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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended March 8, 2006

OR



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

For the transition period from  to

Commission
File Number: 0-21203

DIEDRICH COFFEE, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|DELAWARE                                                       |  | 33-0086628                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)

28 EXECUTIVE PARK, SUITE 200

IRVINE, CALIFORNIA 92614

(Address of principal executive offices, including
zip code)

(949) 260-1600

(Registrants telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer
and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large Accelerated Filer ̈ |  | Accelerated Filer ̈ |  | Non-Accelerated Filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES ̈NO x

As of April 17, 2006, there were 5,307,789 shares of common stock of the registrant outstanding.



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DIEDRICH COFFEE, INC.

INDEX



|                               |  |                                                                                       |  |            
|------------------------------ |  | ------------------------------------------------------------------------------------- |  | -----------
|                               |  |                                                                                       |  | Page Number
|PART I  FINANCIAL INFORMATION |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Financial Statements                                                                  |  |            
|                               |  |                                                                                      
|                               |  | Condensed Consolidated Balance Sheets (Unaudited)                                     |  | 1          
|                               |  |                                                                                      
|                               |  | Condensed Consolidated Statements of Operations (Unaudited)                           |  | 2          
|                               |  |                                                                                      
|                               |  | Condensed Consolidated Statements of Cash Flows (Unaudited)                           |  | 3          
|                               |  |                                                                                      
|                               |  | Notes to Condensed Consolidated Financial Statements (Unaudited)                      |  | 4          
|                               |  |                                                                                      
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 11         
|                               |  |                                                                                      
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 20         
|                               |  |                                                                                      
|Item 4.                        |  | Controls and Procedures                                                               |  | 21         
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                     |  | 21         
|                               |  |                                                                                      
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                   |  | 21         
|                               |  |                                                                                      
|Item 6.                        |  | Exhibits                                                                              |  | 22         
|                               | 
|Signatures                     |  | 25                                                                                   



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PART I - FINANCIAL INFORMATION



|Item 1. | Financial Statements.
|------- | ---------------------

DIEDRICH COFFEE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ----------- | - | ------------- | - | ----------- | -
|                                                                                                                                                                   |  | March 8, 2006 |             |   | June 29, 2005 |  
|                                                                                                                                                                   |  | (Unaudited)   |             |   |               |  
|Assets                                                                                                                                                             |  |               |             |   |               |   |             |  
|Current assets:                                                                                                                                                    |  |               |             |   |               |   |             |  
|Cash                                                                                                                                                               |  | $             | 4,286,000   |   |               | $ | 10,493,000  |  
|Restricted cash                                                                                                                                                    |  |               | 578,000     |   |               |   |            |  
|Accounts receivable, less allowance for doubtful accounts of $1,372,000 at March 8, 2006 and $1,392,000 at June 29,
2005                                           |  |               | 3,527,000   |   |               |   | 2,203,000   |  
|Inventories                                                                                                                                                        |  |               | 3,163,000   |   |               |   | 3,426,000   |  
|Income tax refund                                                                                                                                                  |  |               | 158,000     |   |               |   | 1,220,000   |  
|Current portion of notes receivable                                                                                                                                |  |               | 1,155,000   |   |               |   | 1,165,000   |  
|Advertising fund assets, restricted                                                                                                                                |  |               | 242,000     |   |               |   | 218,000     |  
|Prepaid expenses                                                                                                                                                   |  |               | 740,000     |   |               |   | 489,000     |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Total current assets                                                                                                                                               |  |               | 13,849,000  |   |               |   | 19,214,000  |  
|Property and equipment, net                                                                                                                                        |  |               | 10,010,000  |   |               |   | 7,974,000   |  
|Goodwill                                                                                                                                                           |  |               | 8,179,000   |   |               |   | 8,179,000   |  
|Notes receivable                                                                                                                                                   |  |               | 3,800,000   |   |               |   | 4,554,000   |  
|Cash surrender value of life insurance policy                                                                                                                      |  |               | 372,000     |   |               |   |            |  
|Other assets                                                                                                                                                       |  |               | 400,000     |   |               |   | 392,000     |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Total assets                                                                                                                                                       |  | $             | 36,610,000  |   |               | $ | 40,313,000  |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Liabilities and Stockholders Equity                                                                                                                               |  |               |             |   |               |   |             |  
|Current liabilities:                                                                                                                                               |  |               |             |   |               |   |             |  
|Current installments of obligations under capital leases                                                                                                           |  | $             | 19,000      |   |               | $ | 85,000      |  
|Accounts payable                                                                                                                                                   |  |               | 3,613,0000  |   |               |   | 2,642,000   |  
|Accrued compensation                                                                                                                                               |  |               | 1,839,000   |   |               |   | 2,886,000   |  
|Accrued expenses                                                                                                                                                   |  |               | 1,714,000   |   |               |   | 1,366,000   |  
|Franchisee deposits                                                                                                                                                |  |               | 546,000     |   |               |   | 632,000     |  
|Deferred franchise fee income                                                                                                                                      |  |               | 65,000      |   |               |   | 91,000      |  
|Advertising fund liabilities                                                                                                                                       |  |               | 242,000     |   |               |   | 218,000     |  
|Accrued provision for store closure                                                                                                                                |  |               |            |   |               |   | 91,000      |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Total current liabilities                                                                                                                                          |  |               | 8,038,000   |   |               |   | 8,011,000   |  
|Obligations under capital leases, excluding current installments                                                                                                   |  |               | 314,000     |   |               |   | 328,000     |  
|Deferred rent                                                                                                                                                      |  |               | 599,000     |   |               |   | 452,000     |  
|Deferred compensation                                                                                                                                              |  |               | 390,000     |   |               |   |            |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Total liabilities                                                                                                                                                  |  |               | 9,341,000   |   |               |   | 8,791,000   |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Commitments and contingencies (notes 4 and 7)                                                                                                                      |  |               |             |   |               |   |             |  
|Stockholders equity:                                                                                                                                              |  |               |             |   |               |   |             |  
|Common stock, $0.01 par value; authorized 8,750,000 shares; 5,308,000 and 5,273,000 shares issued and outstanding at March 8, 2006 and
June 29, 2005, respectively |  |               | 53,000      |   |               |   | 53,000      |  
|Additional paid-in capital                                                                                                                                         |  |               | 58,905,000  |   |               |   | 58,481,000  |  
|Accumulated deficit                                                                                                                                                |  |               | (31,689,000 | ) |               |   | (27,012,000 | )
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Total stockholders equity                                                                                                                                         |  |               | 27,269,000  |   |               |   | 31,522,000  |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  
|Total liabilities and stockholders equity                                                                                                                         |  | $             | 36,610,000  |   |               | $ | 40,313,000  |  
|                                                                                                                                                                   |  |               |             |   |               |   |             |  

See accompanying notes to condensed consolidated financial statements.



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DIEDRICH COFFEE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)



|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|---------------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | -------------------------------- | - | ---------- | ------------------------------------ |  | - | ------------------------------------ | - |  | - | ---------- | -
|                                                                                         |  | Twelve Weeks Ended March 8,
2006 |            |   | Twelve Weeks Ended March 9,
2005 |   |            | Thirty-six Weeks Ended March 8,
2006 |  |   | Thirty-six Weeks Ended March 9,
2005 |  
|Net revenue:                                                                             |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Retail sales                                                                             |  | $                                | 7,975,000  |   |                                  | $ | 7,115,000  |                                      |  | $ | 24,007,000                           |   |  | $ | 21,801,000 |  
|Wholesale and other                                                                      |  |                                  | 5,102,000  |   |                                  |   | 3,427,000  |                                      |  |   | 14,496,000                           |   |  |   | 11,374,000 |  
|Franchise revenue                                                                        |  |                                  | 972,000    |   |                                  |   | 1,082,000  |                                      |  |   | 2,668,000                            |   |  |   | 3,107,000  |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Total net revenue                                                                        |  |                                  | 14,049,000 |   |                                  |   | 11,624,000 |                                      |  |   | 41,171,000                           |   |  |   | 36,282,000 |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Costs and expenses:                                                                      |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Cost of sales and related occupancy costs                                                |  |                                  | 7,713,000  |   |                                  |   | 5,806,000  |                                      |  |   | 22,152,000                           |   |  |   | 17,904,000 |  
|Operating expenses                                                                       |  |                                  | 4,299,000  |   |                                  |   | 3,801,000  |                                      |  |   | 12,927,000                           |   |  |   | 11,590,000 |  
|Depreciation and amortization                                                            |  |                                  | 617,000    |   |                                  |   | 563,000    |                                      |  |   | 1,775,000                            |   |  |   | 1,697,000  |  
|General and administrative expenses                                                      |  |                                  | 3,313,000  |   |                                  |   | 2,333,000  |                                      |  |   | 9,677,000                            |   |  |   | 7,550,000  |  
|(Gain) loss on asset disposals                                                           |  |                                  | 5,000      |   |                                  |   | (2,000     | )                                    |  |   | 22,000                               |   |  |   | (14,000    | )
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Total costs and expenses                                                                 |  |                                  | 15,947,000 |   |                                  |   | 12,501,000 |                                      |  |   | 46,553,000                           |   |  |   | 38,727,000 |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Operating loss                                                                           |  |                                  | (1,898,000 | ) |                                  |   | (877,000   | )                                    |  |   | (5,382,000                           | ) |  |   | (2,445,000 | )
|Interest expense                                                                         |  |                                  | (25,000    | ) |                                  |   | (52,000    | )                                    |  |   | (85,000                              | ) |  |   | (145,000   | )
|Interest and other income, net                                                           |  |                                  | 118,000    |   |                                  |   | 56,000     |                                      |  |   | 406,000                              |   |  |   | 55,000     |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Loss from continuing operations before income tax provision                              |  |                                  | (1,805,000 | ) |                                  |   | (873,000   | )                                    |  |   | (5,061,000                           | ) |  |   | (2,535,000 | )
|Income tax benefit                                                                       |  |                                  | (121,000   | ) |                                  |   | (340,000   | )                                    |  |   | (384,0000                            | ) |  |   | (973,000   | )
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Net loss from continuing operations                                                      |  |                                  | (1,684,000 | ) |                                  |   | (533,000   | )                                    |  |   | (4,677,000                           | ) |  |   | (1,562,000 | )
|Discontinued operations:                                                                 |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Income from discontinued operations, net of $341,000 and $985,000 of taxes, respectively |  |                                  |           |   |                                  |   | 576,000    |                                      |  |   |                                     |   |  |   | 1,656,000  |  
|Gain on sale of discontinued operations, net of $3,376,000 taxes                         |  |                                  |           |   |                                  |   | 15,558,000 |                                      |  |   |                                     |   |  |   | 15,558,000 |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Net (loss) income                                                                        |  | $                                | (1,684,000 | ) |                                  | $ | 15,601,000 |                                      |  | $ | (4,677,000                           | ) |  | $ | 15,652,000 |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Basic and diluted net (loss) income per share:                                           |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Loss from continuing operations                                                          |  | $                                | (0.32      | ) |                                  | $ | (0.10      | )                                    |  | $ | (0.88                                | ) |  | $ | (0.30      | )
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Income from discontinued operations, net                                                 |  | $                                |           |   |                                  | $ | 3.09       |                                      |  | $ |                                     |   |  | $ | 3.31       |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Net (loss) income                                                                        |  | $                                | (0.32      | ) |                                  | $ | 2.99       |                                      |  | $ | (0.88                                | ) |  | $ | 3.01       |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Weighted average and equivalent shares outstanding:                                      |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  
|Basic and diluted                                                                        |  |                                  | 5,303,000  |   |                                  |   | 5,214,000  |                                      |  |   | 5,300,000                            |   |  |   | 5,194,000  |  
|                                                                                         |  |                                  |            |   |                                  |   |            |                                      |  |   |                                      |   |  |   |            |  

See accompanying notes to condensed consolidated financial statements.



