**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 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 10, 2004**                                                                                                                                          |
|                                                                                                                                                                                            |
| **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**                                                                                                                                                              |

 

**DIEDRICHCOFFEE, INC.**

(Exact Name of Registrant asSpecified in Its Charter)

 
| **DELAWARE**                                                     |   | **33-0086628**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| (State or  Other Jurisdiction of  Incorporation or Organization) |   | (IRS  Employer Identification No.) |
|                                                             |   |                               |
| **28 EXECUTIVE PARK, SUITE 200  IRVINE, CALIFORNIA 92614**       |
| (Address of  Principal Executive Offices, Including Zip Code)    |
|                                                             |   |                               |
| **(949) 260-1600**                                               |
| (Registrant’s  Telephone Number, Including Area Code)       |

 

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

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).YES  oNO  ý

 

As of April 21, 2004 there were5,161,260 shares of common stock of the registrant outstanding.

 

 

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**DIEDRICHCOFFEE, INC.INDEX**

 

 
| **PART I – FINANCIAL INFORMATION** |                                                                                        |
|-----------------------------------------|---------------------------------------------------------------------------------------------|
|                                    |                                                                                        |
| Item 1.                                 | Financial Statements                                                                        |   |   |
|                                    |                                                                                        |
|                                    | Condensed Consolidated Balance Sheets  (Unaudited)                                          | 1 |
|                                    |                                                                                        |   |
|                                    | Condensed Consolidated Statements of  Operations (Unaudited)                                | 2 |
|                                    |                                                                                        |   |
|                                    | Condensed Consolidated Statements of Cash  Flows (Unaudited)                                | 3 |
|                                    |                                                                                        |   |
|                                    | Notes to Condensed Consolidated Financial  Statements (Unaudited)                           | 4 |
|                                    |                                                                                        |
| Item 2.                                 | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 11 |
|                                    |                                                                                        |   |
| Item 3.                                 | Quantitative and Qualitative Disclosures  About Market Risk                                 | 21 |
|                                    |                                                                                        |   |
| Item 4.                                 | Controls and Procedures                                                                     | 22 |
|                                    |                                                                                        |
| **PART II – OTHER INFORMATION**    |                                                                                        |
|                                    |                                                                                        |
| Item 1.                                 | Legal Proceedings                                                                           | 22 |
|                                    |                                                                                        |
| Item 6.                                 | Exhibits and Reports on Form 8-K                                                            | 22 |
|                                    |                                                                                        |
| Signatures                              | 27                                                                                          |
|                                         |                                                                                             |  |  |  |

 

i

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**PARTI - FINANCIAL INFORMATION**

 

**Item 1.****           FinancialStatements.**

 

DIEDRICHCOFFEE, INC.CONDENSED CONSOLIDATED BALANCESHEETS(UNAUDITED)
|                                                                                                                                               |   | **March 10,  2004** |       | **July 2,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|------------------------|--------|
|                                                                                                                                               |   |                     |       |                   |   |
| **Assets**                                                                                                                                         |   |                     |       |                   |   |
| Current  assets:                                                                                                                                   |   |                     |       |                   |   |
| Cash                                                                                                                                               |   | $                        | 1,392,000  |                   | $      | 2,625,000 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,181,000 at  March 10, 2004 and $1,375,000 at July 2, 2003               |   | 2,433,000                |       | 2,454,000              |   |
| Inventories                                                                                                                                        |   | 2,575,000                |       | 2,611,000              |   |
| Current  portion of notes receivable                                                                                                               |   | 71,000                   |       | 58,000                 |   |
| Prepaid  expenses                                                                                                                                  |   | 661,000                  |       | 901,000                |   |
| Total  current assets                                                                                                                              |   | 7,132,000                |       | 8,649,000              |   |
| Restricted  cash                                                                                                                                   |   | 957,000                  |       | —                 |   |
| Property and  equipment, net                                                                                                                       |   | 7,118,000                |       | 7,052,000              |   |
| Goodwill                                                                                                                                           |   | 10,190,000               |       | 10,190,000             |   |
| Notes  receivable, excluding current portion                                                                                                       |   | 143,000                  |       | 182,000                |   |
| Other assets                                                                                                                                       |   | 496,000                  |       | 469,000                |   |
| Total assets                                                                                                                                       |   | $                        | 26,036,000 |                   | $      | 26,542,000 |   |
|                                                                                                                                               |   |                     |       |                   |   |
| **Liabilities and Stockholders’ Equity**                                                                                                      |   |                     |       |                   |   |
| Current liabilities:                                                                                                                               |   |                     |       |                   |   |
| Current  installments of obligations under capital leases                                                                                          |   | $                        | 171,000    |                   | $      | 185,000 |   |
| Current  installments of long-term debt                                                                                                            |   | 1,517,000                |       | 1,459,000              |   |
| Accounts  payable                                                                                                                                  |   | 2,030,000                |       | 2,108,000              |   |
| Accrued  compensation                                                                                                                              |   | 1,837,000                |       | 1,307,000              |   |
| Accrued  expenses                                                                                                                                  |   | 734,000                  |       | 738,000                |   |
| Franchisee  deposits                                                                                                                               |   | 648,000                  |       | 671,000                |   |
| Deferred  franchise fee income                                                                                                                     |   | 794,000                  |       | 549,000                |   |
| Accrued  provision for store closure                                                                                                               |   | 137,000                  |       | 425,000                |   |
| Total  current liabilities                                                                                                                         |   | 7,868,000                |       | 7,442,000              |   |
| Obligations  under capital leases, excluding current installments                                                                                  |   | 440,000                  |       | 542,000                |   |
| Long term  debt, excluding current installments                                                                                                    |   | 475,000                  |       | 1,491,000              |   |
| Deferred  rent                                                                                                                                     |   | 490,000                  |       | 478,000                |   |
| Total  liabilities                                                                                                                                 |   | 9,273,000                |       | 9,953,000              |   |
| Stockholders’  equity:                                                                                                                        |   |                     |       |                   |   |
| Common  stock, $0.01 par value; authorized 8,750,000 shares; issued and outstanding  5,161,000 shares at March 10, 2004 and July 2, 2003 |   | 52,000                   |       | 52,000                 |   |
| Additional  paid-in capital                                                                                                                        |   | 58,036,000               |       | 58,036,000             |   |
| Accumulated  deficit                                                                                                                               |   | (41,325,000              | )          | (41,499,000            | )      |
| Total  stockholders’ equity                                                                                                                   |   | 16,763,000               |       | 16,589,000             |   |
| Commitments  and contingencies (notes 3, 4 and 7)                                                                                                  |   |                     |       |                   |   |
| Total  liabilities and stockholders’ equity                                                                                                   |   | $                        | 26,036,000 |                   | $      | 26,542,000 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

