaxing. Many of our coffeehouses feature local musicians providing live entertainment certain evenings during the week.

Company Background

        Our predecessor company, Carl E. Diedrich & Sons, Inc. commenced operations in Orange County, California in 1972 and changed its name to Diedrich Coffee when its first retail store opened. We incorporated in California in 1985. We remained a small, family operated business with only three retail locations until 1992, but grew rapidly from 1992 to 1996 through construction of new Diedrich coffeehouses in Orange County, and the acquisition of coffeehouses operated under other brands in Houston, Denver and San Diego which were converted into Diedrich Coffee units. In August 1996, we reincorporated under Delaware law as Diedrich Coffee, Inc., and completed an initial public offering of our common stock in September 1996.

        In September 2000, we negotiated an amendment to our bank credit agreement which, among other things, accelerated the maturity date of all of our bank debt to September 2002, and necessitated the sale of certain of our assets and a careful reevaluation of our previous growth strategy. During

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May 2001, we raised additional capital to improve our liquidity and repay bank debt via a private placement of our stock with a group of new and existing investors.

Industry Overview

        Specialty coffee sales as a percentage of total coffee sales in the United States have been increasing steadily. According to the National Coffee Association, sales of specialty coffee grew from approximately 17% to almost 30% of total coffee sales in the United States from 1989 through 1997. According to the National Coffee Association's 2000 study, 54% of Americans drink coffee every day, representing 110 million daily drinkers. On average, each person drinks 3.1 cups per day. This latest study also indicated that 79% of the US adult population consumed coffee or gourmet coffee in 1999, an all time high. According to the National Coffee Association, 20 million American adults drink gourmet coffee beverages every day.

        The U.S. coffee market consists of two distinct product categories:

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commercial ground roast, mass-merchandised coffee



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specialty coffees, which include gourmet coffees (premium grade arabica coffees sold in whole bean and ground form) and premium coffees (upscale coffees mass-marketed by the leading coffee companies).

        Diedrich Coffee believes that several factors have contributed to the increase in demand for gourmet coffee including:

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greater consumer awareness of gourmet coffee as a result of its increasing availability;



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increased quality differentiation over commercial grade coffees by consumers;



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increased demand for all premium food products, including gourmet coffee, where the differential in price from the commercial brands is small compared to the perceived improvement in product quality and taste; and



•

ease of preparation of gourmet coffees resulting from the increased use of automatic drip coffee makers and home espresso machines.

Diedrich Coffee's Business Model

        Our business objective is a logical extension of our Mission Statement, which states: "We sell great coffee." Therefore, our objective is to sell coffee, without compromising our commitment to quality. We buy only the finest quality green coffee beans available, fresh roast them with our proprietary recipes and subject them to a rigorous internal quality control process. We ensure that care is taken at each and every step of the production and distribution process to preserve that quality.

        We principally sell all of our coffee through two distribution channels, and strive to target our Company resources to increase efficiency and profitability while growing the business within this framework. These two distribution channels are our retail outlets and wholesale distribution. While each of these channels has different customers, cost structures, overhead requirements, competitors, and other fundamental differences, we believe our commitment to quality is essential to successful growth in both of these areas. Important financial information for each of our business segments can be found in Note 15 to our financial statements.

Retail Outlets

        Our retail outlet distribution channel can be divided into two sub-channels, each with its own distinct business model including differences in revenue and cost structure, overhead, and capital requirements. These two retail sub-channels are Company operated retail outlets and franchised retail

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outlets. We view retail outlets as a single distribution channel, despite the differences noted above, primarily because our retail customers do not make any distinction between Company and franchise operated locations. The critical success factors are, therefore, the same for each type of retail location, whether Company operated or franchised—quality of product, service and atmosphere. The economic model and cost structures are also the same for each type of location at the retail unit level, notwithstanding their different direct financial impacts on us in our roles as both an operator and franchiser of retail outlets. Furthermore, the potential contribution of any given outlet, as measured by the amount of roasted coffee produced through our roasting plant, is the same.

        Presently, our largest brand is Gloria Jean's and over 94% of Gloria Jean's retail units are franchised. Gloria Jean's retail units are located throughout the United States, and in 10 foreign countries. Our Diedrich Coffee brand has a higher concentration of Company operated units, with 68% of retail locations operated by the Company. Diedrich units are located primarily in Orange County, California, although there are a number of Diedrich locations in Denver, Houston, and elsewhere in the United States. We also operate retail coffee outlets under a third brand, Coffee People, which are 100% Company operated at this time. Coffee People outlets are all located in Portland, Oregon. Finally, we operate a limited number of kiosks in Arizona under the Coffee Plantation brand name.

        A table summarizing the relative sizes of each of our brands on a unit count basis, and changes in unit count for each over the past two years, is included below.

				Fiscal 2001 Activity							Fiscal 2002 Activity
				Units at June 28, 2000	Opened	Closed		Net transfers between the Company and Franchise(A)		Units at June 27, 2001	Opened	Closed		Net transfers between the Company and Franchise(B)		Units at July 3, 2002
Gloria Jean's Brand
		Company Operated		22	—	(3	)	—		19	—	(3	)	2		18
		Franchise—Domestic		194	7	(24	)	—		177	2	(22	)	(2	)	155
		Franchise—International		62	40	(7	)	—		95	51	(6	)	—		140
	Subtotal Gloria Jean's			278	47	(34	)	—		291	53	(31	)	—		313
Diedrich Coffee Brand
		Company Operated		39	—	(6	)	(7	)	26	—	(1	)	—		25
		Franchise—Domestic		3	6	(2	)	7		14	2	(4	)	—		12
	Subtotal Diedrich			42	6	(8	)	—		40	2	(5	)	—		37
Other Brands
Company Operated				41	1	—		—		42	1	(16	)	—		27
			Total	361	54	(42	)	—		373	56	(52	)	—		377

(A)

This number is the net impact of 9 Company operated Diedrich Coffee coffeehouses transferred to franchisees during the year, and 2 franchised operated coffeehouses transferred from franchisees to the Company.

(B)

This number is the net impact of 1 Company operated Gloria Jean's coffeehouses transferred to a franchisee during the year, and 3 franchised operated coffeehouses transferred from franchisees to the Company.

        We recognize the tremendous importance of our brands to our success in both the retail and wholesale areas of our business. We therefore devote considerable energy to maintaining distinct brand identities. Our brands are differentiated by coffees offered, other product categories offered, format and type of retail location, advertising message, and trade dress.

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Gloria Jean's Coffees

        Gloria Jean's is one of the leaders in specialty grade, flavored coffee in the mall coffee store segment with 313 coffee stores in 37 states across the United States and in 10 foreign countries. Gloria Jean's coffee stores are located almost exclusively in high traffic shopping malls. As a mall coffee store, Gloria Jean's consumer traffic pattern is driven by mall hours and the mall dynamic. Gloria Jean's is busiest on weekends and holidays. The typical Gloria Jean's coffee store is staffed with a manager and a staff of 12 to 15 part-time hourly employees from which the operating shifts are filled. Gloria Jean's outlets tend to open earlier than most mall stores, but in general, operating hours reflect mall hours. Internationally, Gloria Jean's may be found both in malls and on street front locations, along with other non-traditional venues. In addition to coffee beverages and fresh roasted whole bean coffees, Gloria Jean's carries a wide selection of gift items and coffee accessories, and a small selection of bakery items to complement beverage sales. The stores sell from 32 to 48 varieties of flavored and non-flavored coffees. Currently, approximately 50% of sales mix is comprised of beverage sales.

        The success of a Gloria Jean's coffee store depends on three critical components: product quality, selection, and service.

        Product Quality. Gloria Jean's was a pioneer in developing high quality, flavored, specialty coffees, and continues to be a leader in the sale of flavored coffees today. Gloria Jean's flavored coffees begin with a top quality single-origin coffee that is roasted and then coated with proprietary flavorings.

        Product Selection. In the mall environment, the shopping experience is integral to a coffee store, and sales of whole bean coffee and coffee-related merchandise tend to represent a large percentage of the sales mix. Having as many as 40 varieties of flavored coffees, a wide variety of hot and cold beverages, and a good selection of gift items is important. A major benefit of mall retailing is its captive consumer base. The primary function of Gloria Jean's marketing is to entice consumers with eye-catching signage and window displays. A large selection of items helps to attract both new and repeat customers. Once inside a mall, consumers are unlikely to leave to purchase coffee, refreshments or gifts similar to those offered by Gloria Jean's. Mall employees are also captive consumers and represent an important component of our customer base.

        Service. Friendly and efficient customer service is always critical in any retail setting, and is especially important in the mall environment, where shoppers are often in a hurry, and have many choices. Because of the tendency for repeat customers, it is essential that customers receive excellent service.

Diedrich Coffee Coffeehouses

        Our typical Diedrich Coffee neighborhood coffeehouse is staffed with 1 or 2 managers and a staff of 10 to 15 part-time hourly employees from which the operating shifts are filled. Additionally, local entertainment is used on the weekends to enhance the neighborhood atmosphere. The hours for each coffeehouse are established based upon location and customer demand, but typically are from 6:00 a.m. to 11:00 p.m.

        In addition to coffee beverages and fresh roasted whole bean coffees, all of our Diedrich Coffee coffeehouses offer a limited selection of light food items such as bagels, croissants and pastries, and dessert items, such as cookies and cakes, to complement beverage sales. Our coffeehouses sell more than 20 different selections of regular and decaffeinated roasted whole bean coffees, and they carry select coffee-related merchandise items. The success of a Diedrich Coffee retail coffeehouse depends upon three critical components: product quality, service and ambiance.

        Product Quality. We are the only specialty coffee retailer whose founder, Martin Diedrich, comes from three generations of experience in the specialty coffee industry. Mr. Diedrich, Vice Chairman and Chief Coffee Officer, is intimately involved in the daily business of sourcing, tasting and roasting

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coffees. He is also directly involved in "Coffee University", our training program for coffeehouse team members. Due to Mr. Diedrich's unique background and experience, we are able to identify and secure exceptional coffees and roast them to perfection.

        Service. Our coffeehouses deliver specific consumer benefits that address a wide range of otherwise unmet needs in the suburban neighborhoods of America. As a neighborhood coffeehouse, we are the non-alcoholic answer to the corner pub. Our employees greet regular customers by name and acknowledge all patrons by name at the point of drink pick-up. While a large percentage of coffeehouse business is quick morning coffee pick-up, where speed is an important aspect of our overall service, our coffeehouses place a greater emphasis on hospitality and customer interaction to encourage development of strong afternoon and evening business. This is complemented by our selection of desserts, pastries and quality, non-caffeinated beverages. Surveys and customer comments indicate that patrons are treated as part of the Diedrich Coffee community and frequently visit the coffeehouse.

        Ambiance. Our coffeehouses are specifically designed to encourage guests to linger with friends and business associates, or to relax alone in comfort. Ample seating is augmented with sofas and comfortable chairs to create intimate nooks for meeting and relaxing. A weekly entertainment schedule is provided to encourage patrons to revisit on weekend evenings. A signature element of our full size coffeehouses is a coffee bar, where customers can sit at a barstool and watch the barista prepare espresso-based drinks, similar to the way patrons in traditional pubs and taverns interact with the bartender and other customers at the bar.

Wholesale Segment

        We presently have over 426 wholesale accounts not affiliated with our retail locations, which purchase coffee from us under both the Diedrich Coffee and Gloria Jean's brands. Our current wholesale accounts are in the OCS market, chain restaurants, independent restaurants and other hospitality industry accounts and specialty retailers. Additionally, our franchise agreements require both Gloria Jean's and Diedrich Coffee franchisees to purchase substantially all of their coffee from us, and we record a wholesale gross profit on such sales.

OCS Market

        We primarily sell our premium coffees to OCS distributors in whole bean and ground coffee form for use in traditional coffee brewing equipment found in most office environments. During fiscal 2000, we entered into a Licensing Agreement with Keurig, Inc. whereby we utilize Keurig's patented single-serve coffee brewing technology and its existing extensive distribution channels within the OCS market. During fiscal 2002, we sold over 21 million individual serving "K-cups" of both Diedrich Coffee and Gloria Jean's coffee through this distribution channel. Keurig is presently developing a variation of its OCS market brewing technology for at home use by consumers, and we intend to participate actively in that Keurig market as well if at home use is successfully established.

Chain Restaurants

        As specialty coffee has grown in overall popularity, restaurant customers are demanding a high quality cup of coffee as a supplement to a fine meal. Our chain accounts include Ruby's Restaurants, Ruth's Chris Steakhouse (California and Arizona locations), and Islands Restaurants. We not only supply coffee to these customers, but also approve their equipment and train their employees to ensure that the quality of coffee served meets our rigorous quality standards. It is common for our chain restaurant wholesale customers to specify in their menus that they serve Diedrich Coffee or Gloria Jean's coffee, providing us with additional exposure to the restaurants' patrons.

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Other Unaffiliated Wholesale Accounts

        We also supply coffee on a wholesale basis to a number of smaller, often independent, operators in the restaurant and hospitality industries and specialty retailers. These wholesale accounts are typically in the same geographic areas where our retail outlets have created strong brand awareness and demand. We are careful to balance the benefit of new wholesale accounts near our existing retail outlets against the risk of "cannibalization" of these units. This risk can be successfully managed. Many of our wholesale accounts, such as hotels, restaurants, golf course snack bars and airport concessions have their own "captive" customer base. In such cases, the risk of cannibalization is minimal, since a customer would not likely stop their activity in such locations to visit one of our coffeehouses or mall based coffee stores for a beverage, and then return to their previous activity at those wholesale customer locations. Additionally, if sales conflicts arise as we develop new retail locations in the future, we can cease selling to then-existing wholesale accounts.

Growth Strategy

        Retail Segment Growth.    We expect future growth in our retail segment to occur in two ways: via comparable store sales growth in each of our retail brands, and from new retail unit growth. New unit growth will be achieved primarily through the development of new Gloria Jean's mall coffee stores and Diedrich Coffee coffeehouses by franchisees. This development is expected to occur throughout the United States, as well as internationally for Gloria Jean's. For Diedrich Coffee, franchise development will occur less rapidly, relative to Gloria Jean's, due to the relatively small size of the Diedrich system at the present time, and few existing franchisees. New unit growth for Diedrich will be concentrated almost exclusively in southern California, where existing brand awareness and our retail unit support infrastructure is the greatest, and expand out from that base over time into areas of geographic proximity. In the near term, retail growth under our Coffee People brand will occur exclusively through comparable store sales growth, as no new retail units are planned presently.

        For the foreseeable future, development of new retail locations by the Company will be undertaken on a very selective basis. For both Gloria Jean's and Diedrich, such new company-store development will be done primarily for the purpose of facilitating new franchise development, rather than as part of a deliberate strategy to increase the size of the Company-operated retail unit portfolio. Therefore, increased development of new retail units by the Company will likely be accompanied by increased sales of Company-operated retail units to franchisees. For a variety of reasons, retail units sold by the Company to franchisees in any given period may not necessarily coincide precisely with the specific new units developed by the Company in that same period. Development of new retail units by the Company is expected to support new franchise development in a number of ways, including opportunistically obtaining control of good locations as they become available, increasing awareness of our specialty coffee brands by real estate developers and landlords of prime retail properties as they develop new retail venues, and by prospective retail coffeehouse customers, improving the cost effectiveness of architectural plans for new prototypes, and leveraging purchasing efficiencies system-wide for new unit equipment and fixtures packages, and increasing awareness among prospective franchisees and their lenders.

Gloria Jean's Franchise Growth

        Since the acquisition of Gloria Jean's in 1999, we have made a number of modifications to the Gloria Jean's franchising business model to strengthen the Gloria Jean's system. A new form of franchise agreement was adopted which incorporated many provisions common in other successful franchise systems. Screening of financial qualifications of franchise candidates has been improved in terms of consistency and accuracy. Franchisees are now encouraged to obtain their own master leases directly from mall owners, rather than subleasing their locations from Gloria Jean's. Franchisees are required to hire their own architects and contractors to develop new Gloria Jean's locations to

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approved specifications. Our training program has been completely redesigned in order to improve the quality of store level operations, product quality and the consistency of brand standards. While we feel that these and other changes to the Gloria Jean's franchising model will ultimately result in a stronger Gloria Jean's franchise system, they may result in slower domestic franchise growth in the near term.

        Another factor we must overcome in the near term to resume domestic unit growth for Gloria Jean's is a shortage of projects in our new unit development "pipeline," or inventory of new unit deals in progress. This shortage resulted from our focus on improving the foundation for future franchise development during the past several years since we acquired Gloria Jean's, rather than on opening new retail units. As part of this strengthening of the existing retail base, it was necessary to allow many of the weaker performing and poorer sales potential locations to close. Additional gaps in the flow of new franchise units resulted from several periods where our franchise registration status (required by law to sell new franchises) was temporarily interrupted during certain periods when our financial position was less stable than it is today, and frequent updates of our registration was required.

        There were 13 "premature" franchise unit closures (closures prior to the natural expiration of the underlying master lease) during the most recent fiscal year, for a variety of reasons, and nine other franchise units which closed during the same period because they had reached their lease expiration dates and the underlying leases were not renewed. Retail units in this latter category were most commonly closed because it did not make economic sense to renew the related leases, based on the rent increase required by the landlord, changes in the retail tenant mix (including new competition), desirability of the location, and other factors. We expect to see a significantly lower annual rate of premature unit closures by franchisees in future years, compared to fiscal 2002. However, we continue to anticipate that retail unit closures will occur each year at levels similar to historical trends because of the non-renewal of leases upon their expiration. Therefore, it may be several years before we are able to open a sufficient number of new domestic retail units to offset the cumulative number of unit closures during the same time period, for cumulative net growth in domestic retail unit count compared to the end of fiscal 2002.

        Gloria Jean's has been very successful establishing coffeehouses internationally through Area Development Agreements, and has added a net of 78 new international franchise units during the past two fiscal years. International franchisees operated 140 Gloria Jean's retail locations in 10 countries at July 3, 2002, and we anticipate continued strong growth internationally through existing Area Development Agreements during fiscal 2003. We will also seek to execute new Area Development Agreements and Master Franchise Agreements in order to expand Gloria Jean's international penetration to additional countries in the future.

Diedrich Coffee Franchise Growth

        Our franchise growth strategy for the Diedrich Coffee brand is to attract experienced franchise developers who will develop new retail coffeehouses, kiosks and carts in existing markets, primarily in southern California. We intend to utilize development agreements with new franchise operators, who would be required to commit to build three or more coffeehouses.

        Central to this strategy will be to leverage Diedrich's existing brand awareness and retail operating unit base in central and south Orange County, California, to achieve penetration of this "core" market. Once this is accomplished, our plan is to develop additional franchised retail units in new markets, expanding outwardly from the core market in concentric rings, and focusing sequentially on the next highest priority areas for expansion. Therefore, north Orange County, southern Los Angeles County and northern San Diego County, all of which are in close geographic proximity to Diedrich's existing core base of retail coffeehouses, but which presently have no Diedrich units, would be our next priority once Orange County is nearing maximum penetration. Likewise, once a base of coffeehouses has been successfully established in these immediately adjacent markets, the next sphere of opportunity would

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include parts of the greater Los Angeles and San Diego metropolitan areas progressively further from Orange County. It should be noted that growth potential under such a "concentric rings" strategy would be significant, even though concentrated within a single region, because of the significant population of southern California. Based upon the 2000 census, the five county metropolitan Los Angeles area (which includes Los Angeles, Orange, Riverside, San Bernardino and Ventura Counties) presently has a population in excess of 15 million people, while San Diego County has a population in excess of 2 million people. We believe that this strategy maximizes the likelihood of success of new retail units because of the heightened brand awareness and operational efficiencies.

        As will be the case for our Gloria Jean's brand, new Diedrich units we open as company-operated coffeehouses will be undertaken on a very selective basis, and primarily as a way to facilitate our franchising initiative described above. Also as in the case of our Gloria Jean's operations, we may periodically sell certain company operated Diedrich locations to franchisees as part of this same strategy.

        As of July 3, 2002 we had two area development agreements in effect with franchisees, both of which are for areas outside of California. We anticipate that one of these development agreements will be terminated and the other amended during fiscal 2003, resulting in commitments for approximately three new franchise locations. These figures do not reflect commitments related to any new franchise development agreements we may execute during fiscal 2003.

        Wholesale Distribution Growth.    We have taken significant steps to build our wholesale sales organization over the past two years, and we are actively seeking new distribution channels for our products. We intend to pursue continued growth within our OCS wholesale business by expanding the number of distributors who carry our Keurig Premium Coffee Systems ™ lines of coffees and our whole bean and ground coffee product lines as well. We also offer our coffees on our internet website, and believe that this channel of distribution has significant long term growth potential.

Franchise Support Programs

        We provide a variety of support services to our franchisees. These services include:

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training



•

business consultation



•

marketing



•

product sourcing



•

volume purchasing savings

        We have established an intensive training program for our franchisees, which includes training on in-store operations, coffee knowledge, merchandising, buying, controls and accounting. Management works closely with franchisee representatives on issues that affect the operations of stores. Franchisees are surveyed regularly to provide feedback on subjects that affect the operations of their stores.

Marketing

        Our primary marketing strategy is to develop the Gloria Jean's and the Diedrich Coffee brand through penetration of new and existing markets via franchise growth. The wholesale segment's sales of our branded products in the office coffee service market, chain restaurants, and other venues also helps ensure the visibility of our brands. Our marketing efforts are based upon the belief that the proprietary roast recipes and our commitment to quality and freshness deliver a distinctive advantage in our products. We use word-of-mouth, local store marketing and the inviting atmosphere of our coffeehouses and mall coffee stores to drive brand awareness and comparable store sales growth. We

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also conduct in-store coffee tastings, provide brewed coffee at local neighborhood events, and donate coffee to local charities to increase brand awareness and product trial in the communities where our coffeehouses and mall coffee stores are located.

Product Supply and Roasting

Sourcing

        Coffee beans are an agricultural product grown commercially in over 50 countries in tropical regions of the world. The price and supply of coffee are subject to significant volatility. There are many varieties of coffee and a range of quality grades within each variety. Although the broader coffee market generally treats coffee as a fungible commodity, the specialty coffee industry focuses on the highest grades of coffee. We purchase premium grade arabica coffee beans that we believe to be the best available from each producing region.

Roasting

        We employ a roasting process that varies based upon the variety, quality, origin and physical characteristics of the coffee beans being roasted. Our master roasters, under the supervision of Martin Diedrich, are responsible for the green coffee bean roasting process. They are craftsmen who employ our proprietary roasting formulas while adjusting the formula to take into account the specific attributes of each coffee bean being roasted. Each coffee bean contains aromatic oils and flavor characteristics that develop from the soil, climate and environment where the bean is grown. The skilled roast master determines and carefully controls the roasting conditions in an effort to maximize the flavor potential of each batch of coffee. The roast master hears how the roast pops, smells the developing aroma and identifies the right shades of color. He draws upon experience and knowledge to properly adjust airflow, time and temperature while the roast is in progress in order to optimize each roast.

Freshness

        We are committed to serving our customers beverages and whole bean products from freshly roasted coffee beans. Our coffee is delivered to our retail locations and wholesale customers promptly to guarantee the freshness of each cup of coffee or package of whole coffee beans sold.

Competition

        The specialty coffee market is intensely competitive and highly fragmented. With low barriers to entry, competition in the industry is expected to increase from national and regional chains, as well as local specialty coffee stores. We compete directly against all other premium coffee roasters, wholesalers and retailers, including other brands of coffeehouses, and mall coffee stores, restaurant and beverage outlets that serve coffee, and a growing number of espresso kiosks, stands, and carts. In addition, we compete to draw consumers of standard or commercial coffee to premium coffee. Our whole bean coffee competes directly against specialty coffees sold at retail through supermarket, specialty retailers and a growing number of specialty coffee stores. We believe that our customers choose among retailers primarily on the basis of product quality, service, coffeehouse ambiance, convenience and, to a lesser extent, on price.

        We compete with a growing number of specialty coffee retailers including Starbucks, Coffee Beanery Ltd., Caribou Coffee, Barnie's, Tully's, New World Coffee & Bagels, Peet's Coffee and many others. The attractiveness of the gourmet specialty coffeehouse market may draw additional competitors with substantially greater financial, marketing and operating resources than us. A number of nationwide coffee manufacturers, such as Kraft General Foods, Proctor & Gamble, and Nestle, distribute coffee products in supermarkets and convenience stores, which may serve as substitutes for

12

our coffees. Other specialty coffee companies including Starbucks, Seattle's Best Coffee, Bucks County, Brothers Gourmet Coffees and Green Mountain Coffee Roasters, sell whole bean coffees in supermarkets and variety and discount stores.

Other Factors

        The performance of individual coffeehouse or mall coffee stores may also be affected by factors such as traffic patterns and the type, number and proximity of competing coffeehouses or mall coffee stores. In addition, factors such as inflation, increased coffee bean, food, labor and employee benefit costs and the availability of experienced management and hourly employees may also adversely affect the specialty coffee retail business in general and our coffeehouses and mall coffee stores in particular.

Seasonality

        Historically, we have experienced variations in sales from quarter-to-quarter due to the peak November-December holiday season, as well as from a variety of other factors, including, but not limited to, general economic trends, the cost of green coffee, competition, marketing programs, weather and special or unusual events.

Intellectual Property

        We own several trademarks and service marks that have been registered with the United States Patent and Trademark Office, including Diedrich Coffee®, Gloria Jean's®, Coffee People®, Motor Moka®, Aero Moka®, Wiener Melange Blend®, Harvest Peak®, and Flor de Apanas®, as well as other slogans, product names, design marks and logos. In addition, we have applications pending with the United States Patent and Trademark Office for a number of additional marks. We also own registrations and have applications pending in numerous foreign countries for the protection of the Diedrich Coffee and Coffee People trademark and service mark. These trademark registrations can generally be renewed as long as we continue to use the marks protected by the registrations. The Gloria Jean's and Diedrich Coffee trademarks are material to our business. We also own a number of common law service marks and trademarks in the United States including "Gloria Jean's Coffee Bean." We have also received trademark and service mark protection for the name Coffee People and related marks in Canada and Japan. We own copyrights on our promotional materials, coffeehouse graphics and operational and training materials. We do not believe that any of these copyrights, valuable as they are, are material to our business.

Employees

        At July 3, 2002, we employed a work force of 882 people, 415 of whom were employed full-time. None of our employees are represented by a labor union, and no employees are currently covered by collective bargaining agreements. We consider our relations with our employees to be good. We regularly review our employee benefits, training and other aspects of employment to attract and to retain valuable employees and managers.

Government Regulation

        In addition to the laws and regulations relating to the food service industry, we are subject to Federal Trade Commission regulation and state laws that regulate the offer and sale of franchises as well as the franchise relationship. The FTC's Trade Regulation Rule relating to Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures generally requires us to give prospective franchisees a franchise offering circular containing information prescribed by the rule. A number of states have laws that regulate the offer and sale of franchises and the franchisor-franchisee relationship. These laws generally require registration of the franchise offering

13

with state authorities before making offers or sales and regulate the franchise relationship by, for example:

•

prohibiting interference with the right of free association among franchisees;



•

prohibiting discrimination in fees and charges;



•

regulating the termination of the relationship by requiring "good cause" to exist as a basis for the termination, advance notice to the franchisee of the termination, and an opportunity to cure a default;



•

requiring repurchase of inventories in some circumstances;



•

restricting nonrenewal by the franchisor;



•

limiting restrictions on transfers or inheritance of the franchisee's interests; and



•

regulating placement of competing units that might adversely affect the franchisee's results.

Failure to comply with these laws may adversely affect us. Any changes to the FTC rule or state franchise laws, or future court or administrative decisions, however, could affect our franchise business. There are also extensive federal, state and local government regulations relating to the development and operation of food service outlets, including laws and regulations relating to: building and seating requirements; the preparation and sale of food; cleanliness; safety in the workplace; and accommodations for the disabled. Our relationship with our employees is also subject to regulation, such as: minimum wage requirements; anti-discrimination laws; overtime and working conditions; and citizenship requirements.

Risk Factors and Trends Affecting Diedrich Coffee and Its Business

Historical losses may continue and, as a result, the price of our common stock may be negatively affected.

        Although Diedrich Coffee had net income of $1,269,000 for the fiscal year ended July 3, 2002, we had a net loss of $3,988,000 for the fiscal year ended June 27, 2001, a net loss of $22,423,000 for the fiscal year ended June 28, 2000, and net losses of $2,562,000, $9,113,000, and $986,000 for the fiscal years ended January 1999, 1998, and 1997, respectively. We may not be able to sustain profitability.

If we are not able to grow our business, the results of our operations and our financial condition may be adversely impacted.

        As of July 3, 2002, we operated 52 Diedrich Coffee or Coffee People retail locations, which we managed on a day-to-day basis, and had 12 franchised Diedrich Coffee coffeehouse locations. We also had 313 Gloria Jean's retail locations, of which 295 were franchised. Our Gloria Jean's retail locations are principally located in malls. To grow, we must:

•

attract single and multi- store franchisees for our Gloria Jean's brand in the United States, and multi-store franchisees and franchise area developers internationally;



•

continue to upgrade products and programs at Gloria Jean's;



•

expand wholesale sales of Diedrich Coffee and Gloria Jean's;



•

attract franchise area developers for Diedrich Coffee and Gloria Jean's in the United States and internationally;



•

obtain (or have our franchise area developers obtain) suitable sites at acceptable costs in highly competitive real estate markets;



•

hire, train and retain qualified personnel;

14

•

integrate newly franchised or corporate locations into existing product distribution;



•

improve inventory control, marketing and information systems; and



•

impose and maintain strict quality control from green coffee acquisition to the fresh cup of brewed coffee in a customer's hand.

        Implementation of our growth strategy may divert management's attention from other aspects of our business and place a strain on management, operational and financial resources, and accounting systems. Future inability to grow our business may adversely affect the results of our operations and our financial condition.

Our franchisees could take actions that could harm our business.

        Franchisees are independent contractors and are not our employees. We provide training and support to our franchisees, and the terms of our franchise agreements require franchisees maintain certain minimum operating standards; however, the quality of franchised operations may be diminished by any number of factors beyond our control. Consequently, franchisees may not successfully operate coffeehouses in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other personnel. In other instances, franchisees may operate their units in conformity with operating standards and specifications required, yet fail to meet their financial obligations to us under the franchise agreement or the sublease for the location, or to vendors, lenders or other creditors. While we have certain contractual remedies in such instances of default, enforcing such remedies typically requires litigation, and therefore our image and reputation, and the image and reputation of other franchisees, may suffer until such litigation is successfully concluded. If a significant number of franchisees were to be in default simultaneously, a larger number of franchise units could be terminated in a given time period than we would be able to re-franchise, or absorb into our company-operated unit base, and system-wide sales could significantly decline. If such an outcome were to occur, we might also be unable to meet our obligations to mall landlords for early termination of the master leases for such locations, which we typically guarantee.

Our growth through franchise area development may not occur as rapidly as we currently anticipate.

        Our ability to recruit, retain and contract with qualified franchise area developers has become, and will continue to be, increasingly important to our operations as we expand. In addition, the coffeehouses contemplated in existing franchise area development agreements may not open on the anticipated development schedule. Our franchisees are dependent upon the availability of adequate sources of financing on acceptable terms in order to meet their development obligations, and the credit markets for such franchise financing have historically been somewhat volatile. Prospective franchise lenders have historically been cautious in their approach to financing smaller or newer, less established retail brands vis-à-vis larger and more established franchised systems. Such financing may not be available to our franchised area developers, or only available upon disadvantageous terms. Our franchise development strategy may not enhance our results of operations. Failure to execute on our strategy to grow through franchise area development would harm our business, financial condition and results of operations.

Our operating results may fluctuate significantly, which could have a negative effect on the price of our common stock.

        Our operating results will fluctuate from quarter to quarter as the result of a number of factors, including:

•

fluctuations in prices of unroasted coffee;

15

•

labor costs for our hourly and management personnel, including increases in federal or state minimum wage requirements;



•

the number, timing, mix and cost of coffeehouse and mall coffee store openings, franchises, acquisitions or closings;



•

comparable store sales results;



•

changes in consumer preferences; and



•

the level of competition from existing or new competitors in the specialty coffee industry.

        From time to time in the future, our operating results likely will fall below the expectations of investors and public market securities analysts. Quarterly fluctuations, for any reason, could cause our stock price to decline. Also, our business is subject to seasonal fluctuations. The November—December holiday season generally experiences the highest sales. In contrast, hot weather tends to depress sales of hot coffee and espresso drinks, especially unseasonably warm weather. Consequently, we will continue to experience significant fluctuations in quarterly results.

        In addition, if we were to open additional Company owned-coffee houses in the future, we would incur significant pre-opening expenses, and the new coffeehouses would likely experience an initial period of operating losses. As a result, the opening of a significant number of Company-owned coffeehouses in a single period would have an adverse effect on our results of operations. Due to the foregoing, we believe that period-to-period comparisons of our historical or future operating results are not necessarily meaningful, and such comparisons should not be relied upon as indicators of future performance.

Because we have only one roasting facility, a significant interruption in the operation of this facility could potentially disrupt our operations.

        We have only one coffee roasting and distribution facility. A significant interruption in the operation of this facility, whether as a result of a natural disaster or other causes, could significantly impair our ability to operate our business on a day-to-day basis.

Future changes in minimum wage requirements could adversely affect our business, financial condition, results of operations or cash flows.

        A number of our employees are subject to various minimum wage requirements. Many of our employees work in retail locations located in California and Oregon, and receive salaries equal to those states' minimum wage laws, which salaries currently exceed the federal minimum wage. There can be no assurance that further increases will not be implemented in these or other jurisdictions in which we operate or seek to operate. There can be no assurance that we will be able to pass additional increases in labor costs through to our guests in the form of price adjustments and, accordingly, such minimum wage increases could have a material adverse effect on our business, financial condition, results of operations or cash flows.

We may not be able to renew leases or control rent increases at our retail locations.

        All of our 70 Company-operated coffeehouses are presently on leased premises. Gloria Jean's stores are generally leased by an indirect subsidiary of Coffee People, although in most cases, the franchisees pay their rent directly to their landlord. Upon the expiration of some of these leases, there is no automatic renewal or option to renew. Consequently, these leases may not be renewed. If they are renewed, rents may increase substantially. Either of these events could adversely affect us. Other leases are subject to renewal at fair market value, which could involve substantial rent increases, or are

16

subject to renewal with scheduled rent increases, which could result in rents being above fair market value.

Our industry is highly competitive and we may not have the resources to compete effectively.

        With low barriers to entry, competition in the industry is expected to increase from national and regional chains, franchise operators and local specialty coffee stores. Our whole bean coffees compete directly against specialty coffees sold at retail through supermarkets, specialty retailers, variety and discount stores, and a growing number of specialty coffee stores. Many specialty coffee companies, including Starbucks, Seattle's Best Coffee, Bucks County, Brothers Gourmet Coffees and Green Mountain Coffee Roasters sell whole bean coffees through these channels. In our sale of coffee beverages and espresso drinks, we compete directly against all other specialty grade coffee roasters, coffeehouses, espresso/coffee bars and mall coffee stores, as well as against restaurant and beverage outlets that serve coffee and a growing number of espresso stands, carts, and stores. Our competition at this level includes a growing number of specialty coffee retailers, including Starbucks, Seattle's Best Coffee, Barnie's, Coffee Beanery Ltd., Caribou Coffee, Peet's Coffee, Tully's Coffee and many others. The attractiveness of the gourmet specialty coffeehouse market may draw additional competitors with substantially greater financial, marketing and operating resources than us. In addition, we compete to draw customers of standard or commercial coffee, and consumers of substitute coffee products manufactured by a number of nationwide coffee manufacturers, such as Kraft General Foods, Proctor & Gamble and Nestle, to specialty grade coffee.

        We believe that our customers choose among retailers primarily on the basis of product quality, service, coffeehouse ambiance, convenience, and, to a lesser extent, on price. The performance of individual coffeehouses or mall coffee stores may also be affected by factors such as traffic patterns and the type, number and proximity of competing coffeehouses or mall coffee stores. In addition, factors such as inflation, increased coffee bean, food, labor and employee benefit costs, and the availability of experienced management and hourly employees may also adversely affect the specialty coffee retail business in general and our coffeehouses and mall coffee stores in particular.

Growth of our international operations may be adversely affected by factors outside of our control.

        We have 140 Gloria Jean's franchised stores located outside of the United States and its territories. As part of our growth strategy, we will be seeking franchise developers internationally for Gloria Jean's stores. As a result, our business and operations will be increasingly subject to the risk of changes in economic conditions and, to a lesser extent, changes in social and political conditions inherent in foreign operations, including changes in U.S. laws and regulations relating to foreign trade and investment. In addition, consumer tastes vary from region to region, and consumers located in the regions in which we intend to expand our retail operations may not be as receptive to specialty coffees as consumers in existing markets.

We must repay approximately $3.0 million in bank debt by March 2005. If we are not able to successfully manage our repayment strategy, or if we are unable to maintain compliance with our new financial covenants, our lender may declare us to be in default and exercise its contractual remedies.

        If we are unable to comply with the terms of the financial covenants contained in our Credit Agreement, our lender may declare a default and immediately accelerate the due date of our outstanding loans. If we are unable to repay our outstanding loans when asked to do so by the lender, the lender may exercise any one or more of the remedies available to it, including foreclosing on the assets pledged to support the loan, which includes virtually all of our assets. The lender may also require our subsidiaries to repay amounts outstanding because each of our subsidiaries is a co-borrower under the Credit Agreement.

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Our Company-operated retail locations are concentrated in the western region of the United States, and therefore our business is subject to fluctuations if adverse business conditions occur in that region.

        Our Company-operated retail locations are primarily located in the western region of the United States. Accordingly, we are susceptible to fluctuations in our business caused by adverse economic or other conditions in this region, including natural or other disasters. In addition, some of our competitors have many more retail locations than we do. Consequently, adverse economic or other conditions in a region, a decline in the profitability of several existing retail locations or the introduction of several unsuccessful new retail locations in a geographic area could have a more significant effect on our results of operations than would be the case for a company with a larger number of retail locations or with more geographically dispersed retail locations.

Our supply costs may be higher than we expect because of fluctuations in availability and cost of unroasted coffee.

        Increases in the price of green coffee, or the unavailability of adequate supplies of green coffee of the quality we seek, whether due to the failure of our suppliers to perform, conditions in coffee-producing countries, or otherwise, could have a material adverse effect on our results of operations. We depend upon both outside brokers and our direct contacts with exporters and growers in countries of origin for our supply of green coffee. Coffee supply and price are subject to significant volatility beyond our control. Although most coffee trades in the commodity market, coffee of the quality we seek tends to trade on a negotiated basis at a substantial premium above commodity coffee pricing, depending upon the origin, supply and demand at the time of purchase. Supply and price can be affected by multiple factors in the producing countries, including weather, political and economic conditions. In addition, green coffee prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations, such as the International Coffee Organization or the Association of Coffee Producing Countries. These organizations have historically attempted to establish commodity price controls of green coffee through agreements establishing export quotas or restricting coffee supplies worldwide. These organizations, or others, may succeed in raising green coffee prices. Should this happen, we may not be able to maintain our gross margins by raising prices without affecting demand.

Compliance with health, franchising and other government regulations applicable to us could have a material adverse affect on our business, financial condition and results of operations.

        Each retail location and roasting facility is and will be subject to licensing and reporting requirements by numerous governmental authorities. These governmental authorities include federal, state and local health, environmental, labor relations, sanitation, building, zoning, fire, safety and other departments relating to the development and operation of retail locations. Our activities are also subject to the Americans with Disabilities Act and related regulations, which prohibit discrimination on the basis of disability in public accommodations and employment. Changes in any or all of these laws or regulations could have a material adverse affect on our business, financial condition and results of operations. Delays or failures in obtaining or maintaining required construction and operating licenses, permits or approvals could delay or prevent the opening of new retail locations, or could materially and adversely affect the operation of existing retail locations. In addition, we may not be able to obtain necessary variances or amendments to required licenses, permits or other approvals on a cost-effective and timely basis in order to construct and develop retail locations in the future.

        We are also subject to federal regulation and certain foreign and state laws that govern the offer and sale of franchises and the franchisor-franchisee relationship. Many foreign and state franchise laws impose substantive requirements on franchise agreements, including limitations on noncompetition provisions and on provisions concerning the termination or nonrenewal of a franchise. Some foreign countries and states require companies to register certain materials before franchises can be offered or

18

sold in that country or state. The failure to obtain or retain licenses or registration approvals to sell franchises could delay or preclude franchise sales and otherwise adversely affect our business, financial condition and results of operations. Additionally, any franchise law violations may give existing and future franchisees a basis to bring claims against Diedrich Coffee. Franchise law violation claims could include unfair business practices, negligent misrepresentation, fraud, and statutory franchise investment and/or relationship violations. Remedies may include damages and/or rescission of the franchise agreement by the franchisee. These claims may already exist and their assertion against us could adversely affect our business, financial condition, and results of operations.

The loss of key personnel or our inability to attract and retain qualified personnel could significantly disrupt our business.

        Our continued success largely will depend on the efforts and abilities of our executive officers and other key employees. The loss of services of these individuals could disrupt operations. Although Diedrich Coffee has employment agreements with each of its executive officers, any of its executive officers can terminate their employment if he or she chooses to do so. In addition, our success and the success of our franchisees will depend upon our and their ability to attract and retain highly motivated, well-qualified retail operators and other management personnel, as well as a sufficient number of qualified employees. Qualified individuals needed to fill these positions are in short supply in some geographic areas. Our inability to recruit and retain such individuals may delay the planned openings of new retail locations or result in higher employee turnover in existing retail locations, which could have a material adverse effect on our business or results of operations.

We could be subject to adverse publicity or claims from our guests.

        We may be the subject of complaints or litigation from guests alleging beverage and food-related illness, injuries suffered on the premises or other quality, health or operational concerns. Adverse publicity resulting from such allegations may materially adversely affect us, regardless of whether such allegations are true or whether we are ultimately held liable. We may also be the subject of complaints or allegations from current, former or prospective employees from time-to-time. A lawsuit or claim could result in an adverse decision against us that could have a material adverse effect on our business, financial condition and results of operations.

Changes in consumer preferences or discretionary spending could negatively affect our results.

        Our retail locations offer specialty coffee beans, brewed coffee beverages, espresso-based beverages, blended drinks and light food items served in a casual setting. Our continued success depends, in part, upon the popularity of these types of coffee-based beverages and this style of casual dining. Shifts in consumer preferences away from our coffee-based beverages or casual setting could materially adversely affect our future profitability. Also, our success depends to a significant extent on numerous factors affecting discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce guest traffic or impose practical limits on pricing, either of which could adversely affect our business, financial condition, operating results and cash flows.

Our lack of diversification may affect business if demand is reduced.

        Our business is primarily centered on one product: fresh specialty grade coffee. To date, our operations have been limited to primarily the purchase and roasting of green coffee beans and the sale of whole bean coffee, coffee beverages and espresso drinks through our franchise coffee stores, coffeehouses, and wholesale coffee and mail order businesses. Any decrease in demand for coffee would have a material adverse effect on our business, operating results and financial condition.

19

Our failure or inability to enforce our trademarks and trade names could adversely affect our efforts to establish brand equity.

        Our ability to successfully expand our concepts will depend in part on our ability to maintain "brand equity" through the use of our trademarks, service marks, trade dress and other proprietary intellectual property, including our name and logos. We currently hold a number of trademarks and service marks related to our brands. Some or all of our rights related to our intellectual property may not be enforceable, even if registered, against any prior users of similar intellectual property or our competitors who seek or intend to utilize similar intellectual property in areas where we operate or intend to conduct operations. If we fail to enforce our intellectual property rights, we may be unable to capitalize on our efforts to maintain brand equity. It is possible that we will encounter claims from prior users of similar intellectual property in areas where we operate or intend to conduct operations, including foreign countries. Claims from prior users could limit our operations and possibly cause us to pay damages or licensing fees to a prior user or registrant of similar intellectual property.

Recent Developments

        As described more fully in the Notes to the accompanying Consolidated Financial Statements, we recorded an asset impairment and restructuring cost charge of $158,000 during the fourth quarter of fiscal 2002. This charge was recorded primarily to write down the carrying value of three coffeehouses we operate, and to reflect additional costs we expect to incur to terminate our remaining lease obligations on four other subleased locations which we no longer operate.

        On May 3, 2002 we announced that J. Michael Jenkins, our Chief Executive Officer, had passed away after failing to recover from gastric cancer. Philip G. Hirsch, who commenced his employment with us as interim CEO when Mr. Jenkins resigned from Diedrich Coffee shortly before his death, assumed the role of Chief Executive Officer effective September 1, 2002.

        On June 19, 2002 we announced that we had executed a seven year agreement with Keurig, Inc. to utilize its patented single-serve coffee brewing technology and distribution network in the Office Coffee Service market. This was a long term extension of a short term agreement we had previously been operating under, since June 2000.