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DIEDRICH COFFEE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



|                                                                                            |  |                                      |            |   |                                      |   |             |  
|------------------------------------------------------------------------------------------- |  | ------------------------------------ | ---------- | - | ------------------------------------ | - | ----------- | -
|                                                                                            |  | Thirty-six Weeks Ended March 8, 2006 |            |   | Thirty-six Weeks Ended March 9,
2005 |  
|Cash flows from operating activities:                                                       |  |                                      |            |   |                                      |   |             |  
|Net (loss) income                                                                           |  | $                                    | (4,677,000 | ) |                                      | $ | 15,652,000  |  
|Gain from discontinued operations                                                           |  |                                      |           |   |                                      |   | (15,558,000 | )
|Income from discontinued operations                                                         |  |                                      |           |   |                                      |   | (1,656,000  | )
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Loss from continuing operations:                                                            |  |                                      | (4,677,000 | ) |                                      |   | (1,562,000  | )
|Adjustments to reconcile net income to net cash (used in) provided by operating activities: |  |                                      |            |   |                                      |   |             |  
|Depreciation and amortization                                                               |  |                                      | 1,775,000  |   |                                      |   | 1,697,000   |  
|Amortization of loan fees                                                                   |  |                                      | 23,000     |   |                                      |   | 23,000      |  
|Amortization of note payable discount                                                       |  |                                      |           |   |                                      |   | 1,000       |  
|Provision for bad debt                                                                      |  |                                      | 96,000     |   |                                      |   | 140,000     |  
|Income tax benefit                                                                          |  |                                      | 1,062,000  |   |                                      |   |            |  
|Provision for inventory obsolescence                                                        |  |                                      | 24,000     |   |                                      |   | 69,000      |  
|Stock compensation expense                                                                  |  |                                      | 287,000    |   |                                      |   |            |  
|Notes receivable issued                                                                     |  |                                      | (35,000    | ) |                                      |   |            |  
|Gain (loss) on disposals of assets                                                          |  |                                      | 22,000     |   |                                      |   | (14,000     | )
|Changes in operating assets and liabilities:                                                |  |                                      |            |   |                                      |   |             |  
|Accounts receivable                                                                         |  |                                      | (1,420,000 | ) |                                      |   | (837,000    | )
|Inventories                                                                                 |  |                                      | 239,000    |   |                                      |   | (354,000    | )
|Prepaid expenses                                                                            |  |                                      | (251,000   | ) |                                      |   | (449,000    | )
|Notes receivable                                                                            |  |                                      | (239,000   | ) |                                      |   | (27,000     | )
|Other assets                                                                                |  |                                      | (408,000   | ) |                                      |   | (405,000    | )
|Accounts payable                                                                            |  |                                      | 971,000    |   |                                      |   | 477,000     |  
|Accrued compensation                                                                        |  |                                      | (657,000   | ) |                                      |   | 495,000     |  
|Accrued expenses                                                                            |  |                                      | 348,000    |   |                                      |   | 116,000     |  
|Franchisee deposits                                                                         |  |                                      | (86,000    | ) |                                      |   | 27,000      |  
|Deferred franchise fee income                                                               |  |                                      | (26,000    | ) |                                      |   | (1,204,000  | )
|Accrued provision for store closure                                                         |  |                                      | (91,000    | ) |                                      |   | (20,000     | )
|Deferred rent                                                                               |  |                                      | 152,000    |   |                                      |   | (19,000     | )
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Net cash used in operating activities                                                       |  |                                      | (2,891,000 | ) |                                      |   | (1,846,000  | )
|Net cash provided by discontinued operations                                                |  |                                      |           |   |                                      |   | 3,012,000   |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Net cash (used in) provided by operating activities                                         |  |                                      | (2,891,000 | ) |                                      |   | 1,166,000   |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Cash flows used in investing activities:                                                    |  |                                      |            |   |                                      |   |             |  
|Capital expenditures for property and equipment                                             |  |                                      | (3,876,000 | ) |                                      |   | (1,942,000  | )
|Proceeds from disposal of property and equipment                                            |  |                                      | 43,000     |   |                                      |   | 31,000      |  
|Proceeds from sale of discontinued operations                                               |  |                                      |           |   |                                      |   | 16,000,000  |  
|Goodwill resulting from acquisition                                                         |  |                                      |           |   |                                      |   | (80,000     | )
|Principal payments on notes receivable                                                      |  |                                      | 1,038,000  |   |                                      |   | 30,000      |  
|Investment in restricted money market account                                               |  |                                      | (578,000   | ) |                                      |   |            |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Net cash (used in) provided by investing activities                                         |  |                                      | (3,373,000 | ) |                                      |   | 14,039,000  |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Cash flows provided by financing activities:                                                |  |                                      |            |   |                                      |   |             |  
|Exercise of stock options                                                                   |  |                                      | 137,000    |   |                                      |   | 364,000     |  
|Borrowings under credit agreement                                                           |  |                                      |           |   |                                      |   | 1,000,000   |  
|Payments on long-term debt                                                                  |  |                                      |           |   |                                      |   | (261,000    | )
|Payments on capital lease obligations                                                       |  |                                      | (80,000    | ) |                                      |   | (109,000    | )
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Net cash provided by financing activities                                                   |  |                                      | 57,000     |   |                                      |   | 994,000     |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Net (decrease) increase in cash                                                             |  |                                      | (6,207,000 | ) |                                      |   | 16,199,000  |  
|Cash at beginning of period                                                                 |  |                                      | 10,493,000 |   |                                      |   | 1,799,000   |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Cash at end of period                                                                       |  | $                                    | 4,286,000  |   |                                      | $ | 17,998,000  |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Supplemental disclosures of cash flow information:                                          |  |                                      |            |   |                                      |   |             |  
|Non-cash transactions:                                                                      |  |                                      |            |   |                                      |   |             |  
|Value of common stock warrants recorded as debt discount                                    |  | $                                    |           |   |                                      | $ | 8,000       |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Cash paid during the period for:                                                            |  |                                      |            |   |                                      |   |             |  
|Interest                                                                                    |  | $                                    | 57,000     |   |                                      | $ | 120,000     |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  
|Income taxes                                                                                |  | $                                    | 61,000     |   |                                      | $ | 12,000      |  
|                                                                                            |  |                                      |            |   |                                      |   |             |  

See accompanying notes to condensed consolidated financial statements.



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DIEDRICH COFFEE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 8, 2006

(UNAUDITED)



|1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|-- | ------------------------------------------

Basis of Presentation

The unaudited condensed consolidated financial statements of Diedrich Coffee, Inc. and its subsidiaries (the Company) have been prepared in
accordance with accounting principles generally accepted in the United States of America, as well as the instructions to Form 10-Q and Article 10 of Regulation S-X. These statements should be read in conjunction with the consolidated financial
statements and the notes thereto included in the Companys Annual Report on Form 10-K/A for the year ended June 29, 2005.

In the opinion of
management, all adjustments (consisting of normal, recurring adjustments and accruals) considered necessary for a fair presentation have been included. Operating results for interim periods are not necessarily indicative of the results expected for
a full year.

Discontinued Operations

On
February 10, 2005, the Company completed the sale of its Gloria Jeans international franchise operations to Jireh International Pty. Ltd., formerly the Gloria Jeans master franchisee for Australia, and certain of its affiliates
(collectively, Jireh) for $16,000,000 in cash and an additional $7,020,000 payable over the next six years under license, roasting and consulting agreements.

The sale included the immediate transfer of related franchise rights to Jireh of 338 Gloria Jeans retail locations outside the U.S. and Puerto Rico, including 242 in Australia.

In accordance with Statement of Financial Accounting Standards (SFAS) 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the
financial results of Gloria Jeans international franchise operations are reported as discontinued operations for all periods presented. There was no activity related to discontinued operations for the thirty-six weeks ended March 8, 2006.

The following accounts are reflected in Discontinued Operations:



| |  |  | International franchise royalties, new store fees and roasting fees
| | - |  | -------------------------------------------------------------------



| |  |  | Wholesale revenue and cost of goods sold associated with the sale of coffee to international franchisees
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | Bad debt expense related to international franchisees
| | - |  | -----------------------------------------------------



| |  |  | General and administrative costs related to international operations and audit, tax and legal fees relating to the transaction
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Gain on sale of the international franchise operations, net of the related tax provision
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | Provision for foreign taxes paid on international revenues
| | - |  | ----------------------------------------------------------

Recent
Accounting Pronouncements

On October 6, 2005, the Financial Accounting Standards Board (FASB) released FASB Staff Position
(FSP) FAS 13-1, Accounting for Rental Costs Incurred during a Construction Period. This FSP affects companies that are engaged in construction activities on buildings or grounds, which are accounted for as operating leases. The
FSP requires companies to expense rental costs associated with these leases starting on the date that the tenant is given control of the premises. As a result, companies must cease capitalizing rental costs during construction periods. The FSP is
effective for the first reporting period beginning after December 15, 2005, which is the fourth quarter of fiscal 2006 for the Company. Retrospective application is permitted but not required. The Company has not yet determined what impact the
adoption of FSP FAS 13-1 will have on its results of operations. The Company believes that the adoption of FSP FAS 13-1 will not have a material impact on its financial position, results of operations or cash flows.

Income Taxes

The Company accounts for income taxes under the asset
and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases
and for operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. In the event the future consequences of differences between financial reporting bases and the
tax bases of the Companys assets and liabilities result in a deferred tax asset, SFAS 109, Accounting for Income Taxes, requires an evaluation of



4



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##### Table of Contents

the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when
it is more likely than not that some portion or all of the deferred tax asset will not be realized.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could materially differ from those estimates.

Stock-Based Compensation

On October 20, 2000, the Companys board of directors authorized the adoption of the Diedrich Coffee, Inc. 2000 Equity Incentive Plan (the 2000 Equity Incentive Plan) and the concurrent
discontinuation of the option grants under the Diedrich Coffee, Inc. Amended and Restated 1996 Stock Incentive Plan and the Diedrich Coffee, Inc. 1996 Non-Employee Directors Stock Option Plan. The Companys stockholders approved the 2000 Equity
Incentive Plan on November 29, 2000. A total of 1,087,500 shares of the Companys common stock may be issued under the 2000 Equity Incentive Plan, as amended. The board of directors determines the number of shares, terms and exercise
periods for awards under the 2000 Equity Incentive Plan on a case by case basis, except for automatic annual grants of options to non-employee directors. Options generally vest ratably over three years and expire ten years from the date of grant.
The exercise price of options is generally equivalent to the fair market value of the Companys common stock on the date of grant.

On June 30,
2005, the Company adopted the provisions of SFAS 123R,Share-Based Payment (SFAS 123R). SFAS 123R sets accounting requirements for share-based compensation to employees and non-employee directors, including employee
stock purchase plans, and requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation.

The Company chose the modified-prospective transition alternatives in adopting SFAS 123R. Under the modified-prospective transition method, compensation cost is recognized in financial statements issued subsequent to
the date of adoption for all stock-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to the date of adoption. Because the Company previously adopted only the pro forma
disclosure provisions of SFAS 123, it will recognize compensation cost relating to the unvested portion of awards granted prior to the date of adoption using the same estimate of the grant-date fair value and the same attribution method used to
determine the pro forma disclosures under SFAS 123, except that forfeitures rate will be estimated for all options, as required by SFAS 123R.

The fair
value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of the price of the
Companys stock. The Company uses historical data to estimate option exercise and employee termination rates within the valuation model. The expected term of options is derived from the output of the option valuation model and represents the
period of time that options are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The fair values of the options were
estimated using the Black-Scholes option-pricing model based on the following weighted average assumptions:



|                        |  |                    |   |  |                        |   |  |               |   |  |               |  
|----------------------- |  | ------------------ | - |  | ---------------------- | - |  | ------------- | - |  | ------------- | -
|                        |  | TWELVE WEEKS ENDED |   |  | THIRTY-SIX WEEKS ENDED |  
|                        |  | March 8, 2006      |   |  | March 9, 2005          |   |  | March 8, 2006 |   |  | March 9, 2005 |  
|Risk free interest rate |  | 4.47               | % |  | 3.81                   | % |  | 4.47          | % |  | 3.81          | %
|Expected life           |  | 2 years            |   |  | 6 years                |   |  | 2 years       |   |  | 6 years       |  
|Expected volatility     |  | 66                 | % |  | 40                     | % |  | 70            | % |  | 43            | %
|Expected dividend yield |  | 0                  | % |  | 0                      | % |  | 0             | % |  | 0             | %
|Forfeiture rate         |  | 4.30               | % |  | 0                      | % |  | 4.30          | % |  | 0             | %



5



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##### Table of Contents

A summary of option activity under our stock option plans for the thirty-six weeks ended
March 8, 2006 is as follows:



|                                     |  |                  |   |  |                              |      |                                                     |     |                             |   |  
|------------------------------------ |  | ---------------- | - |  | ---------------------------- | ---- | --------------------------------------------------- | --- | --------------------------- | - | -
|                                     |  | Number ofoptions |   |  | Weightedaverageexerciseprice |      | Weighted average remaining contractual term (years) |     | Aggregateintrinsicvalue ($)
|Options outstanding at June 29, 2005 |  | 938,000          |   |  | $                            | 5.27 |                                                     |     |                             |   |  
|Plus: Options granted                |  | 120,000          |   |  |                              | 4.97 |                                                     |     |                             |   |  
|Less:                                |  |                  |   |  |                              |      |                                                     |     |                             |   |  
|Options exercised                    |  | (35,000          | ) |  |                              | 3.97 |                                                     |     |                             |   |  
|Options canceled or expired          |  | (50,000          | ) |  |                              | 7.22 |                                                     |     |                             |   |  
|                                     |  |                  |   |  |                              |      |                                                     |     |                             |   |  
|Options outstanding at March 8, 2006 |  | 973,000          |   |  | $                            | 5.18 |                                                     | 6.9 |                             | $ | 
|                                     |  |                  |   |  |                              |      |                                                     |     |                             |   |  
|Options exercisable at March 8, 2006 |  | 722,000          |   |  | $                            | 5.50 |                                                     | 6.3 |                             | $ | 

Stock-based compensation expense included in the statement of operations for the twelve weeks ended March 8,
2006 was approximately $111,000 and for the thirty-six weeks ended March 8, 2006 was approximately $287,000. As of March 8, 2006, there were approximately $410,000 of total unrecognized stock-based compensation cost related to options
granted under our plans that will be recognized over a weighted average period of 1.6 years. The total intrinsic value of options exercised during the thirty-six weeks ended March 8, 2006 was approximately $100,000. No options were exercised in
the twelve weeks ended March 8, 2006.

A summary of the status of the Companys unvested options as of March 8, 2006, and changes during the
thirty-six weeks ended March 8, 2006, is presented below:



|                                  |  |          |   |  |                                              |  
|--------------------------------- |  | -------- | - |  | -------------------------------------------- | -
|Unvested Options                  |  | Options  |   |  | Weighted - Average Grant-Date Fair Value ($) |  
|Unvested options at June 29, 2005 |  | 283,000  |   |  | 3.92                                         |  
|Granted                           |  | 120,000  |   |  | 4.89                                         |  
|Vested                            |  | (102,000 | ) |  | (2.60                                        | )
|Forfeited                         |  | (50,000  | ) |  | (7.16                                        | )
|Unvested options at March 8, 2006 |  | 251,000  |   |  | 4.27                                         |  

The total fair value of vested options during the thirty-six weeks ended March 8, 2006 was $177,000.