1

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DIEDRICHCOFFEE, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)
|                                                    |   | **Twelve Weeks  Ended  March 10,  2004** |      | **Twelve Weeks  Ended  March 12,  2003** |    | **Thirty-Six  Weeks Ended  March 10,  2004** |    | **Thirty-Six  Weeks Ended  March 12,  2003** |       |
|---------------------------------------------------------|--------|-----------------------------------------------|-----------|-----------------------------------------------|---------|---------------------------------------------------|---------|---------------------------------------------------|------------|
| Net revenue:                                            |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Retail sales                                            |   | $                                             | 7,281,000 |                                          | $       | 7,474,000                                         |    | $                                                 | 21,725,000 |   | $ | 23,661,000 |   |
| Wholesale  and other                                    |   | 3,407,000                                     |      | 3,052,000                                     |    | 11,114,000                                        |    | 11,250,000                                        |       |
| Franchise  revenue                                      |   | 1,812,000                                     |      | 1,531,000                                     |    | 5,223,000                                         |    | 4,461,000                                         |       |
| Total  revenue                                          |   | 12,500,000                                    |      | 12,057,000                                    |    | 38,062,000                                        |    | 39,372,000                                        |       |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Costs and  expenses:                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Cost of  sales and related occupancy costs              |   | 5,750,000                                     |      | 5,906,000                                     |    | 17,601,000                                        |    | 18,907,000                                        |       |
| Operating  expenses                                     |   | 3,868,000                                     |      | 3,898,000                                     |    | 11,550,000                                        |    | 12,092,000                                        |       |
| Depreciation  and amortization                          |   | 513,000                                       |      | 421,000                                       |    | 1,541,000                                         |    | 1,327,000                                         |       |
| General and  administrative expenses                    |   | 2,365,000                                     |      | 2,166,000                                     |    | 6,891,000                                         |    | 6,397,000                                         |       |
| Provision  for asset impairment and restructuring costs |   | —                                        |      | (49,000                                       | )  | 94,000                                            |    | 57,000                                            |       |
| (Gain) loss  on asset disposals                         |   | 5,000                                         |      | (117,000                                      | )  | 5,000                                             |    | (119,000                                          | )          |
| Total costs  and expenses                               |   | 12,501,000                                    |      | 12,225,000                                    |    | 37,682,000                                        |    | 38,661,000                                        |       |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Operating  income (loss)                                |   | (1,000                                        | )    | (168,000                                      | )  | 380,000                                           |    | 711,000                                           |       |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Interest  expense                                       |   | (67,000                                       | )         | (55,000                                       | )       | (203,000                                          | )       | (217,000                                          | )          |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Interest and  other income, net                         |   | 9,000                                         |      | 9,000                                         |    | 17,000                                            |    | 33,000                                            |       |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Income  (loss) before income tax provision              |   | (59,000                                       | )    | (214,000                                      | )  | 194,000                                           |    | 527,000                                           |       |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Income tax  provision                                   |   | 10,000                                        |      | 5,000                                         |    | 20,000                                            |    | 44,000                                            |       |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Net income  (loss)                                      |   | $                                             | (69,000   | )                                        | $       | (219,000                                          | )  | $                                                 | 174,000    |   | $ | 483,000 |   |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| Net income  (loss) per share – basic and diluted   |   | $                                             | (0.01)    |                                          | $       | (0.04                                             | )  | $                                                 | 0.03       |   | $ | 0.09 |   |
|                                                    |   |                                          |      |                                          |    |                                              |    |                                              |       |
| 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                                     |    | 5,189,000                                         |    | 5,196,000                                         |       |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

2

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DIEDRICH COFFEE, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)
|                                                                               |   | **Thirty-Six  Weeks Ended  March 10, 2004** |      | **Thirty-Six  Weeks Ended  March 12, 2003** |   |
|------------------------------------------------------------------------------------|--------|--------------------------------------------------|-----------|--------------------------------------------------|--------|
| Cash flows  from operating activities:                                             |   |                                             |      |                                             |   |
| Net income                                                                         |   | $                                                | 174,000   |                                             | $      | 483,000 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                                             |      |                                             |   |
| Depreciation  and amortization                                                     |   | 1,541,000                                        |      | 1,327,000                                        |   |
| Amortization  of loan fees                                                         |   | 64,000                                           |      | 58,000                                           |   |
| Provision  for bad debt                                                            |   | 253,000                                          |      | 228,000                                          |   |
| Provision  for inventory obsolescence                                              |   | 176,000                                          |      | 49,000                                           |   |
| Provision  for asset impairment and restructuring                                  |   | 90,000                                           |      | 57,000                                           |   |
| Provision  for (benefit from) store closure                                        |   | (70,000                                          | )         | 36,000                                           |   |
| Stock  compensation expense                                                        |   | —                                           |      | 56,000                                           |   |
| (Gain) loss  on disposal of assets                                                 |   | 5,000                                            |      | (119,000                                         | )      |
| Changes in  operating assets and liabilities:                                      |   |                                             |      |                                             |   |
| Accounts  receivable                                                               |   | (232,000                                         | )         | (725,000                                         | )      |
| Inventories                                                                        |   | (140,000                                         | )         | (52,000                                          | )      |
| Prepaid  expenses                                                                  |   | 240,000                                          |      | (122,000                                         | )      |
| Other assets                                                                       |   | (95,000                                          | )         | (146,000                                         | )      |
| Accounts  payable                                                                  |   | (78,000                                          | )    | 27,000                                           |   |
| Accrued  compensation                                                              |   | 530,000                                          |      | (93,000                                          | )      |
| Accrued  expenses                                                                  |   | (4,000                                           | )    | 53,000                                           |   |
| Accrued  provision for store closure                                               |   | (218,000                                         | )         | (150,000                                         | )      |
| Deferred  franchise fee income and franchisee deposits                             |   | 222,000                                          |      | 124,000                                          |   |
| Deferred  rent                                                                     |   | 12,000                                           |      | (10,000                                          | )      |
| Net cash  provided by operating activities                                         |   | 2,470,000                                        |      | 1,081,000                                        |   |
| Cash flows  from investing activities:                                             |   |                                             |      |                                             |   |
| Capital  expenditures for property and equipment                                   |   | (1,706,000                                       | )         | (613,000                                         | )      |
| Proceeds  from disposal of property and equipment                                  |   | 8,000                                            |      | 278,000                                          |   |
| Payments received on notes  receivable                                             |   | 26,000                                           |      | 31,000                                           |   |
| Net cash  used in investing activities                                             |   | (1,672,000                                       | )         | (304,000                                         | )      |
| Cash flows  from financing activities:                                             |   |                                             |      |                                             |   |
| Restricted  cash                                                                   |   | (957,000                                         | )         | —                                           |   |
| Payments on  long-term debt                                                        |   | (958,000                                         | )         | (826,000                                         | )      |
| Payments on  capital lease obligations                                             |   | (116,000                                         | )         | (128,000                                         | )      |
| Net cash  used in financing activities                                             |   | (2,031,000                                       | )         | (954,000                                         | )      |
|                                                                               |   |                                             |      |                                             |   |
| Net decrease  in cash                                                              |   | (1,233,000                                       | )         | (177,000                                         | )      |
| Cash at  beginning of period                                                       |   | 2,625,000                                        |      | 2,233,000                                        |   |
| Cash at end  of period                                                             |   | $                                                | 1,392,000 |                                             | $      | 2,056,000 |   |
|                                                                               |   |                                             |      |                                             |   |
| Supplemental  disclosure of cash flow information:                                 |   |                                             |      |                                             |   |
| Cash paid  during the period for:                                                  |   |                                             |      |                                             |   |
| Interest                                                                           |   | $                                                | 133,000   |                                             | $      | 155,000 |   |
| Income taxes                                                                       |   | $                                                | 20,000    |                                             | $      | 46,000 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

