** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

| **ý******                                                                                                                                                             | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934.**  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                       |
| **For  the quarterly period ended March 12, 2003**                                                                                                                         |
|                                                                                                                                                                       |
| **OR**                                                                                                                                                                     |
|                                                                                                                                                                       |
| **o******                                                                                                                                                                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934.** |
|                                                                                                                                                                       |
| **For  the transition period  from           to           ** |
|                                                                                                                                                                       |
| **Commission  File 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.) |
|                                                                                                                                                                       |                                                                                                     |   |
| **2144  MICHELSON DRIVE  IRVINE, CALIFORNIA 92612**                                                                                                                        |
| (Address of Principal  Executive Offices, Including Zip Code)                                                                                                              |
|                                                                                                                                                                       |                                                                                                     |   |
| **(949)  260-1600**                                                                                                                                                        |
| (Registrant’s Telephone  Number, Including Area Code)                                                                                                                 |
|                                                                                                                                                                            |                                                                                                          |  |  |

 

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Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. YES ýNO o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý

 

As of April 24, 2003, there were 5,161,265 shares ofcommon stock of the registrant outstanding.

 

 

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**DIEDRICH COFFEE, INC.**

###### **INDEX**

 
| **PART I – FINANCIAL  INFORMATION** |
|------------------------------------------|
|                                     |
| Item  1.                                 | Financial  Statements |
|                                     |
|                                     | Condensed  Consolidated Balance Sheets (Unaudited) |
|                                     |
|                                     | Condensed  Consolidated Statements of Operations (Unaudited) |
|                                     |
|                                     | Condensed  Consolidated Statements of Cash Flows (Unaudited) |
|                                     |
|                                     | Notes  to Condensed Consolidated Financial Statements (Unaudited) |
|                                     |
| Item  2.                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                     |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk |
|                                     |
| Item  4.                                 | Controls  and Procedures |
|                                     |
| **PART II – OTHER INFORMATION**     |
|                                     |
| Item 1.                                  | Legal Proceedings |
|                                     |
| Item  6.                                 | Exhibits  and Reports on Form 8-K |
|                                     |
|                                     | Signatures and Certifications |
|                                          |  |  |

 

i

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**PARTI - FINANCIAL INFORMATION**

 

**Item 1****.**           **Financial Statements.**

 

DIEDRICH COFFEE, INC.

CONDENSED CONSOLIDATEDBALANCE SHEETS

(UNAUDITED)

 
|                                                                                                                                     |   | **March 12, 2003** |       | **July 3,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------|--------|
|                                                                                                                                     |   |               |       |              |   |
| **Assets**                                                                                                                               |   |               |       |              |   |
| Current assets:                                                                                                                          |   |               |       |              |   |
| Cash                                                                                                                                     |   | $                  | 2,056,000  |              | $      | 2,233,000 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,528,000 at March 12,  2003 and $1,364,000 at July 3, 2002               |   | 2,723,000          |       | 2,215,000         |   |
| Inventories                                                                                                                              |   | 2,601,000          |       | 2,598,000         |   |
| Assets held for  sale                                                                                                                    |   | 46,000             |       | 186,000           |   |
| Current  portion of notes receivable                                                                                                     |   | 56,000             |       | 48,000            |   |
| Prepaid expenses                                                                                                                         |   | 793,000            |       | 667,000           |   |
| Total current  assets                                                                                                                    |   | 8,275,000          |       | 7,947,000         |   |
| Property and  equipment, net                                                                                                             |   | 6,690,000          |       | 7,514,000         |   |
| Costs in excess  of net assets acquired, net of amortization of $1,413,000 at March 12, 2003  and July 3, 2002                           |   | 12,090,000         |       | 12,164,000        |   |
| Notes receivable                                                                                                                         |   | 201,000            |       | 240,000           |   |
| Other assets                                                                                                                             |   | 484,000            |       | 415,000           |   |
| **Total  assets**                                                                                                                        |   | $                  | 27,740,000 |              | $      | 28,280,000 |   |
|                                                                                                                                     |   |               |       |              |   |
| **Liabilities and Stockholders’ Equity**                                                                                            |   |               |       |              |   |
| Current  liabilities:                                                                                                                    |   |               |       |              |   |
| Current  installments of obligations under capital leases                                                                                |   | $                  | 176,000    |              | $      | 189,000 |   |
| Current  installments of long-term debt                                                                                                  |   | 1,200,000          |       | 1,126,000         |   |
| Accounts payable                                                                                                                         |   | 2,117,000          |       | 2,090,000         |   |
| Accrued  compensation                                                                                                                    |   | 1,217,000          |       | 1,310,000         |   |
| Accrued expenses                                                                                                                         |   | 748,000            |       | 695,000           |   |
| Franchise  deposits                                                                                                                      |   | 637,000            |       | 601,000           |   |
| Deferred  franchise fee income                                                                                                           |   | 627,000            |       | 546,000           |   |
| Provision for  store closure                                                                                                             |   | 418,000            |       | 581,000           |   |
| Total  current liabilities                                                                                                               |   | 7,140,000          |       | 7,138,000         |   |
| Obligations  under capital leases, excluding current installments                                                                        |   | 604,000            |       | 732,000           |   |
| Long term debt,  excluding current installments                                                                                          |   | 1,200,000          |       | 2,100,000         |   |
| Deferred rent                                                                                                                            |   | 513,000            |       | 566,000           |   |
| Total  liabilities                                                                                                                       |   | 9,457,000          |       | 10,536,000        |   |
| Stockholders’  equity:                                                                                                              |   |               |       |              |   |
| Common stock,  $0.01 par value; authorized 8,750,000 shares; issued and outstanding 5,161,000  shares at March 12, 2003 and July 3, 2002 |   | 52,000             |       | 52,000            |   |
| Additional  paid-in capital                                                                                                              |   | 58,024,000         |       | 57,968,000        |   |
| Accumulated  deficit                                                                                                                     |   | (39,793,000        | )          | (40,276,000       | )      |
| Total  stockholders’ equity                                                                                                         |   | 18,283,000         |       | 17,744,000        |   |
| Commitments and  contingencies (note 3)                                                                                                  |   |               |       |              |   |
| Subsequent  events (notes 3 and 8)                                                                                                       |   | —             |       | —            |   |
| **Total  liabilities and stockholders’ equity**                                                                                     |   | $                  | 27,740,000 |              | $      | 28,280,000 |   |

 

*See accompanying notes to condensed consolidated financialstatements.*

 

1

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DIEDRICH COFFEE, INC.

CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)

 
|                                                  |   | **Twelve  Weeks  Ended  March 12, 2003** |      | **Twelve  Weeks  Ended  March 6, 2002** |   | **Thirty-Six  Weeks Ended  March 12, 2003** |   | **Thirty-Six  Weeks Ended  March 6, 2002** |       |
|-------------------------------------------------------|--------|------------------------------------------|-----------|-----------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|------------|
| Net  Revenue:                                         |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Retail sales                                          |   | $                                        | 7,474,000 |                                    | $      | 8,610,000                                   |   | $                                          | 23,661,000 |   | $ | 26,971,000 |   |
| Wholesale and  other                                  |   | 3,052,000                                |      | 2,749,000                               |   | 11,250,000                                  |   | 11,521,000                                 |       |
| Franchise  revenue                                    |   | 1,531,000                                |      | 1,701,000                               |   | 4,461,000                                   |   | 4,700,000                                  |       |
| Total revenue                                         |   | 12,057,000                               |      | 13,060,000                              |   | 39,372,000                                  |   | 43,192,000                                 |       |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Costs and  Expenses:                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Cost of sales  and related occupancy costs            |   | 5,906,000                                |      | 6,324,000                               |   | 18,907,000                                  |   | 21,432,000                                 |       |
| Operating  expenses                                   |   | 3,898,000                                |      | 4,011,000                               |   | 12,092,000                                  |   | 12,508,000                                 |       |
| Depreciation and  amortization                        |   | 421,000                                  |      | 522,000                                 |   | 1,327,000                                   |   | 1,733,000                                  |       |
| General and  administrative expenses                  |   | 2,166,000                                |      | 1,934,000                               |   | 6,397,000                                   |   | 6,241,000                                  |       |
| Provision  for (recovery of) asset impairment         |   | (49,000                                  | )         | 367,000                                 |   | 57,000                                      |   | 389,000                                    |       |
| Gain on asset disposals                               |   | (117,000                                 | )         | (21,000                                 | )      | (119,000                                    | )      | (118,000                                   | )          |
| Total costs and  expenses                             |   | 12,225,000                               |      | 13,137,000                              |   | 38,661,000                                  |   | 42,185,000                                 |       |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Operating income  (loss)                              |   | (168,000                                 | )         | (77,000                                 | )      | 711,000                                     |   | 1,007,000                                  |       |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Interest expense                                      |   | (55,000                                  | )         | (128,000                                | )      | (217,000                                    | )      | (433,000                                   | )          |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Interest and  other income, net                       |   | 9,000                                    |      | 15,000                                  |   | 33,000                                      |   | 41,000                                     |       |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Income (loss)  before income tax provision            |   | (214,000                                 | )         | (190,000                                | )      | 527,000                                     |   | 615,000                                    |       |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Income tax  provision                                 |   | 5,000                                    |      | —                                  |   | 44,000                                      |   | 16,000                                     |       |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Net income  (loss)                                    |   | $                                        | (219,000  | )                                       | $      | (190,000                                    | )      | $                                          | 483,000    |   | $ | 599,000 |   |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Net income  (loss) per share – basic and diluted |   | $                                        | (0.04     | )                                       | $      | (0.04                                       | )      | $                                          | 0.09       |   | $ | 0.12 |   |
|                                                  |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Number of shares  used in per share computations:     |   |                                     |      |                                    |   |                                        |   |                                       |       |
| Basic                                                 |   | 5,161,000                                |      | 5,161,000                               |   | 5,161,000                                   |   | 5,161,000                                  |       |
| Diluted                                               |   | 5,161,000                                |      | 5,161,000                               |   | 5,196,000                                   |   | 5,161,000                                  |       |

 

*See accompanying notes to condensed consolidated financialstatements.*

 

2

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DIEDRICH COFFEE, INC.

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(UNAUDITED)