Awards granted prior to the Companys implementation of SFAS 123R were accounted for under the recognition and measurement principles of APB
Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, no stock-based employee compensation cost is reflected in net loss in the accompanying Unaudited Condensed Consolidated Statements of
Operations for the twelve weeks and thirty-six weeks ended March 9, 2005 because all options granted under the Companys plans had exercise prices equal to the market value of the underlying common stock on the date of grant.

Pro forma net income and net income per share, as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation for
periods presented prior to the Companys adoption of SFAS 123R, are as follows:



|                                                                                                                                 |  |                                 |            |   |                                     |   |            |  
|-------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ----------------------------------- | - | ---------- | -
|Pro Forma net income                                                                                                             |  | TWELVE WEEKSENDED March 9, 2005 |            |   | THIRTY-SIX WEEKSENDED March 9, 2005 |  
|Net income                                                                                                                       |  | $                               | 15,601,000 |   |                                     | $ | 15,562,000 |  
|Deduct: Stock-based compensation expense determined under the fair value based method for all awards, net of related tax
effects |  |                                 | (102,000   | ) |                                     |   | (432,000   | )
|                                                                                                                                 |  |                                 |            |   |                                     |   |            |  
|Pro forma net income                                                                                                             |  | $                               | 15,499,000 |   |                                     | $ | 15,220,000 |  
|                                                                                                                                 |  |                                 |            |   |                                     |   |            |  
|Basic and diluted income per share  as reported                                                                                 |  | $                               | 2.99       |   |                                     | $ | 3.01       |  
|                                                                                                                                 |  |                                 |            |   |                                     |   |            |  
|Basic and diluted income per share  pro forma                                                                                   |  | $                               | 2.97       |   |                                     | $ | 2.93       |  
|                                                                                                                                 |  |                                 |            |   |                                     |   |            |  

Cash Surrender Value of Life Insurance

The change in the cash surrender value (CSV) of company owned life insurance (COLI) contracts, net of insurance premiums paid and gains realized, is reported in compensation and benefits
expense. See Note 10.

Reclassifications

Certain
reclassifications have been made to the March 9, 2005 unaudited condensed consolidated financial statements to conform to the March 8, 2006 presentation.



6



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##### Table of Contents

|2. | INVENTORIES
|-- | -----------

Inventories consist of the
following:



|                                  |  |               |           |               |   |          
|--------------------------------- |  | ------------- | --------- | ------------- | - | ---------
|                                  |  | March 8, 2006 |           | June 29, 2005
|Unroasted coffee                  |  | $             | 958,000   |               | $ | 1,481,000
|Roasted coffee                    |  |               | 639,000   |               |   | 643,000  
|Accessory and specialty items     |  |               | 201,000   |               |   | 225,000  
|Other food, beverage and supplies |  |               | 1,365,000 |               |   | 1,077,000
|                                  |  |               |           |               |   |          
|Total inventory                   |  | $             | 3,163,000 |               | $ | 3,426,000
|                                  |  |               |           |               |   |          



|3. | NOTES RECEIVABLE
|-- | ----------------

In November 2005, the Company received a non-interest
bearing note from a franchisee in exchange for franchise fees in the amount of $7,500. The note is due and payable in full on December 1, 2006.

In
November 2005, the Company received a note bearing an annual interest rate of 8% in exchange for point-of-sale equipment in the amount of $7,286. The note is being repaid in monthly installments and due on or before November 14, 2007.

In September 2005, the Company received a non-interest bearing note from a franchisee in exchange for franchise fees in the amount of $20,000. The note
was due and payable in full on January 1, 2006. As agreed between the Company and the franchisee, the debt will be rolled into a new area development agreement that is currently being negotiated with the franchisee.

In February 2005, the Company sold its international franchise operations for $16,000,000 in cash and $7,020,000 in notes receivable payable over the next six years
under license, roasting and consulting agreements. See Note 1 to the condensed consolidated financial statements.

Notes
receivable consist of the following:



|                                                                                                                                                                                                                                                                                        |  |               |            |   |               |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | ------------- | - | ---------- | -
|                                                                                                                                                                                                                                                                                        |  | March 8, 2006 |            |   | June 29, 2005 |  
|Notes receivable bearing interest at rates from 0% to 9.0%, payable in monthly installments of between $284 and $4,268 and due between January
2006 and November 2007. Notes are secured by the assets sold under the asset purchase and sale agreements or general security agreement. |  | $             | 164,000    |   |               | $ | 181,000    |  
|Notes receivable from a corporation discounted at an annual rate of 8.0%, payable annually in installments of between $1,000,000 and
$2,000,000, due between January 2007 and January 2011.                                                                                             |  |               | 4,791,000  |   |               |   | 5,538,000  |  
|Less: current portion of notes receivable                                                                                                                                                                                                                                               |  |               | (1,155,000 | ) |               |   | (1,165,000 | )
|                                                                                                                                                                                                                                                                                        |  |               |            |   |               |   |            |  
|Long-term portion of notes receivable                                                                                                                                                                                                                                                   |  | $             | 3,800,000  |   |               | $ | 4,554,000  |  
|                                                                                                                                                                                                                                                                                        |  |               |            |   |               |   |            |  



|4. | ACCRUED PROVISION FOR STORE CLOSURE
|-- | -----------------------------------

As required by SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities, the Company records estimated costs for store closures when they are incurred rather than at the date of a commitment to an exit or disposal plan. These costs primarily consist
of the estimated cost to terminate real estate leases.



|                                     |  |             |         |                          |   |             |  |   |              |   |  |            |         |   |  |   |       
|------------------------------------ |  | ----------- | ------- | ------------------------ | - | ----------- |  | - | ------------ | - |  | ---------- | ------- | - |  | - | ------
|                                     |  | Beg Balance |         | AmountsChargedto Expense |   | Adjustments |  |   | CashPayments |   |  | EndBalance
|Fiscal year ended June 29, 2005      |  | $           | 109,000 |                          | $ |            |  | $ |             |   |  | $          | (18,000 | ) |  | $ | 91,000
|Thirty-six weeks ended March 8, 2006 |  | $           | 91,000  |                          | $ |            |  | $ | (75,000      | ) |  | $          | (16,000 | ) |  | $ |      

For the thirty-six weeks ended March 8, 2006, the Company adjusted the store closure accrual due to the
transfer of a corporate store to a franchisee. The Company made cash payments in the amount of $16,000 for rent expense at an impaired store location.



7



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##### Table of Contents

|5. | EARNINGS PER SHARE
|-- | ------------------

The following table
sets forth the computation of basic and diluted net loss per share from continuing operations :



|                                                                |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  
|--------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------- | - | --------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ---------- | -
|                                                                |  | Twelve WeeksEnded March 8, 2006 |            |   | Twelve WeeksEnded March 9, 2005 |   |           | Thirty-sixWeeks Ended March 8, 2006 |  |   | Thirty-sixWeeks Ended March 9, 2005 |  
|Numerator:                                                      |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  
|Net loss from continuing operations                             |  | $                               | (1,684,000 | ) |                                 | $ | (533,000  | )                                   |  | $ | (4,677,000                          | ) |  | $ | (1,562,000 | )
|                                                                |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  
|Denominator:                                                    |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  
|Basic weighted average shares outstanding                       |  |                                 | 5,303,000  |   |                                 |   | 5,214,000 |                                     |  |   | 5,300,000                           |   |  |   | 5,194,000  |  
|Effect of dilutive securities                                   |  |                                 |           |   |                                 |   |          |                                     |  |   |                                    |   |  |   |           |  
|                                                                |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  
|Diluted adjusted weighted average shares                        |  |                                 | 5,303,000  |   |                                 |   | 5,214,000 |                                     |  |   | 5,300,000                           |   |  |   | 5,194,000  |  
|                                                                |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  
|Basic and diluted net loss per share from continuing operations |  | $                               | (0.32      | ) |                                 | $ | (0.10     | )                                   |  | $ | (0.88                               | ) |  | $ | (0.30      | )
|                                                                |  |                                 |            |   |                                 |   |           |                                     |  |   |                                     |   |  |   |            |  

For computation of net loss per share from continuing operations, all 973,000 and 952,000 options outstanding
as of March 8, 2006 and March 9, 2005, respectively, were excluded from the calculation of diluted net loss per share because their inclusion would have been anti-dilutive. In addition, all 504,000 outstanding warrants to purchase shares
of common stock as of March 8, 2006 and March 9, 2005 were excluded from the calculation of diluted net loss per share because their inclusion would have been anti-dilutive

The following table sets forth the computation of basic and diluted net income (loss) per share:



|                                              |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           
|--------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------- | - | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ----------
|                                              |  | Twelve WeeksEnded March 8, 2006 |            |   | Twelve WeeksEnded March 9, 2005 |   | Thirty-sixWeeks Ended March 8, 2006 |  |   | Thirty-sixWeeks Ended March 9, 2005
|Numerator:                                    |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           
|Net income (loss)                             |  | $                               | (1,684,000 | ) |                                 | $ | 15,601,000                          |  | $ | (4,677,000                          | ) |  | $ | 15,652,000
|                                              |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           
|Denominator:                                  |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           
|Basic weighted average shares outstanding     |  |                                 | 5,303,000  |   |                                 |   | 5,214,000                           |  |   | 5,300,000                           |   |  |   | 5,194,000 
|Effect of dilutive securities                 |  |                                 |           |   |                                 |   |                                    |  |   |                                    |   |  |   |          
|                                              |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           
|Diluted adjusted weighted average shares      |  |                                 | 5,303,000  |   |                                 |   | 5,214,000                           |  |   | 5,300,000                           |   |  |   | 5,194,000 
|                                              |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           
|Basic and diluted net income (loss) per share |  | $                               | (0.32      | ) |                                 | $ | 2.99                                |  | $ | (0.88                               | ) |  | $ | 3.01      
|                                              |  |                                 |            |   |                                 |   |                                     |  |   |                                     |   |  |   |           



|6. | SEGMENT AND RELATED INFORMATION
|-- | -------------------------------

The Company has three reportable
segments: retail operations, wholesale operations, and franchise operations. The Company evaluates performance of its operating segments based on income (loss) before income taxes.



8



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##### Table of Contents

Summarized financial information concerning the Companys reportable segments is shown in the following table.
Corporate identifiable assets consist of corporate cash, corporate notes receivable, corporate prepaid expenses, and corporate property and equipment. The corporate component of segment loss before tax includes corporate general and administrative
expenses, depreciation and amortization expense, interest income and interest expense.



|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|--------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ---------------------- | - | ---------- | ------------- |  | - | ------------- | - |  | - | ---------- | -
|                                                                            |  | TWELVE WEEKS ENDED |            |   | THIRTY-SIX WEEKS ENDED |  
|                                                                            |  | March 8, 2006      |            |   | March 9, 2005          |   |            | March 8, 2006 |  |   | March 9, 2005 |  
|Revenue:                                                                    |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Retail                                                                      |  | $                  | 7,975,000  |   |                        | $ | 7,115,000  |               |  | $ | 24,007,000    |   |  | $ | 21,801,000 |  
|Wholesale                                                                   |  |                    | 5,102,000  |   |                        |   | 3,427,000  |               |  |   | 14,496,000    |   |  |   | 11,374,000 |  
|Franchise                                                                   |  |                    | 972,000    |   |                        |   | 1,082,000  |               |  |   | 2,668,000     |   |  |   | 3,107,000  |  
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Total revenue                                                               |  | $                  | 14,049,000 |   |                        | $ | 11,624,000 |               |  | $ | 41,171,000    |   |  | $ | 36,282,000 |  
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Interest expense:                                                           |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Retail                                                                      |  | $                  | 7,000      |   |                        | $ | 6,000      |               |  | $ | 20,000        |   |  | $ | 17,000     |  
|Franchise                                                                   |  |                    |            |   |                        |   | 4,000      |               |  |   | 3,000         |   |  |   | 17,000     |  
|Corporate                                                                   |  |                    | 18,000     |   |                        |   | 42,000     |               |  |   | 62,000        |   |  |   | 111,000    |  
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Total interest expense                                                      |  | $                  | 25,000     |   |                        | $ | 52,000     |               |  | $ | 85,000        |   |  | $ | 145,000    |  
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Depreciation and amortization:                                              |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Retail                                                                      |  | $                  | 451,000    |   |                        | $ | 360,000    |               |  | $ | 1,175,000     |   |  | $ | 1,121,000  |  
|Wholesale                                                                   |  |                    | 89,000     |   |                        |   | 135,000    |               |  |   | 377,000       |   |  |   | 392,000    |  
|Franchise                                                                   |  |                    |           |   |                        |   |           |               |  |   |              |   |  |   |           |  
|Corporate                                                                   |  |                    | 77,000     |   |                        |   | 68,000     |               |  |   | 223,000       |   |  |   | 184,000    |  
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Total depreciation and amortization                                         |  | $                  | 617,000    |   |                        | $ | 563,000    |               |  | $ | 1,775,000     |   |  | $ | 1,697,000  |  
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Segment income (loss) from continuing operations before income tax benefit: |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Retail                                                                      |  | $                  | (83,000    | ) |                        | $ | 96,000     |               |  | $ | 43,000        |   |  | $ | 506,000    |  
|Wholesale                                                                   |  |                    | 697,000    |   |                        |   | 382,000    |               |  |   | 2,078,000     |   |  |   | 1,780,000  |  
|Franchise                                                                   |  |                    | 775,000    |   |                        |   | 1,001,000  |               |  |   | 2,193,000     |   |  |   | 2,846,000  |  
|Corporate                                                                   |  |                    | (3,194,000 | ) |                        |   | (2,352,000 | )             |  |   | (9,375,000    | ) |  |   | (7,667,000 | )
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  
|Total segment loss from continuing operations before income tax provision   |  | $                  | (1,805,000 | ) |                        | $ | (873,000   | )             |  | $ | (5,061,000    | ) |  | $ | (2,535,000 | )
|                                                                            |  |                    |            |   |                        |   |            |               |  |   |               |   |  |   |            |  



|                     |  |               |            |               |   |           
|-------------------- |  | ------------- | ---------- | ------------- | - | ----------
|                     |  | March 8, 2006 |            | June 29, 2005
|Identifiable assets: |  |               |            |               |   |           
|Retail               |  | $             | 9,108,000  |               | $ | 7,152,000 
|Wholesale            |  |               | 7,055,000  |               |   | 5,966,000 
|Franchise            |  |               | 1,174,000  |               |   | 2,114,000 
|Corporate            |  |               | 11,094,000 |               |   | 16,902,000
|                     |  |               |            |               |   |           
|Tangible assets      |  |               | 28,431,000 |               |   | 32,134,000
|Goodwill - Retail    |  |               | 1,347,000  |               |   | 1,347,000 
|Goodwill - Wholesale |  |               | 6,311,000  |               |   | 6,311,000 
|Goodwill - Franchise |  |               | 521,000    |               |   | 521,000   
|                     |  |               |            |               |   |           
|Total assets         |  | $             | 36,610,000 |               | $ | 40,313,000
|                     |  |               |            |               |   |           



|7. | LEASE CONTINGENCIES
|-- | -------------------

The Company is liable on the master real property
leases for 78 Gloria Jeans franchise locations. Under the Companys franchising business model, the Company from time to time executes the master lease for locations and enters into subleases on the same terms with its franchisees, which
typically pay their rent directly to the landlords. If any of these franchisees default on their subleases, the Company would be required to make all payments under the master lease. The Companys maximum theoretical future exposure at
March 8, 2006, computed as the sum of all remaining lease payments through the expiration dates of the respective leases, was $19,608,000. This amount does not take into consideration any mitigating measures that the Company could take to
reduce this exposure in the event of default, including re-leasing the location or terminating the master lease by negotiating a lump sum payment to the landlord in an amount that is less than the sum of all remaining future rents.