3

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**DIEDRICHCOFFEE, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSMARCH 10, 2004(UNAUDITED)**

 

1.                                       SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

*Basis ofPresentation*

 

The unaudited condensed consolidatedfinancial statements of Diedrich Coffee, Inc. and its subsidiaries (the“Company”) have been prepared in accordance with accounting principlesgenerally accepted in the United States of America, as well as the instructionsto Form 10-Q and Article 10 of Regulation S-X.  These statements should be read in conjunction with theconsolidated financial statements and the notes thereto included in theCompany’s Annual Report on Form 10-K/A filed on October 3, 2003.

 

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

 

*Use of Estimates*

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

*Stock Option Plans*

 

The Company applies the intrinsicvalue-method of accounting prescribed by Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations, in accounting for employee stock options. As such,compensation expense would be recorded on the date of grant only if the currentmarket price of the underlying stock exceeded the exercise price. Statement ofFinancial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-BasedCompensation,” as amended, established accounting and disclosure requirementsusing a fair value-based method of accounting for stock-based employeecompensation plans.  The Companyhas adopted the disclosure provisions of SFAS No. 123 and continues tofollow APB no. 25 for stock-based employee compensation.

 

Pro forma net income (loss) and pro forma netincome (loss) per share, as if the fair value-based method of SFAS 123 had beenapplied in measuring compensation cost for stock-based awards, is as follows:

 
|                                                                                                                                              |   | **TWELVE  WEEKS ENDED**  |     | **THIRTY-SIX  WEEKS ENDED** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|----------|-----------------------------|--------|
| **Pro Forma**                                                                                                                                     |   | **March 10,  2004** |     | **March 12,  2003**    |   | **March 10,  2004** |   | **March 12,  2003** |   |
| Net income  (loss)                                                                                                                                |   | $                        | (69,000) |                        | $      | (219,000) |   | $ | 174,000 |   | $ | 483,000 |   |
| Stock based  employee compensation expense included in reported net income (loss)                                                                 |   | —                   |     | 56,000                      |   | — |   | 56,000 |   |
| Deduct:  Stock-based employee compensation expense  determined under the fair value based method for all awards, net of related  tax effects |   | (268,000                 | )        | (141,000                    | )      | (654,000 | ) | (369,000 | ) |
| Pro forma  net income (loss)                                                                                                                      |   | $                        | (337,000 | )                      | $      | (304,000 | )  | $ | (480,000 | ) | $ | 170,000 |   |
| Basic and  diluted income (loss) per share                                                                                                        |   | $                        | (0.07)   |                        | $      | (0.06 | )  | $ | (0.09 | ) | $ | 0.03 |   |

 

4

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The fair values of the options granted wereestimated using the Black-Scholes option-pricing model based on the followingweighted average assumptions:

 
|                     |   | **TWELVE AND  THIRTY-SIX  WEEKS ENDED** |   |
|--------------------------|--------|-----------------------------------------|--------|
|                     |   | **March 10,  2004**                |   | **March 12,  2003** | ** ** |
|                     |   |                                    |   |   | ** ** |
| Risk free interest  rate |   | 2.57                                    | %      | 2.57 | % |
| Expected  life           |   | 6 years                                 |   | 6 years |   |
| Expected  volatility     |   | 99                                      | %      | 99 | % |
| Expected  dividend yield |   | 0                                       | %      | 0 | % |

 

*Barter Transaction*

 

At the end of the 2003 holiday period, in theCompany’s second fiscal quarter, the Company recorded an impairment chargereducing holiday gift pack inventory to its net realizable value.  During the current quarter, the Companyexchanged $67,000 of this impaired inventory for advertising barter creditsvalued by the barter provider in excess of the impaired inventory value.  The Company recorded the advertising creditsas a prepaid expense at the $67,000 impaired net realizable value of theinventory exchanged.  Additionally, inaccordance with Emerging Issues Task Force No. 99-17, “Accounting forAdvertising Barter Transactions,” the Company accounted for this transaction asa sale, recording revenue and cost of sales of $67,000, leaving no net impactto income (loss).

 

*Reclassifications*

 

Certain reclassifications have been made tothe March 12, 2003 condensed consolidated financial statements to conformto the March 10, 2004 presentation.