 
|                                                                           |   | **Thirty-Six  Weeks  Ended  March 12, 2003** |      | **Thirty-Six  Weeks  Ended  March 6, 2002** |   |
|--------------------------------------------------------------------------------|--------|----------------------------------------------|-----------|---------------------------------------------|--------|
| Cash  flows from operating activities:                                         |   |                                         |      |                                        |   |
| Net income                                                                     |   | $                                            | 483,000   |                                        | $      | 599,000 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |   |                                         |      |                                        |   |
| Depreciation and  amortization                                                 |   | 1,327,000                                    |      | 1,733,000                                   |   |
| Amortization of  loan fees                                                     |   | 58,000                                       |      | 129,000                                     |   |
| Provision for  (recovery of) bad debt                                          |   | 228,000                                      |      | (306,000                                    | )      |
| Provision for  asset impairment                                                |   | 57,000                                       |      | 389,000                                     |   |
| Provision for  store closure                                                   |   | 36,000                                       |      | 11,000                                      |   |
| Stock  compensation expense                                                    |   | 56,000                                       |      | —                                      |   |
| Gain on disposal  of assets                                                    |   | (119,000                                     | )         | (118,000                                    | )      |
| Changes in  operating assets and liabilities:                                  |   |                                         |      |                                        |   |
| Accounts  receivable                                                           |   | (725,000                                     | )         | 991,000                                     |   |
| Inventories                                                                    |   | (3,000                                       | )         | (118,000                                    | )      |
| Prepaid expenses                                                               |   | (122,000                                     | )         | (369,000                                    | )      |
| Other assets                                                                   |   | (146,000                                     | )         | 47,000                                      |   |
| Accounts payable                                                               |   | 27,000                                       |      | (501,000                                    | )      |
| Accrued  compensation                                                          |   | (93,000                                      | )         | (854,000                                    | )      |
| Accrued expenses                                                               |   | 53,000                                       |      | (394,000                                    | )      |
| Provision for  store closure                                                   |   | (150,000                                     | )         | (658,000                                    | )      |
| Deferred  franchise income and franchisee deposits                             |   | 124,000                                      |      | (224,000                                    | )      |
| Deferred rent                                                                  |   | (10,000                                      | )         | 18,000                                      |   |
| Net cash  provided by operating activities                                     |   | 1,081,000                                    |      | 375,000                                     |   |
| Cash flows from  investing activities:                                         |   |                                         |      |                                        |   |
| Capital  expenditures for property and equipment                               |   | (613,000                                     | )         | (716,000                                    | )      |
| Proceeds from  disposal of property and equipment                              |   | 278,000                                      |      | 1,645,000                                   |   |
| Payments  received on notes receivable                                         |   | 31,000                                       |      | 145,000                                     |   |
| Net cash  provided by (used in) investing activities                           |   | (304,000                                     | )         | 1,074,000                                   |   |
| Cash flows from  financing activities:                                         |   |                                         |      |                                        |   |
| Stock issuance  costs                                                          |   | —                                       |      | (134,000                                    | )      |
| Payments on  long-term debt                                                    |   | (826,000                                     | )         | (1,649,000                                  | )      |
| Payments on  capital lease obligations                                         |   | (128,000                                     | )         | (204,000                                    | )      |
| Net cash used in  financing activities                                         |   | (954,000                                     | )         | (1,987,000                                  | )      |
|                                                                           |   |                                         |      |                                        |   |
| Net decrease in  cash                                                          |   | (177,000                                     | )         | (538,000                                    | )      |
| Cash at  beginning of period                                                   |   | 2,233,000                                    |      | 3,063,000                                   |   |
| Cash at end of  period                                                         |   | $                                            | 2,056,000 |                                        | $      | 2,525,000 |   |
|                                                                           |   |                                         |      |                                        |   |
| Supplemental  disclosure of cash flow information:                             |   |                                         |      |                                        |   |
| Cash paid during  the period for:                                              |   |                                         |      |                                        |   |
| Interest                                                                       |   | $                                            | 155,000   |                                        | $      | 298,000 |   |
| Income taxes                                                                   |   | $                                            | 46,000    |                                        | $      | 18,000 |   |
|                                                                           |   |                                         |      |                                        |   |
| Non-cash  transactions                                                         |   |                                         |      |                                        |   |
| Issuance  of notes receivable                                                  |   | $                                            | —    |                                        | $      | 515,000 |   |
| Asset  purchased under capital lease                                           |   | $                                            | —    |                                        | $      | 225,000 |   |

 

*See accompanying notes to condensed consolidated financialstatements.*

 

3

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**DIEDRICH COFFEE, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**MARCH 12, 2003(UNAUDITED)**

 

1.                                       SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

*Basisof Presentation*

 

The unaudited condensed consolidated financial statements of DiedrichCoffee, Inc.  and its subsidiaries (the“Company”) have been prepared in accordance with generally accepted accountingprinciples, as well as the instructions to Form 10-Q and Article 10 ofRegulation S-X.  These statements shouldbe read in conjunction with the consolidated financial statements and the notesthereto included in the Company’s Annual Report on Form 10-K for the year endedJuly 3, 2002.

 

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

 

*Reclassifications*

 

Certain reclassifications have been made to the March 6, 2002 condensedconsolidated financial statements to conform to the March 12, 2003presentation.

 

*Stock Option Plan*

 

Informationregarding the Company’s stock option plan is summarized below:

 
|                                             |   | **Options** |   | **Weighted  Average  Exercise  Price** |   |
|--------------------------------------------------|--------|-------------|--------|----------------------------------------|--------|
|                                             |   |        |   |                                   |   |
| Number of options  authorized for future grant   |   | 86,968      |   |                                   |   |
| Outstanding at June 27,  2001                    |   | 876,925     |   | $                                      | 16.29  |   |
| Granted                                          |   | 36,250      |   | $                                      | 3.56   |   |
| Exercised                                        |   | —      |   | —                                 |   |
| Forfeited                                        |   | (495,290    | )      | $                                      | 20.42  |   |
| Outstanding at: July 3,  2002                    |   | 417,885     |   | $                                      | 8.65   |   |
| Granted                                          |   | 315,250     |   | $                                      | 3.18   |   |
| Exercised                                        |   | —      |   | —                                 |   |
| Forfeited                                        |   | (152,468    | )      | $                                      | 4.59   |   |
| Outstanding at: March  12, 2003                  |   | 580,667     |   | $                                      | 6.75   |   |
| Weighted-average fair  value of options granted: |   |        |   |                                   |   |
| Year ended July 3, 2002                          |   | $           | 2.62   |                                   |   |   |
| Thirty-six weeks  ended March 12, 2003           |   | $           | 2.90   |                                   |   |   |
| Options  exercisable:                            |   |        |   |                                   |   |
| At July 3, 2002                                  |   | 210,762     |   |                                   |   |
| At March 12,  2003                               |   | 302,828     |   |                                   |   |

 

4

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The following table summarizes information about stock optionsoutstanding at March 12, 2003:

 
|                         |   | **Options Outstanding**                    |   | **Options Exercisable**                        |   |
|------------------------------|--------|--------------------------------------------|--------|------------------------------------------------|--------|
| **Range of  Exercise Price** |   | **Number  Outstanding At  March 12, 2003** |   | **Weighted  Average  Remaining  Life (Years)** |   | **Weighted  Average  Exercise  Price** |   | **Number  Exercisable At  March 12, 2003** |   | **Weighted  Average  Exercise  Price** |   |
|   $ 2.16 - $ 3.67       |   | 102,500                                    |   | 6.48                                           |   | $ | 2.86 |   | 73,333 |   | $ | 2.83 |   |
|   $ 3.80 - $ 3.80       |   | 155,000                                    |   | 8.22                                           |   | $ | 3.80 |   | 51,663 |   | $ | 3.80 |   |
|   $  3.97 - $ 3.97 |   | 124,000                                    |   | 9.55                                           |   | $ | 3.97 |   | — |   | $ | 0.00 |   |
|   $ 4.14 - $ 11.00      |   | 120,625                                    |   | 6.48                                           |   | $ | 8.01 |   | 101,250 |   | $ | 8.69 |   |
| $ 11.12 - $ 41.00            |   | 78,542                                     |   | 6.18                                           |   | $ | 20.10 |   | 76,582 |   | $ | 20.31 |   |
|                         |   | 580,667                                    |   | 7.56                                           |   | $ | 6.75 |   | 302,828 |   | $ | 9.37 |   |

 

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

 
|                                    |   | **Thirty-Six Weeks  Ended  March 12, 2003** |    | **Thirty-Six Weeks  Ended  March 6, 2002** |   |
|-----------------------------------------|--------|---------------------------------------------|---------|-------------------------------------------------|--------|
| **Pro Forma**                           |   |                                        |    |                                            |   |
| Net income                              |   | $                                           | 116,000 |                                            | $      | 1,078,000 |   |
| Basic and  diluted net income per share |   | $                                           | 0.02    |                                            | $      | 0.21 |   |

 

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

 
|                     |   | **Thirty-Six  Weeks Ended  March 12, 2003** |   | **Thirty-Six  Weeks Ended  March 6, 2002** |   |
|--------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| Risk free interest rate  |   | 2.57                                        | %      | 4.00                                       | %      |
| Expected life            |   | 6 years                                     |   | 6 years                                    |   |
| Expected volatility      |   | 99                                          | %      | 86                                         | %      |
| Expected  dividend yield |   | 0                                           | %      | 0                                          | %      |

 

2.                                       INVENTORIES

 

Inventories consist of the following:

 
|                               |   | **March 12,  2003** |      | **July 3,  2002** |   |
|------------------------------------|--------|---------------------|-----------|-------------------|--------|
| Unroasted coffee                   |   | $                   | 1,023,000 |              | $      | 942,000 |   |
| Roasted coffee                     |   | 536,000             |      | 563,000           |   |
| Accessory and  specialty items     |   | 202,000             |      | 237,000           |   |
| Other food,  beverage and supplies |   | 840,000             |      | 856,000           |   |
|                               |   | $                   | 2,601,000 |              | $      | 2,598,000 |   |

 

3.                                       LONG-TERMDEBT

 

Long-term debt consists of the following:

 

5

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|                                                                                                                                                                                                                                               |   | **March 12,  2003** |      | **July 3,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|-------------------|--------|
| **Bank of the West**                                                                                                                                                                                                                               |   |                |      |              |   |
| Note payable bearing  interest at a rate of 3% over LIBOR, or 4.34% as of March 12, 2003 and  payable in monthly installments of $100,000. Due March 31, 2005. Note is  secured by the assets of the Company and its subsidiaries’ stock |   | $                   | 2,400,000 |              | $      | — |   |
| **Fleet  National Bank**                                                                                                                                                                                                                           |   |                |      |              |   |
| Note  payable bearing interest at a rate of 5.38% as of July 3, 2002. Paid in full  on September 3, 2002.                                                                                                                                          |   | —              |      | 3,226,000         |   |
| Less:  current installments                                                                                                                                                                                                                        |   | 1,200,000           |      | 1,126,000         |   |
| Long-term debt,  excluding current installments                                                                                                                                                                                                    |   | $                   | 1,200,000 |              | $      | 2,100,000 |   |

 

On September 3, 2002, the Company entered into a Credit Agreement withUnited California Bank, doing business as Bank of the West (“BOW”) in order torepay the balance of all remaining amounts it owed to Fleet National Bank(“Fleet”) under its credit agreement with Fleet. Under the BOW CreditAgreement, the Company immediately borrowed $3,000,000 under a replacement termloan, the proceeds of which were used to repay the Fleet term loan on September3, 2002, the amended maturity date of the Fleet term loan.

 

The Company’s obligations to BOW under the Credit Agreement are securedby all of the Company’s assets, including the stock of each of its subsidiaries(each of which has guaranteed the Company’s obligations under the agreement),as well as all intangible assets it owns, including the intellectual propertyand trademark assets that the Company and its subsidiaries own.

 

The term loan with BOW requires monthly principal payments of $100,000over 30 months and all amounts the Company owes under the term loan must berepaid by March 31, 2005.  The Companyis required to make monthly interest payments on amounts outstanding under thereplacement term loan, computed at either BOW’s reference rate plus 0.75% or aLIBOR rate plus 3.0% (pursuant to the First Amendment to Credit Agreementdiscussed below). The Company may periodically elect to convert portions of itsreference rate borrowings into LIBOR based borrowings in $100,000 increments,subject to restrictions contained in the agreement. At March 12, 2003, theapplicable interest rate was 4.34%, which was based on the LIBOR rate at thetime.

 

In addition to the term loan, the BOW CreditAgreement provides the Company with a revolving $1,000,000 credit line for theacquisition of specified coffee packaging equipment. Any amounts borrowed underthis credit line will convert to term loans on August 29, 2006 with monthlyprincipal amortization payments beginning September 30, 2003, and alloutstanding balances must be repaid by August 31, 2006. The Company is requiredto pay interest on any borrowings outstanding under this line of credit on amonthly basis at an interest rate computed in the same manner as describedabove for the term loan. There were no amounts outstanding under this creditline at March 12, 2003, although the Company borrowed funds under this creditline on April 10, 2003 as discussed below (see Note 8).

 

The BOW Credit Agreement also provides the Company with two separate$1,000,000 lines of credit for new coffeehouse development, one applicable toborrowings during our fiscal year ending in 2003, and the other to borrowingsduring our fiscal year ending in 2004. Borrowings under each line of creditwill convert to term loans repayable over 36 months, with such repaymentsbeginning July 31, 2003 and due in full by June 30, 2006, in the case ofborrowings under the fiscal 2003 line, and beginning July 31, 2004 and due infull by June 30, 2007, in the case of the fiscal 2004 line. The Company isrequired to pay interest on any borrowings under each line of credit on amonthly basis at an interest rate computed in the same manner as describedabove for the term loan. There were no amounts outstanding under these creditlines at March 12, 2003.

