DIEDRICH COFFEE INC, 10-Q, 1998-12-11

DIEDRICH COFFEE INC
10-Q, 1998-12-11
FOOD STORES

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 28, 1998

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

For the transition period from ___________ to ____________

COMMISSION FILE NUMBER 0-21203

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

DELAWARE 33-0086628
(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)

2144 MICHELSON DRIVE
IRVINE, CALIFORNIA 92612
(Address of Principal Executive Offices including Zip Code)

(949) 260-1600
(Registrant's Telephone Number including Area Code)

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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES /X/ NO / /

As of December 1, 1998, there were 5,988,764 shares of common stock of
the registrant outstanding.

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DIEDRICH COFFEE, INC.

INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION PAGE NO.
<S> <C>

Item 1. Financial Statements

Condensed Balance Sheets............................ 3

Condensed Statements of Operations.................. 4

Condensed Statements of Cash Flows.................. 5

Notes to Condensed Financial Statements............. 6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 10

Liquidity and Capital Resources..................... 13

Item 3 Quantitative and Qualitative Disclosures About
Market Risk......................................... 14

PART II - OTHER INFORMATION

Item 1 Legal Proceedings................................... 15

Item 5 Other Information................................... 15

Item 6 Exhibits and Reports on Form 8-K.................... 15

Signatures.......................................... 16
</TABLE>

2
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

DIEDRICH COFFEE, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>

OCTOBER 28, 1998 JANUARY 28, 1998
----------------- -----------------
<S> <C> <C>
ASSETS (Note 3)

Current Assets:
Cash $ 863,730 $ 1,408,161
Accounts receivable 289,131 181,628
Inventories (Note 2) 1,334,488 1,375,119
Prepaid expenses 292,459 157,393
Income taxes receivable 17,686 42,528
----------------- -----------------
Total current assets 2,797,494 3,164,829

Property and equipment, net 9,388,599 10,104,843
Costs in excess of net assets acquired, net 335,897 389,651
Other assets 270,107 289,103
----------------- -----------------
Total assets $ 12,792,097 $ 13,948,426
----------------- -----------------
----------------- -----------------

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:

Current installments of obligations under capital lease $ 169,488 $ 168,139
Accounts payable 1,395,798 1,204,366
Accrued compensation 848,774 716,742
Accrued expenses 1,220,318 1,796,869
Provision for store closings and restructuring costs 124,217 237,320
----------------- -----------------
Total current liabilities 3,758,595 4,123,436

Obligation under capital lease - long term 306,183 317,292
Long term debt (Note 3) 2,500,000 2,500,000
Deferred rent 200,338 172,231
----------------- -----------------
Total liabilities 6,765,116 7,112,959
----------------- -----------------

Stockholders' Equity: (Note 4)

Common stock 59,478 57,417
Additional paid-in capital 18,254,247 16,928,546
Accumulated deficit (12,286,744) (10,150,496)
------------------ ------------------
Total stockholders' equity 6,026,981 6,835,457
----------------- -----------------
Commitments and contingencies

Total liabilities and stockholders' equity $ 12,792,097 $ 13,948,426
----------------- -----------------
----------------- -----------------
</TABLE>

See accompanying notes to financial statements.

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DIEDRICH COFFEE, INC.
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THIRTEEN WEEKS THIRTEEN WEEKS THIRTY-NINE WEEKS THIRTY-NINE WEEKS
ENDED OCTOBER 28, ENDED OCTOBER 29, ENDED OCTOBER 28, ENDED OCTOBER 29,
1998 1997 1998 1997
---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Net Sales:
Retail $ 5,268,622 $ 4,989,024 $ 15,897,471 $ 15,632,429
Wholesale and other 674,630 573,848 1,998,657 1,608,685
Franchise area development fees 100,000 - 100,000 -
---------------- --------------- ---------------- ---------------
Total 6,043,252 5,562,872 17,996,128 17,241,114
---------------- --------------- ---------------- ---------------

Cost and Expenses:

Cost of sales and related
occupancy costs 2,718,436 2,716,323 8,113,504 8,619,031
Store operating expenses 2,187,605 2,029,491 6,744,513 6,536,446
Other operating expenses 165,595 92,896 460,896 232,985
Depreciation and amortization 490,531 426,778 1,434,105 1,313,294
Provision for store closings and
restructuring costs - - - 4,550,068
General and administrative expenses 1,002,556 951,683 3,090,934 2,695,562
---------------- --------------- ---------------- ---------------
Total 6,564,723 6,217,171 19,843,952 23,947,386
---------------- --------------- ---------------- ---------------

Operating loss (521,471) (654,299) (1,847,824) (6,706,272)

Interest expense (94,640) (79,954) (291,894) (101,605)

Interest and other income 7,280 (4,501) 27,686 (9,258)
---------------- ---------------- ---------------- ----------------

Loss before income taxes (608,831) (738,754) (2,112,032) (6,817,135)

Income tax provision - - 3,690 2,890
---------------- --------------- ---------------- ---------------

Net loss (608,831) $ (738,754) (2,115,722) $ (6,820,025)
---------------- --------------- ---------------- ---------------
---------------- --------------- ---------------- ---------------

Basic net loss per share: $ (0.10) $ (0.14) $ (0.36) $ (1.27)
---------------- --------------- ---------------- ---------------
---------------- --------------- ---------------- ---------------

Diluted net loss per share:

$ (0.10) $ (0.14) $ (0.36) $ (1.27)
---------------- --------------- ---------------- ---------------
---------------- --------------- ---------------- ---------------

Weighted average shares outstanding 5,944,146 5,391,650 5,895,596 5,391,650
---------------- --------------- ---------------- ---------------
---------------- --------------- ---------------- ---------------
</TABLE>

See accompanying notes to financial statements.

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DIEDRICH COFFEE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)

THIRTY-NINE WEEKS THIRTY-NINE WEEKS
ENDED OCTOBER 28, ENDED OCTOBER 29,
1998 1997
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (2,115,722) $ (6,820,025)
Adjustments to reconcile net loss to cash used in operating
activities:
Depreciation and amortization 1,434,105 1,313,294
Provision for asset impairment and restructuring costs - 3,903,280
Changes in assets and liabilities:
Accounts receivable (107,503) (55,522)
Inventories 40,631 45,466
Prepaid expenses (135,066) (335,895
Income taxes receivable 24,842 241,744
Other assets (16,947) 5,124
Accounts payable 191,432 (387,820)
Accrued compensation 19,117 (115,363)
Accrued expenses (47,660) 214,498
Deferred rent 28,107 5,854
---------------- ----------------
Net cash used in operating activities (684,664) (1,985,365)
----------------- ----------------

Cash flows from investing activities:
Capital expenditures for property and equipment (1,103,116) (1,536,263)
Property disposition - -
---------------- ----------------
Net cash used in investing activities $ (1,103,116) $ (1,754,268)
---------------- ----------------
---------------- ----------------

Cash flows from financing activities:
Proceeds from issuance of common stock, net fees paid 1,307,236 -
Proceeds from long-term debt - 3,000,000
Payment on capital lease obligation (63,887) -
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Net cash provided by financing activities $ 1,243,349 $ 3,000,000
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Net increase (decrease) in cash (544,431) (521,628)
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Cash at beginning of period 1,408,161 2,071,904
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Cash at end of period 863,730 $ 1,550,276
---------------- ----------------
---------------- ----------------

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 205,950 $ 64,729
---------------- ----------------
---------------- ----------------
Income taxes $ 3,690 $ 2,890
---------------- ----------------
---------------- ----------------

Non-cash transactions

Equipment purchased under capital lease $ 54,127 $ 146,819
---------------- ----------------
---------------- ----------------

</TABLE>

See accompanying notes to financial statements

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DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
OCTOBER 28, 1998
(UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The unaudited condensed financial statements of Diedrich Coffee, Inc.
(the "Company") have been prepared in accordance with generally accepted
accounting principles for interim financial information. In the opinion of
management, all adjustments (consisting of normal, recurring adjustments and
accruals) considered necessary for a fair presentation of the Company's
financial position at October 28, 1998 and the results of operations and cash
flows for both the thirteen and thirty-nine weeks ended October 28, 1998 and
October 29, 1997 have been included. Results for the interim periods are not
necessarily indicative of the results for an entire year. This information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
January 28, 1998.

In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This pronouncement will require the Company
to recognize derivatives on its balance sheet at fair value. Changes in the fair
values of derivatives that qualify as cash flow hedges will be recognized in
comprehensive income until the hedged item is recognized in earnings. The
Company expects that this new standard will not have a significant effect on its
results of operations. SFAS No. 133 is effective for fiscal years beginning
after June 15, 1999.

NET LOSS PER COMMON SHARE

The computation of basic earnings per share in accordance with
Statement of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per
Share" is based on the weighted average number of common shares outstanding
during the periods presented. All periods presented have been calculated in
accordance with SFAS No. 128.

2. INVENTORIES

Inventories consist of the following:

<TABLE>
<CAPTION>
OCTOBER 28, 1998 JANUARY 28, 1998
---------------- ----------------
<S> <C> <C>

Green coffee (raw materials) $ 449,568 $ 535,885
Roasted coffee (finished goods) 134,909 67,965
Accessory and specialty items 215,153 230,502
Other food, beverage and supplies 534,858 540,767
---------- ----------
$1,334,488 $1,375,119
---------- ----------
---------- ----------
</TABLE>

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DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
OCTOBER 28, 1998
(UNAUDITED)

3. DEBT

Long-term debt consists of the following:

<TABLE>
<CAPTION>
OCTOBER 28, 1998 JANUARY 28, 1998
---------------- ----------------

NUVRTY, INC.
Note payable bearing interest at prime
rate plus 3 1/2%, interest payable monthly.
Note is secured by the assets of the
Company. Due September 30, 2002 $1,000,000 $1,000,000

GRANDVIEW TRUST
Note payable bearing interest at prime
rate plus 3 1/2%, interest payable monthly.
Note is secured by the assets of the
Company. Due October 15, 2002 750,000 750,000

OCEAN TRUST
Note payable bearing interest at prime
rate plus 3 1/2%, interest payable monthly.
Note is secured by the assets of the
Company. Due October 16, 2002 750,000 $750,000
---------- ----------
$2,500,000 $2,500,000
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---------- ----------

</TABLE>

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 is due and payable
on September 30, 2002. The loan is secured by the assets of the Company and
provides 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 Nuvrty Loan Documents, the Company issued a
warrant to Nuvrty to purchase up to 170,000 shares of the Company's common
stock if the loan was repaid in full within 120 days of closing and up to
340,000 shares of the Company's common stock if the loan was not repaid
within 120 days, all at a price of $2.25 per share. The warrants are
exercisable immediately and expire on the later of September 30, 2003 or one
year following payment in full of the loan.

On October 16, 1997 the Company entered into parallel promissory
notes, term loan agreements and security agreements with the Ocean and
Grandview Trusts on terms identical to those entered into with Nuvrty, Inc.
(the "Ocean Trust Loan Documents" and the "Grandview Trust Loan Documents",
respectively). The Ocean Trust Loan Documents and the Grandview Trust Loan
Documents provide for borrowing up to $750,000 from each Trust. Each loan is
secured by the assets of the Company. Interest on advances is accrued and
payable monthly at the prime rate plus 3 1/2%. The Company borrowed $750,000
under each facility. All outstanding principal and accrued interest is due
and payable to each of the Ocean and Grandview Trusts on October 16, 2002.

In connection with the Ocean Trust Loan Documents and the Grandview
Trust Loan Documents the Company issued warrants to each Trust respectively
to purchase up to 127,500 shares each of the Company's common stock if the
loans were repaid in full within 120 days of closing, or up to 255,000 shares
respectively of the Company's common stock if the loans were not repaid in
full within 120 days of closing, all at a price of $2.25 per share. The
warrants are exercisable immediately and expire on the later of October 16,
2003 or one year following payment in full of the respective loans. The
Company used the proceeds from the Ocean Trust and Grandview Trust loans to
pay off and discharge outstanding indebtedness.

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DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
OCTOBER 28, 1998
(UNAUDITED)

The warrants associated with all the above debt were accounted for
in accordance with the provisions of APB 14, "Accounting for Convertible Debt
and Debt Issued Stock Purchase Warrants." Due to the relative immateriality
of the fair value of the warrants, none of the proceeds from issuance of the
debt were allocated to the warrants. The determination of fair value was
calculated using both a Cost of Replacement Model and the Monte Carlo
simulation of possible warrant exercise.

On April 14, 1998 the Company announced the commitment of Franchise
Mortgage Acceptance Company ("FMAC") to make a secured loan of up to $5
million to the Company. After extensive discussions, the Company determined
that the structure required by FMAC was not in the Company's best interest.
In anticipation of this possible outcome, the Company engaged an investment
banker in November 1998 to seek alternative sources of capital. The Company
is currently operating at a net cash deficit and, in addition to working with
the investment bankers, is pursuing alternative sources of capital.
Management believes that one or more of these sources will be in place by the
end of the current fiscal year.

4. STOCKHOLDERS' EQUITY

On April 25, 1997, the Company's Board of Directors approved the
1997 Non-Employee Directors Stock Option Plan under which options for 10,000
shares each were granted to two non-employee directors. These options have an
exercise price of $2.75, became vested on April 25, 1998 and expire on April
25, 2007.

On November 18, 1997, Mr. John E. Martin joined the Company's Board
of Directors as Chairman, replacing Lawrence Goelman. On November 17, 1997,
Mr. Martin entered into a letter agreement with the Company appointing him
Chairman of the Board of the Company. The Company and Mr. Martin also entered
into an agreement under which Mr. Martin would be granted the option to
purchase up to 850,000 shares of the common stock of the Company subject to
stockholder approval ("Martin Option Agreement"). Mr. Martin and the Company
also agreed to terms under which Mr. Martin would purchase 333,333 shares of
the Company's common stock at $3.00 per share, following stockholder approval
of the Martin Option Agreement.

On November 18, 1997, Mr. Timothy J. Ryan joined the Company as
Diedrich Coffee's President and Chief Executive Officer to replace Lawrence
Goelman, Interim 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 600,000
shares of the common stock of the Company and Mr. Ryan would purchase 16,667
shares at $3.00 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
200,000 shares of the Company's common stock to Franchise Mortgage Acceptance
Company ("FMAC") at a price of $6.375 (the stock's closing sale price for
that day on the Nasdaq National Stock Market). In addition, FMAC also
received an option to purchase 100,000 additional shares of the Company's
common stock; this option may be exercised in increments of 25,000 shares or
more and expires on April 3, 2000. The exercise prices of this option are as
follows: 50,000 shares are exercisable at $10.00 per share and $12.50 per
share, respectively. The fair value of this option is estimated to be
$72,042. The estimated fair value of the option has been charged to equity
and will be amortized ratably over the two year life of the option.
Amortization for the period ended July 29, 1998 totaled $11,548. This
transaction was completed on April 3, 1998.

The Company's registration statements on Form S-8 for the 1997
Non-employee Directors Stock Option Plan, the John E. Martin Option Plan and
Agreement and the Tim J. Ryan Option Plan and Agreement were filed on August
12, 1998.

8
<PAGE>

DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
OCTOBER 28, 1998
(UNAUDITED)

The Company filed a registration statement on Form S-3 which was
declared effective on August 24, 1998 registering the following shares: 79,183
shares of common stock are issuable upon exercise of options granted to Steven
Lupinacci (former President and Chief Executive Officer of the Company), 160,000
shares of Common Stock are issuable to The Boston Group (underwriters of the
Company's initial public offering) and certain of its officers and affiliates
upon exercise of warrants to purchase common stock, 25,000 shares of common
stock are issuable upon exercise of options granted to Gregg Rondinelli
(financial consultant to the Company), 85,000 shares of common stock are
issuable to Virginia R. Cirica Trust upon exercise of a warrants, 340,000 shares
of common stock issuable to Nuvurty, Inc. upon the exercise of warrants, 255,000
shares of common stock issuable to Ocean Trust upon exercise of warrants,
255,000 shares of common stock issuable to Grandview Trust upon exercise of
warrants, 200,000 shares of common stock were issued pursuant to the Common
Stock and Option Purchase Agreement with FMAC, and 100,000 shares issuable upon
exercise of options to purchase common stock pursuant to the FMAC agreement.

On September 22, 1998, 6,140 shares of common stock were issued
pursuant to the exercise of certain Boston Group warrants. On October 28, 1998 ,
18.382 shares of common stock were issued pursuant to the exercise of certain
options granted under the Company's 1996 Stock Incentive Plan.

Subsequently to the end of the quarter an additional 15,120 shares of
common stock were issued pursuant to the exercise of certain Boston Group
warrants and 7,472 shares of common stock were issued pursuant to the exercise
of options granted under the Company's 1996 Stock Incentive Plan.

9
<PAGE>

PART I - FINANCIAL INFORMATION

ITEM 2. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

From time to time, in both written reports and oral statements, the
Company makes "forward-looking statements" within the meaning of Federal and
state securities laws. Disclosures that use words such as the Company
"believes," "anticipates," "expects," "may" or "plans" and similar expressions
are intended to identify forward-looking statements. These forward-looking
statements reflect the Company's current expectations and are based upon data
available at the time of the statements. Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from expectations. Any such forward-looking statements, whether made in this
report or elsewhere, should be considered in context with the various
disclosures made by the Company about its business, including the factors
discussed below. These projections or forward looking statements fall under the
safe harbors of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Foreseeable
risks and uncertainties are described elsewhere in this report and in detail
under "Risk Factors and Trends Affecting Diedrich Coffee and Its Business" in
the Company's annual report on Form 10-K for the fiscal year ended January 28,
1998 and in reports filed by the Company with the Securities and Exchange
Commission.

GENERAL

The Company commenced operations in 1972 as a private company and
completed its initial public offering in September 1996. The Company, a custom
roaster of specialty coffee, sells coffee and a broad range of espresso drinks
through its own coffeehouses. The Company's objective is to be the leading
national chain of neighborhood coffeehouses serving the best coffee possible. To
complement its beverage sales, the Company sells light food items and whole bean
coffee through its coffeehouses. The Company also sells roasted coffee as well
as coffee brewing and espresso equipment through its wholesale division. As of
October 28, 1998, the Company operated thirty-six coffeehouses and seven coffee
carts located in California, Colorado and Texas.

FIRST THREE QUARTERS. In the first thirty-nine weeks of the current
fiscal year the Company experienced losses of approximately $2.1 million
principally related to an increase in interest expense and general and
administrative expense. The level of general and administrative expense is
directly related to management's commitment to grow the Company through retail
coffeehouse development, new wholesale channels, and franchise area development.
Achieving this goal depends upon, among other things, obtaining and maintaining
sufficient working capital, aggressive growth in the wholesale division,
execution of new store management systems, successful negotiation of franchise
area development agreements and improved store management and customer
satisfaction. Pursuant to the Company's strategic plan, the roasting facility in
Denver, Colorado was closed in the first quarter and the roasting was
consolidated in Southern California. The Company also closed an under-performing
store in San Diego and one in Denver, Colorado. Four coffee cart locations at
premium Irvine Office Company locations were opened in the first quarter.
Additional coffee cart locations are under consideration and in discussion with
the Irvine Office Company and similar commercial property managers, but no
assurances can be given as to when or how many more coffee carts may be
installed.

AREA DEVELOPMENT. Management's franchise area development goals are to
enter into fifteen to seventeen franchise area development agreements covering
most major U. S. markets by the end of fiscal year 2000. As of July 29, 1998,
the Company had filed a Uniform Franchise Offering Circular in 32 states which
describes the expected terms of the offered franchises. On September 16, 1998
the Company announced its first franchise area development agreement which calls
for the development of 44 coffeehouses and an undisclosed number of carts and
kiosks in the state of North Carolina over a five year period. In connection
with the signing this agreement the Company recorded area development fee income
of $100,000. On November 16, 1998 the Company announced its second franchise
area development agreement which provides for the development of 50 coffeehouses
and an undisclosed number of carts and kiosks in San Diego, Palm Springs and
Temecula, California over the next five years.

10
<PAGE>

Although the Company is engaged in discussions with potential
additional area developers, there can be no assurances given as to when or at
what rate area development agreements are entered into. Area development
agreements commit the area developer to build and open coffeehouses in the
agreed-upon territory according to an agreed-upon schedule covering several
years. No assurances can be given as to the rate of new coffeehouse
construction, much less related franchise revenues. Successful area development
depends significantly upon the expertise, staff and capital of the area
developer as well as all of the contingencies and uncertainties to which the
Company and its business are subject.

Management plans to continue to develop, over the next five years,
Company-owned coffee houses, kiosks and mobile carts in Orange County,
California and in two to four other major U. S. markets. Outside of Orange
County, Company-owned store development will depend upon franchise area
development revenues and continued growth and improvements in Company operations
and coffee house-level execution.

GREEN COFFEE PRICES. Worldwide coffee commodity prices have moderated
from the record levels reached in the second and third quarters of fiscal 1998.
In the first quarter of fiscal year 1999, however, the Company's cost of green
coffee exceeded prior year levels by approximately 7%, while in the second and
third quarters the Company's cost of green coffee fell below the prior year
levels by approximately 8% on a year to date basis. The Company usually pays a
premium over the commodity price for the select grade coffee beans that it
purchases. As worldwide demand for coffee of all types remains strong, the
Company expects the prices that it pays to remain comparatively high into the
foreseeable future.

GREEN COFFEE AVAILABILITY. The Company believes that it has adequate
sources of supply of high quality, green arabica coffee to meet its projected
needs for the foreseeable future. While the Company seeks to carefully
anticipate its green coffee needs, there can be no assurance that supplies and
prices will not be affected by political and social events, the weather in the
coffee growing regions of the world, unexpected demand or other market forces.
Green coffee is an international agricultural commodity product subject to
considerable price fluctuations.

YEAR 2000 As a component of the Company's comprehensive enterprise
information systems architecture review the Year 2000 problem is being addressed
on a system by system basis. To date the Company has upgraded its general
accounting and fixed assets systems to current releases which are Year 2000
compliant. The general accounting system upgrade was planned prior to the
emergence of the Year 2000 problem as a specific project; the cost of this
upgrade was approximately $30,000. The fixed asset system upgrade was
implemented earlier than originally planned in order to address the Year 2000
problem; the cost of this upgrade was approximately $3,500. The Company is
continuing to review its information technology ("IT") hardware and software for
Year 2000 compliance issues and has identified selected additional required
upgrades that in aggregate are expected to cost less that $20,000; the Company
has not completed its review at this time. The Company has not begun its review
of non-IT systems but expects to do this before the end of the current fiscal
year. The Company believes that the most significant risks associated with Year
2000 compliance exist in its general accounting system (which includes invoicing
and accounts receivable for its wholesale business) and within the systems of
the five banks with whom it maintains depository accounts as well as the credit
card processing services. The Company has not confirmed that these organizations
have Year 2000 compliant systems. The Company has no formal contingency plan at
this time. The Company has not yet determined the extent to which it will
develop a formal contingency plan.

11
<PAGE>

SEASONALITY AND QUARTERLY RESULTS. The Company's business is subject to
seasonal fluctuations as well as economic trends that affect retailers in
general. Historically, the Company's net sales have not been realized
proportionately in each quarter, with net sales being the highest during the
last fiscal quarter which includes the December holiday season. Hot weather
tends to reduce sales. Quarterly results are affected by the timing of the
opening of new stores, which may not occur as anticipated due to events outside
the Company's 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. Due to all of the foregoing and variables,
the Company's future earnings and the market price of the Company's securities
are subject to change. There can be no assurance of when the Company will return
to profitability nor of its future growth rate.

RESULTS OF OPERATIONS

THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 28, 1998 COMPARED WITH THE
THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 29, 1997

NET SALES. Net sales for the thirteen weeks ended October 28, 1998
increased 8.6% to $6,043,000 from $5,563,000 for the thirteen weeks ended
October 29, 1997. During this most recent quarter, the Company derived 87.2% of
net sales from its retail coffeehouse operations. The Company's wholesale and
mail order sales accounted for 11.2% of net sales and franchise area development
fees accounted for 1.7% of net sales. Net retail sales for the thirteen weeks
ended October 28, 1998 increased 5.6% to $5,269,000 from $4,989,000 in the
thirteen weeks October 29, 1997. As of October 28, 1998, the Company operated 36
coffeehouses and seven carts; as of October 29, 1997, the Company operated 36
coffeehouses and one cart. The percentage increase in comparable store sales was
1.3% during the third quarter of fiscal 1999.

Wholesale and other sales increased 17.6% to $675,000 in the thirteen
weeks ended October 28, 1998 from $574,000 in the thirteen weeks ended October
29, 1997. The increase reflects increasing demand for the Company's wholesale
coffee products and increased sales efforts. Although the Company anticipates
continued improvement in wholesale sales, this depends upon successful marketing
of products produced using the new packaging equipment which the Company
acquired and installed in the second quarter. There can be no assurances that
the anticipated wholesale sales gains will happen.

Net sales for the thirty-nine weeks ended October 28, 1998 increased
4.4% to $17,996,000 from $17,241,000 for the thirty-nine weeks ended October 29,
1997. Net retail sales for the thirty-nine weeks ended October 28, 1998
increased 1.7% to $15,897,000 from $15,632,000 in the thirty-nine weeks October
29, 1997. Wholesale and other sales for the thirty-nine weeks ended October 28,
1998 increased 24.2% to $1,999,000 from $1,609,000 for the thirty-nine weeks
ended October 29, 1997. The percentage increase in comparable store sales was
1.1% for the thirty-nine weeks ended October 28, 1998.