 

2.                                       INVENTORIES

 

Inventories consist of the following:

 
|                               |   | **March 10, 2004** |      | **July 2, 2003** |   |
|------------------------------------|--------|-------------------------|-----------|-----------------------|--------|
| Unroasted  coffee                  |   | $                       | 905,000   |                  | $      | 1,034,000 |   |
| Roasted  coffee                    |   | 562,000                 |      | 572,000               |   |
| Accessory  and specialty items     |   | 121,000                 |      | 163,000               |   |
| Other food,  beverage and supplies |   | 987,000                 |      | 842,000               |   |
|                               |   | $                       | 2,575,000 |                  | $      | 2,611,000 |   |

 

5

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3.                                       LONG-TERMDEBT

 

Long-term debt consists of the following:

 
|                                                                                                                                                                                                                                                                                   |   | **March 10, 2004** |      | **July 2, 2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|-----------------------|--------|
| **Term Loan**                                                                                                                                                                                                                                                                          |   |                    |      |                  |   |
| Note payable  bearing interest at a rate of 3.25% over LIBOR, or 4.45%, as of  March 10, 2004, and payable in monthly installments of $100,000 plus  interest. Due March 31, 2005. Note is secured by the assets of the  Company and the stock of its subsidiaries.          |   | $                       | 1,200,000 |                  | $      | 2,000,000 |   |
| **Packaging Equipment Note**                                                                                                                                                                                                                                                           |   |                    |      |                  |   |
| Note payable  bearing interest at a rate of 5.77% as of March 10, 2004 and payable in  monthly installments of $26,000 plus interest. Due August 28, 2006. Note  is secured by coffee packaging equipment and a restricted cash balance of  $792,000 at March 10, 2004. |   | 792,000                 |      | 950,000               |   |
|                                                                                                                                                                                                                                                                                   |   | 1,992,000               |      | 2,950,000             |   |
| Less:  current installments                                                                                                                                                                                                                                                            |   | (1,517,000              | )         | (1,459,000            | )      |
| Long-term  debt, excluding current installments                                                                                                                                                                                                                                        |   | $                       | 475,000   |                  | $      | 1,491,000 |   |

 

On September 3, 2002, the Companyentered into a credit agreement (the “Credit Agreement”) with United CaliforniaBank, doing business as Bank of the West (“BOW”).  Two notes payable issued under the Credit Agreement are currentlyoutstanding.  In addition, under theCredit Agreement, the Company has a revolving working capital and letter ofcredit facility.

 

The Company’s obligations under the CreditAgreement are secured by all of the Company’s assets, including the stock ofeach of its subsidiaries (each of which has guaranteed the Company’sobligations under the Credit Agreement), as well as all intangible assets itowns, including the intellectual property and trademark assets that the Companyand its subsidiaries own.

 

In addition to the equipment purchased withthe proceeds of the note, the Packaging Equipment Note is secured by arestricted cash balance on deposit with BOW equal to the lesser of $800,000 orthe outstanding principal balance of the equipment term loan.  The restricted cash balance was $792,000 onMarch 10, 2004.

 

The Credit Agreement also provides theCompany with a $675,000 revolving working capital and letter of creditfacility, subject to a number of restrictions. The Company’s working capitalfacility draws and letters of credit are limited to a combined maximum of$675,000 outstanding at any time. Furthermore, draw-downs against the workingcapital facility are subject to a sub-limit of $500,000, and letters of creditare subject to a sub-limit of $250,000. The Company is permitted to draw funds against the working capitalfacility throughout the fiscal year and may repay amounts that it borrows underthe working capital facility at any time. Therefore, the Company may be able tore-borrow such funds on a revolving basis (subject to restrictions).  The letter of credit facility matures onOctober 15, 2004 and the working capital facility matured on April 15,2004.  The working capital facility wasnot renewed upon its April 15, 2004 maturity, and there were no outstandingamounts under this facility as of March 10, 2004.  Any payments made by BOW with regard to any letter of creditissued under the letter of credit facility must be repaid by the Company immediatelyupon the date of such payment by BOW. As of March 10, 2004, BOW had issued one letter of credit underthis facility for $179,000.

 

In October 2003, BOW provided theCompany with an additional facility for issuance of up to $250,000 of lettersof credit.  The new facility providesthat issued letters of credit are to be secured by restricted cash balances ofan equal amount maintained on deposit with BOW.  As of March 10, 2004, BOW had issued two letters of creditfor a total of $165,000 under this facility. The restricted cash balance was $165,000 on March 10, 2004.

 

6

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The Company is subject to a number ofrestrictions under the Credit Agreement, as amended.  These include limitations on the Company’s ability to sellassets, make capital expenditures, incur additional indebtedness, permit newliens upon the Company’s assets, and pay dividends on or repurchase its commonstock. The Company must also maintain compliance with agreed-upon financialcovenants that require the Company to maintain a specified minimum dollar valuelevel of tangible net worth, maintain a specified minimum dollar value level ofEBITDA for the trailing four fiscal quarters and certain minimum ratios of cashflow to debt service obligations, maintain a specified minimum level ofprofitability, limit the amount of indebtedness it may have outstanding inrelation to its tangible net worth, and require the Company to maintainrestricted cash balances on deposit with BOW equal to the lesser of $800,000 orthe outstanding principal balance of its equipment term loan.  As of March 10, 2004 the Company was incompliance with these covenants.

 

Maturities of long-term debt for periodssubsequent to March 10, 2004 are as follows:

 
| **Periods**           |   |    |      |
|-----------------------|--------|---------|-----------|
| 12 months             |   | $       | 1,517,000 |   |
| 13-24 months          |   | 317,000 |      |
| 25-36 months          |   | 158,000 |      |
| Total  long-term debt |   | $       | 1,992,000 |   |

 

4.                                       ACCRUEDPROVISION FOR STORE CLOSURE

 

Prior to January 1, 2003, 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 January 1, 2003, the Company adopted SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,” and nowrecords these estimated costs when they are incurred rather than at the date ofa commitment to an exit or disposal plan. Such costs primarily consist of theestimated cost to terminate real estate leases.

 
|                                        |   | **Beg Balance** |    | **Amounts  Charged  to Expense** |   | **Adjustments** |   | **Cash  Payments** |     | **End  Balance** |   |
|---------------------------------------------|--------|-----------------|---------|----------------------------------|--------|-----------------|--------|--------------------|----------|------------------|--------|
| Fiscal year  ended July 2, 2003        |   | $               | 581,000 |                             | $      | 193,000         |   | $                  | (116,000 | )                | $      | (233,000 | ) | $ | 425,000 |   |
|                                        |   |            |    |                             |   |            |   |               |     |             |   |
| Thirty-six  weeks ended March 10, 2004 |   | $               | 425,000 |                             | $      | 36,000          |   | $                  | (106,000 | )                | $      | (218,000 | ) | $ | 137,000 |   |
|                                             |        |                 |         |                                  |        |                 |        |                    |          |                  |        |  |  |  |  |  |  |

 

For the thirty-six weeks ended March 10,2004, the $36,000 charged to expense was comprised of a $31,000 charge to costof sales and related occupancy costs, a $4,000 charge to the provision forasset impairment, and a $1,000 charge to general and administrative expense.These charges primarily related to negotiated lease settlements finalizedduring the first quarter of fiscal 2004. Also included in the provision for store closure was a benefit of$106,000, which reduced cost of sales and related occupancy costs due to a favorablelease settlement of a closed location.