        On September 3, 2002, we entered into a new Credit Agreement with United California Bank in order to, among other things, repay the balance of all remaining amounts owed to Fleet National Bank under our prior credit agreement. We immediately borrowed $3,000,000 under the new agreement, and repaid all amounts owed to Fleet on September 3, 2002, the amended maturity date of our loan from Fleet. The terms of our new Credit Agreement are discussed in detail below, under the caption "Outstanding Debt and Financing Arrangements," and in Notes 8 and 17 to the accompanying Consolidated Financial Statements.

Item 2. Properties.

Office Space and Plant

        We lease approximately 57,285 square feet of office space for administrative offices, warehousing, and training facilities in Irvine, California. The lease for this facility expires in October 2003. We currently lease approximately 9,400 square feet of office space in Beaverton, Oregon, though we have sublet this lease, which expires in February 2004. We also have a 60,000 square foot roasting facility located in Castroville, California that is leased through December 31, 2005, with an additional renewal option term of 7 years. We believe that our facilities are generally adequate for our current needs, and that suitable additional production and administrative space will be available as needed for the foreseeable future.

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Company-Owned Locations

        In addition, as of July 3, 2002, we were a party to leases for a total of 70 Company-operated retail locations. During fiscal year 2002, we closed 21 locations. Our Company-operated retail locations on leased premises are subject to varying arrangements specified in property specific leases. For example, some of the leases require a flat rent, subject to regional cost-of-living increases, while others are based upon a percentage of gross sales. In addition, certain of these leases expire in the near future, and there is no automatic renewal or option to renew. No assurance can be given that leases can be renewed, or if renewed, that rents will not increase substantially, both of which would adversely affect us. Other leases are subject to renewal at fair market value, which could involve substantial increases or are subject to renewal with a scheduled rent increase, which could result in rents being above fair market value.

Franchised Stores

        All of our Gloria Jean's locations are operated on leased premises, most situated in regional malls, 173 of which are located in the United States and 140 of which are located in foreign countries. A majority of the leased premises presently occupied by domestic Gloria Jean's franchised outlets are leased by us, and we have entered into sublease agreements with the franchisee on a cost pass-through basis. Gloria Jean's, however, remains obligated under the lease in all such cases. In the future, franchisees will in most cases be required to enter into master leases directly with the mall owner, as well as in the case of renewals of existing location leases as they come up for renewal. Gloria Jean's stores are designed to accommodate locations in various sizes, ranging from 170 square foot kiosk outlets (which sell principally coffee drinks and other beverages) to 2,000 square foot full service stores.

Item 3. Legal Proceedings.

        In the ordinary course of our business, we may become involved in legal proceedings from time to time. As of September 27, 2002, we were not a party to any material pending legal proceedings.

Item 4. Submission of Matters to a Vote of Security Holders.

        None.

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PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.

        Our common stock is reported on the Nasdaq National Market System under the symbol "DDRX." The following table sets forth, for the periods indicated, the range of high and low trading prices for the common stock as reported on the Nasdaq National Market System.

		Price Range(1)
Period
		High		Low
Fiscal Year Ended June 27, 2001
	Twelve Weeks Ended September 20, 2000	$	11.50	$	5.25
	Twelve Weeks Ended December 13, 2000		7.88		1.00
	Twelve Weeks Ended March 7, 2001		5.62		1.00
	Sixteen Weeks Ended June 27, 2001		5.04		2.00
Fiscal Year Ended July 3, 2002
	Twelve Weeks Ended September 19, 2001		4.11		2.47
	Twelve Weeks Ended December 12, 2001		6.38		2.10
	Twelve Weeks Ended March 6, 2002		4.11		3.00
	Seventeen Weeks Ended July 3, 2002		3.85		2.36
Fiscal Year Ended July 2, 2003
	Twelve Weeks Ended September 25, 2002		4.88		1.50

(1)

On May 9, 2001, Diedrich Coffee effected a one-for-four reverse stock split by filing an amendment to its certificate of incorporation. The reverse stock split resulted in every four shares of our outstanding common stock being converted automatically into one share of common stock. Our stock began trading on The Nasdaq National Market on a post-reverse stock split basis on May 11, 2001. All per share amounts have been adjusted for the reverse stock split.

        At September 27, 2002, there were 5,161,267 shares outstanding and 713 stockholders of record of our common stock. We have not paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.

Equity Compensation Plan Information

        The following table summarizes the equity compensation plans under which our common stock may be issued as of July 3, 2002.

Plan category	(a) Number of securities to be issued upon exercise of outstanding options	(b) Weighted-average exercise price of outstanding options		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders	366,742	$	9.11	249,750
Equity compensation plans not approved by security holders	—		—	—
Total	366,742	$	9.11	249,750

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Item 6. Selected Financial Data.

        In an effort to align our fiscal year with that of Coffee People, which we acquired on July 7, 1999, we changed our year end from a fiscal year ending the Wednesday before January 31 to a fiscal year ending on the Wednesday closest to June 30. Accordingly, the selected financial data below includes information as of and for the twenty-two weeks ended June 30, 1999 and as of and for the twenty-six weeks ended July 29, 1998, in addition to the last four fiscal years. This reporting schedule generally results in three 12-week quarters and one 16-week quarter during the fourth fiscal quarter, for a total of 52 weeks. However, due to the alignment of the calendar in 2002, the fiscal year ended July 3, 2002 contains 17 weeks during the fourth fiscal quarter, for a total of 53 weeks. The following selected financial data may not be indicative of our future results of operations and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 24, and should be read in conjunction with our consolidated financial statements and related notes.

				Fiscal Year ended July 3, 2002(A)			Fiscal Year ended June 27, 2001			Fiscal Year ended June 28, 2000			Twenty-Two Weeks Ended June 30, 1999			Fiscal Year Ended January 27, 1999			Twenty-Six Weeks Ended July 29, 1998
				(in thousands, except per share data)
Statement of Operations Data:
	Net Revenue:
		Retail sales		$	38,658		$	46,925		$	48,308		$	8,786		$	21,248		$	10,629
		Wholesale and other			16,681			18,545			19,081			1,467			2,767			1,324
		Franchise revenue			6,868			6,742			6,592			109			200			—
			Total revenue		62,207			72,212			73,981			10,362			24,215			11,953
	Costs and expenses:
		Cost of sales and related occupancy costs			30,439			36,197			38,240			4,600			10,849			5,395
		Operating expenses			17,625			20,779			20,646			3,795			8,887			4,852
		Depreciation and amortization			2,384			4,445			4,331			1,212			1,941			944
		General and administrative expenses			9,772			10,759			15,734			2,013			4,790			2,088
		Provision for asset impairment and restructuring costs			547			2,867			16,370			799			—			—
		(Gain)/loss on asset disposals			(423	)		(173	)		(24	)		4			4			—
			Total costs and expenses		60,344			74,874			95,297			12,423			26,471			13,279
Operating income (loss)					1,863			(2,662	)		(21,316	)		(2,061	)		(2,256	)		(1,326	)
Interest expense and other, net					(537	)		(1,290	)		(1,088	)		(285	)		(302	)		(177	)
Income (loss) before income tax provision					1,326			(3,952	)		(22,404	)		(2,346	)		(2,558	)		(1,503	)
Income tax provision					57			36			19			3			4			(4	)
Net income (loss)				$	1,269		$	(3,988	)	$	(22,423	)	$	(2,349	)	$	(2,562	)	$	1,507
Basic and diluted net income (loss) per share(B)				$	0.25		$	(1.16	)	$	(7.19	)	$	(1.52	)	$	(1.73	)	$	(1.04	)
Balance Sheet Data:
	Working capital (deficiency)			$	809		$	(819	)	$	(4,216	)	$	(2,122	)	$	(655	)	$	(549	)
	Total assets				28,280			31,891			40,330			11,465			12,736			13,026
	Long-term debt and obligations under capital leases, less current portion				2,832			4,219			10,252			2,739			2,783			3,020
	Total stockholders' equity			$	17,744		$	16,613		$	15,122		$	3,780		$	6,027		$	6,604

(A)

Includes 53 weeks of operation.

(B)

All share and per share information has been adjusted to reflect our one-for-four reverse stock split which was effective May 9, 2001.

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Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.

INTRODUCTION

        Management's discussion and analysis of results of operations and financial condition is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in financial condition and results of operations. Our discussion is organized as follows:

•

Overview.  This section provides a general description of Diedrich Coffee's business, as well as recent significant transactions that the Company believes are important in understanding the results of operations, as well as to anticipate future trends in those operations.



•

Results of operations.  This section provides an analysis of the Company's results of operations for all three years presented in the accompanying consolidated statement of operations.



•

Financial condition and liquidity.  This section provides an analysis of the Company's cash flows, as well as a discussion of the Company's outstanding debt and commitments, both firm and contingent, that existed as of July 3, 2002. Included in the discussion of outstanding debt is a discussion of the amount of financial capacity available to fund the Company's future commitments, as well as a discussion of other financing arrangements.



•

Critical accounting policies.  This section discusses those accounting policies that both are considered important to the Company's financial condition and results, and require significant judgment and estimates on the part of management in their application. In addition, all of the Company's significant accounting policies, including the critical accounting policies, are summarized in Note 1 to the accompanying consolidated financial statements.



•

New accounting pronouncements.  This section discusses new accounting pronouncements, dates of implementation and impact on the Company's accompanying consolidated financial statements, if any.

OVERVIEW

        Diedrich Coffee, Inc. is a specialty coffee roaster, wholesaler and retailer. We sell brewed, espresso based and various blended beverages primarily made from our own fresh roasted premium coffee beans, as well as light food items, whole bean coffee and accessories, through our Company operated and franchised retail locations. We also sell whole bean and ground coffees on a wholesale basis in the Office Coffee Service market, and to other wholesale customers, including restaurant chains and other retailers. Our brands include Diedrich Coffee, Gloria Jean's Coffees, and Coffee People. We operate a limited number of kiosks under the Coffee Plantation brand name. As of July 3, 2002, we owned and operated 70 retail locations and franchised 307 other retail locations under these brands, for a total of 377 retail coffee outlets. Our retail units are located in 37 states and 10 foreign countries. We have 426 wholesale accounts with Office Coffee Service distributors, chain and independent restaurants, and others. We operate a large coffee roasting facility in central California that supplies freshly roasted coffee to our retail locations and wholesale accounts.

        Our predecessor company, Carl E. Diedrich & Sons, Inc., commenced operations in Orange County, California in 1972, and changed its name to Diedrich Coffee when its first retail store opened. Diedrich Coffee incorporated in California in 1985. The Company remained a small, family operated business with only three retail locations until 1992, but grew rapidly from 1992 to 1996 through construction of new Diedrich Coffee coffeehouses in Orange County, and the acquisition of coffeehouses operated under other brands in Houston, Denver, and San Diego, which were converted into Diedrich Coffee units. In August 1996, we reincorporated under Delaware law as Diedrich Coffee, Inc., and completed an initial public offering of our common stock in September 1996.

24

        On July 7, 1999, we acquired Coffee People, Inc. Under the terms of that transaction, Coffee People stockholders received $23.0 million in cash and 1.5 million shares of our common stock. The acquisition was funded from the proceeds of an offering of 4.6 million shares of our common stock, as well as a new bank credit agreement entered into at that time which included a $12 million term loan. The brands acquired as a result of the merger include Gloria Jean's, one of the leaders in the mall coffee store segment with coffee stores in 37 states and 10 foreign countries, Coffee People, based primarily in Portland, Oregon, and Coffee Plantation, based primarily in Phoenix, Arizona.

        We experienced significant challenges assimilating Coffee People, a much larger company, and integrating the operations of both companies into a single organization. This occurred for several reasons, including the closure by Gloria Jean's franchisees of a significantly higher than expected number of franchise stores during the first year following the acquisition. Our Diedrich Coffee franchise area developers failed to meet their development schedules during this same period of time. The combination of these franchise unit shortfalls in both of our primary brands led to significant revenue, profit and cash flow shortfalls compared to the levels we had projected when negotiating the terms of our bank credit agreement in 1999, including repayment schedules and financial covenants. As a result of these and other challenges we experienced significant financial difficulties during fiscal 2000.

        On September 26, 2000, we executed an amendment to our bank credit agreement, which, among other things, accelerated the maturity date of all of our bank debt to September 2002, and necessitated the sale of certain of our assets to meet amended terms and covenants, including term loan principal payments required prior to the amended maturity date. On September 27, 2000, our President and Chief Executive Officer retired and was replaced by J. Michael Jenkins. Mr. Jenkins had over 30 years of experience in the restaurant industry, having served as Chief Executive Officer of several large restaurant chains.

        Upon his arrival, Mr. Jenkins immediately conducted a careful review of the strengths and deficiencies of the Company in order to identify and implement a prioritized action plan to resolve our liquidity problems. Several significant changes were made as a result of this review, including the immediate termination of development activities and leases for eight of nine new Company operated coffeehouses previously planned to open during fiscal 2001, cancellation of plans to expand a repositioning test for our Gloria Jean's brand in a different retail format and under a modified brand name, and the immediate cessation of all non-essential capital and overhead expenditures.

        During October 2000, we were notified by Nasdaq that we failed to meet a requirement for continued listing of our common stock on the Nasdaq National Market. On January 9, 2001, we announced a restructuring plan which included the relocation of Gloria Jean's administrative support center from central California to Diedrich Coffee's home office in Orange County, California. The plan also included the elimination of 31 support center positions, the planned closure of four existing locations, and the recording of a $780,000 restructuring and asset impairment charge during the third fiscal quarter as a result of these actions.

        On January 18, 2001, we were notified by Nasdaq of our failure to meet a second requirement for continued listing of our stock. Our Board of Directors determined that it would be in our existing stockholders' best interest for the Company to seek an equity infusion, and on January 26, 2001, we retained an investment banking firm to assist us in the process of raising additional equity capital. Our management subsequently met with a number of potential investors who had expressed interest in investing in the Company, and who had executed strict confidentiality agreements, including trading prohibitions. As a result of this process, in February 2001, a Special Committee of our Board of Directors approved, and we entered into a letter of intent with a group of new and current investors, for a sale of newly issued shares of our common stock and warrants.

        On May 7, 2001 a special stockholders' meeting was held, and our stockholders approved this transaction, as well as a one-for-four reverse stock split and an increase in the number of authorized

25

shares of our stock. Under the terms of the transaction, we sold 8,000,000 shares (pre-stock split) of common stock at $0.75 per share, for gross proceeds of $6 million. The investors also received warrants to purchase an additional 2,000,000 shares (pre-stock split) in the future at $1.20 per share (pre-stock split), exercisable for ten years, as well as registration rights requiring us to register all shares to be sold under the transaction. After the repayment of $3.6 million of bank debt from the proceeds of the offering, and approximately $520,000 of associated transaction costs, we retained net proceeds of approximately $1.9 million. The cash conservation measures noted above, in conjunction with this equity infusion and related debt reduction, significantly improved our financial condition, and on April 18, 2001, we were notified by Nasdaq that we met all requirements for continued listing of our stock.

        On May 15, 2001 we sold our three company operated coffeehouses in Houston, Texas to a franchisee. Several months later, in October, 2001 we sold our interest in the Coffee Plantation trademarks and brand, and sold or otherwise exited all company-operated retail units in Arizona (with the exception of three kiosks on a college campus). We used half of the net proceeds of these sales to further reduce our bank debt by $1.1 million, and retained an equivalent amount to further strengthen our cash working capital resources. Strategically, these divestitures allowed us to focus our limited resources on supporting company store operations in only two geographic markets rather than in four, and more significantly, supporting only three separate brands going forward rather than four. Accordingly, these sales were an important component of our overall action plan to improve the financial strength of the Company.

        On May 3, 2002, we announced that J. Michael Jenkins, our Chief Executive Officer, had passed away after failing to recover from gastric cancer. Philip G. Hirsch, who had commenced his employment with us in the role of interim CEO when Mr. Jenkins resigned from Diedrich Coffee shortly before his death, assumed the role of Chief Executive Officer effective September 1, 2002.

        On September 3, 2002, we entered into a new Credit Agreement with United California Bank in order to, among other things, repay the balance of all remaining amounts owed to Fleet National Bank under our prior credit agreement. We immediately borrowed $3,000,000 under the new agreement, and repaid all amounts owed to Fleet on September 3, 2002, the amended maturity date of our loan from Fleet. The terms of our new Credit Agreement are discussed in detail below, under the caption "Outstanding Debt and Financing Arrangements," and in Notes 8 and 17 to the accompanying Consolidated Financial Statements.

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RESULTS OF OPERATIONS

        The following table sets forth the percentage relationship to total revenue of certain items included in the Company's statements of income for the years indicated:

			Year Ended July 3, 2002		Year Ended June 27, 2001		Year Ended June 28, 2000
Net Revenue:
	Retail sales		62.2	%	65.0	%	65.3	%
	Wholesale and other		26.8		25.7		25.8
	Franchise revenue		11.0		9.3		8.9
		Total revenue	100.0	%	100.0	%	100.0	%
Cost and Expenses:
	Cost of sales and related occupancy costs		48.9	%	50.1	%	51.7	%
	Operating expenses		28.3		28.8		27.9
	Depreciation and amortization		3.8		6.2		5.9
	General and administrative expenses		15.7		14.9		21.2
	Provision for asset impairment and restructuring costs		0.9		3.9		22.1
	Gain on asset disposals		(0.7	)	(0.2	)	0.0
		Total	96.9	%	103.7	%	128.8	%
Operating income (loss)			3.1	%	(3.7	)%	(28.8	)%
Interest expense and other, net			(0.9	)	(1.8	)	(1.5	)
Income (loss) before income tax provision			2.2		(5.5	)	(30.3	)
Income tax provision			0.1		0.1		0.0
Net income (loss)			2.1	%	(5.6	)%	(30.3	)%

Year Ended July 3, 2002 Compared To Year Ended June 27, 2001

        Total Revenue.    Total revenue for the year ended July 3, 2002 decreased by $10,005,000, or 13.9%, to $62,207,000 from $72,212,000 for the year ended June 27, 2001. This decrease consisted of decreases in retail sales and wholesale and other sales, partially offset by an increase in franchise revenue. Each component is discussed below.

        Retail sales revenue for the year ended July 3, 2002 decreased by $8,267,000, or 17.6%, to $38,658,000 from $46,925,000 for the year ended June 27, 2001. This decrease represented the net impact of three factors. First, the number of Company stores decreased in the current year versus the prior year because of the closure of eight poorly performing Company-operated locations since the prior year period and the sale of twelve Company-operated Coffee Plantation coffeehouses. The impact of the reduction in retail sales from the unit closures and sales noted above was approximately $8,388,000. A summary of Company and franchise retail unit activity for both fiscal 2002 and 2001 can be found above under the caption "Diedrich Coffee's Business Model—Retail Outlets." Second, our fiscal year ended July 3, 2002 contained 53 weeks, whereas our fiscal year ended June 27, 2001 included only 52 weeks. The impact of this extra week on comparable store sales was an increase in retail sales of $636,000 during the year ended July 3, 2002 over the prior year. Finally, the balance of the $8,267,000 decrease resulted from a 2.4% decrease in comparable store sales for Company-operated units during the year ended July 3, 2002 as compared to the prior year.

27

        Wholesale revenue for the year ended July 3, 2002 decreased by $1,864,000, or 10.1%, to $16,681,000 from $18,545,000 for the year ended June 27, 2001. This decrease was primarily the net result of the following factors:

        Sale of non-coffee products to Gloria Jean's franchisees.    Sales of non-coffee products decreased by $1,574,000 for the year ended July 3, 2002, a 90.5% decrease versus the prior year. These products include paper cups, napkins, sweetener packets, coffee stirrers and coffee related merchandise, such as ceramic mugs and novelties sold in our Gloria Jean's mall-based coffee stores. We began eliminating most of these lower margin or lower turnover products during fiscal 2001 in order to increase our focus on our core coffee operations. Franchisees now purchase these items directly from outside distributors.

        Roasted coffee sales to franchisees.    Sales of roasted coffee to our franchisees decreased $1,207,000 for the year ended July 3, 2002 because of a decrease in the number of domestic franchise stores in the current year. This resulted from the closure of 26 domestic franchise locations and the transfer of 3 domestic franchise locations to Company locations. The decrease in domestic store count was compounded by lower sales volumes at open stores. Gloria Jean's system comparable sales decreased 3.8% versus the prior year period, further reducing roasted coffee usage.

        Coffee sales to restaurants and specialty retailers.    Wholesale coffee sales to restaurants and specialty retailers decreased $630,000, or 24.3% from the prior year. This decrease was primarily due to the loss of two chain restaurant accounts since the prior year.

        Keurig "K-cup" and other Office Coffee Service sales.    Keurig "K-cup" and other Office Coffee Service sales increased by $1,264,000 for the year ended July 3, 2002, a 25.9% increase over the prior year. This is a continuation of a trend over the past 24 months, as we continue to experience solid growth in this line of business. As noted in our quarterly reports, shortly after the end of the third quarter, we became aware of a potential product failure regarding certain production runs of Keurig K-Cups produced and shipped during the third quarter. We immediately notified our wholesale distribution customers of the potential problem and offered to replace any inventory which could be affected. As of July 3, 2002, all replacement product had been shipped, and revenue had been recognized.

        Holiday gift basket sales.    Holiday gift basket sales increased $283,000, or 46.2%, for the year ended July 3, 2002 versus the prior year due to a change in the gift basket program. During the prior year, we sold only the roasted coffee component of the holiday gift baskets to a distributor, who then purchased the remaining components of the gift baskets and sold the finished product to our franchisees. During the current year, we purchased all non-coffee components and sold the finished gift baskets directly to our franchisees.

        Franchise revenue increased by $126,000, or 1.9%, to $6,868,000 for the year ended July 3, 2002 from $6,742,000 for the year ended June 27, 2001. Franchise revenue consists of initial franchise fees and franchisee renewal fees, area development fees, royalties received on sales at franchised locations, and miscellaneous other franchise revenue as discussed in the table under Revenue Recognition in Note 1 in the accompanying Consolidated Financial Statements. The increase in franchise revenue in fiscal 2002 versus fiscal 2001 is the net impact of several factors. Franchise royalties increased by $449,000 for the year ended July 3, 2002 versus the prior year. This was the net impact of a reduction in domestic franchise royalties and an increase in international royalties. Domestic royalties decreased because of the 29-unit reduction in domestic franchise stores and a decline in comparable store sales. International royalties increased because of an increase in the number of units. Initial franchise fees and franchise renewal fees decreased $252,000 for the year ended July 3, 2002 versus the prior year, as a result of fewer franchise agreements signed. Miscellaneous other franchise revenue decreased slightly by $71,000 compared to the prior year.

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        Cost of Sales and Related Occupancy Costs.    Cost of sales and related occupancy costs for the year ended July 3, 2002 decreased 15.9% to $30,439,000 from $36,197,000 for the year ended June 27, 2001. On a margin basis, cost of sales and related occupancy costs decreased to 48.9% of total revenue during fiscal 2002 versus 50.1% during fiscal 2001. This is the impact of a 1.2 margin basis point decrease in occupancy costs. The occupancy cost margin improvement resulted primarily from the sale and closure of several under-performing units with high occupancy costs as a percentage of sales, as discussed above in the explanation of the change in retail sales. In addition, we reversed $287,000 in closed store reserves, as settlement amounts came out lower than expected. These reversals were offset by $308,000 in additional store closure costs expensed this year. Cost of sales remained constant at 40.9% of total revenue for both the year ended July 3, 2002 and the year ended June 27, 2001. As noted above, shortly after the end of the third fiscal quarter, we became aware of a product defect regarding certain production runs of Keurig K-Cups produced and shipped during the third quarter. During our fourth quarter, we shipped replacement product at a total cost to us of $178,000. Had this product defect not occurred, cost of sales would have decreased to 40.6% of total revenue for the year ended July 3, 2002, a 0.3 margin basis point improvement from the prior year. This potential 0.3 margin basis point improvement would have resulted from the favorable margin impact of discontinuing the sale of lower margin non-coffee product lines, as noted above in the discussion of changes in wholesale revenue, as well as the closure of eight poorly performing stores as noted above in the discussion of changes in retail revenue.

        Operating Expenses.    Operating expenses for the year ended July 3, 2002 decreased by 15.2% to $17,625,000, from $20,779,000 for the year ended June 27, 2001. On a margin basis, operating expenses decreased to 28.3% of revenue during fiscal 2002 versus 28.8% during fiscal 2001. This favorable 0.5 margin basis point change resulted from several factors. First, average operating margins improved from the closure of eight poorly performing locations and the sale of twelve other locations as discussed above. Second, wholesale and bad debt expense declined significantly as a result of a number of new collection policy initiatives implemented since the prior year. Because of these new collection policy initiatives significant amounts that had previously been reserved for were recovered, and the $685,000 in related bad debt reserves were reversed during the year, as follows: $4,000 during the first quarter, $419,000 during the second quarter, $45,000 during the third quarter, and $217,000 during the fourth quarter. The $685,000 in bad debt reserve reversals was partially offset by $288,000 in expense recognized for new receivable amounts which were deemed to become uncollectible during the year. These favorable factors were offset somewhat by a 2.4% decrease in comparable store sales versus the prior year and an increase in our medical benefit and workers' compensation insurance rates in California. Many operating expenses in a retail unit are semi-fixed and, therefore, represent a higher percentage of revenue when retail sales decline.

        Depreciation and Amortization.    Depreciation and amortization decreased by $2,061,000 to $2,384,000 for the year ended July 3, 2002, from $4,445,000 for the year ended June 27, 2001. $803,000 of this decrease is due to our adoption of SFAS 142 as of the beginning of fiscal year 2002. As required under SFAS 142, we have completed a goodwill impairment test as of June 28, 2001, determined that there is no indication of goodwill impairment as of this date, and discontinued periodic amortization of goodwill. Goodwill amortization expense was recorded during the prior year period. In addition, depreciation decreased due to the closure of eight locations and the sale of twelve locations discussed above. Also, certain assets at our Castroville roasting facility were fully depreciated during the year-ended July 3, 2002.

        General and Administrative Expenses.    General and administrative expense decreased by $987,000, or 9.2%, to $9,772,000 for the year ended July 3, 2002 from $10,759,000 for the year ended June 27, 2001. On a margin basis, general and administrative expenses increased to 15.7% of total revenue for the year ended July 3, 2002 from 14.9% of total revenue for the year ended June 27, 2001. This 0.8 unfavorable margin basis point change for the year ended July 3, 2002 resulted from several factors. As

29

noted above, our medical benefit and workers' compensation insurance rates in California increased during the year ended July 3, 2002. This increase was largely offset by a restructuring plan specifically intended to reduce overhead. This restructuring plan eliminated ten support center positions in January 2002.

        Asset Impairment and Restructuring Costs.    Asset impairment and restructuring costs decreased to $547,000 for the year ended July 3, 2002 from $2,867,000 for the year ended June 27, 2001. During fiscal 2002, we recorded asset impairment charges of $195,000, associated with five of our Company locations. This charge was partially offset by an asset impairment reversal of $58,000 to write up the book value of a parcel of land based on proceeds received from its subsequent sale. At the end of fiscal 2002, we agreed to retake possession of four Arizona locations, which we had sold in fiscal 2001. A charge of $89,000 was recorded to reflect the net present value of the remaining lease obligations on these four locations. In addition, we recorded severance costs and related employee benefits of $321,000, associated with the elimination of ten support center positions. During fiscal 2001, we recorded asset impairment charges of $1,536,000 for twelve Coffee Plantation stores located in Arizona and $181,000 relating to property in Portland, Oregon which was held for sale, and $455,000 in impairment charges associated with four Company and one franchise operated locations. A charge of $232,000 was also recorded to reflect the net present value of our remaining lease obligations on four of the twelve Arizona locations. In addition, $298,000 in severance costs associated with the relocation of Gloria Jean's support center and the related elimination of a number of administrative positions, and $165,000 in estimated lease termination costs for the planned closure of four under-performing Company operated locations, were recorded in fiscal 2001.

        Gain on Asset Disposals.    Gain on Asset Disposals increased to $423,000 for the year ended July 3, 2002 from $173,000 for the year ended June 27, 2001, primarily due to the fact that 20 stores were either closed or sold during the year ended July 3, 2002 as opposed to only 9 stores closed or sold during the year ended June 27, 2001.

        Interest Expense and Other, Net.    Interest expense and other, net decreased to $537,000 for the year ended July 3, 2002 from $1,290,000 for the year ended June 27, 2001. This decrease is primarily due to a reduction in our bank note payable from $5,543,000 at June 27, 2001 to $3,226,000 at July 3, 2002, and to a lesser degree, to a reduction in our floating interest rate.

        Income Tax Expense.    Net operating losses generated in previous years resulted in no federal income tax liability and only a nominal amount of state income tax expense for the years ended July 3, 2002 and June 27, 2001. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved. The slight fluctuation in expense between fiscal 2002 versus fiscal 2001 is due to changes in state income taxes owed in conjunction with the portfolio of Company operated Gloria Jean's units, which are located in a variety of states. As of July 3, 2002, a net operating loss for federal income tax purposes of $28,800,000 is available to be utilized against future taxable income for years through fiscal 2022, subject to possible annual limitations pertaining to change in ownership rules under the Internal Revenue Code.

Year Ended June 27, 2001 Compared To Year Ended June 28, 2000

        Total Revenue.    Total revenue for the year ended June 27, 2001 decreased by $1,769,000, or 2.4%, to $72,212,000 from $73,981,000 for the year ended June 28, 2000. This decrease consisted of decreases in retail sales, wholesale sales, and franchise revenue. Each component is discussed below.

30

        Retail sales revenue for the year ended June 27, 2001 decreased by $1,383,000, or 2.9%, to $46,925,000 from $48,308,000 for the year ended June 28, 2000. This decrease is the net impact of a $1,410,000 increase in retail sales from an increase in the number of Company store operating weeks versus the earlier period, which was more than offset by a 5.7% decrease in comparable store sales over the same period of time. Note that the number of operating weeks for Company stores was higher during fiscal 2001 versus fiscal 2000 despite the fact that there were fewer Company stores at the end of the later period. This resulted from the relative timing of openings and closings of Company stores in each of the two years. For example, a Gloria Jean's store transferred from franchise to Company operations near the end of fiscal 2000; therefore, while it represented one Company store at the end of both periods, it contributed 52 weeks of Company store operations during fiscal 2001 versus only eight weeks in fiscal 2000, or an increase of 44 Company store operating weeks in fiscal 2001 versus the earlier period. A summary of Company and franchise retail unit activity for both fiscal 2001 and 2000 can be found above under the caption "Business—Diedrich Coffee's Business Model—Retail Outlets.".

        Wholesale revenue for the year ended June 27, 2001 decreased by $536,000, or 2.8%, to $18,545,000 from $19,081,000 for the year ended June 28, 2000. This decrease was primarily the net result of the following:

        Coffee sales to restaurants and specialty retailers.    Wholesale coffee sales to restaurants and specialty retailers decreased $2,634,000, or 50.4%, from the prior year as we shifted our emphasis from sales to restaurants and specialty retailers to sales to our Office Coffee Service wholesale accounts.

        Sale of non-coffee products to Gloria Jean's franchisees.    Sales of non-coffee products decreased by $2,065,000 for the year ended June 27, 2001, a 54.3% decrease versus the prior year. These products include paper cups, napkins, sweetener packets, coffee stirrers, and coffee related merchandise such as ceramic mugs and novelties sold in our Gloria Jean's mall-based coffee stores. We began eliminating most of these lower margin or lower turnover product lines during fiscal 2001 in order to increase focus on our core coffee operations. Franchisees now purchase these items directly from outside distributors.

        Roasted coffee sales to franchisees.    Sales of roasted coffee to our franchisees decreased $1,202,000 for the year ended June 27, 2001 primarily attributable to the closure of 33 franchised locations during the current year. The reduction in coffee sales due to fewer units was offset by a slightly higher sales volume at open stores. Gloria Jean's system comparable sales increased by 0.4% versus the prior period.

        Keurig "K-Cup" and other Office Coffee Service sales.    Keurig "K-Cup" and other Office Coffee Service sales increased by $4,763,000 for the year ended June 27, 2001, a 3,847.5% increase over the prior year as our entry into this market was only in its initial stages of development during fiscal 2000.

        Holiday gift basket sales.    Holiday gift basket sales increased $602,000 to $613,000 for the year ended June 27, 2001 from $11,000 for the year ended June 28, 2000, as our gift basket program was not fully developed until fiscal 2001. Prior to fiscal 2001, the gift basket program was handled by a third party company to whom we sold the coffee.

        Franchise revenue increased by $150,000, or 2.3%, to $6,742,000 for the year ended June 27, 2001 from $6,592,000 for the year ended June 28, 2000. Franchise revenue consists of initial franchise fees and franchisee renewal fees, area development fees, royalties received on sales at franchised locations, and miscellaneous other franchise revenue. The increase in franchise revenue is the net impact of a $111,000 increase in initial franchise fees, franchise fees, and area development fees, and a smaller increase in other franchise revenue, which was partially offset by a slight reduction in franchise royalties. The net royalty reduction resulted from fewer domestic franchise operating weeks versus the prior year, the unfavorable impact of which more than offset the favorable impact from an increase in the number of international franchise unit operating weeks. International franchise units have a lower

31

average royalty rate than domestic franchise units. See also the table under Revenue Recognition in Note 1 to the attached Consolidated Financial Statements.

        Cost of Sales and Related Occupancy Costs.    Cost of sales and related occupancy costs for the year ended June 27, 2001 decreased 5.3% to $36,197,000 from $38,240,000 for the year ended June 28, 2000. On a margin basis, cost of sales and related occupancy costs decreased to 50.1% of total revenue during fiscal 2001 versus 51.7% during fiscal 2000. This represents a 1.6 favorable margin basis point change. This 1.6 favorable margin basis point change was the combined impact of a 1.3 favorable cost of sales margin basis point change and a 0.3 favorable related occupancy margin basis point change. The favorable cost of sales component resulted from the favorable margin impact of discontinuing the sale of lower margin non-coffee product lines, as noted above in the discussion of changes in wholesale revenue. In addition, both cost of sales and occupancy cost margins improved because of the sale and closure of certain under-performing units with high cost of sales and occupancy costs as a percentage of sales, as discussed in the explanation of the change in retail sales above.

        Operating Expenses.    Operating expenses for the year ended June 27, 2001 increased by 0.6% to $20,779,000, from $20,646,000 for the year ended June 28, 2000. On a margin basis, operating expenses increased to 28.8% of revenue during fiscal 2001 versus 27.9% during fiscal 2000. This unfavorable 0.9 margin basis point change is due to unfavorable changes versus fiscal 2000 in the relationship of operating costs for Company retail units, most notably labor and utilities, to the retail sales from those locations, and resulted primarily from the 5.7% comparable store sales decrease versus fiscal 2000 noted above. Labor, utilities and certain other operating expenses in a retail unit are semi-fixed, rather than completely variable based upon volume, and therefore represent a higher percentage of revenue when retail sales in existing locations decline.

        Depreciation and Amortization.    Depreciation and amortization increased by $114,000 to $4,445,000 for the year ended June 27, 2001, or 6.2% of revenue, from $4,331,000 for the year ended June 28, 2000, or only 5.9% of revenue. The increase was primarily due to an increase in goodwill amortization expense, resulting from a reduction in the amortization period for goodwill. During fiscal 2000, all goodwill associated with the Coffee People acquisition was amortized based upon an assumed 40 year useful life. Beginning in fiscal 2001, the estimated useful lives of goodwill components were reevaluated and assigned 30 year or 10 year remaining useful lives, depending upon whether they related to franchise operations acquired or Company store operations acquired, respectively. In addition, the increase in Company store operating weeks versus fiscal 2000 because of unit count changes, as noted above, resulted in additional depreciation expense versus the prior year pertaining to Company operated coffeehouses.

        General and Administrative Expenses.    General and administrative expense decreased by $4,975,000, or 31.6%, to $10,759,000 for the year ended June 27, 2001 from $15,734,000 for the year ended June 28, 2000. As a percentage of total revenue, general and administrative expenses decreased to 14.9% during fiscal 2001 from 21.2% for fiscal 2000. This decrease was the result of several factors. First, significant non-recurring overhead expenses associated with the initial integration of the Coffee People acquisition were incurred in fiscal 2000, the first year following the acquisition. In addition, significant expenses were incurred in fiscal 2000 in conjunction with the recruitment of a number of new senior management personnel to support anticipated rapid national expansion of the Diedrich Coffee franchise system, including recruitment and relocation costs. Such integration and staffing expenses were not significant in fiscal 2001. Second, during October 2000, the Company implemented a number of measures specifically intended to reduce overhead, and in January 2001 we announced a restructuring plan which included the consolidation of our previously separate support centers for Diedrich Coffee and Gloria Jean's, as well as the closure of division field offices in Portland, Oregon and Phoenix, Arizona, and the elimination of 31 overhead positions. Approximately one half of the

32

expected annualized savings from these measures was realized during fiscal 2001, representing favorable overhead expense comparisons versus fiscal 2000.

        Asset Impairment and Restructuring Costs.    Asset impairment and restructuring costs decreased to $2,867,000 for the year ended June 27, 2001 from $16,370,000 for the year ended June 28, 2000. During fiscal 2001, the Company recorded asset impairment charges of $1,536,000 for twelve Coffee Plantation stores located in Arizona and $181,000 relating to property in Portland which was held for sale, and $455,000 in impairment charges associated with four Company and one franchise operated locations. A charge of $232,000 was also recorded to reflect the net present value of our remaining lease obligations on four of the twelve Arizona locations. In addition, $298,000 in severance costs associated with the relocation of Gloria Jean's support center and the related elimination of a number of administrative positions, and $165,000 in estimated lease termination costs for the planned closure of four under-performing Company operated locations, were recorded in fiscal 2001. During the year ended June 28, 2000, the Company recorded $16,370,000 in asset impairment and restructuring charges due to the write-down of goodwill associated with the Coffee People acquisition.

        Interest Expense and Other, Net.    Interest expense and other, net increased slightly to $1,290,000 for the year ended June 27, 2001 from $1,088,000 for the year ended June 28, 2000. The increase is primarily due to a reduction in interest income in fiscal 2001 versus fiscal 2000. The Company had sizable cash reserves on deposit in interest bearing accounts during the first two quarters of fiscal 2000, immediately following receipt of cash proceeds from a public stock offering and a new bank term loan which financed the Coffee People acquisition, and to a lesser degree, during the last two months of fiscal 2001 following an equity infusion in May 2001. Average cash balances deposited in interest bearing accounts were therefore higher during fiscal 2000 than in fiscal 2001, as were average interest rates earned on such cash balances.

        Income Tax Expense.    Net operating losses generated in the years ended June 27, 2001 and June 28, 2000 resulted in no federal income tax liability and only a nominal amount of state income tax expense for those periods. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved. The slight fluctuation in expense between fiscal 2001 versus fiscal 2000 is due to changes in state income taxes owed in conjunction with the portfolio of Company operated Gloria Jean's units, which are located in a variety of states. As of June 27, 2001, a net operating loss for federal income tax purposes of $28,000,000 is available to be utilized against future taxable income for years through fiscal 2014, subject to possible annual limitations pertaining to change in ownership rules under the Internal Revenue Code.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Current Financial Condition

        At July 3, 2002, Diedrich Coffee had working capital of $809,000, total assets of $28,280,000 and $17,744,000 of stockholders' equity, compared to a working capital deficit of $819,000, total assets of $31,891,000 and $16,613,000 of stockholders' equity at June 27, 2001.

Cash Flows

        Cash provided by operating activities totaled $447,000 for the year ended July 3, 2002 as compared to cash used in operating activities of $213,000 for the year ended June 27, 2001. This improvement is the net result of many factors more fully enumerated in the consolidated statements of cash flows in the accompanying consolidated financial statements.

        Net cash provided by investing activities for the year ended July 3, 2002 totaled $1,471,000, as compared with $162,000 in net cash provided by investing activities for the year ended June 27, 2001. During the year ended July 3, 2002, we received $2,187,000 in proceeds from the sale of assets,

33

including $1,203,000 for the sale of twelve Company-operated locations in Arizona, $307,000 for the sale of land and a building in Oregon, and $535,000 for the sale of one Company-operated location in Hawaii. We also received $227,000 in principal payments on notes receivable that were issued by the buyer of the twelve locations in Arizona. These proceeds and notes receivable payments were partially offset by $943,000 in property and equipment expenditures. During the year ended June 27, 2001, the net cash provided by investing activities was primarily due to the fact that proceeds received from the sale of property and equipment were slightly greater than capital expenditures for property and equipment.

        Net cash used in financing activities totaled $2,748,000 for the year ended July 3, 2002, consisting of $2,610,000 in principal payments on long term debt and capital lease obligations and $138,000 in payments related to transaction costs associated with our issuance of common stock during our fiscal year ended June 27, 2001. Net cash provided by financing activities totaled $170,000 for the year ended June 27, 2001. This consisted of $5,536,000 in net proceeds received from the issuance of 8,000,000 shares (pre-reverse split) of our common stock, net of $5,366,000 in principal payments on long term debt and capital lease obligations.

Outstanding Debt and Financing Arrangements

        On July 7, 1999, we entered into a Credit Agreement with BankBoston, N.A. (subsequently merged into Fleet National Bank), which was secured by a pledge of all of our assets and our subsidiaries' stock. It initially provided for a $12 million term loan and a $3 million revolving credit facility. We did not draw down any borrowings under the revolving credit facility during the time it was in place, although the credit facility currently backs $218,000 of outstanding Letters of Credit. Amounts outstanding under the Credit Agreement did bear interest, at our option, at Fleet's base rate plus 1.25% or an adjusted Eurodollar rate plus 3.0%. At July 3, 2002, the applicable interest rate was 5.38%, which was based on the Eurodollar rate at the time. The rate could be fixed over periods ranging from one to six months, at the Company's discretion.

        On September 26, 2000, we entered into a First Amendment to the Credit Agreement with Fleet, to amend certain terms of the original Credit Agreement The First Amendment accelerated the maturity date of all remaining amounts owed under the Credit Agreement to the first business day following August 31, 2002, or September 3, 2002. In addition, the First Amendment specified assets that could be sold by the Company, including two pieces of owned real property under existing Company-operated retail locations, and a vacant parcel of owned but undeveloped real property. The First Amendment also permitted the Company to sell certain Company-operated coffeehouses outside of southern California on a franchise basis. The terms of the First Amendment required that Fleet receive 50% of the net proceeds from any of our asset or equity sales. In January 2001, two of the aforementioned pieces of real property were sold in a sale-leaseback transaction for $415,000. $208,000 of the proceeds from the transaction was remitted to Fleet to pay down debt. In May 2001, three Company-operated coffeehouses in Texas were sold for an aggregate of $1,025,000. $448,500 of the proceeds from the sale was remitted to Fleet. Also in May 2001, we sold 2,000,000 shares (post-split) of our common stock in a private sale. $3,600,000 of the proceeds from the sale was remitted to Fleet. In October 2001, twelve Company-operated coffeehouses in Arizona were sold for an aggregate of $1,382,000 in cash and $515,000 in notes receivable. One-half of the cash payment, $596,000, was remitted to Fleet. In December 2001, a parcel of real property along with a building were sold in a sale-leaseback transaction for $325,000. $140,000 of the proceeds from this sale was remitted to Fleet. In May 2002, a Company-operated coffeehouse located in Hawaii was sold for $535,000 in cash. $267,500 of the proceeds was remitted to Fleet. The proceeds from all six sales discussed above were applied solely to reduce the principal balance of our debt to Fleet.

        Additional changes under the terms of the First Amendment to Credit Agreement included a reduction in the maximum amount available to us under the revolving credit facility from $3,000,000 to

34

$1,293,000, and a restriction that henceforth the credit facility be used only to back up Letters of Credit. The First Amendment to Credit Agreement preserved our ability to obtain third party financing for capital projects and maintenance capital, and increased our flexibility to obtain subordinated debt as a source of additional working capital. Under the First Amendment to Credit Agreement, Fleet waived the previous financial covenant defaults and agreed to new financial covenant ratios going forward based upon updated financial information and projections we had prepared. In addition to agreeing to reset the ratios previously contained in the financial covenants, we and Fleet agreed to a new covenant under the First Amendment that required us to achieve certain predetermined minimum levels of cumulative principal repayments, in addition to any amounts we had already repaid to-date at the time of the First Amendment and in addition to the revised minimum monthly principal payment obligations discussed above: $283,333 by March 2001; $708,333 by June 30, 2001; and $1,619,900 by September 30, 2001. We successfully met all such incremental principal repayment obligations to Fleet before the dates specified above, and we generated the funds to do so primarily from the net proceeds of the above mentioned asset sales and stock issuance.

        On September 3, 2002 we entered into a new Credit Agreement with United California Bank, doing business as Bank of the West, or "BOW", in order to repay the balance of all remaining amounts owed to Fleet under our amended Credit Agreement with Fleet. Under the BOW Credit Agreement, we immediately borrowed $3,000,000 under a replacement term loan, the proceeds of which were used to repay our Fleet term loan on September 3, 2002, the amended maturity date of the Fleet term loan.