COST OF SALES AND RELATED OCCUPANCY COSTS. Cost of roasted coffee,
dairy, food, paper and bar supplies, accessories and clothing (cost of sales)
and rent (related occupancy costs) for the thirteen weeks ended October 28, 1998
increased to $2,718,000 from $2,716,000 for the thirteen weeks ended October 29,
1997. As a percentage of net sales, cost of sales and related occupancy costs
decreased to 44.9% in the third quarter of fiscal 1999 from 48.8% for the third
quarter of fiscal 1998. This decreased percentage was the result of average unit
volume efficiencies resulting from the closure of low volume locations, lower
green coffee prices as well as purchasing efficiencies and the addition of
franchise area development revenues. These more than offset the impact of
increased occupancy costs, and an increase in the percentage of total revenues
contributed by wholesale sales.

Cost of sales and related occupancy costs for the thirty-nine weeks
ended October 28, 1998 decreased to $8,114,000 from $8,619,000 for the
thirty-nine weeks ended October 29, 1997. As a percentage of net sales, costs of
sales and related occupancy costs decreased to 45.1% for the first three
quarters in fiscal 1999 from 50.0% for the first three quarters in fiscal 1998.
This decrease stems from lower green coffee prices, the closure of low volume
locations, and improved controls.

12
<PAGE>

STORE OPERATING EXPENSES. Store operating expenses increased to
$2,188,000 for the thirteen weeks ended October 28, 1998 from $2,029,000 for the
thirteen weeks ended October 29, 1997. As a percentage of retail net sales,
store operating expenses increased to 41.5% in the third quarter of fiscal 1999
from 40.7% in the prior fiscal year's third quarter. For the thirty-nine weeks
ended October 28, 1998, store operating expenses, as a percentage of retail net
sales, increased to 42.4% from 41.8% for the thirty-nine weeks ended October 29,
1997. These increases were due to additional management and related expenses at
the coffeehouse level.

OTHER OPERATING EXPENSES. Other operating expenses (those associated
with wholesale and other sales) increased to $166,000 for the third quarter of
fiscal 1999 from $93,000 in the third quarter of fiscal 1998. These expenses, as
a percentage of the net sales from the wholesale division, increased to 24.5%
from 16.2%. For the thirty-nine weeks ended October 28, 1998, other operating
expenses, as a percentage of wholesale net sales, increased to 23.1% from 14.5%
for the thirty-nine weeks ended October 29, 1997. These increases reflect the
cost of additional management and sales staff recruited to further develop the
sales of the wholesale division. As a percentage of net sales these costs should
decrease as wholesale sales increase

DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
to $491,000 for the thirteen weeks ended October 28, 1998 from $427,000 for the
thirteen weeks ended October 29, 1997. As a percentage of net sales,
depreciation and amortization increased to 8.1% in comparison to 7.7% in the
prior year. Depreciation and amortization increased to $1,434,000 for the
thirty-nine weeks ended October 28, 1998 from $1,313,000 for the thirty-nine
weeks ended October 29, 1997.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased to $1,003,000 for the third quarter of fiscal 1999 from
$952,000 for the third quarter of fiscal 1998. As a percentage of net sales,
general and administrative expenses decreased to 16.6% from 17.1%. The Company
believes that it will continue to see a reduction in general and administrative
expenses relative to sales over the next several quarters as revenue flows
increase, assuming successful execution of the new business plan. As a
percentage of net sales, general and administrative expenses increased to 17.2%
for the thirty-nine weeks ended October 28, 1998 from 15.6% for the thirty-nine
weeks ended October 29, 1997 due to the ongoing costs associated with the
management resources added in the fourth quarter of fiscal 1998 and the first
half of fiscal 1999.

PROVISION FOR STORE CLOSINGS AND RESTRUCTURING COSTS. The restructuring
charge recorded in fiscal 1998 included primarily lease termination and other
costs associated with store closures as well as a provision for the impairment
of long-lived assets in accordance with SFAS No. 121.

INTEREST EXPENSE. Interest expense increased to $87,000 for the
thirteen weeks ended October 28, 1998 from $84,000 for the thirteen weeks ended
October 29, 1997. For the thirty-nine weeks ended October 28, 1998 interest and
other increased to $264,000 from $111,000 for the thirty-nine weeks ended
October 29, 1997; this increase resulted from the addition of the $2.5 million
in long-term debt and $553,000 in assets under capital leases.

LOSS BEFORE TAXES. Loss before taxes for the thirteen weeks ended
October 28, 1998 was $609,000 compared to loss before taxes of $739,000 for the
thirteen weeks ended October 29, 1997. This decreased loss was primarily due to
franchise area development income and improved retail operating margins. Loss
before taxes for the thirty-nine weeks ended October 28, 1998 was $2,112,000
compared to a loss before taxes of $6,820,000 for the thirty-nine weeks ended
October 29, 1997. This change was principally the result of the restructuring
charge taken in the first quarter of fiscal 1998.

LIQUIDITY AND CAPITAL RESOURCES

The Company had working capital deficit of $(961,000) as of October 28,
1998 compared to working capital deficit of $(959,000) as of January 28, 1998.
The current period working capital includes remaining restructuring liabilities
of $124,000. Cash used by operating activities for the thirty-nine weeks ended
October 28, 1998 totaled $(685,000).

<PAGE>

On April 3, 1998, the Company closed a private placement with Franchise
Mortgage Acceptance Company of Los Angeles, California ("FMAC") of 200,000
shares of Company restricted common stock at a price of $6.375 per share, or
approximately a $1,275,000 equity investment in the Company. In addition to the
private purchase, FMAC also acquired options to purchase restricted shares of
the Company's common stock, 50,000 shares at $10.00 and 50,000 shares at $12.50.
John Martin, Chairman of the Board of the Company, serves as a member of the
Board of Directors of FMAC.

The Company believes that cash from operations and the aforementioned
financing activities will be sufficient to satisfy the Company's working capital
needs through fiscal year 2000.

ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

DERIVATIVE INSTRUMENTS. The Company did not invest in market risk
sensitive instruments in fiscal 1998, nor in the first two quarters of 1999.
From time to time, the Company enters into agreements to purchase green coffee
in the future at prices to be determined within two to twelve months of the time
of actual purchase. At October 28, 1998 these commitments totaled $559,000.
These agreements are tied to specific market prices (defined by both the origin
of the coffee and the month of delivery) but the Company has significant
flexibility in selecting the date of the market price to be used in each
contract. The Company does not use commodity based financial instruments to
hedge coffee or any other commodity as the Company believes there will continue
to be a high probability of maintaining a strong correlation between increases
in green coffee prices and the final selling prices of the Company's products.

MARKET RISK. The Company's market risk exposure with regard to
financial instruments is to changes in the "prime rate" in the United States.
The Company borrowed $2,500,000 at the prime rate plus 3 1/2%. At July 29, 1998,
a hypothetical 100 basis point increase in the prime rate would result in
additional interest expense of $25,278 on an annualized basis. At October 28,
1998 the prime rate was 8%.

The Company does not and has not used derivative financial instruments
for any purpose, including hedging or mitigating interest rate risk.

14
<PAGE>

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of its business, the Company may become
involved in legal proceedings from time to time. As of December 1, 1998, the
Company was not a party to any material pending legal proceedings.

ITEM 5. OTHER INFORMATION

MINIMUM ADVANCE NOTICE OF STOCKHOLDER PROPOSALS. Stockholders of
the Company are advised that the Company must be notified at least 45 days
prior to the month and day of mailing the prior year's proxy statement of any
proposal or solicitation that any stockholder intends to present at the next
annual meeting of stockholders AND which the stockholder has not sought to
have included in the Company's Proxy Statement for the meeting in accordance
with Rule 14a-8 under the Securities Exchange Act. If a proponent fails to
notify the Company before the required deadline, management proxies will be
allowed to use their discretionary voting authority when the proposal is
raised at the annual meeting, without any discussion of the matter in the
Company's Proxy Statement.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(A) EXHIBITS

Set forth below is a list of the exhibits included as part of this
Quarterly Report.

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
3.1 Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
10.46 Form of Franchise Agreement
10.47 Form of Area Development Agreement
27 Financial data schedule
</TABLE>

(1) Incorporated by reference to the exhibit of the same number to
the Company's Registration Statement on Form S-1 (No.
333-08633), as amended, as declared effective by the Securities
and Exchange Commission on September 11, 1996.

(B) REPORTS ON FORM 8-K

None.

15
<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

Dated: December 10, 1998 DIEDRICH COFFEE, INC.

/s/ TIMOTHY J. RYAN
-------------------------------------
Timothy J. Ryan,
President and Chief Executive Officer
(Principal Executive Officer)

/s/ ANN WRIDE
-------------------------------------
Ann Wride
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

<PAGE>
EXHIBIT 10.46

DIEDRICH COFFEE

FRANCHISE AGREEMENT

<PAGE>

TABLE OF CONTENTS

ARTICLE 1 DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . 1

ARTICLE 2 GRANT. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.1 Grant. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.2 No Sublicensing Rights . . . . . . . . . . . . . . . . . . . 4
2.3 No Exclusive Territory . . . . . . . . . . . . . . . . . . . 4

ARTICLE 3 TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
3.1 Initial Term . . . . . . . . . . . . . . . . . . . . . . . . 5
3.2 No Renewal Right . . . . . . . . . . . . . . . . . . . . . . 5
3.3 Notice Required by Law . . . . . . . . . . . . . . . . . . . 5

ARTICLE 4 PAYMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . 5
4.1 Initial Franchise Fees . . . . . . . . . . . . . . . . . . . 5
4.2 Continuing Royalty . . . . . . . . . . . . . . . . . . . . . 5
4.3 Advertising Fee. . . . . . . . . . . . . . . . . . . . . . . 5
4.4 Pre-Authorized Payments. . . . . . . . . . . . . . . . . . . 6
4.5 Other Payments . . . . . . . . . . . . . . . . . . . . . . . 6
4.6 Application of Funds . . . . . . . . . . . . . . . . . . . . 7
4.7 Interest and Charges for Late Payments . . . . . . . . . . . 7

ARTICLE 5 CONSTRUCTION AND COMMENCEMENT OF BUSINESS. . . . . . . . . . 7
5.1 Location . . . . . . . . . . . . . . . . . . . . . . . . . . 7
5.2 Franchisor Site Selection Assistance . . . . . . . . . . . . 7
5.3 Lease. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
5.4 Construction and Renovation. . . . . . . . . . . . . . . . . 9
5.5 Maintaining and Remodeling of Coffeehouse. . . . . . . . . .10

ARTICLE 6 TRAINING . . . . . . . . . . . . . . . . . . . . . . . . . .11
6.1 Initial Training Program . . . . . . . . . . . . . . . . . .11
6.2 Additional Training. . . . . . . . . . . . . . . . . . . . .12
6.3 Other Assistance . . . . . . . . . . . . . . . . . . . . . .13

ARTICLE 7 OBLIGATIONS OF FRANCHISOR. . . . . . . . . . . . . . . . . .13
7.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .13
7.2 Franchisor Default . . . . . . . . . . . . . . . . . . . . .14
7.3 No Other Obligations . . . . . . . . . . . . . . . . . . . .14

ARTICLE 8 MANUALS AND STANDARDS OF OPERATOR
QUALITY, CLEANLINESS AND SERVICE . . . . . . . . . . . . . .14
8.1 Product Line and Service . . . . . . . . . . . . . . . . . .14
8.2 Containers, Fixtures and Other Goods . . . . . . . . . . . .15
8.3 Menus. . . . . . . . . . . . . . . . . . . . . . . . . . . .15
8.4 POS System . . . . . . . . . . . . . . . . . . . . . . . . .15
8.5 Manuals. . . . . . . . . . . . . . . . . . . . . . . . . . .15
8.6 Hours. . . . . . . . . . . . . . . . . . . . . . . . . . . .16

i
<PAGE>

8.7 Compliance with Applicable Law . . . . . . . . . . . . . . .17
8.8 Signs, Designs and Forms of Publicity. . . . . . . . . . . .17
8.9 Uniforms and Employee Appearance . . . . . . . . . . . . . .18
8.10 Vending or Other Machines. . . . . . . . . . . . . . . . . .18
8.11 Co-Branding. . . . . . . . . . . . . . . . . . . . . . . . .18

ARTICLE 9 ADVERTISING AND CO-OPS . . . . . . . . . . . . . . . . . . .18
9.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .18
9.2 Local Advertising. . . . . . . . . . . . . . . . . . . . . .19
9.3 Co-op Advertising. . . . . . . . . . . . . . . . . . . . . .19
9.4 Advertising Program. . . . . . . . . . . . . . . . . . . . .20
9.5 Telephone Numbers and Directory Advertising. . . . . . . . .21
9.6 Promotional Campaigns. . . . . . . . . . . . . . . . . . . .21

ARTICLE 10 DISTRIBUTION AND PURCHASE OF
EQUIPMENT, SUPPLIES, AND OTHER PRODUCTS. . . . . . . . . . .21
10.1 Coffee and Diedrich Coffee Brand Products. . . . . . . . . .21
10.2 Proprietary Products . . . . . . . . . . . . . . . . . . . .22
10.3 Non-Proprietary Products . . . . . . . . . . . . . . . . . .22
10.4 Purchases from Franchisor, Extensions of Credit. . . . . . .23
10.5 Purchase/Distribution Programs . . . . . . . . . . . . . . .24
10.6 Test Marketing . . . . . . . . . . . . . . . . . . . . . . .24

ARTICLE 11 REPORTS, BOOKS AND RECORDS, INSPECTIONS. . . . . . . . . . .25
11.1 General Reporting. . . . . . . . . . . . . . . . . . . . . .25
11.2 Inspections. . . . . . . . . . . . . . . . . . . . . . . . .26
11.3 Audits . . . . . . . . . . . . . . . . . . . . . . . . . . .26

ARTICLE 12 MARKS. . . . . . . . . . . . . . . . . . . . . . . . . . . .27
12.1 Use of Marks . . . . . . . . . . . . . . . . . . . . . . . .27
12.2 Non-Use of Trade Name. . . . . . . . . . . . . . . . . . . .27
12.3 Use of Other Marks . . . . . . . . . . . . . . . . . . . . .27
12.4 Non-ownership of Marks . . . . . . . . . . . . . . . . . . .27
12.5 Defense of Marks . . . . . . . . . . . . . . . . . . . . . .27
12.6 Prosecution of Infringers. . . . . . . . . . . . . . . . . .28
12.7 Modification of Marks. . . . . . . . . . . . . . . . . . . .28
12.8 Acts in Derogation of the Marks. . . . . . . . . . . . . . .28
12.9 Assumed Name Registration. . . . . . . . . . . . . . . . . .28

ARTICLE 13 COVENANTS REGARDING OTHER BUSINESS INTERESTS . . . . . . . .29
13.1 Non-Competition and Trade Secrets. . . . . . . . . . . . . .29
13.2 Operator's Affiliates. . . . . . . . . . . . . . . . . . . .30

ARTICLE 14 INTERFERENCE WITH EMPLOYMENT RELATIONS . . . . . . . . . . .30

ARTICLE 15 NATURE OF INTEREST, ASSIGNMENT . . . . . . . . . . . . . . .31

<PAGE>

15.1 Assignment by Franchisor . . . . . . . . . . . . . . . . . .31
15.2 Assignment by Operator . . . . . . . . . . . . . . . . . . .31

ARTICLE 16 DEFAULT AND TERMINATION. . . . . . . . . . . . . . . . . . .33
16.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .33
16.2 Automatic Termination Without Notice . . . . . . . . . . . .33
16.3 Option to Terminate Without Notice . . . . . . . . . . . . .34
16.4 Termination With Notice and Opportunity To Cure. . . . . . .36
16.5 Reimbursement of Franchisor Costs. . . . . . . . . . . . . .36
16.6 Cross-Default. . . . . . . . . . . . . . . . . . . . . . . .37
16.7 Notice Required By Law . . . . . . . . . . . . . . . . . . .37

ARTICLE 17 RIGHTS AND OBLIGATIONS UPON TERMINATION. . . . . . . . . . .37
17.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .37
17.2 Survival of Obligations. . . . . . . . . . . . . . . . . . .38
17.3 No Ownership of Marks. . . . . . . . . . . . . . . . . . . .38
17.4 Government Filings . . . . . . . . . . . . . . . . . . . . .38

ARTICLE 18 INSURANCE. . . . . . . . . . . . . . . . . . . . . . . . . .38
18.1 Insurance. . . . . . . . . . . . . . . . . . . . . . . . . .38
18.2 Use of Proceeds. . . . . . . . . . . . . . . . . . . . . . .39
18.3 Proof of Insurance . . . . . . . . . . . . . . . . . . . . .39

ARTICLE 19 RELATIONSHIP OF PARTIES, DISCLOSURE. . . . . . . . . . . . .39
19.1 Relationship of Operator to Franchisor . . . . . . . . . . .39
19.2 Indemnity by Operator. . . . . . . . . . . . . . . . . . . .39

ARTICLE 20 NOTICES. . . . . . . . . . . . . . . . . . . . . . . . . . .40
20.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .40

ARTICLE 21 MISCELLANEOUS PROVISIONS . . . . . . . . . . . . . . . . . .40
21.1 Franchisor's Right To Cure Defaults. . . . . . . . . . . . .40
21.2 Waiver and Delay . . . . . . . . . . . . . . . . . . . . . .41
21.3 Survival of Covenants. . . . . . . . . . . . . . . . . . . .41
21.4 Successors and Assigns . . . . . . . . . . . . . . . . . . .41
21.5 Joint and Several Liability. . . . . . . . . . . . . . . . .41
21.6 Governing Law. . . . . . . . . . . . . . . . . . . . . . . .42
21.7 Entire Agreement . . . . . . . . . . . . . . . . . . . . . .42
21.8 Titles For Convenience . . . . . . . . . . . . . . . . . . .42
21.9 Gender And Construction. . . . . . . . . . . . . . . . . . .42
21.10 Severability . . . . . . . . . . . . . . . . . . . . . . . .42
21.11 Counterparts . . . . . . . . . . . . . . . . . . . . . . . .43
21.12 Fees and Expenses. . . . . . . . . . . . . . . . . . . . . .43
21.13 Waiver of Jury . . . . . . . . . . . . . . . . . . . . . . .43

ARTICLE 22 SUBMISSION OF AGREEMENT. . . . . . . . . . . . . . . . . . .43

iii
<PAGE>

22.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .43

ARTICLE 23 ACKNOWLEDGEMENT. . . . . . . . . . . . . . . . . . . . . . .43
23.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . .43
23.2 Due Execution. . . . . . . . . . . . . . . . . . . . . . . .43

</TABLE>

<PAGE>

Exhibit A - Minimum Hours of Operation

<PAGE>

DIEDRICH COFFEE
FRANCHISE AGREEMENT

THIS AGREEMENT is made this _____ day of _______________ , 199__ (the
"Effective Date") by and between Diedrich Coffee, Inc., a California
corporation, located at 2144 Michelson Drive, Irvine, California 92612, (the
"Franchisor"), and ____________________________________________________, [ ]
an individual OR [ ] a ___________________ organized under the laws of
_________________ (the "Operator"), with reference to the following facts:

A. Franchisor owns certain proprietary and other property rights
and interests in and to the "Diedrich Coffee" trademark and service mark, and
such other trademarks, service marks, logo types and commercial symbols as
Franchisor may from time to time authorize or direct Operator to use in
connection with the operation of a "Diedrich Coffee" Coffeehouse (the "Marks").

B. Franchisor has developed and continues to develop a system for
the operation of coffeehouses, kiosks and coffee carts and merchandising of
Diedrich Coffee Authorized Products, which system features distinctive signs,
recipes, and various trade secrets and other confidential information, and in
some cases also includes architectural designs, trade dress, uniforms, equipment
specifications, layout plans, inventory, record-keeping and marketing techniques
(the "System").

C. Operator desires to obtain a license and franchise to operate a
single Coffeehouse under the Marks and in strict accordance with the System, and
the standards and specifications established by Franchisor, and Franchisor is
willing to grant Operator such license and franchise under the terms and
conditions of this Agreement.

NOW, THEREFORE, the parties agree as follows:

ARTICLE 1
DEFINITIONS

In this Agreement the following capitalized terms shall have the
meanings set forth below, unless the context otherwise requires:

"Advertising Fee" shall have the meaning set forth in Section 4.3.

"Applicable Law" means and includes applicable common law and all applicable
statutes, laws, rules, regulations, ordinances, policies and procedures
established by any

1
<PAGE>

Governmental Authority governing the operation of the Coffeehouse, including
all immigration, labor, disability, food and drug laws, health and safety
regulations, and Americans With Disabilities Act requirements, as in effect
on the Effective Date hereof, and as may be amended from time to time.

"Assets" shall have the meaning set forth in Section 15.3.

"Assignment" shall have the meaning set forth in Section 15.2.

"Authorized Diedrich Coffee Products" means the specific espresso drinks and
coffees, roasted coffee beans and blends, premium teas, baked goods, snacks
and other food items and ancillary products, which may include coffee making
equipment, cups, hats, t-shirts and novelty items, as specified by Franchisor
from time to time in Franchisor's Manuals, or as otherwise directed by
Franchisor in writing, for sale at the Operator's Coffeehouse, prepared and
served in strict accordance with Franchisor's recipes, quality standards and
specifications, including specifications as to ingredients, brand names,
preparation and presentation.

"Barrista" means a person who has been certified by Franchisor as an expert
in the knowledge and preparation of espresso drinks.

"Business Entity" means any general partnership or limited partnership (each
of which shall be referred to as a "Partnership"), limited liability company,
and any trust, association, corporation or other entity which is not an
individual.

"Closing" shall have the meaning set forth in Section 15.3.2 and shall refer
to the closing of a sale of Operator's Assets to Franchisor pursuant to
Section 15.3.1.

"Coffeehouse" shall refer to the full service location, kiosk, or coffee cart
operated pursuant to this Agreement under Franchisor's Marks and in
accordance with the System and specializing in the sale of Authorized
Diedrich Coffee Products.

"Continuing Royalty" shall have the meaning set forth in Section 4.2

"Co-op Advertising Regions" shall have the meaning set forth in Section 9.2.

"Designated Operator Representative" shall have the meaning set forth in
Section 6.1.1.

"Diedrich Coffee Branded Product" is any product now existing or developed in
the future that bears or is packaged under any of Franchisor's Marks.

"Effective Date" means the date indicated in the first paragraph of this
Agreement.

"Governmental Authority" means and include all Federal, state, county,
municipal and local governmental and quasi-governmental agencies, commissions
and authorities.

2
<PAGE>

"Gross Sales" means gross revenues (excluding allowances and sales taxes)
received or receivable by Operator as payment, whether in cash or for credit
or barter (and, if for credit or barter, whether or not payment is received
therefor), for all espresso, coffee, tea and other beverages, roasted coffee
beans, food, and other goods, services, and supplies sold or prepared in
Operator's Coffeehouse, or which are promoted or sold under any of the
Franchisor's Marks.

"Initial Fee" shall have the meaning set forth in Section 4.1

"Lease" shall have the meaning set forth in Section 5.3.

"Leasehold Improvements" shall have the same meaning set forth in Section
5.4.1.

"Location" shall have the meaning set forth in Section 5.1.1.

"Manuals" means Franchisor's Front Line Team Member Training Guide; Diedrich
Coffee Operations Manual and Support Manual, and all related manuals now or
hereafter created by Franchisor for use in the operation of a Coffeehouse, as
the same may be amended and revised from time to time, including all
bulletins, supplements and ancillary manuals.

"Marks" shall have the meaning set forth in Recital A above.

"Negotiating Period" shall have the meaning set forth in Section 15.3.4.

"Operator" shall mean the person or Business Entity identified in the first
paragraph of this Agreement, and for purposes of Article 13 only, shall
include Operator's spouse and minor children and its Owners, officers and
directors if Operator is a Business Entity.

"Owner" means any shareholder, member, general or limited partner, trustee,
or other equity owner of a Business Entity.

"Permits" means and include all applicable franchises, licenses, permits,
registrations, certificates and other operating authority required by
Applicable Law.

"Premises" means, in the case of a kiosk or cart, the property at which the
Operator's Coffeehouse is located, including unless otherwise expressly
provided, any ancillary common areas, campus, buildings and other structures
associated with the Premises.

"Supplier" shall have the meaning set forth in Section 10.3.

"System" shall have the meaning set forth in Recital B.

"Term" shall have the meaning set forth in Section 3.1, including any
extensions thereof.

"Trade Secrets" shall have the meaning set forth in Section 13.1.3.
"Transfer Fee" shall have the meaning set forth in Section 15.2.9.

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"Week" shall refer to the 7 day period ending on Sunday of each calendar
week, or such other reporting period hereafter specified by Franchisor.

ARTICLE 2
GRANT

2.1 GRANT.

2.1.1 Franchisor hereby awards Operator the right and
license during the Term, upon the terms and subject to the provisions of this
Agreement, to use and display the Marks, and to use the System, to operate at,
and only at, the Location, one: (check one)

[ ] Full Service Coffeehouse
[ ] Kiosk
[ ] Cart

2.1.2 Operator may not use or operate any permanent or
temporary cart, kiosk or other vending device in connection with any full
service Coffeehouse pursuant to this Agreement, except with Franchisor's prior
written consent and pursuant to a separate addendum hereto on a form specified
by Franchisor.

2.2 NO SUBLICENSING RIGHTS. Operator shall not
subfranchise, sublicense, subcontract, sublease, or enter any management
agreement providing for the right to operate the Coffeehouse or to use the
System granted pursuant to this Agreement.