 

7

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5.                                       EARNINGSPER SHARE

 

The following table sets forth thecomputation of basic and diluted net income per share:

 
|                                           |   | **Twelve Weeks  Ended  March 10,  2004** |    | **Twelve  Weeks Ended  March 12,  2003** |   | **Thirty-Six  Weeks Ended  March 10,  2004** |   | **Thirty-Six  Weeks Ended  March 12,  2003** |    |
|------------------------------------------------|--------|-----------------------------------------------|---------|-----------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|---------|
| **Numerator:**                                 |   |                                          |    |                                          |   |                                              |   |                                              |    |
| Net income  (loss)                             |   | $                                             | (69,000 | )                                             | $      | (219,000                                          | )      | $                                                 | 174,000 |   | $ | 483,000 |   |
| **Denominator:**                               |   |                                          |    |                                          |   |                                              |   |                                              |    |
| Basic  weighted average shares outstanding     |   | 5,161,000                                     |    | 5,161,000                                     |   | 5,161,000                                         |   | 5,161,000                                         |    |
|                                           |   |                                          |    |                                          |   |                                              |   |                                              |    |
| Effect of  dilutive securities                 |   | —                                        |    | —                                        |   | 28,000                                            |   | 35,000                                            |    |
|                                           |   |                                          |    |                                          |   |                                              |   |                                              |    |
| Diluted  adjusted weighted average shares      |   | 5,161,000                                     |    | 5,161,000                                     |   | 5,189,000                                         |   | 5,196,000                                         |    |
|                                           |   |                                          |    |                                          |   |                                              |   |                                              |    |
| Basic and  diluted net income (loss) per share |   | $                                             | (0.01   | )                                             | $      | (0.04                                             | )      | $                                                 | 0.03    |   | $ | 0.09 |   |

 

Of the 972,000 options outstanding as of March 10, 2004, all 972,000were excluded from the calculation of diluted net loss per share for the twelveweeks ended March 10, 2004 as their inclusion would have beenanti-dilutive.  The calculation ofdiluted net income per share for the thirty-six weeks ended March 10, 2004excluded 527,000 options, because the exercise price exceeded the market price.  Further, all the 518,000 warrants topurchase shares of common stock outstanding during the twelve weeks andthirty-six weeks ended March 10, 2004 were excluded from the calculation ofdiluted net income per share as their inclusion would have been anti-dilutivefor the twelve weeks ended March 10, 2004 and because the exercise priceexceeded the market price for the thirty-six weeks ended March 10, 2004.  For the twelve weeks ended March 12, 2003all 581,000 options were excluded from the calculation of diluted net loss pershare, as their inclusion would have been anti-dilutive. During the thirty-sixweeks ended March 12, 2003, 358,000 options were excluded from the calculationof diluted net income per share, because the exercise price exceeded the marketprice.  Further, all of the 730,000warrants to purchase shares of common stock outstanding during the twelve andthe thirty-six weeks ended March 12, 2003, were excluded from the calculationof diluted net income (loss) per share as their inclusion would have beenanti-dilutive for the twelve weeks ended March 12, 2003 and because theexercise price exceeded the market price for the thirty-six weeks ended March12, 2003.

 

6.                                       SEGMENTAND RELATED INFORMATION

 

The Companyhas three reportable segments:  retailoperations, wholesale operations and franchise operations.  The Company evaluates performance of itsoperating segments based on income before income taxes.

 

8

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Summarizedfinancial information concerning the Company’s reportable segments is shown inthe following table.  Other identifiableassets consist of corporate cash, corporate notes receivable, corporate prepaidexpenses, and corporate property and equipment.  The other component of segment profit (loss) before tax includescorporate general and administrative expenses, depreciation and amortizationexpense and interest expense.

 
|                                                     |                 | **TWELVE WEEKS ENDED**   |       | **THIRTY-SIX WEEKS ENDED** |       |
|----------------------------------------------------------|----------------------|--------------------------|------------|----------------------------|------------|
|                                                     |                 | **March 10,  2004** |       | **March 12,  2003**   |       | **March 10,  2004** |   | **March 12,  2003** |   |
| Revenue:                                                 |                 |                     |       |                       |       |   |   |   |   |
| Retail                                                   |                 | $                        | 7,281,000  |                       | $          | 7,474,000 |   | $ | 21,725,000 |   | $ | 23,661,000 |   |
| Wholesale                                                |                 | 3,407,000                |       | 3,052,000                  |       | 11,114,000 |   | 11,250,000 |   |
| Franchise                                                |                 | 1,812,000                |       | 1,531,000                  |       | 5,223,000 |   | 4,461,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Total  revenue                                           |                 | $                        | 12,500,000 |                       | $          | 12,057,000 |   | $ | 38,062,000 |   | $ | 39,372,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Interest  expense:                                       |                 |                     |       |                       |       |   |   |   |   |
| Retail                                                   |                 | $                        | 8,000      |                       | $          | 9,000 |   | $ | 22,000 |   | $ | 28,000 |   |
| Franchise                                                |                 | 6,000                    |       | 10,000                     |       | 27,000 |   | 38,000 |   |
| Other                                                    |                 | 53,000                   |       | 36,000                     |       | 154,000 |   | 151,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Total  interest expense                                  |                 | $                        | 67,000     |                       | $          | 55,000 |   | $ | 203,000 |   | $ | 217,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Depreciation  and amortization:                          |                 |                     |       |                       |       |   |   |   |   |
| Retail                                                   |                 | $                        | 306,000    |                       | $          | 285,000 |   | $ | 836,000 |   | $ | 913,000 |   |
| Wholesale                                                |                 | 148,000                  |       | 70,000                     |       | 414,000 |   | 216,000 |   |
| Franchise                                                |                 | 1,000                    |       | 4,000                      |       | 4,000 |   | 13,000 |   |
| Other                                                    |                 | 58,000                   |       | 62,000                     |       | 287,000 |   | 185,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Total  depreciation and amortization                     |                 | $                        | 513,000    |                       | $          | 421,000 |   | $ | 1,541,000 |   | $ | 1,327,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Segment  profit (loss) before income tax provision:      |                 |                     |       |                       |       |   |   |   |   |
| Retail                                                   |                 | $                        | 196,000    |                       | $          | 454,000 |   | $ | 812,000 |   | $ | 1,250,000 |   |
| Wholesale                                                |                 | 444,000                  |       | 142,000                    |       | 1,754,000 |   | 1,431,000 |   |
| Franchise                                                |                 | 1,736,000                |       | 1,322,000                  |       | 4,846,000 |   | 4,425,000 |   |
| Other                                                    |                 | (2,435,000               | )          | (2,132,000                 | )          | (7,218,000 | ) | (6,579,000 | ) |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
| Total  segment profit (loss) before income tax provision |                 | $                        | (59,000    | )                          | $          | (214,000 | ) | $ | 194,000 |   | $ | 527,000 |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |
|                                                     |                 | **March 10,  2004** |       | **July 2,  2003**     |       |   |   |   |   |
|                                                     | Identifiable assets: |                     |       |                       |       |   |   |   |   |   |
|                                                     |                 | Retail                   |       | $                          | 5,642,000  |   | $ | 5,567,000 |   |   |   |   |   |
|                                                     |                 | Wholesale                |       | 5,446,000                  |       | 5,584,000 |   |   |   |   |   |
|                                                     |                 | Franchise                |       | 1,378,000                  |       | 1,373,000 |   |   |   |   |   |
|                                                     |                 | Other                    |       | 3,380,000                  |       | 3,828,000 |   |   |   |   |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |   |
|                                                     |                 | Tangible assets          |       | 15,846,000                 |       | 16,352,000 |   |   |   |   |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |   |
|                                                     | Goodwill - Retail    |                     | 1,267,000  |                       | 1,267,000  |   |   |   |   |   |
|                                                     | Goodwill - Wholesale |                     | 6,311,000  |                       | 6,311,000  |   |   |   |   |   |
|                                                     | Goodwill - Franchise |                     | 2,612,000  |                       | 2,612,000  |   |   |   |   |   |
|                                                     |                 |                     |       |                       |       |   |   |   |   |   |
|                                                     |                 | Total assets             |       | $                          | 26,036,000 |   | $ | 26,542,000 |   |   |   |   |   |
|                                                          |                      |                          |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