        Our obligations to BOW under the Credit Agreement are secured by all of our assets, including the stock of each of our subsidiaries (each of which guarantees our obligations under the Agreement), as well as all intangible assets we own, including the intellectual property and trademark assets that we and our subsidiaries own.

        The term loan with BOW requires monthly principal payments of $100,000 over 30 months and all amounts we owe under the term loan must be repaid by March 31, 2005. We are required to make monthly interest payments on amounts outstanding under the replacement term loan, computed at either BOW's prime rate plus 0.75% or a LIBOR rate plus 2.50%. We may periodically elect to convert portions of our prime rate borrowings into LIBOR based borrowings in $100,000 increments, subject to restrictions contained in the Agreement.

        In addition to the term loan, the BOW Credit Agreement provides us with a revolving $1,000,000 credit line for the acquisition of specified coffee packaging equipment. Any amounts we borrow under this line will convert to term loans with monthly principal amortization payments beginning September 30, 2003, and we must repay all outstanding balances by August 31, 2006. We are required to pay interest on any borrowings outstanding under this line of credit on a monthly basis, at an interest rate computed in the same manner as described above for the term loan.

        The BOW Credit Agreement also provides us with two separate $1,000,000 lines of credit for new coffeehouse development, one applicable to borrowings during our fiscal year ending in 2003, and the other to borrowings during our fiscal year ending in 2004. Borrowings under each line of credit will convert to term loans repayable over 36 months, with such repayments beginning July 31, 2003 and due in full by June 30, 2006, in the case of borrowings under the fiscal 2003 line, and beginning July 31, 2004 and due in full by June 30, 2007, in the case of the fiscal 2004 line. We are required to pay interest on borrowings under each line of credit on a monthly basis, computed as described above.

        Finally, the BOW Credit Agreement provides us with a $675,000 revolving working capital and letter of credit facility, subject to a number of restrictions. Our working capital facility draws and letters of credit are limited to a combined maximum of $675,000 outstanding at any time. Furthermore, draw downs against our working capital facility are subject to a sub-limit of $500,000, and letters of credit are subject to a sub-limit of $250,000. We may only draw funds against our working capital facility during the first and fourth quarters of each fiscal year, although letters of credit issued under the letter of

35

credit facility may be outstanding throughout the year. We may repay amounts that we borrow under the working capital facility at any time, and we may therefore be able to re-borrow such funds on a revolving basis (subject to restrictions including those summarized above). All amounts outstanding under our new working capital facility are required to be repaid by August 31, 2003. Any payments made by BOW with regard to any letter of credit issued under the letter of credit facility must be repaid by us immediately upon the date of such payment by BOW. As of September 3, 2002, BOW issued two stand by letters of credit, which back the two outstanding Fleet letters of credit discussed above.

        We are subject to a number of additional restrictions under our new Credit Agreement. These include limitations on our ability to sell assets, make capital expenditures, incur additional indebtedness, permit new liens upon our assets, and pay dividends on or repurchase our common stock. We must also maintain compliance with agreed-upon financial covenants that limit the amount of indebtedness that we may have outstanding in relation to our tangible net worth, require us to maintain a specified minimum dollar value level of tangible net worth, require us to maintain a specified minimum dollar value level of EBITDA for the trailing four fiscal quarters, require us to maintain a specified minimum level of profitability, and require us to maintain minimum aggregate cash balances in our various BOW bank accounts of at least $800,000 for all but ten business days each fiscal year.

        Based upon the terms of our new bank Credit Agreement, our recent operating performance and business outlook, and status of our balance sheet, we believe that cash, cash from operations, and funds available under our new Credit Agreement will be sufficient to satisfy our working capital needs at the anticipated operating levels for at least the next twelve months.

Other Commitments

        The following represents a comprehensive list of our contractual obligations and commitments as of July 3, 2002:

	Payments Due by Period
	Total		2003		2004		2005		2006		2007		Thereafter
	(In thousands)
Note Payable	$	3,226	$	1,126	$	1,200	$	900	$	—	$	—	$	—
Capital Leases		1,281		282		242		203		115		44		395
Operating Leases		17,807		3,845		3,399		2,901		2,280		1,500		3,882
Green Coffee Commitments		4,853		2,382		1,571		900		—		—		—
	$	27,167	$	7,635	$	6,412	$	4,904	$	2,395	$	1,544	$	4,277

        We are obligated under non-cancelable operating leases for our coffee houses, roasting facility and administrative offices. Lease terms are generally for ten to twenty years with renewal options and generally require us to pay a proportionate share of real estate taxes, insurance, common area and other operating costs. Some retail leases provide for contingent rental payments based on sales thresholds. In addition, we are contingently liable on the master leases for 137 franchise locations. Under our historical franchising business model, we executed the master leases for these locations, and entered into subleases on the same terms with our franchisees, who pay their rent directly to the landlords. Should any of these franchisees default on their subleases, we would be responsible for the remaining lease payments. Our maximum theoretical future exposure at July 3, 2002, computed as the sum of all remaining lease payments through the expiration dates of the respective leases, was $20,328,000. This amount does not take into consideration any mitigating measures we could take to reduce this exposure in the event of default, including re-leasing the locations, or terminating the master lease by negotiating a lump sum payment to the landlord less than the sum of all remaining future rents.

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CRITICAL ACCOUNTING POLICIES

        The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts. The estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and on various other factors that are believed to be reasonable. Accounts significantly impacted by estimates and assumptions include, but are not limited to, franchise receivables, allowance for bad debt reserves, assets held for sale, fixed asset lives, goodwill, intangible assets, income taxes, self-insurance and workers' compensation reserves, store closure reserves, and contingencies. We believe that the following represent our critical accounting policies and estimates used in the preparation of our consolidated financial statements. The following discussion, however, does not list all of our accounting policies and estimates.

Revenue Recognition—Franchise Operations

        Initial franchise fees are recognized when a franchised coffeehouse begins operations, at which time the Company has performed its obligations related to such fees. Fees received pursuant to area development agreements, which grant the right to develop franchised units in future periods in specific geographic areas, are deferred and recognized on a pro rata basis as the franchised units subject to the development agreements begin operations. In light of our revenue recognition policies, we have little or no control over when we recognize revenue related to these initial franchise fees and area development fees. We monitor the financial condition of franchisees and record provisions for estimated losses on receivables when we believe that our franchisees are unable to make required payments to us. If sales or economic conditions worsen for our franchisees, their financial performance may worsen, our collection rates may decline and we may be required to assume their responsibility for lease payments on franchised restaurants.

Valuation of Long- Lived Assets

        We evaluate the carrying value of assets for impairment when the operations of one or more of our brands experience a negative event, including, but not limited to, a significant downturn in sales, a substantial loss of customers, an unfavorable change in demographics or unit closures. Upon the occurrence of a negative event, we estimate the future undiscounted cash flows for the individual units that are affected by the negative event. If the projected cash flows do not exceed the carrying value of the assets allocated to each unit, we write-down the assets to fair value based on: the estimated net proceeds we believe we can obtain for the unit upon sale, the discounted projected cash flows derived from the unit or the historical net proceeds obtained from sales of similar units. The most significant assumptions in our analysis are those used when we estimate a unit's future cash flows. We generally use the assumptions in our strategic plan and modify them as necessary based on unit specific information. If our assumptions are incorrect, the carrying value of our operating unit assets may be overstated or understated.

Goodwill

        In July 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) Nos. 141 and 142, "Business Combinations", and "Goodwill and Other Intangible Assets". The Company chose to early adopt the provisions of SFAS No. 142 effective June 30, 2001. The Company adopted SFAS No. 141 immediately upon its release. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 28, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could

37

trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of acquired assets or the strategy for the overall business, and significant negative industry or economic trends. Upon the adoption of SFAS No. 142, the carrying value of the Company's goodwill and other intangible assets was determined to not be impaired. Our goodwill impairment analysis uses estimates and assumptions in order to determine the fair value of our reporting units. If our assumptions are incorrect, the carrying value of our goodwill may be overstated.

Store Closure Reserves

        We decide whether to close a unit based on its recent cash flows and its future estimated profitability. We evaluate each unit's performance each financial period. When units perform poorly, we consider the demographics of the location as well as our ability to cause an unprofitable unit to become profitable. Based on management's judgment, we estimate the future cash flows of the unit. If we determine that the unit will not be profitable, and there are no contractual requirements that require us to continue to operate the unit, we close the unit. We establish a reserve for the net present value of the unit's future rents and other fixed costs. The most significant assumptions we make in determining store closure reserves are assumptions regarding the estimated costs to maintain vacant properties. Additionally, the amount of the reserve established for future lease payments on leased vacant units is dependent on our ability to successfully negotiate early termination lease agreements with our landlords. If the costs to maintain properties rise or if it takes longer than anticipated to sell properties or terminate leases, we may need to record additional reserves.

NEW ACCOUNTING PRONOUNCEMENTS

        In June 2001, the Financial Accounting Standards Board issued Statement on Financial Accounting Standards No. 143, "Accounting for Retirement Obligations". Statement No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period which it is incurred if a reasonable estimate of fair value can be made. Statement No. 143 is effective for our fiscal year 2003. Management does not believe the adoption of this standard will have a material impact on our financial position, results of operation, or liquidity.

        In August 2001, the Financial Accounting Standards Board issued Statement on Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". Statement No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001. Statement No. 144 will be effective for our fiscal year 2003. Management does not believe the adoption of this standard will have a material impact on our financial position, results of operation, or liquidity.

        In April 2002, the Financial Accounting Standards Board issued Statement on Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Statement No. 145 provides new guidance on the criteria used to classify debt extinguishments as extraordinary items and requires sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Statement No. 145 will be effective for our fiscal year 2004. Management does not believe the adoption of this standard will have a material impact on our financial position, results of operation, or liquidity.

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        In July 2002, the Financial Accounting Standards Board issued Statement No. 146, "Accounting for Costs Associated with Exit of Disposal Activities. Statement No. 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by Statement No. 146 include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operations, plant closing or other exit or disposal activities. Statement No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with early adoption encouraged. We have not assessed whether the adoption of this standard will have a material impact on our financial position, results of operation, or liquidity.

OTHER MATTERS

Seasonality and Quarterly Results

        Our business is subject to seasonal fluctuations as well as economic trends that affect retailers in general. Historically, our net sales have not been realized proportionately in each quarter, with net sales being the highest during the last fiscal quarter, which includes the November - 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 events outside our control. As a result of these factors, and of the other contingencies and risk factors described elsewhere in this report, the financial results for any individual quarter may not be indicative of the results that may be achieved in a full fiscal year.

Item 7a. Quantitative and Qualitative Disclosures About Market Risk.

Market Risk Sensitive Items Entered Into for Trading Purposes

        None.

Market Risk Sensitive Items Entered Into for Other Than Trading Purposes

        We have exposure to market risk from two primary sources—interest rate risk and commodity price risk.

Interest Rate Risk

        We are exposed to market risk from changes in interest rates on our outstanding bank debt. At July 3, 2002, we had $3,226,000 in bank debt that was tied to changes in short term interest rates. At year end, the interest rate was the "adjusted Eurodollar rate" plus 3%, or 5.38%. The rate can be fixed over periods ranging from one to six months, at our discretion. At July 3, 2002, a hypothetical 100 basis point increase in the adjusted Eurodollar rate would result in additional interest expense of $32,000 on an annualized basis.

Commodity Price Risk

        Green coffee, the principal raw material for our products, is subject to significant price fluctuations caused by a number of factors, including weather, political, and economic conditions. To date, we have not used commodity based financial instruments to hedge against fluctuations in the price of coffee. To ensure that we have an adequate supply of coffee, however, we enter into agreements to purchase green coffee in the future that may or may not be fixed as to price. At July 3, 2002, we had commitments to purchase coffee through fiscal year 2005, totaling $4,853,000 for 3,609,000 pounds of green coffee, all of which were fixed as to price. The coffee scheduled to be delivered to us in fiscal year 2003 pursuant to these commitments will satisfy approximately 51% of our anticipated green coffee requirements for this fiscal year. Assuming we require approximately 1,743,000 additional pounds of green coffee during fiscal 2002 for which no price has yet been fixed, each $0.01 per pound increase in the price of green coffee could result in $17,000 of additional cost. However, because the price we

39

pay for green coffee is negotiated with suppliers, we believe that the commodity market price for green coffee would have to increase significantly, as much as $0.25 per pound, before suppliers would increase the price they charge us.

Item 8. Financial Statements and Supplementary Data.

        The financial statements and supplementary data required by this item are set forth at the end of this Annual Report on Form 10-K beginning on page F-1.

Item 9. Changes in and Discussions With Accountants on Accounting and Financial Disclosure.

        None.

PART III

Item 10. Directors and Executive Officers of the Registrant.

        The information required by this item is incorporated herein by reference from the portions of the definitive Proxy Statement captioned "Election of Directors," "Compensation of Executive Officers," and "Section 16(a) Beneficial Ownership Reporting Compliance."

Item 11. Executive Compensation.

        The information required by this item is incorporated herein by reference from the portions of the Definitive Proxy Statement captioned "Compensation of Executive Officers" and "Director Compensation."

Item 12. Security Ownership of Certain Beneficial Owners and Management.

        The information required by this item is incorporated herein by reference from the portion of the Definitive Proxy Statement captioned "Security Ownership of Certain Beneficial Owners and Management."

Item 13. Certain Relationships and Related Transactions.

        The information required by this item is incorporated herein by reference from the portion of the Definitive Proxy Statement captioned "Certain Transactions Regarding Diedrich Coffee."

Item 14. Controls and Procedures.

        Not applicable

PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a) and (d)    Financial Statements and Schedules.

The financial statements and schedules required to be filed hereunder are set forth at the end of this Report beginning on page F-1.

(b).    Reports on Form 8-K.

        None.

(c).    Exhibits.

        See Exhibit Index below.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) 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.

	DIEDRICH COFFEE, INC.
September 30, 2002	By:	/s/  PHILIP HIRSCH Philip Hirsch Chief Executive Officer (Principal Executive Officer)

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/  PAUL HEESCHEN Paul Heeschen	Chairman of the Board of Directors	September 30, 2002
/s/  PHILIP HIRSCH Philip Hirsch	President and Chief Executive Officer (Principal Executive Officer)	September 30, 2002
/s/  MATTHEW MCGUINNESS Matthew McGuinness	Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	September 30, 2002
/s/  MARTIN DIEDRICH Martin Diedrich	Chief Coffee Officer, Vice Chairman of the Board of Directors and Secretary	September 30, 2002
Lawrence Goelman	Director
/s/  PETER CHURM Peter Churm	Director	September 30, 2002
/s/  RANDY POWELL Randy Powell	Director	September 30, 2002
/s/  RICHARD SPENCER Richard Spencer	Director	September 30, 2002

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CERTIFICATION

        Each of the undersigned, in his capacity as the Chief Executive Officer and Chief Financial Officer of Diedrich Coffee, Inc., as the case may be, provides the following certifications required by 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, and 17 C.F.R. §240.13a-14.

Certification of Chief Executive Officer

        I, Philip G. Hirsch, certify that:

        1.    I have reviewed this annual report on Form 10-K of Diedrich Coffee, Inc.

        2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and

        3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.

        Date: September 27, 2002

By: /s/  PHILIP G. HIRSCH Philip G. Hirsch
Chief Executive Officer

Certification of Chief Financial Officer

        I, Matthew C. McGuinness, certify that:

        1.    I have reviewed this annual report on Form 10-K of Diedrich Coffee, Inc.

        2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and

        3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.

        Date: September 27, 2002

By: /s/ MATTHEW C. McGUINNESS MATTHEW C. MCGUINNESS
Executive Vice President and Chief Financial Officer

42

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Independent Auditors' Report	F-2
Consolidated Balance Sheets	F-3
Consolidated Statements of Operations	F-4
Consolidated Statements of Stockholders' Equity	F-5
Consolidated Statements of Cash Flows	F-6
Notes to Consolidated Financial Statements	F-7
Schedule II—Valuation and Qualifying Accounts	F-31

F-1

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Diedrich Coffee, Inc.:

        We have audited the accompanying consolidated balance sheets of Diedrich Coffee, Inc. and subsidiaries as of July 3, 2002 and June 27, 2001, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended July 3, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Diedrich Coffee, Inc. and subsidiaries as of July 3, 2002 and June 27, 2001, and the results of its operations and its cash flows for each of the years in the three-year period ended July 3, 2002, in conformity with accounting principles generally accepted in the United States of America.

/s/ KPMG LLP

Costa Mesa, California
September 6, 2002

F-2

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		July 3, 2002			June 27, 2001
Assets
Current assets:
	Cash	$	2,233,000		$	3,063,000
	Accounts receivable, less allowance for doubtful accounts of $1,364,000 at July 3, 2002 and $2,007,000 at June 27, 2001		2,215,000			1,718,000
	Inventories		2,598,000			2,843,000
	Assets held for sale		186,000			1,694,000
	Current portion of notes receivable		48,000			—
	Prepaid expenses		667,000			233,000
Total current assets			7,947,000			9,551,000
Property and equipment, net			7,514,000			9,364,000
Costs in excess of net assets acquired, net of amortization of $1,413,000 at July 3, 2002 and $1,423,000 at June 27, 2001			12,164,000			12,250,000
Notes receivable			240,000			—
Other assets			415,000			726,000
Total assets		$	28,280,000		$	31,891,000
Liabilities and Stockholders' Equity
Current liabilities:
	Current installments of obligations under capital leases	$	189,000		$	272,000
	Current installments of long-term debt		1,126,000			2,040,000
	Accounts payable		2,090,000			2,239,000
	Accrued compensation		1,310,000			1,954,000
	Accrued expenses		695,000			1,141,000
	Franchisee deposits		601,000			648,000
	Deferred franchise fee income		546,000			704,000
	Provision for store closure		581,000			1,372,000
Total current liabilities			7,138,000			10,370,000
Obligations under capital leases, excluding current installments			732,000			716,000
Long term debt, excluding current installments			2,100,000			3,503,000
Deferred rent			566,000			689,000
Total liabilities		$	10,536,000		$	15,278,000
Stockholders' Equity:
Common stock, $.01 par value; authorized 8,750,000 shares; issued and outstanding 5,161,000 shares at July 3, 2002 and at June 27, 2001			52,000			52,000
Additional paid-in capital			57,968,000			58,106,000
Accumulated deficit			(40,276,000	)		(41,545,000	)
	Total stockholders' equity		17,744,000			16,613,000
	Commitments and contingencies (Notes 8 10 and 13)		—			—
	Subsequent event (Note 17)		—			—
Total liabilities and stockholders' equity		$	28,280,000		$	31,891,000

See accompanying notes to consolidated financial statements.

F-3

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

			Year Ended July 3, 2002			Year Ended June 27, 2001			Year Ended June 28, 2000
Net Revenue:
	Retail sales		$	38,658,000		$	46,925,000		$	48,308,000
	Wholesale and other			16,681,000			18,545,000			19,081,000
	Franchise revenue			6,868,000			6,742,000			6,592,000
		Total revenue		62,207,000			72,212,000			73,981,000
Cost and Expenses:
	Cost of sales and related occupancy costs			30,439,000			36,197,000			38,240,000
	Operating expenses			17,625,000			20,779,000			20,646,000
	Depreciation and amortization			2,384,000			4,445,000			4,331,000
	General and administrative expenses			9,772,000			10,759,000			15,734,000
	Provision for asset impairment and restructuring costs			547,000			2,867,000			16,370,000
	Gain on asset disposals			(423,000	)		(173,000	)		(24,000	)
		Total costs and expenses		60,344,000			74,874,000			95,297,000
Operating income (loss)				1,863,000			(2,662,000	)		(21,316,000	)
Interest expense				(600,000	)		(1,342,000	)		(1,316,000	)
Interest and other income, net				63,000			52,000			228,000
Income (loss) before income tax provision				1,326,000			(3,952,000	)		(22,404,000	)
Income tax provision				57,000			36,000			19,000
Net income (loss)			$	1,269,000		$	(3,988,000	)	$	(22,423,000	)
Net income (loss) per share—basic and diluted			$	0.25		$	(1.16	)	$	(7.19	)
Weighted average shares outstanding—basic and diluted				5,161,000			3,436,000			3,120,000

See accompanying notes to consolidated financial statements.

F-4

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

	Common Stock
				Additional Paid-In- Capital			Accumulated Deficit
	Shares	Amount								Total
Balance, June 30, 1999	1,551,000	$	16,000	$	18,873,000		$	(15,109,000	)	$	3,780,000
Exercise of options and warrants	3,000		—		38,000			—			38,000
Acquisition of Coffee People and proceeds from secondary offering, net	1,607,000		16,000		33,711,000			—			33,727,000
Amortization of options	—		—		25,000			(25,000	)		—
Net loss	—		—		—			(22,423,000	)		(22,423,000	)
Balance, June 28, 2000	3,161,000		32,000		52,647,000			(37,557,000	)		15,122,000
Issuance of stock, net	2,000,000		20,000		5,459,000			—			5,479,000
Net loss	—		—		—			(3,988,000	)		(3,988,000	)
Balance, June 27, 2001	5,161,000		52,000		58,106,000			(41,545,000	)		16,613,000
Stock issuance costs	—		—		(138,000	)		—			(138,000	)
Net income	—		—		—			1,269,000			1,269,000
Balance, July 3, 2002	5,161,000	$	52,000	$	57,968,000		$	(40,276,000	)	$	17,744,000

See accompanying notes to consolidated financial statements.

F-5

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

			Year Ended July 3, 2002			Year Ended June 27, 2001			Year Ended June 28, 2000
Cash flows from operating activities:
	Net income (loss)		$	1,269,000		$	(3,988,000	)	$	(22,423,000	)
	Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
		Depreciation and amortization		2,384,000			4,445,000			4,331,000
		Amortization of loan fees		189,000			281,000			79,000
		Provision for bad debt		(397,000	)		1,102,000			566,000
		Provision for asset impairment and restructuring		547,000			2,867,000			16,370,000
		Provision for store closure		21,000			—			—
		Gain on disposal of assets		(423,000	)		(173,000	)		(24,000	)
		Changes in operating assets and liabilities, net of acquisitions:
		Accounts receivable		(100,000	)		(461,000	)		(411,000	)
		Inventories		47,000			1,450,000			487,000
		Prepaid expenses		(438,000	)		150,000			340,000
		Income taxes receivable		—			16,000			1,000
		Other assets		51,000			(316,000	)		90,000
		Accounts payable		(146,000	)		(4,244,000	)		1,669,000
		Accrued compensation		(920,000	)		342,000			(173,000	)
		Accrued expenses		(516,000	)		(1,141,000	)		(1,956,000	)
		Provision for store closure		(932,000	)		(412,000	)		(335,000	)
		Deferred franchise fees income and franchisee deposits		(219,000	)		(67,000	)		638,000
		Deferred rent		29,000			(64,000	)		79,000
Net cash provided by (used in) operating activities				446,000			(213,000	)		(672,000	)
Cash flows from investing activities:
	Capital expenditures for property and equipment			(943,000	)		(1,764,000	)		(3,423,000	)
	Proceeds from disposal of property and equipment			2,187,000			1,961,000			107,000
	Issuance of note receivable						(35,000	)		—
	Payments received on notes receivable			227,000			—			—
	Acquisitions, net of cash acquired			—			—			(21,215,000	)
Net cash provided by (used in) investing activities				1,471,000			162,000			(24,531,000	)
Cash flows from financing activities:
	Payments on long-term debt			(2,317,000	)		(5,123,000	)		(8,475,000	)
	Payments on capital lease obligations			(292,000	)		(243,000	)		(884,000	)
	Proceeds from issuance of common stock, net of fees paid			(138,000	)		5,536,000			25,351,000
	Proceeds from issuance of debt, net of issuance costs			—			—			11,603,000
Net cash provided by (used in) financing activities				(2,747,000	)		170,000			27,595,000
Net increase (decrease) in cash				(830,000	)		119,000			2,392,000
Cash at beginning of year				3,063,000			2,944,000			552,000
Cash at end of year			$	2,233,000		$	3,063,000		$	2,944,000
Supplemental disclosure of cash flow information:
	Cash paid during the period for:
		Interest	$	435,000		$	1,253,000		$	1,039,000
		Income taxes	$	59,000		$	20,000		$	19,000
	Non-cash transactions:
		Issuance of notes receivable	$	515,000		$	—		$	—
		Accrued stock issuance costs	$	—		$	57,000		$	—
		Assets purchased under capital leases	$	225,000		$	180,000		$	—
		Issuance of common stock to acquire Coffee People	$	—		$	—		$	8,415,000

See accompanying notes to consolidated financial statements.

F-6

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies and Practices

Business

        Diedrich Coffee, Inc. is a specialty coffee roaster, wholesaler, retailer and franchiser whose brands include Diedrich Coffee, Gloria Jean's, and Coffee People. The Company, as of July 3, 2002, owns and operates 70 retail locations and is the franchiser of 307 retail locations. The retail units are located in 37 states and 10 foreign countries. The Company also has over 390 wholesale accounts with businesses and restaurant chains. In addition, the Company operates a large coffee roasting facility in central California that supplies freshly roasted coffee beans to its retail locations and to its wholesale accounts.

Basis of Presentation and Fiscal Year End

        The consolidated financial statements include the accounts of Diedrich Coffee, Inc. and its wholly owned subsidiaries (the "Company"). All significant intercompany transactions are eliminated. The Company's fiscal year end is the Wednesday closest to June 30. In both years 2001 and 2000, this resulted in a 52-week year. Due to the alignment of the calendar in 2002, however, the year ended July 3, 2002 contains 53 weeks.

Inventories

        Inventories are stated at the lower of cost or market. The cost for inventories is determined using the first-in, first-out method.

Property and Depreciation

        Property and equipment, including assets under capital leases are recorded at cost. Depreciation is calculated using the straight-line method over estimated useful lives of three to seven years. Property and equipment held under capital leases and leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the term of the related leases.

        Major remodels and improvements are capitalized. Maintenance and repairs that do not improve or extend the life of the respective assets are charged to expense as incurred.

Deferred Financing Costs

        Costs related to the issuance of debt are deferred and amortized using a method which approximates the effective interest method as a component of interest expense over the terms of the respective debt issues.

Store Pre-opening Costs

        Direct and incremental costs prior to the opening of a coffeehouse location are expensed as incurred.

Fair Value of Financial Instruments

        The carrying amounts of cash, accounts receivable, notes receivable, accounts payable, accrued compensation and accrued expenses approximate fair value because of the short-term maturity of these financial instruments. The Company believes the carrying amounts of the Company's long-term debt approximates fair value because the interest rate on this instrument is subject to change with market

F-7

interest rates and other terms and conditions are consistent with terms currently available to the Company.

Rent Expense

        Certain lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing on a date other than the date of initial occupancy. Rent expense is recorded on a straight-line basis over the respective terms of the leases.

Income Taxes

        Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date.

Net Income (Loss) per Common Share

        "Basic" earnings per share represents net earnings divided by the weighted average shares outstanding, excluding all potentially dilutive common shares. "Diluted" earnings per-share, reflects the dilutive effect of all potentially dilutive common shares.

        On May 9, 2001, the Company filed an amendment to its certificate of incorporation that caused each four outstanding shares of its common stock to be converted into one share of its common stock (see Note 11). All share and per share amounts have been adjusted for this reverse stock split.

Costs in Excess of Net Assets Acquired

        Prior to June 28, 2001, costs in excess of net assets acquired were amortized on a straight-line basis over the expected periods to be benefited. The Company assessed the recoverability of this intangible asset by determining whether the amortization of the balance over its remaining life could be recovered through undiscounted future operating cash flows of the acquired operation. The amount of goodwill impairment, if any, was measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. The assessment of the recoverability of goodwill would be impacted if estimated future operating cash flows were not achieved.

        In July 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) Nos. 141 and 142, "Business Combinations", and "Goodwill and Other Intangible Assets". The Company chose to early adopt SFAS No. 142 effective June 28, 2001. The Company adopted SFAS No. 141 immediately upon its release. No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment annually or

F-8

whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of acquired assets or the strategy for the overall business, and significant negative industry or economic trends. Upon the adoption of SFAS No. 142, the carrying value of the Company's goodwill and other intangible assets was determined to not be impaired.

Stock Option Plans

        The Company applies the intrinsic value-method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, in accounting for employee options. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation," established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123.

Long-Lived Assets and Certain Identifiable Intangibles

        The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". This Statement requires that long-lived assets be reviewed and impaired whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Revenue Recognition

        Retail and wholesale sales are recorded when payment is tendered at point of sale for retail, and upon shipment of product for wholesale. Initial franchise fees are recognized when a franchised coffeehouse begins operations, at which time the Company has performed its obligations related to such fees. Fees received pursuant to area development agreements, which grant the right to develop franchised coffeehouses in future periods in specific geographic areas, are deferred and recognized on a pro rata basis as the franchised coffeehouses subject to the development agreements begin operations. Both initial franchise fees and area development fees are collectively referred to as "Front end fees" in the table below, since each is collected (if applicable) before the franchised location begins operation, and both types of fees are nonrefundable. Area development fees typically apply in the case of international franchise development, whereas initial franchise fees apply primarily in the case of domestic franchise development. Franchise royalties are recognized as earned, based upon a percentage of a franchise coffeehouse sales over time.

F-9

        The following table details the various components included in franchise revenue:

	July 3, 2002		June 27, 2001		June 28, 2000
Royalties	$	5,859,000	$	5,410,000	$	5,429,000
Front End Fees		566,000		818,000		707,000
Other		443,000		514,000		456,000
Total	$	6,868,000	$	6,742,000	$	6,592,000

Shipping and Handling Costs

        Shipping and handling costs are included as a component of cost of sales and related occupancy costs. A corresponding amount is billed to our wholesale customers, and is included as a component of wholesale and other revenue.

Advertising and Promotion Costs

        Advertising costs are expensed as incurred. Promotion costs, or advertising events, are charged to expense in the period of the promotional event. During the years ended July 3, 2002, June 27, 2001 and June 28, 2000, $572,000, $695,000, and $1,355,000, respectively, was charged to operating expenses. Coupons and other sales discounts are accounted for as reductions of revenue.

Store Closures

        The estimated cost associated with closing under-performing stores is accrued in the period in which the store is identified for closure by management under a plan of termination. Such costs primarily include the estimated cost to terminate a lease.

	Beg Balance		Amounts Charged to Expense		Cash Payments			End Balance
Provision for Store Closure
Year ended June 27, 2001	$	1,387,000	$	947,000	$	(962,000	)	$	1,372,000
Year ended July 3, 2002	$	1,372,000	$	141,000	$	(932,000	)	$	581,000

        For the year ended July 3, 2002, amounts charged to expense are included as components of provision for asset impairment and restructuring costs ($120,000) and cost of sales and related occupancy costs ($21,000). The $21,000 charge to cost of sales and related occupancy costs was the net result of a $287,000 decrease in expense due to negotiated legal settlements finalized at amounts lower than expected, offset by $308,000 in additional store closure costs expensed this year. For the year ended June 27, 2001, amounts charged to expense are included as components of provision for asset impairment and restructuring costs ($397,000) and cost of sales and related occupancy costs ($550,000).

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the

F-10

date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications

        Certain reclassifications have been made to prior periods to conform to the 2002 presentation.

2. Inventories

        Inventories consist of the following:

	July 3, 2002		June 27, 2001
Unroasted coffee	$	942,000	$	717,000
Roasted coffee		563,000		733,000
Accessory and specialty items		237,000		316,000
Other food, beverage and supplies		856,000		1,077,000
	$	2,598,000	$	2,843,000

3. Assets Held for Sale

        During June 2001, the Company entered into a letter of intent to sell eight of its coffeehouses in Phoenix, Arizona, along with related intangible assets including the "Coffee Plantation" trademarks and tradename. Under the terms of the sale, which closed in October 2001, the buyers also assumed operation of four additional coffeehouses on a sublease basis, with an option to purchase them in the future at a predetermined price. Other terms of the transaction include the right for the Company to continue using the Coffee Plantation trademarks on a royalty-free basis for the three remaining Company operated Coffee Plantation locations. The buyers also executed a long term exclusive supply agreement which provides, among other things, that the Company will be their wholesale supplier of roasted coffee for the units noted above (and any other new Coffee Plantation units they may acquire or develop during the term of the agreement), and commits the buyers to certain minimum levels of coffee purchases annually. All of the net assets relating to these stores were classified as Assets Held for Sale as of June 27, 2001.

        Assets Held for Sale also includes a piece of land located in Oregon, which the Company had for sale as of June 27, 2001, and which the Company sold on July 12, 2002. In addition, Assets Held for Sale as of July 3, 2002 includes three Company owned coffeehouses in New Hampshire which the Company intends to sell to a franchisee, with an expected closing date of November 1, 2002.

	July 3, 2002		June 27, 2001
Phoenix assets held for sale	$	—	$	1,534,000
Oregon assets held for sale		155,000		160,000
New Hampshire assets held for sale		31,000		—
Total assets held for sale	$	186,000	$	1,694,000

F-11

4. Notes Receivable

        In October 2001, the Company sold eight of its coffeehouses in Phoenix, Arizona for $1,382,000 in cash and $515,000 in notes receivable. Under the terms of this sale, the buyers also assumed operation of four additional coffeehouses on a sublease basis, with an option to purchase them in the future at a predetermined price. Another term of the transaction provided the Company the right to continue to use the Coffee Plantation trademarks and trade name on a royalty-free basis for the Company's five remaining company-operated locations. The buyers also executed a seven year exclusive coffee supply agreement which provides, among other things, that the Company will supply roasted coffee to the units noted above (and any other new Coffee Plantation units that the buyers may acquire or develop during the term of the agreement). Under the coffee supply agreement, the buyers are required to purchase certain minimum levels of coffee annually.

        Notes receivable at July 3, 2002 consist of the following:

	Current Portion		Long-Term Portion
Notes receivable from a corporation: Notes receivable bearing interest at rates from 0.0% to 10.0%, payable in monthly installments varying between $3,333 and $25,000. Due between October 3, 2005 and October 5, 2006. Notes are secured by the assets purchased under the Asset Purchase and Sale Agreements.	$	48,000	$	240,000

5. Property and Equipment

        Property and equipment is summarized as follows:

	July 3, 2002			June 27, 2001
Land	$	—		$	190,000
Buildings		365,000			388,000
Leasehold improvements		6,244,000			6,345,000
Equipment		11,765,000			11,545,000
Furniture and fixtures		951,000			1,011,000
Construction in progress		285,000			165,000
		19,610,000			19,644,000
Accumulated depreciation and amortization		(12,096,000	)		(10,280,000	)
	$	7,514,000		$	9,364,000

        Property held under capitalized leases in the amount of $958,000 and $733,000 at July 3, 2002 and June 27, 2001, respectively, is included in equipment. Accumulated amortization of such equipment amounted to $569,000 at July 3, 2002, and $446,000 at June 27,2001.

6. Acquisition of Coffee People, Inc.

        On July 7, 1999, the Company acquired Coffee People pursuant to an Agreement and Plan of Merger. The acquisition was affected through the merger of CP Acquisition Corp., an indirect wholly

F-12

owned subsidiary of the Company, with and into Coffee People. As a result of the acquisition, each share of Coffee People common stock was converted into the right to receive $2.11 in cash and 0.035 shares of the Company's common stock, resulting in a total of 375,000 shares of Company common stock being issued at a fair value of $8,415,000. At the time of the acquisition, Coffee People owned 65 retail stores and franchised 253 retail stores in 36 states and 7 foreign countries under the names Gloria Jean's, Coffee People and Coffee Plantation.

        The Company, in recording the fair value of assets acquired and liabilities assumed, has made certain estimates. These estimates consisted primarily of recording property and equipment at estimated fair value. The acquisition was accounted for as a purchase.

        The assets acquired, including the costs in excess of net assets acquired, and liabilities assumed in the acquisition of Coffee People are summarized in the following table.

Fair value of tangible assets acquired		$	14,883,000
Costs in excess of net assets acquired			29,744,000
Liabilities assumed at fair value			(13,957,000	)
Common stock issued			(8,415,000	)
	Net cash paid for acquisition		22,255,000
Cash acquired in acquisition			1,761,000
	Cash paid for acquisition	$	24,016,000

        In conjunction with the transaction, the Company acquired 31 corporate owned Gloria Jean's stores, of which 14 continue to operate as corporate owned Gloria Jean's stores, 12 have been sold to Gloria Jean's franchisees, and 5 were closed as of June 28, 2000. Under the provisions of Emerging Issues Task Force 87-11 "Allocation of Purchase Price to Assets to Be Sold", the Company has excluded the operating results of the 17 stores from the consolidated statement of operations for the year ended June 28, 2000. The total revenue excluded from the Company's consolidated statement of operations for the year ended June 28, 2000 totaled $1,654,117, and the related net losses totaled $393,691. Such net losses have been charged against the reserve for disposal of stores. During the fourth quarter of the year ended June 28, 2000, the Company decided to keep seven of the stores that were originally designated to be disposed of. In accordance with Emerging Issues Task Force 90-6 "Accounting for Certain Events Not Addressed in Issue No. 87-11 Relating to Acquired Operating Unit to Be Sold", the Company reversed the results of operations of these seven stores out of the reserve and included the results of operations for the first, second and third quarter in the condensed consolidated statement of operations for the year ended June 28, 2000. The impact of the reversal on total revenue in the fourth quarter for the year ended June 28, 2000 was $1,155,101 and the impact on the statement of operations was an additional net loss of $115,632.

7. Intangible Assets

        Effective June 28, 2001, the Company adopted Statements of Financial Accounting Standards (SFAS) Nos. 141 and 142, "Business Combinations" and "Goodwill and Other Intangible Assets," respectively, which require that the Company prospectively cease amortization of goodwill and instead conduct periodic tests of goodwill for impairment. The Company completed a test for goodwill impairment as of June 28, 2001, and determined that no goodwill impairment was indicated as of that

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date. The following table shows, on a pro-forma basis, what earnings and earnings per share would have been if the new accounting standards had been applied for the periods indicated:

	Fifty-Two Weeks Ended June 27, 2001			Fifty-Two Weeks Ended June 28, 2000
Reported net loss	$	(3,988,000	)	$	(22,423,000	)
Add back: goodwill amortization		803,000			745,000
Adjusted net loss	$	(3,185,000	)	$	(21,678,000	)
Per share information:
Basic and Diluted:
Reported net loss	$	(1.16	)	$	(7.19	)
Goodwill amortization		0.23			0.24
Adjusted net loss	$	(0.93	)	$	(6.95	)

        The following table details the balances of our amortizable intangible assets that continue to be amortized as of July 3, 2002:

	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Leasehold interests	$	3,000	$	2,000	$	1,000
Leasehold rights	$	23,000	$	21,000	$	2,000
Trademarks	$	32,000	$	5,000	$	27,000

        The weighted average amortization period for the intangible assets is approximately 25 years. The following table shows the estimated amortization expense for these assets for each of the five succeeding fiscal years:

Fiscal year:
2003	$	3,000
2004	$	1,000
2005	$	1,000
2006	$	1,000
2007	$	1,000

        Changes in the carrying amount of goodwill for the fifty-three weeks ended July 3, 2002 are summarized as follows:

Balance as of June 27, 2001	$	12,250,000
Goodwill dispositions, net		(86,000	)
Balance as of July 3, 2002	$	12,164,000

        The goodwill disposition of $86,000 related to a Coffee People location which closed in December, 2001.

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8. Debt

        Long-term debt consists of the following:

	July 3, 2002		June 27, 2001
Fleet National Bank
Note payable bearing interest at a rate of 5.38% as of July 3, 2002 and payable in monthly installments of $100,000. Due September 1, 2002. Note is secured by the assets of the Company and its subsidiaries' stock	$	3,226,000	$	5,543,000
Less: current installments		1,126,000		1,200,000
Less: 50% of proceeds from planned asset sales (Note 3), which are reflected as current installments		—		840,000
Long-term debt, excluding current installments	$	2,100,000	$	3,503,000

        On July 7, 1999, the Company entered into a Credit Agreement with BankBoston, N.A. (subsequently merged into Fleet National Bank) secured by a pledge of all of the Company's assets and its subsidiaries' stock. It initially provided for a $12 million term loan and a $3 million revolving credit facility. The term loan provided for principal repayment based upon a five-year amortization, with quarterly principal payments of $666,667 and quarterly interest payments based upon a formula described below. The Company has not drawn down any borrowings under the revolving credit facility since it was established, although the credit facility backed $218,000 of outstanding Letters of Credit as of July 3, 2002. Amounts outstanding under the Credit Agreement bear interest, at the Company's option, at Fleet's base rate plus 1.25% or an adjusted Eurodollar rate plus 3.0%. At July 3, 2002, the applicable interest rate was 5.38%, which was based on the Eurodollar rate at the time. The rate can be fixed over periods ranging from one to six months, at the Company's discretion.

        Due to various problems encountered in the year subsequent to the acquisition of Coffee People, Inc. the Company announced, on June 29, 2000, that it expected to be in default under the Credit Agreement because of its inability to satisfy certain financial covenants. The Company simultaneously announced that it had entered into a Letter Agreement with Fleet under which the bank agreed to extend the due date of the June 30, 2000 quarterly principal payment to July 31, 2000, and to forbear until July 31, 2000 from exercising any of its rights and remedies arising from financial covenant defaults. The Company subsequently made its July 31, 2000 principal payment on the extended due date. On August 17, 2000, the Company entered into an extension of the June 27, 2000 Letter Agreement, which extended through September 30, 2000 the bank's forbearance from exercising any of its default remedies.

        On September 26, 2000, the Company entered into the First Amendment to Credit Agreement with Fleet to amend certain terms of the original Credit Agreement. The First Amendment provided for, among other things: a significant reduction in the required minimum principal amortization payments going forward, an acceleration in the maturity date of all amounts owed under the Credit Agreement, an agreement between the Company and the bank about certain assets that the Company intends to sell and about the payment of future sale proceeds to the bank, the introduction of an additional event of default, a reduction in the overall amount of the revolving credit facility, new restrictions governing use of the facility and a modification of the financial covenants going forward.

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The interest rate and the timing of quarterly interest payments under the original Credit Agreement remained unchanged under the First Amendment to Credit Agreement.

        Specifically, under the terms of the First Amendment, no further principal payments on the term loan were required from August 1, 2000 until January 31, 2001. The Company began making principal payments of $25,000 per month on February 1, 2001, which payment amount increased to $100,000 per month on July 1, 2001. Minimum monthly payments of $100,000 are required until all amounts owed under the Credit Agreement are repaid. The First Amendment accelerated the maturity date of all remaining amounts owed under the Credit Agreement to the first business day after August 31, 2002 (in essence, September 3, 2002). In addition, the First Amendment identified certain assets that Fleet would consent to the sale of by the Company, including two pieces of Company owned real property under existing retail locations, and a vacant parcel of owned but undeveloped real property. The First Amendment also permitted the Company to sell certain Company-operated coffeehouses outside of southern California on a franchise basis. The terms of the First Amendment required that Fleet receive 50% of the net proceeds from any of any asset or equity sales by the Company.

        In January 2001, two of the aforementioned pieces of real property were sold in a sale-leaseback transaction for $415,000. $208,000 of the proceeds from the transaction was remitted to Fleet. In May 2001, three Company-operated coffeehouses in Texas were sold for an aggregate of $1,025,000. $448,500 of the proceeds from the sale was remitted to Fleet. Also in May 2001, the Company sold 2,000,000 shares (post-split) of Company common stock in a private sale. $3,600,000 of the proceeds from the sale was remitted to Fleet. In October 2001, twelve Company-operated coffeehouses in Arizona were sold for an aggregate of $1,382,000 in cash and $515,000 in notes receivable. One-half of the cash payment, $596,000, was remitted to Fleet. In December 2001, a parcel of real property along with a building were sold in a sale-leaseback transaction for $325,000. $140,000 of the proceeds from this sale was remitted to Fleet. In May 2002, a Company-operated coffeehouse located in Hawaii was sold for $535,000 in cash. $267,500 of the proceeds was remitted to Fleet. The proceeds from all six sales discussed above were applied solely to the Company's principal note payable balance.

        The First Amendment also introduced an additional event of default under the Credit Agreement. The First Amendment specifies that a materially adverse change in the financial condition of the Company or any of its subsidiaries, as determined by the bank in its sole and exclusive discretion, is an event of default. Under any event of default, the bank may declare all amounts owed immediately due and payable. Additional changes under the terms of the First Amendment include a reduction in the maximum amount available under the revolving credit facility, a portion of which the Company had previously been unable to access because of the covenant defaults, from $3,000,000 to $1,293,000, and a restriction that the credit facility be used only to back up existing and future standby Letters of Credit. The First Amendment preserves the Company's ability to obtain third party financing for capital projects and maintenance capital, and increases its flexibility to obtain subordinated debt as a source of additional working capital. Under the First Amendment, the bank waived the previous financial covenant defaults and agreed to new financial covenant ratios going forward based upon updated financial information and projections prepared by the Company. In addition to resetting the ratios in the financial covenants, the parties agreed to a new covenant under the First Amendment that requires the Company to achieve certain predetermined minimum levels of cumulative principal repayments in addition to amounts already paid to date in fiscal 2001 or reflected in the new go forward minimum monthly principal payment obligations discussed above: $283,333 by March 2001; $708,333 by June 30, 2001; and $1,619,900 by September 30, 2001. All such incremental principal repayment obligations due

F-16

prior to the accelerated maturity date have been met as of July 3, 2002, and were generated primarily from the net proceeds paid to the bank from the above mentioned asset sales and stock issuance.