9



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##### Table of Contents

|8. | OUTSTANDING FINANCING ARRANGEMENTS AND RESTRICTED CASH
|-- | ------------------------------------------------------

On May 10,
2004, the Company entered into a $5,000,000 Contingent Convertible Note Purchase Agreement (the Note Purchase Agreement). The agreement allows the Company, at its election, to issue notes to the lender, Sequoia Enterprises L.P., up to an
aggregate principal amount of $5,000,000. The notes are amortized on a monthly basis at a rate that will repay 60% of the principal amount of each note by May 10, 2007. The remaining 40% will mature on that date. Interest was initially payable
at LIBOR plus 3.30%, and a facility fee of 1.00% annually is payable on the unused portion of the facility. The Note Purchase Agreement contains covenants that, among other matters, limit the amount of indebtedness that the Company may have
outstanding in relation to its tangible net worth and that originally required the Company to maintain a specified minimum dollar value of earnings before interest, tax, depreciation and amortization for the trailing four fiscal quarters (the
Minimum EBITDA Covenant). The notes are convertible into the Companys common stock only upon certain changes of control. For notes issued and repaid, warrants to purchase shares are issued with the same rights and restrictions for
exercise as existed for convertibility of the notes at the time of their issuance. Warrants are exercisable only in the event of a change of control and were to expire on May 10, 2008. The lender under this agreement is the Companys
largest single stockholder and the chairman of the Companys board of directors serves as the sole general partner of this limited partnership.

On
May 10, 2004, upon entering into the Note Purchase Agreement, the Company immediately issued a $1,000,000 note under the facility and used the proceeds from that note and other available cash to repay all outstanding debt with Bank of the West.
On September 15, 2004, the Company issued a second note for $1,000,000 under this facility. The price of the Companys common stock on May 10, 2004, the date that the first $1,000,000 note was issued, was $3.95 per share. The price of
the Companys common stock on September 15, 2004, the date the second $1,000,000 note was issued, was $4.95 per share. Both the notes were fully repaid in fiscal year 2005, and thus a total of 455,184 warrants are issuable upon a change in
control. The Company has issued 4,219 warrants as of March 8, 2006. As of March 8, 2006, the Company had no borrowings outstanding under the facility.

On June 30, 2004, the Company entered into Amendment No. 1 to Contingent Convertible Note Purchase Agreement (Amendment No. 1) which revised the definition of Availability to mean, on any date, the
loan amount less the sum of the principal amounts then outstanding under the Note Purchase Agreement. Under the original Note Purchase Agreement, availability was calculated using a formula that reduced availability over time.

As a result of cumulative losses over the last three quarters, the Company was not in compliance with all agreement covenants for the current quarter. On March 31,
2006, the Company entered into Amendment No. 2 to Contingent Convertible Note Purchase Agreement (Amendment No. 2). Amendment No. 2: (i) contains a waiver with respect to the existing default of the Minimum EBITDA
Covenant and removes the Minimum EBITDA from the Note Purchase Agreement; (ii) clarifies that warrants to purchase common stock of the Company will be issued with respect to repaid principal amounts only upon a change in control of the Company;
(iii) increases the interest rate applicable to outstanding amounts under the credit facility by 2%, to LIBOR plus 5.30%; and (iv) extends the exercise date of all warrants issued or to be issued under the Note Purchase Agreement by one
year, to May 10, 2009. The maturity date for any notes issued in the future was unaffected by Amendment No. 2. The Company is in compliance with all agreement covenants as amended by Amendment No. 2 for the quarter ended March 8,
2006.

On October 15, 2005, the Amended and Restated Credit Agreement with Bank of the West expired. On November 4, 2005, the Company entered
into a new Credit Agreement with Bank of the West. The agreement provides for a $750,000 letter of credit facility that expires on October 15, 2006. The letter of credit facility is secured by a deposit account at Bank of the West. As of
March 8, 2006, this deposit account had a balance of $578,000, which is shown as restricted cash on the consolidated balance sheets. As of March 8, 2006, $651,000 of letters of credit were outstanding under the letter of credit facility.
The agreement contains covenants that, among other matters, require the Company to submit financial statements to the bank within specified time periods. As of March 8, 2006, the Company was in compliance with all Bank of the West agreement
covenants.



|9. | DISCONTINUED OPERATIONS
|-- | -----------------------

On February 10, 2005, the Company completed
the sale of its Gloria Jeans international franchise operations to Jireh International Pty. Ltd., formerly the Gloria Jeans master franchisee for Australia, and certain of its affiliates (collectively, Jireh) for $16,000,000
in cash and an additional $7,020,000 payable over the next six years under license, roasting and consulting agreements.

The sale included immediate
transfer to Jireh of 338 Gloria Jeans retail locations outside the U.S. and Puerto Rico, including 242 in Australia. After all payments have been made to the Company under the license, roasting and consulting agreements, all remaining Gloria
Jeans trademarks, including those in the U.S., will be transferred to Jireh. Concurrent with such future transfer, the Companys U.S.-based Gloria Jeans subsidiary will enter into a perpetual, royalty-free master franchise agreement
with Jireh under which the Company will continue to have exclusive rights to operate, franchise and develop Gloria Jeans locations throughout the U.S. and Puerto Rico and to continue its wholesale operations under the Gloria Jeans brand
in these same markets.



10



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##### Table of Contents

The Company has agreed to not compete internationally through its Diedrich Coffee or Coffee People brands for a period of
two years from the date of sale. Other than that restriction, the Companys domestic Gloria Jeans outlets, its Castroville roasting operations, its wholesale operations and its company operated Diedrich Coffee and Coffee People retail
outlets were not significantly affected by this transaction.

In accordance with SFAS 144, the financial results of Gloria Jeans international
franchise operations are reported as discontinued operations for all periods presented.

The financial results included in
discontinued operations were as follows:



|                                                                                                                                                                         |  |                    |   |                        |   |               |  |               |   |  |   |           
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | - | ---------------------- | - | ------------- |  | ------------- | - |  | - | ----------
|                                                                                                                                                                         |  | TWELVE WEEKS ENDED |   | THIRTY-SIX WEEKS ENDED
|                                                                                                                                                                         |  | March 8, 2006      |   | March 9, 2005          |   | March 8, 2006 |  | March 9, 2005
|Net revenue                                                                                                                                                              |  | $                  |  |                        | $ | 1,780,000     |  | $             |  |  | $ | 3,910,000 
|                                                                                                                                                                         |  |                    |   |                        |   |               |  |               |   |  |   |           
|Earnings from discontinued operations before income taxes                                                                                                                |  | $                  |  |                        | $ | 917,000       |  | $             |  |  | $ | 2,641,000 
|                                                                                                                                                                         |  |                    |   |                        |   |               |  |               |   |  |   |           
|Earnings from discontinued operations, net of $341,000 tax for the twelve weeks ended March 9, 2005 and net of $985,000 tax for the
thirty-six weeks ended March 9, 2005 |  | $                  |  |                        | $ | 576,000       |  | $             |  |  | $ | 1,656,000 
|Gain on sale of discontinued operations, net of $3,376,000 tax                                                                                                           |  |                    |   |                        |   | 15,558,000    |  |               |   |  |   | 15,558,000
|                                                                                                                                                                         |  |                    |   |                        |   |               |  |               |   |  |   |           
|Total income from discontinued operations, net of tax                                                                                                                    |  | $                  |  |                        | $ | 16,134,000    |  | $             |  |  | $ | 17,214,000
|                                                                                                                                                                         |  |                    |   |                        |   |               |  |               |   |  |   |           



|10. | EMPLOYEE BENEFIT PLANS
|--- | ----------------------

401(k) Plan

The Company maintains a 401(k) Salary Deferral Plan (the 401(k) Plan) whereby eligible employees may voluntarily contribute up to 20% of compensation, subject
to certain statutory limits. The Company may match a percentage of employee contributions at its discretion. Employer matching contributions relating to the 401(k) Plan totaled $13,000 and $38,000 for the twelve and thirty-six weeks ended March 8,
2006, respectively, and $11,000 and $28,000 for the twelve and thirty-six weeks ended March 9, 2005, respectively.

Deferred Compensation Plan

Effective December 15, 2005, the Company amended its non-qualified deferred compensation plan. Under the amended plan, participants may elect to defer,
on a pre-tax basis, a portion (from 0% to 100%) of their base salary, service bonus, and performance-based compensation. Any amounts deferred by a participant will be credited to the participants deferred compensation account. The plan further
provides that the Company may make discretionary contributions to a plan participants deferred compensation account. Each plan participant will be vested in the amounts held in the plan participants deferred compensation account as
follows: (i) one hundred percent (100%) vested at all times with respect to all amounts of deferred compensation; and (ii) one hundred percent (100%) vested at all times with respect to all employer discretionary contributions. The Company made no
discretionary contributions to plan participants accounts for the twelve and thrity-six weeks ended March 8, 2006.

The plan also provides that any
amounts deferred under the plan may not be distributed to a plan participant until the earlier of: (i) the plan participants separation from service with the Company; (ii) the Plan participants retirement from the Company; (iii) the plan
participants disability; (iv) the plan participants death; (v) the occurrence of a change in control of the Company; (vi) the occurrence of an unforeseeable emergency, as defined in the plan; or (vii) such other date as set forth in the
plan participants deferral election, including a date that occurs prior to the plan participants separation from service with the Company. Any amounts distributed to a plan participant will be paid in a form specified by the plan
participant, or in the form of either a lump sum payment in an amount equal to the plan participants deferred compensation account balance or equal annual installments of the plan participants deferred compensation account balance over a
period not to exceed (i) 20 years in the case of a distribution due to separation from service, death or disability or (ii) five years in the case of a distribution for educational expenses.

During the fiscal quarter ended March 8, 2006, the Company purchased a company-owned life insurance (COLI) contract insuring one of the participants in the
deferred compensation plan. The policy is held in a trust to provide additional benefit security for the deferred compensation plan. The assets in the trust are owned by the Company and are subject to claims of its creditors. The gross cash
surrender value of these contracts as of March 8, 2006 was $372,000 as shown in the accompanying consolidated balance sheets. Total death benefits payable were $10,347,000 at March 8, 2006. Management intends to use the future death benefits from
these insurance contracts to fund the deferred compensation arrangements; however, there may not be a direct correlation between the timing of the future cash receipts and disbursements under these arrangements.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------

A WARNING ABOUT FORWARD LOOKING STATEMENTS.

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



| |  |  | the financial and operating performance of our retail operations;
| | - |  | -----------------------------------------------------------------



| |  |  | our ability to maintain profitability over time;
| | - |  | ------------------------------------------------



| |  |  | the successful execution of our growth strategies;
| | - |  | --------------------------------------------------



| |  |  | our franchisees adherence to our practices, policies and procedures;
| | - |  | ---------------------------------------------------------------------



| |  |  | the impact of competition; and
| | - |  | ------------------------------



| |  |  | the availability of working capital.
| | - |  | ------------------------------------

Additional risks and uncertainties
are described elsewhere in this report and in detail under the caption Risk Factors and Trends Affecting Diedrich Coffee and Its Business in our Annual Report on Form 10-K for the fiscal year ended June 29, 2005 and in other reports
that we file with the Securities and Exchange Commission. We undertake no obligation to revise or update any forward-looking statements whether as a result of new information, future events or changed circumstances. Unless otherwise indicated,
we, us, our, and similar terms refer to Diedrich Coffee, Inc. and its subsidiaries.