2.3 NO EXCLUSIVE TERRITORY.

2.3.1 The license and franchise granted to the
Operator under this Agreement is non-exclusive, and does not grant Operator any
protected trading area or territory, nor any rights to obtain additional
franchises from Franchisor. Without limiting the generality of the foregoing,
the Franchisor expressly reserves the exclusive, unrestricted right, in its sole
and absolute discretion, directly and indirectly:

(a) to own or operate, and to franchise and license
others to own, operate or co-brand, coffeehouses, kiosks, and carts at any
location other than at the specific Location identified in Section 5.1.1,
regardless of its proximity to the Coffeehouse operated pursuant hereto; and

(b) to produce, promote, license, distribute and
market products, whether or not they bear any of the Marks, at wholesale or
retail, through its employees, affiliates, representatives, licensees,
franchisees, assigns, agents and others, including bulk and pre-packaged roasted
coffee, premium teas, ice cream, beverages, snacks and other food products;
clothing; books, souvenirs and novelty items, through any outlet or channel

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of commerce, including grocery stores and convenience stores (regardless of
their proximity to Operator's Coffeehouse), sales by means of the internet,
mail order catalogs, direct mail advertising, vending machines and other
distribution methods.

ARTICLE 3
TERM

3.1 INITIAL TERM. Subject to earlier termination pursuant
to Article 16, the Term of this Agreement shall begin on the Effective Date and
continue for a period of 10 years.

3.2 NO RENEWAL RIGHT. Operator shall not have any right to
renew this Agreement or to enter into a new franchise agreement for Operator's
Coffeehouse.

3.3 NOTICE REQUIRED BY LAW. If applicable law requires that
Franchisor give notice to Operator prior to the expiration of the Term, this
Agreement shall remain in effect on a week to week basis until Franchisor has
given the notice required by such applicable law.

ARTICLE 4
PAYMENTS

4.1 INITIAL FRANCHISE FEES. Operator shall pay to
Franchisor an initial franchise fee (the "Initial Fee") equal to $20,000, or
$7,500 if the Operator's Coffeehouse is a kiosk or cart. The Initial Fee shall
be payable in good funds 50% upon signing this Agreement, and 50% at or prior to
opening the Coffeehouse to the public, and shall be deemed fully earned by
Franchisor upon the execution of this Agreement by Franchisor and Operator and
shall be non-refundable, in whole or in part, under any circumstances.

4.2 CONTINUING ROYALTY. Operator shall pay to Franchisor
each Week during the Term, an amount equal to the following percentage of its
Gross Sales during the preceding Week (the "Continuing Royalty"): (a) 5% in the
case of a full service Coffeehouse; or (b) 7.5% in the case of a Kiosk or Cart.
Operator shall cause its Continuing Royalty for each Week to be actually
received by Franchisor on or before Wednesday of the following of Week, or the
following business day if Wednesday falls on a legal holiday during which
Operator's bank is closed.

4.3 ADVERTISING FEE. Operator shall pay to Franchisor each
Week during the Term, simultaneously with its Continuing Royalty payments and in
the manner described in Section 4.2, an Advertising Fee equal to up to 2%, as
established by Franchisor, of its Gross Sales during the preceding Week
("Advertising Fee").

4.3.1 Until an Advertising Program shall have been
established pursuant to Section 9.3, Franchisor shall refund up to the full
amount of Operator's

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Advertising Fee payments to reimburse Operator for approved Coffeehouse
advertising expenditures, in accordance with such reasonable policies and
procedures as Franchisor may establish from time to time, which may include,
among other requirements, submission of evidence Operator's actual
expenditures.

4.3.2 Following implementation of the Advertising
Program, Franchisor shall contribute the Advertising Fee to the Advertising
Program to be administered in the manner provided in Section 9.3.

4.4 PRE-AUTHORIZED PAYMENTS.

4.4.1 If Operator fails to report its sales on a
timely basis in accordance with Section 11.1, Franchisor may estimate the amount
of Operator's sales, and deposit or transfer the reported, or in the absence of
a report, the estimated, amounts due into its own account, using the Operator's
pre-authorized checks or other instruments or authority.

4.4.2 At Franchisor's request, Operator shall instruct
its bank to pay the amount of its weekly Continuing Royalty, Advertising Fee and
other fees directly to Franchisor from Operator's account, by electronic funds
transfer or such other automatic payment mechanism which Franchisor may
designate and upon the terms and conditions set forth in the Operations Manual,
and promptly upon Franchisor's request, Operator shall execute or re-execute and
deliver to Franchisor such pre-authorized check forms and other instruments or
drafts required by Franchisor's bank, payable against Operator's bank account,
to enable Franchisor to draw Operator's Continuing Royalty, Advertising Fee and
other sums payable under the terms of this Agreement.

4.5 OTHER PAYMENTS. In addition to all other payments
provided herein, Operator shall pay to Franchisor, its parent companies,
subsidiaries, affiliates and designees, as applicable, promptly when due:

4.5.1 All amounts advanced by Franchisor or which
Franchisor has paid, or for which Franchisor has become obligated to pay on
behalf of Operator for any reason whatsoever.

4.5.2 All sums due on account of the purchase of
products or services by or for the account of Operator.

4.5.3 The amount of all sales taxes, use taxes,
personal property taxes and similar taxes, which shall be imposed upon Operator
and required to be collected or paid by Franchisor (a) on account of Operator's
Gross Sales, or (b) on account of Continuing Royalties, Advertising Fees or
Initial Fees collected by Franchisor from Operator (but excluding ordinary
income taxes). Franchisor, at its sole discretion, may collect the taxes in the
same manner as franchise fees are collected herein and if Franchisor collects
such taxes, Franchisor shall promptly pay the tax collections to the appropriate
governmental authority; provided, however, that it shall be Operator's

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responsibility to pay any sales, use or other taxes now or hereinafter
imposed on Initial Fees, Continuing Royalties, and Advertising Fees imposed
by any Governmental Authorities.

4.6 APPLICATION OF FUNDS. If Operator shall be delinquent
in the payment of any obligation to Franchisor hereunder, or under any other
agreement with Franchisor, Franchisor shall have the absolute right to apply any
payments received from Operator to any obligation owed, whether under this
Agreement or otherwise, notwithstanding any contrary designation by Operator as
to application.

4.7 INTEREST AND CHARGES FOR LATE PAYMENTS.

4.7.1 If Operator shall fail to pay to Franchisor the
entire amount of the Continuing Royalty, Advertising Fee or any other sums owed
to Franchisor, promptly when due, Operator shall pay to Franchisor, in addition
to all other amounts which are due but unpaid, interest on the unpaid amounts,
from the due date thereof, at the rate of 1-1/2% per month, or the highest rate
allowable under applicable law, whichever is less.

4.7.2 If any check, draft, electronic or otherwise, is
unpaid because of insufficient funds or otherwise, then Operator shall pay
Franchisor's expenses arising from such non-payment, including bank fees in the
amount of at least $30.00, hourly staff charges arising from such default, and
any other related expenses incurred by Franchisor.

ARTICLE 5
CONSTRUCTION AND COMMENCEMENT OF BUSINESS

5.1 LOCATION.

5.1.1 Operator's Coffeehouse shall be located at the
following address: ________________________________________________, and if the
Coffeehouse is a kiosk or cart, the following specific location at the address
inserted above: ___________________________________________________________ (the
"Location").

5.1.2 Operator may not relocate the Coffeehouse,
including in the case of a kiosk or cart relocating to any other location within
the Premises, without Franchisor's prior written consent. Any attempt to do so
shall be a material breach hereof.

5.2 FRANCHISOR SITE SELECTION ASSISTANCE. Franchisor may
voluntarily (without obligation) assist Operator in identifying or obtaining
a location. Franchisor's said assistance, if any, shall not be construed to
insure or guarantee the profitable or successful operation of the Location by
Operator, and Franchisor hereby expressly disclaims any responsibility
therefor. Operator acknowledges that it is its sole responsibility to find a
suitable Location, that the location of the Coffeehouse will be a

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critical factor in the success of Operator's business, and that Franchisor is
not obligated to directly or indirectly identify or obtain a location for
Operator.

5.3 LEASE. If the Location is leased or subleased by
Operator, (i) Franchisor shall have the right of approval of such lease or
sublease, as applicable (the "Lease"), a true and correct copy of which shall
be delivered to Franchisor at least 15 days prior to the execution thereof;
(ii) the term of said Lease shall be for a period which is not less than the
Term of this Agreement, unless Franchisor shall approve, in writing, a
shorter term; (iii) Operator shall neither create nor purport to create any
obligations on behalf of Franchisor, nor grant or purport to grant to the
landlord thereunder any rights against Franchisor, nor agree to any other
term, condition, or covenant which is inconsistent with any provision of this
Franchise Agreement; (iv) Operator shall duly and timely perform all of the
terms, conditions, covenants and obligations imposed upon him under the
Lease; (v) the Location shall be constructed and improved pursuant to the
provisions of Section 5.4 hereof; (vi) the Lease shall grant Franchisor an
option, without cost or expense to Franchisor, to assume the Lease in the
event of termination or expiration of the Franchise Agreement for any reason,
and shall expressly provide that Franchisor shall have the right (but not the
obligation) to succeed to Operator's rights under the Lease if Operator fails
to exercise any option to renew, and upon Operator's default thereunder, and
that upon any alleged breach thereof by Operator, the landlord thereunder
shall be obligated to notify Franchisor in writing at least 15 days prior to
its termination or non-renewal and, in the case of a default, Franchisor
shall have the right, but not the obligation, to cure the breach and to
succeed to Operator's rights under said Lease by giving written notice of
such election to Operator and such landlord; Operator hereby appoints
Franchisor as its attorney-in-fact to execute an assignment and all other
documents and instruments which Franchisor deems necessary or appropriate to
effectuate the foregoing; (vii) a fully executed copy of said Lease shall be
delivered to Franchisor promptly following the execution thereof; and (viii)
the Lease shall provide that it may not be assigned, subleased, modified or
amended without Franchisor's prior written consent and that Franchisor shall
be provided with copies of all such assignments, subleases, modifications and
amendments, and shall consent in advance to any assignment or sublease to
Franchisor or a "Diedrich Coffee" franchisee or licensee approved by
Franchisor during the initial term or any renewal term of the Lease. In all
cases, the Lease shall provide that upon expiration or termination thereof
for any reason, Operator shall, upon Franchisor's demand, remove all of the
Marks from the Location and Premises and modify the decor of the Location so
that it no longer resembles, in whole or in part, a Diedrich Coffee
coffeehouse, kiosk or cart and that if Operator shall fail do so, Franchisor
will be given written notice and the right to enter the Location and Premises
to make such alterations, in which event Operator shall reimburse Franchisor
for all direct and indirect costs and expense it may incur in connection
therewith, including attorney's fees.

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5.4 CONSTRUCTION AND RENOVATION.

5.4.1 If on the Effective Date the Coffeehouse,
Location or Premises at which the Coffeehouse will operate has not been
constructed, or if the same has been constructed but does not comply with
Franchisor's current standards in effect for new "Diedrich Coffee"
coffeehouses, kiosks or carts, as applicable, Operator shall at its sole cost
and expense promptly cause the Coffeehouse and Location to be constructed,
equipped and improved in accordance with such standards and specifications.
Except to the extent otherwise agreed to by Franchisor, all fixtures,
furnishings, equipment and signs ("Leasehold Improvements") shall be
purchased by Operator only from suppliers and manufacturers approved by
Franchisor.

5.4.2 Following the Effective Date and prior to any
construction or renovation of the Coffeehouse or Location, Franchisor shall
provide Operator with copies of Franchisor's specifications for the design
and layout of the Coffeehouse and required Leasehold Improvements. Operator
shall, in all respects, comply with all such specifications and criteria
unless Franchisor shall, in writing, agree to modifications thereof.
Operator shall employ architects, engineers and general contractors of its
own selection, and at its sole cost and expense, to prepare such
architectural, engineering and construction drawings and site plans, and/or
to modify the standard architectural, engineering and construction drawings
and site plans which may be provided by Franchisor, and to obtain all Permits
required to construct, remodel, renovate, and/or equip the Coffeehouse and
Location. All such drawings and plans, and all modifications and revisions
thereto, shall be submitted to Franchisor for its prior review and approval
before Operator's commencement of construction pursuant thereto. When
completed, said Coffeehouse and Location shall in all respect strictly comply
with the Franchisor's specifications therefor, as modified or revised if
applicable with Franchisor's prior written consent.

5.4.3 Subject only to causes beyond the reasonable
control of Operator, such as, by way of illustration, strikes, material
shortages, fires and other acts of God, which Operator could not by the
exercise of due diligence have avoided, Operator shall complete construction
or renovation, as the case may be, of the Location and Coffeehouse and shall
install all Leasehold Improvements therein as soon as possible, but in any
event within 3 months after commencement of construction. At all times prior
to Operator commencing the operation of the Coffeehouse, Franchisor shall
have the right, and Operator shall provide access to Franchisor, to inspect
and examine the Premises, Location, Coffeehouse and all Leasehold
Improvements, for the purpose of insuring compliance with Franchisor's
standards and specifications.

5.4.4 Operator shall commence the operation of the
Coffeehouse not later than 6 months following the Effective Date.

5.4.5 The time periods for the commencement and
completion of construction and the installation of Leasehold Improvements as
referred to in this Section 5.4 are of the essence of this Agreement. If
Operator fails to perform its obligations

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contained in this Section, the Franchisor may deem the Operator's failure to
so perform its obligations as aforesaid to constitute a material breach of
this Agreement.

5.5 MAINTAINING AND REMODELING OF COFFEEHOUSE.

5.5.1 Operator at all times during the Term shall
maintain the condition and appearance of its Coffeehouse in accordance with
the Manuals and consistent with the image of a "Diedrich Coffee" Coffeehouse
as attractive, clean, and efficiently operated, offering high quality food
products and beverages, efficient and courteous service, and pleasant
ambiance. If at any time in the Franchisor's reasonable judgment, the
general state of repair, appearance or cleanliness of the Location (including
the Coffeehouse and the non-Coffeehouse portion of Operator's Location and
Premises, and parking areas) or its Leasehold Improvements, does not meet the
Franchisor's standards therefor, Operator shall immediately upon receipt of
notice from Franchisor specifying the action to be taken by Operator to
correct such deficiency, repair and refurbish the Coffeehouse, the Location
and the Premises, as applicable, and make such modifications and additions to
its layout, decor and general theme, as may be required from time to time to
maintain such condition, appearance, efficient operation, ambiance and
overall image, including without limitation, replacement of worn out or
obsolete Leasehold Improvements, and repair and paint the interior and
exterior of the Coffeehouse, and appurtenant parking areas (if any), and
periodic cleaning and redecorating. Operator shall fully implement and
complete such repairs, painting, refurbishment and changes within 90 days
after receipt of said written notice. Such maintenance shall not be deemed
to constitute remodeling, as set forth below.

5.5.2 From time to time during the Term, Franchisor
may require Operator at Operator's sole cost and expense to refurbish,
remodel and improve the Coffeehouse to conform the Operator's building
design, trade dress, color schemes, and presentation of Marks to the
Franchisor's then current public image. Such a remodeling may include
extensive structural changes to the Coffeehouse and replacement or
modification of Leasehold Improvements as well as such other changes as the
Franchisor may direct, and Operator shall undertake such a program promptly
upon notice from the Franchisor, and shall complete any such remodeling as
expeditiously as possible, but in any event within 90 days of commencing
same. Franchisor may, on one or more occasions, waive or defer for such
period of time as Franchisor may deem appropriate, Operator's obligation to
remodel any such Coffeehouse, if Franchisor determines in its reasonable
judgment that any such Coffeehouse is, on the date scheduled for commencement
of such remodel, in substantial conformity with Franchisor's then current
standard system decor specifications, or if the proposed remodeling is within
the last two years prior to the expiration of the Term.

5.5.3 If the Coffeehouse is damaged or destroyed by
fire or any other casualty, Operator, within 30 days thereof, shall initiate
such repairs or reconstruction, and thereafter in good faith and with due
diligence continue (until completion) such repairs or reconstruction, in order
to restore the premises of the Coffeehouse to its original condition prior to
such casualty. If, in Franchisor's reasonable

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judgment, the damage or destruction is of such a nature or to such extent
that it is feasible for Operator to repair or reconstruct the Location and
the Coffeehouse in conformance with the then standard "Diedrich Coffee" decor
specifications, the Franchisor may require Operator, by giving written notice
thereof, that Operator repair or reconstruct the Location and Coffeehouse in
conformance with the then standard System decor specifications.

ARTICLE 6
TRAINING

6.1 INITIAL TRAINING PROGRAM.

6.1.1 Operator shall, at all times, employ a
general manager and one or more assistant managers and other employees
acceptable to Franchisor each of whom shall have been trained and qualified
as "Barristas" in accordance with Franchisors policies and standards, and at
least one of whom shall be working at the Coffeehouse at all times while the
Coffeehouse is open to the public. At no extra charge, Franchisor shall
provide an initial training program in the Franchisor's System and methods of
operation to up to 5 persons selected by Operator who shall be the general
manager and assistant manager(s) of the Coffeehouse. Said initial training
program shall consist of up to 4 weeks of training, as Franchisor in its
reasonable judgment may determine, at one or more of the following locations:
(i) Franchisor's corporate headquarters in Irvine, California, (ii) at a
Franchisor-owned or franchised coffeehouse, (iii) at Operator's Location, or
(iv) at such place or places as may be designated by Franchisor. In the case
of a Operator which is a Business Entity, Franchisor may require the general
manager to be an Owner, officer or other designated representative selected
by Operator and acceptable to, and approved by Franchisor ("Designated
Operator Representative"). Subject to Section 6.1.4, Franchisor will bear
its costs of providing the initial training program concurrently to up to 5
persons pursuant to this Section 6.1.1, including Franchisor's staff
salaries, materials, and all technical training tools. Operator shall pay all
travel, living, compensation, and other expenses, if any, incurred by
Operator and/or Operator's employees in connection with attendance at
training programs. Operator may not open its Coffeehouse until such training
shall have been successfully completed by Operator's general manager,
assistant manager and Operator's management team and staff has been certified
by Franchisor. Franchisor shall pay no compensation for any services
performed by trainee(s) in connection with such training programs.

6.1.2 The contents of the initial training program
and manner of conducting such program shall be at Franchisor's sole
discretion and control, however, the training course will be structured to
provide practical training in the implementation and operation of a
Coffeehouse and may include such topics as on-site coffee and espresso drink
and food preparation, Barrista training, use of point of sale cash register
and/or computer systems, inventory, cash handling, Diedrich Coffee standards,
personnel management, marketing techniques, reports, equipment maintenance,
safety and security, customer service techniques and financial controls.

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6.1.3 Franchisor shall provide the initial training
at no additional charge pursuant to Sections 6.1.1 and 6.1.2 only if this is
the first Coffeehouse operated by Operator, and not if Operator has otherwise
previously received such training for this Location. Unless otherwise agreed
in writing by Franchisor, the Designated Operator Representative shall become
a certified trainer and thereafter train its Coffeehouse general manager,
assistant manager(s) and other employees pursuant to Section 6.1.4.

6.1.4 Unless waived by Franchisor, each of
Operator's general managers, assistant managers and staff shall have
satisfactorily completed Franchisor's initial training program as required
pursuant to Section 6.1.1, PROVIDED, HOWEVER, that if general manager or
Designated Operator Representative has been approved by Franchisor as a
certified trainer, Operator's general manager, assistant managers or staff
for the Coffeehouse may be trained by such certified trainer in lieu of
attending Franchisor's initial training program as required pursuant to
Section 6.1.1. Should Franchisor determine that any general manager's,
assistant manager's or other employee's training is unsatisfactory,
Franchisor may required such person(s) (or a replacement trainee acceptable
to Franchisor) to undergo further training by Franchisor at a time scheduled
by Franchisor, until Franchisor is satisfied that Operator's trainee has
satisfactorily completed the training course and Operator shall advance or
reimburse, at Franchisor's option, all direct and indirect costs and expense
that Franchisor may incur for the wages, lodging, subsistence and travel of
Franchisor's personnel, if conducted at the Coffeehouse in Franchisor's
discretion, for the duration of the extended training and Franchisor's then
current standard training fee. Operator acknowledges that because of
Franchisor's superior skill and knowledge with respect to the training and
skill required to manage the Coffeehouse, its judgment as to whether or not
the Operator or his manager has satisfactorily completed such training shall
be determined by Franchisor in its sole subjective judgment, exercised in
good faith.

6.2 ADDITIONAL TRAINING. Franchisor may, from time to
time, at its discretion, make available to Operator or its manager and/or
Designated Operator Representative, or any of them, additional optional
training courses or programs during the term of this Agreement held on a
national or regional basis at locations selected by Franchisor to instruct
Operator with regard to new procedures or programs which Franchisor deems, in
its reasonable judgment, to be of material importance to the operation of the
Coffeehouse by its franchisees. Such supplementary training may relate, by
way of illustration, to product production techniques, new recipes,
marketing, bookkeeping, accounting and general operating procedures, and the
establishment, development and improvement of computer systems. Franchisor
may establish charges applicable to all franchisees similarly situated for
such optional training courses. The time and place of such training courses
shall be at Franchisor's sole discretion. Operator shall pay all
transportation costs, food, lodging and similar costs incurred in connection
with attendance at such courses. Franchisor shall pay no compensation for
any services performed by trainee(s) in connection with such training
programs.

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6.3 OTHER ASSISTANCE.

6.3.1 Operator shall have the right, at no
additional charge, to inquire of Franchisor's headquarters staff, its field
representatives and training staff with respect to problems relating to the
operation of the Coffeehouse, by telephone or correspondence, and Franchisor
shall use its best efforts to diligently respond to such inquiries, in order
to assist Operator in the operation of the Coffeehouse. At no time shall
reasonable assistance be interpreted to require Franchisor to pay any money
to Operator.

6.3.2 Franchisor may, from time to time, at its
discretion, cause its field representatives to visit Operator's Coffeehouse
for the purpose of rendering advice and consultation or training, with
respect to the Coffeehouse, its operation and performance, and compliance by
Operator with the Operations Manual. If provided at the Operator's request,
the Franchisor may require the Operator to pay such training charges as may
be then in effect, and to reimburse Franchisor for all transportation costs,
food, lodging and similar costs incurred by Franchisor and its personnel in
connection with such training.

6.3.3 In the event of any sale transfer, or
assignment, the transferee/assignee must be trained by Franchisor as a
condition of Franchisor's consent to such transfer. All transfer fees and
tuition costs for such training shall be paid to Franchisor in advance of the
attendance by such transferee and its employees in accordance with Section
15.2.9 herein. No Coffeehouse shall be opened or re-opened until Franchisor
certifies that the transferee is approved to operate the respective
Coffeehouse.

ARTICLE 7
OBLIGATIONS OF FRANCHISOR

7.1 GENERAL. Franchisor shall perform the following
obligations:

7.1.1 To review and approve or disapprove the
Operator's proposed Location;

7.1.2 To supply to Operator a set of standard decor
and layout plans and to thereafter approve the initial decor and layout of
Operator's Coffeehouse;

7.1.3 To loan Operator a copy of its Manuals which
contain mandatory and suggested specifications, standards and procedures.
The Manuals are confidential and remains Franchisor's property.

7.1.4 To provide the training and assistance described
in Article 6.

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7.1.5 To administer in good faith the Advertising
Program described in Section 9.3, if and when implemented.

7.1.6 To use its best efforts, in good faith, to
supply Operator's requirements for roasted coffee beans and blends in
sufficient quantities to meet Operator's needs for its Coffeehouse, as
provided in Section 10.1.2.

7.2 FRANCHISOR DEFAULT. Franchisor shall not, and can
not be held in breach of this Agreement until (i) Franchisor has received
written notice from Operator describing in detail any alleged breach from
Operator; and (ii) Franchisor has failed to remedy the breach within a
reasonable period of time after such notice, which period shall not be less
than 60 days plus such additional time as reasonably required by Franchisor
if because of the nature of the alleged breach it cannot reasonably be cured
within said 60 days, provided Franchisor promptly commences and continues
diligently to cure such alleged breach. This is a material term of this
Agreement and may not be modified or changed by any arbitrator in an
arbitration proceeding or otherwise.

7.3 NO OTHER OBLIGATIONS. Franchisor shall not be
obligated to provide any services to Operator except expressly provided
herein and any and all other services which Franchisor may provide to
Operator during the Term shall be at its sole discretion and Franchisor may
cease to provide the same without notice of further obligation to Operator.

ARTICLE 8
MANUALS AND STANDARDS OF OPERATOR
QUALITY, CLEANLINESS AND SERVICE

In order to promote the value and goodwill of Franchisor's Marks and
the System and to protect Franchisor's Marks and the other Diedrich Coffee
operators who comprise the Diedrich Coffee franchise system, Operator shall
conduct its business in accordance with the standards promulgated by
Franchisor as follows:

8.1 PRODUCT LINE AND SERVICE. Operator shall serve all
and only Authorized Diedrich Coffee Products at or from the Coffeehouse, all
of which shall be purchased by Operator from a Franchisor or a designated or
approved distributor or manufacturer, as provided in Article 10. Operator
acknowledges that Authorized Diedrich Coffee Products may differ at
Coffeehouses, kiosks, carts, and may vary depending on the operating season
and geographic location of the Operator's Coffeehouse or other factors.

8.1.1 Operator shall not produce, advertise for
sale, sell or give away any goods or services unless the same product has
been approved in the Manuals as an Authorized Diedrich Coffee Product
approved for sale in Operator's Coffeehouse and has not been thereafter
disapproved in writing by Franchisor.