        As described more fully below in note 17 ("Subsequent Event"), the Company repaid all of its obligations to Fleet on September 3, 2002 in conjunction with the refinancing of its bank debt via a new credit agreement entered into with a new lender at that time. In accordance with SFAS No. 6, as of July 3, 2002, the Company has classified the note payable to Fleet in accordance with the terms of this new credit agreement.

        On September 30, 1997 the Company entered into a promissory note, term loan agreement and security agreement with Nuvrty, Inc., a Colorado corporation controlled by Amre Youness, a former director of the Company (the "Nuvrty Loan Documents"). All outstanding principal and accrued interest was due and payable on September 30, 2002. The loan was secured by the assets of the Company and provided for borrowings up to $1,000,000 with interest accruing and paid monthly at the prime rate plus 3-1/2%. The Company borrowed the full amount under the loan. In connection with the acquisition of Coffee People (note 6), the Company repaid the loan on July 8, 1999.

        In connection with the Nuvrty Loan Documents, the Company issued a warrant to Nuvrty to purchase 85,000 shares of the Company's common stock at a price of $9.00 per share. The warrants are exercisable immediately and expire on September 30, 2003.

        Maturities of long-term debt for years subsequent to July 3, 2002 are as follows:

Fiscal Year
2003	$	1,126,000
2004		1,200,000
2005		900,000
Total long-term debt	$	3,226,000

9. Accrued Expenses

        The following table sets forth details of accrued expenses:

	July 3, 2002		June 27, 2001
Accrued severance and relocation costs	$	14,000	$	151,000
Due to franchisee trust accounts		126,000		336,000
Accrued interest		4,000		46,000
Accrued professional fees		101,000		110,000
Other accrued expenses		450,000		498,000
Total accrued expenses	$	695,000	$	1,141,000

F-17

        The following table sets forth details of accrued severance and relocation:

	Beg Balance		Amounts Charged to Expense		Cash Payments			End Balance
Accrued severance and relocation:
Year ended June 27, 2001	$	548,000	$	372,000	$	(769,000	)	$	151,000
Year ended July 3, 2002	$	151,000	$	311,000	$	(448,000	)	$	14,000

        For the year ended July 3, 2002, amounts charged to expense are included as components of provision for asset impairment and restructuring costs ($275,000) and general and administrative expenses ($36,000). Due to lower than expected relocation costs for an employee and the fact that several employees found new employment before their severance agreements ran out, $64,000 in expense was reversed during the year ended July 3, 2002. For the year ended June 27, 2001, amounts charged to expense are included as components of provision for asset impairment and restructuring costs ($298,000) and general and administrative expenses ($74,000).

        Accrued severance and relocation costs as of July 3, 2002 include severance expenses resulting from the elimination of ten support center positions, and the closure of certain under-performing Company operated locations during the fiscal year ended July 3, 2002. Accrued severance and relocation costs as of June 27, 2001 include estimated costs associated with the relocation of the administrative support center for the Company's Gloria Jean's division to the Company's home office in Irvine, California, severance expenses resulting from the elimination of thirty-one administrative positions, and the closure of certain under-performing Company operated locations during the the fiscal year ended June 27, 2001.

10. Commitments and Contingencies

Lease Commitments

        As of July 3, 2002, the Company leases warehouse and office space in Irvine, California, Castroville, California, and Beaverton, Oregon, as well as 85 retail locations expiring at various dates through November 2016. The leases for five of the coffeehouse locations are guaranteed by an officer/director of the Company. Certain of the coffeehouse leases require the payment of property taxes, normal maintenance and insurance on the properties and additional rents based on percentages of sales in excess of various specified retail sales levels. Contingent rent expense was insignificant for all periods presented.

F-18

        Future minimum lease payments under non-cancelable operating leases and capital leases as of July 3, 2002 are as follows:

Year Ending June	Non-cancelable Operating Leases		Capital Leases
2003	$	3,845,000	$	282,000
2004		3,399,000		242,000
2005		2,901,000		203,000
2006		2,280,000		115,000
2007		1,500,000		44,000
Thereafter		3,882,000		395,000
	$	17,807,000		1,281,000
Less amount representing interest				(360,000	)
Present value of minimum lease payments (8% to 15%)				921,000
Less current installments				189,000
Obligations under capital leases, excluding current installments			$	732,000

        Rent expense under operating leases approximated $5,511,000, $7,034,000, and $7,886,000 for the years ended July 3, 2002, June 27, 2001 and June 28, 2000, respectively.

        Total minimum lease payments have not been reduced for future minimum sublease rentals of $3,586,000 under certain operating subleases.

        The Company has leased and subleased land and buildings to others, primarily as a result of the franchising of certain restaurants. Many of these leases provide for fixed payments with contingent rents when sales exceed certain levels, while others provide for monthly rentals based on a percentage of sales. Lessees generally bear the cost of maintenance, insurance, and property taxes.

        Minimum future rentals to be received as of July 3, 2002 are as follows:

Year Ending June
2003	$	858,000
2004		811,000
2005		601,000
2006		390,000
2007		344,000
Thereafter		582,000
Total minimum future rentals	$	3,586,000

        In addition, the Company is contingently liable on the master leases for 137 franchise locations. Under the Company's historical franchising business model, the Company executed the master leases for these locations, and entered into subleases on the same terms with its franchisees, who pay their rent directly to the landlords. Should any of these franchisees default on their subleases, the Company

F-19

would be responsible. The Company's maximum theoretical future exposure at July 3, 2002, computed as the sum of all remaining lease payments through the expiration dates of the respective leases, was $20,328,000. This amount does not take into consideration any mitigating measures the Company could take to reduce this exposure in the event of default, including re-leasing the locations, or terminating the master lease by negotiating a lump payment to the landlord less than the sum of all remaining future rents.

Purchase Commitments

        At July 3, 2002, we had commitments to purchase coffee through fiscal year 2005, totaling $4,853,000 for 3,609,000 pounds of green coffee, all of which were fixed as to price. Such contracts are generally short-term in nature, and the Company believes that their cost approximates fair market value.

Contingencies

        The Company self-insures its healthcare coverage up to $40,000 per employee per plan year. Accruals for claims under the Company's self-insurance coverage program are recorded on a claim-incurred basis. The Company accrues for those claim exposures which are probable of occurrence, and can be reasonably estimated.

        In the ordinary course of its business, the Company may become involved in legal proceedings from time to time. The Company is not aware of any pending legal proceedings which in the opinion of management, based in part on advice from legal counsel, would significantly adversely affect the Company's financial position or results of operations.

11. Stockholders' Equity

        In July 1996, the Company adopted the 1996 Stock Incentive Plan (the "Incentive Plan"), which authorized the granting of a variety of stock-based incentive awards, including incentive and nonstatutory stock options. A total of 193,750 shares have been reserved for issuance under the Incentive Plan. The stockholders approved at the 1997 annual meeting of stockholders, an increase of 75,000 shares reserved for issuance pursuant to the Incentive Plan. The Incentive Plan is administered by a committee of the Board of Directors, who determine the recipients and terms of the awards granted. Under the Incentive Plan, options to purchase common stock may be granted with an exercise price below market value of such stock on the grant date.

        In July 1996, the Company adopted the 1996 Non-Employee Directors Stock Option Plan (the "Directors Plan"), which authorizes the granting of non-qualified stock options to independent directors. A total of 31,250 shares have been reserved for issuance under the Directors Plan. Pursuant to the Directors Plan, each non-employee director receives certain automatic grants of options, which generally vest over two years. All non-employee director options have a term of ten years and an exercise price equal to the fair market value of the Company's common stock on the date of grant.

        On April 25, 1997, the Company's Board of Directors approved the 1997 Non-Employee Director's Stock Option Plan, whereby 2,500 shares each were granted to two non-employee directors. These options, which have an exercise price of $11.00, became vested on April 25, 1998 and expire on April 25, 2007.

F-20

        On November 18, 1997, Mr. John E. Martin joined the Company's Board of Directors as Chairman. The Company and Mr. Martin entered into an agreement under which Mr. Martin would be granted the option to purchase 212,500 shares of the common stock of the Company subject to stockholder approval. Mr. Martin and the Company also agreed to terms under which Mr. Martin would purchase 83,333 shares at $12.00 per share in the Company pursuant to a private sale of restricted stock.

        On November 18, 1997, Mr. Timothy J. Ryan joined the Company as Diedrich Coffee's President and Chief Executive Officer. Subject to stockholder approval, the Company entered into a performance based Stock Option Plan and Agreement under which Mr. Ryan would be granted the option to purchase up to 150,000 shares of the common stock of the Company and Mr. Ryan would purchase 4,167 shares at $12.00 per share in the Company pursuant to a private sale of restricted stock.

        On January 22, 1998 the stockholders of the Company approved the stock option plans and agreements with John Martin and Timothy Ryan. On January 28, 1998 Messrs. Martin and Ryan completed their respective private purchases of Company stock of $1,000,000 and $50,000, respectively.

        On March 30, 1998 the Company agreed to a private placement of 50,000 shares of the Company's common stock to Franchise Mortgage Acceptance Company ("FMAC") at a price of $25.50 (the stock's closing sale price for that day on the Nasdaq National Market). In addition, FMAC also received an option to purchase 25,000 additional shares of the Company's common stock; this option could have been exercised in increments of 6,250 shares or more and expired on April 3, 2000. The exercise prices of this option are as follows: 12,500 shares are exercisable at $40.00 per share and $50.00 per share respectively. This transaction was completed on April 3, 1998, at which time Mr. John E. Martin served as Chairman of Diedrich Coffee, Inc., and served on the Board of Directors of FMAC.

        On July 7, 1999, the Company completed a secondary offering of 1,232,500 shares (including an over-allotment option). All of the shares of common stock were sold on behalf of the Company, of which 82,500 shares of common stock were sold pursuant to the exercise of the underwriters' over-allotment option. The net proceeds of the offering to the Company, after deducting approximately $4.1 million in underwriters' commissions and related expenses, were approximately $25.4 million.

        Effective September 22, 2000, the Company granted J. Michael Jenkins, then Diedrich Coffee's President and Chief Executive Officer, the option to purchase up to 125,000 shares of the Company's common stock. The options granted to Mr. Jenkins are exercisable at a price of $7.00 per share, in four equal installments on each of the first four anniversary dates of September 22, 2000.

        On October 20, 2000, the Company's board of directors authorized the adoption of the Diedrich Coffee 2000 Equity Incentive Plan and the concurrent discontinuation of option grants under the Company's Amended and Restated 1996 Stock Incentive Plan and the Company's 1996 Non-Employee Directors Stock Option Plan. A total of 187,500 shares of the Company's common stock may be issued under the 2000 Equity Incentive Plan.

        On October 20, 2000, the Company's board of directors adopted the Diedrich Coffee, Inc. 2000 Non-Employee Directors Stock Option Plan. This plan provides for a one-time grant of an option to purchase 2,000 shares of the Company's common stock to three of its non-employee directors, Messrs. Churm, Goelman and Heeschen. Each option granted under the 2000 Non-Employee Directors Stock Option Plan is effective as of October 20, 2000 and has a term of ten years. The options will vest and become exercisable on October 20, 2001, at an exercise price of $5.36 per share.

F-21

        On March 14, 2001, the Company's board of directors approved and adopted an amendment to the certificate of incorporation, subject to stockholder approval, to increase the authorized number of shares of common stock from 6,250,000 to 8,750,000.

        On May 8, 2001, the Company sold 2,000,000 shares of its common stock and issued warrants to purchase an additional 500,000 shares of common stock. The net proceeds to the Company from this sale, after deducting approximately $520,000 in stock issuance costs, were $5,459,000.

        On May 9, 2001, the Company filed an amendment to its certificate of incorporation that caused each four outstanding shares of its common stock to be converted into one share of its common stock. All share and per share amounts have been adjusted for this reverse stock split.

        Information regarding the Company's stock option plan is summarized below:

		Options			Weighted Average Exercise Price
Number of options authorized for future grant			249,750
Outstanding at June 30, 1999			546,392		$	24.68
	Granted		158,189		$	19.36
	Exercised		(3,333	)	$	11.48
	Forfeited		(115,642	)	$	27.08
Outstanding at June 28, 2000			585,606		$	22.88
	Granted		324,375		$	19.36
	Exercised		—			—
	Forfeited		(53,056	)	$	20.79
Outstanding at: June 27, 2001			856,925		$	16.29
	Granted		36,250		$	3.56
	Exercised		—			—
	Forfeited		(526,433	)	$	20.42
Outstanding at: July 3, 2002			366,742		$	9.11
Weighted-average fair value of options granted:
	Year ended June 28, 2000	$	16.60
	Year ended June 27, 2001	$	4.26
	Year ended July 3, 2002	$	2.62
Options exercisable:
	At June 28, 2000		283,745
	At June 27, 2001		314,587
	At July 3, 2002		210,762

F-22

        The following table summarizes information about stock options outstanding at July 3, 2002:

		Options Outstanding				Options Exercisable
Range of Exercise Price		Number Outstanding At July 3, 2002	Weighted Average Remaining Life (Years)	Weighted Average Exercise Price		Number Exercisable At July 3, 2002	Weighted Average Exercise Price
$	3.04 - $10.99	224,375	9.02	$	3.89	81,454	$	3.95
$	11.00 - $15.99	89,292	5.79	$	12.39	85,914	$	12.36
$	16.00 - $23.99	28,275	7.33	$	21.99	18,844	$	21.98
$	24.00 - $35.99	19,800	6.32	$	27.51	19,550	$	27.52
$	36.00 - $49.99	5,000	4.19	$	39.50	5,000	$	39.50
		366,742	7.89	$	9.11	210,762	$	12.02

        Pro forma net loss and pro forma net loss per share, as if the fair value-based method has been applied in measuring compensation cost for stock-based awards:

		Year Ended July 3, 2002		Year Ended June 27, 2001			Year Ended June 28, 2000
Pro Forma
	Net income (loss)	$	1,926,000	$	(4,911,000	)	$	(23,482,000	)
	Basic and diluted income (loss) per share	$	0.37	$	(1.43	)	$	(7.53	)

        The fair values of the options granted were estimated using the Black-Scholes option-pricing model based on the following weighted average assumptions:

	Year Ended July 3, 2002		Year Ended June 27, 2001		Year Ended June 28, 2000
Risk free interest rate	4.00	%	4.82	%	6.28	%
Expected life	6 years		6 years		6 years
Expected volatility	86	%	182	%	72	%
Expected dividend yield	0	%	0	%	0	%

F-23

12. Income Taxes

        The components of the income tax expense are as follows:

		Year Ended July 3, 2002		Year Ended June 27, 2001		Year Ended June 28, 2000
Current:
	Federal	$	—	$	—	$	—
	State		57,000		36,000		19,000
			57,000		36,000		19,000
Deferred:
	Federal		—		—		—
	State		—		—		—
		$	57,000	$	36,000	$	19,000

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. The significant components of deferred tax assets and liabilities are as follows:

		July 3, 2002			June 27, 2001
Deferred tax assets:
	Net operating loss carryforwards	$	10,727,000		$	10,439,000
	Intangible assets		860,000			732,000
	Depreciation		976,000			1,252,000
	Property and equipment impairment		1,397,000			1,695,000
	Accrued expenses		841,000			1,201,000
	Restructure and store closure accruals		226,000			462,000
	AMT credit		—			27,000
	Other		53,000			89,000
Total gross deferred tax assets			15,080,000			15,897,000
Less valuation allowance			(15,080,000	)		(15,897,000	)
Deferred tax liabilities			—			—
Net deferred tax assets		$	—		$	—

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        A reconciliation of the statutory Federal income tax rate with the Company's effective income tax expense (benefit) rate is as follows:

	Year Ended July 3, 2002		Year Ended June 27, 2001		Year Ended June 28, 2000
Federal statutory rate	34.0	%	(34.0	)%	(34.0	)%
State income taxes, net of Federal benefit	5.00		(5.57	)	(3.34	)
Goodwill and other non-deductible costs	18.58		(13.00	)	2.66
Valuation allowance	(61.74	)	26.56		34.6
Other	8.44		0.00		0.00
	4.28	%	0.92	%	0.08	%

        As of July 3, 2002, the Company had net operating loss (NOL) carryforwards of approximately $28,800,000 and $19,000,000 for Federal and state purposes, respectively. The Federal NOL is available to offset future federal taxable income through 2022, and the state NOL is available to offset future state taxable income through 2007. The utilization of certain NOL carryforwards could be limited due to restriction imposed under Federal and state laws upon a change in ownership.

        In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is not more likely than not that the Company will realize the benefits of these deductible differences, and thus has recorded a valuation allowance against the entire deferred tax asset.

13. Impairment and Restructuring Charges

        The Company recorded an asset impairment charge of $22,000 during its second quarter of fiscal 2002, related to the closure of one of its Coffee People coffeehouses. The book value of this unit was written down to reflect the proceeds the Company received from its landlord during the third quarter as a concession for terminating the Company's lease early.

        The Company recorded a charge of $367,000 during its third quarter of fiscal 2002 for asset impairment and restructuring costs. This charge was comprised of severance costs of $290,000 and related employee benefit costs of $46,000 associated with the elimination of ten support center positions, plus estimated lease termination costs of $31,000 for the planned closure of one underperforming Company operated location.

        The Company recorded an asset impairment and restructuring cost charge of $158,000 during its fourth quarter of fiscal 2002. This charge was comprised of a charge of $142,000 to write down the carrying value of three Company operated coffeehouses, slightly offset by a ($58,000) reversal of a previously recorded impairment charge, in order to reflect the actual sales price of a piece of land. At the end of fiscal 2002 the Company learned it would be required to take back four Arizona coffeehouse locations which it had previously subleased, as described below. A fourth quarter charge of

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$89,000 was recorded to reflect additional costs the Company expects to incur to terminate its remaining lease obligations on these four locations. The final component of the fourth quarter charge was a reduction in previously recorded restructuring costs of ($15,000), due to several former employees finding new employment prior to the expiration of their severance agreements.

        The Company recorded an asset impairment charge of $1,855,000 during its fourth quarter of fiscal 2001. $1,536,000 of the charge relates to twelve Coffee Plantation stores located in Phoenix, Arizona, eight of which were classified as held for sale at June 27, 2001 (see note 3). The book values of the eight units held for sale were written down to reflect the anticipated net proceeds. The other four locations were subleased (see note 3), and the book values of the stores' assets were adjusted downward to reflect management's best estimate of their remaining fair market values. $181,000 of the impairment charge relates to other assets being held for sale (see note 3). The charge reflects management's best estimate of the eventual net proceeds. The remaining fourth quarter impairment charge of $138,000 represented a reduction in the carrying value of two underperforming Company operated locations, one franchised location, and the write off of initial development costs of one planned location, which will not be opened. Additionally, the Company recorded a charge of $232,000 to reflect the net present value of future cash outflows the Company expects to incur for the remaining lease obligations on the four Arizona locations, which the Company sublet.

        The Company recorded a charge of $780,000 during its third quarter of fiscal 2001 for asset impairment and restructuring costs. This charge included severance costs of $298,000 associated with the relocation of the administrative support center for the Company's Gloria Jean's division to its home office in Irvine, California, plus the elimination of a number of administrative positions, estimated lease termination costs of $165,000 for the planned closure of four underperforming Company operated locations during the next twelve months, and related asset impairment charges of $317,000.

        In the fourth quarter of the year ended June 28, 2000, the Company evaluated the recoverability of the carrying value of its long-lived assets, including intangibles of all its divisions. Considerable management judgment is necessary to estimate future cash flow. As a result of this evaluation, the Company determined that Gloria Jean's estimated future cash flows were insufficient to recover the carrying value of certain of Gloria Jean's long-lived assets. Accordingly, the Company adjusted the carrying value of Gloria Jean's long-lived assets, primarily costs in excess of net assets acquired, resulting in a noncash impairment charge of approximately $14,818,000 against costs in excess of net assets acquired and an additional $343,000 against property and equipment. The Company also recorded an impairment charge for its Diedrich Coffee division in the amount of $423,000 and for its Coffee People and Coffee Plantation divisions in the amount of $786,000. Total asset impairment charges recorded in the fourth quarter of the year ended June 28, 2000 were $16,370,000.

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14. Earnings Per Share

        The following table sets forth the computation of basic and diluted loss per share:

		Year Ended July 3, 2002		Year Ended June 27, 2001			Year Ended June 28, 2000
Numerator:
	Net income (loss)	$	1,269,000	$	(3,988,000	)	$	(22,423,000	)
Denominator:
	Basic weighted average common shares outstanding		5,161,000		3,436,000			3,120,000
	Effect of dilutive securities		—		—			—
	Diluted weighted average common shares outstanding		5,161,000		3,436,000			3,120,000
Basic and diluted net income (loss) per share		$	0.25	$	(1.16	)	$	(7.19	)

        For the years ended July 3, 2002, June 27, 2001 and June 28, 2000, employee stock options of 339,000, 857,000, and 586,000, respectively, and warrants of 730,000, 730,000, and 230,000 (as described in note 8), were not included in the computation of diluted earnings per share as their impact would have been anti-dilutive.

15. Segment Information

        The Company has three reportable segments, retail operations, wholesale operations and franchise operations. The Company evaluates performance of its operating segments based on income before provision for asset impairment and restructuring costs, income taxes, interest expense, depreciation and amortization, and general and administrative expenses.

        Summarized financial information concerning the Company's reportable segments is shown in the following table. The other total assets consist of corporate cash, corporate notes receivable, corporate prepaid expenses, and corporate property, plant and equipment. The other component of segment

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profit before tax includes corporate general and administrative expenses, provision for asset impairment and restructuring costs, depreciation and amortization expense, and interest expense.

	Retail Operations		Wholesale Operations			Franchise Operations		Other			Total
Year ended July 3, 2002
Total revenue	$	38,658,000	$	16,681,000		$	6,868,000	$	—		$	62,207,000
Interest expense		64,000		—			70,000		466,000			600,000
Depreciation and amortization		1,480,000		581,000			—		323,000			2,384,000
Segment profit (loss) before tax		1,921,000		2,913,000			6,920,000		(10,428,000	)		1,326,000
Total assets as of July 3, 2002	$	9,972,000	$	10,937,000		$	3,846,000	$	3,525,000		$	28,280,000
Year ended June 27, 2001
Total revenue	$	46,925,000	$	18,545,000		$	6,742,000	$	—		$	72,212,000
Interest expense		65,000		—			91,000		1,186,000			1,342,000
Depreciation and amortization		2,613,000		678,000			308,000		846,000			4,445,000
Segment profit (loss) before tax		882,000		2,959,000			5,236,000		(13,029,000	)		(3,952,000	)
Total assets as of June 27, 2001	$	12,952,000	$	11,510,000		$	3,254,000	$	4,175,000		$	31,891,000
Year ended June 28, 2000
Total revenue	$	48,308,000	$	19,081,000		$	6,592,000	$	—		$	73,981,000
Interest expense		64,000		—			143,000		1,109,000			1,316,000
Depreciation and amortization		2,205,000		669,000			745,000		712,000			4,331,000
Segment profit (loss) before tax		2,739,000		(8,005,000	)		168,000		(17,306,000	)		(22,404,000	)

16. Selected Quarterly Financial Data (Unaudited)

        The quarterly results of operations for the years ended July 3, 2002 and June 27, 2001 were as follows:

		First Quarter			Second Quarter		Third Quarter			Fourth Quarter
		(in thousands, except per share data)
Year Ended July 3, 2002:
	Total revenue	$	14,140		$	15,992	$	13,060		$	19,015
	Operating income (loss)		(386	)		1,470		(77	)		856
	Net income (loss)		(546	)		1,335		(190	)		670
	Net income (loss) per share		(0.11	)		0.26		(0.04	)		0.13
Year Ended June 27, 2001:
	Total revenue	$	16,870		$	19,383	$	15,829		$	20,130
	Operating income (loss)		(763	)		532		(305	)		(2,126	)
	Net income (loss)		(1,112	)		164		(632	)		(2,408	)
	Net income (loss) per share		(0.36	)		0.04		(0.20	)		(0.59	)

        Quarterly operating results are not necessarily representative of operations for a full year for various reasons, including the seasonal nature of our business, which may affect sales volume and food costs. For the year ended July 3, 2002, all quarters have 12 week accounting periods, except the fourth quarter, which has a 17 week accounting period. For the year ended June 27, 2001, all quarters have 12 week accounting periods, except the fourth quarter, which has a 16 week accounting period.

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        The Company recorded asset impairment and restructuring charges of $158,000 and $2,087,000 during the fourth quarters of the years ended July 3, 2002 and June 27, 2001, respectively (see note 13).

        The Company reversed $216,000 in bad debt reserves during the fourth quarter of the year ended July 3, 2002 due to the recovery of amounts that had previously been reserved.

        During the fourth quarter ended July 3, 2002, the Company recorded $167,000 in estimated lease termination costs to cover a sublessor who had defaulted on a lease. In addition, the Company reversed $153,000 in closed store reserves, as settlement amounts came out lower than expected.

17. Subsequent Event

        On September 3, 2002 the Company entered into a new Credit Agreement with United California Bank, doing business as Bank of the West, or "BOW", in order to repay the balance of all remaining amounts owed to Fleet under its amended Credit Agreement with Fleet. Under the BOW Credit Agreement, the Company immediately borrowed $3,000,000 under a replacement term loan, the proceeds of which were used to repay its Fleet term loan on September 3, 2002, the amended maturity date of the Fleet term loan.

        The Company's obligations to BOW under the Credit Agreement are secured by all of its assets, including the stock of each of its subsidiaries (each of which guarantees the Company's obligations under the Agreement), as well as all intangible assets it owns, including the intellectual property and trademark assets that we and our subsidiaries own.

        The term loan with BOW requires monthly principal payments of $100,000 over 30 months and all amounts the Company owes under the term loan must be repaid by March 31, 2005. The Company must make monthly interest payments on amounts outstanding under the replacement term loan, computed at either BOW's prime rate plus 0.75% or a LIBOR rate plus 2.50%, and it may periodically elect to convert portions of our prime rate borrowings into LIBOR based borrowings in $100,000 increments, subject to restrictions contained in the Agreement.

        In addition to the term loan, the BOW Credit Agreement provides the Company with a revolving $1,000,000 credit line for the acquisition of specified coffee packaging equipment. Any amounts borrowed under this line will convert to term loans with monthly principal amortization payments beginning September 30, 2003, and all outstanding balances must be repaid by August 31, 2006. The Company is required to pay interest on any borrowings outstanding under this line of credit on a monthly basis, at an interest rate computed in the same manner as described above for the term loan.

        The BOW Credit Agreement also provides the Company two separate $1,000,000 lines of credit for new coffeehouse development, one applicable to borrowings during our fiscal year ending in 2003, and the other to borrowings during our fiscal year ending in 2004. Borrowings under each line of credit will convert to term loans repayable over 36 months, with such repayments beginning July 31, 2003 and due in full by June 30, 2006, in the case of borrowings under the fiscal 2003 line, and beginning July 31, 2004 and due in full by June 30, 2007, in the case of the fiscal 2004 line. The Company is required to pay interest on borrowings under each line of credit on a monthly basis, computed as described above.

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        Finally, the BOW Credit Agreement provides the Company a $675,000 revolving working capital and letter of credit facility, subject to a number of restrictions. Working capital facility draws and letters of credit are limited to a combined maximum of $675,000 outstanding at any time. Furthermore, draw downs against the working capital facility are subject to a sub-limit of $500,000, and letters of credit are subject to a sub-limit of $250,000. The Company may only draw funds against the working capital facility during the first and fourth quarters of each fiscal year, although letters of credit issued under the letter of credit facility may be outstanding throughout the year. The Company may repay amounts borrowed under the working capital facility at any time, and it may therefore be able to re-borrow such funds on a revolving basis (subject to restrictions including those summarized above). All amounts outstanding under the new working capital facility are required to be repaid by August 31, 2003. Any payments made by BOW with regard to any letter of credit issued under the letter of credit facility must be repaid by the Company immediately upon the date of such payment by BOW. As of September 3, 2002, BOW issued two stand by letters of credit, which back the two outstanding Fleet letters of credit discussed above (note 8).

        The Company is subject to a number of additional restrictions under its new Credit Agreement with BOW. These include limitations on its ability to sell assets, make capital expenditures, incur additional indebtedness, permit new liens upon our assets, and to pay dividends on or repurchase its common stock. The Company must also maintain compliance with agreed-upon financial covenants that limit the amount of indebtedness that it may have outstanding in relation to its tangible net worth, require it to maintain a specified minimum dollar value level of tangible net worth, require it to maintain a specified minimum dollar value level of EBITDA for the trailing four fiscal quarters, require it to maintain a specified minimum level of profitability, and require the Company to maintain minimum aggregate cash balances in its various BOW bank accounts of at least $800,000 for all but ten business days each fiscal year.

F-30

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

		Balance at Beginning of Period		Provisions			Additional Provisions Obtained in Acquisitions		Accounts Written Off			Balance at End of Period
Allowance for Bad Debt:
	Year ended June 28, 2000	$	31,000	$	566,000		$	1,314,000	$	(773,000	)	$	1,138,000
	Year ended June 27, 2001	$	1,138,000	$	1,102,000		$	-0-	$	(233,000	)	$	2,007,000
	Year ended July 3, 2002	$	2,007,000	$	(397,000	)	$	-0-	$	(246,000	)	$	1,364,000

F-31

DIEDRICH COFFEE, INC.

INDEX TO EXHIBITS

Exhibit Number	Description
2.1	Agreement and Plan of Merger dated as of March 16, 1999, by and among Diedrich Coffee, CP Acquisition Corp., a wholly owned subsidiary of Diedrich Coffee, and Coffee People, Inc.(1)
3.1	Restated Certificate of Incorporation of the Company, dated May 11, 2001(2)
3.2	Bylaws of the Company(3)
4.1	Purchase Agreement for Series A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee, Martin R. Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P.(3)
4.2	Purchase Agreement for Series B Preferred Stock dated as of June 29, 1995 by and among Diedrich Coffee, Martin R. Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, L.P. and Diedrich Partners I, L.P.(3)
4.3	Specimen Stock Certificate(3)
4.4	Form of Conversion Agreement in connection with the conversion of Series A and Series B Preferred Stock into Common Stock(3)
4.5	Registration Rights Agreement, dated May 8, 2001(2)
4.6	Form of Warrant, dated May 8, 2001(2)
10.1	Form of Indemnification Agreement(3)
10.2	Amended and Restated Diedrich Coffee 1996 Stock Incentive Plan(4)*
10.3	Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan(3)*
10.4	Agreement of Sale dated as of February 23, 1996 by and among Diedrich Coffee (as purchaser) and Brothers Coffee Bars, Inc. and Brothers Gourmet Coffees, Inc. (as sellers)(3)
10.5	Employment Agreement by and between the Company and Timothy J. Ryan retaining Mr. Ryan as Chief Executive Officer, dated as of November 17, 1997(5)*
10.6	Form of Warrant Agreement made in favor of Nuvrty, Inc., the Ocean Trust and the Grandview Trust(6)
10.7	Form of Common Stock and Option Purchase Agreement with Franchise Mortgage Acceptance Company dated as of April 3, 1998(7)
10.8	Employment Agreement with Catherine Saar dated June 11, 1998(8)*
10.9	Form of Franchise Agreement(9)
10.10	Form of Area Development Agreement(9)
10.11	Form of Employment Agreement with Martin R. Diedrich dated June 29, 2001(10)*
10.12	Credit Agreement, dated as of July 7, 1999, by and among BankBoston, N.A., Diedrich Coffee and its subsidiaries(11)
10.13	Security Agreement, dated as of July 7, 1999, by and among BankBoston, N.A., and Diedrich Coffee(11)
10.14	Securities Pledge Agreement, dated as of July 7, 1999, by and among BankBoston, N.A., Diedrich Coffee and its subsidiaries(11)
10.15	Trademark Security Agreement, dated as of July 7, 1999, by and among BankBoston, N.A., Diedrich Coffee and its subsidiaries(11)
10.16	Form of Term Note made in favor of BankBoston, N.A.(11)
10.17	Form of Revolving Note made in favor of BankBoston, N.A.(11)
10.18	Employment Agreement with Matt McGuinness dated effective March 13, 2000(12)*
10.19	First Amendment to Credit Agreement dated as of September 26, 2000(12)
10.20	Second Amendment to Credit Agreement dated as of February 26, 2001(13)
10.21	Letter Agreement re: employment with J. Michael Jenkins dated September 2000(12)*
10.22	Letter Agreement re: employment with Carl Mount dated October 29, 1999(14)*

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10.23	Letter Agreement re: employment with Edward A. Apffel dated May 25, 2000(14)*
10.24	Diedrich Coffee, Inc. 2000 Non-Employee Directors Stock Option Plan(15)*
10.25	Stock Option Plan and Agreement with J. Michael Jenkins, dated September 22, 2000(16)*
10.26	Diedrich Coffee, Inc. 2000 Equity Incentive Plan(16)*
10.27	Common Stock and Warrant Purchase Agreement, dated March 14, 2001(17)
10.28	Employment agreement with Philip G. Hirsch, dated March 20, 2002(10)*
10.29	Employment agreement with Philip G. Hirsch, effective as of September 1, 2002*
10.30	Credit Agreement, dated September 3, 2002, by and between Diedrich Coffee, Inc. and Bank of the West d/b/a/ United California Bank
10.31	Form of Guaranty
10.32	Form of Guarantor Security Agreement
10.33	Form of Supplemental Security Agreement
10.34	Security Agreement, dated September 3, 2002, by and between Diedrich Coffee, Inc. and Bank of the West d/b/a/ United California Bank
21.1	List of Subsidiaries(12)
23.1	The Report and Schedule and Consent of Independent Auditors
99.1	Certification Pursuant to 18 USC Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*

management contract or compensatory plan or arrangement

(1)

Previously filed as Appendix A to Diedrich Coffee's Registration Statement on Form S-4, filed with the Securities and Exchange Commission on April 23, 1999.

(2)

Previously filed as an exhibit to Diedrich Coffee's Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 16, 2001.

(3)

Previously filed as an exhibit to Diedrich Coffee'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.

(4)

Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on Form 10-Q for the period ended September 22, 1999, filed with the Securities and Exchange Commission on November 5, 1999.

(5)

Previously filed as an exhibit to Diedrich Coffee's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 25, 1997.

(6)

Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on Form 10-Q for the period ended October 29, 1997, filed with the Securities and Exchange Commission on December 11, 1997.

(7)

Previously filed as an exhibit to Diedrich Coffee's Annual report on Form 10-K for the fiscal year ended January 28, 1998.

(8)

Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on Form 10-Q for the period ended July 29, 1998, filed with the Securities and Exchange Commission on September 10, 1998.

(9)

Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on Form 10-Q for the period ended April 28, 1999, filed with the Securities and Exchange Commission on December 11, 1998.

(10)

Previously filed as an exhibit to Diedrich Coffee's Annual Report on Form 10-K for the year ended June 27, 2001, filed with the Securities and Exchange Commission on September 25, 2001.

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(11)

Incorporated by reference to Diedrich Coffee's Transition Report on Form 10-Q for the period from January 28, 1999 to June 30, 1999, filed with the Securities and Exchange Commission on August 16, 1999.

(12)

Previously filed as an exhibit to Diedrich Coffee's annual report on Form 10-K for the fiscal year ended June 28, 2000.

(13)

Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on Form 10-Q for the period ended March 7, 2001, filed with the Securities and Exchange Commission on April 23, 2001.

(14)

Previously filed as an exhibit to Diedrich Coffee's Report on Form 10-Q for the period ended September 20, 2000, filed with the Securities and Exchange Commission on November 6, 2000.

(15)

Previously filed as an exhibit to Diedrich Coffee's Registration Statement on Form S-8, filed with the Securities and Exchange Commission on November 21, 2000.

(16)

Previously filed as an exhibit to Diedrich Coffee's Report on Form 10-Q for the period ended December 13, 2000, filed with the Securities and Exchange Commission on January 29, 2001.

(17)

Previously filed as an exhibit to the Definitive Proxy Statement, filed with the Securities and Exchange Commission on April 12, 2001.

(18)

Previously filed as an exhibit to Diedrich Coffee's Report on Form 10-Q for the period ended March 6, 2002, filed with the Securities and Exchange Commission on April 19, 2002.

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DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
A WARNING ABOUT FORWARD-LOOKING STATEMENTS
PART I
PART II
INTRODUCTION
OVERVIEW
RESULTS OF OPERATIONS
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CRITICAL ACCOUNTING POLICIES
NEW ACCOUNTING PRONOUNCEMENTS
OTHER MATTERS
PART III
PART IV
SIGNATURES
CERTIFICATION
DIEDRICH COFFEE, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
DIEDRICH COFFEE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DIEDRICH COFFEE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
DIEDRICH COFFEE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
DIEDRICH COFFEE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
DIEDRICH COFFEE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DIEDRICH COFFEE, INC. AND SUBSIDIARIES SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS
DIEDRICH COFFEE, INC. INDEX TO EXHIBITS

EX-10.29

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EXHIBIT 10.29

EMPLOYMENT AGREEMENT

        THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into by and between DIEDRICH COFFEE, INC., a Delaware corporation (the "Company") and PHILIP G. HIRSCH (the "Executive"), and shall be effective as of September 1, 2002 (the "Effective Date").

RECITALS

        The Company and the Executive desire to enter into this Agreement to establish the terms and conditions of the Executive's employment by the Company as its Chief Executive Officer.

AGREEMENT

        NOW, THEREFORE, in consideration of the foregoing recital, and subject to the conditions and covenants set forth herein, the parties agree as follows:

ARTICLE I
DUTIES AND TERM

        1.01    Duties.    The Company hereby employs the Executive as its Chief Executive Officer and the Executive hereby accepts such employment upon the terms and subject to the conditions set forth in this Agreement. Unless earlier terminated, the term of the Executive's employment under this Agreement shall commence on the Effective Date and shall continue until August 31, 2004 (the "Term"). The Executive shall perform such duties and functions consistent with his role as Chief Executive Officer as may from time to time be assigned to him by the Board of Directors of the Company (the "Board").

        1.02    Other Business.    The Executive agrees that during the course of the Company's business hours throughout the Term, he will devote the whole of his time, attention and efforts to the performance of his duties and obligations hereunder. The Executive shall not, during the Term, without the written approval of the Board first had and obtained in each instance, (a) directly or indirectly, be employed by, an advisor to or an investor in any business enterprise that offers products or services competitive with the Company's or (b) engage in any activity that materially interferes with the Executive's performance of the duties assigned the Executive hereunder, in each case as determined in the sole and absolute discretion of the Board.

ARTICLE II
COMPENSATION AND BENEFITS

        2.01    Salary and Bonus.    For all services to be rendered by the Executive under this Agreement, the Company shall pay, or cause to be paid, to the Executive in cash, payable in accordance with the normal payroll practices of the Company for senior executive officers (including deductions, withholdings and collections as required by law), the following:

        (a)    Annual Base Salary.    An annual base salary (the "Annual Base Salary") equal to $325,000 per year (paid on a bi-weekly basis). During the Term, the Compensation Committee of the Board (the "Compensation Committee") shall review the Executive's Annual Base Salary on or about each anniversary of this Agreement. The Compensation Committee, in its sole and absolute discretion, may adjust the Executive's Annual Base Salary as it deems necessary or appropriate.

        (b)    Annual Incentive Bonus.    A cash bonus (the "Annual Incentive Bonus") of up to fifty percent (50%) of the Executive's Annual Base Salary, as determined by the Compensation Committee in its sole and absolute discretion and subject to the achievement of specified objectives and targets established by the Compensation Committee.

        (c)    Gross Amounts.    The Annual Base Salary and Annual Incentive Bonus set forth in this Article II shall be the gross amounts of such Annual Base Salary and Annual Incentive Bonus. The Executive is responsible for paying any and all taxes due on any amounts received by him as Annual Base Salary and Annual Incentive Bonus, including, but not limited to, any income tax, social security tax, Medicare tax or capital gains tax.

        2.02    Stock Options.    Contemporaneously with the execution of this Agreement, the Company will grant non-qualified options to purchase one hundred twenty thousand (120,000) shares of common stock of the Company under the Company's 2000 Equity Incentive Plan (the "Plan") upon the terms and conditions set forth on the Option Grant Schedule attached hereto, and upon such other terms and conditions contained in the Plan. The Board will review the issuance of additional stock options annually.

        2.03    Executive Benefits.    During the Term of the Executive's employment:

        (a)    Healthcare.    The Company shall provide and pay for the cost of premiums for health, dental and medical insurance coverage for the Executive and the Executive's dependents consistent with the coverage generally made available by the Company to senior executives of the Company and providing benefits at least as favorable to the Executive's current level of coverage.

        (b)    Expenses.    The Executive shall be entitled to receive prompt reimbursement for all reasonable and necessary travel and other business expenses incurred or paid by the Executive in connection with the performance of his services under this Agreement in accordance with the Company's policies for other senior executives of the Company.

        (c)    Vacation.    The Executive shall be entitled to paid vacation leave consistent with the Company's policies for other senior executives of the Company.

        (d)    Additional Future Benefits.    In addition to the benefits set forth above, the Executive shall be entitled to participate in any other policies, programs and benefits that the Company may, in its sole and absolute discretion, make generally available to its other senior executives from time to time, including, but not limited to, health, dental, medical, life and disability insurance, pension and retirement plan, stock plans and other similar programs.

ARTICLE III
TERMINATION OF EMPLOYMENT

        3.01    Termination of Employment.    The Executive's employment under this Agreement is expressly "at will," and either the Executive or the Company may terminate the Executive's employment with the Company at any time and for any reason, with or without cause. Any termination of the Executive's employment is, however, subject to the terms and provisions of Sections 3.02, 3.03 and 3.04 of this Agreement.

        3.02    Death or Disability.

        (a)    Death.    The Executive's employment under this Agreement shall terminate immediately and without notice by the Company upon the death of the Executive.

        (b)    Disability.    The Executive's employment under this Agreement shall terminate in the event that the Executive is unable to perform his duties or responsibilities because of a mental or physical ailment or incapacity for an aggregate of ninety (90) calendar days during any calendar year (whether or not consecutive) (a "Disability"). This Agreement, and the Executive's employment hereunder, shall immediately terminate upon the delivery of a written notice to the Executive of his termination pursuant to this Section.

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        (c)    Compensation.    In the event the Executive is terminated pursuant to Section 3.02(a) or (b), he shall be entitled to receive all unpaid salary up to the termination date and any compensation attributable to accrued, but unpaid vacation days. The Executive shall not be entitled to any other payments, benefits or rights associated with employment.

        3.03    Termination by the Company.

        (a)    Termination by the Company.    At any time prior to the expiration of the Term, the Executive's employment under this Agreement may be terminated by the Company either for cause (as defined below) or without any cause. The term "cause" shall mean the following:

(i)

the willful failure or refusal to carry out the reasonable directions (written or oral) of the Board, which directions are consistent with the Executive's duties set forth hereunder and which the Board believes in good faith to be in the best interests of the Company;



(ii)

the Executive's material breach of his duties regarding Confidential Information contained in Section 4.01 hereof;



(iii)

a willful act by the Executive that constitutes gross negligence in the performance of the Executive's duties under this Agreement and which materially injures the Company;



(iv)

a conviction for a violation of a state or federal criminal law involving the commission of a felony or other crime involving moral turpitude; or



(v)

unethical business practices, including fraud or dishonesty, in connection with the Company's business.

Provided, however, that with respect to events described in Section 3.03(a)(i) above, the Company shall give written notice to the Executive of any such event and the Executive shall have thirty (30) days, beginning on the date of delivery of such written notice, to cure same, or if such event cannot be cured within said thirty (30) day period, the Executive shall commence his efforts to cure the event within the thirty (30) day period and diligently work to cure such event within a reasonable time period. If the Executive, within said thirty (30) day period or within a reasonable time period, as applicable, does not cure the event for which notice has been provided under subparagraph (a)(i) above, then the Executive's employment under this Agreement may be terminated by the Company by delivery to the Executive of written notice of termination, and such termination shall be effective as of the date of delivery of such written notice.

        (b)    Termination For Cause.    If the Company terminates Executive's employment for cause prior to the expiration of the Term, then the Executive shall be entitled to receive all unpaid salary up to the termination date and any compensation attributable to accrued, but unpaid vacation days. The Executive shall not be entitled to any other payments, benefits or rights associated with employment.