 

Finally, the BOW Credit Agreement provides the Company with a $675,000revolving working capital and letter of credit facility, subject to a number ofrestrictions. Working capital facility draws and letters of credit are

 

6

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limited to a combined maximum of $675,000 outstanding at any time.Furthermore, draw downs against the working capital facility are subject to asub-limit of $500,000, and letters of credit are subject to a sub-limit of$250,000. The Company may only draw funds against the working capital facilityduring the first and fourth quarters of each fiscal year, although letters ofcredit issued under the letter of credit facility may be outstanding throughoutthe year. The Company may repay amounts borrowed under the working capitalfacility at any time, and it may therefore be able to re-borrow such funds on arevolving basis (subject to restrictions including those summarized above). Allamounts outstanding under the working capital facility are required to berepaid by August 31, 2003. Any payments made by BOW with regard to any letterof credit issued under the letter of credit facility must be repaid by theCompany immediately upon the date of such payment by BOW. As of March 12, 2003,BOW had issued one letter of credit for $178,000.

 

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

 

Effective December 17, 2002, based upon the Company’s assessment thatit would otherwise be unable to comply with one of the covenants containedtherein, the Company and BOW executed a First Amendment to Credit Agreement,which reduced the trailing four fiscal quarter EBITDA requirement and increasedthe interest rate on the replacement term loan from a spread of 2.5% over LIBORto a spread of 3.0 % over LIBOR. The interest rate spread for the Company’soption to compute interest based on BOW’s reference rate was unchanged underthe Amendment.

 

Effective March 11, 2003, based upon the Company’s assessment that itmight otherwise be unable to comply with one of the covenants contained in theCredit Agreement, as amended, the Company and BOW executed a Second Amendmentto the Credit Agreement. Among other matters, the Amendment modified a certaincovenant that the Company would have otherwise failed to meet due to its netloss for the quarter ended March 12, 2003. In addition, the Second Amendment modified the terms of the CreditAgreement to eliminate the unutilized $1,000,000 line of credit for newcoffeehouse development applicable to borrowings during the Company’s fiscalyear ending in 2003, and imposed certain new restrictions on its ability toutilize the separate $1,000,000 line of credit for new coffeehouse developmentapplicable to borrowings during its fiscal year ending in 2004.

 

On September 30, 1997, the Company entered into a promissory note,term loan agreement and security agreement with Nuvrty, Inc., a Coloradocorporation controlled by Amre Youness, a former director of the Company.  All outstanding principal and accruedinterest was due and payable on September 30, 2002.  The loan was secured by the assets of theCompany and provided for borrowings up to $1,000,000 with interest accruing andpaid monthly at the prime rate plus 3.5%. The Company borrowed the full amount under the loan.  In connection with the acquisition of CoffeePeople, the Company repaid the loan on July 8, 1999. When entering intothe promissory note with Nuvrty, the Company issued a warrant to Nuvrty topurchase 85,000 shares of the Company’s common stock at a price of $9.00 pershare.  The warrants are exercisableimmediately and expire on September 30, 2003. The fair value of thewarrants associated with all the above debt was insignificant.

 

Maturities of long-term debt for years subsequent toMarch 12, 2003 are as follows:

 

| **Fiscal  Year**      |   |      |      |
|-----------------------|--------|-----------|-----------|
| 2003                  |   | $         | 1,200,000 |   |
| 2004                  |   | 1,200,000 |      |
| Total long-term  debt |   | $         | 2,400,000 |   |

 

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4.                                       PROVISIONFOR STORE CLOSURE

 

Prior to December 31, 2002, the estimated costassociated with closing under-performing stores was accrued in the period inwhich the store was identified for closure by management under a plan oftermination. Effective December 31, 2002, the Company adopted Statement ofFinancial Accounting Standards (SFAS) No. 146, “Accounting for Costs Associatedwith Exit or Disposal Activities,” and now records these estimated costs whenthey are incurred rather than at the date of a commitment to an exit ordisposal plan. Such costs primarily consist of the estimated cost to terminatereal estate leases. During the nine months ended March 12, 2003, the Companyrecorded a net recovery of $13,000, comprised of $36,000 in lease terminationexpenses, offset by the reversal of $49,000 in lease termination expenses dueto the fact that the related location was sold and the Company is no longerliable under the lease. The $36,000 in lease termination expenses is includedin cost of sales and related occupancy costs, and the $49,000 reversal isincluded in provision for asset impairment on the condensed consolidatedstatement of operations.

 

Provision for store closure consists of thefollowing:

 
|                                   |   | **Beg Balance** |      | **Amounts  Charged  to Expense** |   | **Cash  Payments** |   | **End Balance** |     |
|----------------------------------------|--------|-----------------|-----------|----------------------------------|--------|--------------------|--------|-----------------|----------|
| Year ended July  3, 2002               |   | $               | 1,372,000 |                             | $      | 141,000            |   | $               | (932,000 | ) | $ | 581,000 |   |
| Thirty-six weeks  ended March 12, 2003 |   | $               | 581,000   |                             | $      | (13,000            | )      | $               | (150,000 | ) | $ | 418,000 |   |

 

5.                                       EARNINGSPER SHARE

 

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

 
|                                           |   | **Twelve  Weeks Ended  March 12, 2003** |     | **Twelve  Weeks Ended  March 6, 2002** |   | **Thirty-Six  Weeks Ended  March 12, 2003** |   | **Thirty-Six  Weeks Ended  March 6, 2002** |    |
|------------------------------------------------|--------|-----------------------------------------|----------|----------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|---------|
| **Numerator**:                                 |   |                                    |     |                                   |   |                                        |   |                                       |    |
| Net income  (loss)                             |   | $                                       | (219,000 | )                                      | $      | (190,000                                    | )      | $                                          | 483,000 |   | $ | 599,000 |   |
| **Denominator:**                               |   |                                    |     |                                   |   |                                        |   |                                       |    |
| Basic  weighted average shares outstanding     |   | 5,161,000                               |     | 5,161,000                              |   | 5,161,000                                   |   | 5,161,000                                  |    |
|                                           |   |                                    |     |                                   |   |                                        |   |                                       |    |
| Effect of  dilutive securities                 |   | —                                  |     | —                                 |   | 35,000                                      |   | —                                     |    |
|                                           |   |                                    |     |                                   |   |                                        |   |                                       |    |
| Diluted weighted  average shares               |   | 5,161,000                               |     | 5,161,000                              |   | 5,196,000                                   |   | 5,161,000                                  |    |
|                                           |   |                                    |     |                                   |   |                                        |   |                                       |    |
| Basic  and diluted net income (loss) per share |   | $                                       | (0.04    | )                                      | $      | (0.04                                       | )      | $                                          | 0.09    |   | $ | 0.12 |   |

 

All of the 730,000 warrants to purchase sharesof common stock outstanding during the twelve and the thirty-six weeks endedMarch 12, 2003 were excluded from the calculation of diluted net income (loss)per share as their inclusion would have been anti-dilutive. During thethirty-six weeks ended March 12, 2003, 188,000 options outstanding wereincluded in the calculation of diluted net income (loss) per share. Thisresulted in 35,000 dilutive shares for the thirty-six weeks ended March 12,2003. For the twelve weeks ended March 12, 2003, 581,000 options outstandingwere excluded from the calculation of diluted net income (loss) per share, astheir inclusion would have been anti-dilutive. During both the twelve and thethirty-six weeks ended March 6, 2002, 468,000 options outstanding and all ofthe 730,000 warrants to purchase shares of common stock outstanding wereexcluded from the calculation of diluted net income (loss) per share as theirinclusion would have been anti-dilutive.

 

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6.                                       SEGMENTAND RELATED INFORMATION

 

The Company has three reportablesegments:  retail operations, wholesaleoperations and franchise operations. The Company evaluates performance of its operating segments based onincome before income taxes.

 

Summarized financial informationconcerning the Company’s reportable segments is shown in the followingtable.  The other total assets consistof corporate cash, corporate notes receivable, corporate prepaid expenses, andcorporate property and equipment.  Theother component of segment profit before tax includes corporate general andadministrative expenses, depreciation and amortization expense and interestexpense.

 
|                                               |   | **Retail  Operations** |      | **Wholesale  Operations** |   | **Franchise  Operations** |   | **Other**  |      | **Total** |   |
|----------------------------------------------------|--------|------------------------|-----------|---------------------------|--------|---------------------------|--------|------------|-----------|-----------|--------|
| **Twelve Weeks Ended****March  12, 2003**          |   |                   |      |                      |   |                      |   |       |      |      |   |
| Total revenue                                      |   | $                      | 7,474,000 |                      | $      | 3,052,000                 |   | $          | 1,531,000 |      | $      | — |   | $ | 12,057,000 |   |
| Interest expense                                   |   | 10,000                 |      | —                    |   | 9,000                     |   | 36,000     |      | 55,000    |   |
| Depreciation and  amortization                     |   | 289,000                |      | 71,000                    |   | —                    |   | 61,000     |      | 421,000   |   |
| Segment profit  (loss) before income tax provision |   | 453,000                |      | 142,000                   |   | 1,327,000                 |   | (2,136,000 | )         | (214,000  | )      |
| Total assets as  of March 12, 2003                 |   | $                      | 9,319,000 |                      | $      | 11,132,000                |   | $          | 4,039,000 |      | $      | 3,250,000 |   | $ | 27,740,000 |   |

 
|                                               |   | **Retail  Operations** |       | **Wholesale  Operations** |       | **Franchise  Operations** |       | **Other**  |       | **Total** |       |
|----------------------------------------------------|--------|------------------------|------------|---------------------------|------------|---------------------------|------------|------------|------------|-----------|------------|
| **Twelve Weeks Ended****March  6, 2002**           |   |                   | ** ** |                      | ** ** |                      | ** ** |       | ** ** |      | ** ** |
| Total revenue                                      |   | $                      | 8,610,000  |                      | $          | 2,749,000                 |       | $          | 1,701,000  |      | $          | — |   | $ | 13,060,000 |   |
| Interest expense                                   |   | 16,000                 |       | —                    |       | 17,000                    |       | 95,000     |       | 128,000   |       |
| Depreciation and  amortization                     |   | 345,000                |       | 103,000                   |       | —                    |       | 74,000     |       | 522,000   |       |
| Segment profit  (loss) before income tax provision |   | 487,000                |       | (11,000                   | )          | 1,766,000                 |       | (2,432,000 | )          | (190,000  | )          |
| Total assets as  of March 6, 2002                  |   | $                      | 10,741,000 |                      | $          | 10,672,000                |       | $          | 3,049,000  |      | $          | 3,947,000 |   | $ | 28,409,000 |   |

 

 
|                                               |   | **Retail  Operations** |       | **Wholesale  Operations** |   | **Franchise  Operations** |   | **Other**  |      | **Total** |   |
|----------------------------------------------------|--------|------------------------|------------|---------------------------|--------|---------------------------|--------|------------|-----------|-----------|--------|
| **Thirty-Six Weeks Ended March 12,  2003**         |   |                   |       |                      |   |                      |   |       |      |      |   |
| Total revenue                                      |   | $                      | 23,661,000 |                      | $      | 11,250,000                |   | $          | 4,461,000 |      | $      | — |   | $ | 39,372,000 |   |
| Interest expense                                   |   | 28,000                 |       | —                    |   | 38,000                    |   | 151,000    |      | 217,000   |   |
| Depreciation and  amortization                     |   | 927,000                |       | 216,000                   |   | —                    |   | 184,000    |      | 1,327,000 |   |
| Segment profit  (loss) before income tax provision |   | 1,220,000              |       | 1,432,000                 |   | 4,453,000                 |   | (6,578,000 | )         | 527,000   |   |
|                                                    |        |                        |            |                           |        |                           |        |            |           |           |        |  |  |  |  |  |

 
|                                               |   | **Retail  Operations** |       | **Wholesale  Operations** |   | **Franchise  Operations** |   | **Other**  |      | **Total** |   |
|----------------------------------------------------|--------|------------------------|------------|---------------------------|--------|---------------------------|--------|------------|-----------|-----------|--------|
| **Thirty-Six Weeks Ended March 6,  2002**          |   |                   |       |                      |   |                      |   |       |      |      |   |
| Total revenue                                      |   | $                      | 26,971,000 |                      | $      | 11,521,000                |   | $          | 4,700,000 |      | $      | — |   | $ | 43,192,000 |   |
| Interest expense                                   |   | 46,000                 |       | —                    |   | 49,000                    |   | 338,000    |      | 433,000   |   |
| Depreciation and  amortization                     |   | 1,055,000              |       | 444,000                   |   | —                    |   | 234,000    |      | 1,733,000 |   |
| Segment profit  (loss) before income tax provision |   | 1,247,000              |       | 1,690,000                 |   | 4,764,000                 |   | (7,086,000 | )         | 615,000   |   |
|                                                    |        |                        |            |                           |        |                           |        |            |           |           |        |  |  |  |  |  |