11



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##### Table of Contents

INTRODUCTION

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



| |  |  | Overview. This section provides a general description of our business and recent significant transactions that we believe are important in understanding our results of
operations. This section also contains a discussion of trends in our operations and key performance indicators that we use to evaluate business results.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Results of operations. This section provides an analysis of our results of operations presented in the accompanying unaudited condensed consolidated statements of
operations by comparing the results for the twelve and thirty-six weeks ended March 8, 2006 to the results for the twelve and thirty-six weeks ended March 9, 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Financial condition, liquidity and capital resources. This section provides an analysis of our cash flows and a discussion of our outstanding debt and commitments, both
firm and contingent, that existed as of March 8, 2006. Included in the discussion of outstanding debt is a discussion of our financial capacity to fund our future commitments and a discussion of other financing arrangements.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical accounting estimates. This section contains a discussion of the accounting policies that we believe are important to our financial condition and results and
that require significant judgment and estimates on the part of management in their application. In addition, all of our significant accounting policies, including the critical accounting policies, are summarized in Note 1 to the accompanying
unaudited condensed consolidated financial statements.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

OVERVIEW

Business

We are a specialty coffee roaster, wholesaler and retailer.
We sell brewed, espresso based and various blended beverages primarily made from our own fresh roasted premium coffee beans, as well as light food items, whole bean coffee and accessories, through our company operated and franchised retail
locations. We also sell whole bean and ground coffees on a wholesale basis in the Office Coffee Service market and to other wholesale customers, including restaurant chains and other retailers. We roast coffee at our coffee roasting facility in
central California. It supplies freshly roasted coffee to our company operated and franchised retail locations and to our wholesale accounts.

Our brands
include Diedrich Coffee, Gloria Jeans, and Coffee People. The Diedrich Coffee and Coffee People brands are primarily company store operations and the Gloria Jeans brand is primarily a franchised store operation. As of March 8, 2006,
we owned and operated 57 retail locations and franchised 145 other retail locations under these brands, for a total of 202 retail coffee outlets. As of March 8, 2006, our retail units were located in 33 states and we had over 460 wholesale
accounts with Office Coffee Service distributors, chain and independent restaurants and others. Although the specialty coffee industry is dominated by a single company with more than 10,000 locations, we are one of the nations largest
specialty coffee retailers.

We believe that we are differentiated from other specialty coffee companies by the quality of our coffee products, the
superior personalized customer service that we provide to our customers and the warm and friendly ambiance that our coffeehouses offer. We serve our distinctively roasted coffee products in all of our brand locations and an extensive variety of fine
quality flavored whole bean coffees are offered in our Gloria Jeans brand stores. Our roasting recipes take into account the specific variety, origin and physical characteristics of each coffee bean to maximize its unique flavor.

Recent Developments

On January 25, 2006, we announced that
Peter Churm had rejoined our board of directors.

On January 3, 2006, we announced the appointment of Sean M. McCarthy to serve as our Chief Financial
Officer following the planned retirement of Martin A. Lynch on January 1, 2006.

On December 14, 2005, we announced the appointment of Stephen V.
Coffey to serve as our Chief Executive Officer following the resignation of Roger M. Laverty on December 13, 2005.



12



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##### Table of Contents

Sale of International Franchise Operations

On February 10, 2005, we sold our international Gloria Jeans operations to our former Australian master franchisee, Jireh International Pty. Ltd., and certain of its affiliates. From this sale, we received
$16,000,000 in cash and expect to receive a total of $7,020,000 over the next six years under license, roasting and consulting agreements. Through March 8, 2006, we had received $1,000,000 of these payments.

A table summarizing the relative sizes of each of our brands, on a unit count basis, and changes in unit count for each brand for fiscal 2004 and fiscal 2005 through the
thirty-six weeks ended March 8, 2006, is set forth below:



|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|--------------------------------------------- |  | ---------------------- |  | ------ |  | --------------- | - |  | ----------------------------------------------- | - |  | ---------------------- |  | ------ |  | ------ | - |  | ------------------------------------------ | - |  | ----------------------
|                                              |  | Units at June 30, 2004 |  | Opened |  | Closed/Sold (A) |   |  | Net transfers between the Company and Franchise |   |  | Units at June 29, 2005 |  | Opened |  | Closed |   |  | Nettransfersbetween theCompanyandFranchise |   |  | Units at March 8, 2006
|Gloria Jeans Brand                           |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Company Operated                              |  | 10                     |  | 1      |  | (1              | ) |  | 1                                               |   |  | 11                     |  | 1      |  | (1     | ) |  | (3                                         | ) |  | 8                     
|Franchise  Domestic                          |  | 137                    |  | 11     |  | (15             | ) |  | (1                                              | ) |  | 132                    |  | 13     |  | (13    | ) |  | 3                                          |   |  | 135                   
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Total Company Operated and Franchise-Domestic |  | 147                    |  | 12     |  | (16             | ) |  |                                                |   |  | 143                    |  | 14     |  | (14    | ) |  |                                           |   |  | 143                   
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Franchise  International                     |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Australia                                     |  | 196                    |  | 46     |  | (242            | ) |  |                                                |   |  |                       |  |       |  |       |   |  |                                           |   |  |                      
|Far East/Asia (B)                             |  | 19                     |  |       |  | (19             | ) |  |                                                |   |  |                       |  |       |  |       |   |  |                                           |   |  |                      
|Mexico                                        |  | 17                     |  |       |  | (17             | ) |  |                                                |   |  |                       |  |       |  |       |   |  |                                           |   |  |                      
|Other (C)                                     |  | 50                     |  | 14     |  | (64             | ) |  |                                                |   |  |                       |  |       |  |       |   |  |                                           |   |  |                      
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Total Franchise - International               |  | 282                    |  | 60     |  | (342            | ) |  |                                                |   |  |                       |  |       |  |       |   |  |                                           |   |  |                      
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Subtotal Gloria Jeans                        |  | 429                    |  | 72     |  | (358            | ) |  |                                                |   |  | 143                    |  | 14     |  | (14    | ) |  |                                           |   |  | 143                   
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Diedrich Coffee Brand                         |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Company Operated                              |  | 23                     |  | 3      |  |                |   |  |                                                |   |  | 26                     |  | 1      |  |       |   |  | (1                                         | ) |  | 26                    
|Franchise  Domestic                          |  | 7                      |  | 1      |  | (1              | ) |  |                                                |   |  | 7                      |  | 1      |  |       |   |  | 1                                          |   |  | 9                     
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Subtotal Diedrich                             |  | 30                     |  | 4      |  | (1              | ) |  |                                                |   |  | 33                     |  | 2      |  |       |   |  |                                           |   |  | 35                    
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Coffee People Brand                           |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Company Operated                              |  | 23                     |  | 3      |  | (1              | ) |  |                                                |   |  | 25                     |  | 4      |  | (5     | ) |  | (1                                         | ) |  | 23                    
|Franchise  Domestic                          |  |                       |  |       |  |                |   |  |                                                |   |  |                       |  |       |  |       |   |  | 1                                          |   |  | 1                     
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Subtotal Coffee People                        |  | 23                     |  | 3      |  | (1              | ) |  |                                                |   |  | 25                     |  | 4      |  | (5     | ) |  |                                           |   |  | 24                    
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       
|Total                                         |  | 482                    |  | 79     |  | (360            | ) |  |                                                |   |  | 201                    |  | 20     |  | (19    | ) |  |                                           |   |  | 202                   
|                                              |  |                        |  |        |  |                 |   |  |                                                 |   |  |                        |  |        |  |        |   |  |                                            |   |  |                       



|(A) | On February 10, 2005, in connection with the sale of our international Gloria Jeans operations, we sold the franchise rights to 338 Gloria Jeans retail locations to
Jireh International Pty. Ltd. and certain of its affiliates.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(B) | Includes Japan and Korea.
|--- | -------------------------



|(C) | Includes Guam, Indonesia, Ireland, Turkey, Malaysia, New Zealand, Philippines, United Arab Emirates, Romania, South Africa and Thailand.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------

Seasonality and Quarterly Results

Our business is subject to
seasonal fluctuations as well as economic trends that affect retailers in general. Historically, our net sales are highest during our second fiscal quarter, which includes the November  December holiday season. Hot weather tends to reduce
sales. Quarterly results are affected by the timing of the opening of new stores, which may not occur as anticipated due to events outside our control. As a result of these factors, the financial results for any individual quarter may not be
indicative of the results that may be achieved in a full fiscal year.

Key Performance Indicators

We use several key indicators to evaluate the performance of our business. These indicators include same-store sales growth, the number of company operated and franchised
stores opened and closed, and the measured relationship of cost of sales and related occupancy costs, operating expenses and general and administrative expenses to sales.



13



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##### Table of Contents

Same-store sales growth, or comparative sales growth, is a primary statistic used in the retail industry to measure core
revenues. This measure compares sales for all units open for one year or more to the comparable prior year period. We use this measure to evaluate single coffeehouse, total brand and total company sales performance. Until recently, comparable sales
of our company operated stores had declined primarily as a result of aging stores, a lack of capital to fund store improvements, and no new store openings. New stores typically achieve relatively strong comparative sales growth in their early years.
Franchised units that are located in shopping malls have also experienced declining sales due to overall declines in mall traffic.

The number of operating
units opened and closed is also a measure of the health of our brands and our business, although it is affected by a number of factors, including the availability of capital to finance growth. Unlike new company operated stores, new franchised
stores do not require our capital. In addition, franchised stores typically make an immediate profit contribution, whereas company stores generally are not profitable in the first year.

We use the relationship between cost of sales and related occupancy costs and operating expenses to sales to measure the operating efficiency of our individual coffeehouses and to measure the relationship between
general and administrative expenses to sales to monitor and control the level of corporate overhead. Recently, cost of sales and related occupancy costs have increased and gross margins have decreased primarily as a result of the increase in the
number of company operated retail locations and Keurig related wholesale sales, which have lower gross margins than other wholesale sales, and have become a higher percentage of our overall revenue mix. Operating expenses have increased in the past
two years as a result of dedicating more in-store labor and supervision to our retail stores. General and administrative expenses have increased as a percentage of sales due to staffing for accelerated growth and to the effect of continuing declines
in sales on a relatively fixed expense base.

RESULTS OF OPERATIONS

Twelve weeks ended March 8, 2006 compared with the twelve weeks ended March 9, 2005

Total
Revenue. Total revenue for the twelve weeks ended March 8, 2006 increased by $2,425,000, or 20.9%, to $14,049,000 from $11,624,000 for the twelve weeks ended March 9, 2005. Each component of total revenue is discussed below.

Retail Sales. Retail sales for the twelve weeks ended March 8, 2006 increased by $860,000, or 12.1%, to $7,975,000 from $7,115,000 for the
prior year period. This increase was primarily due to a net increase of two company operated stores since March 9, 2005 and to company operated same store sales increase of 5.7%. Retail sales from our internet website also increased by $93,000, or
67.4%, to $231,000 for the twelve weeks ended March 8, 2006 from $138,000 for the twelve weeks ended March 9, 2005.

Wholesale Revenue.
Our wholesale sales for the twelve weeks ended March 8, 2006 increased by $1,675,000, or 48.9%, to $5,102,000 from $3,427,000 for the twelve weeks ended March 9, 2005. This increase was primarily the net result of the following factors:

Keurig K-cup and other Third Party Wholesale sales. Third party wholesale sales for the twelve weeks ended
March 8, 2006 increased by $1,524,000, or 60.8%, to $4,029,000 from $2,505,000 for the twelve weeks ended March 9, 2005 led by a 70.2% growth in Keurig K-cup sales.

Roasted coffee sales to franchisees. Sales of roasted coffee to our franchisees increased $152,000 for the twelve weeks ended March 8,
2006 due primarily to the timing of holiday shipments to franchisees in the current year period and relatively flat same store sales in the twelve weeks ended March 8, 2006.

Franchise Revenue. Our franchise revenue consists of initial franchise fees, franchise renewal fees, area development fees, and royalties received on sales at franchised locations. Franchise revenue
decreased by $110,000, or 10.2%, to $972,000 for the twelve weeks ended March 8, 2006 from $1,082,000 for the twelve weeks ended March 9, 2005. Of the decline, $60,000 was due to a reclassification of certain fees as a reduction of general
and administrative marketing expenses. The balance of the decline, $50,000, was due primarily to higher average sales volumes in the new franchise stores opened since the beginning of the prior year and relatively flat same store sales in the twelve
weeks ended March 8, 2006.

Cost of Sales and Related Occupancy Costs. Cost of sales and related occupancy costs for the twelve weeks
ended March 8, 2006 increased $1,907,000, or 32.8%, to $7,713,000 from $5,806,000 in the prior year period. Because little of these costs relate to franchise revenue, the most relevant benchmark of these costs is their relationship to total
retail and wholesale sales. Using that measure, cost of sales and related occupancy costs increased to 59.0% of retail and wholesale sales for the twelve weeks ended March 8, 2006 from 55.1% in the twelve weeks ended March 9, 2005. Retail
cost of sales increased from 34.5% to 37.0% due in part to an increase in roasted coffee costs and a higher percentage of higher cost whole bean coffee sales. Wholesale cost of sales increased from 72.7% to 74.2% primarily due to a higher percentage
of higher cost Keurig business for the twelve weeks ended March 8, 2006. Occupancy costs for the twelve weeks ended March 8, 2006 increased $115,000, or 13.4%, to $975,000 from $860,000 in the prior year period primarily due to the higher
rents associated with new retail stores and lease renewals at existing retail stores.



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Operating Expenses. Operating expenses for the twelve weeks ended March 8, 2006, as a percentage of
retail and wholesale sales, decreased from 36.1% of retail and wholesale sales for the twelve weeks ended March 9, 2005 to 32.9% for the twelve weeks ended March 8, 2006 due primarily to the increase in third party wholesale sales and
lower workers compensation expenses.

Depreciation and Amortization. Depreciation increased by $54,000 to $617,000 for the twelve
weeks ended March 8, 2006 from the prior year fiscal quarter due mostly to capital assets that have been acquired as part of new store construction.