        (c)    Termination Without Cause.    If the Company terminates Executive's employment for any reason other than for cause prior to the expiration of the Term, then, in addition to all unpaid salary and unpaid benefits to which the Executive is entitled through the termination date under this Agreement:

(i)

the Executive shall be entitled to receive bi-weekly payments equal to one year of the Executive's then current Annual Base Salary; and



(ii)

if the Executive elects to continue healthcare benefits pursuant to COBRA, the Company shall be obligated to pay the costs of such healthcare insurance continuation until the first anniversary of the date of his termination.

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The payments made to the Executive pursuant to Section 3.03(c)(i) and (ii), if any, shall cease if the Executive accepts full time employment or works full time as an independent contractor after the date of his termination by the Company. With respect to the foregoing, the Board, in good faith, shall determine whether Executive is employed full time or working full time as an independent contractor. Other than as expressly set forth in this Section 3.03(c), the Executive shall not be entitled to any other compensation or benefits as a result of being terminated without cause.

        3.04    Termination by the Executive.

        (a)    Termination by the Executive.    At any time prior to the expiration of the Term of this Agreement, the Executive may terminate his employment with the Company for good reason (defined below) or for any other reason. The term "good reason" shall mean the following:

(i)

a reduction of the Executive's then current Annual Base Salary;



(ii)

a repeated, material breach of the Company's obligations under Section 2 hereof;



(iii)

the termination of, or a material reduction in, any employee benefit or perquisite enjoyed by the Executive (other than as part of an across-the-board reduction applying to all executive officers of the Company that has been approved by the Board);



(iv)

the removal of the Executive from the Executive's position as Chief Executive Officer; or



(v)

the receipt of a directive from the Board to commit an illegal act;

        (b)    Termination Without Good Reason.    If the Executive terminates his employment prior the end of the Term for any reason other than a good reason, then the Executive shall be entitled to receive all unpaid salary up to the termination date and any compensation attributable to accrued, but unpaid vacation days. After the date of his termination, he shall not be entitled to any other payments, benefits or rights associated with employment.

        (c)    Termination For Good Reason.    If the Executive terminates his employment for good reason prior to the end of the Term, then, in addition to all unpaid salary and unpaid benefits to which the Executive is entitled through the termination date under this Agreement, the Executive shall be entitled to receive bi-weekly payments equal to one year of the Executive's then current Annual Base Salary.

ARTICLE IV
CONFIDENTIAL INFORMATION AND NONSOLICITATION

        4.01    Confidential Information.    The Executive acknowledges and agrees that the Company has developed and uses certain proprietary and confidential information, data, processes, business methods, computer software, data bases, customer lists and know-how ("Confidential Information"). The Executive agrees that the Confidential Information is a trade secret of the Company which shall remain the sole property of the Company notwithstanding that the Executive, as an employee of the Company, may participate in the development of the Confidential Information. During the term of this Agreement and at all times thereafter, other than in the performance of his duties hereunder, the Executive shall not disclose any Confidential Information to any person or entity for any reason or purpose whatsoever, nor shall the Executive make use of any Confidential Information for the Executive's own benefit or for the benefit of any other person or entity. Upon termination of this Agreement for any reason, the Executive will promptly surrender to the Company all Confidential Information in the Executive's possession or under the Executive's control, whether prepared by the Executive or by others.

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        4.02    Nonsolicitation.    The Executive agrees that for a period of three (3) years following the termination of the Executive's employment hereunder, the Executive will not directly or indirectly solicit or attempt to solicit any of the employees of or consultants to the Company to leave the Company or to become employees of or consultants to any other person or entity if such employment or consulting would interfere with such employee's or consultant's ability to continue providing services to the Company.

ARTICLE V
MISCELLANEOUS

        5.01    Modification and Waiver of Breach.    This Agreement shall not be altered, amended or modified except by written instrument executed by the Company and the Executive. A waiver of, or failure to insist upon compliance with, any term, covenant, agreement or condition contained in this Agreement shall not be deemed a waiver of any other term, covenant, agreement or condition and any waiver of any other term, covenant, agreement or condition, and any waiver of any default in any such term, covenant, agreement or condition shall not be deemed a waiver of any later default thereof or of any other term, covenant, agreement or condition.

        5.02    Assignment, Successors.    This Agreement may not be assigned by either party hereto without the prior written consent of the other party. This Agreement shall be binding upon and inure to the benefit of the Executive and the Executive's estate and the Company and any assignee of or successor to the Company.

        5.03    Notices.    All notices, requests, demands and other communications under this Agreement must be in writing and shall be deemed given upon personal delivery, facsimile transmission (with confirmation of receipt), delivery by a reputable overnight courier service or five (5) days following deposit in the United States mail (if sent by certified or registered mail, postage prepaid, return receipt requested), in each case duly addressed to the party to whom such notice or communication is to be given as follows:

To the Company:	Diedrich Coffee, Inc. 2144 Michelson Drive Irvine, California 92612 Attention: Chairman of the Board Fax Number: (949) 260-1610
To the Executive:	Philip G. Hirsch [Address]

        Any party may change its address for the purpose of this Section 5.03 by giving the other party written notice of the new address in the manner set forth above.

        5.04    Severability.    If all or any part of this Agreement is declared by any court or governmental authority to be unlawful or invalid, such unlawfulness or invalidity shall not serve to invalidate any portion of this Agreement not declared to be unlawful or invalid. Any paragraph or part of a paragraph so declared to be unlawful or invalid shall, if possible, be construed in a manner which will give effect to the terms of such paragraph or part of a paragraph to the fullest extent possible while remaining lawful and valid.

        5.05    Entire Agreement.    This Agreement, along with the terms of the Company's 2000 Equity Incentive Plan, contains the entire agreement between the Company and the Executive with respect to the subject matters hereof and supersedes all prior or contemporaneous agreements, arrangements or understandings, written or oral, with respect to the subject matters hereof.

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        5.06    Legal Fees; Arbitration.    The parties hereto expressly agree that in the event of any dispute, controversy or claim by any party regarding this Agreement, the prevailing party shall be entitled to reimbursement by the other party to the proceeding of reasonable attorney's fees, expenses and costs incurred by the prevailing party. Any controversy, dispute or claim arising out of, in connection with, or in relation to the interpretation, performance or breach of this Agreement or otherwise arising out of the execution hereof, including any claim based on contract, tort or statute, shall be resolved, at the request of any party, by submission to binding arbitration at the Orange County, California offices of Judicial Arbitration & Mediation Services, Inc. ("JAMS"), and any judgment or award rendered by JAMS shall be final, binding and unappealable, and judgment may be entered by any state or federal court having jurisdiction thereof Any party can initiate arbitration by sending written notice of intention to arbitrate (the "Demand") by registered or certified mail to all parties and to JAMS. The Demand shall contain a description of the dispute, the amount involved, and the remedy sought. The arbitrator shall be a retired or former judge agreed to between the parties from the JAMS' panel. If the parties are unable to agree, JAMS shall provide a list of three available judges and each party may strike one. The remaining judge shall serve as the arbitrator. Each party hereto intends that the provisions to arbitrate set forth herein be valid, enforceable and irrevocable. In his award, the arbitrator shall allocate, in his discretion, among the parties to the arbitration all costs of the arbitration, including the fees of the arbitrator and reasonable attorneys' fees, costs and expert witness expenses of the parties. The parties hereto agree to comply with any award made in any such arbitration proceedings that has become final and agree to the entry of a judgment in any jurisdiction upon any award rendered in such proceeding becoming final.

        5.07    Governing Law.    This Agreement shall be governed by and construed in accordance with the laws of the State of California, without regard to its choice of law principles.

        5.08    Counterparts.    This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

        IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written.

THE COMPANY:
DIEDRICH COFFEE, INC.
By:	/s/  PAUL C. HEESCHEN Paul C. Heeschen Chairman of the Board of Directors
THE EXECUTIVE:
PHILIP G. HIRSCH
/s/  PHILIP G. HIRSCH Philip G. Hirsch

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OPTION GRANT SCHEDULE

Date of Grant:	The date of grant shall be the date that the Board approves the grant of the Options (the "Grant Date").
Number of Option Shares:	120,000 non-qualified option shares (the "Options").
Exercise Price:	The exercise price shall be the average of the last reported price of the Company's common stock on the Nasdaq National Market on the five trading days prior to the Grant Date.
Vesting Schedule:	(a) 60,000 options shall vest on August 31, 2003; and (b) 60,000 options shall vest on August 31, 2004.
Expiration Date:	(a) If the Company terminates Executive "for cause," then all of his unexercised Options (whether or not vested) will expire and become unexercisable as of the date of such termination.
	(b) If Executive's employment ceases for any other reason, (including, but not limited to, termination by the Company without cause, Executive's resignation for any reason, expiration of the Term, death or disability) then: (i) all Options that have not become exercisable as of the date of termination or resignation will immediately terminate and become unexercisable; and (ii) all Options that have become exercisable will terminate and become unexercisable on the two year anniversary of the date that Executive ceased to be employed by the Company.
Additional Terms:	The Options shall be subject to the terms and conditions of the Plan.

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EXHIBIT 10.29

EMPLOYMENT AGREEMENT
RECITALS
AGREEMENT
ARTICLE I DUTIES AND TERM
ARTICLE II COMPENSATION AND BENEFITS
ARTICLE III TERMINATION OF EMPLOYMENT
ARTICLE IV CONFIDENTIAL INFORMATION AND NONSOLICITATION
ARTICLE V MISCELLANEOUS
OPTION GRANT SCHEDULE

EX-10.30

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EXHIBIT 10.30

CREDIT AGREEMENT

        THIS CREDIT AGREEMENT (the "Agreement") is made and dated as of the 3rd day of September, 2002, by and between BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK (the "Lender"), and DIEDRICH COFFEE, INC., a Delaware corporation (the "Company").

RECITALS

        A.    The Company has requested that the Lender: (1) extend new credit facilities to the Company in the forms of a equipment acquisition facility, a working capital line of credit, a letter of credit facility, and facilities to finance certain expansion expenditures of the Company, and (2) refinance the term loan facility described on Annex 1 attached hereto (the "Existing Term Loan Facility").

        B.    The Lender has agreed to such requests on the terms and subject to the conditions set forth herein and the parties hereto desire to enter into this Agreement to evidence such credit facilities.

        NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows:

AGREEMENT

        1.    Keurig Equipment Acquisition Line.

        1(a)    Credit Limit.    Subject to the terms and conditions set forth herein, from and after the Effective Date (as that term and capitalized terms used herein and not otherwise defined herein are defined in Paragraph 16 below), the Lender agrees that it shall from time to time to but not including the Equipment Acquisition Line Conversion Date make loans (each, an "Equipment Acquisition Loan") to the Company in an aggregate amount not to exceed at any one time outstanding the Equipment Acquisition Line Credit Limit. Principal amounts prepaid hereunder prior to the Equipment Acquisition Line Conversion Date may be reborrowed on the terms and subject to the conditions set forth in Paragraph 10(b) below, it being expressly acknowledged and agreed that the credit facility provided under this Paragraph 1 is a revolving credit facility.

        1(b)    Principal Repayment; Conversion to Term Loan.    The Company shall pay the principal amount of each Equipment Acquisition Term Loan on the Equipment Acquisition Line Conversion Date; provided, however, that if but only if on the Equipment Acquisition Line Conversion Date there does not exist an Event of Default or Potential Default, the outstanding principal balance of all Equipment Acquisition Loans (or such portion thereof as the Company shall elect) shall be converted into a term loan (the "Equipment Acquisition Line Term-Out Loan"). The principal amount of the Equipment Acquisition Line Term-Out Loan shall be payable in thirty five (35) consecutive equal monthly installments, said installments to be payable on the last Business Day of each calendar month, commencing on September 30, 2003, and one final installment in an amount necessary to repay the outstanding principal balance of the Equipment Acquisition Line Term-Out Loan in full on August 31, 2006.

        1(c)    Payment of Interest.    Interest on Equipment Acquisition Loans and, following the Equipment Acquisition Line Conversion Date, the Equipment Acquisition Line Term-Out Loan, shall be payable at the rates and at the times provided in Paragraphs 7(a) and 7(b) below.

        1(d)    Use of Proceeds.    The proceeds of the Equipment Acquisition Loans shall be used solely for the purchase of the Keurig Equipment.

        2.    Fiscal Year 2003 Expansion Line.

        2(a)    Credit Limit.    Subject to the terms and conditions set forth herein, from and after the Effective Date, the Lender agrees that it shall from time to time to but not including the FY 2003 Expansion Line Conversion Date make loans (each, a "FY 2003 Expansion Line Loan") to the Company in an aggregate amount not to exceed at any one time outstanding the FY 2003 Expansion Line Credit Limit. Principal amounts prepaid hereunder prior to the FY 2003 Expansion Line Conversion Date may be reborrowed on the terms and subject to the conditions set forth in Paragraph 10(b) below, it being expressly acknowledged and agreed that the credit facility provided under this Paragraph 2 is a revolving credit facility.

        2(b)    Principal Repayment; Conversion to Term Loan.    The Company shall pay the principal amount of each FY 2003 Expansion Line Loan on the FY 2003 Expansion Line Conversion Date; provided, however, that if but only if on the FY 2003 Expansion Line Conversion Date there does not exist an Event of Default or Potential Default, the outstanding principal balance of all FY 2003 Expansion Line Loans (or such portion thereof as the Company shall elect) shall be converted into a term loan (the "FY 2003 Expansion Line Term-Out Loan"). The principal amount of the FY 2003 Expansion Line Term-Out Loan shall be payable in thirty five (35) consecutive equal monthly installments, said installments to be payable on the last Business Day of each calendar month, commencing on July 31, 2003, and one final installment in an amount necessary to repay the outstanding principal balance of the FY 2003 Expansion Line Term-Out Loan in full on June 30, 2006.

        2(c)    Payment of Interest.    Interest on FY 2003 Expansion Line Loans and, following the FY 2003 Expansion Line Conversion Date, the FY 2003 Expansion Line Term-Out Loan, shall be payable at the rates and at the times provided in Paragraphs 7(a) and 7(b) below.

        2(d)    Use of Proceeds.    The proceeds of the FY 2003 Expansion Line Loans shall be used solely to finance Expansion Expenditures of the Company.

        3.    Fiscal Year 2004 Expansion Line.

        3(a)    Credit Limit.    Subject to the terms and conditions set forth herein, from and after the FY 2004 Expansion Line Effective Date, the Lender agrees that it shall from time to time to but not including the FY 2004 Expansion Line Conversion Date make loans (each, a "FY 2004 Expansion Line Loan") to the Company in an aggregate amount not to exceed at any one time outstanding the FY 2004 Expansion Line Credit Limit. Principal amounts prepaid hereunder prior to the FY 2004 Expansion Line Conversion Date may be reborrowed on the terms and subject to the conditions set forth in Paragraph 10(b) below, it being expressly acknowledged and agreed that the credit facility provided under this Paragraph 3 is a revolving credit facility.

        3(b)    Principal Repayment; Conversion to Term Loan.    The Company shall pay the principal amount of each FY 2004 Expansion Line Loan on the FY 2004 Expansion Line Conversion Date; provided, however, that if but only if on the FY 2004 Expansion Line Conversion Date there does not exist an Event of Default or Potential Default, the outstanding principal balance of all FY 2004 Expansion Line Loans (or such portion thereof as the Company shall elect) shall be converted into a term loan (the "FY 2004 Expansion Line Term-Out Loan"). The principal amount of the FY 2004 Expansion Line Term-Out Loan shall be payable in thirty five (35) consecutive equal monthly installments, said installments to be payable on the last Business Day of each calendar month, commencing on July 31, 2004, and one final installment in an amount necessary to repay the outstanding principal balance of the FY 2004 Expansion Line Term-Out Loan in full on June 30, 2007.

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        3(c)    Payment of Interest.    Interest on FY 2004 Expansion Line Loans and, following the FY 2004 Expansion Line Conversion Date, the FY 2004 Expansion Line Term-Out Loan, shall be payable at the rates and at the times provided in Paragraphs 7(a) and 7(b) below.

        3(d)    Use of Proceeds.    The proceeds of the FY 2004 Expansion Line Loans shall be used solely to finance Expansion Expenditures of the Company.

        4.    Working Capital Facility

        4(a)    Credit Limit.    Subject to the terms and conditions set forth herein, from and after the Effective Date, the Lender agrees that it shall from time to time to but not including the Working Capital Facility Maturity Date make loans (each, a "Working Capital Loan") to the Company in an aggregate amount not to exceed at any one time outstanding the lesser of: (i) $500,000.00, and (ii) $675,000.00 minus the dollar amount of all Outstanding Letters of Credit and unrepaid L/C Drawings as of such date (the "Working Capital Facility Credit Limit"). Principal amounts prepaid hereunder prior to the Working Capital Facility Maturity Date may be reborrowed on the terms and subject to the conditions set forth in Paragraph 10(b) below, it being expressly acknowledged and agreed that the credit facility provided under this Paragraph 4 is a revolving credit facility. The Company hereby acknowledges and agrees that the Company may only request, and the Lender is only obligated to fund (subject to all other provisions contained in this Agreement), Working Capital Loans during the First Quarter and Fourth Quarter of any Fiscal Year.

        4(b)    Principal Repayment; Working Capital to Term Loan.    The Company shall pay the principal amount of each Working Capital Loan on the Working Capital Facility Maturity Date.

        4(c)    Payment of Interest.    Interest on Working Capital Loans shall be payable at the rates and at the times provided in Paragraphs 7(a) and 7(b) below.

        4(d)    Use of Proceeds.    The proceeds of Working Capital Loans shall be used for working capital purposes.

        5.    Letter of Credit Facility.

        5(a)    Letter of Credit Sublimit.    On the terms and subject to the conditions set forth herein, the Lender shall from time to time from and after the Effective Date, issue standby letters of credit (each a "Letter of Credit" and, collectively, the "Letters of Credit") for the account of the Company; provided, however that in no event shall the Lender issue any Letter of Credit hereunder if after giving effect to such issuance:

        (1)  The aggregate dollar amount of Outstanding Letters of Credit and unrepaid L/C Drawings would exceed the L/C Facility Sublimit; or

        (2)  The aggregate dollar amount of all Outstanding Letters of Credit and unrepaid L/C Drawings plus the aggregate amount of all Working Capital Loans outstanding would exceed $675,000.00.

        5(b)    Issuance of Letters of Credit.    Each Letter of Credit, and any amendment, renewal or extension thereof, shall be requested by the Company at least thirty (30) Business Days prior to the proposed issuance, amendment, renewal or extension date by delivery to the Lender of a duly executed Letter of Credit Application, accompanied by all other L/C Documents which the Lender may require as a condition to the requested action. No Letter of Credit shall have a stated expiration date (or provide for the extension of such stated expiration date or the issuance of any replacement therefor) later than thirty (30) days past the regularly scheduled Working Capital Facility Maturity Date.

        5(c)    Repayment of L/C Drawings.    Each L/C Drawing shall be payable in full by the Company on the date of such L/C Drawing.

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        5(d)    Absolute Obligation to Repay.    The Company's obligation to repay L/C Drawings shall be absolute, irrevocable and unconditional under any and all circumstances whatsoever and irrespective of any set-off, counterclaim or defense to payment which the Company may have or have had, against any Lender or any other Person, including, without limitation, any set-off, counterclaim or defense based upon or arising out of:

        (1)  Any lack of validity or enforceability of this Agreement or any of the other Loan Documents;

        (2)  Any amendment or waiver of or any consent to departure from the terms of any Letter of Credit;

        (3)  The existence of any claim, setoff, defense or other right which the Company or any other Person may have at any time against any beneficiary or any transferee of any Letter of Credit (or any Person for whom any such beneficiary or any such transferee may be acting);

        (4)  Any allegation that any demand, statement or any other document presented under any Letter of Credit is forged, fraudulent, invalid or insufficient in any respect, or that any statement therein is untrue or inaccurate in any respect whatsoever or that variations in punctuation, capitalization, spelling or format were contained in the drafts or any statements presented in connection with any L/C Drawing;

        (5)  Any payment by the Lender under any Letter of Credit against presentation of a draft or certificate that does not strictly comply with the terms of such Letter of Credit, or any payment made by the Lender under any Letter of Credit to any Person purporting to be a trustee in bankruptcy, debtor-in-possession, assignee for the benefit of creditors, liquidator, receiver or other representative of or successor to any beneficiary or any transferee of any Letter of Credit, including any arising in connection with any insolvency proceeding;

        (6)  Any exchange, release or non-perfection of any Collateral; or

        (7)  Any other circumstance or happening whatsoever, whether or not similar to any of the foregoing, including any other circumstance that might otherwise constitute a defense available to, or a discharge of the Company.

Nothing contained herein shall constitute a waiver of any rights of the Company against the Lender arising out of the gross negligence or willful misconduct of the Lender in connection with any Letter of Credit issued hereunder; provided, however, that the exercise of such rights is subject to and conditioned upon the prior payment in full of all Obligations, including, without limitation, unrepaid L/C Drawings, and termination of the credit facility evidenced hereby.

        5(e)    Uniform Customs and Practice.    The Uniform Customs and Practice for Documentary Credits as published by the International Chamber of Commerce most recently at the time of issuance of any Letter of Credit shall (unless otherwise expressly provided in such Letter of Credit) apply to such Letter of Credit.

        5(f)    Relationship to Letter of Credit Applications.    In the event of any inconsistency between the terms and provisions of this Agreement and the terms and provisions of the Letter of Credit Applications, the terms and provisions of this Agreement shall supersede and govern.

        6.    Replacement Term Loan Facility.

        6(a)    Credit Limit; Repayment of Principal.    On the terms and subject to the conditions set forth herein, the Lender agrees that on the Effective Date it shall advance, in a single disbursement, a term loan in a principal amount not to exceed $3,000,000.00 (the "Replacement Term Loan"). Following disbursement, amounts repaid on account of the Replacement Term Loan may not be reborrowed. The principal amount of the Replacement Term Loan shall be payable

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monthly, on the last Business Day of each calendar month, commencing September 30, 2002, in twenty nine (29) consecutive equal monthly installments of $100,000.00 and one final installment in the amount necessary to repay the Replacement Term Loan in full on March 31, 2005.

        6(b)    Payment of Interest.    Interest on the Replacement Term Loan and portions thereof outstanding shall be payable at the rates and times provided in Paragraphs 7(a) and 7(b) below.

        6(c)    Use of Proceeds.    The proceeds of the Replacement Term Loan shall be utilized to pay all amounts outstanding under the Existing Term Loan Facility in full.

        7.    Pricing Provisions.

        7(a)    Applicable Interest Rates.    The Company shall pay interest on Loans outstanding from the date disbursed to but not including the date of payment, at a rate per annum equal to, at the option of and as selected by the Company from time to time and subject to provisions set forth in this Paragraph 7:

        (1)  The floating Reference Rate during the applicable computation period plus three quarters of one percent (0.75%); or

        (2)  The LIBOR Rate for the selected Interest Period plus two and one-half percent (2.50%).

        7(b)    Interest Billing and Payment Requirements.    Interest accruing on Loans shall be payable monthly, in arrears, for each calendar month on the last Business Day of such calendar month in the amount set forth in an interest billing for such Loans delivered to the Company by the Lender (which delivery may be telephonic).

        7(c)    Requests for and Funding of Loans.

        (1)  Subject to the timing provisions relating to the funding of or conversion into LIBOR Rate Loans provided in Paragraph 7(d) below, if the Company desires to borrow an Equipment Acquisition Loan, a FY 2003 Expansion Line Loan, a Working Capital Loan, or following the FY 2004 Expansion Line Effective Date, a FY 2004 Expansion Line Loan hereunder, the Company shall deliver a Loan Request therefor to the Lender no later than: (i) in the case of a Loan to be initially funded as a LIBOR Rate Loan, 11:00 a.m. (Los Angeles time) on the proposed funding date, and (ii) in the case of a Loan to be initially funded as a Reference Rate Loan, 2:30 p.m. (Los Angeles time) on the proposed funding date.

        (2)  The principal amount of each LIBOR Rate Loan (including any Reference Rate Loan which is converted into a LIBOR Rate Loan) shall be in the minimum amount of $100,000.00.

        (3)  All Loan Requests shall be irrevocable and shall be delivered in writing (which may be by facsimile transmission), or telephonically to be promptly confirmed in writing (which may be by facsimile transmission).

        (4)  Subject to the conditions set forth in Paragraph 10(b) below, the Lender shall make available each requested Loan by crediting the amount thereof, in immediately available same day funds, to the Funding Account at the opening of business of the Lender at its Contact Office on the first Business Day immediately following the receipt of such Loan Request.

        7(d)    Conversion and Continuation Options.

        (1)  The Company may elect from time to time to convert portions of outstanding LIBOR Rate Loans to Reference Rate Loans or to convert portions of outstanding Reference Rate Loans to LIBOR Rate Loans by giving the Lender irrevocable notice of such election:

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(i) in the case of LIBOR Rate Loans being converted into Reference Rate Loans, no later than 2:30 p.m. (Los Angeles time) on the date of the proposed conversion, and (ii) in the case of Reference Rate Loans being converted into LIBOR Rate Loans, no later than 11:00 a.m. (Los Angeles time) on the date of the proposed conversion. Any conversion of LIBOR Rate Loans to Reference Rate Loans may only be made on the last day of the applicable Interest Period. No Reference Rate Loan may be converted into a LIBOR Rate Loan if an Event of Default or Potential Default has occurred and is continuing at the requested conversion date.

        (2)  The Company may elect from time to time to have outstanding LIBOR Rate Loans continued as LIBOR Rate Loans upon the expiration of the Interest Period applicable thereto by giving the Lender irrevocable notice of such election no later than 11:00 a.m. (Los Angeles time) on the last day of such Interest Period; provided, however, that no LIBOR Rate Loan may be continued as such when any Event of Default or Potential Default has occurred and is continuing, but shall be automatically converted to a Reference Rate Loan on the last day of the Interest Period applicable thereto. If the Company shall fail to give notice of its election to continue a LIBOR Rate Loan as a LIBOR Rate Loan as provided above, the Company shall be deemed to have elected to convert such LIBOR Rate Loan to a Reference Rate Loan on the last day of the applicable Interest Period.

        (3)  Each request for the conversion into or continuation of a LIBOR Rate Loan shall be evidenced by the timely delivery by the Company to the Lender of a duly executed Loan Request (which delivery may be by facsimile transmission) or, but only with the prior agreement of the Lender, telephonically.

        7(e)    Illegality.    Notwithstanding any other provisions herein, if any law, regulation, treaty or directive or any change therein or in the interpretation (whether by the Lender, in its reasonable judgment, or by any Governmental Authority) or application thereof, shall make it unlawful for the Lender to make or maintain LIBOR Rate Loans as contemplated by this Agreement: (1) the commitment of the Lender hereunder to make or to continue LIBOR Rate Loans or to convert Reference Rate Loans to LIBOR Rate Loans shall forthwith be canceled and (2) Loans then outstanding as LIBOR Rate Loans, if any, shall be converted automatically to Reference Rate Loans at the end of their respective Interest Periods or within such earlier period as may be required by law. In the event of a conversion of any LIBOR Rate Loan prior to the end of its applicable Interest Period the Company hereby agrees promptly to pay the Lender, upon demand, the amounts required pursuant to Paragraph 7(h) below, it being agreed and understood that such conversion shall constitute a prepayment for all purposes hereof. The provisions hereof shall survive the termination of this Agreement and payment of the outstanding Loans and all other Obligations.

        7(f)    Requirements of Law; Increased Costs.    In the event that any applicable law, order, regulation, treaty or directive issued by any central bank or other governmental authority, agency or instrumentality or in the governmental or judicial interpretation or application thereof, or compliance by the Lender with any request or directive (whether or not having the force of law) issued by any central bank or other governmental authority, agency or instrumentality:

        (1)  Does or shall subject the Lender to any tax of any kind whatsoever with respect to this Agreement or any Loans made hereunder, or change the basis of taxation of payments to the Lender of principal, fee, interest or any other amount payable hereunder (except for change in the rate of tax on the overall net income of the Lender);

        (2)  Does or shall impose, modify or hold applicable any reserve, capital requirement, special deposit, compulsory loan or similar requirements against assets held by, or deposits or other liabilities in or for the account of, advances or loans by, or other credit extended by, or

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any other acquisition of funds by, any office of the Lender which are not otherwise included in the determination of interest payable on the Obligations; or

        (3)  Does or shall impose on the Lender any other condition;

and the result of any of the foregoing is to increase the cost to the Lender of making, renewing or maintaining any Loan or to reduce any amount receivable in respect thereof or the rate of return on the capital of the Lender or any corporation controlling the Lender, then, in any such case, the Company shall promptly pay to the Lender, upon its written notice and demand made through the Lender, any additional amounts necessary to compensate the Lender for such additional cost or reduced amounts receivable or rate of return as determined by the Lender with respect to this Agreement or Loans made hereunder. If the Lender becomes entitled to claim any additional amounts pursuant to this Paragraph 7(f), it shall promptly notify the Company of the event by reason of which it has become so entitled. A certificate as to any additional amounts payable pursuant to the foregoing sentence containing the calculation thereof in reasonable detail submitted by the Lender to the Company shall be conclusive in the absence of manifest error. The provisions hereof shall survive the termination of this Agreement and payment of the outstanding Loans and all other Obligations.

        7(g)    Funding.    The Lender shall be entitled to fund all or any portion of the Loans in any manner it may determine in its sole discretion, including, without limitation, in the Grand Cayman inter-bank market, the London inter-bank market and within the United States.

        7(h) Prepayment Premium. In addition to all other payment obligations hereunder, in the event: (1) a LIBOR Rate Loan is prepaid prior to the last day of the applicable Interest Period, whether following the occurrence of an Event of Default or otherwise, or (2) the Company shall fail to continue or to make a conversion to a LIBOR Rate Loan after the Company has given notice thereof as provided in Paragraph 7(d) above, then the Company shall immediately pay to the Lender an additional premium sum compensating the Lender for losses, costs and expenses incurred by the Lender in connection with such prepayment or such failure to borrow, continue or convert. If the Lender becomes entitled to claim any additional amounts pursuant to this Paragraph 7(h), it shall promptly notify the Company of the event by reason of which it has become so entitled. A certificate as to any additional amounts payable pursuant to the foregoing sentence containing the calculation thereof in reasonable detail submitted by the Lender to the Company shall be conclusive in the absence of manifest error. Determination of amounts payable under this Paragraph 7(h) in connection with any LIBOR Rate Loan shall be calculated as though the Lender funded such LIBOR Rate Loan through the purchase of a deposit of the type and maturity corresponding to the deposit used as a reference in determining the interest rate applicable to such LIBOR Rate Loan, whether in fact that is the case or not. The provisions of this Paragraph 7(h) shall survive the termination of this Agreement and the payment of all Loans and all other Obligations.

        7(i)    Default Interest.    Following the occurrence and during the continuance of an Event of Default, all Obligations outstanding shall, unless such requirement is waived in writing by the Lender, bear interest at a default rate which is three percent (3%) in excess of the rate or rates otherwise payable under this Agreement, in either case until the earlier of (1) the date on which such Event of Default shall be cured or waived pursuant to the terms of this Agreement, and (2) the date on which all Obligations (including, without limitation, all accrued and unpaid default interest) shall be paid in full, said default interest to be payable by the Company upon demand of the Lender.

        7(j)    Fees.    The Company shall pay to the Lender on or before the Effective Date, a one time, non-refundable facility fee in the amount of $25,000.00.

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        7(k)    Letter of Credit Fees.    The Company shall pay to the Lender:

        (1)  On or before the date of issuance by the Lender of a Letter of Credit, a non-refundable issuance fee in an amount equal to the greater of: (i) $410.00, or (ii) the per annum rate of one percent (1.00%) multiplied by the face amount of such Letter of Credit for the effective term of such Letter of Credit;

        (2)  From time to time upon demand by the Lender, such additional fees and charges, including, without limitation, renewal, increase, extension and transfer fees and miscellaneous charges relating to the Letters of Credit as the Lender customarily charges with respect to similar letters of credit issued by it; and

        (3)  All costs incurred and payments made by the Lender by reason of any further assessment, reserve, deposit or similar requirement or any surcharge, tax or fee imposed upon it or as a result of its compliance with any directive or requirement of any regulatory authority pertaining or relating to any Letter of Credit.

        7(l)    Computations.    All computations of interest and fees payable hereunder shall be based upon a year of three hundred and sixty (360) days for the actual number of days elapsed.

        8.    Miscellaneous Provisions.

        8(a)    Open Book Account.    The obligation of the Company to repay the Loans shall be evidenced by notations on the books and records of the Lender. If requested by the Company from time to time, the Lender shall deliver a statement of account to the Company setting forth the unpaid balance of Loans outstanding hereunder. Such statement shall (absent clerical error) be deemed conclusively correct and accepted by the Company unless the Company notifies the Lender to the contrary within ten (10) Business Days following delivery of such statement. Upon any advance of any Equipment Acquisition Loan, FY 2003 Expansion Line Loan, FY 2004 Expansion Line Loan, or Working Capital Loan or payment or prepayment of any Loan, the Lender is hereby authorized to record the date and amount of each such advance made by the Lender, or the date and amount of each such payment or prepayment of principal of the Loans on its books (or by any analogous method the Lender may elect consistent with its customary practices) and any such recordation shall constitute prima facie evidence of the accuracy of the information so recorded absent manifest error. The failure of the Lender to make any such notation shall not affect in any manner or to any extent the Company's Obligations hereunder.

        8(b)    Nature and Place of Payments.    All payments made on account of the Obligations shall be made by the Company to the Lender without setoff or counterclaim, in lawful money of the United States of America in immediately available same day funds, free and clear of and without deduction for any taxes, fees or other charges of any nature whatsoever imposed by any taxing authority and must be received by the Lender by 2:30 p.m. (Los Angeles time) on the day of payment, it being expressly agreed and understood that if a payment is received after the applicable deadline by the Lender, such payment will be considered to have been made by the Company on the next succeeding Business Day and interest thereon shall be payable by the Company at then applicable rate during such extension. All payments on account of the Obligations shall be made to the Lender through the Contact Office. If any payment required to be made by the Company hereunder becomes due and payable on a day other than a Business Day, the due date thereof shall be extended to the next succeeding Business Day and interest thereon shall be payable at then applicable rate during such extension. The Lender is hereby irrevocably authorized by the Company, without prior notice to the Company, but is not obligated, to debit any general operating accounts of the Company maintained with the Lender for the full amount of monthly and periodic interest billings, fees and other Obligations payable hereunder which the Lender is authorized to collect; provided, however, that the failure of the Lender to so

8

debit such accounts shall not in any manner or to any extent affect the obligation of the Company to pay such Obligations as provided herein and in the other Loan Documents.

        8(c)    Prepayments.

        (1)  The Company may prepay Loans (other than LIBOR Rate Loans) in whole or in part at any time, it being agreed and understood that LIBOR Rate Loans outstanding may only be repaid at the end of their respective Interest Periods.

        (2)  All prepayments on the Term Loans shall be applied against principal installments thereon in inverse order of maturity.

        (3)  In the event notwithstanding the prohibition set forth in subparagraph (1) above a LIBOR Rate Loan is prepaid prior to the end of its Interest Period, the Company shall concurrently pay to the Lender all amounts, if any, required pursuant to Paragraph 7(h) above.

        (4)  If at any time the Company shall fail to maintain Liquid Assets in an aggregate dollar amount equal to or greater than $800,000.00 in accounts maintained with the Lender, upon notice from the Lender (which notice may be telephonic), the Company shall immediately prepay the principal amount and all accrued but unpaid interest with respect to all Working Capital Loans outstanding as of such date, together with all amounts, if any, required pursuant to Paragraph 7(h) above.

        8(d)    Allocation of Payments Received Following Default.    Following the occurrence of an Event of Default and acceleration of the Obligations, all amounts received by the Lender on account of the Obligations shall be applied by the Lender as follows:

        (1)  First, to the payment of reasonable expenses incurred by the Lender in connection with the enforcement of its rights under the Loan Documents, including, without limitation, all costs and expenses of collection, attorneys' fees, court costs and foreclosure expenses;

        (2)  Then, to the Lender until all outstanding Loans, interest accrued thereon, and unrepaid L/C Drawings have been paid in full, said amounts to be allocated first to interest and then, but only after all accrued interest has been paid in full, to principal;

        (3)  Then, to the Lender on account of all other outstanding Obligations until the same have been paid and performed in full;

        (4)  Then, and if but only if there remain Outstanding any Letters of Credit, to the Lender to hold as cash collateral for the obligation of the Company to reimburse any future L/C Drawings as the same may occur, until there are no further Outstanding Letters of Credit; and

        (5)  Then, to such Persons as may be legally entitled thereto.

        8(e)    Telephonic/Facsimile Communications.    Any agreement of the Lender herein to receive certain notices by telephone or facsimile is solely for the convenience and at the request of the Company. The Lender shall be entitled to rely on the authority of any Person reasonably believed by the Lender to be an authorized Person and the Lender shall not have any liability to the Company or other Person on account of any action taken or not taken by the Lender in reasonable reliance upon such telephonic or facsimile notice. The obligation of the Company to repay the Loans shall not be affected in any way or to any extent by any failure by the Lender to receive written confirmation of any telephonic or facsimile notice or the receipt by the Lender of a confirmation which is at variance with the terms understood by the Lender to be contained in the telephonic or facsimile notice.

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        9.    Collateral and Credit Support Documents.

        9(a)    Collateral Security.    As collateral security for the Obligations, on or before the Effective Date the Company shall execute and deliver to the Lender each of the following: (1) a security agreement in the form of that attached hereto as Exhibit A (the "Security Agreement") pursuant to which the Company shall grant to the Lender a security interest in the Collateral, which security interest shall be first priority and perfected to the extent required by the Lender, (2) if required by the Lender, supplemental security agreements in recordable form for filing with the U.S. Patent and Trademark Office and Copyright Office covering all federally registered patents, trademarks and copyrights of the Company (the "Supplemental PTO Agreements"), and (3) such authorizations to file UCC financing statements as the Lender shall request.

        9(b)    Guarantor Credit Support.    As additional credit support for the Obligations, on or before the Effective Date, the Company shall cause each of the Initial Guarantors to execute and deliver to the Lender each of the following: (1) a credit guaranty in the of that attached hereto as Exhibit B (each, a "Guaranty") pursuant to which such Guarantor shall guarantee the Obligations on the terms and conditions set forth therein, (2) a security agreement in the form of that attached hereto as Exhibit C (each, a "Guarantor Security Agreement") pursuant to which such Guarantor shall grant to the Lender a security interest in the collateral described therein, which security interest shall be first priority and perfected to the extent required by the Lender, (3) if required by the Lender, Supplemental PTO Agreements, and (4) such authorizations to file UCC financing statements as the Lender shall request.

        9(c)    Additional Guarantor Credit Support.    As additional credit support for the Obligations, the Company shall cause each Subsidiary of the Company formed or acquired after the Effective Date to execute and deliver to the Lender, on the date of the formation or acquisition of such Subsidiary, each of the following: (1) a Guaranty, (2) a Guarantor Security Agreement, (3) if required by the Lender, Supplemental PTO Agreements, and (4) such authorizations to file UCC financing statements as the Lender shall request.

        9(d)    Additional Documents.    The Company agrees to execute and deliver and to cause to be executed and delivered to the Lender on or before the Effective Date and from time to time thereafter, such additional documents, instruments and agreements, including, without limitation, notices to and consents of third parties, as are in the Lender's judgment necessary or desirable to obtain for the Lender the benefit of the Collateral and the Loan Documents.

        10.    Conditions Precedent.

        10(a)    Effective Date.    As conditions precedent to the effectiveness of this Agreement:

        (1)  The Company shall have delivered or shall have had delivered to the Lender, in form and substance satisfactory to the Lender and its counsel and duly executed and certified as required, each of the following:

        (i)    This Agreement;

        (ii)  The Security Agreement;

        (iii)  From each of the Initial Guarantors, a Guaranty;

        (iv)  From each of the Initial Guarantors, a Guarantor Security Agreement;

        (v)  Any Supplemental PTO Agreements requested by the Lender;

        (vi)  All UCC financing statements and other documents, instruments and agreements deemed necessary or appropriate by the Lender to confirm, obtain and maintain in favor of the Lender a first priority, perfected security interest in and lien upon the Collateral,

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accompanied by such evidence as the Lender may reasonably require that after the filing of such UCC financing statements and other documents, as applicable, the Lender will have a first priority, perfected security interest in the Collateral to the extent required by the Lender;

        (vii) A certificate of the Secretary or an Assistant Secretary of the Company certifying the names and true signatures of the officers of the Company authorized to execute and deliver the Loan Documents to which the Company is party and attaching: (x) a copy of the Articles of Incorporation of the Company and any amendments thereto, certified by the Secretary of State of the State of California, (y) a copy of the Bylaws of the Company and any amendments thereto, certified as being accurate and complete, and (z) copies of resolutions of the Board of Directors of the Company approving the execution and delivery of the Loan Documents to which the Company is party, the performance of its obligations thereunder and the consummation of the transactions contemplated by the Loan Documents;

        (viii)  A certificate of the Secretary or an Assistant Secretary of each of the Initial Guarantors certifying the names and true signatures of the officers of such Guarantor authorized to execute and deliver the Loan Documents to which such Guarantor is party and attaching: (x) a copy of the Articles of Incorporation of such Guarantor and any amendments thereto, certified by the Secretary of State of the state in which such Guarantor is organized, (y) a copy of the Bylaws of such Guarantor and any amendments thereto, certified as being accurate and complete, and (z) copies of resolutions of the Board of Directors of such Guarantor approving the execution and delivery of the Loan Documents to which such Guarantor is party, the performance of its obligations thereunder and the consummation of the transactions contemplated by the Loan Documents;

        (ix)  Evidence of good standing for the Company and each of the Initial Guarantors in the state in which such Person is organized;

        (x)  An opinion of counsel to the Company and the Initial Guarantors in form and substance satisfactory to the Lender;

        (xi)  Such landlord estoppel certificates and consents to removal of personal property, as the Lender may reasonably require, all in form and substance satisfactory to the Lender;

        (xii) Evidence satisfactory to the Lender that upon the funding of the Replacement Term Loan, all Indebtedness of the Company outstanding under the Existing Term Loan Facility shall have been paid in full, the credit facilities evidenced thereby terminated and any and all Liens securing the Indebtedness thereunder terminated or assigned to the Lender, as required by the Lender; and

        (xiii)  Evidence satisfactory to the Lender that any fees required to be paid pursuant to Paragraph 7(j) above and all other Indebtedness, fees, costs and expenses payable by the Company hereunder on or prior to the Effective Date shall have been paid or will be timely paid; and

        (2)  All acts and conditions (including, without limitation, the obtaining of any necessary regulatory approvals and the making of any required filings, recordings or registrations) required to be done and performed and to have happened precedent to the execution, delivery and performance of the Loan Documents and to constitute the same legal, valid and binding obligations, enforceable in accordance with their respective terms, shall have been

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done and performed and shall have happened in due and strict compliance with all applicable laws.

If the conditions precedent set forth in this Paragraph 10(a) shall not have occurred on or before September 30, 2002, then any agreement on the part of the Lender hereunder shall, at the option of the Lender, terminate and be of no further force or effect.

        10(b)    All Credit Events.    As conditions precedent to the Lender's obligation to fund any Loan or issue any Letter of Credit on or after the Effective Date or to permit the continuation of any LIBOR Rate Loan as such or the conversion of any Loan to a LIBOR Rate Loan, at and as of the date of such funding, continuation or conversion:

        (1)  In the case of an Equipment Acquisition Loan, a FY 2003 Expansion Line Loan, a FY 2004 Expansion Line Loan, or a Working Capital Loan, the Company shall have delivered a written Loan Request therefore;

        (2)  In the case of the issuance of a Letter of Credit, there shall have been delivered to the Lender a Letter of Credit Application and all required L/C Documents relating thereto, and the Company shall be in compliance with the limits set forth in Paragraph 5(a) above;

        (3)  The representations and warranties of the Company and its Subsidiaries contained in the Loan Documents shall be accurate and complete in all material respects as if made on and as of the date of such funding, continuation or conversion;

        (4)  There shall not have occurred and be continuing an Event of Default or Potential Default;

        (5)  If such Loan is a Working Capital Loan: (i) the aggregate amount of Working Capital Loans outstanding shall not exceed the Working Capital Facility Credit Limit, and (ii) Liquid Assets in an aggregate dollar amount equal to or greater than $800,000.00 shall be in accounts maintained with the Lender; and

        (6)  If such Loan is an Equipment Acquisition Loan, a FY 2003 Expansion Line Loan, a FY 2004 Expansion Line Loan, or a Working Capital Loan, evidence satisfactory to the Lender that the proceeds of such Loan will be used for the purposes set forth in Paragraphs 1(d), 2(d), 3(d), and 4(d) above, as applicable.

By delivering a Loan Request to the Lender hereunder, the Company shall be deemed to have represented and warranted the accuracy and completeness of the statements set forth in subparagraphs (b)(2) through (b)(6) above, as applicable.