 

7.                                       INTANGIBLEASSETS

 

Effective June 28, 2001, the Company adoptedSFAS Nos. 141 and 142, “Business Combinations” and “Goodwill and OtherIntangible Assets,” respectively, which require that the Company prospectivelycease

 

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amortization of goodwill and instead conduct periodic tests of goodwillfor impairment.  The Company completed atest for goodwill impairment as of July 3, 2002, and determined that nogoodwill impairment was indicated as of that date. The Company has selected itsfiscal year end as the annual date at which it will test for the impairment ofgoodwill. The following table details the balances of the Company’s amortizableintangible assets that continue to be amortized as of March 12, 2003:

 
|                 |   | **Gross  Carrying Amount** |   | **Accumulated  Amortization** |   | **Net****Carrying  Amount** |   |
|----------------------|--------|----------------------------|--------|-------------------------------|--------|-----------------------------|--------|
| Leasehold  interests |   | $                          | 3,000  |                          | $      | 2,000                       |   | $ | 1,000 |   |
| Leasehold rights     |   | $                          | 23,000 |                          | $      | 23,000                      |   | $ | — |   |
| Trademarks           |   | $                          | 32,000 |                          | $      | 6,000                       |   | $ | 26,000 |   |

 

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

 

| **Fiscal  year:** |   |   |   |
|-------------------|--------|--------|--------|
| 2003              |   | $      | 2,000  |   |
| 2004              |   | $      | 1,000  |   |
| 2005              |   | $      | 1,000  |   |
| 2006              |   | $      | 1,000  |   |
| 2007              |   | $      | 1,000  |   |

 

Changes in the carrying amount of goodwill forthe twenty-four weeks ended March 12, 2003 are summarized as follows:

 
| Balance as of  July 3, 2002   |   | $       | 12,164,000 |   |
|-------------------------------|--------|---------|------------|--------|
| Dispositions                  |   | (74,000 | )          |
| Balance as of  March 12, 2003 |   | $       | 12,090,000 |   |

 

The goodwill disposition of $74,000 related to threeCoffee Plantation locations, which closed in December 2002.

 

8.                                       SUBSEQUENTEVENTS

 

On April 10, 2003, theCompany borrowed $950,000 from BOW under its revolving $1,000,000 credit linedesignated for equipment purchases, and immediately purchased coffee packagingequipment for the same amount. Under the terms of the BOW Credit Agreement,this amount will convert to a 36-month term loan on August 29, 2003, with theentire outstanding balance to be repaid by August 31, 2006.

 

On April 14, 2003, theCompany sold three of its Company-operated locations in New England to afranchisee for $810,000, plus $90,000 in franchise fees. The net book value of$46,000 related to these three coffeehouses was included on the condensedconsolidated balance sheet in Assets Held for Sale as of March 12, 2003.

 

On April 25, 2003, theCompany announced that it had appointed a new Chief Executive Officer, Roger M.Laverty. The employment agreement between the Company and Mr. Laverty willbecome effective April 29, 2003.

 

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**Item 2****.**           **Management’s Discussion And Analysis OfFinancial Condition And Results Of Operations.**

 

**AWarning About Forward Looking Statements.**

 

We make forward-looking statements in thisquarterly report that are subject to risks and uncertainties.  These forward-looking statements includeinformation about possible or assumed future results of our financialcondition, operations, plans, objectives and performance. Additionally, when weuse the words “believe,” “expect,” “anticipate,” “estimate” or similarexpressions, we are making forward-looking statements.  Many possible events or factors could affectour future financial results and performance. This could cause our results or performance to differ materially fromthose expressed in our forward-looking statements. You should consider theserisks when you review this report, along with the following possible events orfactors:

 

•            the financial andoperating performance of our retail operations;

 

•            our ability tomaintain profitability over time;

 

•            ourability to perform within the terms of our credit agreement;

 

•            the successfulexecution of our growth strategies;

 

•            franchisees’adherence to our practices, policies and procedures;

 

•            the impact ofcompetition; and

 

•            the availability ofworking capital.

 

Foreseeable risks anduncertainties are described elsewhere in this report and in detail under thecaption “Risk Factors and Trends Affecting Diedrich Coffee and Its Business” inour Annual Report on Form 10-K for the fiscal year ended July 3, 2002 and inother reports that we file with the Securities and Exchange Commission. Weundertake no obligation to publicly release the results of any revision of theforward-looking statements. Unless otherwise indicated, “we,” “us,” “our,” andsimilar terms refer to Diedrich Coffee, Inc.

 

**General.**

 

Diedrich Coffee, Inc. is aspecialty coffee roaster, wholesaler and retailer.  We sell brewed, espresso-based and various blended beveragesprimarily made from our own fresh roasted premium coffee beans, as well aslight food items, whole bean coffee, and accessories through our Companyoperated and franchised retail locations. We also sell whole bean and ground coffees on a wholesale basis througha network of distributors in the Office Coffee Service (“OCS”) market, and toother wholesale customers, including restaurant chains and otherretailers.  Our brands include DiedrichCoffee, Gloria Jean’s Coffees and Coffee People.  As of March 12, 2003, Diedrich Coffee owned and operated 62retail locations and franchised 346 other retail locations under these brands,for a total of 408 retail coffee outlets. Our retail units are located in 36states and 10 foreign countries.  As ofMarch 12, 2003, we also have over 390 wholesale accounts with OCS distributors,chain and independent restaurants and others. In addition, we operate a large coffee roasting facility in centralCalifornia that supplies freshly roasted coffee to our retail locations andwholesale accounts.

 

*Retail Outlets*

 

Our retail outlet distribution channel can bedivided into two sub-channels, each with its own distinct business model,including differences in revenue and cost structure, overhead, and capitalrequirements.  These two retail sub-channelsare Company operated retail outlets and franchised retail outlets.  We view retail outlets as a singledistribution channel, despite the differences noted above, primarily becauseour retail customers do not make any distinction between Company and franchiseoperated locations.  The criticalsuccess factors are, therefore, the same for each type of retail location,whether Company operated or franchised: quality of product, service, andatmosphere.  The economic model and coststructures are also the same for each type of location at the retail unit

 

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level, notwithstanding their different direct financial impacts on usin our roles as both an operator and franchiser of retail outlets.  Furthermore, the potential contribution ofany given outlet, as measured by the amount of roasted coffee produced throughour roasting plant, is the same.

 

Presently, our largest brand is Gloria Jean’sand over 95% of Gloria Jean’s retail units are franchised. Gloria Jean’s retailunits are located throughout the United States, and in 10 foreign countries.Our Diedrich Coffee brand has a higher concentration of Company operated units,with 69% of retail locations operated by us. Diedrich Coffee units are locatedprimarily in Orange County, California, although there are a number of Diedrichlocations in Denver, Houston, and elsewhere in the United States. We alsooperate retail coffee outlets under a third brand, Coffee People, which are100% Company operated at this time. Our Coffee People outlets are all locatedin Portland, Oregon.

 

A table summarizing the relative sizes ofeach of our brands, on a unit count basis, and changes in unit count for eachover the thirty-six weeks ended March 12, 2003, is set forth below:

 
|                           |   | **Units at  July 3,  2002** |   | **Opened** |   | **Closed** |   | **Net transfers  between the  Company and  Franchise** |   | **Units at  March 12,  2003** |   |
|--------------------------------|--------|-----------------------------|--------|------------|--------|------------|--------|--------------------------------------------------------|--------|-------------------------------|--------|
| **Gloria Jean’s Brand**   |   |                        |   |       |   |       |   |                                                   |   |                          |   |
| Company Operated               |   | 18                          |   | —     |   | —     |   | (3                                                     | )      | 15                            |   |
| Franchise – Domestic      |   | 155                         |   | 2          |   | (18        | )      | 3                                                      |   | 142                           |   |
| Franchise – International |   | 140                         |   | 54         |   | (1         | )      | —                                                 |   | 193                           |   |
| Subtotal Gloria Jean’s    |   | 313                         |   | 56         |   | (19        | )      | —                                                 |   | 350                           |   |
| **Diedrich Coffee Brand**      |   |                        |   |       |   |       |   |                                                   |   |                          |   |
| Company Operated               |   | 25                          |   | —     |   | —     |   | —                                                 |   | 25                            |   |
| Franchise – Domestic      |   | 12                          |   | —     |   | (1         | )      | —                                                 |   | 11                            |   |
| Subtotal Diedrich              |   | 37                          |   | —     |   | (1         | )      | —                                                 |   | 36                            |   |
| **Other Brands**               |   |                        |   |       |   |       |   |                                                   |   |                          |   |
| Company Operated               |   | 27                          |   | —     |   | (5         | )      | —                                                 |   | 22                            |   |
| **Total**                      |   | 377                         |   | 56         |   | (25        | )      | —                                                 |   | 408                           |   |

 

*Wholesale Distribution*

 

We currently have over 390 wholesale accountsnot affiliated with our retail locations, which purchase coffee from us underboth the Diedrich Coffee and Gloria Jean’s brands. Our current wholesaleaccounts are in the Office Coffee Supply market, chain restaurants, independentrestaurants, other hospitality industry enterprises and specialtyretailers.  Additionally, our franchiseagreements require both Diedrich Coffee and Gloria Jean’s franchisees topurchase substantially all of their coffee from us.

 

*Seasonality and Quarterly Results*

 

Our business is subject to seasonalfluctuations as well as economic trends that affect retailers in general.Historically, our net sales have not been realized proportionately in eachquarter, with net sales being the highest during the second fiscal quarter,which includes the November – December holiday season. Hot weather tends toreduce sales. Quarterly results are affected by the timing of the opening ofnew stores, which may not occur as anticipated due to events outside ourcontrol. As a result of these factors, the financial results for any individualquarter may not be indicative of the results that may be achieved in a fullfiscal year.

 

12

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**Resultsof Operations.**

 

*Twelve Weeks Ended March 12, 2003 Comparedwith the Twelve Weeks Ended March 6, 2002*

 

***Total Revenue.***  Total revenue for the twelve weeks endedMarch 12, 2003 decreased by $1,003,000, or 7.7%, to $12,057,000 from$13,060,000 for the twelve weeks ended March 6, 2002. This decrease wasattributable to decreases in retail and franchise revenue, partially offset byan increase in wholesale and other revenue. Each component is discussed below.

 

Retail sales for the twelve weeks ended March12, 2003 decreased by $1,136,000, or 13.2%, to $7,474,000 from $8,610,000 forthe prior year period.  This decreaseprimarily represented the net impact of several factors. First, the number ofCompany stores decreased in the current year versus the earlier period becauseof the closure of 10 poorly performing Company-operated locations, the closureof three Company-operated kiosks, and the sale of four other Company-operatedlocations since the beginning of the prior year period. The reduction in retailsales from the unit divestitures noted above was approximately $1,207,000.Retail sales were further reduced by a 4.9%, or $306,000, decrease incomparable store sales for Company operated units during the quarter. Thesedecreases were partially offset by an increase in retail sales of approximately$311,000 due to the transfer to Company operations of three previouslyfranchised locations, as well as a $66,000 increase in retail sales from ourinternet website.

 

Wholesale revenue increased $303,000, or11.0%, to $3,052,000 for the twelve weeks ended March 12, 2003 from $2,749,000for the prior year period.  Thisincrease was primarily the net result of the following factors:

 

*Keurig “K-cup” and other OCS sales*.  Keurig and other Office Coffee Service salesincreased by $655,000 to $1,416,000 for the twelve weeks ended March 12, 2003,an 86.0% increase over the year ago quarter. This is primarily due to unusuallylow sales of K-cups in the prior year period as a result of a product recallprogram in place at that time to replace damaged product in wholesalecustomers’ inventories.