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8.1.2 All coffee, coffee drinks and other food and
beverage products sold by Operator shall be of the highest quality, and the
ingredients, composition, specifications, and preparation of such food
products shall conform strictly with the instructions and recipes provided by
Franchisor or contained in Franchisor's Manuals, and with the further
requirements of Franchisor as they are communicated to Operator from time to
time.

8.2 CONTAINERS, FIXTURES AND OTHER GOODS. Operator
agrees that all food and drink items served at the Coffeehouse shall be
served in approved containers bearing accurate reproductions of Franchisor's
Marks. All containers, napkins, bags, cups, matches, menus and other
packaging and like articles used in connection with Operator's Coffeehouse
shall conform to Franchisor's specifications, shall be imprinted with
Franchisor's Marks and shall be purchased by Operator from a distributor or
manufacturer approved in writing by Franchisor, as provided in Article 10,
which approval will not be unreasonably withheld. No item of merchandise,
furnishings, interior and exterior decor items, supplies, fixtures, equipment
or utensils bearing any of Franchisor's Marks shall be used in or upon any
Coffeehouse unless the same shall have been first submitted to and approved
in writing by Franchisor.

8.3 MENUS. All Authorized Diedrich Coffee Products shall
be distributed under the specific name designated by Franchisor. Operator
shall not remove any Authorized Diedrich Coffee Product from the Operator's
menu unless Operator is so instructed by Franchisor.

8.4 POS SYSTEM. Operator shall purchase, use and
maintain the point of sale cash collection system (the "POS System") as
specified in the Manuals or otherwise by Franchisor in writing. The POS
System may include a cash register, register tape printer, magnetic stripe
reader and cash drawer. Upon at least 90 days prior written notice,
Franchisor may require Operator to computerize the POS System and connect the
POS System to Operator's telephone line(s) via modem or other communications
medium. At Franchisor's request, Operator shall also maintain membership in
a designated third party network (such as CompuServe, AOL, MSN, Prodigy,
etc.) for the purpose of implementing, transmitting, collecting and
maintaining any Information or data exchange system. Within a reasonable
time upon Franchisor's request, Operator shall apply for and maintain debit
cards, credit cards or other non-cash systems existing or developed in the
future to enable customers to purchase Authorized Diedrich Coffee Products
via such procedure, as specified by Franchisor.

8.5 MANUALS. Operator shall operate the Coffeehouse in
strict compliance with the standard procedures, policies, rules and
regulations established by Franchisor and incorporated in Franchisor's
Manual(s). The subject matter of the Manuals may include, without
limitation, matters such as: forms, information relating to product and menu
specifications, cash control, purchase orders, general operations, labor
schedules, personnel, Gross Sales reports, payroll procedures, training and
accounting; safety and sanitation; design specifications and color of
uniforms; display of signs and notices; authorized and required equipment and
fixtures, including specifications therefor;

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Mark usage; insurance requirements; lease requirements; decor; standards for
management and personnel, hours of operation; yellow page and local
advertising formats; standards of maintenance and appearance of the
Coffeehouse; and required posting of notices to customers as to how to
contact the Franchisor to submit complaints. Without limiting the generality
of the foregoing, the Franchisor may establish emergency procedures pursuant
to which it may require Operator to temporarily close the Coffeehouse to the
public, in which event Franchisor shall not be liable to Operator for any
losses or costs, including consequential damages or loss profits occasioned
thereby.

8.5.1 Franchisor shall have the right to modify the
Manuals at any time and from time to time by the addition, deletion or other
modification to the provisions thereof. All such modifications shall be
equally applicable to all similarly situated franchisees who are required by
their franchise agreements to comply therewith, and no such modification
shall alter Operator's fundamental status and rights under this Agreement.
Modifications in the Manuals shall become effective upon delivery of written
notice thereof to Operator unless a longer period is specified in such
written notice. The Manuals, as modified from time to time as hereinabove
provided shall be an integral part of this Agreement and reference made in
this Agreement, or in any amendments, exhibits or schedules hereto, to the
Manuals shall be deemed to mean the Manuals kept current by amendments from
time to time.

8.5.2 Upon the execution of this Agreement,
Franchisor shall furnish to Operator one copy of the Manuals, unless Operator
purchased the Coffeehouse from an existing franchisee or entered into this
Agreement as a renewal or extension of a pre-existing franchise agreement for
the same Location. The Manuals and all amendments to the Manuals (and copies
thereof) are copyrighted and remain Franchisor's property. They are loaned
to Operator for the term of the Agreement, and must be returned to Franchisor
upon the Agreement's termination or expiration. The Manuals are highly
confidential documents which contain certain trade secrets of Franchisor, and
Operator shall never reveal, and shall take all reasonable precautions, both
during and after the Term of this Agreement, to assure that its employees or
any other party under Operator's control, shall never reveal any of the
contents of the Manuals or any other publication, recipe or secret provided
by Franchisor, except as is necessary for the operation of Operator's
Coffeehouse. Upon the expiration or termination of this Agreement for any
reason whatsoever, Operator shall immediately return the Manuals to
Franchisor. Operator shall not make, or cause or allow to be made, any
copies or reproductions of all or any portion of the Manuals without
Franchisor's express prior written consent.

8.6 HOURS. Subject to Applicable Law to the contrary,
Franchisor and Operator agree that Operator's Coffeehouse shall be open and
operational during at least the minimum hours and days set forth on Exhibit A
which is attached hereto and incorporated herein by this reference. Operator
shall diligently and efficiently exercise its best efforts to achieve the
maximum Gross Sales possible from its Location, and shall remain open for longer
hours if additional opening hours are reasonably required to maximize operations
and sales. Without limiting the foregoing, if the hours set forth in

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Exhibit A are incorrect in relation to the sales potential of Operator's
Coffeehouse, then Franchisor and Operator shall reasonably adjust such hours
by jointly establishing new hours of operation. It is acknowledged that the
hours of other operators will vary in relation to each respective location,
and local legal restrictions, if any.

8.6.1 Authorized Diedrich Coffee Products shall be
marketed by approved menu formats to be utilized in Operator's Coffeehouse.
The approved and authorized menu and menu format(s) may include, in
Franchisor's discretion, requirements concerning organization, graphics,
product descriptions, illustrations, and any other matters (except prices)
related to the menu, whether or not similar to those listed. In Franchisor's
discretion, the menu and/or menu format(s) may vary depending upon region,
market size, season and other factors. Franchisor may change the menu and/or
menu format(s) from time to time or region to region or authorize tests from
region to region or authorize non-uniform regions or Coffeehouses within
regions, in which case Operator will be given a reasonable time (not longer
than 60 days) to discontinue use of any old menu format(s) and implement use
of the new menu format(s).

8.6.2 Operator shall, upon receipt of notice from
Franchisor, add any Authorized Diedrich Coffee Products to its menu according
to the instructions contained in the notice. Operator shall have a minimum
of 30 days after receipt of written notice in which to fully implement any
such change. Operator shall cease selling any previously approved or
discontinued product within 30 days after receipt of notice that the product
is no longer approved.

8.7 COMPLIANCE WITH APPLICABLE LAW. Operator shall
operate its Coffeehouse as a clean, orderly, legal and respectable place of
business in accordance with Franchisor's business standards and merchandising
policies, and shall comply with all Applicable Laws. Operator shall not
cause or allow any part of its Location or Premises to be used for any
immoral or illegal purpose.

8.8 SIGNS, DESIGNS AND FORMS OF PUBLICITY. Operator
shall maintain suitable signs and/or awnings at, on, or near the front of the
Location and Premises, identifying the Location as a "Diedrich Coffee"
Coffeehouse, which shall conform in all respects to Franchisor's
specifications and requirements and the layout and design plan approved for
the Location, subject only to restrictions imposed by Applicable Law.
Without limiting the foregoing:

8.8.1 Operator will cause to have Diedrich Coffee
signs (a) on each pole sign and each monument sign existing or to be erected;
(b) on any other free standing sign on the Location existing or to be
erected, and (c) on two sides of the Location and, in the case of a kiosk or
cart, the Premises building.

8.8.2 No sign used at or in connection with the
Coffeehouse shall contain any trademark, service mark, logo type or
commercial symbol of any other person or Business Entity except as expressly
authorized by Franchisor in writing.

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8.8.3 No exterior or interior sign or any design,
advertisement, sign, or form of publicity, including form, color, number,
location, and size, shall be used by Operator unless first submitted to
Franchisor and approved in writing (except with respect to prices).

8.9 UNIFORMS AND EMPLOYEE APPEARANCE. Operator shall
cause all employees, while working in Coffeehouses, to: (i) wear uniforms of
such color, design, and other specifications as Franchisor may designate from
time to time, and (ii) present a neat and clean appearance. In the event the
type of uniform utilized by Operator is removed from the list of approved
uniforms, Operator shall have 180 days from receipt of written notice of such
removal to discontinue use of its existing inventory of uniforms and
implement the approved type of uniform.

8.10 VENDING OR OTHER MACHINES. Except with Franchisor's
prior written approval, Operator shall not cause or allow vending or game
machines or any other mechanical device to be installed or maintained in its
Location, and in the case of a kiosk or cart shall use its best efforts to
prevent the installation or maintenance of same at the Premises.

8.11 CO-BRANDING. Operator may not install any co-brand
at Operator's Location without Franchisor's prior written consent, which may
be granted or withheld in its sole discretion, and, if granted may be subject
to such terms and conditions as Franchisor may establish. For the purpose of
this article, a co-brand shall be defined as an independent operating system
owned by another entity (not Franchisor) that is incorporated as an
operational part within the Operator's Premises. An example would be an
independent ice cream/yogurt operation installed within Operator's Location.
Nothing herein shall prevent Franchisor from co-branding or authorizing any
third party to co-brand "Diedrich Coffee" coffeehouses, kiosks or carts in
conjunction with such third party's operations.

ARTICLE 9
ADVERTISING AND CO-OPS

9.1 GENERAL REQUIREMENTS. Operator shall conduct all
local advertising and promotion in accordance with such policies and
provisions with respect to format, content, media, geographic coverage and
other criteria as are from time to time contained in the Manuals, or as
otherwise directed by Franchisor, and shall not use or publish any
advertising material which does not conform to said policies and provisions
or as to which Operator shall not have received Franchisor's prior written
approval; PROVIDED, HOWEVER, that if Franchisor shall not object to any
proposed advertisement submitted by Operator for approval within 10 business
days after Franchisor's receipt thereof, such advertisement shall be deemed
approved subject to Franchisor's right to subsequently withdraw its approval.

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9.2 LOCAL ADVERTISING. Each calendar quarter, Operator
shall expend an amount of not less than 2% of its Gross Sales for Local
Advertising relating to Operator's Coffeehouse which amount may be reduced in
accordance with Section 9.3.4 below. Such local advertising must include
Franchisee listing its Store in the white pages and yellow pages of such
telephone directories distributed in Operator's area as Franchisor authorizes
or directs, the cost of which shall be in addition to said 2% of Gross Sales.
Operator's advertisement in the yellow pages must be listed under each
category specified by Franchisor. Operator shall deliver evidence of such
expenditures in the form and manner prescribed by Franchisor from time to
time.

9.3 CO-OP ADVERTISING. The Franchisor shall have the
right at any time, and from time to time, to create regions for regional
cooperative advertising ("Co-op Advertising Regions"), which shall function
for the purpose of creating a cohesive team to coordinate advertising,
marketing efforts and programs and maximizing the efficient use of local
and/or regional advertising media.

9.3.1 If and when Franchisor creates a Co-op
Advertising Region for the region in which Operator's Coffeehouse is located,
Operator and, if Franchisor owns a Coffeehouse in such Co-op Advertising
Region, Franchisor, shall become subscribers and members thereof and shall
execute a Subscription Agreement on a form prescribed by Franchisor, and
participate therein in accordance with the Subscription Agreement and the
Certificate of Incorporation and Bylaws of such Co-op Advertising Region.
The size and content of such regions, when and if established by the
Franchisor, shall be binding upon Operator, all other "Diedrich Coffee"
franchisees similarly situated and Franchisor, if applicable. At all
meetings of such Co-op Advertising Region each participating Operator, as
well as Franchisor, if applicable, shall be entitled to one vote for each
Coffeehouse owned by Operator and located within such Co-op Advertising
Region. At any time upon reasonable notice, 20% of the eligible member
votes, a majority of the directors of such Co-op Advertising Region (who
shall be elected in accordance with the Bylaws of such Co-op Advertising
Region), or Franchisor by itself, may call a meeting of all members of a
Co-op Advertising Region. Except for any amendment of the Certificate of
Incorporation, Operating Agreement or By-laws of the Co-op Advertising Region
(which shall require the affirmative vote of the Franchisor), all matters
concerning operation of a Co-op Advertising Region shall be decided by
majority vote, provided that a quorum is present, and such vote shall bind
all members of said region, including Franchisor. For purposes hereof, a
quorum shall consist of members entitled to cast at least 50% of the total
number of votes in such Co-op Advertising Region.

9.3.2 Operator and other franchisees who are
members of the Co-op Advertising Region will contribute to the Co-op
Advertising Region such amount as may be determined by vote of the Co-op
Advertising Region (not to exceed 2% of the Gross Sales of each members
Coffeehouse(s) located in the region) only to the extent actually paid by
Operator and after written approval of the Co-op Advertising Region's
advertising plans.

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9.3.3 Each Co-op Advertising Region will decide as
to the usage of funds contributed pursuant to Section 9.2.2 for media time,
production of media materials, whether for radio, television, newspapers or
store level materials such as flyers, or posters, or for any other type of
advertising or marketing use, and then such Co-op Advertising Region shall in
writing request approval from Franchisor to use said funds in said manner.
Franchisor shall not withhold approval unreasonably, but no placement of
advertising or commitment of advertising funds on behalf of an Co-op
Advertising Region will be made without Franchisor's prior written approval.
Franchisor reserves the right to establish general standards concerning the
operation of the Co-op Advertising Region, advertising agencies retained by
Co-op Advertising Region, and advertising programs conducted by Co-op
Advertising Region.

9.3.4 Expenditures made by Operator pursuant to any
Co-op Advertising Region program, in accordance with this Section 9.3, shall
be credited against Operator's local advertising requirement described in
Section 9.2 above.

9.4 ADVERTISING PROGRAM.

9.4.1 Franchisor shall administratively segregate
on its books and records all Advertising Fees received from Operator and all
other franchisees of Franchisor. Nothing herein shall be deemed to create a
trust fund, and Franchisor may commingle advertising fees with its general
operating funds and expend such sums in the manner herein provided. For each
Coffeehouse that Franchisor or any of its affiliate operates, Franchisor or
such affiliate will similarly allocate to the Advertising Program the amount
that would be required to be contributed to the Advertising Program if it
were a franchised Coffeehouse.

9.4.2 If less than the total of all contributions
and allocations to the Advertising Program are expended during any fiscal
year, such excess may be accumulated for use during subsequent years. If
Franchisor advances money to the Advertising Program, Franchisor will be
entitled to be reimbursed for such advances, including interest at the rate
equal to the Franchisor's cost of funds. Each determination by Franchisor of
an interest rate hereunder shall be conclusive and binding for all purposes,
absent manifest error.

9.4.3 An amount equal to all Advertising Program
revenues and allocations will be expended for national, regional, or local
advertising, public relations or promotional campaigns or programs designed
to promote and enhance the image, identity or patronage of franchised and
Franchisor-owned "Diedrich Coffee" Coffeehouses. Such expenditures may
include, without limitation (a) to conduct marketing studies, and to produce
and purchase advertising art, commercials, musical jingles, print
advertisements, point of sale materials, media advertising, outdoor
advertising art, and direct mail pamphlets and literature; and (b) a payment
to Franchisor or its affiliates, for internal expenses incurred to administer
the Advertising Program. Franchisor shall determine, in its final and
subjective discretion, exercised in good faith, the cost, media, content,
format, style, timing, allocation and all other matters relating to such
advertising,

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public relations and promotional campaigns. Although the Franchisor will
attempt to allocate advertising expenditures fairly and in good faith,
nothing herein shall be construed to require Franchisor to allocate or expend
Advertising Program Contributions or allocations so as to benefit any
particular franchisee or group of franchisees on a pro rata or proportional
basis or otherwise. Franchisor may make copies of advertising materials
available to Operator with or without additional reasonable charge, as
determined by Franchisor. Any additional advertising shall be at the sole
cost and expense of Operator.

9.4.4 Upon written request, Franchisor shall
furnish to Operator within 120 days after the end of each calendar year, a
report for the preceding year, prepared and certified correct by an officer
of the Franchisor containing the calculations of the amount which Franchisor
actually expended during such calendar year and the amount remaining which
shall be carried over for use during the following year(s).

9.5 TELEPHONE NUMBERS AND DIRECTORY ADVERTISING. In
addition to the Advertising Fees, and Operator's required expenditures for
Co-op Advertising, Operator shall, at its sole expense, subscribe for and
maintain throughout the Term, or such lesser period designated by Franchisor,
one or more listed telephone numbers which shall be listed in the white pages
and under such headings in the yellow pages of such telephone directory or
directories as Franchisor may designate or approve which service Operator's
Location and adjacent or nearby areas. Franchisor reserves the right to
establish general standards concerning directory and other types of
advertising.

9.6 PROMOTIONAL CAMPAIGNS. From time to time during the
term hereof, Franchisor shall have the right to establish and conduct
promotional campaigns on a national or regional basis, which may by way of
illustration and not limitation promote particular products or marketing
themes. Operator agrees to participate in such promotional campaigns upon
such terms and conditions as the Franchisor may establish. Operator
acknowledges and agrees that such participation may require Operator to
purchase point of sale advertising material, posters, flyers, product
displays and other promotional material, and to the extent permitted by
Applicable Law may establish the maximum prices which Operator may impose for
products offered in the promotion.

ARTICLE 10
DISTRIBUTION AND PURCHASE OF
EQUIPMENT, SUPPLIES, AND OTHER PRODUCTS

10.1 COFFEE AND DIEDRICH COFFEE BRAND PRODUCTS.

10.1.1 At all times throughout the Term, Operator
shall purchase and maintain in inventory such types and quantities of
Authorized Diedrich Coffee Products as are needed to meet reasonably
anticipated consumer demand. Operator shall purchase Diedrich Coffee Brand
Products, and all roasted coffee beans and blends served, offered or sold at
the Coffeehouse, solely and exclusively from Franchisor or its designated
third party distributors or suppliers.

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10.1.2 Franchisor shall use its best efforts, in
good faith, to supply Operator's requirements for roasted coffee beans and
blends in sufficient quantities to meet Operator's needs for its Coffeehouse,
at Franchisor's then current published wholesale prices, which may be changed
or modified from time to time without prior notice.

10.2 PROPRIETARY PRODUCTS. Franchisor may, from time to
time throughout the Term hereof in its sole subjective discretion exercised
in good faith, require that Operator purchase, use, offer and/or promote,
and maintain in stock at the Coffeehouse in such quantities as are needed to
meet reasonably anticipated consumer demand, certain proprietary powder mixes
and other ingredients and raw materials, which are manufactured in accordance
with Franchisor's proprietary recipes, specifications and/or formulas
("Proprietary Products"). Operator shall purchase Proprietary Products only
from Franchisor (if it sells the same) or its designees. Franchisor shall
not be obligated to reveal such recipes, specifications and/or formulas of
such Proprietary Products to Operator, non-designated suppliers, or any other
third parties.

10.3 NON-PROPRIETARY PRODUCTS. Franchisor may designate
baked goods and other food and dairy products, condiments, beverages, paper
goods, fixtures, furnishings, equipment (including espresso and coffee-making
equipment), uniforms, supplies, menus, packaging, forms, POS and cash
register systems, computer hardware, software, modems and peripheral
equipment and other products, supplies and equipment other than Proprietary
Products which Operator may or must use and/or offer and sell at the
Coffeehouse ("Non-Proprietary Products"). Operator may, but shall not be
obligated to, purchase such Non-Proprietary Products from Franchisor, if
Franchisor supplies same. Operator may use, offer or sell only such
Non-Proprietary Products that Franchisor has expressly authorized, or that
were purchased or obtained from Franchisor or a producer, manufacturer or
supplier ("Supplier") designated or approved by Franchisor pursuant to
Section 10.3.2 below.

10.3.1 Operator may purchase authorized
Non-Proprietary Products from (i) Franchisor, (ii) Suppliers designated by
Franchisor, or (iii) Suppliers selected by Operator and approved in writing
by Franchisor prior to Operator making such purchase(s). Each such Supplier
designated or approved by Franchisor must comply with Franchisor's usual and
customary requirements regarding insurance, indemnification, and
non-disclosure, and shall have demonstrated to the reasonable satisfaction of
Franchisor: (a) its ability to supply a Non-Proprietary Product meeting the
specifications of Franchisor, which may include, without limitation,
specifications as to brand name and model, contents, quality, freshness and
compliance with governmental standards and regulations; and (b) its
reliability with respect to delivery and the consistent quality of its
products or services.

10.3.2 If Operator should desire to procure
authorized Non-Proprietary Products from a Supplier other than Franchisor or
one previously approved or designated by Franchisor, Operator shall deliver
written notice to Franchisor of its desire to seek approval of such Supplier,
which notice shall (i) identify the name and address of such Supplier, (ii)
contain such information as may be requested by Franchisor

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or required to be provided pursuant to the Manuals (which may include
reasonable financial, operational and economic information regarding its
business ), and (iii) identify the authorized Non-Proprietary Products
desired to be purchased from such Supplier. Franchisor shall, upon request
of Operator, furnish to Operator specifications for such Non-Proprietary
Products if such are not contained in the Manuals. The Franchisor may
thereupon request that the proposed Supplier furnish Franchisor at no cost to
Franchisor product samples, specifications and such other information as
Franchisor may require. Franchisor or its representatives shall also be
permitted to inspect the facilities of the proposed Supplier and establish
economic terms, delivery, service and other requirements consistent with
other distribution relationships for other Diedrich Coffee Coffeehouses.

(a) Franchisor will use its good faith efforts to notify
Operator of its decision within 90 days after Franchisor's receipt of
Operator's request for approval and other requested information and items in
full compliance with Section 10.3.2. Nothing in this article shall require
Franchisor to approve any distributor, and without limiting Franchisor's
right to approve or disapprove a Supplier in its discretion, Operator
acknowledges that it is generally disadvantageous to the system generally
from a cost and service basis to have more than one distributor in any given
market area and that among the other factors Franchisor may consider in
deciding whether to approve a proposed Supplier, it may consider the affect
that such approval may have on the ability of Franchisor and its franchisees
to obtain the lowest distribution costs and on the quality and uniformity of
products offered system-wide by Diedrich Coffee franchisees. Franchisor may
revoke its approval upon the Supplier's failure to continue to meet any of
Franchisor's criteria.

(b) As a further condition of such approval, Franchisor
may require such Supplier to agree in writing: (i) to provide from time to
time upon Franchisor's request free samples of any Non-Proprietary Product it
intends to supply to Operator, (ii) to faithfully comply with Franchisor's
specifications for applicable Non-Proprietary Products sold by it, (iii) to
sell any Non-Proprietary Product bearing the Marks only to franchisees of
Franchisor and only pursuant to a Trademark License Agreement in form
prescribed by Franchisor (which may require payment of a royalty), (iv) to
provide to Franchisor duplicate purchase invoices for Franchisor's records
and inspection purposes and (v) to otherwise comply with Franchisor's
reasonable requests.

(c) Operator or the proposed Supplier shall pay to
Franchisor in advance all of Franchisor's reasonably anticipated costs in
reviewing the application of the Supplier to service the Operator and all
current and future reasonable costs and expenses, including travel and living
costs, related to inspecting, reinspecting and auditing the Suppliers'
facilities, equipment, and food products, and all product testing costs paid
by Franchisor to third parties.

10.4 PURCHASES FROM FRANCHISOR, EXTENSIONS OF CREDIT.

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10.4.1 Franchisor shall not be liable to Operator on
account of any delay or failure in the manufacture, delivery or shipment of
roasted coffee beans, blends or other products caused by events or
circumstances beyond Franchisor's reasonable control including such events as
labor or material shortages, conditions of supply and demand, import/export
restrictions, or disruptions in Franchisor's supply sources. In the event
from time to time that the available supply of any product is inadequate to
fulfill the needs or orders of all coffeehouses operated by Franchisor, its
affiliates and its franchisees, including Operator, Franchisor shall make
such allocations of product as it may decide in good faith.

10.4.2 All product orders by Operator shall be
subject to acceptance by Franchisor at Franchisor's designated offices, and
Franchisor reserves the right to accept or reject, in whole or in part, any
order placed by Operator. Operator shall submit to Franchisor, upon written
request, financial statements which contain sufficient information to enable
Franchisor to determine the credit limits, if any, to be extended to
Operator. Franchisor, in its sole discretion, may establish the credit
terms, if any, upon which it will accept Operator's orders, and may require
Operator to pay for orders on a cash-in-advance or cash-on-delivery basis.

10.4.3 Each order placed by Operator, whether oral
or written, for any product shall be deemed to incorporate all of the terms
and conditions of this Agreement, shall be deemed subordinate to this
Agreement in any instance where any term or condition of such order conflicts
with any term or condition of this Agreement, and shall include such
information as Franchisor may from time to time specify, and shall be
submitted on such form of purchase order as my be prescribed by Franchisor
from time to time. No purchase order submitted by Operator shall contain any
terms except as approved in writing by Franchisor, nor be deemed complete
unless all of the information required by the prescribed purchase order form,
as revised from time to time, is provided by Operator. No new or additional
term or condition contained in any order placed by Operator shall be deemed
valid, effective or accepted by Franchisor unless such term or condition
shall have been expressly accepted by Franchisor in writing.