General and Administrative Expenses. Our general and administrative expenses increased by $980,000, or 42.0%, to $3,313,000 for the twelve weeks ended March 8, 2006. As a percentage of total revenue, general and
administrative expenses increased from 20.0% for the twelve weeks ended March 9, 2005 to 23.6% for the twelve weeks ended March 8, 2006. An increase of $374,000 was attributed to salaries, temporary help, consulting and related costs
primarily in the areas of franchise sales, training, construction and store supervision, and includes $96,000 of severance expense resulting from the departure of our former vice president of information systems, partially offset by a reduced
provision for corporate bonuses. We also incurred a $111,000 increase in stock-based compensation expense due to the adoption of SFAS 123R in the first quarter of fiscal 2006, as well as net $481,000 increase in legal fees. These expenses were
offset by a $73,000 decrease for the Gloria Jeans brand resulting from a change in the classification for coordination fees previously reflected in franchise income.

Interest Expense and Other, Net. Interest expense, interest income and other income, net was a net income of $4,000 in the twelve weeks ended March 9, 2005 and was a net income of $93,000 in the
twelve weeks ended March 8, 2006. This change was due to interest income on the proceeds from the sale of our international Gloria Jeans franchise operations and a reduction of interest expense.

Income Tax Benefit. We had losses from continuing operations and income from discontinued operations for the twelve weeks ended March 9, 2005. In
accordance with SFAS 109 Accounting for Income Taxes, the income tax benefit generated by the loss from continuing operations was $340,000 for the twelve weeks ended March 9, 2005. Tax expense for the twelve weeks ended
March 8, 2006 includes an adjustment to increase the year-to-date tax benefit by $69,000. The tax benefit was generated primarily due to net operating loss carry-backs to offset taxable income reported for the year ended June 29, 2005. Due
to the uncertainty of future taxable income, deferred tax assets resulting from the net operating loss carry-forwards have been fully reserved.

Results of Discontinued Operations. As a result of the sale of the international Gloria Jeans franchise operations on February 10, 2005, the results from this component of our business are presented as
discontinued operations for the fiscal twelve weeks ended March 9, 2005 in accordance with SFAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets. For the twelve weeks ended March 9, 2005, income from discontinued
operations was $576,000, net of $341,000 in taxes.

Thirty-six weeks ended March 8, 2006 compared with the thirty-six weeks ended March 9,
2005

Total Revenue. Total revenue for the thirty-six weeks ended March 8, 2006 increased by $4,889,000, or 13.5%, to $41,171,000
from $36,282,000 for the thirty-six weeks ended March 9, 2005. Each component of total revenue is discussed below.

Retail Sales. Retail sales
for the thirty-six weeks ended March 8, 2006 increased by $2,206,000, or 10.1%, to $24,007,000 from $21,801,000 for the prior year period. This increase was primarily due to company operated same store sales increase of 3.8% and includes a
$200,000, or 47.3%, increase in e-commerce retail sales.

Wholesale Revenue. Our wholesale sales for the thirty-six weeks ended March 8, 2006
increased by $3,122,000, or 27.4%, to $14,496,000 from $11,374,000 for the thirty-six weeks ended March 9, 2005. This increase was primarily the net result of the following factors:

Keurig K-cup and other Third Party Wholesale sales. Third party wholesale sales for the thirty-six weeks ended March 8, 2006
increased by $3,118,000, or 43.9%, to $10,225,000 from $7,107,000 for the thirty-six weeks ended March 9, 2005 led by a 54.3% growth in the Keurig K-cup sales.

Roasted coffee sales to franchisees. Sales of roasted coffee to our franchisees remained flat for the thirty-six weeks ended March 8,
2006 increasing by $5,000 compared to same quarter prior year due to 2.4% negative same store sales for the three quarters of fiscal 2006 for the Gloria Jeans franchise system which reduced roasted coffee usage, and was offset in part by the
timing of holiday shipments to franchisees in the current year period.



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Franchise Revenue. Our franchise revenue consists of initial franchise fees, franchise renewal fees, area
development fees, and royalties received on sales at franchised locations. Our franchise revenue decreased by $439,000, or 14.1%, to $2,668,000 for the thirty-six weeks ended March 8, 2006 from $3,107,000 for the thirty-six weeks ended
March 9, 2005. Of the decline, $241,000 was due to a reclassification of certain fees as a reduction of general and administrative marketing expenses. The balance of the decline, $198,000, was due to a decline in franchise royalties and
franchise fee revenue, primarily resulting from to declining same store sales at franchise locations along with fewer new store openings compared to prior year.

Cost of Sales and Related Occupancy Costs. Cost of sales and related occupancy costs for the thirty-six weeks ended March 8, 2006 increased $4,248,000, or 23.7%, to $22,152,000 from $17,904,000 in the prior year
period. Because little of these costs relate to franchise revenue, the most relevant benchmark of these costs is their relationship to total retail and wholesale sales. Using that measure, cost of sales and related occupancy costs increased to 57.5%
of retail and wholesale sales for the thirty-six weeks ended March 8, 2006 from 54.0% in the thirty-six weeks ended March 9, 2005. The increase is primarily due to a higher percentage of higher cost Keurig business which increased
wholesale cost of sales from 69.6% to 72.4% for the thirty-six weeks ended March 8, 2006. Occupancy costs for the thirty-six weeks ended March 8, 2006 increased $443,000, or 17.4%, to $2,982,000 from $2,539,000 in the prior year period
primarily due to the higher rents associated with new retail stores and lease renewals at existing retail stores.

Operating Expenses.
Operating expenses for the thirty-six weeks ended March 8, 2006 as a percentage of retail and wholesale sales decreased from 34.9% of retail and wholesale sales for the thirty-six weeks ended March 9, 2005 to 33.6% for the thirty-six weeks
ended March 8, 2006 due primarily to the increase in third party wholesale sales and lower workers compensation expense.

Depreciation and
Amortization. Depreciation and amortization increased by $78,000 to $1,775,000 for the thirty-six weeks ended March 8, 2006 from the prior year period due mostly to capital assets that have been acquired as part of new store
construction.

General and Administrative Expenses. General and administrative expenses increased by $2,127,000, or 28.2%, to
$9,677,000 for the thirty-six weeks ended March 8, 2006 from the prior year period. As a percentage of revenue, general and administrative expenses increased to 23.5% in the first thirty-six weeks of fiscal 2006 from 20.8% in the prior year
period. This increase resulted from $1,015,000 of salaries, temporary help, consulting and related costs, including $419,000 of expense resulting from the departures of our former chief executive officer and vice president of information systems,
$296,000 related to salaries associated with construction, training and franchise development primarily related to efforts to grow our Gloria Jeans brand, and $235,000 related to salaries associated with store supervision, training, and
marketing primarily related to efforts to grow our Diedrich and Coffee People brands. We also incurred $287,000 of compensation expense for the thirty-six weeks ended March 8, 2006 due to the adoption of SFAS 123R in the first quarter of the
fiscal 2006 and a net $512,000 increase in legal fees. We also incurred $335,000 in outside services primarily resulting from $237,000 of audit and tax fees expensed in the current fiscal year, but related to the 2005 fiscal year end audit and tax
returns. In addition, advertising costs for our Diedrich Coffee brand were up by $249,000 resulting from cable advertising and production costs. These expenses were offset by a $225,000 decrease for the Gloria Jeans brand resulting from a
change in the classification for coordination fees previously reflected in franchise income.

Interest Expense and Other, Net. Interest
expense, interest income and other income, net which was a net expense of $90,000 for the thirty-six weeks ended March 9, 2005 and was a net income of $321,000 in the thirty-six weeks ended March 8, 2006. This change was due to interest
income on the proceeds from the sale of our international Gloria Jeans franchise operations and a reduction of interest expense.

Income Tax
Benefit. We had losses from continuing operations and income from discontinued operations for the thirty-six weeks ended March 9, 2005. In accordance with SFAS 109, Accounting for Income Taxes, the income tax benefit
generated by the loss from continuing operations was $973,000 for the thirty-six weeks ended March 9, 2005. For the thirty-six weeks ended March 8, 2006, a tax benefit of $384,000 was generated primarily due to net operating loss
carry-backs to offset taxable income reported for the year ended June 29, 2005. As of March 8, 2006, net operating loss carry-forwards for federal and state income tax purposes of approximately $7,400,000 and $4,174,000, respectively, are
available to be utilized against future taxable income for years through fiscal 2025 for federal taxes and 2015 for state taxes, subject to annual limitation pertaining to change in ownership rules under the Internal Revenue Code. Due to the
uncertainty of future taxable income, deferred tax assets resulting from the net operating loss carry-forwards have been fully reserved.

Results of
Discontinued Operations. As a result of the sale of the international Gloria Jeans franchise operations on February 10, 2005, the results from this component of our business are presented as discontinued operations for the
fiscal thirty-six weeks ended March 9, 2005 in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. For the thirty-six weeks ended March 9, 2005, income from discontinued operations was
$1,656,000, net of $985,000 in taxes.



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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Current Financial Condition. At March 8, 2006, we had cash of $4,286,000 as compared to $10,493,000 at June 29, 2005, and we had working capital
of $5,811,000 as compared to working capital of $11,203,000 at June 29, 2005. Total outstanding capital lease obligations decreased to $333,000 at March 8, 2006 from $413,000 at June 29, 2005. No long-term debt was outstanding at
March 8, 2006 or June 29, 2005. From June 29, 2005 to March 8, 2006, stockholders equity decreased from $31,522,000 to $27,269,000.

The accounts receivable balance of $3,527,000 as of March 8, 2006 is an increase of $1,324,000 from the June 29, 2005 balance of $2,203,000. This increase is related to the seasonality of our business and to an increase in
wholesale sales to third parties. The accounts payable balance of $3,613,000 as of March 8, 2006 is an increase of $971,000 from the June 29, 2005 balance of $2,642,000. This increase is attributable to an increase in capital spending.

Cash Flows. Cash used in operating activities for the thirty-six weeks ended March 8, 2006 totaled $2,891,000 as compared with
$1,846,000 cash used in operating activities for the thirty-six weeks ended March 9, 2005. This increase is the net result of many factors more fully enumerated in the Unaudited Condensed Consolidated Statement of Cash Flows in the accompanying
financial statements.

Net cash used in investing activities for the thirty-six weeks ended March 8, 2006 totaled $3,373,000 as compared with net cash
provided of $14,039,000 for the thirty-six weeks ended March 9, 2005. During the thirty-six weeks ended March 8, 2006, a total of $3,876,000 was used to invest in property and equipment in our store remodel project (approximately
$340,000), new stores (approximately $2,616,000), our Castroville roasting facility (approximately $470,000) and our home office facility (approximately $450,000). These expenditures were partially offset by $1,038,000 of payments received on notes
receivable and $43,000 of proceeds received from sales of property and equipment. Our investment in a restricted money market account was $578,000 at March 8, 2006.

Net cash provided by financing activities for the thirty-six weeks ended March 8, 2006 totaled $57,000 as compared to $994,000 for the thirty-six weeks ended March 9, 2005. The decrease is primarily
attributed to $1,000,000 in borrowings under our contingent convertible note purchase agreement during the thirty-six weeks ended March 9, 2005 with no comparable activity in the current period.

Outstanding Debt and Financing Arrangements. On May 10, 2004, we entered into a $5,000,000 Contingent Convertible Note Purchase Agreement (the
Note Purchase Agreement). The agreement provides for us to, at our election, issue notes to the lender, Sequoia Enterprises L.P., up to an aggregate principal amount of $5,000,000. The notes are amortized on a monthly basis at a rate
that will repay 60% of the principal amount of each note by May 10, 2007. The remaining 40% will mature on that date. Interest was initially payable at LIBOR plus 3.30%, and a facility fee of 1.00% annually is payable on the unused portion of
the facility. The Note Purchase Agreement contains covenants that, among other matters, limit the amount of indebtedness that we may have outstanding in relation to our tangible net worth and that originally required us to maintain a specified
minimum dollar value of earnings before interest, tax, depreciation and amortization for the trailing four fiscal quarters (the Minimum EBITDA Covenant). The notes are convertible into our common stock only upon certain changes of
control. For notes issued and repaid, warrants to purchase shares are issued with the same rights and restrictions for exercise as existed for convertibility of the notes at the time of their issuance. Warrants are exercisable only in the event of a
change of control and were to expire on May 10, 2008. The lender under this agreement is our largest single stockholder and the chairman of our board of directors serves as the sole general partner of this limited partnership.

On May 10, 2004, upon entering into the Note Purchase Agreement, we immediately issued a $1,000,000 note under the facility and used the proceeds from that note and
other available cash to repay all outstanding debt with Bank of the West. On September 15, 2004, we issued a second note for $1,000,000 under this facility. The price of our common stock on May 10, 2004, the date that the first $1,000,000
note was issued, was $3.95 per share. The price of our common stock on September 15, 2004, the date the second $1,000,000 note was issued, was $4.95 per share. Both the notes were fully repaid in fiscal year 2005, and thus a total of 455,184
warrants are issuable upon a change in control. We have issued 4,219 warrants as of March 8, 2006. As of March 8, 2006, we had no borrowings outstanding under the facility.

On June 30, 2004, we entered into Amendment No. 1 to Contingent Convertible Note Purchase Agreement (Amendment No. 1) which revised the definition of Availability to mean, on any
date, the loan amount less the sum of the principal amounts then outstanding under the Note Purchase Agreement. Under the original Note Purchase Agreement, availability was calculated using a formula that reduced availability over time.