        11.    Representations and Warranties of the Company.    As an inducement to the Lender to enter into this Agreement and to fund Loans as provided herein, the Company represents and warrants to the Lender that:

        11(a)    Financial Condition.    The financial statements, dated the Statement Date and the Interim Date, copies of which have heretofore been furnished to the Lender by the Company, are complete and correct in all material respects and present fairly in accordance with GAAP the consolidated and consolidating financial condition of the Company and its Subsidiaries at such dates and the results of its operations and changes in financial position for the fiscal periods then ended, subject, in the case of the financial statements dated as of the Interim Date, to normal year-end audit adjustments.

        11(b)    No Change.    Since the Statement Date there has been no Material Adverse Effect.

        11(c)    Corporate Existence; Compliance with Law.    The Company and each of its Subsidiaries: (1) is duly organized, validly existing and in good standing as a corporation under the laws of the

12

jurisdiction of its organization and is qualified to do business in each jurisdiction where its ownership of property or conduct of business requires such qualification and where failure to qualify is reasonably likely to have a Material Adverse Effect, (2) has the corporate power and authority and the legal right to own and operate its property and to conduct business in the manner in which it does and proposes so to do, and (3) is in material compliance with all Requirements of Law and Contractual Obligations, the failure to comply with which could have a Material Adverse Effect.

        11(d)    Corporate Power; Authorization; Enforceable Obligations.    The Company and each of its Subsidiaries has the power and authority and the legal right to execute, deliver and perform the Loan Documents to which it is a party and has taken all necessary corporate or other organizational action to authorize the execution, delivery and performance of such Loan Documents. The Loan Documents to which the Company and each of its Subsidiaries are party have been duly executed and delivered on behalf of such Person and constitute legal, valid and binding obligations of such Person, enforceable against such Person in accordance with their respective terms, subject to the effect of applicable bankruptcy and other similar laws affecting the rights of creditors generally and the effect of equitable principles whether applied in an action at law or a suit in equity.

        11(e)    No Legal Bar.    The execution, delivery and performance of the Loan Documents to which the Company and each of its Subsidiaries is party, the borrowing hereunder and the use of the proceeds thereof, will not violate any Requirement of Law or any Contractual Obligation of the Company or any of its Subsidiaries in any material respect or create or result in the creation of any Lien on any assets of the Company or any of its Subsidiaries (other than the Liens created by the Loan Documents).

        11(f)    No Material Litigation.    No litigation, investigation or proceeding of or before any arbitrator, court or Governmental Authority is pending or, to the knowledge of the Company or any of its Subsidiaries, threatened by or against the Company or any of its Subsidiaries or against its or their properties or revenues which is likely to be adversely determined and which, if adversely determined, is likely to have a Material Adverse Effect.

        11(g)    Taxes.    The Company and each of its Subsidiaries has filed or caused to be filed all U.S. and other material tax returns that are required to be filed and has paid all taxes shown to be due and payable on said returns or on any assessments made against it or any of its property other than taxes which are being contested in good faith by appropriate proceedings and as to which the Company or such Subsidiary, as applicable, has established adequate reserves in conformity with GAAP.

        11(h)    Investment Company Act.    Neither the Company nor any of its Subsidiaries is an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended.

        11(i)    Subsidiaries.    Set forth on Schedule 11(i) is an accurate and complete list of the Subsidiaries of the Company, their respective jurisdictions of incorporation and the percentage of their capital stock owned by the Company or Subsidiaries of the Company. All of the issued and outstanding share of capital stock of such Subsidiaries have been duly authorized and issued and are fully paid and non-assessable.

        11(j)    Federal Reserve Board Regulations.    Neither the Company nor any of its Subsidiaries is engaged nor will it engage, principally or as one of its important activities, in the business of extending credit for the purpose of "purchasing" or "carrying" any "margin stock" within the respective meanings of such terms under Regulation U. No part of the proceeds of any Loan issued hereunder will be used for "purchasing" or "carrying" "margin stock" as so defined or for

13

any purpose which violates, or which would be inconsistent with, the provisions of the Regulations of the Board of Governors of the Federal Reserve System.

        11(k)    ERISA.    The Company and each of its Subsidiaries is in compliance in all material respects with the requirements of ERISA and, to the knowledge of the Company, no Reportable Event has occurred under any Plan maintained by the Company and any of its Subsidiaries which is likely to result in the termination of such Plan for purposes of Title IV of ERISA.

        11(l)    Assets.    The Company and each of its Subsidiaries has good and marketable title to all property and assets reflected in the financial statements dated the Statement Date referred to in Paragraph 11(a) above, except property and assets sold or otherwise disposed of in the ordinary course of business subsequent to the Statement Date. Neither the Company nor any of its Subsidiaries has outstanding Liens on any of its properties or assets nor are there any security agreements to which the Company or any of its Subsidiaries, including the Company, is a party, or title retention agreements, whether in the form of leases or otherwise, of any personal property except as permitted under Paragraph 13(a) below.

        11(m)    Securities Acts.    Neither the Company nor any of its Subsidiaries has issued any unregistered securities in violation of the registration requirements of Section 5 of the Securities Act of 1933, as amended, or any other law, and is not in material violation of any rule, regulation or requirement under the Securities Act of 1933, as amended, or the Securities and Exchange Act of 1934, as amended. The Company is not required to qualify an indenture under the Trust Indenture Act of 1939, as amended, in connection with its execution and delivery of the Loan Documents.

        11(n)    Consents, Etc.    No consent, approval, authorization of, or registration, declaration or filing with any Governmental Authority or any other Person is required in connection with the execution and delivery of the Loan Documents (other than filings to perfect the Liens granted pursuant to the Loan Documents) or the performance of or compliance with the terms, provisions and conditions hereof or thereof other than such as have been obtained prior to the Effective Date.

        11(o)    Hazardous Materials.    Neither the Company nor, to the knowledge of the Company, any other Person has: (1) caused or permitted any Hazardous Materials to be disposed of in, on, under or about any Property or any part thereof, and neither any Property, nor any part thereof, has ever been used (whether by the Company or, to the knowledge of the Company, by any other Person) for activities involving, directly or indirectly, the disposal of any Hazardous Materials; (2) caused or permitted to be incorporated into or utilized in the construction of any improvements located on any Property any chemical, material, or substance to which exposure is prohibited, limited or regulated by any Hazardous Materials Laws or which, even if not so regulated, is known to pose a hazard (either in its present form or if disturbed or removed) to the health and safety of the occupants of any Property or of property adjacent to any Property; or (3) discovered any occurrence or condition on any Property that could cause any Property or any part thereof to be in violation of any Hazardous Materials Laws.

        11(p)    Regulated Entities.    Neither the Company nor any of its Subsidiaries is subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act, the Interstate Commerce Act, any state public utilities code, or any other Federal or state statute or regulation limiting its ability to incur Indebtedness.

        11(q)    Copyrights, Patents, Trademarks and Licenses, Etc.    The Company and each of its Subsidiaries or is licensed or otherwise have the right to use all of the patents, trademarks, service marks, trade names, copyrights, contractual franchises, authorizations and other rights used by such Person in the conduct of its business. To the knowledge of the Company, no slogan or other

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advertising device, product, process, method, substance, part or other material now employed, or now contemplated to be employed, by the Company or any of its Subsidiaries infringes upon any rights held by any other Person in any material respect. No claim or litigation regarding any of the foregoing is pending or, to the Company's knowledge, threatened and, to the knowledge of the Company, no patent, invention, device, application, principle or any statute, law, rule, regulation, standard or code is pending or proposed, which, in either case, could reasonably be expected to have a Material Adverse Effect.

        11(r)    Insurance.    The properties and assets of the Company and each of its Subsidiaries are insured with financially sound and reputable insurance companies (not Affiliates) acceptable to the Lender, in such amounts, with such deductibles and covering such risks as are customarily carried by companies engaged in similar businesses and owning similar properties in localities where the Company and such Subsidiaries operate.

        12.    Affirmative Covenants.    The Company hereby covenants and agrees with the Lender that, as long as any Obligations remain unpaid or the Lender has any obligation to make Loans hereunder, the Company shall:

        12(a)    Financial Statements and Reports.    Furnish or cause to be furnished to the Lender:

        (1)  Within one hundred twenty (120) days after the last day of each Fiscal Year, a copy of the consolidated and consolidating statements of income and cash flow statements for the Company and its Subsidiaries for such year and balance sheets as of the end of such Fiscal Year presented fairly in accordance with GAAP and reviewed by a firm of independent certified public accountants reasonably acceptable to the Lender; provided, however, that a copy of an audited 10-K the Company has submitted for filing with the Securities and Exchange Commission for such Fiscal Year may be substituted for such documents unless the Company is otherwise notified by the Lender;

        (2)  Within sixty (60) days after the last day of each fiscal quarter, a copy of the consolidated and consolidating statements of income and cash flow statements for the Company and its Subsidiaries for such fiscal quarter and balance sheets as of the end of such fiscal quarter presented fairly in accordance with GAAP and reviewed by a firm of independent certified public accountants reasonably acceptable to the Lender; provided, however, that a copy of an audited 10-Q the Company has submitted for filing with the Securities and Exchange Commission for such fiscal quarter may be substituted for such documents unless the Company is otherwise notified by the Lender;

        (3)  Within thirty (30) days after the end of each fiscal quarter, a receivables aging report, a payables aging report, same store sales and EBITDA reports, and inventory reports for the Company and its Subsidiaries as of the last day of such fiscal quarter, said reports to be in form and detail reasonably satisfactory to the Lender;

        (4)  Copies of all proxy statements, financial statements, and reports which the Company sends to its stockholders, and copies of all regular, periodic and special reports, and all registration statements under the Act which the Company files with the Securities and Exchange Commission or any Governmental Authority which may be substituted therefor, or with any national securities exchange; and

        (5)  Promptly upon request of the Lender, such additional financial and other information, including, without limitation, financial statements of the Company and its Subsidiaries as the Lender may from time to time reasonably request, including, without limitation, such information as is necessary to enable the Lender to assign or participate out any of its interests in the Loans and other Obligations hereunder.

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        12(b)    Payment of Indebtedness.    And shall cause each of its Subsidiaries to, pay, discharge or otherwise satisfy at or before maturity or before it becomes delinquent, defaulted or accelerated, as the case may be, all its Indebtedness (including taxes), except Indebtedness being contested in good faith and for which provision is made to the satisfaction of the Lender for the payment thereof in the event the Company or such Subsidiary is found to be obligated to pay such Indebtedness and which Indebtedness is thereupon promptly paid by the Company or such Subsidiary.

        12(c)    Maintenance of Existence and Properties.    And shall cause each of its Subsidiaries to: (1) maintain its corporate existence (except, subject to the requirements of Paragraph 13(c) below, a merger into the Company or another Subsidiary), (2) maintain all rights, privileges, licenses, approvals, franchises, properties and assets necessary or desirable in the normal conduct of its business (except to the extent that failure to do so could not reasonably be expected to have a Material Adverse Effect), and (3) comply in all material respects with all Contractual Obligations and Requirements of Law the failure to comply with which could reasonably expected to have a Material Adverse Effect.

        12(d)    Inspection of Property; Books and Records; Discussions.    And shall cause each of its Subsidiaries to, keep proper books of record and account in which full, true and correct entries in conformity with GAAP and all Requirements of Law and permit representatives of the Lender to visit and inspect any of its or their properties and examine and make abstracts from any of its or their books and records at any reasonable time and as often as may reasonably be desired by the Lender and to discuss the business, operations, properties and financial and other condition of the Company and its Subsidiaries with officers and employees of the Company, and with its or their independent certified public accountants. As long as there has not occurred and is continuing an Event of Default or Potential Default, such inspections shall be at no cost to the Company.

        12(e)    Notices.    Promptly give written notice to the Lender of:

        (1)  The occurrence of any Potential Default or Event of Default;

        (2)  Any litigation or proceedings affecting the Company or any of its Subsidiaries or the Collateral involving amounts in excess of $100,000.00 in the aggregate; and

        (3)  Any other event which, in the reasonable business judgment of the Company, could have a Material Adverse Effect.

        12(f)    Expenses.    Pay all reasonable out-of-pocket expenses (including fees and disbursements of outside counsel and allocated costs of internal counsel) of incurred by or assessed against the Lender incident to: (1) the preparation, negotiation and closing of the transaction contemplated hereby and the administration of the Loan Documents; and (2) the protection of the rights of the Lender under the Loan Documents and the enforcement of payment of the Obligations, whether by judicial proceedings or otherwise, including, without limitation, in connection with bankruptcy, insolvency, liquidation, reorganization, moratorium or other similar proceedings involving the Company or a "workout" of the Obligations. The Obligations of the Company under this Paragraph 12(f) shall be effective and enforceable whether or not any Loan is funded and shall survive payment of all other Obligations.

        12(g)    Loan Documents.    Comply with and observe all terms and conditions of the Loan Documents.

        12(h)    Insurance.    And shall cause each of its Subsidiaries to, obtain and maintain insurance, including, without limitation, property insurance, casualty insurance and general liability insurance, with responsible companies, in such amounts and against such risks as are usually carried by

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corporations engaged in similar businesses similarly situated, and furnish the Lender upon request with certificates evidencing such insurance.

        12(i)    Hazardous Materials.    And shall cause each of its Subsidiaries to:

        (1)  Conduct its operations and keep and maintain its Properties in material compliance with all applicable Environmental Laws.

        (2)  Give prompt written notice to the Lender, but in no event later than ten (10) days after becoming aware thereof, of the following: (i) any enforcement, cleanup, removal or other governmental or regulatory actions instituted, completed or threatened against the Company or any of its Affiliates or any of their respective properties pursuant to any applicable Environmental Laws where the potential liability to the Company or any of its Subsidiaries could reasonably be expected to be in excess of $100,000.00 in the aggregate for all such cases, (ii) all other Environmental Claims, and (iii) any environmental or similar condition on any real property adjoining or in the vicinity of the property of the Company or its Affiliates that could reasonably be anticipated to cause such property or any part thereof to be subject to any restrictions on the ownership, occupancy, transferability or use of such property under any Environmental Laws.

        (3)  Upon the written request of the Lender, submit to the Lender, at the Company's sole cost and expense, at reasonable intervals, a report providing an update of the status of any environmental, health or safety compliance, hazard or liability issue identified in any notice required pursuant to this Paragraph 12(i).

        (4)  At all times indemnify and hold harmless the Lender from and against all liability arising out of any Environmental Claims, except those Environmental Claims caused as a primary and direct result of the gross negligence or willful misconduct of the Lender.

        12(j)    ERISA.    Furnish to the Lender promptly and in any event within ten (10) days after the Company knows or has reason to know of the occurrence of a Reportable Event with respect to a Plan with regard to which notice must be provided to the PBGC, a copy of such materials required to be filed with the PBGC with respect to such Reportable Event and in each such case a statement of the chief financial officer of the Company setting forth details as to such Reportable Event and the action which the Company proposes to take with respect thereto.

        12(k)    Compliance with Laws.    And shall cause each of its Subsidiaries to, comply, in all material respects with all Requirements of Law and Contractual Obligations the failure to comply with which could reasonably be expected to have a Material Adverse Effect.

        12(l)    Line Cleanup.    Reduce the dollar amount of Working Capital Loans outstanding to zero during the Second Quarter and Third Quarter of each Fiscal Year.

        13.    Negative Covenants.    The Company hereby agrees that, as long as any Obligations remain unpaid or the Lender has any obligation to make Loans hereunder, the Company shall not, directly or indirectly:

        13(a)    Liens.    Nor permit any of its Subsidiaries to create, incur, assume or suffer to exist any Lien upon any of its property and assets, including, without limitation, property and assets included in the Collateral, except Liens securing the Obligations and:

        (1)  Liens or charges for current taxes, assessments or other governmental charges which are not delinquent or which remain payable without penalty, or the validity of which are contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof, provided the Company or such Subsidiary shall have set aside on its books and shall maintain adequate reserves for the payment of same in conformity with GAAP;

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        (2)  Liens, deposits or pledges made to secure statutory obligations, surety or appeal bonds, or bonds to obtain, or to obtain the release of, attachments, writs of garnishment or for stay of execution, or to secure the performance of bids, tenders, contracts (other than for the payment of borrowed money), leases or for purposes of like general nature in the ordinary course of the business of the Company and its Subsidiaries;

        (3)  Purchase money security interests for property hereafter acquired, conditional sale agreements, or other title retention agreements, with respect to property hereafter acquired; provided, however, that no such security interest or agreement shall extend to any property other than the property acquired and the principal amount of the Indebtedness secured thereby shall not exceed one hundred percent (100%) of the cost of such property;

        (4)  Statutory Liens of landlord's, carriers, warehousemen, mechanics, materialmen and other similar Liens imposed by law and created in the ordinary course of business for amounts not yet due or which are being contested in good faith by appropriate proceedings and with respect to which adequate reserves are being maintained in conformity with GAAP;

        (5)  Attachment and judgment Liens not otherwise constituting an Event of Default each of which Lien is in existence less than thirty (30) days after the entry thereof or with respect to which execution has been stayed, payment is covered in full by insurance, or the Borrowers shall in good faith be prosecuting an appeal or proceedings for review and shall have set aside on its books such reserves as may be required by GAAP with respect to such judgment or award; and

        (6)  Liens existing on the Effective Date shown on the financial statements referred in Paragraph 11(a) above (other than Liens securing Indebtedness under the Existing Term Loan Facility).

        13(b)    Indebtedness.    Nor permit any of it Subsidiaries to create, incur, assume or suffer to exist, or otherwise become or be liable in respect of any Indebtedness except:

        (1)  The Obligations;

        (2)  Indebtedness reflected in the financial statements referred to in Paragraph 11(a) above (other than Indebtedness under the Existing Term Loan Facility);

        (3)  Trade debt incurred in the ordinary course of business and outstanding less than ninety (90) days after the same has become due and payable or which is being contested in good faith, provided provision is made to the reasonable satisfaction of the Lender for the eventual payment thereof in the event it is found that such contested trade debt is payable by it;

        (4)  Indebtedness secured by Liens permitted under Paragraph 13(a)(1) through (a)(5) above;

        (5)  Letters of Credit Nos. 1297258 and 50090701 issued by Fleet National Bank for the account of the Company and the Guarantors, which letters of credit will not be renewed or in any way extended longer than the expiration dates set forth thereon as of the Effective Date; and

        (6)  Other Indebtedness (restricted to purchase money transactions) not to exceed $100,000.00 in the aggregate at any time outstanding.

        13(c)    Consolidation and Merger.    Nor permit any of its Subsidiaries to liquidate or dissolve or enter into any consolidation, merger, partnership, joint venture, syndicate or other combination other than mergers and consolidations of Subsidiaries into the Company or other Subsidiaries or other mergers, consolidations and acquisitions in which the Company shall be the surviving

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corporation; provided, however, in no event shall the Company make acquisitions for a total consideration in excess of $250,000.00 during any Fiscal Year.

        13(d)    Payment of Dividends.    Declare or pay any dividends upon its shares of stock now or hereafter outstanding or make any distribution of assets to its stockholders as such, whether in cash, property or securities, except dividends payable in shares of capital stock.

        13(e)    Repurchase of Stock.    Nor permit any of its Subsidiaries to acquire, purchase, redeem or retire any shares of its capital stock now or hereafter outstanding, in one transaction or a series of transactions.

        13(f)    Sale of Assets.    Nor permit any of its Subsidiaries to sell, lease, assign, transfer or otherwise dispose of any of its assets, whether now owned or hereafter acquired, other than: (1) dispositions of inventory in the ordinary course of business (which dispositions may be made free from the Liens of the Loan Documents), the disposition in the ordinary course of business, without replacement, of equipment which is obsolete or no longer needed in the conduct of its business and the disposition and replacement in the ordinary course of business of equipment with other equipment of at least equal utility and value (provided that, except for purchase money security interests and rights of lessors of equipment if permitted hereunder, the Lender's Lien upon such newly-acquired equipment shall have the same priority as the Lender's Lien upon the replaced equipment), (2) the liquidation of assets of retail stores which have been closed, and (3) the sale of retail stores in accordance with Paragraph 13(p) below.

        13(g)    Limitation on Transactions with Affiliates.    Nor permit any of its Subsidiaries to purchase, acquire or lease any property from, or sell, transfer or lease any property to, or lend or advance any money to, or borrow any money from, or guarantee any obligation of, or acquire any stock, obligations or securities of, or enter into any merger or consolidation agreement, or any management or similar fee, agreement with, any Affiliate, or enter into any other transaction or arrangement or make any payment to or otherwise deal with, in the ordinary course of business or otherwise, any Affiliate other than: (1) on terms no less favorable to the Company or such Subsidiary as would be obtained in an arms-length transaction with a non-Affiliate, and (2) if but only if such transaction, arrangement, payment or other dealing would not violate any other term or provision of this Agreement or the other Loan Documents.

        13(h)    Accounting Changes.    Make any significant change in accounting treatment or reporting practices, except as required by GAAP, or change its fiscal year.

        13(i)    Capital Expenditures.    Nor permit any of its Subsidiaries to make or commit to make Capital Expenditures (including Expansion Expenditures) in excess of $3,800,000.00 in the aggregate during the Fiscal Year ending on July 2, 2003 and $2,000,000.00 in the aggregate during any Fiscal Year thereafter.

        13(j)    Loans; Advances.    Nor permit any of its Subsidiaries to, directly or indirectly, make or commit to make any advance, loan or extension of credit (other than extensions of credit to customers in the ordinary course of business) or capital contribution to any Person other than: (1) trade credit extended in the ordinary course of business, (2) loan and advances to employees in an aggregate amount not to exceed $50,000.00 at any time outstanding, and (3) intercompany loans and investments in other Subsidiaries or the Company.

        13(k)    Leverage Ratio.    Permit as of the end of any fiscal quarter, the ratio of Indebtedness of the Company and its Subsidiaries on a consolidated basis to the Effective Tangible Net Worth of the Company and its Subsidiaries on a consolidated basis to be less than 2.75:1.00.

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        13(l)    Minimum Effective Tangible Net Worth.    Permit as of the end of any fiscal quarter the Effective Tangible Net Worth of the Company and its Subsidiaries on a consolidated basis to be less than $4,900,000.00.

        13(m)    Minimum EBITDA.    Permit as of the end of any fiscal quarter, calculated for such fiscal quarter and the immediately preceding three fiscal quarters, EBITDA of the Company and its Subsidiaries on a consolidated basis to be less than $4,000,000.00.

        13(n)    Profitability.

        (1)  Permit the combined net income of the Company and its Subsidiaries, determined in accordance with GAAP, as of the end of any fiscal quarter other than the First Quarter of any Fiscal Year to be less than $1.00; and

        (2)  Permit losses as of the end of the First Quarter of any Fiscal Year to be more than $400,000.00.

        13(o)    Minimum Liquid Assets    Permit for more than ten (10) Business Days during any Fiscal Year, the aggregate dollar amount of Liquid Assets held by the Company in accounts maintained with the Lender to be less than $800,000.00.

        13(p)    Retail Stores    Permit, during any fiscal year of the Company, the number of stores directly operated by the Company or its Subsidiaries which have been sold during such fiscal year to exceed fifteen percent (15%) of the total number of retail stores directly operated by the Company or its Subsidiaries as of the first day of such fiscal year.

        14.    Events of Default.    Upon the occurrence of any of the following events (an "Event of Default"):

        14(a)The Company shall fail to pay any principal or interest on the Loans or fees on the date when due or shall fail to pay within five (5) days of the date when due any other Obligation under the Loan Documents; or

        14(b)Any representation or warranty made by the Company or any of the Guarantors in any Loan Document shall be inaccurate or incomplete in any material respect on or as of the date made; or

        14(c)The Company shall fail to maintain its corporate existence or shall default in the observance or performance of any covenant or agreement contained in Paragraph 12(l) or Paragraphs 13(a) through 13(n) above;

        14(d)The Company shall default in the observance or performance of the covenant contained in Paragraph 13(o) above and such default shall continue five (5) days after delivery by the Lender to the Company of written notice of such default; or

        14(e)The Company or any of the Guarantors shall fail to observe or perform any other term or provision contained in the Loan Documents and such failure shall continue thirty (30) days after delivery by the Lender to the Company of written notice of such failure; or

        14(f)(1) The Company or any of the Guarantors shall default in any payment of principal of or interest on any Indebtedness (other than the Obligations) or (2) any Person shall default in the payment of any Indebtedness upon which the Company or any of the Guarantors is contingently liable, or (3) any other event shall occur, the effect of which is to permit such Indebtedness to be declared or otherwise to become due prior to its stated maturity; or

        14(g)(1) The Company or any of the Guarantors shall commence any case, proceeding or other action (i) under any existing or future law of any jurisdiction, domestic or foreign, relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking to have an order for relief

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entered with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (ii) seeking appointment of a receiver, trustee, custodian or other similar official for it or for all or any substantial part of its assets, or the Company or any of the Guarantors shall make a general assignment for the benefit of its creditors; or (2) there shall be commenced against the Company or any of the Guarantors any case, proceeding or other action of a nature referred to in clause (1) above which (i) results in the entry of an order for relief or any such adjudication or appointment, or (ii) remains undismissed, undischarged or unbonded for a period of sixty (60) days; or (3) there shall be commenced against the Company or any of the Guarantors any case, proceeding or other action seeking issuance of a warrant of attachment, execution, distraint or similar process against all or substantially all of its assets which results in the entry of an order for any such relief which shall not have been vacated, discharged, stayed, satisfied or bonded pending appeal within sixty (60) days from the entry thereof; or (4) the Company or any of the Guarantors shall take any action in furtherance of, or indicating its consent to, approval of, or acquiescence in (other than in connection with a final settlement), any of the acts set forth in clause (1), (2) or (3) above; or (5) the Company or any of the Guarantors shall generally not, or shall be unable to, or shall admit in writing its inability to pay its debts as they become due; or

        14(h)(1) Any Person shall engage in any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975 of the Code) involving any Plan, (2) any "accumulated funding deficiency" (as defined in Section 302 of ERISA), whether or nor waived, shall exist with respect to any Plan, (3) a Reportable Event shall occur with respect to, or proceedings shall commence to have a trustee appointed, or a trustee shall be appointed, to administer or to terminate, any Single Employer Plan, which Reportable Event or institution of proceedings is, in the reasonable opinion of the Lender, likely to result in the termination of such Plan for purposes of Title IV of ERISA, and, in the case of a Reportable Event, the continuance of such Reportable Event unremedied for ten days after notice of such Reportable Event pursuant to Section 4042(a), (c) or (d) of ERISA is given or the continuance of such proceedings for ten days after commencement thereof, as the case may be, (4) any Single Employer Plan shall terminate for purposes of Title IV of ERISA, (5) any withdrawal liability to a Multiemployer Plan shall be incurred by the Company or (6) any other event or condition shall occur or exist; and in each case in clauses (1) through (6) above, such event or condition, together with all other such events or conditions, if any, is likely to subject the Company to any tax, penalty or other liabilities in the aggregate material in relation to the business, operations, property or financial or other condition of the Company; or

        14(i)One or more judgments or decrees in excess of $500,000.00 in the aggregate shall be entered against the Company or any of the Guarantors and such judgments or decrees shall not have been vacated, discharged, stayed, satisfied or bonded pending appeal within sixty (60) days from the entry thereof; or

        14(j)Any of the Guarantors shall fail to observe or perform any provision of its Guaranty, or any other Loan Document to which it is party, or shall attempt to rescind or revoke its Guaranty or any other such Loan Document, with respect to future transactions or otherwise; or

        14(k)There shall occur following the Effective Date any event which is reasonably likely to have a Material Adverse Effect; or

        14(k)The Lien of the Lender upon any of the Collateral shall cease to be perfected or shall cease to have the priority required pursuant to the Loan Documents;

THEN, automatically upon the occurrence of an Event of Default under Paragraph 14(g) above and, in all other cases, at the option of the Lender: (1) the Lender's obligation to make Loans or issue Letters of Credit shall terminate and the principal balance of outstanding Loans and interest

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accrued but unpaid thereon and all other Obligations shall become immediately due and payable, without demand upon or presentment to the Company, which are expressly waived by the Company, and (2) the Lender may immediately exercise all rights, powers and remedies available to it at law, in equity or otherwise, including, without limitation, under the Collateral Documents and the Guaranties.

        15.    Miscellaneous Provisions.

        15(a)    No Assignment.    The Company may not assign its rights or obligations under this Agreement or any other Loan Document without the prior written consent of the Lender. Any purported assignment in violation of this Paragraph 15(a) shall automatically be deemed null and void. Subject to the foregoing, all provisions contained in this Agreement and in any document or agreement referred to herein or relating hereto shall inure to the benefit of the Lender, its successors and assigns, and shall be binding upon the Company, its successors and assigns.

        15(b)    Amendment.    Neither this Agreement nor any other Loan Document may be amended or terms or provisions hereof waived unless such amendment or waiver is in writing and signed by the Lender and the Company.

        15(c)    Cumulative Rights; No Waiver.    The rights, powers and remedies of the Lender under this Agreement and the other Loan Documents are cumulative and in addition to all rights, power and remedies provided under any and all agreements between the Company and the Lender relating hereto, at law, in equity or otherwise. Any delay or failure by the Lender to exercise any right, power or remedy shall not constitute a waiver thereof by the Lender, and no single or partial exercise by the Lender of any right, power or remedy shall preclude other or further exercise thereof or any exercise of any other rights, powers or remedies.

        15(d)    Entire Agreement.    This Agreement and the documents and agreements referred to herein embody the entire agreement and understanding between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof and thereof.

        15(e)    Survival.    All representations, warranties, covenants and agreements contained in this Agreement and in the other Loan Documents on the part of the Company shall survive the termination of this Agreement and shall be effective until the Obligations are paid and performed in full or longer as expressly provided herein.

        15(f)    Notices.    All notices given by any party to the others under this Agreement and the other Loan Documents shall be in writing unless otherwise provided for herein, delivered by facsimile transmission, by personal delivery or by overnight courier, addressed to the party as set forth on Annex 2 attached hereto, as such Annex 2 may be amended from time to time. Any party may change the address to which notices are to be sent by notice of such change to each other party given as provided herein. Such notices shall be effective on the date received.

        15(g)    Governing Law.    This Agreement and the other Loan Documents shall be governed by and construed in accordance with the internal laws of the State of California.

        15(h)    Assignments, Participations, Etc.

        (1)  The Lender may at any time with, but only so long as there does not exist an Event of Default, the consent of the Company (such consent not to be unreasonably withheld), assign and delegate to one or more financial institutions (each an "Assignee") all, or any part of its rights and obligations hereunder and under the other Loan Documents

        (2)  In addition, the Lender may at any time sell to one or more financial institutions or other Persons participating interests in any Loans, the funding commitment of the Lender (including any commitment to fund future Loans) and the other interests of the Lender

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hereunder and under the other Loan Documents; provided, however, that (i) the Lender's obligations under this Agreement shall remain unchanged, (ii) the Lender shall remain solely responsible for the performance of such obligations, and (iii) the Company shall continue to deal solely and directly with the Lender in connection with this Agreement and the other Loan Documents.

        (3)  Notwithstanding any other provision contained in this Agreement or any other Loan Document to the contrary, the Lender may assign all or any portion of the Loans held by it to any Federal Reserve Bank or the United States Treasury as collateral security pursuant to Regulation A of the Board of Governors of the Federal Reserve System and any Operating Circular issued by such Federal Reserve Bank.

        15(i)    Counterparts.    This Agreement and the other Loan Documents may be executed in any number of counterparts, all of which together shall constitute one agreement.

        15(j)    Consent to Jurisdiction.    ANY LEGAL ACTION OR PROCEEDING WITH RESPECT TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT MAY BE BROUGHT IN THE COURTS OF THE STATE OF CALIFORNIA OR OF THE UNITED STATES FOR THE CENTRAL DISTRICT OF CALIFORNIA, AND BY EXECUTION AND DELIVERY OF THIS AGREEMENT, EACH OF THE COMPANY AND THE LENDER CONSENTS, FOR ITSELF AND IN RESPECT OF ITS PROPERTY, TO THE NON-EXCLUSIVE JURISDICTION OF THOSE COURTS. EACH OF THE COMPANY AND THE LENDER IRREVOCABLY WAIVES ANY OBJECTION, INCLUDING ANY OBJECTION TO THE LAYING OF VENUE OR BASED ON THE GROUNDS OF FORUM NON CONVENIENS, WHICH IT MAY NOW OR HEREAFTER HAVE TO THE BRINGING OF ANY ACTION OR PROCEEDING IN SUCH JURISDICTION IN RESPECT OF THIS AGREEMENT OR ANY DOCUMENT RELATED HERETO. THE COMPANY AND THE LENDER EACH WAIVE PERSONAL SERVICE OF ANY SUMMONS, COMPLAINT OR OTHER PROCESS, WHICH MAY BE MADE BY ANY OTHER MEANS PERMITTED BY CALIFORNIA LAW.

        15(k)    Waiver of Jury Trial.    THE COMPANY AND THE LENDER EACH WAIVE THEIR RESPECTIVE RIGHTS TO A TRIAL BY JURY OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF OR RELATED TO THIS AGREEMENT, THE OTHER LOAN DOCUMENTS, OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY, IN ANY ACTION, PROCEEDING OR OTHER LITIGATION OF ANY TYPE BROUGHT BY ANY OF THE PARTIES AGAINST ANY OTHER PARTY OR ANY PARTICIPANT OR ASSIGNEE, WHETHER WITH RESPECT TO CONTRACT CLAIMS, TORT CLAIMS, OR OTHERWISE. THE COMPANY AND THE LENDER EACH AGREE THAT ANY SUCH CLAIM OR CAUSE OF ACTION SHALL BE TRIED BY A COURT TRIAL WITHOUT A JURY. WITHOUT LIMITING THE FOREGOING, THE PARTIES FURTHER AGREE THAT THEIR RESPECTIVE RIGHT TO A TRIAL BY JURY IS WAIVED BY OPERATION OF THIS SECTION AS TO ANY ACTION, COUNTERCLAIM OR OTHER PROCEEDING WHICH SEEKS, IN WHOLE OR IN PART, TO CHALLENGE THE VALIDITY OR ENFORCEABILITY OF THIS AGREEMENT OR THE OTHER LOAN DOCUMENTS OR ANY PROVISION HEREOF OR THEREOF. THE COMPANY WAIVES ITS RIGHT TO NOTICE OR HEARING WITH RESPECT TO ANY PREJUDGMENT REMEDY. THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS.

        15(l)    Indemnity.    Whether or not the transactions contemplated hereby are consummated, the Company shall indemnify and hold the Lender and each of its officers, directors, employees,

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counsel, agents and attorneys-in-fact (each, an "Indemnified Person") harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, charges, expenses and disbursements (including reasonable attorney's fees and expenses, including the documented cost of internal counsel) of any kind or nature whatsoever which may at any time (including at any time following repayment of the Loans) be imposed on, incurred by or asserted against any such Person in any way relating to or arising out of the inaccuracy or incompleteness of any representation or warranty made by the Company or the Guarantor in any Loan Document or otherwise relating to or arising out of this Agreement or any document contemplated by or referred to herein, or the transactions contemplated hereby or any action taken or omitted by any such Person under or in connection with any of the foregoing, including with respect to any investigation, litigation or proceeding (including any insolvency proceeding or appellate proceeding) related to or arising out of this Agreement or the Loans or the use of the proceeds thereof, whether or not any Indemnified Person is a party thereto (all the foregoing, collectively, the "Indemnified Liabilities"); provided, however, that the Company shall have no obligation hereunder to any Indemnified Person with respect to Indemnified Liabilities resulting from the gross negligence or willful misconduct of such Indemnified Person. The agreements in this Paragraph 13(l) shall survive payment of all other Obligations and the termination of this Agreement.

        15(m)    Marshalling; Payments Set Aside.    The Lender shall not be under any obligation to marshall any assets in favor of the Company or any other Person or against or in payment of any or all of the Obligations. To the extent that the Company makes a payment or payments to the Lender or the Lender enforces the Liens under the Collateral Documents or exercises its rights of set-off, and such payment or payments or the proceeds of such enforcement or set-off or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside or required (including pursuant to any settlement entered into by the Lender in its discretion) to be repaid to a trustee, receiver or any other party in connection with any insolvency proceeding, or otherwise, then, to the extent of such recovery the obligation or part thereof originally intended to be satisfied shall be revived and continued in full force and effect as if such payment had not been made or such enforcement or set-off had not occurred.

        15(n)    Set-off.    In addition to any rights and remedies of the Lender provided by law, if an Event of Default exists, the Lender is authorized at any time and from time to time, without prior notice to the Company, any such notice being waived by the Company to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held by, and other indebtedness at any time owing to, the Lender to or for the credit or the account of the Company against any and all Obligations owing to the Lender, now or hereafter existing, irrespective of whether or not the Lender shall have made demand under this Agreement or any Loan Document and although such Obligations may be contingent or unmatured. The Lender agrees promptly to notify the Company after any such set-off and application made by the Lender; provided, however, that the failure to give such notice shall not affect the validity of such set-off and application.

        15(o)    Severability.    The illegality or unenforceability of any provision of this Agreement or any other Loan Document or any instrument or agreement required hereunder or thereunder shall not in any way affect or impair the legality or enforceability of the remaining provisions hereof or thereof.

        15(p)    No Third Parties Benefited.    This Agreement and the other Loan Documents are made and entered into for the sole protection and legal benefit of the Company and the Lender and their permitted successors and assigns, and no other Person shall be a direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any of the other Loan Documents. The Lender shall not have any obligation to any Person not a party to this Agreement or other Loan Documents.

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        15(q)    No Further Commitment.    THE COMPANY EXPRESSLY ACKNOWLEDGES AND AGREES THAT NOTHING CONTAINED IN THIS AGREEMENT OR THE OTHER LOAN DOCUMENTS SHALL IN ANY MANNER OR TO ANY EXTENT CONSTITUTE OR BE IMPLIED TO CONSTITUTE ANY AGREEMENT OF THE LENDER TO EXTEND THE MATURITY DATE OF ANY CREDIT FACILITY BEING PROVIDED TO THE COMPANY BY THE LENDER BEYOND THE DATE SET FORTH HEREIN, NOTWITHSTANDING THE COMPLIANCE OF THE COMPANY WITH ALL TERMS AND CONDITIONS SET FORTH HEREIN. THE COMPANY HEREBY REPRESENTS AND WARRANTS TO THE LENDER THAT IT IS TAKING SUCH ACTIONS AS ARE NECESSARY TO ASSURE THE AVAILABILITY TO THE COMPANY OF FINANCING FOR ITS OPERATIONS FROM AND AFTER SUCH DATES FROM SOURCES OTHER THAN THE LENDER.

        16.    Definitions.    For purposes of this Agreement, the terms set forth below shall have the following meanings:

        "Affiliate" shall mean, as to any Person, any other Person directly or indirectly controlling, controlled by or under direct or indirect common control with, such Person. "Control" as used herein means with respect to any business entity the power to direct the management and policies of such business entity.

        "Agreement" shall mean this Credit Agreement, as the same may be amended, extended or replaced from time to time.

        "Business Day" shall mean any day other than a Saturday, a Sunday or a day on which banks in Los Angeles, California are authorized or obligated to close their regular banking business.

        "Capital Expenditures" shall mean, for any period, the aggregate of all expenditures by the Company and its Subsidiaries for the acquisition or leasing of fixed or capital assets or additions to equipment (including replacements, capitalized repairs and improvements during such period) which should be capitalized under GAAP on a consolidated balance sheet of the Company, less net proceeds from sales of fixed or capital assets received by the Company and its Subsidiaries during such period.

        "Collateral" shall mean, collectively and severally, all property and assets of the Company which is at any time subject to a Lien in favor of the Lender under the Collateral Documents.

        "Collateral Documents" shall mean, collectively and severally, the Security Agreement, each of the Guarantor Security Agreements, and all other documents, instruments and agreements at any time executed and delivered to the Lender relating to the Collateral, and shall include any and all amendments and extensions and replacements thereof.

        "Commonly Controlled Entity" of a Person shall mean a Person, whether or not incorporated, which is under common control with such Person within the meaning of Section 411(c) of the Internal Revenue Code.

        "Contact Office" shall mean the Lender's office located at 4400 Mac Arthur Boulevard, Suite 150, Newport Beach, California 92660, or such other office as the Lender may notify the Company from time to time in writing.

        "Contractual Obligation" as to any Person shall mean any provision of any security issued by such Person or of any agreement, instrument or undertaking to which such Person is a party or by which it or any of its property is bound.

        "EBITDA" shall mean, with respect to any Person for any fiscal period, earnings (exclusive of extraordinary gains) and before deductions for interest and income taxes plus depreciation and amortization.

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        "Effective Date" shall mean the date on which all of the conditions precedent set forth in Paragraph 10(a) above shall have been met to the satisfaction of the Lender.

        "Effective Tangible Net Worth" shall mean, with respect to any Person, total assets (exclusive of goodwill, patents, trademarks, trade names, copyrights, organization expense, investments in and all amounts due from Affiliates, officers, or employees), plus Subordinated Debt, less Total Liabilities (excluding Subordinated Debt), at such time.

        "Environmental Claims" shall mean all claims, however asserted, where the potential liability to the Company and its Subsidiaries could reasonably be expected to be in excess of $250,000.00 in the aggregate with respect to all such claims, by any governmental authority or other person alleging potential liability or responsibility for violation of any Environmental Law or for release or injury to the environment or threat to public health, personal injury (including sickness, disease or death), property damage, natural resources damage, or otherwise alleging liability or responsibility for damages (punitive or otherwise), cleanup, removal, remedial or response costs, restitution, civil or criminal penalties, injunctive relief, or other type of relief resulting from or based upon (a) the presence, placement, discharge, emission or release (including intentional and unintentional, negligent and non-negligent, sudden or non-sudden, accidental or non-accidental placement, spills, leaks, discharges, emissions or releases) of any Hazardous Materials at, in, or from property owned, operated or controlled by the Company, or (b) any other circumstances forming the basis of any violation, or alleged violation, of any Environmental Law.

        "Environmental Laws" shall mean all federal, state or local laws, statutes, common law duties, rules, regulations, ordinances and codes, together with all administrative orders, directed duties, requested, licenses, authorizations and permits of, and agreements with, any governmental authorities, in each case relating to environmental, health, safety and land use matters; including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), the Clean Air Act, the Federal Water Pollution Control Act of 1972, the Solid Waste Disposal Act, the Federal Resource Conservation and Recovery Act, the Toxic Substances Control Act, the Emergency Planning and Community Right-to-Know Act, the California Waste Control Law, the California Solid Waste Management, Resource, Recovery and Recycling Act, the California Water Code and the California Health and Safety Code.

        "Equipment Acquisition Line Conversion Date" shall mean August 29, 2003.

        "Equipment Acquisition Line Credit Limit" shall mean $1,000,000.00.

        "Equipment Acquisition Line Term-Out Loan shall have the meaning given such term in Paragraph 1(b) above.

        "Equipment Acquisition Loan" shall have the meaning given such term in Paragraph 1(a) above.

        "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as the same may from time to time be supplemented or amended.

        "Event of Default" shall have the meaning given such term in Paragraph 14 above.

        "Expansion Expenditures" shall mean Capital Expenditures directly related to the construction of new stores.

        "Existing Term Loan Facility" shall have the meaning given such term in Recital A above.

        "First Quarter" shall mean, with respect to any Fiscal Year, the fiscal quarter ending on or about September 30.

        "Fiscal Year" shall mean each fiscal year of the Company, with each such fiscal year ending on the Wednesday closest to the last calendar day of each June.

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        "Fourth Quarter" shall mean, with respect to any Fiscal Year, the fiscal quarter ending on or about June 30.

        "Funding Account" shall mean account no. 106116938 maintained in the Company's name with the Lender.

        "FY 2003 Expansion Line Conversion Date" shall mean June 30, 2003.

        "FY 2003 Expansion Line Credit Limit" shall mean $1,000,000.00.

        "FY 2003 Expansion Line Loan" shall have the meaning given such term in Paragraph 2(a) above.

        "FY 2003 Expansion Line Term-Out Loan" shall have the meaning given such term in Paragraph 2(b) above.

        "FY 2004 Expansion Line Conversion Date" shall mean June 30, 2004.

        "FY 2004 Expansion Line Credit Limit" shall mean $1,000,000.00.

        "FY 2004 Expansion Line Effective Date" shall mean July 1, 2003.

        "FY 2004 Expansion Line Loan" shall have the meaning given such term in Paragraph 2(a) above.

        "FY 2004 Expansion Line Term-Out Loan" shall have the meaning given such term in Paragraph 2(b) above.

        "GAAP" shall mean generally accepted accounting principles in the United States of America in effect from time to time.

        "Governmental Authority" shall mean any nation or government, any state or other political subdivision thereof, or any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government.

        "Guarantors" shall mean, collectively and severally, each of the Initial Guarantors and each Subsidiary of the Company formed or acquired following the Effective Date.