10.5 PURCHASE/DISTRIBUTION PROGRAMS. Operator agrees that
at such times that Franchisor establishes a regional purchase or distribution
program, or both, for any of the Operator's goods, raw materials or supplies,
which may benefit Operator by reduced price, lower labor costs, production of
improved Authorized Product(s), increased reliability in supply, improved
distribution, cost control (establishment of consistent pricing for
reasonable periods to avoid market fluctuations), improved operations by
Operator OR other tangible benefits to Operator, Operator will participate in
such purchasing program in accordance with the terms of such program.

10.6 TEST MARKETING. Franchisor may, from time to time,
authorize Operator to test market products and/or services in connection with
the operation of the Coffeehouse. Operator shall cooperate with Franchisor
in connection with the conduct of such test marketing programs and shall
comply with the Franchisor's rules and regulations established from time to
time in connection herewith.

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ARTICLE 11
REPORTS, BOOKS AND RECORDS, INSPECTIONS

11.1 GENERAL REPORTING. Operator shall submit weekly
financial reporting forms and such other financial, operational and
statistical information as Franchisor may require to: (i) assist Operator in
the operation of its Coffeehouse in accordance with the System; (ii) allow
Franchisor to monitor the Operator's Gross Sales, purchases, costs and
expenses; (iii) enable Franchisor to develop chain wide statistics which may
improve bulk purchasing; (iv) assist Franchisor in the development of new
Authorized Products or the removal of existing unsuccessful products; (v)
enable Franchisor to refine existing Authorized Diedrich Coffee Products;
(vi) generally improve chain-wide understanding of the System (collectively,
the "Information"). Without limiting the generality of the foregoing:

11.1.1 Unless otherwise directed by Franchisor in
writing, by the Tuesday following each Week, or at such other times as may be
established by Franchisor, Operator shall submit to Franchisor by facsimile a
written weekly summary in form prescribed by Franchisor showing the results
of its operations for that Week. Operator will allow Franchisor to poll on a
daily basis at a time selected by the Franchisor the Operator's Coffeehouse
computerized POS system to retrieve sales, usage, and operations data.

11.1.2 On or before the 10th day of each month
during the Term hereof, Operator shall submit a monthly sales summary signed
by Operator, on a form prescribed by Franchisor, reporting all Gross Sales
for the preceding month, together with such additional financial information
as Franchisor may from time to time request.

11.1.3 On or before the 30th day following each
calendar quarter during the Term hereof, Operator shall submit to Franchisor
financial statements for the preceding quarter, including a balance sheet and
profit and loss statement, prepared in the form and manner prescribed by the
Franchisor and in accordance with generally accepted accounting principles,
which shall be certified by Operator to be accurate and complete.

11.1.4 Operator shall submit to Franchisor a
semi-annual Profit and Loss Statement, signed and certified by Operator. The
Profit and Loss Statement shall be prepared by a Certified or Public
Accountant, in accordance with generally accepted accounting principles, and
shall provide Operator's sales, expenses and financial status with respect to
Operator's Coffeehouse. Operator shall submit to Franchisor a copy of the
original signed 1120 or 1120S tax form each and every year or any other forms
which take the place of the 1120 or 1120S forms. Operator shall also provide
Franchisor with copies of signed original sales and use tax forms
contemporaneously with their filing with the appropriate state or local
authority. Franchisor reserves the right to require such further

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information concerning Operator's Coffeehouse as Franchisor may from time to
time reasonably request.

11.1.5 Within 60 days following the end of each
calendar year, Operator shall submit to Franchisor an unaudited annual
financial statement prepared in accordance with generally accepted accounting
principles, and in such form and manner prescribed by Franchisor, which shall
be certified by Operator to be accurate and complete.

11.1.6 Operator shall immediately (in no event more
than 24 hours following) notify Franchisor of any (a) incident that may
adversely affect the operation or financial condition of Operator's
Coffeehouse, Franchisor or its affiliates; (b) legal action (including the
commencement of a suit or proceeding, or the threat thereof), (c) issuance of
any writ, order, injunction, award or decree of any court, agency or
Government authority, including any citation, fine or closing order, or (d)
any other adverse inquiry, notice, demand or sanction received by Operator
relating to the operation of the Coffeehouse or Location, including any
alleged violation of any Applicable Law, including health, safety or
employment law violations, and including any labor dispute or actual or
threatened labor strike, work stoppage, lock-out or other incident relating
to any labor agreement, and shall provide Franchisor with copies of all
related correspondence and other communications and information relating
thereto.

11.2 INSPECTIONS. Franchisor's authorized representatives
shall have the right to enter Operator's Location and Coffeehouse during
business hours, with or without notice, without unreasonably disrupting
Operator's business operations, for the purposes of examining same,
conferring with Operator's employees, inspecting and checking operations,
food, beverages, furnishings, interior and exterior decor, supplies,
fixtures, and equipment, and determining whether the business is being
conducted in accordance with this Agreement, the System and the Manuals. If
any such inspection indicates any deficiency or unsatisfactory condition with
respect to any matter required under this Agreement or the Manuals, including
but not limited to quality, cleanliness, service, health and authorized
product line, Franchisor will notify Operator in writing of Operator's
non-compliance with the Manuals, the System, or this Agreement. Operator
shall have 24 hours after receipt of such notice, or such other greater time
period as Franchisor in its sole discretion may provide, to correct or repair
such deficiency or unsatisfactory condition, if it can be corrected or
repaired within such period of time. If not, Operator shall within such time
period commence such correction or repair and thereafter diligently pursue it
to completion.

11.3 AUDITS. Upon 10 days prior written notice,
Franchisor, its agents or representatives may audit Operator's books and
records in accordance with generally accepted standards established by
certified public accountants. In connection with such audit(s) or other
operational visits, Operator shall keep its cash receipts records, weekly and
monthly control forms, accounts payable records including all payments to
Operator's Suppliers in its Coffeehouse or at its business office for 5 years
after their due date, which records shall be available for examination by
Franchisor or its representative(s), at

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Franchisor's request. Without any prior written notice, Franchisor, its
agents or representatives may inspect Operator's entire Coffeehouse and
Operator's daily, weekly and monthly statistical information which is
required under the Operational Manual. Operator shall make such information
available for such inspections in recognition that an operational inspection
cannot succeed without review of essential statistical information. If any
audit or other investigation reveals an under-reporting or under-recording
error of 5% percent or more, then in addition to any other sums due, the
expenses of the audit/inspection shall be borne and paid by Operator upon
billing by Franchisor, plus interest at the highest compound rate authorized
by law, but not to exceed the rate of 15% percent per annum.

ARTICLE 12
MARKS

12.1 USE OF MARKS. The Coffeehouse herein licensed and
franchised shall be named "Diedrich Coffee" without any suffix or prefix
attached thereto and Operator shall use and display such of the Franchisor's
Marks and such signs, advertising and slogans as Franchisor may from time to
time prescribe or approve. Upon expiration or sooner termination of this
Agreement, Franchisor may, if Operator does not do so, execute in Operator's
name and on Operator's behalf, any and all documents necessary in
Franchisor's judgment to end and cause the discontinuance of Operator's use
of the Marks and Franchisor is hereby irrevocably appointed and designated as
Operator's attorney-in-fact so to do.

12.2 NON-USE OF TRADE NAME. If Operator is a Business
Entity, it shall not use Franchisor's Marks, or Franchisor's trade name, or
any words or symbols which are confusingly similar to the Marks, as all or
part of Operator's name.

12.3 USE OF OTHER MARKS. Operator shall not display the
trademark, service mark, trade name, insignia or logotype of any other person
or Business Entity in connection with the operation of the Coffeehouse
without the express prior written consent of Franchisor, which may be
withheld in its sole subjective discretion.

12.4 NON-OWNERSHIP OF MARKS. Nothing herein shall give
Operator any right, title or interest in or to any of the Marks, except a
mere privilege and license during the term hereof, to display and use the
same according to the terms and conditions herein contained.

12.5 DEFENSE OF MARKS. If Operator receives notice, or is
informed, of any claim, suit or demand against Operator on account of any
alleged infringement, unfair competition, or similar matter on account of its
use of the Marks in accordance with the terms of this Agreement, Operator
shall promptly notify Franchisor of any such claim, suit or demand.
Thereupon, Franchisor shall take such action as it may deem necessary and
appropriate to protect and defend Operator against any such claim by any
third party; Franchisor shall not be obligated to take any such action,
however. Operator shall not

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settle or compromise any such claim by a third party without the prior
written consent of Franchisor. Franchisor shall have the sole right to
defend, compromise or settle any such claim, in its discretion, at
Franchisor's sole cost and expense, using attorneys of its own choosing, and
Operator shall cooperate fully with Franchisor in connection with the defense
of any such claim. Operator may participate at its own expense in such
defense or settlement, but Franchisor's decisions with regard thereto shall
be final.

12.6 PROSECUTION OF INFRINGERS. If Operator shall receive
notice or is informed or learns that any third party, which it believes to be
unauthorized to use the Marks, is using the Marks or any variant thereof,
Operator shall promptly notify Franchisor of the facts relating to such
alleged infringing use. Thereupon, Franchisor shall, in its sole discretion,
determine whether or not it wishes to take any action against such third
person on account of such alleged infringement of the Marks. Operator shall
have no right to make any demand against any such alleged infringer or to
prosecute any claim of any kind or nature whatsoever against such alleged
infringer for or on account of such infringement.

12.7 MODIFICATION OF MARKS. From time to time, in the
Manuals or in directives or bulletins supplemental thereto, Franchisor may
add to, delete or modify any or all of the Marks. Operator shall use, or
cease using, as may be applicable, the Marks, including but not limited to,
any such modified or additional trade names, trademarks, service marks,
logotypes and commercial symbols, in strict accordance with the procedures,
policies, rules and regulations contained in the Manuals or in written
directives issued by Franchisor to Operator, as though they were specifically
set forth in this Agreement.

12.8 ACTS IN DEROGATION OF THE MARKS. Operator agrees
that the Marks are the exclusive property of Franchisor and Operator now
asserts no claim and will hereafter assert no claim to any goodwill,
reputation or ownership thereof by virtue of Operator's licensed and/or
franchised use thereof, or otherwise. Operator shall not do or permit any
act or thing to be done in derogation of any of the rights of Franchisor in
connection with the same, either during the Term of this Agreement or
thereafter, and that it will use the Marks only for the uses and in the
manner licensed and/or franchised hereunder and as herein provided. Without
limiting the foregoing, Operator shall not interfere in any manner with, or
attempt to prohibit, the use of Franchisor's Marks by any other franchisee or
licensee of Franchisor.

12.9 ASSUMED NAME REGISTRATION. If Operator is required
to do so by any statute or ordinance, Operator shall promptly upon the
execution of this Agreement file with applicable government agencies or
offices, a notice of its intent to conduct its business under the name
"Diedrich Coffee". Promptly upon the expiration or termination of this
Agreement for any reason whatsoever, Operator shall promptly execute and file
such documents as may be necessary to revoke or terminate such assumed name
registration, and if Operator shall fail to promptly execute and file such
documents as may be necessary to effectively revoke and terminate such
assumed name registration, Operator

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hereby irrevocably appoints Franchisor as its Attorney-in-fact to do so for
and on behalf of Operator.

ARTICLE 13
COVENANTS REGARDING OTHER BUSINESS INTERESTS

13.1 NON-COMPETITION AND TRADE SECRETS. Operator
acknowledges that the Diedrich Coffee System is unique and distinctive and
has been developed by Franchisor at great effort, time, and expense, and that
Operator has regular and continuing access to valuable and confidential
information, training, and trade secrets regarding the Diedrich Coffee
System. Operator recognizes its obligations to keep confidential such
information as set forth herein. Operator therefore agrees as follows:

13.1.1 During the Term except with Franchisor's
prior written consent, neither Operator, nor any Owner, officer or director
of Operator, shall, in any capacity whatsoever, either directly or
indirectly, individually or through any Business Entity, engage in the
roasting of green coffee beans, the sale of roasted coffee beans or ground
coffee produced by third parties, or the production or sale at retail or
wholesale of any espresso or coffee product, or have any employment or other
financial interest in any Business Entity engaged in the foregoing; and

13.1.2 Upon the expiration or termination of this
Agreement, or if Operator assigns or transfers its interest herein to any
person or Business Entity, or if any Owner, officer or director of Operator
shall terminate his or her relationship with Operator, then for a period of
24 months thereafter, neither Operator nor such Owner, officer or director,
as applicable, shall, in any capacity whatsoever, either directly or
indirectly, individually or through any Business Entity, engage in the
production or sale at retail of any type of any espresso or coffee product,
or have any employment or interest in any firm engaged in the production or
sale at retail or wholesale of any such products, at a site within 1 mile of
the Location or any other "Diedrich Coffee" coffeehouse, kiosk or cart then
existing, unless Franchisor gives its prior written consent.

13.1.3 Franchisor possesses and continues to
develop, and during the course of the relationship established hereunder,
Operator shall have access to, proprietary and confidential information,
including recipes, secret ingredients, specifications, procedures, concepts
and methods and techniques of operating the Coffeehouse and producing
Authorized Diedrich Coffee Products (the "Trade Secrets"). Franchisor will
disclose certain of its Trade Secrets to Operator in the Operating Manual,
bulletins, supplements, confidential correspondence, or other confidential
communications, and through the Franchisor's training program and other
guidance and management assistance, and in performing Franchisor's other
obligations and exercising Franchisor's rights under this Agreement. "Trade
Secrets shall not include information which: (a) has entered the public
domain or was known to Operator prior to Franchisor's disclosure of such
information to Operator, other than by the breach of an obligation of
confidentiality owed (by anyone) to Franchisor; (b) becomes known to Operator
from a source other than

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Franchisor and other than by the breach of an obligation of confidentiality
owed (by anyone) to Franchisor; or (c) was independently developed by
Operator without the use or benefit of any of the Franchisor's Trade Secrets;
The burden of proving the applicability of the foregoing will reside with
Operator.

13.1.4 Operator shall acquire no interest in the
Trade Secrets other than the right to use them in developing and operating
the Business during the Term of this Agreement. Operator's duplication or
use of the Trade Secrets in any other endeavor or business shall constitute
an unfair method of competition. Operator shall: (i) not use the Trade
Secrets in any business or other endeavor other than in connection with the
Business; (ii) maintain absolute confidentiality of the Trade Secrets during
and after the Term of this Agreement; (iii) make no unauthorized copy of any
portion of the Trade Secrets, including without limitation, the Operating
Manual, bulletins, supplements, confidential correspondence, or other
confidential communications, whether written or oral; and (iv) operate and
implement all reasonable procedures prescribed from time to time by
Franchisor to prevent unauthorized use and disclosure of the Trade Secrets,
including without limitation, restrictions on disclosure to employees and use
of non-disclosure and non-competition provisions as Franchisor prescribes in
employment agreements with employees who may have access to the Trade
Secrets. Promptly upon Franchisor's request, Operator shall deliver executed
copies of such agreements to Franchisor.

13.1.5 In the event any portion of the above
covenants violates laws affecting Operator, or is held invalid or
unenforceable in a final judgment to which Franchisor and Operator are
parties, then the maximum legally allowable restriction permitted by law
shall control and bind Operator. Franchisor may at any time unilaterally
reduce the scope of any part of the above covenants, and Operator shall
comply with any such reduced covenant upon receipt of written notice.

13.2 OPERATOR'S AFFILIATES. For purposes of this Article
only, "Operator" shall mean and include the individual Operator; Operator's
spouse and minor children and its Owners, officers and directors if Operator
is a Business Entity and Operator shall, except as Franchisor may otherwise
agree, cause each such person to acknowledge and agree to be bound by the
provisions of Section 13.1. The provisions of this Article shall not limit,
restrain or otherwise affect any right or cause of action which may accrue to
Franchisor for any infringement of, violation of, or interference with, this
Agreement, or Franchisor's Marks, System, trade secrets, or any other
proprietary aspects of Franchisor's business.

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ARTICLE 14
INTERFERENCE WITH EMPLOYMENT RELATIONS

Without Franchisor's prior written consent, during the term of this
Agreement, Operator shall not employ or seek to employ, directly or
indirectly, any person serving in an executive, managerial or operational
position who is at the time or was at any time during the prior 6 months
employed by Franchisor or any of its Affiliates. Request for Franchisor's
consent shall be sent in writing to Franchisor.

ARTICLE 15
NATURE OF INTEREST, ASSIGNMENT

15.1 ASSIGNMENT BY FRANCHISOR. Franchisor shall have the
right to transfer or assign this Agreement to any person or legal entity who
assumes its terms and agrees to comply with Franchisor's obligations
contained herein. Franchisor shall have no liability for the performance of
any obligations contained in this Agreement after the effective date of such
transfer or assignment.

15.2 ASSIGNMENT BY OPERATOR. The rights and duties
created by this Agreement are personal to Operator. Accordingly, except as
otherwise may be permitted herein, neither Operator nor any person with an
interest in Operator shall, without Franchisor's prior written consent,
directly or indirectly sell, assign, transfer, convey, give away, pledge,
mortgage, or otherwise encumber any direct or indirect interest in this
Agreement (an "Assignment") . Any such purported Assignment occurring by
operation of law or otherwise without Franchisor's prior written consent
shall constitute a default of this Agreement by Operator, and shall be null
and void. Except in the instance of Operator advertising to sell its
Coffeehouse pursuant to the terms hereof, Operator shall not, without
Franchisor's prior written consent, offer for sale or transfer at public or
private auction or advertise publicly for sale or transfer, the furnishings,
interior and exterior decor items, supplies, fixtures, equipment, Operator's
Lease or the real or personal property used in connection with Operator's
Coffeehouse.

If Operator is a Business Entity, any sale, assignment, transfer,
conveyance, gift, pledge, mortgage, or other encumbrance of 50% or more of
the outstanding and issued stock or other ownership interest of Operator by
one or more transfers or any other event(s) or transaction(s) which, directly
or indirectly, effectively changes management control of Operator shall
constitute an "Assignment" hereunder. Franchisor will not unreasonably
withhold its consent to any transfer or assignment which is subject to the
restrictions of this Article, provided however, Franchisor may impose any
reasonable condition to the granting of its consent, and requiring Operator
to satisfy any or all of the following conditions shall be deemed reasonable:

15.2.1 Upon the execution of this Agreement and upon
each direct or indirect transfer of an interest in this Agreement or in
Operator and at any other time upon Franchisor's request, Operator shall,
within 5 days prior to such transfer or at any

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other time at Franchisor's request, furnish Franchisor with an estoppel
agreement indicating any and all causes of action, if any, that Operator may
have against Franchisor or if none exist, so stating, and a list of all
Owners having an interest in this Agreement or in Operator, the percentage
interest of Owner, and a list of all officers and directors, in such form as
Franchisor may require;

15.2.2 Operator's written request for transfer of
either a partial or whole interest in this Agreement or Operator's
Coffeehouse must be accompanied by an offer to Franchisor of a right of first
refusal at the same price offered by any bona fide buyer. Franchisor shall
have the right and option, exercisable within 15 days after receipt of such
written notification, to send written notice to Operator or such person that
Franchisor or its third-party designee, intends to purchase the interest
which is proposed to be transferred, on the same terms and conditions offered
by the third party. If Franchisor accepts such offer, the training and
transfer/administrative fees due by Operator in accordance with Section
15.2.9 shall be waived by Franchisor. Any material change in the terms of an
offer prior to closing shall cause it to be deemed a new offer, subject to
the same right of first refusal by Franchisor, or its third-party designee,
as in the case of the initial offer. Franchisor's failure to exercise such
option shall not constitute a waiver of any other provision of this
Agreement, including any of the requirements of this Article with respect to
the proposed transfer;

15.2.3 The Operator is not in default under the
terms of this Agreement, the Manuals or any other obligations owed
Franchisor, and all of its then-due monetary obligations to Franchisor have
been paid in full;

15.2.4 The Operator and its Owners, if the Operator
is a Business Entity, have executed a general release under seal, in a form
prescribed by Franchisor, of any and all claims against Franchisor, its
affiliates, subsidiaries, shareholders, directors, officers, and employees;

15.2.5 The transferee/assignee has demonstrated to
Franchisor's satisfaction that it meets all of Franchisor's then-current
requirements for new operators or for holders of an interest in a franchise,
including, without limitation, possession of good moral character and
reputation, satisfactory credit ratings, acceptable business qualifications,
and the ability to fully comply with the terms of this Agreement;

15.2.6 The transferee/assignee has assumed this
Agreement by a written assumption agreement approved by Franchisor, or has
agreed to do so at closing, and at closing executes an assumption agreement
approved by Franchisor;

15.2.7 The transferee/assignee, its manager or other
employees responsible for the operation of the Coffeehouse have
satisfactorily completed Franchisor's training program;

15.2.8 The transferee/assignee executes such other
documents as Franchisor may require, including a replacement franchise
agreement on the then-standard

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franchise agreement form used by Franchisor, in order to assume all of the
obligations of this Agreement, to the same extent, and with the same effect,
as previously assumed by the assignor;

15.2.9 The Operator transfers all Franchise
Agreements between Operator and Franchisor to the same transferee/assignee;
and

15.2.10 Upon submission Operator's request
for Franchisor's consent to any proposed transfer or assignment, Operator
shall pay to Franchisor a transfer fee ("Transfer Fee") equal to the greater
of: (a) 2% of all consideration received or receivable, directly or
indirectly, by Operator in connection with the transfer or assignment, or (b)
the sum of (i) a $1,500 administrative/transfer fee, plus (ii) a $15,000
training fee (payable only for the first assigned franchise agreement in the
case of multiple franchise agreements being assigned simultaneously to the
same assignee). Such Transfer Fee will not be due with respect to any
transfer that (together with all other related previous, simultaneous, or
proposed transfers) does not result in the transfer of control of Operator.

15.2.11 Franchisor's consent to a transfer
shall not constitute a waiver of any claims it may have against the
transferring party arising out of this Agreement or otherwise.

ARTICLE 16
DEFAULT AND TERMINATION

16.1 GENERAL. Franchisor shall have the right to
terminate this Agreement prior to its scheduled expiration date pursuant to
Section 3.1 only for "cause". "Cause" is hereby defined as a material breach
of this Agreement. Franchisor shall exercise its right to terminate this
Agreement upon notice to Operator upon the following circumstances and
manners.

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16.2 AUTOMATIC TERMINATION WITHOUT NOTICE. Subject to
Applicable Laws of the jurisdiction in which Operator's Coffeehouse is
located to the contrary, Operator shall be deemed to be in default under this
Agreement, and all rights granted herein shall automatically terminate
without notice to Operator if: (i) Operator shall be adjudicated bankrupt or
judicially determined to be insolvent (subject to any contrary provisions of
any applicable state or federal laws), shall admit to its inability to meet
its financial obligations as they become due, or shall make a disposition for
the benefit of its creditors; (ii) Operator shall allow a judgment against
him in the amount of more than $5,000 to remain unsatisfied for a period of
more than 30 days (unless a supersedeas or other appeal bond has been filed);
(iii) if the Coffeehouse or Location, or the Operator's assets are seized,
taken over or foreclosed by a government official in the exercise of its
duties, or seized, taken over, or foreclosed by a creditor or lienholder
provided that a final judgment against the Operator remains unsatisfied for
30) days (unless a supersedes or other appeal bond has been filed); (iv) if a
levy of execution of attachment has been made upon the license granted by
this Agreement or upon any property used in the Coffeehouse, and it is not
discharged within 5 days of such levy or attachment; (v) if Operator permits
any mechanics lien to attach to the Coffeehouse or to any equipment or other
Leasehold Improvements; (vi) allows or permits any judgment to be entered
against Franchisor or its subsidiaries or affiliated corporations, arising
out of or relating to the operation of Operator's Coffeehouse; or (vii) is
convicted of any felony, or any criminal misconduct relevant to the operation
of the Coffeehouse.