As a result of our cumulative losses over the last three quarters, we were not in compliance with all agreement covenants for the current quarter. On March 31,
2006, we entered into Amendment No. 2 to Contingent Convertible Note Purchase Agreement (Amendment No. 2). Amendment No. 2: (i) contains a waiver with respect to the existing default of the Minimum EBITDA Covenant and
removes the Minimum EBITDA from the Note Purchase Agreement; (ii) clarifies that warrants to purchase common stock of the Company will be issued with respect to repaid principal amounts only upon a change in control of the Company;
(iii) increases the interest rate applicable to outstanding amounts under the credit facility by 2%, to LIBOR plus 5.30%; and



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(iv) extends the exercise date of all warrants issued or to be issued under the Note Purchase Agreement by one year, to May 10, 2009. The maturity
date for any notes issued in the future was unaffected by Amendment No. 2. We are in compliance with all agreement covenants as amended by Amendment No 2 for the quarter ended March 8, 2006.

On October 15, 2005, the Amended and Restated Credit Agreement with Bank of the West expired. On November 4, 2005, we entered into a new Credit Agreement with
Bank of the West. The agreement provides for a $750,000 letter of credit facility that expires on October 15, 2006. The letter of credit facility is secured by a deposit account at Bank of the West. As of March 8, 2006, this deposit
account has a balance of $578,000, which is shown as restricted cash on the consolidated balance sheets. As of March 8, 2006, $651,000 of letters of credit were outstanding under the letter of credit facility. The agreement contains covenants
that, among other matters, require us to submit our financial statements to the bank within specified time periods. As of March 8, 2006, we were in compliance with all Bank of the West agreement covenants.

Based upon the terms of our credit agreements, our recent operating performance and business outlook, and the status of our balance sheet, we believe that cash from
operations, cash and cash equivalents, and funds available under our credit agreements will be sufficient to satisfy our working capital needs at the anticipated operating levels for at least the next twelve months. Our future capital requirements
will depend on many factors, including the extent and timing of the rate at which our business grows, if at all, with corresponding demands for working capital. We may be required to seek additional funding through either debt financing, or public
or equity, or a combination of funding methods to meet our capital requirements and sustain our operations. However, additional funds may not be available on terms acceptable to us or at all.

Other Commitments. The following represents a comprehensive list of our contractual obligations and commitments as of March 8, 2006:



|                                                                   |  |                      |        |        |   |         |  |         |       |         |   |         |  |            |       |  |   |       |  |   |       
|------------------------------------------------------------------ |  | -------------------- | ------ | ------ | - | ------- |  | ------- | ----- | ------- | - | ------- |  | ---------- | ----- |  | - | ----- |  | - | ------
|                                                                   |  | Payments Due by Year
|                                                                   |  | Total                |        | 1 year |   | 2 years |  | 3 years |       | 4 years |   | 5 years |  | Thereafter
|                                                                   |  | (In thousands)      
|Capital leases                                                     |  | $                    | 333    |        | $ | 19      |  | $       | 20    |         | $ | 22      |  | $          | 22    |  | $ | 25    |  | $ | 225   
|Company operated retail locations and other operating leases       |  |                      | 27,010 |        |   | 3,934   |  |         | 3,579 |         |   | 3,364   |  |            | 3,017 |  |   | 2,541 |  |   | 10,575
|Gloria Jeans franchise operated retail locations operating leases |  |                      | 19,608 |        |   | 4,231   |  |         | 3,424 |         |   | 2,567   |  |            | 2,238 |  |   | 1,812 |  |   | 5,336 
|Green coffee commitments                                           |  |                      | 2,627  |        |   | 2,259   |  |         | 292   |         |   | 76      |  |            |      |  |   |      |  |   |      
|                                                                   |  |                      |        |        |   |         |  |         |       |         |   |         |  |            |       |  |   |       |  |   |       
|                                                                   |  | $                    | 49,578 |        | $ | 10,443  |  | $       | 7,315 |         | $ | 6,029   |  | $          | 5,277 |  | $ | 4,378 |  | $ | 16,136
|                                                                   |  |                      |        |        |   |         |  |         |       |         |   |         |  |            |       |  |   |       |  |   |       

As of March 8, 2006, there were employment agreements with three of our officers that provide for severance
payments in the event that these individuals are terminated by us without cause or they terminate their employment as a result of a constructive termination. These severance payments range from six months to one years salary. Our maximum
theoretical liability for severance under the contracts is currently $587,000. Additionally, we have an agreement with Coffee Management Company (CMC) under which our Chief Executive Officer provides services to us. If this engagement is
terminated before June 14, 2006, then CMC will receive an engagement severance payment equal to $60,000. Because these amounts are contingent, they have not been included in the table above.

The agreement with CMC also provides for a one-time bonus that is payable at the end of the engagement. The bonus will be paid in the form of stock (60%) and cash (40%)
and will be in an amount that is equal to the sum of 5.0% of the appreciation of our total market capitalization during the term of the engagement (as measured by the increase in our stock price). In addition, if we are acquired by any person or
entity, other than a current affiliate, within twelve months of the termination date of the engagement, and the per share consideration paid in connection with the acquisition multiplied by the then outstanding shares of capital stock (the
Disposition Value) is greater than the market capitalization at the end of the engagement (the Termination Market Capitalization), CMC will receive an additional bonus equal to 5.0% of the difference of the Disposition Value
less the Termination Market Capitalization; provided, however, that the additional bonus will not be paid if the engagement is terminated by either party prior to June 14, 2006. Since there was no appreciation in our market capitalization as of
March 8, 2006, no liability for bonus was recorded as of that date.

As reflected in the table above, we have obligations under non-cancelable operating
leases for our coffee houses, roasting facility and administrative offices. Lease terms are generally for periods of 10 to 20 years with renewal options, and generally require us to pay a proportionate share of real estate taxes, insurance, common
area, and other operating costs. Some retail leases provide for contingent rental payments based on sales thresholds. In addition, we are liable on the master real property leases for 78 Gloria Jeans franchise locations. Under our franchising
business model, from time to time we execute the master lease for a location and enter into subleases on the same terms with our franchisees, which typically pay their rent directly to the landlords. If any of these franchisees default on their
subleases, we would be required to make all payments under the master lease. Our maximum theoretical future exposure at March 8, 2006, computed as the sum of all remaining lease payments through the expiration dates of the respective leases,
was $19,608,000. This amount does not take into consideration any mitigating measures that we could take to reduce this exposure in the event of default, including re-leasing the location or terminating the master lease by negotiating a lump sum
payment to the landlord in an amount that is less than the sum of all remaining future rents.

CRITICAL ACCOUNTING ESTIMATES

The preparation of our unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported
amounts. The estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and on various other factors that we believe to be reasonable. Accounts significantly impacted by estimates and assumptions include, but
are not limited to, franchise receivables, allowance for bad debt reserves, fixed asset lives, goodwill, intangible assets, income taxes, self-insurance and workers compensation reserves, store closure reserves, stock-based compensation, the
valuation allowance



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for net deferred tax assets and contingencies. We believe that the following represent the critical accounting policies and estimates that we use in the
preparation of our unaudited condensed consolidated financial statements. The following discussion, however, does not list all of our accounting policies and estimates.

Impairment of Property and Equipment and Other Amortizable Long-Lived Assets Held and Used

Each quarter we
evaluate the carrying value of individual stores when the operating results have reasonably progressed to a point to adequately evaluate the probability of continuing operating losses or a current expectation that a store will be sold or otherwise
disposed of before the end of its previously estimated useful life. In making these judgments, we consider the period of time since the store was opened or remodeled, and the trend of operations and expectations for future sales growth. For stores
selected for review, we estimate the future estimated cash flows from operating the store over its estimated useful life. We make judgments about future same-store sales and the operating expenses and estimated useful life that we would expect with
such level of same-store sales.

The most significant assumptions in our analysis are those used when we estimate a units future cash flows. We
generally use the assumptions in our strategic plan and modify them as necessary based on unit specific information. If our assumptions are incorrect, the carrying value of our operating unit assets may be overstated or understated.

Impairment of Goodwill

At the reporting unit level, goodwill
is tested for impairment annually or whenever an event or circumstance indicates that it is more likely than not an impairment may have occurred. We consider the reporting unit level to be the segment level since the components within each segment
have similar economic characteristics, including products and services, production processes, types or classes of customers and distribution methods. The impairment, if any, is measured based on the estimated fair value of the segment. Fair value
can be determined based on discounted cash flows or valuations of similar businesses. Impairment occurs when the carrying amount of goodwill exceeds its estimated fair value.

The most significant assumptions we use in this analysis are those made in estimating future cash flows. In estimating future cash flows, we consider historical results as well as the assumptions utilized in our
strategic plan for items such as same-store sales, store count growth rates, and the discount rate we consider to be the market discount rate used for acquisitions of similar businesses.

If our assumptions used in performing the impairment test prove inaccurate, the fair value of the segments may ultimately prove to be significantly lower, thereby causing the carrying value to exceed the fair value
and indicating an impairment has occurred. If our assumptions are incorrect, the carrying value of our goodwill may be understated or overstated. Our annual impairment measurement date is our fiscal year-end.

Estimated Liability for Closing Stores

We make decisions to
close stores based on prospects for estimated future profitability and sometimes we are forced to close stores due to circumstances beyond our control (for example, a landlords refusal to negotiate a new lease). Our management team evaluates
each stores performance every period. When stores continue to perform poorly, we consider the demographics of the location, as well as the likelihood of being able to improve the performance of an unprofitable store. Based on managements
judgment, we estimate the future cash flows. If we determine that the store will not, within a reasonable period of time, operate at break-even cash flow or be profitable, and we are not contractually obligated to continue operating the store, we
may close the store. Additionally, franchisees may close stores for which we are the primary lessee. If the franchisee cannot make payments on the lease, we continue making the lease payments and establish an estimated liability for the closed store
if we decide not to operate it as a company operated store. Effective January 1, 2003, we establish the estimated liability on the actual closure date.

The estimated liability for closing stores on properties vacated is generally based on the term of the lease and the lease termination fee we expect to pay, as well as estimated maintenance costs until the lease has been abated. The amount
of the estimated liability established is generally the present value of these estimated future payments. The interest rate used to calculate the present value of these liabilities is based on our incremental borrowing rate at the time the liability
is established. The related discount is amortized and shown in the provision for asset impairment and restructuring costs, net in our unaudited condensed consolidated statements of earnings.

A significant assumption used in determining the amount of the estimated liability for closing stores is the amount of the estimated liability for future lease payments
on vacant stores, which we determine based on our assessment of our ability to successfully negotiate early terminations of our lease agreements with the lessors or to sublease the property. Additionally, we estimate the cost to maintain leased and
owned vacant properties until the lease has been abated. If the costs to maintain properties increase, or it takes longer than anticipated to sell properties or sublease or terminate leases, we may need to record additional estimated liabilities. If
the



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leases on the vacant stores are not terminated or subleased on the terms we used to estimate the liabilities, we may be required to record losses in future
periods. Conversely, if the leases on the vacant stores are terminated or subleased on more favorable terms than we used to estimate the liabilities, we reverse previously established estimated liabilities, resulting in an increase in operating
income.

Estimated Liability for Self-Insurance

Effective October 1, 2003, we became self-insured for a portion of our current years losses related to workers compensation insurance. We have obtained stop loss insurance for individual workers compensation claims
with a $250,000 deductible per occurrence and a program maximum for all claims of $750,000. Insurance liabilities and reserves are accounted for based on actuarial estimates of the amount of incurred and unpaid losses. These estimates rely on
actuarial observations of historical claim loss development. The actuary, in determining the estimated liability, bases the assumptions on the average historical losses on claims we have incurred. The actual loss development may be better or worse
than the development we estimated in conjunction with the actuary. In that event, we will modify the reserve. As such, if we experience a higher than expected number of claims or the costs of claims rise more than expected, then we may, in
conjunction with the actuary, adjust the expected losses upward and our future self-insurance expenses will rise.

Franchised Operations

We monitor the financial condition of our franchisees and record provisions for estimated losses on receivables when we believe that our
franchisees are unable to make their required payments to us. Each period we perform an analysis to develop estimated bad debts for each franchisee. We then compare the aggregate result of that analysis to the amount recorded in our unaudited
condensed consolidated financial statements as the allowance for doubtful accounts and adjust the allowance as appropriate. Over time, our assessment of individual franchisees may change. For instance, in the past, we have had some franchisees which
we had determined required an estimated loss equal to the total amount of the receivable, but which have paid us in full or established a consistent record of payments (generally one year) such that we subsequently determined that an allowance was
no longer required.

Depending on the facts and circumstances, there are a number of different actions we and/or our franchisees may take to resolve
franchise collections issues. These actions may include the purchase of franchise stores by us or by other franchisees, a modification to the franchise agreement, which may include a provision to defer certain royalty payments or reduce royalty
rates in the future, a restructuring of the franchisees business and/or finances (including the restructuring of leases for which we are the primary or secondary obligee), or, if necessary, the termination of the franchise agreement. The
allowance is based on our assessment of the most probable course of action that will occur.

In accordance with SFAS 146, which we adopted on
January 1, 2003, an estimated liability for future lease obligations on stores operated by franchisees for which we are the primary or secondary obligee is established on the date the franchisee closes the store. Also, we record an estimated
liability for subsidized lease payments when we sign a sublease agreement committing us to the subsidy.

The amount of the estimated liability is
established using the methodology described above under the heading Estimated Liability for Closing Stores. Consistent with SFAS 146, we have not established an additional estimated liability for potential losses not yet incurred. If
sales trends or economic conditions worsen for our franchisees, their financial health may worsen, our collection rates may decline and we may be required to assume the responsibility for additional lease payments on franchised stores. Entering into
restructured franchise agreements may result in reduced franchise royalty rates in the future.