        "Guarantor Security Agreement" shall have the meaning given such term in Paragraph 9(b) above, and shall include any and all amendments and extensions and replacements thereof.

        "Guaranty" shall have the meaning given such term in Paragraph 9(b) above, and shall include any and all amendments and extensions and replacements thereof.

        "Hazardous Materials" shall mean: (a) "hazardous substances", "hazardous wastes," "hazardous materials," or "toxic substances," as defined in any of the Hazardous Material Laws; (b) any pollutant or contaminant, or hazardous, dangerous or toxic chemical, material, waste or substance ("pollutant") which Hazardous Material Laws prohibit, limit or otherwise regulate as to use, exposure, release, generation, manufacture, sale, transport, handling, storage, treatment, reuse, presence, disposal or recycling; (c) petroleum, crude oil or any fraction of petroleum or crude oil; (d) any radioactive material, including any source, special nuclear or by-product material, as defined at 42 U.S.C. §2011 et seq., and amendments thereto and reauthorizations thereof; (e) asbestos-containing materials in any form or condition; and (f) polychlorinated biphenyls.

        "Indebtedness" of any Person shall mean all items of indebtedness which, in accordance with GAAP and practices, would be included in determining liabilities as shown on the liability side of a statement of condition of such Person as of the date as of which indebtedness is to be determined, including, without limitation, all obligations for money borrowed and capitalized lease obligations, and shall also include all indebtedness and liabilities of others assumed or guaranteed by such Person or in respect of which such Person is secondarily or contingently liable (other than by

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endorsement of instruments in the course of collection) whether by reason of any agreement to acquire such indebtedness or to supply or advance sums or otherwise.

        "Initial Guarantors" shall mean each of the following, collectively and severally: (1) Coffee People Worldwide, Inc., a Delaware corporation, (2) Coffee People, Inc., an Oregon corporation, (3) Gloria Jean's, Inc., a Delaware corporation, (4) Edglo Enterprises, Inc., an Illinois corporation, (5) Gloria Jean's Gourmet Coffees Corp., an Illinois corporation, and (6) Gloria Jean's Gourmet Coffees Franchising Corp., an Illinois corporation.

        "Interim Date" shall mean May 29, 2002.

        "Interest Period" shall mean, with respect to any LIBOR Rate Loan, the period commencing on the date such Loan is advanced and ending one, two, three, four, five, or six months thereafter, as designated in the related Loan Request; provided, however, that: (1) any Interest Period which would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day; (2) in the case of an Equipment Acquisition Loan, no Interest Period shall end after the Equipment Acquisition Line Conversion Date, (3) in the case of a FY 2003 Expansion Line Loan, no Interest Period shall end after the FY 2003 Expansion Line Conversion Date, (4) in the case of a FY 2004 Expansion Line Loan, no Interest Period shall end after the FY 2003 Expansion Line Conversion Date, (5) in the case of a Working Capital Loan, no Interest Period shall end after the Working Capital Facility Maturity Date, and (6) in the case of any Term Loan, no Interest Period shall end after the scheduled final maturity date therefor.

        "Keurig Equipment" shall mean the Packaging Lines as defined in that certain Licensing Agreement dated as of March 13, 2000 by and between the Company and Keurig, Inc which the Company has the right to purchase thereunder.

        "L/C Documents" shall mean any and all documents, instruments and agreements as the Lender may require be delivered to it as a condition precedent to the issuance by the Lender of a Letter of Credit.

        "L/C Drawing" shall mean any drawing under a Letter of Credit.

        "L/C Facility Sublimit" shall mean $250,000.00.

        "Lender" shall have the meaning given such term in the introductory paragraph hereof.

        "Letter of Credit" shall have the meaning given such term in Paragraph 5(a) above.

        "Letter of Credit Application" shall mean an application for the issuance of a Letter of Credit in form satisfactory to the Lender.

        "LIBOR Rate" shall mean, with respect to any Interest Period for a LIBOR Rate Loan, the rate for the applicable Interest Period determined by the Lender's Treasury Desk as being the arithmetic mean (rounded upwards, if necessary, to the nearest whole multiple of one-sixteenth of one percent (¹/16%)) of the U.S. dollar London Interbank Offered Rates for such period appearing on Page 3750 (or such other page as may replace page 3750) of the Telerate screen at or about 11:00 a.m. (London time) on the second Business Day prior to the first days of such Interest Period (adjusted for any and all assessments, surcharges and reserve requirements.

        "LIBOR Rate Loan" shall mean a Loan during such time as it is made and/or being maintained at a rate of interest based upon the LIBOR Rate.

        "Lien" shall mean any security interest, mortgage, pledge, lien, claim on property, charge or encumbrance (including any conditional sale or other title retention agreement), any lease in the nature thereof, and the filing of or agreement to give any financial statement under the Uniform Commercial Code of any jurisdiction.

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        "Liquid Assets" shall mean cash, cash equivalents, marketable securities, and such other similar items as may be agreed upon by the Company and the Lender from time to time.

        "Loan Documents" shall mean this Agreement, the Collateral Documents, the Guaranties and each other document, instrument or agreement executed by the Company or the Guarantors in connection herewith or therewith, as any of the same may be amended, extended or replaced from time to time.

        "Loan Request" shall mean a request for a Loan in form satisfactory to the Lender.

        "Loans" shall mean, collectively and severally, the Equipment Acquisition Loans, the FY 2003 Expansion Line Loans, the FY 2004 Expansion Line Loans, the Working Capital Facility Loans and the Term Loans.

        "Material Adverse Effect" shall mean a material adverse change in, or a material adverse effect upon, any of: (a) the operations, business, properties, condition (financial or otherwise) or prospects of the Company; (b) a material impairment of the ability of the Company or the Guarantor to perform under any Loan Document to which it is party and to avoid any Event of Default; or (c) a material adverse effect upon the legality, validity, binding effect or enforceability of any Loan Document or the perfection or priority of the Lender's security interest in the Collateral.

        "Multiemployer Plan" as to any Person shall mean a Plan of such Person which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA.

        "Obligations" shall mean any and all debts, obligations and liabilities of the Company to the Lender (whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, created or incurred), arising out of or related to the Loan Documents.

        "Outstanding" shall mean with respect to Letters of Credit, any Letter of Credit which has not been canceled, expired, unutilized or fully drawn upon and reference to the "amount" of any Outstanding Letter of Credit shall be deemed to mean the amount available for drawing thereunder.

        "PBGC" shall mean the Pension Benefit Guaranty Corporation established pursuant to Subtitle A of Title IV of ERISA and any successor thereto.

        "Person" shall mean any corporation, natural person, firm, joint venture, partnership, limited liability company, trust, unincorporated organization, government or any department or agency of any government.

        "Plan" shall mean as to any Person, any pension plan that is covered by Title IV of ERISA and in respect of which such Person or a Commonly Controlled Entity of such Person is an "employer" as defined in Section 2(5) of ERISA.

        "Potential Default" shall mean an event which but for the lapse of time or the giving of notice, or both, would constitute an Event of Default.

        "Property" shall mean, collectively and severally, any and all real property, including all improvements and fixtures thereon, owned or occupied by the Company, including all real properties which are the subject of franchise agreements.

        "Reference Rate" shall mean the fluctuating per annum rate announced from time to time by the Lender in Los Angeles, California, as its "Reference Rate". The Reference Rate is a rate set by the Lender based upon various factors including the Lender's costs and desired return, general economic conditions, and other factors, and is used as a reference point for pricing some loans, which may be priced at, above or below the Reference Rate.

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        "Reference Rate Loans" shall mean Loans or portions thereof during such time as they are made and/or being maintained at a rate of interest based upon the Reference Rate.

        "Regulation U" shall mean Regulation U of the Board of Governors of the Federal Reserve System (12 C.F.R. § 221), as the same may from time to time be amended, supplemented or superseded.

        "Replacement Term Loan" shall have the meaning given such term in Paragraph 6(a) above.

        "Reportable Event" shall mean a reportable event as defined in Title IV of ERISA, except actions of general applicability by the Secretary of Labor under Section 110 of ERISA.

        "Requirements of Law" shall mean as to any Person the Certificate/Articles of Incorporation and ByLaws or other organizational or governing documents of such Person, and any law, treaty, rule or regulation, or a final and binding determination of an arbitrator or a determination of a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject.

        "Second Quarter" shall mean, with respect to any Fiscal Year, the fiscal quarter ending on or about December 31.

        "Security Agreement" shall have the meaning given such term in Paragraph 9(a) above, and shall include any and all amendments and extensions and replacements thereof.

        "Single Employer Plan" shall mean as to any Person any Plan of such Person which is not a Multiemployer Plan.

        "Statement Date" shall mean June 27, 2001.

        "Subordinated Debt" shall mean for any Person Indebtedness of such Person subordinated to the Obligations pursuant to a written subordination agreement in form and substance acceptable to the Lender, in its sole and absolute discretion.

        "Subsidiary" shall mean with respect to any Person, any corporation, partnership or joint venture more than fifty percent (50%) of the stock or other ownership interest of which having by the terms thereof ordinary voting power to elect the board of directors, managers or trustees of such corporation, partnership or joint venture shall, at the time as of which any determination is being made, be owned by such Person, either directly or through Subsidiaries of such Person (irrespective of whether or not at the time stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency).

        "Term Loans" shall mean, collectively and severally, the Replacement Term Loan, the Equipment Acquisition Term Loan, the FY 2003 Expansion Line Term-Out Loan, and the FY 2004 Expansion Line Term-Out Loan.

        "Third Quarter" shall mean, with respect to any Fiscal Year, the fiscal quarter ending on or about March 31.

        "Total Liabilities" shall mean for any Person at any time of determination, all liabilities of such Person which in accordance with GAAP would be shown on the liability side of a balance sheet of such Person, as determined in accordance with GAAP.

        "Working Capital Facility Credit Limit" shall have the meaning give such term in Paragraph 4(a) above.

        "Working Capital Loan" shall have the meaning given such term in Paragraph 4(a) above.

        "Working Capital Facility Maturity Date" shall mean August 31, 2003.

[Signature Page Following]

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        IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first above written.

DIEDRICH COFFEE, INC., a Delaware corporation
By:	/s/  PHILIP G. HIRSCH
Name:	Philip G. Hirsch
Title:	Chief Executive Officer
By:	/s/  MATTHEW C. MCGUINNESS
Name:	Matthew C. McGuinness
Title:	Executive Vice President and Chief Financial Officer
BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK
By:	/s/  BRUCE YOUNG
Name:	Bruce Young, Vice President

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EXHIBIT 10.30

CREDIT AGREEMENT
RECITALS
AGREEMENT

EX-10.31

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EXHIBIT 10.31

FORM OF
GUARANTY

        THIS GUARANTY (the "Guaranty") is made and dated as of the 3rd day of September, 2002 by                        , a                        ("Guarantor").

RECITALS

        A.    This Guaranty is being executed and delivered to BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK (the "Lender") pursuant to that certain Credit Agreement dated concurrently herewith by and among DIEDRICH COFFEE, INC., a California corporation (the "Company") and the Lender (as amended, extended and replaced from time to time, the "Credit Agreement," and with capitalized terms not otherwise defined herein used with the meanings given such terms in the Credit Agreement).

        B.    Pursuant to the Credit Agreement the Lender has agreed to extend credit to the Company on the terms and subject to the conditions set forth therein.

        C.    As a condition precedent to the Lender's obligation to extend credit under the Credit Agreement, Guarantor is required, among other things, to execute and deliver this Guaranty to the Lender.

        NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Guarantor hereby agrees as follows:

AGREEMENT

        1.    Guarantor hereby absolutely and unconditionally guarantees the payment when due, upon maturity, acceleration or otherwise, of all Obligations of the Company to the Lender under the Credit Agreement, including in all cases, whether heretofore, now, or hereafter made, incurred or created, whether voluntary or involuntary and however arising, absolute or contingent, liquidated or unliquidated, determined or undetermined, whether or not such Obligations are from time to time reduced, or extinguished and thereafter increased or incurred, whether the Company may be liable individually or jointly with others, whether or not recovery upon such Obligations may be or hereafter become barred by any statute of limitations, and whether or not such Obligations may be or hereafter become otherwise unenforceable.

        2.    Guarantor hereby absolutely and unconditionally guarantees the payment of the Obligations, whether or not due or payable by the Company, upon: (a) the dissolution, insolvency or business failure of, or any assignment for benefit of creditors by, or commencement of any bankruptcy, reorganization, arrangement, moratorium or other debtor relief proceedings by or against, either the Company or Guarantor, as applicable, or (b) the appointment of a receiver for, or the attachment, restraint of or making or levying of any order of court or legal process affecting, the property of either the Company or Guarantor, and unconditionally promises to pay such Obligations to the Lender, or order, on demand, in lawful money of the United States.

        3.    The liability of Guarantor hereunder is exclusive and independent of any security for or other guaranty of the Obligations, whether executed by Guarantor or by any other party, and the liability of Guarantor hereunder is not affected or impaired by (a) any direction of application of payment by the Company or by any other party, or (b) any other guaranty, undertaking or maximum liability of Guarantor or of any other party as to the Obligations, or (c) any payment on or in reduction of any such other guaranty or undertaking, or (d) any revocation or release of any obligations of any other guarantor of the Obligations, or (e) any dissolution, termination or increase, decrease or change in personnel of Guarantor, or (f) any payment made to the Lender on the Obligations which the Lender

repays to the Company pursuant to court order in any bankruptcy, reorganization, arrangement, moratorium or other debtor relief proceeding, and Guarantor waives any right to the deferral or modification of Guarantor's obligations hereunder by reason of any such proceeding.

        4.    (a)    The obligations of Guarantor hereunder are independent of the obligations of the Company with respect to the Obligations, and a separate action or actions may be brought and prosecuted against Guarantor whether or not action is brought against the Company and whether or not the Company be joined in any such action or actions. Guarantor waives, to the fullest extent permitted by law, the benefit of any statute of limitations affecting its liability hereunder or the enforcement thereof. Any payment by the Company or other circumstance which operates to toll any statute of limitations as to the Company shall operate to toll the statute of limitations as to Guarantor.

                (b)    All payments made by Guarantor under this Guaranty shall be made without set-off or counterclaim and free and clear of and without deductions for any present or future taxes, fees, withholdings or conditions of any nature ("Taxes"). Guarantor shall pay any such Taxes, including Taxes on any amounts so paid, and will promptly furnish the Lender copies of any tax receipts or such other evidence of payment as the Lender may require.

        5.    Guarantor authorizes the Lender (whether or not after termination of this Guaranty), without notice or demand (except as shall be required by applicable statute and cannot be waived), and without affecting or impairing its liability hereunder, from time to time to (a) renew, compromise, extend, increase, accelerate or otherwise change the time for payment of, or otherwise change the terms of Obligations or any part thereof, including increase or decrease of the rate of interest thereon; (b) take and hold security for the payment of this Guaranty or the Obligations and exchange, enforce, waive and release any such security; (c) apply such security and direct the order or manner of sale thereof as the Lender in its reasonable discretion may determine (for the avoidance of doubt, it shall not be reasonable for the Lender to apply sums received by it in such way as to trigger an Event of Default under the Credit Agreement if such Event of Default could have been avoided through a different application of such sums reasonably acceptable to the Lender); and (d) release or substitute any one or more endorsers, guarantors, the Company or other obligors. The Lender may, without notice to or the further consent of the Company or Guarantor, assign this Guaranty in whole or in part to any person acquiring an interest in the Obligations.

        6.    It is not necessary for the Lender to inquire into the capacity or power of the Company or the officers acting or reasonably believed to be acting on their behalf, and Obligations made or created in reasonable reliance upon the professed exercise of such powers shall be guaranteed hereunder.

        7.    Guarantor waives any right to require the Lender to (a) proceed against the Company or any other party; (b) proceed against or exhaust any security held from the Company; or (c) pursue any other remedy whatsoever. Guarantor waives any personal defense based on or arising out of any personal defense of the Company other than payment in full of the Obligations, including, without limitation, any defense based on or arising out of the disability of either the Company, or the unenforceability of the Obligations or any part thereof from any cause, or the cessation from any cause of the liability of the Company other than payment in full of the Obligations. The Lender may, at its election, foreclose on any security held for the Obligations by one or more judicial or nonjudicial sales, or exercise any other right or remedy they may have against the Company, or any security, without affecting or impairing in any way the liability of Guarantor hereunder except to the extent the Obligations have been paid. Guarantor waives all rights and defenses arising out of an election of remedies, even though that election of remedies, such as a nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed Guarantor's rights of subrogation and reimbursement against the principal by operation of Section 580d of the California Code of Civil Procedure.

        8.    Guarantor hereby waives any claim or other rights which Guarantor may now have or may hereafter acquire against the Company or any other guarantor of all or any of the Obligations that

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arise from the existence or performance of Guarantor's obligations under this Guaranty or any other of the Loan Documents (all such claims and rights being referred to as the "Guarantor's Conditional Rights"), including, without limitation, any right of subrogation, reimbursement, exoneration, contribution, or indemnification, any right to participate in any claim or remedy which the Lender has against the Company or any collateral which the Lender now has or hereafter acquires for the Obligations, whether or not such claim, remedy or right arises in equity or under contract, statute or common law, by any payment made hereunder or otherwise, including, without limitation, the right to take or receive from the Company, directly or indirectly, in cash or other property or by setoff or in any other manner, payment or security on account of such claim or other rights. If, notwithstanding the foregoing provisions, any amount shall be paid to Guarantor on account of Guarantor's Conditional Rights and either (a) such amount is paid to Guarantor at any time when the Obligations shall not have been paid or performed in full, or (b) regardless of when such amount is paid to Guarantor any payment made by the Company to the Lender is at any time determined to be a preferential payment, then such amount paid to Guarantor shall be deemed to be held in trust for the benefit of Lender and shall forthwith be paid to the Lender to be credited and applied upon the Obligations, whether matured or unmatured, in such order and manner as Lender, in its reasonable discretion, shall determine (for the avoidance of doubt, it shall not be reasonable for the Lender to apply sums received by it in such way as to trigger an Event of Default under the Credit Agreement if such Event of Default could have been avoided through a different application of such sums reasonably acceptable to the Lender). To the extent that any of the provisions of this Paragraph 8 shall not be enforceable, Guarantor agrees that until such time as the Obligations have been paid and performed in full and the period of time has expired during which any payment made by the Company or Guarantor may be determined to be a preferential payment, Guarantor's Conditional Rights to the extent not validly waived shall be subordinate to the Lender's right to full payment and performance of the Obligations and Guarantor shall not seek to enforce Guarantor's Conditional Rights during such period.

        9.    Guarantor waives all presentments, demands for performance, protests and notices, including, without limitation, notices of nonperformance, notices of protest, notices of dishonor, notices of acceptance of this Guaranty, and notices of the existence, creation or incurring of new or additional Obligations. Guarantor assumes all responsibility for being and keeping itself informed of either the Company's financial condition and assets, and of all other circumstances bearing upon the risk of nonpayment of the Obligations and the nature, scope and extent of the risks which Guarantor assumes and incurs hereunder, and agrees that the Lender shall have no duty to advise Guarantor of information known to it regarding such circumstances or risks.

        10.  In addition to the Obligations, Guarantor agrees to pay reasonable attorneys' fees and all other reasonable costs and expenses incurred by the Lender in enforcing this Guaranty in any action or proceeding arising out of or relating to this Guaranty.

        11.  Guarantor hereby represents and warrants to the Lender that:

        (a)  Guarantor: (1) has the power and authority and the legal right to own and operate Guarantor's property and to conduct business in the manner in which Guarantor does and proposes so to do, (2) is in compliance with all Requirements of Law binding upon or applicable to Guarantor, and (3) has reviewed and approved the Credit Agreement and the other Loan Documents;

        (b)  Guarantor has the corporate power and authority and the legal right to execute, deliver and perform this Guaranty. This Guaranty has been duly executed and delivered by Guarantor and constitute the legal, valid and binding obligation of Guarantor, enforceable against Guarantor in accordance with its terms, except as such enforceability may be affected by the effect of bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect relating to or affecting the rights or remedies of creditors generally;

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        (c)  The execution, delivery and performance of this Guaranty by Guarantor will not violate any Requirement of Law or Contractual Obligation binding upon or applicable to Guarantor; and

        (d)  All representations and warranties relating to Guarantor set forth in the Credit Agreement are accurate and complete in all respects.

        12.  Guarantor hereby covenants and agrees with the Lender that it will cooperate with the Company to facilitate the Company's compliance with all the covenants set forth in the Credit Agreement. Guarantor further agrees to execute any and all further documents, instruments and agreements as the Lender from time to time reasonably requests to evidence Guarantor's obligations hereunder.

        13.  This Guaranty shall be governed by and construed in accordance with the laws of the State of California without giving effect to its choice of law rules.

        14.  ANY LEGAL ACTION OR PROCEEDING WITH RESPECT TO THIS GUARANTY MAY BE BROUGHT IN THE COURTS OF THE STATE OF CALIFORNIA OR OF THE UNITED STATES FOR THE CENTRAL DISTRICT OF CALIFORNIA, AND BY EXECUTION AND DELIVERY OF THIS GUARANTY, GUARANTOR CONSENTS, FOR ITSELF AND IN RESPECT OF ITS PROPERTY, TO THE NON-EXCLUSIVE JURISDICTION OF THOSE COURTS. GUARANTOR IRREVOCABLY WAIVES ANY OBJECTION, INCLUDING ANY OBJECTION TO THE LAYING OF VENUE OR BASED ON THE GROUNDS OF FORUM NON CONVENIENS, WHICH IT MAY NOW OR HEREAFTER HAVE TO THE BRINGING OF ANY ACTION OR PROCEEDING IN SUCH JURISDICTION IN RESPECT OF THIS GUARANTY. GUARANTOR WAIVES PERSONAL SERVICE OF ANY SUMMONS, COMPLAINT OR OTHER PROCESS, WHICH MAY BE MADE BY ANY OTHER MEANS PERMITTED BY CALIFORNIA LAW.

        15.  GUARANTOR, AND BY ACCEPTING THIS GUARANTY THE LENDER, WAIVES ITS RIGHTS TO A TRIAL BY JURY OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF OR RELATED TO THIS GUARANTY OR THE TRANSACTIONS CONTEMPLATED HEREBY, IN ANY ACTION, PROCEEDING OR OTHER LITIGATION OF ANY TYPE BROUGHT BY ANY PARTY AGAINST ANY OTHER PARTY, WHETHER WITH RESPECT TO CONTRACT CLAIMS, TORT CLAIMS, OR OTHERWISE. GUARANTOR AND THE LENDER AGREE THAT ANY SUCH CLAIM OR CAUSE OF ACTION SHALL BE TRIED BY A COURT TRIAL WITHOUT A JURY. WITHOUT LIMITING THE FOREGOING, GUARANTOR FURTHER AGREES THAT ITS RIGHT TO A TRIAL BY JURY IS WAIVED BY OPERATION OF THIS SECTION AS TO ANY ACTION, COUNTERCLAIM OR OTHER PROCEEDING WHICH SEEKS, IN WHOLE OR IN PART, TO CHALLENGE THE VALIDITY OR ENFORCEABILITY OF THIS GUARANTY OR ANY PROVISION HEREOF. THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS GUARANTY.

        IN WITNESS WHEREOF, the Guarantor has caused this Guaranty to be executed as of the day and year first written above.

[GUARANTOR]

By:

Name:

Its:

By:

Name:

Its:

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EXHIBIT 10.31

FORM OF GUARANTY
RECITALS
AGREEMENT

EX-10.32

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EXHIBIT 10.32

FORM OF
GUARANTOR SECURITY AGREEMENT

        THIS SECURITY AGREEMENT (the "Security Agreement") is made and dated as of the 3rd day of September, 2002 by and between                        , a                         corporation ("Company"), and BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK (the "Lender").

RECITALS

        A.    Pursuant to that certain Credit Agreement dated of even date herewith by and between Diedrich Coffee, Inc., a Delaware corporation (the "Borrower") and the Lender (as amended, extended and replaced from time to time, the "Credit Agreement," and with capitalized terms not otherwise defined herein used with the meanings given such terms in the Credit Agreement) the Lender has agreed to extend credit to the Borrower from time to time.

        B.    As a condition precedent to the Lender's obligation to extend credit under the Credit Agreement, Company entered into that certain Guaranty dated as of even date herewith (the "Guaranty"), pursuant to which Company guaranteed the Obligations of the Borrower under the Credit Agreement on the terms and conditions set forth therein.

        C.    As security for the payment and performance of the Secured Obligations (as defined in Paragraph 3 below), Company is required to execute and deliver this Security Agreement, and to grant to the Lender and to create a security interest in certain property of Company, as hereinafter provided.

        NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows:

AGREEMENT

        1.    Grant of Security Interest.    Company hereby pledges, assigns and grants to the Lender a security interest in the property described in Paragraph 2 below (collectively and severally, the "Collateral") to secure payment and performance of the Secured Obligations.

        2.    Collateral.    The Collateral shall consist of all right, title and interest of Company in and to the following:

        (a)  One hundred percent (100%) of all shares of capital stock, now owned or hereafter acquired by the Company of each now existing and hereafter formed or acquired directly owned Subsidiary of the Company, together with, in all cases, all new, substituted and additional securities at any time issued with respect thereto (collectively and severally, the "Pledged Shares") with all the Pledged Shares in existence as of the date hereof being listed and described on Schedule 1 hereto);

        (b)  All now existing and hereafter arising rights of the holder of Pledged Shares with respect thereto, including, without limitation, all voting rights and all rights to cash and noncash dividends and other distributions on account thereof;

        (c)  All now existing and hereafter arising accounts, chattel paper, documents, instruments, letter-of-credit rights, commercial tort claims, and general intangibles (as those terms are defined in the California Uniform Commercial Code as in effect from time to time (the "Code")) of Company, whether or not arising out of or in connection with the sale or lease of goods or the rendering of services, and all rights of Company now and hereafter arising in and to all security agreements, guaranties, leases and other writings securing or otherwise relating to any such accounts, chattel paper, documents, instruments, letter-of-credit rights, commercial tort claims and general intangibles;

        (d)  All inventory of Company, now owned and hereafter acquired, wherever located, including, without limitation, all merchandise, goods and other personal property which are held for sale or lease or leased by Company or to be furnished under a contract of service, all raw materials, work in process, materials used or consumed in Company's business and finished goods, all goods in which Company has an interest in mass or a joint or other interest or gifts of any kind (including goods in which Company has an interest or right as consignee), and all goods which are returned to or repossessed by Company, together with all additions and accessions thereto and replacements therefor and products thereof and documents therefor;

        (e)  All equipment of Company, now owned and hereafter acquired, wherever located, and all parts thereof and all accessions, additions, attachments, improvements, substitutions and replacements thereto and therefor, including, without limitation, all machinery, tools, dies, blueprints, catalogues, computer hardware and software, furniture, furnishings and fixtures;

        (f)    All now existing and hereafter acquired Computer Hardware and Software Collateral, Copyright Collateral, Patent Collateral, Trademark Collateral and Trade Secrets Collateral (as those terms are defined in Paragraph 16 below) (collectively, the "Intellectual Property Collateral");

        (g)  All deposit accounts, now existing and hereafter arising or established, maintained in Company's name with any financial institution, and any and all funds at any time held therein and all certificates, instruments and other writings, if any, from time to time representing, evidencing or deposited into such accounts, and all interest, dividends, cash, instruments and other property from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the foregoing;

        (h)  All of Company's right, title and interest in and to (but not Company's obligations under) all now existing and hereafter arising contracts and agreements to which Company is party, including, without limitation, each of the agreements listed on Schedule 2 hereto, in each case as such agreements may be amended, supplemented or otherwise modified from time to time (such agreements, as so amended, supplemented or modified, individually, an "Assigned Agreement," and, collectively, the "Assigned Agreements"), including, without limitation, all rights of Company to receive moneys due and to become due under or pursuant to the Assigned Agreements, all rights of Company to receive proceeds of any insurance, indemnity, warranty or guaranty with respect to the Assigned Agreements, all claims of Company for damages arising out of or for breach of or default under the Assigned Agreements, and all rights of Company to terminate, amend, supplement or modify the Assigned Agreements, to perform thereunder and to compel performance and otherwise exercise all remedies thereunder; provided, however, that with respect to any such contract or agreement where the grant of a security interest in Company's right, title and interest therein is prohibited by the terms thereof, or would give any other party the right to terminate its obligations thereunder, or is not permitted because any necessary consent to such grant has not been obtained, the Collateral shall include only the rights of Company to receive moneys due and to become due, if any, under or pursuant to such contract or agreement;

        (i)    All now existing and hereafter acquired books, records, writings, data bases, information and other property relating to, used or useful in connection with, embodying, incorporating or referring to, any of the foregoing Collateral;

        (j)    All other property of Company now or hereafter in the possession, custody or control of the Lender, and all property of Company in which the Lender now has or hereafter acquires a security interest;

        (k)  All now existing and hereafter acquired cash and cash equivalents held by Company not otherwise included in the foregoing Collateral; and

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        (l)    All products and proceeds of the foregoing Collateral. For purposes of this Security Agreement, the term "proceeds" shall have the meaning provided in the Code, and also includes any voluntary or involuntary disposition, and all rights to payment, including return premiums, with respect to any insurance.

Notwithstanding anything herein to the contrary, in no event shall the Collateral include, and the Company shall not be deemed to have granted a security interest in, any of the Company's rights or interests in any license, permit, contract or agreement (or in any Equipment leased or financed thereunder) to which the Company is a party or any of its rights or interests thereunder to the extent, but only to the extent, that such a grant would, under the terms of such license, permit, contract or agreement or otherwise, result in a breach of the terms of, or constitute a default under any license, permit, contract or agreement (other than to the extent that any such term would be rendered ineffective pursuant to Sections 9-401, 9-406(d), 9-407, 9-408 or 9-409 under the Code or any other applicable law (including the Bankruptcy Code) or principles of equity); provided, that immediately upon the ineffectiveness, lapse or termination of any such provision, the Collateral shall include, and the Company shall be deemed to have granted a security interest in, all such rights and interest as if such provision had never been in effect.

        3.    Secured Obligations.    The obligations secured by this Security Agreement shall consist of all obligations of Company under the Guaranty and each other Loan Document, in each case whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, created or incurred (the "Secured Obligations").

        4.    Representations and Warranties.    In addition to all representations and warranties of Company set forth in the other Loan Documents, which are incorporated herein by this reference, Company hereby represents and warrants that:

        (a)  Company is the sole owner of and has good and marketable title to the Collateral (or, in the case of after-acquired Collateral, at the time Company acquires rights in the Collateral, except as specifically disclosed on Schedule 5 hereto.

        (b)  No Person has (or, in the case of after-acquired Collateral, at the time Company acquires rights therein, will have) any right, title, claim or interest (by way of security interest or other Lien or charge) in, against or to the Collateral other than as permitted by the Credit Agreement, except as specifically disclosed on Schedule 5 hereto.

        (c)  All information heretofore, herein or hereafter supplied to the Lender by or on behalf of Company with respect to the Collateral is accurate and complete in all material respects.

        (d)  Company has delivered to the Lender all instruments and chattel paper (in each case, in excess of $5,000.00) and other items of Collateral in which a security interest is or may be perfected by possession, together with such additional writings, including, without limitation, assignments, with respect thereto as the Lender shall request.

        (e)  The Company is (or, in the case of after-acquired Pledged Shares, at the time the Company acquires rights therein will be) the record and beneficial owner of, and has (and will have) good and marketable title to the Pledged Shares. The Pledged Shares have been (or will be) validly issued and are (or upon issuance will be) fully paid and non-assessable and there are no (and in the future will be no) outstanding options, warrants or shareholder or other similar agreements with respect to the Pledged Shares.

        (f)    All of the trademarks of the Company registered or applied to be registered with the United States Patent and Trademark Office as of the date hereof are as set forth on Schedule 3 hereto.

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        5.    Covenants and Agreements of Company.    In addition to all covenants and agreements of Company set forth in the other Loan Documents, which are incorporated herein by this reference, Company hereby agrees, at no cost or expense to the Lender:

        (a)  To do all acts (other than acts which are required to be done by the Lender) that may be necessary to maintain, preserve and protect the Collateral and the first priority, perfected security interest of the Lender therein.

        (b)  Not to use or permit any Collateral to be used unlawfully or in violation of any provision of this Security Agreement, any other agreement with the Lender related hereto, or any law, rule, regulation, order, writ, judgment, injunction, decree or award binding on Company or affecting any of the Collateral or any contractual obligation affecting any of the Collateral.

        (c)  To pay promptly when due all taxes, assessments, charges, encumbrances and Liens now or hereafter imposed upon or affecting any Collateral.

        (d)  To appear in and defend any action or proceeding which may affect its title to or the Lender's interest in the Collateral.

        (e)  Not to surrender or lose possession of (other than to the Lender), sell, encumber, lease, rent, or otherwise dispose of or transfer any Collateral or right or interest therein except as expressly provided herein and in the other Loan Documents, and to keep the Collateral free of all levies and security interests or other Liens or charges except as permitted by the Credit Agreement or otherwise approved in writing by the Lender; provided, however, that, unless an Event of Default shall have occurred and be continuing, Company may, in the ordinary course of business, sell or lease any Collateral (1) consisting of Inventory, or (2) in connection with the closing of a retail store or the sale of a retail store in accordance with Paragraph 13(p) of the Credit Agreement.

        (f)    To account fully for and promptly deliver to the Lender, in the form received, all documents, chattel paper in excess of $5,000.00, all stock certificates evidencing Pledged Shares, instruments in excess of $5,000.00 and agreements constituting Collateral hereunder, and all proceeds of the Collateral received, all endorsed to the Lender or in blank, as requested by the Lender, and accompanied by such stock powers as appropriate and until so delivered all such documents, instruments, agreements and proceeds shall be held by Company in trust for the Lender, separate from all other property of Company.

        (g)  To keep separate, accurate and complete records of the Collateral and to provide the Lender with such records and such other reports and information relating to the Collateral as the Lender may reasonably request from time to time.

        (h)  To give the Lender thirty (30) days prior written notice of any change in Company's chief place of business or legal name or trade name(s) or style(s) referred to in Paragraph 11 below.

        (i)    To keep the records concerning the Collateral at the location(s) referred to in Paragraph 11 below and not to remove such records from such location(s) without the prior written consent of the Lender.

        (j)    To keep the Collateral at the warehouse location(s) referred to in Paragraph 11 below and not to remove the Collateral from such warehouse location(s) without the prior written consent of the Lender.

        (k)  To keep the Collateral in good condition and repair and not to cause or permit any waste or unusual or unreasonable depreciation of the Collateral.

        6.    Authorized Action by Secured Party.    Company hereby agrees that following the occurrence and during the continuance of an Event of Default, without presentment, notice or demand, and without

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affecting or impairing in any way the rights of the Lender with respect to the Collateral, the obligations of Company hereunder or the Secured Obligations, the Lender may, but shall not be obligated to and shall incur no liability to Company or any third party for failure to, take any action which Company is obligated by this Security Agreement to do and to exercise such rights and powers as Company might exercise with respect to the Collateral, and Company hereby irrevocably appoints the Lender as its attorney-in-fact to exercise such rights and powers, including without limitation, to:

        (a)  Collect by legal proceedings or otherwise and endorse, receive and receipt for all dividends, interest, payments, proceeds and other sums and property now or hereafter payable on or on account of the Collateral.

        (b)  Enter into any extension, reorganization, deposit, merger, consolidation or other agreement pertaining to, or deposit, surrender, accept, hold or apply other property in exchange for the Collateral.

        (c)  Insure, process and preserve the Collateral.

        (d)  Transfer the Collateral to its own or its nominee's name.

        (e)  Make any compromise or settlement, and take any action it deems advisable, with respect to the Collateral.

        (f)    Subject to the provisions of Paragraph 7 below, notify any obligor on any Collateral to make payment directly to the Lender.

Company hereby grants to the Lender an exclusive, irrevocable power of attorney, with full power and authority in the place and stead of Company to take all such action permitted under this Paragraph 6; provided, however, that the Lender agrees that it shall not exercise such power of attorney unless there shall have occurred and be continuing an Event of Default. Company agrees to reimburse the Lender upon demand for any costs and expenses, including, without limitation, reasonable attorneys' fees, the Lender may incur while acting as Company's attorney-in-fact hereunder, all of which costs and expenses are included in the Secured Obligations secured hereby. It is further agreed and understood between the parties hereto that such care as the Lender gives to the safekeeping of its own property of like kind shall constitute reasonable care of the Collateral when in the Lender's possession; provided, however, that the Lender shall not be required to make any presentment, demand or protest, or give any notice and need not take any action to preserve any rights against any prior party or any other person in connection with the Secured Obligations or with respect to the Collateral.

        7.    Collection of Collateral Payments.

        (a)  Company shall, at its sole cost and expense, use commercially reasonable best efforts to obtain payment, when due and payable, of all sums due or to become due with respect to any Collateral ("Collateral Payments" or a "Collateral Payment"), including, without limitation, the taking of such action with respect thereto as the Lender may reasonably request, or, in the absence of such request, as Company may reasonably deem advisable; provided, however, that Company shall not, without the prior written consent of the Lender, grant or agree to any rebate, refund, compromise or extension with respect to any Collateral Payment or accept any prepayment on account thereof other than in the ordinary course of Company's business. Upon the request of the Lender made at any time following the occurrence and during the continuance of an Event of Default, Company will notify and direct any party who is or might become obligated to make any Collateral Payment, to make payment thereof to such accounts as the Lender may direct in writing and to execute all instruments and take all action required by the Lender to ensure the rights of the Lender in any Collateral subject to the Federal Assignment of Claims Act of 1940, as amended.

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        (b)  Upon the request of the Lender made at any time following the occurrence and during the continuance of an Event of Default, Company will, forthwith upon receipt, transmit and deliver to the Lender, in the form received, all cash, checks, drafts and other instruments for the payment of money (properly endorsed where required so that such items may be collected by the Lender) which may be received by Company at any time as payment on account of any Collateral Payment and if such request shall be made, until delivery to the Lender, such items will be held in trust for the Lender and will not be commingled by Company with any of its other funds or property. Thereafter, the Lender is hereby authorized and empowered to endorse the name of Company on any check, draft or other instrument for the payment of money received by the Lender on account of any Collateral Payment if the Lender believes such endorsement is necessary or desirable for purposes of collection.

        (c)  Company will indemnify and save harmless the Lender from and against all reasonable liabilities and expenses on account of any adverse claim asserted against the Lender relating to any moneys received by the Lender on account of any Collateral Payment and such obligation of Company shall continue in effect after and notwithstanding the discharge of the Secured Obligations and the release of the security interest granted in Paragraph 1 above.

        8.    Additional Covenants Regarding Intellectual Property Collateral.

        (a)  Company shall not, unless it shall either reasonably and in good faith determine that such Collateral is of negligible economic value to Company or that there is a valid purpose to do otherwise:

        (1)  Permit any Patent Collateral to lapse or become abandoned or dedicated to the public or otherwise be unenforceable;

        (2)  (i) Fail to continue to use any of the Trademark Collateral in order to maintain all of the Trademark Collateral in full force free from any claim of abandonment for non-use, (ii) fail to maintain as in the past the quality of products and services offered under all of the Trademark Collateral, (iii) fail to employ all of the Trademark Collateral registered with any Federal or state or foreign authority with an appropriate notice of such registration, (iv) adopt or use any other Trademark which is confusingly similar or a colorable imitation of any of the Trademark Collateral, (v) use any of the Trademark Collateral registered with any Federal or state or foreign authority except for the uses for which registration or application for registration of all of the Trademark Collateral has been made, or (vi) do or permit any act or knowingly omit to do any act whereby any of the Trademark Collateral may lapse or become invalid or unenforceable; or

        (3)  Do or permit any act or knowingly omit to do any act whereby any of the Copyright Collateral or any of the Trade Secrets Collateral may lapse or become invalid or unenforceable or placed in the public domain except upon expiration of the end of an unrenewable term of a registration thereof.

        (b)  Company shall notify the Lender immediately if it knows, or has reason to know, that any application or registration relating to any material item of the Intellectual Property Collateral may become abandoned or dedicated to the public or placed in the public domain or invalid or unenforceable, or of any adverse determination or development (including the institution of, or any such determination or development in, any proceeding in the United States Patent and Trademark Office, the United States Copyright Office or any foreign counterpart thereof or any court) regarding Company's ownership of any of the Intellectual Property Collateral, its right to register the same or to keep and maintain and enforce the same.

        (c)  In no event shall Company or any of its agents, employees, designees or licensees file an application for the registration of any Intellectual Property Collateral with the United States Patent

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and Trademark Office, the United States Copyright Office or any similar office or agency in any other country or any. political subdivision thereof, unless it promptly informs the Lender, and upon request of the Lender, executes and delivers any and all agreements, instruments, documents and papers as the Lender may reasonably request to evidence the Lender's security interest in such Intellectual Property Collateral and the goodwill and general intangibles of Company relating thereto or represented thereby.

        (d)  Company shall, contemporaneously herewith, execute and deliver to the Lender such supplemental agreements for filing in the United States Patent and Trademark Office and United States Copyright Office as the Lender may require and shall execute and deliver to the Lender any other document required to acknowledge or register or perfect the Lender's interest in any part of the Intellectual Property Collateral.

        9.    Administration of the Pledged Shares.    In addition to any provisions of this Security Agreement which govern the administration of the Collateral generally, the following provisions shall govern the administration of the Pledged Shares:

        (a)  Until there shall have occurred and be continuing an Event of Default, the Company shall be entitled to vote or consent with respect to the Pledged Shares in any manner not inconsistent with this Security Agreement or any document or instrument delivered or to be delivered pursuant to or in connection with any thereof and to receive all dividends paid with respect to the Pledged Shares. If there shall have occurred and be continuing an Event of Default and the Lender shall have notified the Company that the Lender desires to exercise its proxy rights with respect to all or a portion of the Pledged Shares, the Company hereby grants to the Lender an irrevocable proxy for the Pledged Shares pursuant to which proxy the Lender shall be entitled to vote or consent, in its discretion, and in such event the Company agrees to deliver to the Lender such further evidence of the grant of such proxy as the Lender may request.

        (b)  In the event that at any time or from time to time after the date hereof, the Company, as record and beneficial owner of the Pledged Shares, shall receive or shall become entitled to receive, any dividend or any other distribution whether in securities or property by way of stock split, spin-off, split-up or reclassification, combination of shares or the like, or in case of any reorganization, consolidation or merger, and the Company, as record and beneficial owner of the Pledged Shares, shall thereby be entitled to receive securities or property in respect of such Pledged Shares, then and in each such case, the Company shall deliver to the Lender and the Lender shall be entitled to receive and retain all such securities or property as part of the Pledged Shares as security for the payment and performance of the Secured Obligations; provided, however, that until there shall have occurred and be continuing an Event of Default, the Company shall be entitled to retain any cash dividends paid on account of the Pledged Shares.

        (c)  Upon the occurrence and during the continuation of an Event of Default, the Lender is authorized to sell the Pledged Shares and, at any such sale of any of the Pledged Shares, if it deems it advisable to do so, to restrict the prospective bidders or purchasers to persons or entities who (1) will represent and agree that they are purchasing for their own account, for investment, and not with a view to the distribution or sale of any of the Pledged Shares; and (2) satisfy the offeree and purchaser requirements for a valid private placement transaction under Section 4(2) of the Securities Act of 1933, as amended (the "Act"), and under Securities and Exchange Commission Release Nos. 33-6383; 34-18524; 35-22407; 39-700; IC-12264; AS-306, or under any similar statute, rule or regulation. the Company agrees that disposition of the Pledged Shares pursuant to any private sale made as provided above may be at prices and on other terms less favorable than if the Pledged Shares were sold at public sale, and that the Lender has no obligation to delay the sale of any Pledged Shares for public sale under the Act. The Company agrees that a private sale or sales made under the foregoing circumstances shall be deemed to

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have been made in a commercially reasonable manner. In the event that the Lender elects to sell the Pledged Shares, or part of them, and there is a public market for the Pledged Shares, in a public sale the Company shall use its commercially reasonable best efforts to register and qualify the Pledged Shares, or applicable part thereof, under the Act and all state Blue Sky or securities laws required by the proposed terms of sale and all expenses thereof shall be payable by the Company, including, but not limited to, all costs of (i) registration or qualification of, under the Act or any state Blue Sky or securities laws or pursuant to any applicable rule or regulation issued pursuant thereto, any Pledged Shares, and (ii) sale of such Pledged Shares, including, but not limited to, brokers' or underwriters' commissions, fees or discounts, accounting and legal fees, costs of printing and other expenses of transfer and sale.

        (d)  If any consent, approval or authorization of any state, municipal or other governmental department, agency or authority should be necessary to effectuate any sale or other disposition of the Pledged Shares, or any part thereof, the Company will execute such applications and other instruments as may be required in connection with securing any such consent, approval or authorization, and will otherwise use its commercially reasonable best efforts to secure the same.