16.3 OPTION TO TERMINATE WITHOUT NOTICE. Operator shall
be deemed to be in default and Franchisor may, at its option, terminate this
Agreement and all rights granted hereunder, without affording Operator any
opportunity to cure the default, effective immediately upon receipt of notice
by Franchisor upon the occurrence of any of the following events:

16.3.1 ABANDONMENT. If Operator shall abandon the
Coffeehouse. For purposes of this Agreement, "abandon" shall refer to (i)
Operator's failure, at any time during the term of this Agreement, to keep
the Coffeehouse open and operating for business for a period of 5 consecutive
days, except as provided in the Manuals, (ii) Operator's failure to keep the
Coffeehouse open and operating for any period after which it is not
unreasonable under the facts and circumstances for Franchisor to conclude
that Operator does not intend to continue to operate the franchise, unless
such failure to operate is due to fire, flood, earthquake or other similar
causes beyond Operator's control, and (iii) failure to actively and
continuously maintain and answer Operator's telephone;

16.3.2 ASSIGNMENT, DEATH OR INCAPACITY. If Operator
shall purport to sell, assign, transfer or encumber in whole or in part the
Coffeehouse, or any substantial portion of its assets, without the prior
written consent of Franchisor; provided, however, that on written request and
on condition that the Coffeehouse continues to be operated in conformity with
this Agreement, (i) upon the death or legal incapacity of a Operator who is
an individual, Franchisor shall allow up to 6 months after such death or
legal incapacity for the heirs, personal representatives, or conservators
(the "Heirs") of Operator either to enter into a new Franchise Agreement upon
Franchisor's then current

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<PAGE>

form (except that no initial franchise fee or transfer fee shall be charged),
if Franchisor is subjectively satisfied that the Heirs meet Franchisor's
standards and qualifications, or if not so satisfied to allow the Heirs to
sell the Coffeehouse to a person approved by Franchisor, or (ii) upon the
death or legal incapacity of a member or stockholder owning 50% or more of
the capital stock, membership interests or voting power of a corporate or
limited liability company Operator, or a general or limited partner owning
50% or more of any of the Partnership Rights of a Operator which is a
Partnership, Franchisor shall allow a period of up to 6 months after such
death or legal incapacity for the Heirs to seek and obtain Franchisor's
consent to the transfer or Assignment of such stock, membership interests or
Partnership Rights to the Heirs or to another person acceptable by
Franchisor. If, within said 6 month period, said Heirs fail either to enter
into a new franchise agreement or to sell the Coffeehouse to a person
approved by Franchisor pursuant to Section 15.2, or fail either to receive
Franchisor's consent to the transfer or Assignment of such stock, membership
interest or Partnership Rights to the Heirs or to another person acceptable
by Franchisor, as provided in Section 15.2, this Agreement shall thereupon
automatically terminate;

16.3.3 REPEATED DEFAULTS. If Operator shall default
in any material obligation as to which Operator has previously received 3 or
more written notices of default from Franchisor setting forth the material
breach complained of within the preceding 12 months, such repeated course of
conduct shall itself be grounds for termination of this Agreement without
further notice or opportunity to cure;

16.3.4 MISREPRESENTATION. If Operator makes any
material misrepresentations relating to the acquisition of the Coffeehouse.

16.3.5 VIOLATION OF LAW. If Operator fails, for a
period of 10 days after having received notification of noncompliance from
Franchisor or any governmental or quasi-governmental agency or authority, to
comply with any federal, state or local law or regulation applicable to the
operation of the Coffeehouse;

16.3.6 HEALTH OR SAFETY VIOLATIONS. Operator's
conduct of the Coffeehouse licensed pursuant to this Agreement is so contrary
to this Agreement, the System and the Manuals as to constitute an imminent
danger to the public health (for example, selling spoiled food knowing that
the food products are spoiled or allowing a dangerous condition arising from
a failure to strictly comply with any health code or ordinance or other
Applicable Law to continue despite Operator's knowledge of such condition),
or selling expired or other unauthorized products to the public after notice
of default and continuing to sell such products whether or not Operator has
cured the default after one or more notices;

16.3.7 UNFAIR COMPETITION. Any violation by
Operator of Section 13.1; Operator's intentional disclosure or use of the
contents of the Manual, trade secrets or confidential or proprietary
information provided to Operator by Franchisor in violation of this
Agreement, excluding independent acts of employees or others if Operator has
failed to exercise its best efforts to prevent such disclosures or use;

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16.3.8 UNDER REPORTING. If an audit or
investigation conducted by Franchisor hereof discloses that Operator has
knowingly maintained false books or records, or submitted false reports to
Franchisor, or knowingly understated its Gross Sales or withheld the
reporting of same as herein provided;

16.3.9 CRIMINAL OFFENSES. If Operator is convicted
of a felony or any other crime or offense that is reasonably likely, in the
sole opinion of Franchisor, to adversely affect the System, the Marks, the
goodwill associated therewith, or Franchisor's interest therein;

16.3.10 ASSIGNMENT WITHOUT CONSENT. If
Operator purports to make any Assignment without Franchisor's prior written
consent or in violation of the terms of Section 15.2 of this Agreement;

16.3.11 INTELLECTUAL PROPERTY. If Operator
misuses or makes any unauthorized use of the Marks or otherwise materially
impairs the goodwill associated therewith or Franchisor's rights therein, or
which reflects materially and unfavorably upon the operation and reputation
of the Coffeehouse or System.

16.4 TERMINATION WITH NOTICE AND OPPORTUNITY TO CURE.
Except for any default by Operator under Sections 16.2 or 16.3, or as
otherwise expressly provided in this Agreement, Operator shall have 10 days
(5 days in the case of any default in the timely payment of sums due to
Franchisor or its Affiliates), after Franchisor's written notice of default
within which to remedy any default under this Agreement, and to provide
evidence of such remedy to Franchisor. If any such default is not cured
within that time period, or such longer time period as Applicable Law may
require or as Franchisor may specify in the notice of default, this Agreement
and all rights granted by it shall thereupon automatically terminate without
further notice or opportunity to cure.

Operator shall be in material default under this Article for any
failure to comply with any of the requirements imposed by this Agreement.
Such material defaults shall include the occurrence of any one or more of the
following events:

16.4.1 Operator's failure, refusal, or neglect to
promptly pay any monies owed to Franchisor, its subsidiaries or affiliates,
when due, or to submit the financial or other information required by
Franchisor under this Agreement;

16.4.2 Operator's failure to maintain the standards
specified by Franchisor in the Manual or otherwise;

16.4.3 Operator's failure, refusal or neglect to
obtain Franchisor's prior written approval or consent as required by this
Agreement;

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<PAGE>

16.4.4 Operator's misuse or unauthorized use of
Franchisor's Marks or other material impairment of the goodwill associated
therewith or Franchisor's rights therein;

16.4.5 Operator's commencement of or conducting any
business operation, or marketing of any product, under a name or mark which,
in Franchisor's reasonable opinion, is confusingly similar to Franchisor's
Marks;

16.4.6 Operator's default, without cure after the
applicable grace period, under any Lease, mortgage, or deed of trust covering
the Location; or

16.4.7 Operator's failure to procure or maintain the
insurance required by this Agreement or in the Lease for the Location.

16.5 REIMBURSEMENT OF FRANCHISOR COSTS. In the event of a
default by Operator, all of Franchisor's costs and expenses arising from such
default, including reasonable legal fees and reasonable hourly charges of
Franchisor's administrative employees shall be paid to Franchisor by Operator
within 5 days after cure.

16.6 CROSS-DEFAULT. Any material default by Operator
under the terms and conditions of this Agreement or any Lease, or any other
agreement between Franchisor, or its affiliate, and Operator, or any default
by Operator of its obligations to any Advertising Cooperative of which it is
a member, shall be deemed to be a material default of each and every said
agreement. Furthermore, in the event of termination, for any cause, of this
Agreement or any other agreement between the parties hereto, Franchisor may,
at its option, terminate any or all said agreements.

16.7 NOTICE REQUIRED BY LAW. Notwithstanding anything to
the contrary contained in this Article 16, in the event any valid, Applicable
Law of a competent Governmental Authority having jurisdiction over this
Agreement and the parties hereto shall limit Franchisor's rights of
termination hereunder or shall require longer notice periods than those set
forth above, this Agreement shall be deemed amended to conform to the minimum
notice periods or restrictions upon termination required by such laws and
regulations. Franchisor shall not, however, be precluded from contesting the
validity, enforceability or application of such laws or regulations in any
action, hearing or dispute relating to this Agreement or the termination
thereof.

ARTICLE 17
RIGHTS AND OBLIGATIONS UPON TERMINATION

17.1 GENERAL. Upon the expiration or termination of
Operator's rights granted under this Agreement:

17.1.1 Operator shall immediately cease to use
Franchisor's Marks, and any confusingly similar trademark, service mark,
trade name, logotype, or other

37
<PAGE>

commercial symbol or insignia. Operator shall at its own cost, make cosmetic
changes to Operator's Coffeehouse so that it no longer contains or resembles
Franchisor's proprietary designs including, but not limited to, Operator
shall remove all Diedrich Coffee identifying materials and distinctive
Diedrich Coffee cosmetic features and finishes, interior wall coverings and
colors, exterior finishes and colors, signage and Diedrich Coffee counter
equipment (which shall be deemed proprietary to Franchisor) from the Location
as Franchisor may reasonably direct.

17.1.2 Franchisor may retain all fees paid pursuant
to this Agreement, and Operator shall immediately pay any and all amounts
owing to Franchisor, its subsidiaries and affiliates.

17.1.3 Any and all obligations of Franchisor to
Operator under this Agreement shall immediately cease and terminate.

17.1.4 Any and all rights of Operator under this
Agreement shall immediately cease and terminate.

17.1.5 Franchisor shall have the option, exercisable
by written notice within 30 days after the termination of this Agreement, to
take an assignment of all telephone numbers (and associated listings) for
Operator's Coffeehouse. Operator is not entitled to any compensation from
Franchisor if Franchisor exercises this option.

17.2 SURVIVAL OF OBLIGATIONS. In no event shall a
termination or expiration of this Agreement affect Operator's obligations to
take or abstain from taking any action in accordance with this Agreement.
The provisions of this Agreement which constitute post-termination covenants
and agreements including the obligation of Franchisor and Operator to
arbitrate any and all disputes shall survive the termination or expiration of
this Agreement.

17.3 NO OWNERSHIP OF MARKS. Operator acknowledges and
agrees that rights in and to Franchisor's Marks and the use thereof shall be
and remain the property of Franchisor.

17.4 GOVERNMENT FILINGS. In the event Operator has
registered any of Franchisor's Marks or the name "Diedrich Coffee" as part of
Operator's assumed, fictitious or corporate name, Operator shall promptly
amend such registration to delete Franchisor's Marks therefrom.

ARTICLE 18
INSURANCE

18.1 INSURANCE. Operator shall obtain and maintain insurance
coverage which shall in each instance designate Franchisor and designated
parent companies, subsidiaries,

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and affiliates as additional named insureds, with an insurance company
approved by Franchisor, which approval shall not be unreasonably withheld as
follows:

18.1.1 comprehensive general liability insurance
(including products liability); with coverage of $1,000,000.00 to
$3,000,000.00 combined single limit for death, personal injury, and
$100,000.00 property damage coverage;

18.1.2 business interruption insurance, including
Continuing Royalty coverage, for 12 months after casualty, in amounts equal
to at least $100,000 ($50,000 in the case of a cart or kiosk);

18.1.3 workers' compensation insurance as required
by Applicable Law; and

18.1.4 windstorm, fire, and extended coverage
insurance, insuring the construction of improvements and completed
Coffeehouse operated by Operator, for the full replacement value thereof.

18.2 USE OF PROCEEDS. In the event of damage to the
Coffeehouse covered by insurance, the proceeds of any such insurance shall be
used to restore the Coffeehouse to its original condition as soon as
possible, unless such restoration is prohibited by the Location lease or
Franchisor has otherwise consented to in writing. Upon the obtaining of such
insurance, Operator shall promptly provide to Franchisor proof of such
insurance coverage and/or at such other times upon the request of Franchisor.

18.3 PROOF OF INSURANCE. Operator shall, prior to opening
its Coffeehouse, file with Franchisor, certificates of such insurance and
shall promptly pay all premiums on the policies as they become due. In
addition, the policies shall contain a provision requiring 30 days prior
written notice to Franchisor of any proposed cancellation, modification, or
termination of insurance. If Operator fails to obtain and maintain the
required insurance, Franchisor may, at its option, in addition to any other
rights it may have, procure such insurance for Operator without notice and
Operator shall pay, upon demand, the premiums and Franchisor's costs in
taking such action.

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<PAGE>

ARTICLE 19
RELATIONSHIP OF PARTIES, DISCLOSURE

19.1 RELATIONSHIP OF OPERATOR TO FRANCHISOR. It is expressly
agreed that the parties intend by this Agreement to establish between
Franchisor and Operator the relationship of franchisor and franchisee. It is
further agreed that Operator has no authority to create or assume in
Franchisor's name or on behalf of Franchisor, any obligation, express or
implied, or to act or purport to act as agent or representative on behalf of
Franchisor for any purpose whatsoever. Neither Franchisor nor Operator is
the employer, employee, agent, partner or co-venturer of or with the other,
each being independent. Operator agrees that it will not hold himself out as
the agent, employee, partner or co-venturer of Franchisor. All employees
hired by or working for Operator shall be the employees of Operator and shall
not, for any purpose, be deemed employees of Franchisor or subject to
Franchisor control. Each of the parties shall file its own tax, regulatory
and payroll reports, and be responsible for all employee benefits and workers
compensation payments, with respect to its respective employees and
operations, saving and indemnifying the other party hereto of and from any
liability of any nature whatsoever by virtue thereof.

Neither shall have the power to bind or obligate the other except
specifically as set forth in this Agreement. Franchisor and Operator agree
that the relationship created by this Agreement is not a fiduciary
relationship. Operator shall not, under any circumstances, act or hold itself
out as an agent or representative of Franchisor.

19.2 INDEMNITY BY OPERATOR. Operator hereby agrees to
protect, defend and indemnify Franchisor, and all of its past, present and
future partners, shareholders, direct and indirect parent companies,
subsidiaries, affiliates, officers, directors, employees, attorneys and
designees and hold them harmless from and against any and all costs and
expenses, including attorneys' fees, court costs, losses, liabilities,
damages, claims and demands of every kind or nature on account of any actual
or alleged loss, injury or damage to any person or Business Entity or to any
property arising out of or in connection with Operator's operation of the
Location and Coffeehouse pursuant hereto.

ARTICLE 20
NOTICES

20.1 GENERAL. Except as otherwise expressly provided
herein, all written notices and reports permitted or required to be delivered
by the parties pursuant hereto shall be deemed so delivered at the time
delivered by hand, one business day after transmission by facsimile,
telegraph or other electronic system (with confirmation copy sent by regular
U.S. mail), or 3 business days after placement in the United States Mail by
Registered or Certified Mail, Return Receipt Requested, postage prepaid and
addressed as follows:

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If to Franchisor: Diedrich Coffee
2144 Michelson Drive
Irvine, CA 92612
Attn: President

Facsimile No.: (714) 756-1144

With copy (which shall not constitute notice) to:

Kenneth R. Costello, Esq.
Jenkens & Gilchrist P.C.
12100 Wilshire Blvd., 15th Floor
Los Angeles, CA 90025
Facsimile No.: (213) 688-3460

If to Operator: ______________________
______________________
______________________
______________________
Facsimile No. _______________

Any party may change his or its address by giving 10 days prior written
notice of such change to all other parties.

ARTICLE 21
MISCELLANEOUS PROVISIONS

21.1 FRANCHISOR'S RIGHT TO CURE DEFAULTS. In addition to
all other remedies herein granted if Operator shall default in the
performance of any of its obligations or breach any term or condition of this
Agreement or any related agreement, Franchisor may, at its election,
immediately or at any time thereafter, without waiving any claim for breach
hereunder and without notice to Operator, cure such default for the account
and on behalf of Operator, and the cost to Franchisor thereof shall be due
and payable on demand and shall be deemed to be additional compensation due
to Franchisor hereunder and shall be added to the amount of compensation next
accruing hereunder, at the election of Franchisor.

21.2 WAIVER AND DELAY. No waiver by Franchisor of any
breach or series of breaches or defaults in performance by Operator, and no
failure, refusal or neglect of Franchisor to exercise any right, power or
option given to it hereunder or under any other franchise agreement between
Franchisor and Operator, whether entered into before, after or
contemporaneously with the execution hereof (and whether or not related to
the Coffeehouse) or to insist upon strict compliance with or performance of
Operator's obligations under this Agreement, any other franchise agreement
between Franchisor and Operator, whether entered into before, after or
contemporaneously with the execution

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<PAGE>

hereof (and whether or not related to the Coffeehouse) or the Manuals, shall
constitute a waiver of the provisions of this Agreement or the Manuals with
respect to any subsequent breach thereof or a waiver by Franchisor of its
right at any time thereafter to require exact and strict compliance with the
provisions thereof. Franchisor will consider written requests by Operator
for Franchisor's consent to a waiver of any obligation imposed by this
Agreement. Operator agrees, however, that Franchisor is not required to act
uniformly with respect to waivers, requests and consents as each request will
be considered on a case by case basis, and nothing shall be construed to
require Franchisor to grant any such request. Any waiver granted by
Franchisor shall be without prejudice to any other rights Franchisor may
have, will be subject to continuing review by Franchisor, and may be revoked,
in Franchisor's sole discretion, at any time and for any reason, effective
upon 10 days prior written notice to Operator. Franchisor makes no
warranties or guarantees upon which Operator may rely, and assumes no
liability or obligation to Operator by providing any waiver, approval,
consent, assistance, or suggestion to Operator in connection with this
Agreement, or by reason of any neglect, delay, or denial of any request.

21.3 SURVIVAL OF COVENANTS. The covenants contained in
this Agreement which, by their terms, require performance by the parties
after the expiration or termination of this Agreement, shall be enforceable
notwithstanding said expiration or other termination of this Agreement for
any reason whatsoever.

21.4 SUCCESSORS AND ASSIGNS. This Agreement shall be
binding upon and inure to the benefit of the successors and assigns of
Franchisor and shall be binding upon and inure to the benefit of Operator and
its or their respective heirs, executors, administrators, successors and
assigns, subject to the restrictions on transfer or Assignment contained
herein.

21.5 JOINT AND SEVERAL LIABILITY. If Operator consists of
more than one person or entity, or a combination thereof, the obligations and
liabilities of each such person or entity to Franchisor are joint and several.

21.6 GOVERNING LAW. This Agreement shall be governed by
and construed in accordance with the laws of the State of California, except
for the provisions in Article 13 which shall be governed by the laws of the
state in which the Coffeehouse is located.

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<PAGE>

21.7 ENTIRE AGREEMENT. This Agreement contains all of the
terms and conditions agreed upon by the parties hereto with reference to the
subject matter hereof. No other agreements oral or otherwise shall be deemed
to exist or to bind any of the parties hereto and all prior agreements,
understandings and representations are merged herein and superseded hereby.
Operator represents that there are no contemporaneous agreements or
understandings relating to the subject matter hereof between the parties that
are not contained herein. No officer or employee or agent of Franchisor has
any authority to make any representation or promise not contained in this
Agreement or in any Offering Circular for prospective franchisees required by
applicable law, and Operator agrees that it has executed this Agreement
without reliance upon any such representation or promise. This Agreement
cannot be modified or changed except by written instrument signed by all of
the parties hereto.

21.8 TITLES FOR CONVENIENCE. Article and Section titles
used in this Agreement are for convenience only and shall not be deemed to
affect the meaning or construction of any of the terms, provisions,
covenants, or conditions of this Agreement.

21.9 GENDER AND CONSTRUCTION. All terms used in any one
number or gender shall extend to mean and include any other number and gender
as the facts, context, or sense of this Agreement or any article or Section
hereof may require. As used in this Agreement, the words "include,"
"includes" or "including" are used in a non-exclusive sense. Unless
otherwise expressly provided herein to the contrary, any consent, approval or
authorization of Franchisor which Operator may be required to obtain
hereunder may be given or withheld by Franchisor in its sole discretion, and
on any occasion where Franchisor is required or permitted hereunder to make
any judgment or determination, including any decision as to whether any
condition or circumstance meets Franchisor's standards or satisfaction,
Franchisor may do so in its sole subjective judgment.

21.10 SEVERABILITY. Nothing contained in this Agreement
shall be construed as requiring the commission of any act contrary to law.
Whenever there is any conflict between any provisions of this Agreement or
the Manuals and any present or future statute, law, ordinance or regulation
contrary to which the parties have no legal right to contract, the latter
shall prevail, but in such event the provisions of this Agreement or the
Manuals thus affected shall be curtailed and limited only to the extent
necessary to bring it within the requirements of the law. If any part,
article, section, sentence or clause of this Agreement or the Manuals shall
be held to be indefinite, invalid or otherwise unenforceable, the indefinite,
invalid or unenforceable provision shall be deemed deleted, and the remaining
part of this Agreement shall continue in full force and effect.

21.11 COUNTERPARTS. This Agreement may be executed in any
number of counterparts, each of which shall be deemed to be an original and
all of which together shall be deemed to be one and the same instrument.

21.12 FEES AND EXPENSES. Should any party hereto commence
any action or proceeding for the purpose of enforcing, or preventing the
breach of, any provision

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hereof, whether by judicial or quasi-judicial action or otherwise, or for
damages for any alleged breach of any provision hereof, or for a declaration
of such party's rights or obligations hereunder, the prevailing party shall
be reimbursed by the losing party for all costs and expenses incurred in
connection therewith, including, but not limited to, attorneys' fees. All
sums which are due but unpaid to Franchisor or Operator shall bear interest
from the date due at the highest rate permissible by applicable law.

21.13 WAIVER OF JURY. IN ALL CASES, OPERATOR AND
FRANCHISOR EACH WAIVES ANY RIGHT TO A TRIAL BY JURY.

ARTICLE 22
SUBMISSION OF AGREEMENT

22.1 GENERAL. The submission of this Agreement does not
constitute an offer and this Agreement shall become effective only upon the
execution thereof by Franchisor and Operator. This agreement shall not be
binding on Franchisor unless and until it shall have been accepted and signed
on its behalf by the president or chief financial officer of Franchisor.
This agreement shall not become effective until and unless operator shall
have been furnished by Franchisor with all disclosure documents, in written
form, as may be required under or pursuant to applicable law, for requisite
time periods.

ARTICLE 23
ACKNOWLEDGEMENT

23.1 GENERAL. Operator, and its Owners, jointly and
severally acknowledge that they have carefully read this Agreement and all
other related documents to be executed concurrently or in conjunction with
the execution hereof, that they have obtained the advice of counsel in
connection with entering into this Agreement, that they understand the nature
of this Agreement, and that they intend to comply herewith and be bound
hereby.

23.2 DUE EXECUTION. The submission of this Agreement to
Operator does not constitute an offer and this Agreement shall become
effective only upon the execution thereof by Franchisor and Operator. This
agreement shall not become effective until and unless operator shall have
been furnished by franchisor with such disclosure, in written form, as may be
required under or pursuant to applicable law.

IN WITNESS WHEREOF, the parties hereof have executed this Agreement
as of the date of execution by Franchisor.

DIEDRICH COFFEE

By:
---------------------------
Its: President

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<PAGE>

OPERATOR:
---------------------

By:
---------------------------
Its:
---------------------------

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<PAGE>

EXHIBIT A
MINIMUM HOURS OF OPERATION

Minimum Operating Hours: [_:__] a.m. to [_:__] p.m.
_________ days per week

<PAGE>

EXHIBIT 10.47

DIEDRICH COFFEE, INC.,

AREA DEVELOPMENT AGREEMENT

DATED: ______________

<PAGE>

TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>

I. GRANT OF AREA DEVELOPMENT FRANCHISE. . . . . . . . . . . . . . . . .1
1.1 Grant of Area Development Franchise. . . . . . . . . . . . .1
1.2 No Trademark License . . . . . . . . . . . . . . . . . . . .2
1.3 Definitions. . . . . . . . . . . . . . . . . . . . . . . . .2

II. DEVELOPER'S DEVELOPMENT OBLIGATION . . . . . . . . . . . . . . . . .4
2.1 Minimum Development Obligation . . . . . . . . . . . . . . .4
2.2 Force Majeure. . . . . . . . . . . . . . . . . . . . . . . .5
2.3 Developer May Exceed Minimum Development Obligation. . . . .5
2.4 Servicing of Excluded Venues by Developer. . . . . . . . . .6
2.5 Servicing of Wholesale Accounts. . . . . . . . . . . . . . .6

III. EXCLUSIVITY. . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
3.1 Exclusivity. . . . . . . . . . . . . . . . . . . . . . . . .6

IV. TERM OF AREA DEVELOPMENT AGREEMENT . . . . . . . . . . . . . . . . .7
4.1 Term . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
4.2 Renewal. . . . . . . . . . . . . . . . . . . . . . . . . . .7
4.3 Limited Additional Development Right . . . . . . . . . . . .8
4.4 Exercise of Right of Additional Development. . . . . . . . .8
4.5 Conditions to Exercise of Right of Additional Development. .8

V. PAYMENTS BY DEVELOPER. . . . . . . . . . . . . . . . . . . . . . . .9
5.1 Development Area Fees. . . . . . . . . . . . . . . . . . . .9
5.2 Franchise Fees for Each Coffeehouse. . . . . . . . . . . . .9

VI. EXECUTION OF INDIVIDUAL FRANCHISE AGREEMENTS . . . . . . . . . . . 10
6.1 Site Approval, Submission of Offering Circular, Execution
of Franchise Agreement . . . . . . . . . . . . . . . . . . 10
6.2 Condition Precedent To Company's Obligations . . . . . . . 11

VII. ASSIGNABILITY AND SUBFRANCHISING . . . . . . . . . . . . . . . . . 11
7.1 Assignability By Company . . . . . . . . . . . . . . . . . 11
7.2 No Subfranchising by Developer . . . . . . . . . . . . . . 11
7.3 Assignment by Developer. . . . . . . . . . . . . . . . . . 12
7.4 Individual Franchise Agreements. . . . . . . . . . . . . . 13

VIII. NON-COMPETITION, NON-SOLICITATION, TRADE SECRETS . . . . . . . . . 13
8.1 In Term. . . . . . . . . . . . . . . . . . . . . . . . . . 13
8.2 Post-Term. . . . . . . . . . . . . . . . . . . . . . . . . 13

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8.3 Modification . . . . . . . . . . . . . . . . . . . . . . . 14
8.4 Personnel. . . . . . . . . . . . . . . . . . . . . . . . . 14
8.5 Trade Secrets. . . . . . . . . . . . . . . . . . . . . . . 15

IX. TERMINATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
9.1 Termination Pursuant To A Material Breach Of This
Agreement. . . . . . . . . . . . . . . . . . . . . . . . . 15
9.2 Termination by Reason of a Material Breach of Other
Agreement. . . . . . . . . . . . . . . . . . . . . . . . . 16
9.3 Effect of Termination. . . . . . . . . . . . . . . . . . . 16

X. BUSINESS ENTITY DEVELOPER. . . . . . . . . . . . . . . . . . . . . 16
10.1 Business Entity Developer. . . . . . . . . . . . . . . . . 16

XI. GENERAL CONDITIONS AND PROVISIONS. . . . . . . . . . . . . . . . . 17
11.1 Relationship of Developer to Company . . . . . . . . . . . 17
11.2 Indemnity by Developer . . . . . . . . . . . . . . . . . . 17
11.3 Limitation of Liability. . . . . . . . . . . . . . . . . . 18
11.4 Waiver and Delay . . . . . . . . . . . . . . . . . . . . . 18
11.5 Survival of Covenants. . . . . . . . . . . . . . . . . . . 18
11.6 Successors and Assigns . . . . . . . . . . . . . . . . . . 18
11.7 Joint and Several Liability. . . . . . . . . . . . . . . . 19
11.8 Governing Law. . . . . . . . . . . . . . . . . . . . . . . 19
11.9 Entire Agreement . . . . . . . . . . . . . . . . . . . . . 19
11.10 Titles For Convenience . . . . . . . . . . . . . . . . . . 19
11.11 Gender And Construction. . . . . . . . . . . . . . . . . . 20
11.12 Severability . . . . . . . . . . . . . . . . . . . . . . . 20
11.13 Counterparts . . . . . . . . . . . . . . . . . . . . . . . 20
11.14 Fees and Expenses. . . . . . . . . . . . . . . . . . . . . 20
11.15 Notices. . . . . . . . . . . . . . . . . . . . . . . . . . 21

XII. SUBMISSION OF AGREEMENT. . . . . . . . . . . . . . . . . . . . . . 22
12.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . 22

XIII. ACKNOWLEDGMENT . . . . . . . . . . . . . . . . . . . . . . . . . . 22
13.1 General. . . . . . . . . . . . . . . . . . . . . . . . . . 22

EXHIBIT A DEVELOPMENT AREA . . . . . . . . . . . . . . . . . . . . . 24

EXHIBIT B MINIMUM DEVELOPMENT OBLIGATIONS. . . . . . . . . . . . . . 25

EXHIBIT C DEVELOPER INFORMATION. . . . . . . . . . . . . . . . . . . 26

EXHIBIT D EXCEPTIONS TO SECTION 8.1. . . . . . . . . . . . . . . . . 27

</TABLE>
ii

<PAGE>

AREA DEVELOPMENT AGREEMENT

THIS AREA DEVELOPMENT AGREEMENT (the "Agreement") is made and
entered into this ___ day of __________, 19__, (the "Effective Date") by and
between Diedrich Coffee, Inc. ("Company"), a California corporation, and
____________, a ______________________ ("Developer"), with reference to the
following facts:

A. Company intends to license certain proprietary and
other property rights and interests in and to the "Diedrich Coffee" name and
such other trademarks, trade names, service marks, logotypes, insignias,
trade dress and designs which Company may from time to time authorize or
direct Developer to use in connection with the operation of Coffeehouse (the
"Marks").