7.                                       LEASECONTINGENCIES

 

We are liableon the master leases for 118 franchise locations. Under the Company’shistorical franchising business model, the Company executed the master leasesfor these locations and entered into subleases on the same terms with itsfranchisees, which typically pay their rent directly to the landlords. If anyof these franchisees default on their subleases, the Company would be requiredto make all payments under the master leases. The Company’s maximum theoreticalfuture exposure at March 10, 2004, computed as

 

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the sum of allremaining lease payments through the expiration dates of the respective leases,was $20,900,000. This amount does not take into consideration any mitigatingmeasures that the Company could take to reduce this exposure in the event ofdefault, including re-leasing the locations or terminating the master lease bynegotiating a lump sum payment to the landlord in an amount that is less thanthe sum of all remaining future rents.

 

8.             SELF-INSURANCE

 

EffectiveOctober 1, 2003, the Company became self-insured for workers compensation witha $250,000 deductible per occurrence and a program maximum for all claims of$750,000.

 

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**Item 2.****           Management’sDiscussion And Analysis Of Financial Condition And Results Of Operations.**

 

**A Warning AboutForward Looking Statements.**

 

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

 

•            thefinancial and operating performance of our retail operations;

 

•            ourability to maintain profitability over time;

 

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

 

•            thesuccessful execution of our growth strategies;

 

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

 

•            theimpact of competition; and

 

•            theavailability of working capital.

 

Foreseeablerisks and uncertainties are described elsewhere in this report and in detailunder the caption “Risk Factors and Trends Affecting Diedrich Coffee and ItsBusiness” in our Annual Report on Form 10-K/A for the fiscal year endedJuly 2, 2003 and in other reports that we file with the Securities andExchange Commission. We undertake no obligation to publicly release the resultsof any revision of the forward-looking statements. Unless otherwise indicated,“we,” “us,” “our,” and similar terms refer to Diedrich Coffee, Inc.

 

**General.**

 

DiedrichCoffee, Inc. is a specialty coffee roaster, wholesaler and retailer.  We sell brewed, espresso-based and variousblended beverages primarily made from our own fresh roasted premium coffeebeans, as well as light food items, whole bean coffee, and accessories throughour Company operated and franchised retail locations.  We also sell whole bean and ground coffees on a wholesale basisthrough a network of distributors in the office coffee service (“OCS”) market,and to other wholesale customers, including restaurant chains and otherretailers.  Our brands include DiedrichCoffee, Gloria Jean’s Coffees and Coffee People.  As of March 10, 2004, Diedrich Coffee owned and operated 58retail locations and franchised 415 other retail locations under these brands,for a total of 473 retail coffee outlets. Our retail units are located in 35states and 13 foreign countries.  As ofMarch 10, 2004, we also have over 460 wholesale accounts with OCSdistributors, chain and independent restaurants and others.  In addition, we operate a large coffeeroasting facility in central California that supplies freshly roasted coffee toour retail locations and wholesale accounts.

 

*Retail Outlets*

 

Our retailoutlet distribution channel can be divided into two sub-channels, each with itsown distinct business model, including differences in revenue and coststructure, overhead, and capital requirements. These two retail sub-channels are Company operated retail outlets andfranchised retail outlets.  We viewretail outlets as a single distribution channel, despite the differences notedabove, primarily because our retail customers do not make any distinctionbetween Company and franchise

 

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operated locations.  The critical success factors are, therefore, the same for eachtype of retail location, whether Company operated or franchised: quality ofproduct, service, and atmosphere.  Theeconomic model and cost structures are also the same for each type of locationat the retail unit level, notwithstanding their different direct financialimpacts on us in our roles as both an operator and franchiser of retailoutlets.  Furthermore, the potentialcontribution of any given outlet to which we provide coffee, as measured by theamount of roasted coffee produced through our roasting plant, is the same.

 

Presently, ourlargest brand is Gloria Jean’s and approximately 97% of Gloria Jean’s retailunits are franchised. Gloria Jean’s retail units are located throughout theUnited States and in 13 foreign countries. Our Diedrich Coffee brand has ahigher concentration of Company operated units, with 78% of retail locationsoperated by us. Diedrich Coffee units are located primarily in Orange County,California, although there are a number of Diedrich locations in Denver,Houston, and elsewhere in the United States. We also operate retail coffeeoutlets under a third brand, Coffee People, which are 100% Company operated atthis time. Our Coffee People outlets are all located in Portland, Oregon.