 

*Wholesale revenue from franchisees*.  Sales of roasted coffee to our franchiseesdecreased $298,000, or 19.6%, for the twelve weeks ended March 12, 2003, whichwas the combined impact of an 18 unit decrease in the number of domesticfranchises compared to the prior year, and a 10.3% decrease in Gloria Jean’sfranchise comparable store sales for the quarter.

 

*Coffee sales to independent and chainrestaurants and specialty retailers*.  Wholesale coffee sales to independent andchain restaurants and other specialty retailers decreased by $65,000, or 14.1%,versus the year ago quarter. We are reducing our focus on independent andspecialty retailer accounts because many of these accounts represent only asingle or few retail locations and require proportionately more resources tosupport.

 

*Coffee sales to grocery retailers. *Although we beganselling coffee through the grocery distribution channel during our secondfiscal quarter this year, revenue on our initial coffee shipments netted tozero because the wholesale selling value of such shipments was applied againstour “slotting fee” obligations to a grocery store chain. It is customary to paygrocery chains such fees to set up the initial distribution of  product in their retail store system. Duringthe twelve weeks ended March 12, 2003, however, such slotting fees were fullycovered by cumulative shipments, and we recognized $11,000 in net revenue onsubsequent shipments during the balance of the quarter.

 

Franchise revenue decreased by $170,000, or10.0%, to $1,531,000 for the twelve weeks ended March 12, 2003 from $1,701,000for the prior year period.  Franchiserevenue consists of initial franchise fees and franchise renewal fees, areadevelopment fees, royalties received on sales at franchised locations, andmiscellaneous other franchise revenue, including coordination fees receivedfrom product suppliers. The decrease in franchise revenue was primarily theresult of a decrease in franchise royalties versus the prior year period. Thiswas the net impact of a reduction in domestic franchise royalties, which waspartially offset by an increase in international royalties. Domestic royaltiesdecreased primarily because of the 18-unit reduction in domestic franchisestores compared to a year earlier. International royalties increased because ofa 67-unit increase in the number of international outlets compared to the prioryear, although international franchise units pay a lower average royalty ratecompared to domestic franchises. Miscellaneous other franchise revenue,including vendor coordination fees, decreased by approximately $43,000 comparedto the prior year period.

 

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***Cost of Sales andRelated Occupancy Costs*.**  Cost of sales and related occupancy costs for the twelve weeksended March 12, 2003 decreased 6.6% to $5,906,000 from $6,324,000 for the prioryear period.  On a margin basis, cost ofsales and related occupancy costs increased to 49.0% of total revenue for thetwelve weeks ended March 12, 2003 from 48.4% of total revenue for the twelveweeks ended March 6, 2002.  This unfavorable0.6 margin basis point change was the net impact of a favorable 0.2 percentagepoint change in cost of sales, and an unfavorable 0.8 margin basis point changein occupancy costs.

 

Cost of sales as a percentage of totalrevenue decreased slightly during the current quarter due to the net impact oftwo factors. First, our cost of sales margin improved this quarter versus ayear ago due to the impact of the Keurig K-Cup return discussed above because$297,000 of additional cost of sales was recognized in the prior year to writeoff defective inventory returned by customers. This improvement was partiallyoffset by our initial wholesale shipments of coffee into the grocery storedistribution channel during the current year. Because we recorded the relatedproduct cost of sales of grocery coffee shipments during the quarter at theirfull cost, but recognized only a portion of the related revenue (see discussionabove under Total Revenue – Coffee sales to grocery retailers), the groceryprogram resulted in an increase in cost of sales as a percentage of revenueduring the quarter. Occupancy costs as a percentage of revenue increasedprimarily due to a lease settlement amount of $123,000 that we received andrecorded in the prior year quarter, with no corresponding amount received inthe current year quarter. This unfavorable comparison versus the prior year waspartially offset by the divestiture of 29-Company operated units, as notedabove in the discussion of changes in retail revenue. These units weregenerally closed or sold because of worse than average sales volumes or higherthan average occupancy costs relative to sales volume.

 

***Operating Expenses.**** *Operating expenses for the twelveweeks ended March 12, 2003 decreased by $113,000, or 2.8%, to $3,898,000 from$4,011,000 during the prior year period. On a margin basis, operating expenses increased to 32.3% of totalrevenue during the current year period from 30.7% for the year ago quarter.This unfavorable 1.6 margin basis point change resulted from severalfactors.  Bad debt expense increased by$148,000 versus the year ago period. As previously noted during the prior yearperiod, we collected a number of receivables that had previously been reservedfor as a result of an aggressive collection program implemented at that time.This resulted in the reversal of bad debt reserves in the prior year period anda relative increase in current year bad debt expense on a comparative basiswith the prior year. Advertising expense also increased versus the prior yearas part of an overall effort to increase comparable store sales in retail unitsand to add new accounts at the wholesale level. We also incurred additional newselling expenses in the current year, which are classified as “operatingexpenses,” as we launched our grocery store sales program. As described in thediscussion of cost of sales above, this program resulted in nominal new revenueduring the current year period because of our accounting for slotting fees andthe impact of these new expenses, when analyzed as a percentage of revenue, resultedin an erosion of reported margins. Finally, we experienced an increase in ourworkers’ compensation insurance rates in our retail coffeehouses compared tothe prior year, resulting in an increase in operating expenses as a percentageof revenue.

 

***Depreciation andAmortization*.** Depreciation and amortization decreased by $101,000 to $421,000 for thetwelve weeks ended March 12, 2003 from $522,000 for the twelve weeks endedMarch 6, 2002. This decrease was primarily due to the divestiture of Company-operatedretail locations discussed above.

 

***General andAdministrative Expenses*.**  General and administrative expenses increased by $232,000, or12.0%, to $2,166,000 for the twelve weeks ended March 12, 2003 from $1,934,000for the twelve weeks ended March 6, 2002. On a margin basis, general andadministrative expenses increased to 18.0% of total revenue in the thirdquarter of fiscal 2003 from 14.8% in the year ago quarter.  This 3.2 unfavorable margin basis point changewas the net result of several factors. First, we began adding resources duringthe current year in the areas of franchise sales, real estate, construction andfranchise operations in order to increase our ability to support new franchisestore development. As such, we incurred $146,000 in increased expenses in thesedepartments for the twelve weeks ended March 12, 2003 as compared with theprior year period. We also incurred recruitment fees of $64,000 in connectionwith hiring an executive search firm to find a new Chief Executive Officer. Wealso incurred $56,000 in increased Directors & Officers liability insurancepremiums versus a year ago.  Inaddition, our workers’ compensation insurance rates increased versus the prioryear, which increased the cost of home office support center personnel.Finally, it should be noted that many of our general and administrativeexpenses are relatively fixed, and therefore on a margin basis represent ahigher percentage of revenue when our revenue declines.

 

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***Provision for(Recovery of) Asset Impairment*.**  Provision for asset impairment costsdecreased $416,000 to a recovery of $49,000 for the twelve weeks ended March12, 2003, from $367,000 of expense in the prior year period. During the currentquarter, we reversed $49,000 in closed store lease reserves associated with aclosed coffeehouse in Arizona, which was subleased for the balance of themaster lease term on a full pass-through rental basis. During the year agoquarter, we recorded a charge of $367,000 for asset impairment andrestructuring costs. That charge was primarily comprised of severance andrelated employee benefit costs associated with the elimination of a number ofsupport center positions.

 

***Gain on AssetDisposals.*** Gain on asset disposals increased by $96,000 to $117,000 for the twelveweeks ended March 12, 2003, from $21,000 in the prior year period. During thecurrent quarter, we recognized a net gain of $117,000, which was the net resultof a $122,000 gain on the sale of a closed location partially offset by thewrite-off of equipment from other closed locations. During the year agoquarter, we recognized a net gain of $21,000 on the closure of four locationsand the sale of related equipment.

 

***Interest Expense andOther, Net.**** *Interestexpense and other, net decreased by $67,000 to $46,000 for the twelve weeksended March 12, 2003 from $113,000 for the twelve weeks ended March 6, 2002.This decrease is primarily due to a reduction in the amount of our bank debt,and to a lesser degree to a reduction in our interest rate.

 

*Thirty-Six Weeks Ended March 12, 2003 Comparedwith the Thirty-Six Weeks Ended March 6, 2002*

 

***Total Revenue.***  Total revenue for the thirty-six weeks endedMarch 12, 2003 decreased by $3,820,000, or 8.8%, to $39,372,000 from$43,192,000 for the thirty-six weeks ended March 6, 2002. This decrease wasattributable to decreases in retail sales, wholesale and other revenue andfranchise revenue.  Each component isdiscussed below.

 

Retail sales for the thirty-six weeks ended March12, 2003 decreased by $3,310,000, or 12.3%, to $23,661,000 from $26,971,000 forthe prior year period.  This decreaseprimarily represented the net impact of several factors.  First, the number of Company storesdecreased in the current year versus the earlier period because of the closureof 10 poorly performing Company-operated locations, the closure of threeCompany-operated kiosks, and the sale of 16 other Company-operated locationssince the beginning of the prior year period. The reduction in retail salesfrom the unit divestitures noted above was approximately $4,654,000. Retailsales were further reduced by a 0.8%, or $58,000, decrease in comparable storesales for Company-operated units on a year to date basis compared to the prioryear. This decrease was partially offset by an increase in retail sales ofapproximately $1,219,000 due to the transfer to Company operations of threepreviously franchised locations, since the prior year period, and a $183,000increase in retail sales from our internet website.

 

Wholesale revenue decreased $271,000, or2.4%, to $11,250,000 for the thirty-six weeks ended March 12, 2003 from$11,521,000 for the prior year period. This decrease was primarily the net result of the following factors:

 

*Wholesale revenue from franchisees*.  Sales of roasted coffee to our franchiseesdecreased $593,000, or 9.3%, for the thirty-six weeks ended March 12, 2003primarily because of an 18 unit decrease in the number of domestic franchisescompared to the prior year, and a 1.0% decrease in Gloria Jean’s franchisecomparable store sales on a year to date basis versus the prior year period.

 

*Keurig “K-cup” and other OCS sales*.  Keurig and other Office Coffee Service salesincreased by $504,000 to $4,252,000 for the thirty-six weeks ended March 12,2003, a 13.4% increase over the year ago period. As noted above in thediscussion of quarterly results, prior year sales were negatively impacted by aproduct defect regarding certain production runs of Keurig K-Cups produced andshipped during the third fiscal quarter last year.

 

*Coffee sales to independent and chainrestaurants and specialty retailers*.  Wholesale coffee sales to independent andchain restaurants and other specialty retailers decreased by $193,000, or14.1%, versus the year ago period. We are reducing our focus on independent andspecialty retailer accounts because many of these accounts represent only asingle or few retail locations and require proportionately more resources tosupport.

 

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*Coffee sales to grocery retailers.*Althoughwe began selling coffee through the grocery distribution channel during oursecond fiscal quarter this year, revenue on our initial coffee shipments nettedto zero because the wholesale selling value of such shipments was appliedagainst our “slotting fee” obligations to a grocery store chain. It iscustomary to pay grocery chains such fees to set up the initial distribution ofproduct in their retail store system. During the final six weeks of thethirty-six weeks ended March 12, 2003, however, such slotting fees were fullycovered by cumulative shipments, and we recognized $11,000 in revenue onsubsequent shipments during the balance of the third fiscal quarter.

 

Franchise revenue decreased by $239,000, or5.1%, to $4,461,000 for the thirty-six weeks ended March 12, 2003 from$4,700,000 for the prior year period. The decrease in franchise revenue is the net impact of several factors.Initial franchise fees and franchise renewal fees increased approximately$75,000 on a year to date basis versus the prior year, as a result of anincrease in franchise agreements sold or renewed. Franchise royalties decreased$224,000 versus the prior year period. This was the net impact of a reductionin domestic franchise royalties and an increase in international royalties.Domestic royalties decreased primarily because of the 18-unit reduction indomestic franchise stores from March 6, 2002 to March 12, 2003, and a 1.0%decrease in franchise comparable store sales. International royalties increasedbecause of a 67-unit increase in the number of international outlets comparedto the prior year, although international franchise units pay a lower averageroyalty rate compared to domestic franchises. Miscellaneous other franchiserevenue, including vendor coordination fees, decreased by $90,000 compared tothe prior year.