B. Company has developed and continues to develop a
system for the operation of coffeehouses, kiosks and coffee carts and
merchandising of Diedrich Coffee Authorized Products, which system features
distinctive signs, recipes, and various trade secrets and other confidential
information, and in some cases also includes architectural designs, trade
dress, uniforms, equipment specifications, layout plans, inventory,
record-keeping and marketing techniques (the "System").

C. Company desires to expand and develop its system of
"Diedrich Coffee" Coffeehouses, and seeks sophisticated and efficient
multi-unit franchisees who will develop numerous Coffeehouses within
designated areas.

D. Developer desires to build and operate "Diedrich
Coffee" Coffeehouses, and Company desires to grant to Developer the right to
build and operate said Coffeehouses in accordance with the terms and upon the
conditions contained in this Agreement.

WHEREFORE IT IS AGREED

I.
GRANT OF AREA DEVELOPMENT FRANCHISE

I.1 GRANT OF AREA DEVELOPMENT FRANCHISE.

Upon the terms and subject to the conditions of this
Agreement, Company hereby grants to Developer, and Developer hereby accepts,
the right, during the term hereof, to develop Coffeehouses solely at Venues
within the Development Area.

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<PAGE>

I.2 NO TRADEMARK LICENSE.

No right or license is granted to Developer hereunder to use
any trademarks, trade names, service marks, logotypes, insignias, trade dress
or designs owned by Company, such right and license being granted solely
pursuant to Franchise Agreement(s) executed pursuant to Section 6.1 below.

I.3 DEFINITIONS. In this Agreement, (a) capitalized
terms not otherwise defined herein shall have the meaning given such term in
the Franchise Agreement, and (b) the following capitalized terms shall have
the meanings set forth below, unless the context otherwise requires:

"Applicable Law" means and includes applicable common law and all applicable
statutes, laws, rules, regulations, ordinances, policies and procedures
established by any Governmental Authority, governing the operation of the
Coffeehouse, including all immigration, labor, disability, food and drug
laws, health and safety regulations, and Americans With Disabilities Act
requirements, as in effect on the Effective Date hereof, and as may be
amended from time to time.

"Authorized Products" means the specific espresso drinks and coffees, roasted
coffee beans and blends, premium teas, baked goods, snacks and other food
items and ancillary products, which may include coffee making equipment,
cups, hats, t-shirts and novelty items, as specified by Company from time to
time in Company's Manuals, or as otherwise directed by Company in writing,
for sale at the Developer's Coffeehouse, prepared and served in strict
accordance with Company's recipes, quality standards and specifications,
including specifications as to ingredients, brand names, preparation and
presentation.

"Business Entity" means any limited liability company or Partnership, and any
trust, association, corporation or other entity which is not an individual.

"Coffeehouse" shall refer to the full service location, kiosk, or coffee cart
operated under the Marks and in accordance with the System and specializing
in the sale of Authorized Products, pursuant to a validly executed Franchise
Agreement.

"Development Area" shall mean and refer to the geographical area set forth in
Exhibit "A" which is annexed hereto and by this reference made a part hereof

"Development Period" shall mean each of the time periods during which
Developer shall have the right and obligation to construct, equip, open and
thereafter continue to operate Coffeehouses in accordance with the Minimum
Development Obligation.

"Diedrich Coffee Branded Product" is any product now existing or developed in
the future that bears or is packaged under any of the Marks.

"Effective Date" means the date indicated in the first paragraph of this
Agreement.

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"Excluded Venues" shall mean stores operated at institutional settings,
including airports, colleges and universities, schools, hospitals, military
and other governmental facilities, office or in-plant food service
facilities, shopping mall food courts operated by a master concessionaire,
and any venue in which food service is or may be provided by a master
concessionaire or contract food service provider.

"Franchise Agreement" means the then current form of agreement prescribed by
Company and used to grant to Developer the right to own and operate a single
Coffeehouse in the Development Area, including all exhibits, riders,
guarantees or other related instruments, all as amended from time to time.

"Governmental Authority" means and includes all Federal, state, county,
municipal and local governmental and quasi-governmental agencies, commissions
and authorities.

"Gross Sales" means gross revenues (excluding allowances and sales taxes)
received or receivable by Developer as payment, whether in cash or for credit
or barter (and, if for credit or barter, whether or not payment is received
therefor), for all espresso, coffee, tea and other beverages, roasted coffee
beans, food, and other goods, services, and supplies sold or prepared in any
and all of Developer's Coffeehouses, or which are promoted or sold under any
of the Marks.

"Manuals" means Company's Front Line Team Member Training Guide; training
software; Diedrich Coffee Operations Manual and Support Manual, and related
manuals now or hereafter created by Company for use in connection with the
operation of a Coffeehouse, as the same may be amended and revised from time
to time, including all bulletins, supplements and ancillary manuals.

"Marks" shall have the meaning set forth in Recital A.

"Minimum Development Obligation" shall mean the Developer's right and
obligation to construct, equip, open and thereafter continue to operate at
Venues within the Development Area not less than the cumulative number of
Coffeehouses set forth in Exhibit "B," which is annexed hereto and by this
reference made a part hereof, within each of the Development Periods
specified therein.

"Offering Circular" means the Uniform Franchise Offering Circular or its
equivalent as may be required by applicable law.

"Partnership" means any general partnership or limited partnership.

"Permits" means and include all applicable franchises, licenses, permits,
registrations, certificates and other operating authority required by
Applicable Law.

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"Premises" means, in the case of a kiosk or cart, the property at which such
Coffeehouse is located, including unless otherwise expressly provided, any
ancillary common areas, campus, buildings and other structures associated
with the Premises.

"Term" shall have the meaning set forth in Section 4.1 including any
extensions thereof.

"Then-current" as used in this Agreement and applied to the Offering Circular
and Area Development Agreement shall mean the form then currently provided to
prospective franchisees or area franchisees, or if not then being so
provided, then such form selected by the Company in its sole discretion which
previously has been delivered to and executed by a franchisee of Company.

"System" shall have the meaning set forth in Recital B above.

"Venue" shall mean all types of locations other than "Excluded Venues".

"Week" shall refer to the 7 day period ending on Sunday of each calendar
week, or such other reporting period hereafter specified by Company.

II.
DEVELOPER'S DEVELOPMENT OBLIGATION

II.1 MINIMUM DEVELOPMENT OBLIGATION.

II.1.1 Developer shall construct, equip, open and thereafter
continue to operate at Venues within the Development Area not less than the
cumulative number of Coffeehouses within each of the Development Periods
specified in Exhibit "B".

II.1.2 Developer shall have the right to close any
Coffeehouse opened pursuant to this Agreement if Developer demonstrates to
Company's reasonable satisfaction that the site has not operated profitably
and is unlikely in the future to operate profitably, provided that Developer
obtains Company's prior written consent to such closure, which Company shall
grant or withhold based upon Company's reasonable business judgment. For
purposes of Developer's Minimum Development Obligation, such closed
Coffeehouse shall continue to be counted as an operating Coffeehouses for a
period of 12 months following closure, and Developer shall be deemed in
breach of the Minimum Development Obligation if immediately after said 12
month period the cumulative number of Coffeehouses then-operating is not
equal to or greater than the cumulative number required to have been in
operation as of the end of the immediately preceding Development Period.
Developer shall execute a new Franchise Agreement pursuant to Section 6.1 for
each subsequently opened Restaurant, even if opened as a "replacement" for
the closed Restaurant.

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II.1.3 If a Coffeehouse opened and operated by Developer is
destroyed or damaged, other than by a voluntary act of Developer, so that
such Coffeehouse cannot continue to operate, the destroyed or damaged
Coffeehouse shall continue to count toward satisfaction of the Minimum
Development Schedule (during the period until such substitute location
opens), BUT ONLY IF (i) Developer shall repair and restore such Coffeehouse
to Company's then approved plans and specifications within 120 days after the
occurrence of such destruction or damage, subject to delays permitted by
Section 2.2, or (ii) Developer shall, within 120 days after the occurrence of
such destruction or damage, open a Coffeehouse at a substitute location
within the Development Area in accordance with Company's then approved plans
and specifications (any such substitute location and the lease for such
location must be approved in writing in advance by Company pursuant hereto
and Developer shall execute a new Franchise Agreement therefor, pursuant to
Section 6.1).

II.2 FORCE MAJEURE.

Should Developer be unable to meet the Minimum Development
Obligation solely as the result of Force Majeure, including, but not limited
to strikes, material shortages, fires, floods, earthquakes, and other acts of
God, or by force of law (including, but not limited to any legal disability
of Company to deliver any Offering Circular required by law to be delivered
as contemplated by Section 6.1 of this Agreement), which result in the
inability of Developer to construct or operate Coffeehouse(s) in all or
substantially all of the Development Area, and which Developer could not by
the exercise of due diligence have avoided, the Development Periods shall be
extended by the amount of time during which such Force Majeure shall exist.

II.3 DEVELOPER MAY EXCEED MINIMUM DEVELOPMENT OBLIGATION.

II.3.1 Provided that Company is satisfied, in its sole
subjective judgment, that Developer has the requisite skills, financial
resources, management structure, personnel and other capabilities to do so,
and subject to the terms and conditions of this Agreement and the Franchise
Agreements, Developer may during the Term construct, equip, open and operate
more Coffeehouses at Venues within the Development Area than required in the
Minimum Development Obligation.

II.3.2 Although Company reserves the right to assess
Developer's capabilities to exceed the Minimum Development Obligation,
nothing in this Section 2.3 is intended to limit or restrict Developer's
right or ability, subject to the terms of this Agreement, to construct,
equip, open and operate the number of Coffeehouses within the Development
Area required by the Minimum Development Obligation.

II.4 SERVICING OF EXCLUDED VENUES BY DEVELOPER.

In the event that Company licenses one or more third party(ies)
to operate any "Diedrich Coffee" coffeehouse, kiosk or cart at an Excluded Venue
within the

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Development Area, Company shall provide Developer with the opportunity to
sign an agreement which among other things provides Developer the right to
act during the Term hereof as Company's representative to provide such
services and assistance to such third party(ies) as Company may specify, in
exchange for which Company shall pay Developer an amount equal to 20% of the
gross revenues actually received by Company from the licensee on account of
the operation of the Excluded Venue, including revenues in the form of
royalties and from the purchase of coffee and other products from Company
(but excluding any payments by the licensee for Company's Advertising
Program, if applicable).

II.5 SERVICING OF WHOLESALE ACCOUNTS

Notwithstanding Section 3.1.3(ii), Company shall not
distribute and market, or appoint any third party distributor to distribute
and market, within the Development Area, "Diedrich Coffee" brand named
espresso, ground coffee and roasted coffee beans, or tea to restaurants or
other wholesale accounts who will use such raw products to produce and sell
brewed beverages to the public (i.e., expressly excluding the sale of such
items pre-packaged for resale or otherwise intended for resale as raw,
unbrewed ingredients), or in conjunction with office coffee system services
("Wholesale Distribution Activities"), unless Company shall have first
provided Developer the opportunity for a period of at least 30 days to
negotiate in good faith a mutually acceptable agreement ("Distribution
Agreement") under which Developer may act as Company's wholesale distributor
and account representative with respect to such Wholesale Distribution
Activities in the Development Area. The term "Wholesale Distribution
Activities" includes sales of the foregoing products to wholesale accounts
which are located in Excluded Venues, but which do not operate under the
"Diedrich Coffee" name (e.g., a college cafeteria). If the parties are
unable to agree upon a mutually acceptable Distribution Agreement within said
30 day period, Company shall be free to undertake or to appoint a third party
to undertake such Wholesale Distribution Activities without further
obligation to Developer.

III.
EXCLUSIVITY

III.1 EXCLUSIVITY.

III.1.1 During the Term of this Agreement,
subject to Sections 3.1.2 and 3.1.3, Company shall not operate or grant a
license or franchise to any other person to operate a "Diedrich Coffee"
coffeehouse at any site within the Development Area other than an Excluded
Venue.

III.1.2 Company expressly reserves the
exclusive, unrestricted right, in its sole and absolute discretion, directly
and indirectly, through its employees, affiliates, representatives,
licensees, assigns, agents and others, to own or operate and to franchise or
license others (which may include its affiliates and joint ventures in which
it or its affiliates are participants) to own or operate "Diedrich Coffee"
coffeehouses (i) at any location outside

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the geographic area comprising the Development Area, including immediately
adjacent to the Development Area, and (ii) at any site or location which is
an Excluded Venue as that term is defined in Section 1.3, even if located
within the Development Area, and regardless of its proximity to any
Coffeehouse developed or under development or consideration by Developer.

III.1.3 In addition, Company expressly
reserves the exclusive, unrestricted right, in its sole and absolute
discretion, directly and indirectly, through its employees, affiliates,
representatives, licensees, assigns, agents and others, (i) to own or operate
and to franchise or license others (which may include its affiliates and
joint ventures in which it or its affiliates are participants) to own or
operate coffeehouses, restaurants and other businesses which operate under
names other than "Diedrich Coffee" at any location, and of any type or
category whatsoever, and whether within or outside the Development Area, and
regardless of its proximity to any Coffeehouse developed or under development
or consideration by Developer; and (ii) subject to Section 2.5, to produce,
license, distribute and market "Diedrich Coffee" brand named products, and
products bearing other marks, including espresso, ground coffee and roasted
coffee beans, tea, and other food and beverage products, clothing, souvenirs
and novelty items, at or through any location or outlet whether or not
operating under the "Diedrich Coffee" name, including grocery stores and
convenience stores (including those which may be located within the
Development Area), and through any distribution channel, at wholesale or
retail, including by means of mail order catalogs, direct mail advertising,
internet marketing and other distribution methods.

IV.
TERM OF AREA DEVELOPMENT AGREEMENT

IV.1 TERM.

The Term of this Agreement shall commence on the Effective
Date and, unless sooner terminated in accordance with the provisions herein,
or extended as provided in Section 2.2, shall continue for a period of five
(5) years.

IV.2 RENEWAL.

Developer shall have no right to renew this Agreement. After
the expiration of the Term, or the sooner termination of this Agreement,
Company, and its affiliates may construct, equip, open and operate, and
license or franchise others to construct, equip, open and operate additional
Coffeehouses in the Development Area, and at any Venue, without any
restriction.

IV.3 LIMITED ADDITIONAL DEVELOPMENT RIGHT.

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Within 60 days prior to the expiration of the Term, if
Company shall determine that further development of the Development Area is
desirable, Company shall notify Developer in writing of Company's
determination to develop additional Coffeehouses in the Development Area and
a plan for such development over a five year term. Subject to the conditions
set forth in Section 4.5 of this Agreement, Developer shall have a prior
right to undertake the additional development which Company shall have set
forth in its notice to Developer. This right of additional development by
Developer shall be exercised only in accordance with Section 4.4 and is
subject to the conditions set forth in Section 4.5. If such right of
additional development is not exercised by Developer, Company or any
franchisee franchised by Company may construct, equip, open and operate
additional Coffeehouses in the Development Area.

IV.4 EXERCISE OF RIGHT OF ADDITIONAL DEVELOPMENT.

At the time Company delivers to Developer Company's written
notice of its determination to undertake additional development in the
Development Area, Company shall also deliver to Developer a copy of Company's
then-current Offering Circular and two copies of the then-current area
development agreement. The new area development agreement, which may vary
substantially from this Agreement, will reflect Developer's new development
obligation consistent with Company's plan for additional development set
forth in its notice to Developer. Notwithstanding the foregoing or
inconsistent terms of such area development agreement, the fees specified in
Section 5.1 and 5.2 of this Agreement shall continue to apply. Within thirty
(30) days after Developer's receipt of the Offering Circular and the new area
development agreement, but no sooner than immediately after any applicable
waiting periods prescribed by law have passed, Developer shall execute two
copies of the area development agreement described in the Offering Circular
and return them to Company. If Developer has so executed and returned the
copies and has satisfied the conditions set forth in Section 4.5, Company
will execute the copies and return one fully executed copy to Developer.

IV.5 CONDITIONS TO EXERCISE OF RIGHT OF ADDITIONAL
DEVELOPMENT.

Developer's right to additional development described in
Section 4.3 shall be subject to Developer's fulfillment of the following
conditions precedent:

IV.5.1 Developer shall have fully performed all of
its obligations under this Agreement and all other agreements between Company
and Developer.

IV.5.2 Developer shall have demonstrated to Company
Developer's financial capacity to perform the additional development
obligations set forth in the new area development agreement. In determining
if Developer is financially capable, Company will apply the same criteria to
Developer as it applies to prospective area franchisees at that time.

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IV.5.3 At expiration of the Term, Developer shall
continue to operate, in the Development Area, not less than the cumulative
number of Coffeehouses required by the Minimum Development Obligation set
forth in Exhibit "B".

V.
PAYMENTS BY DEVELOPER

V.1 DEVELOPMENT AREA FEES. Developer shall pay an annual
fee to Company in cash or by certified check in consideration of the rights
granted to Developer hereunder and subject to the conditions contained herein
(singularly a "Development Area Fee" and collectively, the "Development Area
Fees"), payable as follows: (a) upon execution of this Agreement, Developer
shall pay a Development Area Fee in the amount of $___________, and (b) on or
before each anniversary of the Effective Date, Developer shall pay an annual
Development Area Fee in the amount of $___________. The Development Area
Fees shall be deemed fully earned upon the payment thereof and shall be
non-refundable under any circumstances.

V.2 FRANCHISE FEES FOR EACH COFFEEHOUSE. Notwithstanding
the terms of the standard form of Franchise Agreements that Developer shall
execute pursuant to Section 6.1 for each Coffeehouse opened in the
Development Area:

V.2.1 Developer shall pay an initial franchise fee
of $20,000 (or $7,500 in the case of a kiosk or cart) for each Coffeehouse,
payable upon execution of each Franchise Agreement executed pursuant hereto
(the "Initial Fee"); and

V.2.2 Each of the Franchise Agreements executed
pursuant hereto for Coffeehouses in the Development Area will require
Developer to pay a monthly Continuing Royalty equal to 5% (or 7.5% in the
case of a kiosk or cart) of Gross Sales. The definition of "Gross Sales" set
forth herein shall apply to all Franchise Agreements executed by Developer
pursuant to Section 6.1, notwithstanding any inconsistent definition in such
Franchise Agreements.

V.2.3 The amount of the Initial Fee for each
Franchise Agreement executed pursuant to Section 6.1 shall be adjusted to
reflect the increase if any in the Consumer Price Index, All Urban Consumers,
Los Angeles/Anaheim/Riverside, All Items (revised 1982-1984:100) published by
the United States Department of Labor, Bureau of Statistics ("Index"),
between the Index published two (2) months prior to the date of the execution
of the Franchise Agreement executed pursuant to Section 6.1, or the date of
the transfer, as applicable ("Adjustment Index") and the Index published two
(2) months prior to the month in which this Agreement is executed ("Beginning
Index"). If the Index is changed so that the base year differs from that
used in the Beginning Index, the Index shall be converted in accordance with
the conversion factor published by the United States Department of Labor,
Bureau of Statistics. If the Index is discontinued or revised during the

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term, such other governmental index or computation with which it is replaced
shall be used in order to obtain substantially the same result as would be
obtained if the Index had not been discontinued or revised. Should the Index
be discontinued or become unavailable to the general public, or should the
method of computation be fundamentally changed, another index selected by
Company and generally recognized as authoritative shall be substituted.

VI.
EXECUTION OF INDIVIDUAL FRANCHISE AGREEMENTS

VI.1 SITE APPROVAL, SUBMISSION OF OFFERING CIRCULAR,
EXECUTION OF FRANCHISE AGREEMENT.

VI.1.1 After Developer has located a site for
construction of a Coffeehouse, Developer shall submit to Company such
information regarding the proposed site as Company shall require, in the form
which Company shall from time to time require, together with the terms of any
proposed lease relating to such site. Company may seek such additional
information as it deems necessary within 30 days of submission of the
prospective site, and Developer shall respond promptly to such request for
additional information.

VI.1.2 If Company shall not reject the site in
writing within 30 days, or within 30 days after a receipt of such additional
information, whichever is later, the site shall be deemed approved.
Company's approval of a site proposed by Developer will not be unreasonably
withheld or delayed.

VI.1.3 Promptly after approval of any site, Company
shall, if required by Applicable Law and if it has not done so already,
transmit to Developer an Offering Circular and two execution copies of the
Franchise Agreement pertaining to the approved site. Immediately upon
receipt of the Offering Circular, Developer shall return to Company a signed
copy of the Acknowledgment of Receipt of the Offering Circular. Not less
than ten (10) business days, nor more than thirty (30) business days after
Company's delivery of such Offering Circular, Developer shall execute and
deliver to Company two copies of said Franchise Agreement and (subject to
Section 5.2 hereof) pay to the Company the Initial Fee therefor as provided
in Section 5.2.1 above.

VI.1.4 Company shall, promptly upon receipt of said
documents and Initial Fee, execute and return to Developer one copy of the
Franchise Agreement. Developer shall then procure the site by purchase or
lease, and return one copy of the executed lease or, if purchased, the deed
evidencing Developer's right to occupy the approved site. Developer shall
then commence construction and operation of the Coffeehouse pursuant to the
terms of the Franchise Agreement.

VI.1.5 Notwithstanding the foregoing, Company's
obligation to deliver Franchise Agreements shall be subject to Company's
legal authority to do so, and if

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Company is not legally able to deliver an Offering Circular to Developer by
reason of any lapse or expiration of its franchise registration, or because
Company is in the process of amending any such registration, or for any
reason beyond Company's reasonable control, Company may delay approval of the
site for Developer's proposed Coffeehouse and delivery of its Offering
Circular until such time as Company is legally able to deliver an Offering
Circular. In no event shall Company be liable to Developer for any loss,
cost or expense occasioned by such delays.

VI.2 CONDITION PRECEDENT TO COMPANY'S OBLIGATIONS.

It shall be a condition precedent to Company's obligations
pursuant to Section 6.1, that Developer shall have performed all of his
obligations under and pursuant to all agreements between Developer and
Company.

VII.
ASSIGNABILITY AND SUBFRANCHISING

VII.1 ASSIGNABILITY BY COMPANY.