        (e)  Nothing contained in this Paragraph 9 shall be deemed to limit the other obligations of the Company contained in the Credit Agreement or this Security Agreement and the rights of the Lender hereunder or thereunder.

        10.    Remedies.    Upon the occurrence and during the continuance of an Event of Default, the Lender may, without notice to or demand on Company and in addition to all rights and remedies available to the Lender with respect to the Secured Obligations, at law, in equity or otherwise, do any one or more of the following:

        (a)  Foreclose or otherwise enforce the Lender's security interest in any manner permitted by law or provided for in this Security Agreement.

        (b)  Sell, lease or otherwise dispose of any Collateral at one or more public or private sales at the Lender's place of business or any other place or places, including, without limitation, any broker's board or securities exchange, whether or not such Collateral is present at the place of sale, for cash or credit or future delivery, on such terms and in such manner as the Lender may determine.

        (c)  Recover from Company all costs and expenses, including, without limitation, reasonable attorneys' fees (including the allocated cost of internal counsel), incurred or paid by the Lender in exercising any right, power or remedy provided by this Subsidiary Security Agreement.

        (d)  Require Company to assemble the Collateral and make it available to the Lender at a place to be designated by the Lender.

        (e)  Enter onto property where any Collateral is located and take possession thereof with or without judicial process.

        (f)    Prior to the disposition of the Collateral, store, process, repair or recondition it or otherwise prepare it for disposition in any manner and to the extent the Lender deems appropriate and in connection with such preparation and disposition, without charge, use any trademark, tradename, copyright, patent or technical process used by Company.

Company shall be given five (5) Business Days' prior notice of the time and place of any public sale or of the time after which any private sale or other intended disposition of Collateral is to be made, which notice Company hereby agrees shall be deemed reasonable notice thereof. Upon any sale or other disposition pursuant to this Security Agreement, the Lender shall have the right to deliver, assign and transfer to the purchaser thereof the Collateral or portion thereof so sold or disposed of. Each purchaser at any such sale or other disposition (including the Lender) shall hold the Collateral free

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from any claim or right of whatever kind, including any equity or right of redemption of Company and Company specifically waives (to the extent permitted by law) all rights of redemption, stay or appraisal which it has or may have under any rule of law or statute now existing or hereafter adopted.

        11.    Chief Place of Business; Collateral Location; Records Location.    Company represents that the state in which it was organized and its chief place of business are as set forth on Schedule 4 attached hereto; that the only trade name(s) or style(s) used by Company are set forth on said Schedule 4; and that, except as otherwise disclosed to the Lender in writing prior to the date hereof, the Collateral and Company's records concerning the Collateral are located at its chief place of business.

        12.    Waiver of Hearing.    Company expressly waives to the extent permitted under applicable law any constitutional or other right to a judicial hearing prior to the time the Lender takes possession or disposes of the Collateral upon the occurrence and during the continuance of an Event of Default.

        13.    Cumulative Rights.    The rights, powers and remedies of the Lender under this Security Agreement shall be in addition to all rights, powers and remedies given to the Lender by virtue of any statute or rule of law, the Credit Agreement or any other agreement, all of which rights, powers and remedies shall be cumulative and may be exercised successively or concurrently without impairing the Lender's security interest in the Collateral.

        14.    Waiver.    Any forbearance or failure or delay by the Lender in exercising any right, power or remedy shall not preclude the further exercise thereof, and every right, power or remedy of the Lender shall continue in full force and effect until such right, power or remedy is specifically waived in a writing executed by the Lender. Company waives any right to require the Lender to proceed against any person or to exhaust any Collateral or to pursue any remedy in the Lender's power.

        15.    Setoff.    Company agrees that the Lender may exercise its rights of setoff with respect to the Secured Obligations in the same manner as if the Secured Obligations were unsecured.

        16.    Intellectual Property Collateral.    For purposes of this Security Agreement, the following capitalized terms shall have the following meanings:

        "Computer Hardware and Software Collateral" means all of Company's right, title and interest in all now existing and hereafter created or acquired:

        (a)  Computer and other electronic data processing hardware, integrated computer systems, central processing units, memory units, display terminals, printers, features, computer elements, card readers, tape drives, hard and soft disk drives, cables, electrical supply hardware, generators, power equalizers, accessories and all peripheral devices and other related computer hardware;

        (b)  Software programs (including both source code, object code and all related applications and data files), whether owned, licensed or leased, designed for use on the computers and electronic data processing hardware described in subparagraph (a) above;

        (c)  All firmware associated therewith;

        (d)  All documentation (including flow charts, logic diagrams, manuals, guides and specifications) with respect to such hardware, software and firmware described in subparagraph (a) through (c) above; and

        (e)  All rights with respect to all of the foregoing, including, without limitation, any and all of Company's copyrights, licenses, options, warranties, service contracts, program services, test rights, renewal rights and indemnifications and any substitutions, replacements, additions or model conversions of any of the foregoing.

        "Copyright Collateral" means copyrights and all semi-conductor chip product mask works of Company, whether statutory or common law, registered or unregistered, now or hereafter in force

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throughout the world including, without limitation, all of Company's right, title and interest in and to all copyrights and mask works registered in the United States Copyright Office or anywhere else in the world, and all applications for registration thereof, whether pending or in preparation, all copyright and mask work licenses, the right of Company to sue for past, present and future infringements of any thereof, all rights of Company corresponding thereto throughout the world, all extensions and renewals of any thereof and all proceeds of the foregoing, including, without limitation, licenses, royalties, income, payments, claims damages and proceeds of suit.

        "Patent Collateral" means:

        (a)  All of Company's letters patent and applications for letters patent throughout the world, including all of Company's patent applications in preparation for filing anywhere in the world and with the United States Patent and Trademark Office;

        (b)  All of Company's patent licenses;

        (c)  All reissues, divisions, continuations, continuations-in-part, extensions, renewals and reexaminations of any of the items described in clauses (a) and (b); and

        (d)  All proceeds of, and rights associated with, the foregoing (including license royalties and proceeds of infringements suits), the right of Company to sue third parties for past, present or future infringements of any patent or patent application of Company, and for breach of enforcement of any patent license, and all rights corresponding thereto throughout the world.

        "Trademark Collateral" means:

        (a)  All of Company's trademarks, trade names, corporate names, business names, fictitious business names, trade styles, service marks, certification makers, collective marks, logos, other source of business identifiers, prints and labels on which any of the foregoing have appeared or appear, designs and general intangibles of a like nature (all of the foregoing items in this clause (a) being collectively called a "Trademark"), now existing anywhere in the world or hereafter adopted or acquired, whether currently in use or not, all registrations and recordings thereof and all applications in connection therewith, whether pending or in preparation for filing, including registrations, recordings and applications in the United States Patent and Trademark Office or in any office or agency of the United States of America or any State thereof or any foreign country;

        (b)  All of Company's Trademark licenses;

        (c)  All reissues, extensions or renewals of any of the items described in clauses (a) and (b);

        (d)  All of the goodwill of the business of Company connected with the use of, and symbolized by the items described in, clauses (a) and (b), and

        (e)  All proceeds of, and rights of Company associated with, the foregoing, including any claim by Company against third parties for past, present or future infringement or dilution of any Trademark, Trademark registration or Trademark license, or for any injury to the goodwill associated with the use of any such Trademark or for breach or enforcement of any Trademark license.

        "Trade Secrets Collateral" means common law and statutory trade secrets and all other confidential or proprietary or useful information and all know-how obtained by or used in or contemplated at any time for use in the business of Company (all of the foregoing being collectively called a "Trade Secret"), whether or not such Trade Secret has been reduced to a writing or other tangible form including all documents and things embodying, incorporating or referring in any way to such Trade Secret, all Trade Secret licenses, including the right to sue for

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and to enjoin and to collect damages for the actual or threatened misappropriation of any Trade Secret and for the breach or enforcement of any such Trade Secret license.

        17.    Financing Statements.    The Company hereby acknowledges and agrees that the Lender, in connection with the filing of any UCC financing statements necessary to perfect or maintain the perfection of its Lien in the Collateral hereunder, may utilize a general description of the Collateral, such as "all now owned and hereafter acquired personal property of the Company."

        18    Governing Law.    This Security Agreement shall be governed by and construed in accordance with the internal laws of the State of California.

        IN WITNESS WHEREOF, this Security Agreement is executed as of the day and year first above written.

[GUARANTOR]

By:

Name:

Its:

By:

Name:

Its:

BANK OF THE WEST, doing business as
UNITED CALIFORNIA BANK

By:

Name:

Its:

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EXHIBIT 10.32

FORM OF GUARANTOR SECURITY AGREEMENT
RECITALS
AGREEMENT

EX-10.33

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EXHIBIT 10.33

FORM OF
SUPPLEMENTAL SECURITY AGREEMENT
(Trademarks)

        THIS SUPPLEMENTAL SECURITY AGREEMENT (the "Supplemental Trademark Agreement") is made and dated this 3rd day of September, 2002 by and between DIEDRICH COFFEE, INC., a Delaware corporation ("Borrower") and BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK (the "Lender") with respect to that certain Credit Agreement dated as of even date herewith by and between the Borrower and the Lender (as amended, extended and replaced from time to time, the "Credit Agreement" and with all capitalized terms not otherwise defined herein used with the meaning given such terms in the Credit Agreement).

RECITALS

        A.    Pursuant to that certain Security Agreement dated as of even date herewith between Borrower and the Lender (as amended from time to time, the "Security Agreement"), Borrower has granted to the Lender a first priority perfected security interest in certain assets of Borrower, including, without limitation, all patents, trademarks, service marks, trade names, copyrights, goodwill, licenses and other intellectual property owned by Borrower or used in Borrower's business.

        B.    The parties hereto desire to supplement the Security Agreement as it relates to certain of such intellectual property consisting generally of trademarks and to create hereby a document appropriate for recordation in the Patent and Trademark Office of the United States (the "PTO").

        NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows:

AGREEMENT

        1.    Confirmation of Grant of Security Interest.    Borrower hereby confirms the grant of security interest, pledge, assignment and mortgage set forth in the Security Agreement and acknowledges that the Collateral described therein includes, without limitation, all of Borrower's right, title and interest in the following (the "Trademark Collateral"):

        (a)  All trademarks, service marks, designs, logos, indicia, tradenames, corporate names, company names, business names, fictitious business names trade styles and other source, product and business identifiers pertaining to the products, services and business of Borrower, whether now owned or hereafter acquired, including, without limitation, the trademarks specifically described on Schedule I attached hereto, as the same may be amended or replaced from time to time with the consent of the Lender;

        (b)  All now existing and hereafter arising registrations and applications for registration relating to any of the foregoing, all renewals and extensions thereof throughout the world in perpetuity, and all rights to make such applications and to renew and extend the same;

        (c)  All now existing and hereafter arising rights and licenses to make, have made, use and/or sell any items disclosed and claimed by any of the foregoing;

        (d)  All now existing and hereafter arising right (but not the obligation) to register claims under any state, federal or foreign trademark law or regulation;

        (e)  All now existing and hereafter arising rights, claims and interests under licensing or other contracts pertaining to any of the foregoing to the extent such rights are assignable;

        (f)    All now existing and hereafter arising documents, instruments and agreements which reveal the name and address of sources of supply, distribution methods and all terms of purchase,

rental, license or use and delivery for all materials, products and components used in connection with any of the foregoing;

        (g)  All now existing and hereafter arising specifications as to and quality control manuals used in connection with the operations conducted under the name of or in connection with the foregoing;

        (h)  All now existing and hereafter arising goodwill associated with any of the foregoing;

        (i)    All now existing and hereafter arising right (but not the obligation) to sue or bring opposition or cancellation proceedings in the name of Borrower or the Lender for past, present and future infringements of any of the foregoing;

        (j)    All products and Proceeds of any of the foregoing.

        2.    Additional Representation and Warranty and Covenant.    In addition to all representations and warranties, covenants and agreements set forth in the Security Agreement, Borrower hereby:

        (a)  Represents and warrants that Schedule I attached hereto sets forth an accurate and complete list of all trademarks owned by Borrower which are registered with the PTO as of the date hereof; and

        (b)  Agrees to promptly notify the Lender in writing of any additional trademarks registered with the PTO of which Borrower becomes the owner and to amend Schedule I accordingly.

        3.    No Present Assignment.    Neither the Security Agreement, this Supplemental Trademark Agreement nor any other document, instrument or agreement creates or is intended to create a present assignment of the Trademark Collateral. Subject to the rights of the Lender under the Security Agreement and this Supplemental Trademark Agreement, it is the intention of the parties hereto that Borrower continue to own the Trademark Collateral and that upon the indefeasible payment and performance in full of the Obligations, the rights of the Lender under the Security Agreement and this Supplemental Trademark Agreement in and to the Trademark Collateral shall be released and terminated.

        4.    Relationship to Security Agreement.    The Trademark Collateral shall constitute Collateral for all purposes of the Security Agreement and the other Loan Documents and the Lender shall have all rights, powers and remedies with respect to the Trademark Collateral to the same extent as they have with respect to other Collateral. Reference is hereby made to the Security Agreement, the terms and conditions of which are incorporated herein by this reference.

        IN WITNESS WHEREOF, this Supplemental Trademark Agreement is executed as of the date first written above.

DIEDRICH COFFEE, INC., a Delaware corporation
By:
Name:
Title:
By:
Name:
Title:
BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK
By:	Bruce Young, Vice President

2

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EXHIBIT 10.33

FORM OF SUPPLEMENTAL SECURITY AGREEMENT (Trademarks)
RECITALS
AGREEMENT

EX-10.34

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EXHIBIT 10.34

SECURITY AGREEMENT

        THIS SECURITY AGREEMENT (the "Security Agreement") is made and dated as of the 3rd day of September, 2002 by and between DIEDRICH COFFEE, INC., a Delaware corporation ("Company"), and BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK (the "Lender").

RECITALS

        A.    Pursuant to that certain Credit Agreement dated of even date herewith by and between Company and the Lender (as amended, extended and replaced from time to time, the "Credit Agreement," and with capitalized terms not otherwise defined herein used with the meanings given such terms in the Credit Agreement) the Lender has agreed to extend credit to Company from time to time.

        B.    As a condition precedent to the Lender's obligation to extend credit under the Credit Agreement and as security for the payment and performance of the Obligations, Company is required to execute and deliver this Security Agreement, and to grant to the Lender and to create a security interest in certain property of Company, as hereinafter provided.

        NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows:

AGREEMENT

        1.    Grant of Security Interest.    Company hereby pledges, assigns and grants to the Lender a security interest in the property described in Paragraph 2 below (collectively and severally, the "Collateral") to secure payment and performance of the Obligations.

        2.    Collateral.    The Collateral shall consist of all right, title and interest of Company in and to the following:

        (a)  One hundred percent (100%) of all shares of capital stock, now owned or hereafter acquired by the Company of each now existing and hereafter formed or acquired directly owned Subsidiary of the Company, together with, in all cases, all new, substituted and additional securities at any time issued with respect thereto (collectively and severally, the "Pledged Shares") with all the Pledged Shares in existence as of the date hereof being listed and described on Schedule 1 hereto);

        (b)  All now existing and hereafter arising rights of the holder of Pledged Shares with respect thereto, including, without limitation, all voting rights and all rights to cash and noncash dividends and other distributions on account thereof;

        (c)  All now existing and hereafter arising accounts, chattel paper, documents, instruments, letter-of-credit rights, commercial tort claims, and general intangibles (as those terms are defined in the California Uniform Commercial Code as in effect from time to time (the "Code")) of Company, whether or not arising out of or in connection with the sale or lease of goods or the rendering of services, and all rights of Company now and hereafter arising in and to all security agreements, guaranties, leases and other writings securing or otherwise relating to any such accounts, chattel paper, documents, instruments, letter-of-credit rights, commercial tort claims and general intangibles;

        (d)  All inventory of Company, now owned and hereafter acquired, wherever located, including, without limitation, all merchandise, goods and other personal property which are held for sale or lease or leased by Company or to be furnished under a contract of service, all raw

materials, work in process, materials used or consumed in Company's business and finished goods, all goods in which Company has an interest in mass or a joint or other interest or gifts of any kind (including goods in which Company has an interest or right as consignee), and all goods which are returned to or repossessed by Company, together with all additions and accessions thereto and replacements therefor and products thereof and documents therefor;

        (e)  All equipment of Company, now owned and hereafter acquired, wherever located, and all parts thereof and all accessions, additions, attachments, improvements, substitutions and replacements thereto and therefor, including, without limitation, all machinery, tools, dies, blueprints, catalogues, computer hardware and software, furniture, furnishings and fixtures;

        (f)    All now existing and hereafter acquired Computer Hardware and Software Collateral, Copyright Collateral, Patent Collateral, Trademark Collateral and Trade Secrets Collateral (as those terms are defined in Paragraph 16 below) (collectively, the "Intellectual Property Collateral");

        (g)  All deposit accounts, now existing and hereafter arising or established, maintained in Company's name with any financial institution, and any and all funds at any time held therein and all certificates, instruments and other writings, if any, from time to time representing, evidencing or deposited into such accounts, and all interest, dividends, cash, instruments and other property from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the foregoing; provided, however, that the Collateral shall not include any of the accounts maintained with the Lender in which Liquid Assets are being held pursuant to Paragraph 13(o) of the Credit Agreement;

        (h)  All of Company's right, title and interest in and to (but not Company's obligations under) all now existing and hereafter arising contracts and agreements to which Company is party, including, without limitation, each of the agreements listed on Schedule 2 hereto, in each case as such agreements may be amended, supplemented or otherwise modified from time to time (such agreements, as so amended, supplemented or modified, individually, an "Assigned Agreement," and, collectively, the "Assigned Agreements"), including, without limitation, all rights of Company to receive moneys due and to become due under or pursuant to the Assigned Agreements, all rights of Company to receive proceeds of any insurance, indemnity, warranty or guaranty with respect to the Assigned Agreements, all claims of Company for damages arising out of or for breach of or default under the Assigned Agreements, and all rights of Company to terminate, amend, supplement or modify the Assigned Agreements, to perform thereunder and to compel performance and otherwise exercise all remedies thereunder; provided, however, that with respect to any such contract or agreement where the grant of a security interest in Company's right, title and interest therein is prohibited by the terms thereof, or would give any other party the right to terminate its obligations thereunder, or is not permitted because any necessary consent to such grant has not been obtained, the Collateral shall include only the rights of Company to receive moneys due and to become due, if any, under or pursuant to such contract or agreement;

        (i)    All now existing and hereafter acquired books, records, writings, data bases, information and other property relating to, used or useful in connection with, embodying, incorporating or referring to, any of the foregoing Collateral;

        (j)    All other property of Company now or hereafter in the possession, custody or control of the Lender, and all property of Company in which the Lender now has or hereafter acquires a security interest;

        (k)  All now existing and hereafter acquired cash and cash equivalents held by Company not otherwise included in the foregoing Collateral; and

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        (l)    All products and proceeds of the foregoing Collateral. For purposes of this Security Agreement, the term "proceeds" shall have the meaning provided in the Code, and also includes any voluntary or involuntary disposition, and all rights to payment, including return premiums, with respect to any insurance.

Notwithstanding anything herein to the contrary, in no event shall the Collateral include, and the Company shall not be deemed to have granted a security interest in, any of the Company's rights or interests in any license, permit, contract or agreement (or in any Equipment leased or financed thereunder) to which the Company is a party or any of its rights or interests thereunder to the extent, but only to the extent, that such a grant would, under the terms of such license, permit, contract or agreement or otherwise, result in a breach of the terms of, or constitute a default under any license, permit, contract or agreement (other than to the extent that any such term would be rendered ineffective pursuant to Sections 9-401, 9-406(d), 9-407, 9-408 or 9-409 under the Code or any other applicable law (including the Bankruptcy Code) or principles of equity); provided, that immediately upon the ineffectiveness, lapse or termination of any such provision, the Collateral shall include, and the Company shall be deemed to have granted a security interest in, all such rights and interest as if such provision had never been in effect.

        3.    Obligations.    The obligations secured by this Security Agreement shall consist of all Obligations of Company under the Credit Agreement and each other Loan Document, in each case whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, created or incurred.

        4.    Representations and Warranties.    In addition to all representations and warranties of Company set forth in the other Loan Documents, which are incorporated herein by this reference, Company hereby represents and warrants that:

        (a)  Company is the sole owner of and has good and marketable title to the Collateral (or, in the case of after-acquired Collateral, at the time Company acquires rights in the Collateral, except as specifically disclosed on Schedule 5 hereto.

        (b)  No Person has (or, in the case of after-acquired Collateral, at the time Company acquires rights therein, will have) any right, title, claim or interest (by way of security interest or other Lien or charge) in, against or to the Collateral other than as permitted by the Credit Agreement, except as specifically disclosed on Schedule 5 hereto.

        (c)  All information heretofore, herein or hereafter supplied to the Lender by or on behalf of Company with respect to the Collateral is accurate and complete in all material respects.

        (d)  Company has delivered to the Lender all instruments and chattel paper (in each case, in excess of $5,000.00) and other items of Collateral in which a security interest is or may be perfected by possession, together with such additional writings, including, without limitation, assignments, with respect thereto as the Lender shall request.

        (e)  The Company is (or, in the case of after-acquired Pledged Shares, at the time the Company acquires rights therein will be) the record and beneficial owner of, and has (and will have) good and marketable title to the Pledged Shares. The Pledged Shares have been (or will be) validly issued and are (or upon issuance will be) fully paid and non-assessable and there are no (and in the future will be no) outstanding options, warrants or shareholder or other similar agreements with respect to the Pledged Shares.

        (f)    All of the trademarks of the Company registered or applied to be registered with the United States Patent and Trademark Office as of the date hereof are as set forth on Schedule 3 hereto.

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        5.    Covenants and Agreements of Company.    In addition to all covenants and agreements of Company set forth in the other Loan Documents, which are incorporated herein by this reference, Company hereby agrees, at no cost or expense to the Lender:

        (a)  To do all acts (other than acts which are required to be done by the Lender) that may be necessary to maintain, preserve and protect the Collateral and the first priority, perfected security interest of the Lender therein.

        (b)  Not to use or permit any Collateral to be used unlawfully or in violation of any provision of this Security Agreement, any other agreement with the Lender related hereto, or any law, rule, regulation, order, writ, judgment, injunction, decree or award binding on Company or affecting any of the Collateral or any contractual obligation affecting any of the Collateral.

        (c)  To pay promptly when due all taxes, assessments, charges, encumbrances and Liens now or hereafter imposed upon or affecting any Collateral.

        (d)  To appear in and defend any action or proceeding which may affect its title to or the Lender's interest in the Collateral.

        (e)  Not to surrender or lose possession of (other than to the Lender), sell, encumber, lease, rent, or otherwise dispose of or transfer any Collateral or right or interest therein except as expressly provided herein and in the other Loan Documents, and to keep the Collateral free of all levies and security interests or other Liens or charges except as permitted by the Credit Agreement or otherwise approved in writing by the Lender; provided, however, that, unless an Event of Default shall have occurred and be continuing, Company may, in the ordinary course of business, sell or lease any Collateral (1) consisting of Inventory, or (2) in connection with the closing of a retail store or the sale of a retail store in accordance with Paragraph 13(p) of the Credit Agreement.

        (f)    To account fully for and promptly deliver to the Lender, in the form received, all documents, chattel paper in excess of $5,000.00, all stock certificates evidencing Pledged Shares, instruments in excess of $5,000.00 and agreements constituting Collateral hereunder, and all proceeds of the Collateral received, all endorsed to the Lender or in blank, as requested by the Lender, and accompanied by such stock powers as appropriate and until so delivered all such documents, instruments, agreements and proceeds shall be held by Company in trust for the Lender, separate from all other property of Company.

        (g)  To keep separate, accurate and complete records of the Collateral and to provide the Lender with such records and such other reports and information relating to the Collateral as the Lender may reasonably request from time to time.

        (h)  To give the Lender thirty (30) days prior written notice of any change in Company's chief place of business or legal name or trade name(s) or style(s) referred to in Paragraph 11 below.

        (i)    To keep the records concerning the Collateral at the location(s) referred to in Paragraph 11 below and not to remove such records from such location(s) without the prior written consent of the Lender.

        (j)    To keep the Collateral at the warehouse location(s) referred to in Paragraph 11 below and not to remove the Collateral from such warehouse location(s) without the prior written consent of the Lender.

        (k)  To keep the Collateral in good condition and repair and not to cause or permit any waste or unusual or unreasonable depreciation of the Collateral.

        6.    Authorized Action by Secured Party.    Company hereby agrees that following the occurrence and during the continuance of an Event of Default, without presentment, notice or demand, and without

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affecting or impairing in any way the rights of the Lender with respect to the Collateral, the obligations of Company hereunder or the Obligations, the Lender may, but shall not be obligated to and shall incur no liability to Company or any third party for failure to, take any action which Company is obligated by this Security Agreement to do and to exercise such rights and powers as Company might exercise with respect to the Collateral, and Company hereby irrevocably appoints the Lender as its attorney-in-fact to exercise such rights and powers, including without limitation, to:

        (a)  Collect by legal proceedings or otherwise and endorse, receive and receipt for all dividends, interest, payments, proceeds and other sums and property now or hereafter payable on or on account of the Collateral.

        (b)  Enter into any extension, reorganization, deposit, merger, consolidation or other agreement pertaining to, or deposit, surrender, accept, hold or apply other property in exchange for the Collateral.

        (c)  Insure, process and preserve the Collateral.

        (d)  Transfer the Collateral to its own or its nominee's name.

        (e)  Make any compromise or settlement, and take any action it deems advisable, with respect to the Collateral.

        (f)    Subject to the provisions of Paragraph 7 below, notify any obligor on any Collateral to make payment directly to the Lender.

Company hereby grants to the Lender an exclusive, irrevocable power of attorney, with full power and authority in the place and stead of Company to take all such action permitted under this Paragraph 6; provided, however, that the Lender agrees that it shall not exercise such power of attorney unless there shall have occurred and be continuing an Event of Default. Company agrees to reimburse the Lender upon demand for any costs and expenses, including, without limitation, reasonable attorneys' fees, the Lender may incur while acting as Company's attorney-in-fact hereunder, all of which costs and expenses are included in the Obligations secured hereby. It is further agreed and understood between the parties hereto that such care as the Lender gives to the safekeeping of its own property of like kind shall constitute reasonable care of the Collateral when in the Lender's possession; provided, however, that the Lender shall not be required to make any presentment, demand or protest, or give any notice and need not take any action to preserve any rights against any prior party or any other person in connection with the Obligations or with respect to the Collateral.

        7.    Collection of Collateral Payments.

        (a)  Company shall, at its sole cost and expense, use commercially reasonable best efforts to obtain payment, when due and payable, of all sums due or to become due with respect to any Collateral ("Collateral Payments" or a "Collateral Payment"), including, without limitation, the taking of such action with respect thereto as the Lender may reasonably request, or, in the absence of such request, as Company may reasonably deem advisable; provided, however, that Company shall not, without the prior written consent of the Lender, grant or agree to any rebate, refund, compromise or extension with respect to any Collateral Payment or accept any prepayment on account thereof other than in the ordinary course of Company's business. Upon the request of the Lender made at any time following the occurrence and during the continuance of an Event of Default, Company will notify and direct any party who is or might become obligated to make any Collateral Payment, to make payment thereof to such accounts as the Lender may direct in writing and to execute all instruments and take all action required by the Lender to ensure the rights of the Lender in any Collateral subject to the Federal Assignment of Claims Act of 1940, as amended.

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        (b)  Upon the request of the Lender made at any time following the occurrence and during the continuance of an Event of Default, Company will, forthwith upon receipt, transmit and deliver to the Lender, in the form received, all cash, checks, drafts and other instruments for the payment of money (properly endorsed where required so that such items may be collected by the Lender) which may be received by Company at any time as payment on account of any Collateral Payment and if such request shall be made, until delivery to the Lender, such items will be held in trust for the Lender and will not be commingled by Company with any of its other funds or property. Thereafter, the Lender is hereby authorized and empowered to endorse the name of Company on any check, draft or other instrument for the payment of money received by the Lender on account of any Collateral Payment if the Lender believes such endorsement is necessary or desirable for purposes of collection.

        (c)  Company will indemnify and save harmless the Lender from and against all reasonable liabilities and expenses on account of any adverse claim asserted against the Lender relating to any moneys received by the Lender on account of any Collateral Payment and such obligation of Company shall continue in effect after and notwithstanding the discharge of the Obligations and the release of the security interest granted in Paragraph 1 above.

        8.    Additional Covenants Regarding Intellectual Property Collateral.

        (a)  Company shall not, unless it shall either reasonably and in good faith determine that such Collateral is of negligible economic value to Company or that there is a valid purpose to do otherwise:

        (1)  Permit any Patent Collateral to lapse or become abandoned or dedicated to the public or otherwise be unenforceable;

        (2)  (i) Fail to continue to use any of the Trademark Collateral in order to maintain all of the Trademark Collateral in full force free from any claim of abandonment for non-use, (ii) fail to maintain as in the past the quality of products and services offered under all of the Trademark Collateral, (iii) fail to employ all of the Trademark Collateral registered with any Federal or state or foreign authority with an appropriate notice of such registration, (iv) adopt or use any other Trademark which is confusingly similar or a colorable imitation of any of the Trademark Collateral, (v) use any of the Trademark Collateral registered with any Federal or state or foreign authority except for the uses for which registration or application for registration of all of the Trademark Collateral has been made, or (vi) do or permit any act or knowingly omit to do any act whereby any of the Trademark Collateral may lapse or become invalid or unenforceable; or

        (3)  Do or permit any act or knowingly omit to do any act whereby any of the Copyright Collateral or any of the Trade Secrets Collateral may lapse or become invalid or unenforceable or placed in the public domain except upon expiration of the end of an unrenewable term of a registration thereof.

        (b)  Company shall notify the Lender immediately if it knows, or has reason to know, that any application or registration relating to any material item of the Intellectual Property Collateral may become abandoned or dedicated to the public or placed in the public domain or invalid or unenforceable, or of any adverse determination or development (including the institution of, or any such determination or development in, any proceeding in the United States Patent and Trademark Office, the United States Copyright Office or any foreign counterpart thereof or any court) regarding Company's ownership of any of the Intellectual Property Collateral, its right to register the same or to keep and maintain and enforce the same.

        (c)  In no event shall Company or any of its agents, employees, designees or licensees file an application for the registration of any Intellectual Property Collateral with the United States Patent

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and Trademark Office, the United States Copyright Office or any similar office or agency in any other country or any. political subdivision thereof, unless it promptly informs the Lender, and upon request of the Lender, executes and delivers any and all agreements, instruments, documents and papers as the Lender may reasonably request to evidence the Lender's security interest in such Intellectual Property Collateral and the goodwill and general intangibles of Company relating thereto or represented thereby.

        (d)  Company shall, contemporaneously herewith, execute and deliver to the Lender such supplemental agreements for filing in the United States Patent and Trademark Office and United States Copyright Office as the Lender may require and shall execute and deliver to the Lender any other document required to acknowledge or register or perfect the Lender's interest in any part of the Intellectual Property Collateral.

        9.    Administration of the Pledged Shares.    In addition to any provisions of this Security Agreement which govern the administration of the Collateral generally, the following provisions shall govern the administration of the Pledged Shares:

        (a)  Until there shall have occurred and be continuing an Event of Default, the Company shall be entitled to vote or consent with respect to the Pledged Shares in any manner not inconsistent with this Security Agreement or any document or instrument delivered or to be delivered pursuant to or in connection with any thereof and to receive all dividends paid with respect to the Pledged Shares. If there shall have occurred and be continuing an Event of Default and the Lender shall have notified the Company that the Lender desires to exercise its proxy rights with respect to all or a portion of the Pledged Shares, the Company hereby grants to the Lender an irrevocable proxy for the Pledged Shares pursuant to which proxy the Lender shall be entitled to vote or consent, in its discretion, and in such event the Company agrees to deliver to the Lender such further evidence of the grant of such proxy as the Lender may request.

        (b)  In the event that at any time or from time to time after the date hereof, the Company, as record and beneficial owner of the Pledged Shares, shall receive or shall become entitled to receive, any dividend or any other distribution whether in securities or property by way of stock split, spin-off, split-up or reclassification, combination of shares or the like, or in case of any reorganization, consolidation or merger, and the Company, as record and beneficial owner of the Pledged Shares, shall thereby be entitled to receive securities or property in respect of such Pledged Shares, then and in each such case, the Company shall deliver to the Lender and the Lender shall be entitled to receive and retain all such securities or property as part of the Pledged Shares as security for the payment and performance of the Company Obligations; provided, however, that until there shall have occurred and be continuing an Event of Default, the Company shall be entitled to retain any cash dividends paid on account of the Pledged Shares.

        (c)  Upon the occurrence of an Event of Default, the Lender is authorized to sell the Pledged Shares and, at any such sale of any of the Pledged Shares, if it deems it advisable to do so, to restrict the prospective bidders or purchasers to persons or entities who (1) will represent and agree that they are purchasing for their own account, for investment, and not with a view to the distribution or sale of any of the Pledged Shares; and (2) satisfy the offeree and purchaser requirements for a valid private placement transaction under Section 4(2) of the Securities Act of 1933, as amended (the "Act"), and under Securities and Exchange Commission Release Nos. 33-6383; 34-18524; 35-22407; 39-700; IC-12264; AS-306, or under any similar statute, rule or regulation. The Company agrees that disposition of the Pledged Shares pursuant to any private sale made as provided above may be at prices and on other terms less favorable than if the Pledged Shares were sold at public sale, and that the Lender has no obligation to delay the sale of any Pledged Shares for public sale under the Act. The Company agrees that a private sale or sales made under the foregoing circumstances shall be deemed to have been made in a commercially

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reasonable manner. In the event that the Lender elects to sell the Pledged Shares, or part of them, and there is a public market for the Pledged Shares, in a public sale the Company shall use its commercially reasonable best efforts to register and qualify the Pledged Shares, or applicable part thereof, under the Act and all state Blue Sky or securities laws required by the proposed terms of sale and all expenses thereof shall be payable by the Company, including, but not limited to, all costs of (i) registration or qualification of, under the Act or any state Blue Sky or securities laws or pursuant to any applicable rule or regulation issued pursuant thereto, any Pledged Shares, and (ii) sale of such Pledged Shares, including, but not limited to, brokers' or underwriters' commissions, fees or discounts, accounting and legal fees, costs of printing and other expenses of transfer and sale.

        (d)  If any consent, approval or authorization of any state, municipal or other governmental department, agency or authority should be necessary to effectuate any sale or other disposition of the Pledged Shares, or any part thereof, the Company will execute such applications and other instruments as may be required in connection with securing any such consent, approval or authorization, and will otherwise use its commercially reasonable best efforts to secure the same.

        (e)  Nothing contained in this Paragraph 9 shall be deemed to limit the other obligations of the Company contained in the Credit Agreement or this Security Agreement and the rights of the Lender hereunder or thereunder.

        10.    Remedies.    Upon the occurrence and during the continuance of an Event of Default, the Lender may, without notice to or demand on Company and in addition to all rights and remedies available to the Lender with respect to the Obligations, at law, in equity or otherwise, do any one or more of the following:

        (a)  Foreclose or otherwise enforce the Lender's security interest in any manner permitted by law or provided for in this Security Agreement.

        (b)  Sell, lease or otherwise dispose of any Collateral at one or more public or private sales at the Lender's place of business or any other place or places, including, without limitation, any broker's board or securities exchange, whether or not such Collateral is present at the place of sale, for cash or credit or future delivery, on such terms and in such manner as the Lender may determine.

        (c)  Recover from Company all costs and expenses, including, without limitation, reasonable attorneys' fees (including the allocated cost of internal counsel), incurred or paid by the Lender in exercising any right, power or remedy provided by this Subsidiary Security Agreement.

        (d)  Require Company to assemble the Collateral and make it available to the Lender at a place to be designated by the Lender.

        (e)  Enter onto property where any Collateral is located and take possession thereof with or without judicial process.

        (f)    Prior to the disposition of the Collateral, store, process, repair or recondition it or otherwise prepare it for disposition in any manner and to the extent the Lender deems appropriate and in connection with such preparation and disposition, without charge, use any trademark, tradename, copyright, patent or technical process used by Company.

Company shall be given five (5) Business Days' prior notice of the time and place of any public sale or of the time after which any private sale or other intended disposition of Collateral is to be made, which notice Company hereby agrees shall be deemed reasonable notice thereof. Upon any sale or other disposition pursuant to this Security Agreement, the Lender shall have the right to deliver, assign and transfer to the purchaser thereof the Collateral or portion thereof so sold or disposed of. Each purchaser at any such sale or other disposition (including the Lender) shall hold the Collateral free

8

from any claim or right of whatever kind, including any equity or right of redemption of Company and Company specifically waives (to the extent permitted by law) all rights of redemption, stay or appraisal which it has or may have under any rule of law or statute now existing or hereafter adopted.

        11.    Chief Place of Business; Collateral Location; Records Location.    Company represents that the state in which it was organized and its chief place of business are as set forth on Schedule 4 attached hereto; that the only trade name(s) or style(s) used by Company are set forth on said Schedule 4; and that, except as otherwise disclosed to the Lender in writing prior to the date hereof, the Collateral and Company's records concerning the Collateral are located at its chief place of business.

        12.    Waiver of Hearing.    Company expressly waives to the extent permitted under applicable law any constitutional or other right to a judicial hearing prior to the time the Lender takes possession or disposes of the Collateral upon the occurrence and during the continuance of an Event of Default.

        13.    Cumulative Rights.    The rights, powers and remedies of the Lender under this Security Agreement shall be in addition to all rights, powers and remedies given to the Lender by virtue of any statute or rule of law, the Credit Agreement or any other agreement, all of which rights, powers and remedies shall be cumulative and may be exercised successively or concurrently without impairing the Lender's security interest in the Collateral.

        14.    Waiver.    Any forbearance or failure or delay by the Lender in exercising any right, power or remedy shall not preclude the further exercise thereof, and every right, power or remedy of the Lender shall continue in full force and effect until such right, power or remedy is specifically waived in a writing executed by the Lender. Company waives any right to require the Lender to proceed against any person or to exhaust any Collateral or to pursue any remedy in the Lender's power.

        15.    Setoff.    Company agrees that the Lender may exercise its rights of setoff with respect to the Obligations in the same manner as if the Obligations were unsecured.

        16.    Intellectual Property Collateral.    For purposes of this Security Agreement, the following capitalized terms shall have the following meanings:

        "Computer Hardware and Software Collateral" means all of Company's right, title and interest in all now existing and hereafter created or acquired:

        (a)  Computer and other electronic data processing hardware, integrated computer systems, central processing units, memory units, display terminals, printers, features, computer elements, card readers, tape drives, hard and soft disk drives, cables, electrical supply hardware, generators, power equalizers, accessories and all peripheral devices and other related computer hardware;

        (b)  Software programs (including both source code, object code and all related applications and data files), whether owned, licensed or leased, designed for use on the computers and electronic data processing hardware described in subparagraph (a) above;

        (c)  All firmware associated therewith;

        (d)  All documentation (including flow charts, logic diagrams, manuals, guides and specifications) with respect to such hardware, software and firmware described in subparagraph (a) through (c) above; and

        (e)  All rights with respect to all of the foregoing, including, without limitation, any and all of Company's copyrights, licenses, options, warranties, service contracts, program services, test rights, renewal rights and indemnifications and any substitutions, replacements, additions or model conversions of any of the foregoing.

        "Copyright Collateral" means copyrights and all semi-conductor chip product mask works of Company, whether statutory or common law, registered or unregistered, now or hereafter in force

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throughout the world including, without limitation, all of Company's right, title and interest in and to all copyrights and mask works registered in the United States Copyright Office or anywhere else in the world, and all applications for registration thereof, whether pending or in preparation, all copyright and mask work licenses, the right of Company to sue for past, present and future infringements of any thereof, all rights of Company corresponding thereto throughout the world, all extensions and renewals of any thereof and all proceeds of the foregoing, including, without limitation, licenses, royalties, income, payments, claims damages and proceeds of suit.

        "Patent Collateral" means:

        (a)  All of Company's letters patent and applications for letters patent throughout the world, including all of Company's patent applications in preparation for filing anywhere in the world and with the United States Patent and Trademark Office;

        (b)  All of Company's patent licenses;

        (c)  All reissues, divisions, continuations, continuations-in-part, extensions, renewals and reexaminations of any of the items described in clauses (a) and (b); and

        (d)  All proceeds of, and rights associated with, the foregoing (including license royalties and proceeds of infringements suits), the right of Company to sue third parties for past, present or future infringements of any patent or patent application of Company, and for breach of enforcement of any patent license, and all rights corresponding thereto throughout the world.

        "Trademark Collateral" means:

        (a)  All of Company's trademarks, trade names, corporate names, business names, fictitious business names, trade styles, service marks, certification makers, collective marks, logos, other source of business identifiers, prints and labels on which any of the foregoing have appeared or appear, designs and general intangibles of a like nature (all of the foregoing items in this clause (a) being collectively called a "Trademark"), now existing anywhere in the world or hereafter adopted or acquired, whether currently in use or not, all registrations and recordings thereof and all applications in connection therewith, whether pending or in preparation for filing, including registrations, recordings and applications in the United States Patent and Trademark Office or in any office or agency of the United States of America or any State thereof or any foreign country;

        (b)  All of Company's Trademark licenses;

        (c)  All reissues, extensions or renewals of any of the items described in clauses (a) and (b);

        (d)  All of the goodwill of the business of Company connected with the use of, and symbolized by the items described in, clauses (a) and (b), and

        (e)  All proceeds of, and rights of Company associated with, the foregoing, including any claim by Company against third parties for past, present or future infringement or dilution of any Trademark, Trademark registration or Trademark license, or for any injury to the goodwill associated with the use of any such Trademark or for breach or enforcement of any Trademark license.

        "Trade Secrets Collateral" means common law and statutory trade secrets and all other confidential or proprietary or useful information and all know-how obtained by or used in or contemplated at any time for use in the business of Company (all of the foregoing being collectively called a "Trade Secret"), whether or not such Trade Secret has been reduced to a writing or other tangible form including all documents and things embodying, incorporating or referring in any way to such Trade Secret, all Trade Secret licenses, including the right to sue for

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and to enjoin and to collect damages for the actual or threatened misappropriation of any Trade Secret and for the breach or enforcement of any such Trade Secret license.

        17.    Financing Statements.    The Company hereby acknowledges and agrees that the Lender, in connection with the filing of any UCC financing statements necessary to perfect or maintain the perfection of its Lien in the Collateral hereunder, may utilize a general description of the Collateral, such as "all now owned and hereafter acquired personal property of the Company."

        18    Governing Law.    This Security Agreement shall be governed by and construed in accordance with the internal laws of the State of California.

        IN WITNESS WHEREOF, this Security Agreement is executed as of the day and year first above written.

DIEDRICH COFFEE, INC., a Delaware corporation
By:	/s/  PHILIP G. HIRSCH
Name:	Philip G. Hirsch
Its:	Chief Executive Officer
By:	/s/  MATTHEW C. MCGUINNESS
Name:	Matthew C. McGuinness
Its:	Executive Vice President and Chief Financial Officer
BANK OF THE WEST, doing business as UNITED CALIFORNIA BANK
By:	/s/  BRUCE YOUNG
Name:	Bruce Young
Its:	Vice President

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EXHIBIT 10.34

SECURITY AGREEMENT
RECITALS
AGREEMENT

EX-23.1

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THE REPORT ON SCHEDULE AND CONSENT OF INDEPENDENT AUDITORS

The Board of Directors
Diedrich Coffee, Inc:

The audits referred to in our report dated September 6, 2002, included the related financial statement schedule as of July 3, 2002, June 27, 2001 and June 28, 2000. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We consent to incorporation by reference in the registration statements (Nos. 333-66744, 333-74626, 333-52190, 333-50412) of Diedrich Coffee, Inc. and subsidiaries, of our report dated September 6, 2002, relating to the consolidated balance sheets of Diedrich Coffee, Inc. and subsidiaries as of July 3, 2002 and June 27, 2001, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended July 3, 2002, and the related schedule, which reports appear in the July 3, 2002 annual report on Form 10-K of Diedrich Coffee, Inc. and subsidiaries.

Costa Mesa, California
September 30, 2002

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THE REPORT ON SCHEDULE AND CONSENT OF INDEPENDENT AUDITORS

EX-99.1

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Exhibit 99.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        Each of the undersigned hereby certifies, in his capacity as an officer of Diedrich Coffee, Inc. (the "Company"), for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge:

•

the Annual Report of the Company on Form 10-K for the period ended July 3, 2002 fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934; and



•

the information contained in such report fairly presents, in all material respects, the financial condition and results of operation of the Company.

Dated: September 30, 2002

/s/  PHILIP G. HIRSCH Philip G. Hirsch
Chief Executive Officer

/s/  MATTHEW C. MCGUINNESS Matthew C. McGuinness

Executive Vice President and Chief Financial Officer

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Exhibit 99.1