 

***Cost of Sales andRelated Occupancy Costs*.**  Cost of sales and related occupancy costs for the thirty-sixweeks ended March 12, 2003 decreased 11.8% to $18,907,000 from $21,432,000 forthe prior year period.  On a marginbasis, cost of sales and related occupancy costs decreased to 48.0% of totalrevenue on a year to date basis from 49.6% of total revenue in the prior year.This 1.6 favorable margin basis point change was the combined impact of a 0.6favorable cost of sales margin basis point change, and a 1.0 favorableoccupancy costs margin basis point change. These margin basis pointimprovements resulted primarily from the divestiture of 29 Company-operatedunits noted above in the discussion of changes in retail revenue, as theseunits were generally closed or sold because of worse than average sales volumesor higher than average occupancy costs relative to sales volume.

 

***Operating Expenses.**** *Operating expenses for thethirty-six weeks ended March 12, 2003 decreased 3.3% to $12,092,000 from$12,508,000 for the prior year period. On a margin basis, operating expenses increased to 30.7% of totalrevenue during the current year period from 29.0% for the year ago period.  This unfavorable 1.7 margin basis pointchange for the thirty-six weeks ended March 12, 2003 as compared with the prioryear resulted primarily from the increases in bad debt expense, advertising expense,grocery related selling expenses and worker’s compensation expense noted abovein the discussion of Operating Expenses for the twelve weeks ended March 12,2003.

 

***Depreciation andAmortization*.** Depreciation and amortization decreased by $406,000 to $1,327,000 forthe thirty-six weeks ended March 12, 2003 from $1,733,000 for the thirty-sixweeks ended March 6, 2002. This decrease was primarily due to the divestitureof Company-operated retail locations since the prior year noted in thediscussion of retail sales, above.

 

***General and AdministrativeExpenses*.** General and administrative expenses increased by $156,000, or 2.5%, to$6,397,000 for the thirty-six weeks ended March 12, 2003 from $6,241,000 forthe thirty-six weeks ended March 6, 2002. On a margin basis, general andadministrative expenses increased to 16.2% of total revenue in fiscal 2003 from14.4% in the year ago period.  This 1.8unfavorable margin basis point change was generally the result of the samefactors discussed above for the twelve weeks ended March 12, 2003.

 

***Provision for AssetImpairment*.** Provision for asset impairment costs decreased $332,000 to $57,000 forthe thirty-six weeks ended March 12, 2003 from $389,000 for the thirty-sixweeks ended March 6, 2002. During the current year, we recorded an assetimpairment charge of $106,000 to reduce the carrying value associated with oneof our coffeehouses in Portland, Oregon. In addition, we reversed $49,000 inclosed store lease reserves associated with a closed coffeehouse in Arizona forwhich a full pass-through sublease was obtained. During the prior year, werecorded an asset impairment charge of $22,000, related to the impendingclosure of a Portland coffee kiosk, in addition to the $367,000 recorded duringthe third quarter last year, which is discussed in the quarterly results above.

 

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***Gain on AssetDisposals.*** Gain on asset disposals increased by $1,000 to $119,000 for thethirty-six weeks ended March 12, 2003, from $118,000 in the prior year period.During the thirty six weeks ended March 12, 2003, we recognized a net gain of$117,000, which was the net result of a $122,000 gain on the sale of a closedlocation partially offset by the write-off of equipment from other closedlocations. During the year ago period, we recognized a net gain of $400,000 onthe sale of two locations, partially offset by losses on the closure of severallocations and the sale of related equipment.

 

***Interest Expense andOther, Net.**** *Interestexpense and other, net decreased by $208,000 to $184,000 for the thirty-sixweeks ended March 12, 2003 from $392,000 for the thirty-six weeks ended March6, 2002. This decrease is primarily due to a reduction in our bank debt, and,to a lesser degree, to a reduction in our interest rate.

 

**FinancialCondition, Liquidity and Capital Resources.**

 

***Current FinancialCondition. ***AtMarch 12, 2003, we had working capital of $1,135,000, as compared to workingcapital of $809,000 as of July 3, 2002, and a working capital deficit of$2,728,000 as of March 6, 2002.

 

***Cash Flows. ***Cash providedby operating activities for the thirty-six weeks ended March 12, 2003 totaled$1,081,000 as compared with $375,000 in net cash provided by operatingactivities for the thirty-six weeks ended March 6, 2002.  This improvement is the net result of manyfactors more fully enumerated in the unaudited consolidated statement of cashflows in the accompanying financial statements.

 

Net cash used in investing activities for thethirty-six weeks ended March 12, 2003 totaled $304,000 as compared with netcash provided of $1,074,000 for the thirty-six weeks ended March 6, 2002.During the thirty-six weeks ended March 12, 2003, $613,000 in net cash used ininvesting activities was used for property and equipment expenditures. Theseexpenditures were partially offset by $140,000 in cash received for a parcel ofreal estate we sold in Oregon, $135,000 in cash received for two coffeehouseswe sold in Arizona, $3,000 in miscellaneous small equipment sales, and $31,000of cash received in principal payments on notes receivable we accepted upon thesale of twelve retail locations in Arizona during the prior fiscal year. Duringthe thirty-six weeks ended March 6, 2002, we received $1,645,000 in proceedsfrom the sale of assets, including $1,203,000 for the sale of 12Company-operated locations in Arizona, and $307,000 for the sale of land and abuilding in Oregon. We also received $145,000 in principal payments on notesreceivable issued by the buyer of the 12 locations in Arizona. These proceedsand notes receivable payments were partially offset by $716,000 in property andequipment expenditures.

 

Net cash used in financing activities for thethirty-six weeks ended March 12, 2003 totaled $954,000 as compared to the$1,987,000 in net cash used in financing activities for the thirty-six weeksended March 6, 2002. For both periods the net cash used in financing activitiesconsisted of repayment of long-term debt and capital leases. During thethirty-six weeks ended March 6, 2002, net cash used in financing activitiesalso included $134,000 in payments related to transaction costs associated withour issuance of common stock during our fiscal year ended June 27, 2001.

 

***Outstanding Debt andFinancing Arrangements.***  On September 3, 2002, we entered into a Credit Agreement withUnited California Bank, doing business as Bank of the West or (“BOW”), in orderto repay the balance of all remaining amounts owed to Fleet National Bank(“Fleet”) under our amended Credit Agreement with Fleet. Under the BOW CreditAgreement, we immediately borrowed $3,000,000 under a replacement term loan,the proceeds of which were used to repay our Fleet term loan on September 3,2002, the amended maturity date of the Fleet term loan.

 

Our obligations to BOW under the CreditAgreement are secured by all of our assets, including the stock of each of oursubsidiaries (each of which has guaranteed our obligations under theagreement), as well as all intangible assets we own, including the intellectualproperty and trademark assets that we and our subsidiaries own.

 

The term loan with BOW requires monthly principal payments of $100,000over 30 months and all amounts we owe under the term loan must be repaid byMarch 31, 2005.  We are required to makemonthly interest payments on amounts outstanding under the replacement termloan, computed at either BOW’s reference rate plus 0.75% or a LIBOR rate plus3.0% (pursuant to the First Amendment to Credit Agreement discussed below). Wemay periodically elect to convert portions of our reference rate borrowingsinto LIBOR based borrowings in $100,000

 

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increments, subject to restrictions contained in the agreement. AtMarch 12, 2003, the applicable interest rate was 4.34%, which was based on theLIBOR rate at the time.

 

In addition to the term loan, the BOW CreditAgreement provides us with a revolving $1,000,000 credit line for theacquisition of specified coffee packaging equipment. Any amounts we borrowunder this credit line are scheduled to convert to term loans with monthlyprincipal amortization payments beginning September 30, 2003, and we must repayall outstanding balances by August 31, 2006. We are required to pay interest onany borrowings outstanding under this line of credit on a monthly basis at aninterest rate computed in the same manner as described above for the term loan.There were no amounts outstanding under this credit line at March 12, 2003,although we borrowed funds under this credit line on April 10, 2003 asdiscussed below.

 

The BOW Credit Agreement also provides uswith two separate $1,000,000 lines of credit for new coffeehouse development,one applicable to borrowings during our fiscal year ending in 2003, and theother to borrowings during our fiscal year ending in 2004. Borrowings undereach line of credit will convert to term loans repayable over 36 months, withsuch repayments beginning July 31, 2003 and due in full by June 30, 2006, inthe case of borrowings under the fiscal 2003 line, and beginning July 31, 2004and due in full by June 30, 2007, in the case of the fiscal 2004 line. We arerequired to pay interest on any borrowings under each line of credit on amonthly basis at an interest rate computed in the same manner described abovefor the term loan. There were no amounts outstanding under these credit linesat March 12, 2003.

 

Finally, the BOW Credit Agreement provides uswith a $675,000 revolving working capital and letter of credit facility,subject to a number of restrictions. Our working capital facility draws andletters of credit are limited to a combined maximum of $675,000 outstanding atany time. Furthermore, drawdowns against our working capital facility aresubject to a sub-limit of $500,000, and letters of credit are subject to asub-limit of $250,000. We may only draw funds against our working capitalfacility during the first and fourth quarters of each fiscal year, althoughletters of credit issued under the letter of credit facility may be outstandingthroughout the year. We may repay amounts that we borrow under the workingcapital facility at any time, and we may therefore be able to re-borrow suchfunds on a revolving basis (subject to restrictions including those summarizedabove). All amounts outstanding under our working capital facility are requiredto be repaid by August 31, 2003. Any payments made by BOW with regard to anyletter of credit issued under the letter of credit facility must be repaid byus immediately upon the date of such payment by BOW. As of March 12, 2003, BOWhad issued one letter of credit for $178,000.

 

The BOW agreement imposes severalrestrictions on us, including limitations on our ability to sell assets, makecapital expenditures, incur additional indebtedness, permit new liens upon ourassets, and pay dividends on or repurchase our common stock. We must alsomaintain compliance with agreed-upon financial covenants that limit the amountof indebtedness that we may have outstanding in relation to our tangible networth, require us to maintain a specified minimum dollar value level oftangible net worth, require us to maintain a specified minimum dollar valuelevel of EBITDA for the trailing four fiscal quarters, require us to maintain aspecified minimum level of profitability, and require us to maintain minimumaggregate cash balances in our various BOW bank accounts of at least $800,000for all but ten business days each fiscal year.

 

Effective December 17, 2002, based upon our assessment that we wouldotherwise be unable to comply with one of the covenants contained therein, weand BOW executed a First Amendment to the Credit Agreement, which reduced thetrailing four fiscal quarter EBITDA requirement and increased the interest rateon the replacement term loan to a spread of 3.0 % over LIBOR. The interest ratespread for our option to compute interest based on BOW’s reference rate wasunchanged under the Amendment.

 

On April 10, 2003, we drew down $950,000 under the revolving $1,000,000credit line for the acquisition of specified coffee packaging equipment. Underthe terms of the BOW Credit Agreement, this amount will convert to a 36-monthterm loan on August 29, 2003, with the entire outstanding balance to be repaidby August 31, 2006.

 

Effective March 11, 2003, based upon our assessment that we mightotherwise be unable to comply with one of the covenants contained in the CreditAgreement, as amended, we and BOW executed a Second Amendment to the CreditAgreement. Among other matters, the Amendment modified a certain covenant wewould have otherwise failed to meet due to our net loss for the quarter endedMarch 12, 2003.  Under the SecondAmendment, we are now required to maintain a certain ratio of cash flow to ourcurrent portion of long-term debt.  Inaddition, the Second Amendment modified the terms of the Credit Agreement toeliminate the unutilized $1,000,000 line of credit for

 

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new coffeehouse development applicable to borrowings during our fiscalyear ending in 2003, and imposed certain new restrictions on our ability toutilize the separate $1,000,000 line of credit for new coffeehouse developmentapplicable to borrowings during our fiscal year ending in 2004.  These restrictions stipulate that in orderto utilize this separate $1,000,000 line of credit, our consolidated EBITDA asof the last day of fiscal year ending July 2, 2003 must be equal to or greaterthan $3,200,000, and our consolidated net income for the year ending July 2,2003 must be equal to or greater than $975,000.