 

A tablesummarizing the relative sizes of each of our brands, on a unit count basis,and changes in unit count for each over the thirty-six weeks endedMarch 10, 2004, is set forth below:

 
|                             |   | **Units at  July 3,  2002** |   | **Opened** |   | **Closed** |   | **Net  transfers  between  the  Company  and  Franchise** |   | **Units at  July 2,  2003** |   | **Opened** |   | **Closed** |   | **Net  transfers  between  the  Company  and  Franchise** |   | **Units at  March 10,  2004** |   |
|----------------------------------|--------|----------------------------------|--------|------------|--------|------------|--------|-----------------------------------------------------------|--------|----------------------------------|--------|------------|--------|------------|--------|-----------------------------------------------------------|--------|------------------------------------|--------|
| **Gloria Jean’s Brand**     |   |                             |   |       |   |       |   |                                                      |   |                             |   |       |   |       |   |                                                      |   |                               |   |
| Company  Operated                |   | 18                               |   | —     |   | (1         | )      | (6                                                        | )      | 11                               |   | —     |   | (1         | )      | 2                                                         |   | 12                                 |   |
| Franchise –  Domestic       |   | 155                              |   | 4          |   | (22        | )      | 6                                                         |   | 143                              |   | 8          |   | (10        | )      | (2                                                        | )      | 139                                |   |
| Franchise –  International  |   |                             |   |       |   |       |   |                                                      |   |                             |   |       |   |       |   |                                                      |   |                               |   |
| Australia                        |   | 76                               |   | 66         |   | —     |   | —                                                    |   | 142                              |   | 46         |   | —     |   | —                                                    |   | 188                                |   |
| Far  East/Asia (1)               |   | 16                               |   | 3          |   | (1         | )      | —                                                    |   | 18                               |   | 1          |   | (1         | )      | —                                                    |   | 18                                 |   |
| Mexico                           |   | 12                               |   | 4          |   | (1         | )      | —                                                    |   | 15                               |   | 3          |   | (1         | )      | —                                                    |   | 17                                 |   |
| Other (2)                        |   | 36                               |   | 4          |   | (9         | )      | —                                                    |   | 31                               |   | 17         |   | (2         | )      | —                                                    |   | 46                                 |   |
| Total  Franchise - International |   | 140                              |   | 77         |   | (11        | )      | —                                                    |   | 206                              |   | 67         |   | (4         | )      | —                                                    |   | 269                                |   |
| Subtotal  Gloria Jean’s     |   | 313                              |   | 81         |   | (34        | )      | —                                                    |   | 360                              |   | 75         |   | (15        | )      | —                                                    |   | 420                                |   |
|                             |   |                             |   |       |   |       |   |                                                      |   |                             |   |       |   |       |   |                                                      |   |                               |   |
| **Diedrich Coffee Brand**        |   |                             |   |       |   |       |   |                                                      |   |                             |   |       |   |       |   |                                                      |   |                               |   |
| Company  Operated                |   | 25                               |   | —     |   | —     |   | —                                                    |   | 25                               |   | —     |   | (1         | )      | —                                                    |   | 24                                 |   |
| Franchise –  Domestic       |   | 12                               |   | —     |   | (2         | )      | —                                                    |   | 10                               |   | —     |   | (3         | )      | —                                                    |   | 7                                  |   |
| Subtotal  Diedrich               |   | 37                               |   | —     |   | (2         | )      | —                                                    |   | 35                               |   | —     |   | (4         | )      | —                                                    |   | 31                                 |   |
|                             |   |                             |   |       |   |       |   |                                                      |   |                             |   |       |   |       |   |                                                      |   |                               |   |
| **Coffee People Brand**          |   |                             |   |       |   |       |   |                                                      |   |                             |   |       |   |       |   |                                                      |   |                               |   |
| Company  Operated                |   | 27                               |   | —     |   | (5         | )      | —                                                    |   | 22                               |   | —     |   | —     |   | —                                                    |   | 22                                 |   |
| **Total**                        |   | 377                              |   | 81         |   | (41        | )      | —                                                    |   | 417                              |   | 75         |   | (19        | )      | —                                                    |   | 473                                |   |

 

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(1)                                  IncludesJapan and Korea.

 

(2)                                  IncludesGuam, Indonesia, Ireland, Turkey, Malaysia, New Zealand, Philippines, UnitedArab Emirates and Thailand.

 

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*Wholesale Distribution*

 

We currentlyhave over 460 wholesale accounts not affiliated with our retail locations thatpurchase coffee from us under both the Diedrich Coffee and Gloria Jean’sbrands. Our current wholesale accounts are in the office coffee supply market,chain restaurants, independent restaurants, other hospitality industryenterprises and specialty retailers. Additionally, except for our franchisees in Australia and Mexico, ourfranchise agreements require both Diedrich Coffee and Gloria Jean’s franchiseesto purchase substantially all of their coffee from us.

 

*Seasonality and Quarterly Results*

 

Our businessis subject to seasonal fluctuations as well as economic trends that affectretailers in general. Historically, our net sales have not been realized proportionatelyin each quarter, with net sales being the highest during the second fiscalquarter, which includes the November – December holiday season. Hotweather tends to reduce sales. Quarterly results are affected by the timing ofthe opening of new stores, which may not occur as anticipated due to eventsoutside our control. As a result of these factors, the financial results forany individual quarter may not be indicative of the results that may beachieved in a full fiscal year.

 

**Results of Operations.**

 

*Twelve WeeksEnded March 10, 2004 Compared with the Twelve Weeks Ended March 12,2003*

 

***TotalRevenue.*** Total revenue for the twelve weeks ended March 10, 2004 increasedby $443,000, or 3.7%, to $12,500,000 from $12,057,000 for the twelve weeksended March 12, 2003. This increase was attributable to increases inwholesale and other sales and franchise revenue, offset by a decrease in retailsales.  Each component is discussedbelow.

 

The mix of Company owned and franchisedstores and the mix of domestic and international stores continues tochange.  Since the beginning of thethird fiscal quarter of fiscal 2003, Company owned stores have declined by anet of four units and franchised stores have increased by a net of 71units.  Domestic stores have declined bya net of 24 units and international stores have grown by 91 units.  These changes impact our retail sales andfranchise revenue results because, among other matters, sales and operatingexpenses are reported for Company stores, but only fees earned under franchiseagreements are reported for franchise units. In addition, domestic franchise fees are at higher rates thaninternational franchise fees, and coffee is sold to domestic franchise stores,but generally not to international stores. Therefore, although the new store growth is much stronger ininternational franchises, per store franchise fees increase more slowly thandomestic per store franchise fees and manufacturing sales and profitability isgenerally not affected by the new international store growth.