This Agreement is fully transferable by Company, in whole or in part, without
the consent of Developer and shall inure to the benefit of any transferee or
their legal successor to Company's interests herein; provided, however, that
such transferee and successor shall expressly agree to assume Company's
obligations under this Agreement. Without limiting the foregoing, Company
may (i) assign any or all of its rights and obligations under this Agreement
to a subsidiary or affiliated entity; (ii) sell its assets, its Marks, or its
System outright to a third party; (iii) go public; (iv) engage in a private
placement of some or all of its securities; (v) merge, acquire other
corporations, or be acquired by another corporation; or (vi) undertake a
refinancing, recapitalization, leveraged buy-out or other economic or
financial restructuring. Company shall be permitted to perform such actions
without liability or obligation to Developer who expressly and specifically
waives any claims, demands or damages arising from or related to any or all
of the above actions (or variations thereof).

VII.2 NO SUBFRANCHISING BY DEVELOPER.

Developer shall not offer, sell, or negotiate the sale of
"Diedrich Coffee" franchises to any third party, either in Developer's own
name or in the name and on behalf of Company, or otherwise subfranchise,
subcontract, share, divide or partition this Agreement, and nothing in this
Agreement will be construed as granting Developer the right to do so.

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<PAGE>

VII.3 ASSIGNMENT BY DEVELOPER.

VII.3.1 This Agreement has been entered into
by Company in reliance upon and in consideration of the individual or
collective character, reputation, skill, attitude, business ability, and
financial capacity of Developer or, if applicable, its shareholders, members
or partners who will actively and substantially participate in the
development, ownership and operation of the Coffeehouses. Therefore, neither
Developer's interest in this Agreement nor any of its rights or privileges
shall be assigned or transferred, voluntarily or involuntarily, in whole or
in part, by operation of law or otherwise, in any manner (an "Assignment"),
without the prior written consent of Company (which it may grant or withhold
in its sole and absolute discretion).

VII.3.2 If Developer is a Business Entity,
each of the following shall be deemed to be an Assignment of this Agreement:
(i) the transfer of fifty percent (50%) or more in the aggregate, whether in
one or more transactions, of the capital stock, membership interests or
voting power of Developer, by operation of law or otherwise; (ii) the
issuance of any securities by Developer which itself or in combination with
any other transaction(s) results in the shareholders, members or partners
existing as of the Effective Date, as applicable, owning fifty percent (50%)
or less of the outstanding shares, membership interests or voting power of
Developer as constituted as of the date hereof; (iii) if Developer is a
Partnership, the withdrawal, death or legal incapacity of a general partner
or limited partner owning fifty percent (50%) or more of the voting power,
property, profits or losses, or partnership interests of the Partnership
(each of which is referred to hereinafter as a "Partnership Right"), or the
admission of any additional general partner or the transfer by any general
partner of any of its Partnership Rights in the Partnership; (iv) the death
or legal incapacity of any shareholder, member or partner owning fifty
percent (50%) or more of the capital stock, voting power, or Partnership
Rights of Developer; and (v) any merger, stock redemption, consolidation,
reorganization or recapitalization involving Developer, or the amendment of
the articles, bylaws or operating agreement of Developer so as to transfer
control of the Developer to a person or Business Entity other than Developer.

VII.3.3 Developer shall not in any event have
the right to pledge, encumber, hypothecate or otherwise give any third party
a security interest in this Agreement in any manner whatsoever without the
express prior written permission of Company, which permission may be withheld
for any reason whatsoever in Company's sole subjective judgment.

VII.4 INDIVIDUAL FRANCHISE AGREEMENTS.

Developer shall not execute any Franchise Agreement, or
construct or equip any Coffeehouse with the intent of transferring or
assigning such Franchise Agreement or Coffeehouse. Developer acknowledges
and agrees that it will not be permitted to assign any

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<PAGE>

Franchise Agreement executed pursuant to this Agreement except in conjunction
with a concurrent assignment to the same assignee of all of the Franchise
Agreements executed pursuant to this Agreement, and otherwise in accordance
with the terms and conditions of said Franchise Agreement(s).

VIII.
NON-COMPETITION, NON-SOLICITATION, TRADE SECRETS

VIII.1 IN TERM.

Subject to the exceptions, if any, explicitly set forth in
Exhibit D which is annexed hereto and by this reference made a part hereof,
during the term hereof, neither Developer, nor any officer, director,
shareholder, member or general partner of a Developer which is a Business
Entity, shall either directly or indirectly, own, operate, advise, be
employed by, or have any financial interest in any business that features the
sale of coffee, or other food products featured by "Diedrich Coffee"
coffeehouses, wherever located, whether located within or outside the
Development Area unless Company shall consent thereto in writing.

VIII.2 POST-TERM.

Subject to the exceptions, if any, explicitly set forth in
Exhibit D, to the extent permitted by Applicable Law, during the two (2) year
period after the expiration or termination hereof, for any reason, neither
Developer, nor any officer, director, shareholder, member or general partner
of a Developer which is a Business Entity, shall, either directly or
indirectly, own, operate, advise, be employed by, or have any interest in any
business that features the sale of coffee, or other food products featured by
"Diedrich Coffee" coffeehouses, (i) within the Development Area, (ii) within
the County in which any Coffeehouse operated by Developer is located, or
(iii) within an area within ten (10) miles from the location or any then
existing "Diedrich Coffee" Coffeehouse, without the Company's prior written
consent. In applying for such consent, Developer will have the burden of
establishing that any such activity by it will not involve the use of
benefits provided under this Agreement or constitute unfair competition with
Company or other franchisees of the Company.

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VIII.3 MODIFICATION.

The parties have attempted in Sections 8.1 and 8.2 above to
limit the Developer's right to compete only to the extent necessary to
protect the Company from unfair competition. The parties hereby expressly
agree that if the scope or enforceability of Section 8.1 and 8.2 is disputed
at any time by Developer, a court or arbitrator, as the case may be, may
modify either or both of such provisions to the extent that it deems
necessary to make such provision(s) enforceable under Applicable Law. In
addition, the Company reserves the right to reduce the scope of either, or
both, of said provisions without Developer's consent, at any time or times,
effective immediately upon notice to Developer.

VIII.4 PERSONNEL.

VIII.4.1 During the term of this Agreement,
Developer shall not, without the prior written consent of Company, directly
or indirectly:

(a) employ or attempt to employ any
person who at that time is employed by Company, an affiliate of Company, or
any other franchisee, including, without limitation, any coffeehouse manager,
assistant coffeehouse manager, or head chef ("Personnel");

(b) employ or attempt to employ any
Personnel who within six (6) months prior thereto had been employed by
Company, an affiliate of Company, or any other franchisee; or

(c) induce or attempt to induce any
Personnel to leave his or her employment with Company, an affiliate of
Company, or any other franchisee.

VIII.4.2 The prohibitions set forth in Section
8.4.1 above shall also apply during the one (1) year period after the
expiration or termination of this Agreement.

VIII.4.3 During the term of this Agreement,
Company shall not, without the prior written consent of Developer, directly
or indirectly:

(a) employ or attempt to employ any
person who at that time is employed by Developer, an affiliate of Developer,
or any other franchisee, including, without limitation, any Personnel; or

(b) induce or attempt to induce any
Personnel to leave his or her employment with Developer, an affiliate of
Developer, or any other franchisee.

VIII.5 TRADE SECRETS.

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VIII.5.1 Non-disclosure. Company possesses
confidential information including recipes, secret ingredients and certain
confidential specifications, procedures, concepts and methods of marketing
and operating coffeehouses, restaurants and other retail outlets featuring
espresso, ground coffee and roasted coffee beans, tea, and other food and
beverage products (the "Trade Secrets"). Certain of the Trade Secrets may be
disclosed to Developer in Operating Manuals, bulletins, supplements,
confidential correspondence, or other confidential communications, and
through the Company's training program and other guidance and management
assistance, and in performing Company's other obligations and exercising
Company's rights under this Agreement or the Franchise Agreements executed
pursuant hereto. "Trade Secrets" shall not include information which: (a) has
entered the public or was known to Developer prior to Company's disclosure of
such information to Developer, other than by the breach of an obligation of
confidentiality owed (by anyone) to Company; (b) becomes known to Developer
from a source other than Company and other than by the breach of an
obligation of confidentiality owed (by anyone) to Company; or (c) was
independently developed by Developer without the use or benefit of Company's
Trade Secrets; The burden of proving the applicability of the foregoing will
reside with Developer.

VIII.5.2 Limits on use. Developer shall
acquire no interest in the Trade Secrets other than the right to use them in
developing and operating Coffeehouses pursuant to the Franchise Agreements
executed pursuant to Section 6.1 during the term thereof. Developer's
duplication or use of the Trade Secrets in any other endeavor or business
shall constitute an unfair method of competition. Developer shall: (i) not
use the Trade Secrets in any business or other endeavor other than in
connection with such "Diedrich Coffee" Coffeehouses; (ii) maintain absolute
confidentiality of the Trade Secrets during and after this Agreement's term;
(iii) make no unauthorized copy of any portion of the Trade Secrets,
including without limitation, any Operating Manual, bulletins, supplements,
confidential correspondence, or other confidential communications, whether
written or oral; and (iv) operate and implement all reasonable procedures
prescribed from time to time by Company to prevent unauthorized use and
disclosure of the Trade Secrets, including without limitation, restrictions
on disclosure to employees and use of non-disclosure and non-competition
provisions as Company prescribes in employment agreements with employees who
may have access to the Trade Secrets. Promptly upon Company's request,
Developer shall deliver executed copies of such agreements to Company.

IX.
TERMINATION

IX.1 TERMINATION PURSUANT TO A MATERIAL BREACH OF THIS
AGREEMENT.

This Agreement may be terminated by Company in the event of
any material breach by Developer of this Agreement, unless such default is
cured by Developer within 15 days following written notice of the default (or
5 days in the case of a default in the payment of money, including the
failure to pay, when due, the Development Area Fees pursuant to

15
<PAGE>

Article V of this Agreement); provided that the following defaults shall be
deemed incurable: (i) Any attempt by Developer to sell, assign, transfer or
encumber in whole or in part any or all rights and obligations under this
Agreement, in violation of the terms of this Agreement, or without the
written consents required, pursuant to this Agreement; (ii) failure of
Developer to meet the Minimum Development Obligation within the Development
Periods set forth herein; and (iii) any violation by Developer of Article
VIII.

IX.2 TERMINATION BY REASON OF A MATERIAL BREACH OF OTHER
AGREEMENT.

This Agreement may be terminated, at the election of Company,
in the event of the termination by reason of a material breach by Developer
of an individual Franchise Agreement or any other agreement between Company
and Developer, the notice and the opportunity to cure, if any, specified in
the Franchise Agreement or other such agreement.

IX.3 EFFECT OF TERMINATION.

Upon the expiration of the Term, or upon the prior
termination of this Agreement:

IX.3.1 Developer shall have no further right to
construct, equip, own, open or operate additional Coffeehouses which are not,
at the time of such termination or expiration, the subject of a then existing
Franchise Agreement between Developer and Company which is in full force
and effect;

IX.3.2 Company and its affiliates may construct,
equip, open, own or operate, or franchise or license others to construct,
equip, open, own or operate Coffeehouses in the Development Area, except as
may be expressly provided to the contrary in any Franchise Agreement executed
pursuant to this Agreement; and

IX.3.3 Developer shall have no further right under
Sections 2.4 or 2.5 to act as Company's representative or to receive any
amount pursuant to Sections 2.4, 2.5 or otherwise with respect to any
revenues whatsoever received by Company after the termination of this
Agreement (notwithstanding the date on which Company accrued such revenues).

X.
BUSINESS ENTITY DEVELOPER

X.1 BUSINESS ENTITY DEVELOPER.

X.1.1 If Developer is a Business Entity, Developer
represents and warrants that the information set forth in Exhibit "C" which
is annexed hereto and by this reference made a part hereof, is accurate and
complete in all material respects.

16
<PAGE>

X.1.2 Developer shall notify Company in writing
within ten (10) days of any change in the information set forth in Exhibit C.

X.1.3 Developer promptly shall provide such
additional information as Company may from time to time request concerning
all persons who may have any direct or indirect financial interest in
Developer.

XI.
GENERAL CONDITIONS AND PROVISIONS

XI.1 RELATIONSHIP OF DEVELOPER TO COMPANY.

It is expressly agreed that the parties intend by this
Agreement to establish between Company and Developer the relationship of
franchisor and franchisee. It is further agreed that Developer has no
authority to create or assume in Company's name or on behalf of Company, any
obligation, express or implied, or to act or purport to act as agent or
representative on behalf of Company for any purpose whatsoever. Neither
Company nor Developer is the employer, employee, agent, partner or
co-venturer of or with the other, each being independent. Developer agrees
that he will not hold himself out as the agent, employee, partner or
co-venturer of Company. All employees hired by or working for Developer
shall be the employees of Developer and shall not, for any purpose, be deemed
employees of Company or subject to Company control. Each of the parties
agrees to file its own tax, regulatory and payroll reports with respect to
its respective employees and operations, saving and indemnifying the other
party hereto of and from any liability of any nature whatsoever by virtue
thereof.

XI.2 INDEMNITY BY DEVELOPER.

Developer hereby agrees to protect, defend and indemnify
Company, and all of its past, present and future partners, shareholders,
direct and indirect parent companies, subsidiaries, affiliates, officers,
directors, employees, attorneys and designees and hold them harmless from and
against any and all costs and expenses, including attorneys' fees, court
costs, losses, liabilities, damages, claims and demands of every kind or
nature on account of any actual or alleged loss, injury or damage to any
person or Business Entity or to any property arising out of or in connection
with Developer's operation of Coffeehouses pursuant hereto, except to the
extent resulting from the negligence or intentional misconduct of Company.

17
<PAGE>

XI.3 LIMITATION OF LIABILITY

XI.3.1 Company shall not be liable to Developer for
any consequential damages, including but not limited to lost profits,
interest expense, increased construction or occupancy costs, or other costs
and expenses incurred by Developer by reason of any delay in the delivery of
Company's Offering Circular caused by legal incapacity during the Term,
events beyond Company's reasonable control, or other conduct not due to the
gross negligence or misfeasance of Company.

XI.3.2 Developer shall not be liable to Company for
lost profits, interest expenses, or unaccrued future Development Area Fees
upon the termination of this Agreement pursuant to Section 9.1.2 or 9.1.3;
provided, however, this Section 11.3.2 shall not otherwise limit any other
remedy available to Company at law or in equity, nor limit the recovery of
damages to Company, except as provided herein.

XI.4 WAIVER AND DELAY.

No waiver by Company of any breach or series of breaches or
defaults in performance by Developer, and no failure, refusal or neglect of
Company to exercise any right, power or option given to it hereunder or under
any other franchise agreement between Company and Developer, whether entered
into before, after or contemporaneously with the execution hereof (and
whether or not related to the Coffeehouses) or to insist upon strict
compliance with or performance of Developer's obligations under this
Agreement or any other franchise agreement between Company and Developer,
whether entered into before, after or contemporaneously with the execution
hereof (and whether or not related to the Coffeehouses), shall constitute a
waiver of the provisions of this Agreement with respect to any subsequent
breach thereof or a waiver by Company of its right at any time thereafter to
require exact and strict compliance with the provisions thereof.

XI.5 SURVIVAL OF COVENANTS.

The covenants contained in this Agreement which, by their
terms, require performance by the parties after the expiration or termination
of this Agreement, shall be enforceable notwithstanding said expiration or
other termination of this Agreement for any reason whatsoever.

XI.6 SUCCESSORS AND ASSIGNS.

This Agreement shall be binding upon and inure to the benefit
of the successors and assigns of Company and shall be binding upon and inure
to the benefit of Developer and his or their respective heirs, executors,
administrators, successors and assigns, subject to the prohibitions against
Assignment contained herein.

XI.7 JOINT AND SEVERAL LIABILITY.

18
<PAGE>

If Developer consists of more than one person or entity, or a
combination thereof, the obligations and liabilities of each such person or
entity to Company are joint and several.

XI.8 GOVERNING LAW.

This Agreement shall be construed in accordance with the laws
of the State of California, without giving effect to any conflict of laws,
excepting however the provisions of Article VIII respecting Non-Competition
Covenants. Article VIII shall be construed and enforced in accordance with
the laws of the State where the breach of said Section occurs.

THE PARTIES HEREBY WAIVE THEIR RIGHT TO TRIAL BY JURY WITH
RESPECT TO ANY DISPUTE ARISING UNDER THIS AGREEMENT, AND THEY AGREE THAT,
EXCEPT TO THE EXTENT PROHIBITED BY LAW, LOS ANGELES, CALIFORNIA SHALL BE THE
VENUE FOR ANY LITIGATION ARISING UNDER THIS AGREEMENT. THE PARTIES
ACKNOWLEDGE THAT THEY HAVE REVIEWED THIS SECTION AND HAVE HAD THE OPPORTUNITY
TO SEEK INDEPENDENT LEGAL ADVICE AS TO ITS MEANING AND EFFECT.

XI.9 ENTIRE AGREEMENT.

This Agreement and the Exhibits incorporated herein contain
all of the terms and conditions agreed upon by the parties hereto concerning
the subject matter hereof. No other agreements concerning the subject matter
hereof, written or oral, shall be deemed to exist or to bind any of the
parties hereto and all prior agreements, understandings and representations,
are merged herein and superseded hereby. Developer represents that there are
no contemporaneous agreements or understandings between the parties relating
to the subject matter of this Area Development Agreement that are not
contained herein. No officer or employee or agent of Company has any
authority to make any representation or promise not contained in this
Agreement or any Offering Circular for prospective franchisees required by
Applicable Law, and Developer agrees that he has executed this Agreement
without reliance upon any such representation or promise. This Agreement
cannot be modified or changed except by written instrument signed by all of
the parties hereto.

XI.10 TITLES FOR CONVENIENCE.

Article and paragraph titles used in this Agreement are for
convenience only and shall not be deemed to affect the meaning or
construction of any of the terms, provisions, covenants, or conditions of
this Agreement.

19
<PAGE>

XI.11 GENDER AND CONSTRUCTION.

All terms used in any one number or gender shall extend to
mean and include any other number and gender as the facts, context, or sense
of this Agreement or any article or paragraph hereof may require. As used in
this Agreement, the words "include," "includes" or "including" are used in a
non-exclusive sense. Unless otherwise expressly provided herein to the
contrary, any consent, approval or authorization of Company which Developer
may be required to obtain hereunder may be given or withheld by Company in
its sole discretion, and on any occasion where Company is required or
permitted hereunder to make any judgment or determination, including any
decision as to whether any condition or circumstance meets Company's
standards or satisfaction, Company may do so in its sole subjective judgment.

XI.12 SEVERABILITY.

Nothing contained in this Agreement shall be construed as
requiring the commission of any act contrary to law. Whenever there is any
conflict between any provisions of this Agreement and any present or future
statute, law, ordinance or regulation contrary to which the parties have no
legal right to contract, the latter shall prevail, but in such event the
provisions of this Agreement thus affected shall be curtailed and limited
only to the extent necessary to bring it within the requirements of the law.
In the event that any part, article, paragraph, sentence or clause of this
Agreement shall be held to be indefinite, invalid or otherwise unenforceable,
the indefinite, invalid or unenforceable provision shall be deemed deleted,
and the remaining part of this Agreement shall continue in full force and
effect.

XI.13 COUNTERPARTS.

This Agreement may be executed in any number of counterparts,
each of which shall be deemed to be an original and all of which together
shall be deemed to be one and the same instrument.

XI.14 FEES AND EXPENSES.

Should any party hereto commence any action or proceeding for
the purpose of enforcing, or preventing the breach of, any provision hereof,
whether by arbitration, judicial or quasi-judicial action or otherwise, or
for damages for any alleged breach of any provision hereof, or for a
declaration of such party's rights or obligations hereunder, then the
prevailing party shall be reimbursed by the losing party for all costs and
expenses incurred in connection therewith, including, but not limited to,
reasonable attorneys' fees for the services rendered to such prevailing party.

20
<PAGE>

XI.15 NOTICES.

Except as otherwise expressly provided herein, all written
notices and reports permitted or required to be delivered by the parties
pursuant hereto shall be deemed so delivered at the time delivered by hand,
one (1) business day after transmission by facsimile or other electronic
system (with confirmation copy sent by regular U.S. Mail), or three (3)
business days after placement in the United States Mail by Registered or
Certified Mail, Return Receipt Requested, postage prepaid and addressed as
follows:

If to Company:

Diedrich Coffee, Inc.
2144 Michelson Drive
Irvine, California 92612
Telephone No. (714) 260-1600
Facsimile No.: (714) 756-1144

With copy (which shall not constitute notice) to:

Kenneth R. Costello, Esq.
Jenkens & Gilchrist, P.C.
12100 Wilshire Boulevard, 15th Floor
Los Angeles, California 90025
Facsimile No.: (310) 820-8859

If to Developer:

---------------------------------
---------------------------------
---------------------------------
---------------------------------
Facsimile No.: ( )
--------------------------------

or to such other address as such party may designate by ten (10) days'
advance written notice to the other party.

21
<PAGE>

XII.
SUBMISSION OF AGREEMENT

XII.1 GENERAL.

The submission of this Agreement does not constitute an offer
and this Agreement shall become effective only upon the execution thereof by
Company and Developer. THIS AGREEMENT SHALL NOT BE BINDING ON COMPANY UNLESS
AND UNTIL IT SHALL HAVE BEEN ACCEPTED AND SIGNED BY THE PRESIDENT OR CHIEF
FINANCIAL OFFICER OF COMPANY. THIS AGREEMENT SHALL NOT BECOME EFFECTIVE
UNTIL AND UNLESS DEVELOPER SHALL HAVE BEEN FURNISHED BY COMPANY WITH ALL
DISCLOSURE DOCUMENTS, IN WRITTEN FORM, AS MAY BE REQUIRED UNDER OR PURSUANT
TO APPLICABLE LAW, FOR REQUISITE TIME PERIODS.

XIII.
ACKNOWLEDGMENT

XIII.1 GENERAL.

22
<PAGE>

Developer, and its shareholders, members and partners, as
applicable, jointly and severally acknowledge that they have carefully read
this Agreement and all other related documents to be executed concurrently or
in conjunction with the execution hereof, that they have obtained the advice
of counsel in connection with entering into this Agreement, that they
understand the nature of this Agreement, and that they intend to comply
herewith and be bound hereby.

IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be executed as of the first date set forth above.

ACCEPTED on this___ day of _________, 19__.

COMPANY:
Diedrich Coffee, Inc.

By:
--------------------------------------
Its:
--------------------------------------

DEVELOPER:

------------------------------------------

By:
--------------------------------------
Its:
--------------------------------------

------------------------------------------
an Individual

23
<PAGE>

EXHIBIT A
DEVELOPMENT AREA

24
<PAGE>

EXHIBIT B
MINIMUM DEVELOPMENT OBLIGATIONS

Development Cumulative
Period No. to be in
Ending Operation
- ----------- ------------
1___________, 19__ _____

2___________, 19__ _____

3___________, 19__ _____

4___________, 19__ _____

5___________, 19__ _____

25
<PAGE>

EXHIBIT C
DEVELOPER INFORMATION

Developer is a (check as applicable):
[ ] corporation [ ] limited partnership
[ ] limited liability company [ ] general partnership
[ ] Other (specify): ___________________________

The name and address of each shareholder, member, and general and limited
partner of Developer is:

NUMBER OF
SHARES OR
PERCENTAGE
NAME ADDRESS INTEREST
---- ------- ----------
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________

There is set forth below the name and address of each director, member, or
general partner, as applicable, of Developer:

NAME ADDRESS
- ---- -------
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________

There is set forth below the names, and addresses and titles of Developer's
principal officers or partners who will be devoting their full time to the
Coffeehouse:

The address where Developer's Financial Records, and Business Entity records
(e.g. Articles of Incorporation, Bylaws, Operating Agreement, Partnership
Agreement, etc.) are maintained is:

___________________________________
___________________________________
___________________________________

26
<PAGE>

EXHIBIT D

EXCEPTIONS TO SECTION 8.1

________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________

27
<PAGE>

SPOUSAL CONSENT

Each of the undersigned, each being the spouse of an individual who
executed this Agreement as Developer or if Developer is a partnership, a
spouse of a general partner, consents to all of the terms of this Agreement
and the execution thereof.

Dated:_________________________________ By: ____________________________

By: _____________________________

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
DIEDRICH COFFEE, INC. UNAUDITED FINANCIAL STATEMENTS FOR THE THIRTY-NINE
WEEKS ENDED AND AS OF OCTOBER 28, 1998 CONTAINED IN COMPANY'S 3RD
QUARTER 1999 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
</LEGEND>

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-27-1999
<PERIOD-START> JAN-29-1998
<PERIOD-END> OCT-28-1998
<CASH> 863,730
<SECURITIES> 0
<RECEIVABLES> 289,131
<ALLOWANCES> 0
<INVENTORY> 1,334,488
<CURRENT-ASSETS> 2,797,494
<PP&E> 14,405,709
<DEPRECIATION> 5,017,110
<TOTAL-ASSETS> 12,792,097
<CURRENT-LIABILITIES> 3,758,595
<BONDS> 0
0
0
<COMMON> 59,478
<OTHER-SE> 5,967,503
<TOTAL-LIABILITY-AND-EQUITY> 12,792,097
<SALES> 17,996,128
<TOTAL-REVENUES> 17,996,128
<CGS> 8,113,504
<TOTAL-COSTS> 8,113,504
<OTHER-EXPENSES> 11,730,448
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 291,894
<INCOME-PRETAX> (2,112,032)
<INCOME-TAX> 3,690
<INCOME-CONTINUING> (2,115,722)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,115,722)
<EPS-PRIMARY> (0.36)
<EPS-DILUTED> (0.36)

</TABLE>