Valuation Allowance for Net Deferred Tax Assets

As discussed above, we have recorded a 100% valuation allowance against our net deferred tax assets. If we become profitable for a number of years
and our prospects for the realization of our deferred tax assets are more likely than not, we would expect to reverse our valuation allowance and credit income tax expense. In analyzing the prospects for future profitability, many of the assessments
of same-store sales and cash flows discussed above become relevant. When circumstances warrant, we assess the likelihood that our net deferred tax assets will more likely than not be realized from future taxable income. As of March 8, 2006, our
net deferred tax assets were fully reserved with a related valuation allowance that totaled approximately $4,267,000.



|Item 3. | Quantitative And Qualitative Disclosures About Market Risk.
|------- | -----------------------------------------------------------

Market Risk Sensitive Items Entered Into for Trading Purposes

None.



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##### Table of Contents

Market Risk Sensitive Items Entered Into for Other Than Trading Purposes

Interest Rate Risk. We are exposed to market risk from changes in interest rates on our outstanding debt. At March 8, 2006, we had a $5,000,000
loan facility, with no outstanding balance that could be affected by changes in short term interest rates.

Commodity Price Risk. The
supply and price of green coffee, the principal raw material for our products, are subject to significant volatility. Although most coffee trades in the commodity market, coffee of the quality that we seek tends to trade on a negotiated basis at a
substantial premium above commodity coffee prices, depending upon the supply and demand at the time of purchase. Supply and price can be affected by a number of factors in the producing countries, including weather, political and economic
conditions. In addition, green coffee prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations that have historically attempted to influence commodity prices of green coffee
through agreements establishing export quotas or restricting coffee supplies worldwide.

To date, we have not used commodity based financial instruments to
hedge against fluctuations in the price of coffee. To ensure that we have an adequate supply of coffee, however, we enter into agreements to purchase green coffee in the future that may or may not be fixed as to price. As of March 8, 2006, we
had commitments to purchase coffee through fiscal year 2009 totaling $2,627,000 for 1,705,000 pounds of green coffee, some of which commitments were fixed as to price. The coffee scheduled to be delivered to us in the next twelve months pursuant to
these commitments will satisfy approximately 38% of our anticipated green coffee requirements for the next twelve months. Assuming we require approximately 2,736,000 additional pounds of green coffee during the next twelve months for which no price
has yet been fixed, each $0.01 per pound increase in the price of green coffee could result in approximately $27,000 of additional cost.

In addition to
coffee, the cost, availability and quality of non-coffee raw ingredients such as fluid milk products, for our products are subject to a number of factors. In particular, the supply and price of fluid milk has been subject to significant volatility,
in recent years. Our ability to raise sales prices in response to increases in raw ingredient prices may be limited, and our profitability could be adversely affected if the prices of these ingredients were to rise substantially.



|Item 4. | Controls and Procedures.
|------- | ------------------------

(a) As of the end of the period covered
by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.

(b) There was no significant change in our internal control over financial reporting that occurred during our most recent fiscal quarter that materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION



|Item 1. | Legal Proceedings.
|------- | ------------------

In the ordinary course of our business, we may
become involved in legal proceedings from time to time. As of and for the thirty-six week period ending March 8, 2006, we were not a party to any material legal proceedings.



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

The annual
meeting of stockholders was held on March 2, 2006. At the meeting, Peter Churm, Lawrence Goelman, Paul Heeschen, Timothy Ryan and Richard Spencer were elected to the board of directors to serve until the next annual meeting. Set forth below is
a brief description of each matter voted upon at the annual meeting, together with the votes cast on each matter.

Election of Directors

The stockholders elected all of the director nominees named in the proxy statement. The votes cast for each nominee and the votes withheld with respect to each nominee
are set forth below:



|                 |  |           |  |               
|---------------- |  | --------- |  | --------------
|Director Nominee |  | Votes For |  | Votes Withheld
|Peter Churm      |  | 5,057,517 |  | 37,818        
|Lawrence Goelman |  | 4,952,933 |  | 142,402       
|Paul Heeschen    |  | 4,891,722 |  | 203,613       
|Timothy Ryan     |  | 4,395,076 |  | 700,259       
|Richard Spencer  |  | 4,955,294 |  | 140,041       



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Ratification of the Appointment of Independent Registered Public Accounting Firm

The stockholders ratified the appointment of BDO Seidman, LLP as our independent registered public accounting firm for our fiscal year ending June 28, 2006. The
votes cast on the proposal are set forth below:



|        |  |          
|------- |  | ---------
|For     |  | 5,088,084
|Against |  | 1,816    
|Abstain |  | 5,435    



|Item 6. | Exhibits.
|------- | ---------

Set forth below is a
list of the exhibits included as part of this quarterly report.



|            |  |                                                                                                                                                                                                                    
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                        
|            | 
|2.1         |  | Agreement and Plan of Merger, dated March 16, 1999, among Diedrich Coffee, Inc., CP Acquisition Corp., a wholly owned subsidiary of Diedrich Coffee, Inc., and
Coffee People, Inc. (1)                             
|            | 
|3.1         |  | Restated Certificate of Incorporation of Diedrich Coffee, Inc., dated May 11, 2001 (2)                                                                                                                             
|            | 
|3.2         |  | Bylaws of Diedrich Coffee, Inc. (3)                                                                                                                                                                                
|            | 
|4.1         |  | Specimen Common Stock Certificate (4)                                                                                                                                                                              
|            | 
|4.2         |  | Purchase Agreement for Series A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee, Inc., Martin R. Diedrich, Donald M. Holly, SNV Enterprises, and D.C.H., LP
(5)                         
|            | 
|4.3         |  | Purchase Agreement for Series B Preferred Stock dated as of June 29, 1995 by and among Diedrich Coffee, Inc., Martin R. Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, LP, and
Diedrich Partners I, LP (5)
|            | 
|4.4         |  | Form of Conversion Agreement in connection with the conversion of Series A and Series B Preferred Stock into Common Stock (3)                                                                                      
|            | 
|4.5         |  | Common Stock and Warrant Purchase Agreement, dated March 14, 2001 (6)                                                                                                                                              
|            | 
|4.6         |  | Form of Warrant, dated May 8, 2001 (2)                                                                                                                                                                             
|            | 
|4.7         |  | Registration Rights Agreement, dated May 8, 2001 (2)                                                                                                                                                               
|            | 
|4.8         |  | Form of Common Stock and Option Purchase Agreement with Franchise Mortgage Acceptance Company, dated as of April 3, 1998 (7)                                                                                       
|            | 
|10.1        |  | Form of Indemnification Agreement (5)                                                                                                                                                                              
|            | 
|10.2        |  | Diedrich Coffee, Inc. 2000 Equity Incentive Plan (8)*                                                                                                                                                              
|            | 
|10.3        |  | Diedrich Coffee, Inc. 2000 Non-Employee Directors Stock Option Plan (9)*                                                                                                                                           
|            | 
|10.4        |  | Amended and Restated Diedrich Coffee, Inc. 1996 Stock Incentive Plan (10)*                                                                                                                                         
|            | 
|10.5        |  | Diedrich Coffee, Inc. 1996 Non-Employee Directors Stock Option Plan (11)*                                                                                                                                          
|            | 
|10.6        |  | Form of Diedrich Coffee, Inc. Franchise Agreement (12)                                                                                                                                                             
|            | 
|10.7        |  | Form of Gloria Jeans Franchise Agreement (12)                                                                                                                                                                     
|            | 
|10.8        |  | Form of Diedrich Coffee, Inc. Area Development Agreement (12)                                                                                                                                                      
|            | 
|10.9        |  | Credit Agreement with Bank of the West, dated November 4, 2005                                                                                                                                                     
|            | 
|10.14       |  | Employment Agreement with Roger M. Laverty, dated April 24, 2003 (15)*                                                                                                                                             
|            | 
|10.15       |  | Stock Option Plan and Agreement with Roger M. Laverty, dated April 24, 2003 (15)*                                                                                                                                  
|            | 
|10.16       |  | Employment Agreement with Martin A. Lynch, dated March 26, 2004 (16)*                                                                                                                                              
|            | 
|10.17       |  | Employment Agreement with Matthew McGuinness, effective March 13, 2000 (18)*                                                                                                                                       
|            | 
|10.18       |  | Employment Letter regarding the employment of Pamela Britton, dated February 6, 2001 (12)*                                                                                                                         
|            | 
|10.21       |  | Form of Separation Agreement and Release with Martin Diedrich, effective October 28, 2004 (20)*                                                                                                                    



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##### Table of Contents

|      |  |                                                                                                                                                              
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | 
|10.22 |  | Standard Industrial/Commercial Multi-Tenant Lease Agreement by and between The Westphal Family Trust and Diedrich Coffee, Inc., dated September 10, 2003 (21)
|      | 
|10.23 |  | Office Space Lease Agreement by and between The Irvine Company and Diedrich Coffee, Inc., dated August 1, 2003 (21)                                          
|      | 
|10.24 |  | Contingent Convertible Note Purchase Agreement, dated May 10, 2004 (includes form of convertible promissory note and form of warrant) (13)                   
|      | 
|10.25 |  | Amendment No. 1 to Note Purchase Agreement dated June 30, 2004                                                                                               
|      | 
|10.26 |  | Amendment No. 2 to Note Purchase Agreement dated March 31, 2006 (23)                                                                                         
|      | 
|10.27 |  | Asset Purchase Agreement, dated December 5, 2004, by and among, among others, Diedrich Coffee, Inc. and Jireh International Pty. Ltd. (17)                   
|      | 
|10.28 |  | Mutual Release Agreement by and between Diedrich Coffee, Inc. and Roger M. Laverty, dated December 13, 2005 (19)*                                            
|      | 
|10.29 |  | Engagement Agreement by and between Diedrich Coffee, Inc. and Stephen V. Coffey, dated December 14, 2005 (19)*                                               
|      | 
|10.30 |  | Letter Agreement with Sean M. McCarthy, effective January 1, 2006 (22)*                                                                                      
|      | 
|31.1  |  | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                          
|      | 
|31.2  |  | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                          
|      | 
|32.1  |  | Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                          
|      | 
|32.2  |  | Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                          



|* | Management contract or compensatory plan or arrangement
|- | -------------------------------------------------------



|(1) | Previously filed as Appendix A to Diedrich Coffees Registration Statement on Form S-4, filed with the Securities and Exchange Commission on April 23, 1999.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Previously filed as an exhibit to Diedrich Coffees Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 16, 2001.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Previously filed as an exhibit to Diedrich Coffees Registration Statement on Form S-1/A (Registration No. 333-08633), filed with the Securities and Exchange
Commission on August 28, 1996.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Previously filed as an exhibit to Diedrich Coffees Registration Statement on Form S-3 (Registration No. 333-66744), filed with the Securities and Exchange Commission
on August 3, 2001.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Previously filed as an exhibit to Diedrich Coffees Registration Statement on Form S-1 (Registration No. 333-08633), filed with the Securities and Exchange Commission
on July 23, 1996.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Previously filed as Annex B to Diedrich Coffees Definitive Proxy Statement, filed with the Securities and Exchange Commission on April 12, 2001.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended January 28, 1998, filed with the Securities and Exchange
Commission on April 28, 1998.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended December 17, 2003, filed with the Securities and Exchange Commission
on January 30, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) | Previously filed as an exhibit to Diedrich Coffees Registration Statement on Form S-8, filed with the Securities and Exchange Commission on November 21, 2000.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|(11) | Previously filed as an exhibit to Diedrich Coffees Registration Statement on Form S-1/A (Registration No. 333-08633), filed with the Securities and Exchange
Commission on August 12, 1996.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(12) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended September 24, 2003, filed with the Securities and Exchange
Commission on November 7, 2003.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(13) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended June 30, 2004, filed with the Securities and Exchange Commission
on September 28, 2004.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(15) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended March 12, 2003, filed with the Securities and Exchange Commission on
April 28, 2003.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(16) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended March 10, 2004, filed with the Securities and Exchange Commission on
April 26, 2004.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(17) | Previously filed as an exhibit to Diedrich Coffees Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 6, 2004.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------



|(18) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended June 28, 2000, filed with the Securities and Exchange Commission
on September 27, 2000.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(19) | Previously filed as an exhibit to Diedrich Coffees Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 16, 2005.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------



|(20) | Previously filed as an exhibit to Diedrich Coffees Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 3, 2004.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------



|(21) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended July 2, 2003, filed with the Securities and Exchange Commission on
September 30, 2003.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(22) | Previously filed as an exhibit to Diedrich Coffees Current Report on Form 8-K, filed with the Securities and Exchange Commission on January 5, 2006.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------



|(23) | Previously filed as an exhibit to Diedrich Coffees Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 31, 2006.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------



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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.



|                     |  |  |  |                                                                                          
|-------------------- |  |  |  | -----------------------------------------------------------------------------------------
|Date: April 21, 2006 |  |  |  | DIEDRICH COFFEE, INC.                                                                    
|                     |  | 
|                     |  |  |  | /s/ Stephen V. Coffey                                                                    
|                     |  |  |  | Stephen V. Coffey Chief Executive Officer
(On behalf of the registrant)                  
|                     |  | 
|                     |  |  |  | /s/ Sean M. McCarthy                                                                     
|                     |  |  |  | Sean M. McCarthy Vice President and Chief Financial
Officer (Principal financial officer)



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EXHIBIT INDEX



|            |  |                                                                                                    
|----------- |  | ---------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                        
|            | 
|10.9        |  | Credit Agreement with Bank of the West, dated November 4, 2005                                     
|            | 
|10.25       |  | Amendment No. 1 to Note Purchase Agreement, dated June 30, 2004                                    
|            | 
|31.1        |  | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|            | 
|31.2        |  | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|            | 
|32.1        |  | Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|            | 
|32.2        |  | Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002