 

Based upon the terms of the BOW CreditAgreement as amended, including our principal repayment schedule, our recentoperating performance and business outlook, and status of our balance sheet, webelieve that cash, cash from operations, and funds available under our CreditAgreement will be sufficient to satisfy our working capital needs at theanticipated operating levels for at least the next twelve months.

 

***OtherCommitments. ***Thefollowing represents a comprehensive list of our contractual obligations andcommitments as of March 12, 2003:

 
|                     |   | **Payments Due During the Twelve Months Ended** |   |
|--------------------------|--------|-------------------------------------------------|--------|
|                     |   | **Total**                                       |   | **March  2004** |   | **March  2005** |   | **March  2006** |   | **March  2007** |   | **March  2008** |   | **Thereafter** |   |
|                     |   | **(In thousands)**                              |   |
| Note Payable             |   | $                                               | 2,400  |   | $ | 1,200 |   | $ | 1,200 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Capital Leases           |   | 1,075                                           |   | 256 |   | 216 |   | 152 |   | 44 |   | 44 |   | 363 |   |
| Operating Leases         |   | 16,069                                          |   | 3,925 |   | 3,325 |   | 2,831 |   | 1,746 |   | 1,274 |   | 2,968 |   |
| Green Coffee Commitments |   | 3,419                                           |   | 852 |   | 1,687 |   | 880 |   | — |   | — |   | — |   |
|                     |   | $                                               | 22,963 |   | $ | 6,233 |   | $ | 6,428 |   | $ | 3,863 |   | $ | 1,790 |   | $ | 1,318 |   | $ | 3,331 |   |

 

We are obligated under non-cancelableoperating leases for our coffee houses, roasting facility and administrativeoffices.  Lease terms are generally for10 to 20 years with renewal options and generally require us to pay a proportionateshare of real estate taxes, insurance, common area and other operatingcosts.  Some retail leases provide forcontingent rental payments based on sales thresholds. In addition, we arecontingently liable on the master leases for 134 franchise locations. Under ourhistorical franchising business model, we executed the master leases for theselocations and entered into subleases on the same terms with our franchisees.Under these leases, franchisees pay their rent directly to the landlords. Ifany of these franchisees default on their subleases, we would be responsible.Our maximum theoretical future exposure at March 12, 2003, computed as the sumof all remaining lease payments through the expiration dates of the respectiveleases, was $23,784,000. This amount does not take into consideration anymitigating measures we would seek to take to reduce this exposure in the eventof default, including re-leasing the locations or terminating the master leaseby negotiating a lump sum payment to the landlord which is less than the sum ofall remaining future rents.

 

**CriticalAccounting Policies.**

 

The preparation of our consolidated financialstatements requires us to make estimates and assumptions that affect thereported amounts.  The estimates andassumptions are evaluated on an ongoing basis and are based on historicalexperience and on various other factors that are believed to be reasonable.Accounts significantly impacted by estimates and assumptions include, but arenot limited to, franchise receivables, allowance for bad debt reserves, assetsheld for sale, fixed asset lives, goodwill, intangible assets, income taxes,workers’ compensation reserves, store closure reserves, and contingencies. Webelieve that the following represent our critical accounting policies andestimates used in the preparation of our consolidated financial statements. Thefollowing discussion, however, does not list all of our accounting policies andestimates.

 

***Revenue Recognition- Franchise Operations. ***Initialfranchise fees are recognized when a franchised coffeehouse begins operations,at which time we have performed our obligations related to such fees.  Fees received pursuant to area developmentagreements, which grant the right to develop franchised units in future periodsin specific geographic areas, are deferred and recognized on a pro rata basisas the franchised units subject to the development agreements beginoperations.  In light of our revenuerecognition policies, we have little or no control over when we recognizerevenue related to these initial franchise fees and area development fees.  We monitor the financial condition offranchisees and record provisions for estimated losses on receivables when webelieve that our franchisees are unable to make required payments to us.  Additionally, we cease recording royaltiesfrom franchisees that are delinquent in paying us until we have a history ofpayments being made when due.  If salesor economic

 

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conditions worsen for our franchisees, their financial performance mayworsen, our collection rates may decline and we may be required to assume theirresponsibility for lease payments on franchised stores.

 

***Valuation of Long-Lived Assets. ***We evaluate the carrying value of assets for impairmentwhen the operations of one or more of our brands experience a negative event,including, but not limited to, a significant downturn in sales, a substantialloss of customers, an unfavorable change in demographics or unit closures.  Upon the occurrence of a negative event, weestimate the future undiscounted cash flows for the individual units that areaffected by the negative event.  If theprojected cash flows do not exceed the carrying value of the assets allocatedto each unit, we write down the assets to fair value based on:  the estimated net proceeds we believe we canobtain for the unit upon sale, the discounted projected cash flows derived fromthe unit, or the historical net proceeds obtained from sales of similar units.  The most significant assumptions in our analysisare those used when we estimate a unit’s future cash flows.  We generally use the assumptions in ourstrategic plan and modify them as necessary based on unit specific information.  If our assumptions are incorrect, thecarrying value of our operating unit assets may be overstated or understated.

 

***Goodwill. ***Goodwill and intangible assets withindefinite useful lives are tested for impairment annually or whenever eventsor changes in circumstances indicate that the carrying value may not berecoverable. Factors we consider important which could trigger an impairmentreview include significant underperformance relative to expected historical orprojected future operating results, significant changes in the manner of use ofacquired assets or the strategy for the overall business, and significantnegative industry or economic trends. Our goodwill impairment analysis usesestimates and assumptions in order to determine the fair value of our reportingunits. If our assumptions are incorrect, the carrying value of our goodwill maybe overstated. Our annual impairment measurement date is currently our fiscalyear end.

 

***Store ClosureReserves. ***  We decide whether to close a unit based onits recent cash flows and its future estimated profitability.  We evaluate each unit’s performance eachfinancial period.  When units performpoorly, we consider the demographics of the location as well as our ability tocause an unprofitable unit to become profitable. Based on management’sjudgment, we estimate the future cash flows of the unit.  If we determine that the unit will not beprofitable, and there are no contractual requirements that require us tocontinue to operate the unit, we close the unit.  We establish a reserve for the net present value of the unit’sfuture rents and other fixed costs at the time the unit is closed.  The most significant assumptions we make indetermining store closure reserves are assumptions regarding the estimatedcosts to maintain vacant properties. Additionally, the amount of the reserve established for future leasepayments on leased vacant units is dependent on our ability to successfullynegotiate early termination lease agreements with our landlords.  If the costs to maintain properties rise orif it takes longer than anticipated to sell properties or terminate leases, wemay need to record additional reserves.

 

**NewAccounting Pronouncements.**

 

In April 2002, the FASB issued SFAS No. 145,“Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB StatementNo. 13, and Technical Corrections.” SFAS No. 145 provides new guidance on the criteria used to classify debtextinguishments as extraordinary items and requires sale-leaseback accountingfor certain lease modifications that have economic effects that are similar tosale-leaseback transactions.  SFAS No.145 will be effective for our fiscal year 2004.  Management does not believe the adoption of this standard willhave a material impact on our financial position, results of operations, orliquidity.

 

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure.”  SFAS No. 148 amends the disclosurerequirements in SFAS No. 123, “Accounting for Stock-Based Compensation” forannual periods ending after December 15, 2002 and for interim periods beginning

 

20

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after December 15, 2002. Effective for financial statements for fiscal years ending afterDecember 15, 2002, SFAS No. 148 also provides three alternative transitionmethods for companies that choose to adopt the fair value measurementprovisions of SFAS No. 123.  Managementdoes not believe the adoption of this standard will have a material impact onour financial position, results of operations, or liquidity. Quarterly disclosureprovisions have been adopted.

 

InJanuary 2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities,” an interpretation of ARB No. 51. Interpretation 46addresses consolidation by business enterprises of variable interestentities.  Interpretation 46 applies immediately to variable interestentities created after January 31, 2003 and to variable interest entities inwhich an enterprise obtains an interest after that date.  It applies inthe first year or interim period beginning after June 15, 2003 to variableinterest entities in which an enterprise holds a variable interest that itacquired before February 1, 2003.  The Company has not yet determined theimpact of implementing Interpretation 46.

 

#### **Item 3**.           Quantitative And Qualitative DisclosuresAbout Market Risk.

 

**MarketRisk Sensitive Items Entered Into for Trading Purposes**

 

None.

 

**MarketRisk Sensitive Items Entered Into for Other Than Trading Purposes**

 

*Interest Rate Risk*

 

We are exposed to market risk from changes ininterest rates on our outstanding bank debt. At March 12, 2003, we had $2,400,000 in bank debt that could be affectedby changes in short term interest rates. At the end of our third fiscal quarterof fiscal 2003, the interest rate was the LIBOR rate plus 3.0%, or 4.34%. Therate can be fixed over periods ranging from one to six months, at ourdiscretion.  At March 12, 2003, ahypothetical 100 basis point increase in the adjusted LIBOR rate would resultin additional interest expense of $24,000 on an annualized basis.

 

*Commodity Price Risk*

 

Green coffee, the principal raw material forour products, is subject to significant price fluctuations caused by a numberof factors, including weather, political, and economic conditions. To date, wehave not used commodity based financial instruments to hedge againstfluctuations in the price of coffee. To ensure that we have an adequate supplyof coffee, however, we enter into agreements to purchase green coffee in thefuture that may or may not be fixed as to price. At March 12, 2003, we hadcommitments to purchase coffee through fiscal year 2005 totaling $3,419,000 for2,594,000 pounds of green coffee, all of which were fixed as to price. Thecoffee scheduled to be delivered to us throughout the remaining portion of thisfiscal year pursuant to these commitments will satisfy approximately 73% of ouranticipated green coffee requirements for this fiscal year. Assuming we requireapproximately 236,000 additional pounds of green coffee during 2003 for whichno price has yet been fixed, each $0.01 per pound increase in the price ofgreen coffee could result in $2,000 of additional cost. However, because theprice we pay for green coffee is negotiated with suppliers, we believe that thecommodity market price for green coffee would have to increase significantly,by as much as $0.25 per pound, before suppliers would increase the price theycharge us.

 

#### **Item 4**.           Controls and Procedures.

 

Within the 90 days priorto the filing date of this report, we carried out an evaluation, under thesupervision and with the participation of our management, including ourprincipal executive officer and Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures pursuantto Exchange Act Rule 13a-14. Based upon that evaluation, the principalexecutive officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation relating to us (including our subsidiaries) required to be includedin our periodic SEC filings. There have been no significant

 

21

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changes in our internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of theirevaluation.

 

#### **PART II**- OTHER INFORMATION

 

**Item 1.**           **Legal Proceedings.**

 

In the ordinary course of our business, we maybecome involved in legal proceedings from time to time. During the thirty-sixweek period ended March 12, 2003, we were not a party to any material legalproceedings.

 
| **Item 6****.** | **Exhibits and Reports on Form 8-K.**                                                 |
|-----------------|---------------------------------------------------------------------------------------|
|            |                                                                                  |
| (a)   | *Exhibits.*                                                                           |
|            |                                                                                  |
|            | Set forth below is a list of the exhibits included  as part of this quarterly report. |

 

22

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| **Exhibit No.** |   | **Description**                                                                                                                                                                                                   |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                              |
| 2.1             |   | Agreement and Plan of Merger  dated as of March 16, 1999, by and among Diedrich Coffee, CP Acquisition  Corp., a wholly owned subsidiary of Diedrich Coffee, and Coffee People(1)                                 |
|            |   |                                                                                                                                                                                                              |
| 3.1             |   | Restated Certificate of  Incorporation of the Company, dated May 11, 2001(2)                                                                                                                                      |
|            |   |                                                                                                                                                                                                              |
| 3.2             |   | Bylaws of the Company(3)                                                                                                                                                                                          |
|            |   |                                                                                                                                                                                                              |
| 4.1             |   | Purchase Agreement for Series  A Preferred Stock dated as of December 11, 1992 by and among Diedrich Coffee,  Martin R. Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P(3)                             |
|            |   |                                                                                                                                                                                                              |
| 4.2             |   | Purchase Agreement for Series  B Preferred Stock dated as of June 29, 1995 by and among Diedrich Coffee,  Martin R. Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, L.P. and  Diedrich Partners I, L.P(3) |
|            |   |                                                                                                                                                                                                              |
| 4.3             |   | Specimen Stock Certificate(3)                                                                                                                                                                                     |
|            |   |                                                                                                                                                                                                              |
| 4.4             |   | Form of Conversion Agreement  in connection with the conversion of Series A and Series B Preferred Stock  into Common Stock(3)                                                                                    |
|            |   |                                                                                                                                                                                                              |
| 4.5             |   | Registration Rights Agreement,  dated May 8, 2001(2)                                                                                                                                                              |
|            |   |                                                                                                                                                                                                              |
| 4.6             |   | Form of Warrant, dated May 8,  2001(2)                                                                                                                                                                            |
|            |   |                                                                                                                                                                                                              |
| 10.1            |   | Form of Indemnification  Agreement(3)                                                                                                                                                                             |
|            |   |                                                                                                                                                                                                              |
| 10.2            |   | Amended and Restated Diedrich  Coffee, Inc. 1996 Stock Incentive Plan(4)*                                                                                                                                         |
|            |   |                                                                                                                                                                                                              |
| 10.3            |   | Diedrich Coffee, Inc. 1996  Non-Employee Directors Stock Option Plan(3)*                                                                                                                                          |
|            |   |                                                                                                                                                                                                              |
| 10.4            |   | Agreement of Sale dated as of  February 23, 1996 by and among Diedrich Coffee (as purchaser) and Brothers  Coffee Bars, Inc. and Brothers Gourmet Coffees, Inc. (as sellers)(3)                                   |
|            |   |                                                                                                                                                                                                              |
| 10.5            |   | Form of Warrant Agreement made  in favor of Nuvrty, Inc., the Ocean Trust and the Grandview Trust(6)                                                                                                              |
|            |   |                                                                                                                                                                                                              |
| 10.6            |   | Form of Common Stock and  Option Purchase Agreement with Franchise Mortgage Acceptance Company dated as  of April 3, 1998(7)                                                                                      |
|            |   |                                                                                                                                                                                                              |
| 10.7            |   | Form of Franchise Agreement(9)                                                                                                                                                                                    |
|            |   |                                                                                                                                                                                                              |
| 10.8            |   | Form of Area Development  Agreement(9)                                                                                                                                                                            |
|            |   |                                                                                                                                                                                                              |
| 10.9            |   | Form of Employment Agreement  with Martin R. Diedrich dated June 29, 2001(10)*                                                                                                                                    |
|            |   |                                                                                                                                                                                                              |
| 10.10           |   | Credit Agreement, dated as of  July 7, 1999, by and among BankBoston, N.A., Diedrich Coffee and its  subsidiaries(11)                                                                                             |

 

23

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| **Exhibit No.** |   | **Description**                                                                                                                            |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                       |
| 10.11           |   | Security Agreement, dated as  of July 7, 1999, by and between BankBoston, N.A. and Diedrich Coffee(11)                                     |
|            |   |                                                                                                                                       |
| 10.12           |   | Securities Pledge Agreement,  dated as of July 7, 1999, by and among BankBoston, N.A., Diedrich Coffee, and  its subsidiaries(11)          |
|            |   |                                                                                                                                       |
| 10.13           |   | Trademark Security Agreement,  dated as of July 7, 1999, by and among BankBoston, N.A., Diedrich Coffee and  its subsidiaries(11)          |
|            |   |                                                                                                                                       |
| 10.14           |   | Form of Term Note made in  favor of BankBoston, N.A.(11)                                                                                   |
|            |   |                                                                                                                                       |
| 10.15           |   | Form of Revolving Note made in  favor of BankBoston, N.A.(11)                                                                              |
|            |   |                                                                                                                                       |
| 10.16           |   | Employment Agreement with Matt  McGuinness effective March 13, 2000(12)*                                                                   |
|            |   |                                                                                                                                       |
| 10.17           |   | First Amendment to Credit  Agreement dated as of September 26, 2000(12)                                                                    |
|            |   |                                                                                                                                       |
| 10.18           |   | Second Amendment to Credit  Agreement dated as of February 26, 2001(13)                                                                    |
|            |   |                                                                                                                                       |
| 10.19           |   | Letter Agreement re:  employment with Carl Mount dated October 29, 1999(14)*                                                               |
|            |   |                                                                                                                                       |
| 10.20           |   | Letter Agreement re:  employment with Edward A. Apffel dated May 25, 2000(14)*                                                             |
|            |   |                                                                                                                                       |
| 10.21           |   | Diedrich Coffee, Inc. 2000  Non-Employee Directors Stock Option Plan(15)*                                                                  |
|            |   |                                                                                                                                       |
| 10.22           |   | Diedrich Coffee, Inc. 2000  Equity Incentive Plan(16)*                                                                                     |
|            |   |                                                                                                                                       |
| 10.23           |   | Common Stock and Warrant  Purchase Agreement dated March 14, 2001(17)                                                                      |
|            |   |                                                                                                                                       |
| 10.24           |   | Employment agreement with Philip G. Hirsch, dated  March 20, 2002(10)*                                                                     |
|            |   |                                                                                                                                       |
| 10.25           |   | Employment agreement with Philip G. Hirsch,  effective as of September 1, 2002(18)*                                                        |
|            |   |                                                                                                                                       |
| 10.26           |   | Credit Agreement, dated September 3, 2002, by and  between Diedrich Coffee, Inc. and Bank of the West d/b/a/ United California  Bank(18)   |
|            |   |                                                                                                                                       |
| 10.27           |   | Form of Guaranty(18)                                                                                                                       |
|            |   |                                                                                                                                       |
| 10.28           |   | Form of Guarantor Security Agreement(18)                                                                                                   |
|            |   |                                                                                                                                       |
| 10.29           |   | Form of Supplemental Security Agreement(18)                                                                                                |
|            |   |                                                                                                                                       |
| 10.30           |   | Security Agreement, dated September 3, 2002, by and  between Diedrich Coffee, Inc. and Bank of the West d/b/a/ United California  Bank(18) |
|            |   |                                                                                                                                       |
| 10.31           |   | Separation Agreement by and  between Diedrich Coffee, Inc. and Philip G. Hirsch*                                                           |

 

24

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| **Exhibit No.** |   | **Description**                                                                                                                  |
|-----------------|--------|----------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                             |
| 10.32           |   | First Amendment to Credit  Agreement by and between Diedrich Coffee, Inc. and Bank of the West,  effective December 17, 2002(19) |
|            |   |                                                                                                                             |
| 10.33           |   | Second Amendment to Credit Agreement by and between  Diedrich Coffee, Inc. and Bank of the West, effective March 11, 2003        |
|            |   |                                                                                                                             |
| 10.34           |   | Employment Agreement with Roger M. Laverty, dated  April 24, 2003*                                                               |
|            |   |                                                                                                                             |
| 10.35           |   | Stock Option Plan and Agreement with Roger M.  Laverty, dated April 24, 2003*                                                    |
|            |   |                                                                                                                             |
| 99.1            |   | Certification pursuant to USC Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                |

 

----

*                                         Management contract or compensatory plan orarrangement

 

(1)                                  Previously filed as Appendix A to DiedrichCoffee’s Registration Statement on Form S-4, filed with the Securities andExchange Commission on April 23, 1999.

 

(2)                                  Previously filed as an exhibit to DiedrichCoffee’s Current Report on Form 8-K, filed with the Securities and ExchangeCommission on May 16, 2001.

 

(3)                                  Previously filed as an exhibit to DiedrichCoffee’s Registration Statement on Form S-1 (No. 333-08633), as amended, asdeclared effective by the Securities and Exchange Commission on September 11,1996.

 

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

 

(5)                                  Reserved.

 

(6)                                  Previously filed as an exhibit to DiedrichCoffee’s Quarterly Report on Form 10-Q for the period ended October 29, 1997,filed with the Securities and Exchange Commission on December 11, 1997.

 

(7)                                  Previously filed as an exhibit to DiedrichCoffee’s Annual Report on Form 10-K for the fiscal year ended January 28, 1998.

 

(8)                                  Reserved.

 

(9)                                  Previously filed as an exhibit to DiedrichCoffee’s Quarterly Report on Form 10-Q for the period ended April 28, 1999,filed with the Securities and Exchange Commission on December 11, 1998.

 

(10)                            Previously filed as an exhibit to DiedrichCoffee’s Annual Report on Form 10-K for the year ended June 27, 2001, filedwith the Securities and Exchange Commission on September 25, 2001.

 

(11)                            Incorporated by reference to Diedrich Coffee’sTransition Report on Form 10-Q for the period from January 28, 1999 to June 30,1999, filed with the Securities and Exchange Commission on August 16, 1999.

 

(12)                            Previously filed as an exhibit to DiedrichCoffee’s Annual Report on Form 10-K for the fiscal year ended June 28, 2000.

 

25

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(13)                            Previously filed as an exhibit to DiedrichCoffee’s Quarterly Report on Form 10-Q for the period ended March 7, 2001,filed with the Securities and Exchange Commission on April 23, 2001.

 

(14)                            Previously filed as an exhibit to DiedrichCoffee’s Report on Form 10-Q for the period ended September 20, 2000,filed with the Securities and Exchange Commission on November 6, 2000.

 

(15)                            Previously filed as an exhibit to DiedrichCoffee’s Registration Statement on Form S-8, filed with the Securities andExchange Commission on November 21, 2000.

 

(16)                            Previously filed as an exhibit to DiedrichCoffee’s Report on Form 10-Q for the period ended December 13, 2000, filed withthe Securities and Exchange Commission on January 29, 2001.

 

(17)                            Previously filed as anexhibit to the Definitive Proxy Statement, filed with the Securities andExchange Commission on April 12, 2001.

 

(18)                            Previouslyfiled as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for thefiscal year ended July 3, 2002, filed with the Securities and ExchangeCommission on October 1, 2002.

 

(19)                            Previouslyfiled as an exhibit to Diedrich Coffee's Quarterly Report on Form 10-Q for theperiod ended December 18, 2002.

 

(b)         *Reports on Form 8-K.*

 

None.

 

26

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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 theundersigned thereunto duly authorized.

 
| Date:  April 25, 2003 | **DIEDRICH COFFEE, INC.**                                                      |
|----------------------------|--------------------------------------------------------------------------------|
|                       |                                                                           |
|                       |                                                                           |
|                       | /s/ Matthew  C. McGuinness                                                     |   |
|                       | Matthew C.  McGuinness                                                         |
|                       | Executive  Vice President and  Chief Financial Officer                         |
|                       | (Principal  Executive Officer and Principal Financial  and Accounting Officer) |

 

27

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#### **Certifications**

 

I, Matthew C.McGuinness, certify that:

 

1.               I have reviewed this quarterly report onForm 10-Q of Diedrich Coffee, Inc.;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b.              evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c.               presented inthis quarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a.               all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:  | April  25, 2003                                                |
|--------|----------------------------------------------------------------|
|   |                                                           |
|   | /s/  Matthew C. McGuinness                                     |   |
|   | Matthew  C. McGuinness                                         |
|   | Executive  Vice President and Chief Financial Officer          |
|   | (Principal  Executive Officer and Principal Financial Officer) |

 

28

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**Exhibit Index**

 
| **Exhibit No.** |   | **Description**                                                                                                                |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                           |
| 10.31           |   | Separation Agreement by and  between Diedrich Coffee, Inc. and Philip G. Hirsch*                                               |
|            |   |                                                                                                                           |
| 10.33           |   | Second Amendment to Credit Agreement by and between  Diedrich Coffee, Inc. and Bank of the West, effective March 11, 2003 |
|            |   |                                                                                                                           |
| 10.34           |   | Employment Agreement with Roger M. Laverty, dated  April 24, 2003*                                                             |
|            |   |                                                                                                                           |
| 10.35           |   | Stock Option Plan and Agreement with Roger M.  Laverty, dated April 24, 2003*                                                  |

 

29

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