 

Retail sales for the twelve weeks endedMarch 10, 2004 decreased by $193,000, or 2.6%, to $7,281,000 from$7,474,000 in the prior year period. This decrease primarily represented the net impact of several factors.First, the number of Company stores decreased in the current year versus theearlier period because of the closure or sale of six Company operated locationssince the beginning of the prior year period. The reduction in retail salesfrom the sale or closure of these six coffeehouses was approximately $610,000.This decrease was partially offset by a $184,000 increase in newly opened ortransferred store sales, a $37,000 increase in sales from our internet website,and a 2.4% increase in comparable store sales for Company operated unitsincreased retail sales by $196,000.

 

Wholesale revenue increased$355,000, or 11.6%, for the twelve weeks ended March 10, 2004, to$3,407,000 from $3,052,000 in the prior year period.  This increase was primarily the combined result of the followingfactors:

 

*Wholesalerevenue from franchisees*.  Sales to our franchisees increased $81,000, or 6.6%, for thetwelve weeks ended March 10, 2004. Gloria Jean’s domestic franchisecomparable store sales increased 0.6% for the quarter and wholesale revenue fromfranchisees increased $23,000 due to sales of our impaired holiday gift packinventory during the current quarter. At the end of the 2003 holiday period, in our second quarter, werecorded an impairment charge reducing holiday gift pack inventory to its net realizablevalue.  During the current quarter, weexchanged $67,000 of this impaired inventory for advertising barter creditsvalued by the barter provider in excess of the impaired inventory value.  We recorded the advertising credits as aprepaid expense at the $67,000 impaired net realizable value of the inventoryexchanged.  Additionally, we accountedfor this transaction as a sale, recording revenue and cost of sales of $67,000,leaving no net impact to earnings. These increases were partially offset by a decline in the sales ofroasted coffee due to a net 20 unit decrease in the number of domesticfranchises compared to the beginning of the prior year quarter.

 

*Keurig“K-cup” and other OCS sales*.  Keurig and other office coffee service sales increased by$321,000 to $1,737,000 for the twelve weeks ended March 10, 2004, a 22.7%increase over the prior year quarter, due to an increase in the number of K-cupcustomers.

 

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*Coffee salesto independent and chain restaurants and specialty retailers*.  Wholesale coffee sales to independent andchain restaurants and other specialty retailers decreased by $35,000, or 8.8%,versus the prior year quarter because we de-emphasized this less profitablewholesale segment.

 

Franchise revenue increased by$281,000, or 18.4%, for the twelve weeks ended March 10, 2004 to$1,812,000 from $1,531,000 in the prior year period.  Franchise revenue consists of initial franchise fees, franchiserenewal fees, royalties received on sales at franchised locations, andmiscellaneous other franchise revenue, including coordination fees receivedfrom product suppliers. The increase in franchise revenue was the net impact ofseveral factors.  Internationalroyalties increased by $203,000 primarily due to strong growth in Australiaduring the current fiscal quarter.  Additionally, area development fees increased by $211,000 primarily dueto domestic and international store openings during the current fiscalquarter.  These increases were partiallyoffset by a $127,000 decline in domestic royalties and a $6,000 decline incoordination fees due to the net decrease of 20 domestic franchise units in thecurrent quarter compared to the beginning of the prior year quarter.

 

***Cost of Sales and Related Occupancy Costs.***  Cost of sales and related occupancy costsfor the twelve weeks ended March 10, 2004 decreased 2.6% to $5,750,000from $5,906,000 in the prior year period. On a margin basis, cost of sales and related occupancy costs declinedfrom 56.1% of total retail and wholesale sales for the twelve weeks endedMarch 12, 2003 to 53.8% for the twelve weeks ended March 10,2004.  This favorable 2.3 marginimprovement was due to the net impact of a favorable 1.3 margin basis pointchange in cost of sales and a favorable 1.0 margin basis point change inoccupancy costs.  Both cost of sales andoccupancy costs experienced a margin basis point improvement primarily due tothe sale or closure of six Company stores since the beginning of last year’sthird quarter.  The closed stores’ costof sales and occupancy costs were, on a margin basis, approximately 1.0% higherthan the remaining store group. Additionally, cost of sales also improved $71,000 in the wholesalesegment as a result of our exiting the unprofitable grocery channel this year.

 

***OperatingExpenses.**** *Operatingexpenses for the twelve weeks ended March 10, 2004 declined by $30,000, or0.8%, to $3,868,000 from $3,898,000 in the prior year period.  Retail operating expenses as a percentage ofretail sales increased from 43.3% in the prior year quarter to 47.0% in thecurrent year quarter.  The percentageincrease was primarily due to a planned increase in additional in-store andsupervisory labor, and increases in utility and insurance costs.  Wholesale operating expenses, as apercentage of wholesale sales, declined from 15.8% in the prior year thirdquarter to 12.3% in the current year quarter primarily due to the decision towithdraw from the grocery store distribution channel and focus on more profitableopportunities.  Franchise operatingexpense, as a percentage of franchise revenue, declined from 11.9% in the prioryear to 1.3% in the current year, primarily due to lower bad debt provisions inthe current year quarter.

 

***Depreciationand Amortization*.** Depreciation and amortization increased by $92,000 to $513,000 for thetwelve weeks ended March 10, 2004 from $421,000 for the twelve weeks endedMarch 12, 2003.  This increase wasprimarily due to the depreciation of the Keurig packaging equipment purchasedduring fiscal 2003, and the facility improvement program underway in thecurrent year.

 

***Generaland Administrative Expenses*.**  General and administrative expensesincreased by $199,000, or 9.2%, to $2,365,000 for the twelve weeks endedMarch 10, 2004 from $2,166,000 for the prior year quarter. On a marginbasis, general and administrative expenses increased to 18.9% of total revenuein the third quarter of fiscal 2004 from 17.9% in the year ago quarter.  This 1.0 unfavorable margin basis pointchange was primarily related to $189,000 of salary and bonus increases due tothe addition of an Executive Vice President of Development, a Director ofOperations, and the fact that the Chief Executive Officer position was notfilled for part of the prior year period.

 

***Provisionfor Asset Impairment and Restructuring Costs*.**   In the prior year quarter, we reversed$49,000 in closed store lease reserves associated with a closed coffeehouse inArizona.  There were no asset impairmentor restructuring charges in the current year quarter.

 

***Gain (loss) on Asset Disposals. ***In the thirdquarter of our last fiscal year, a $5,000 loss on asset disposals and $122,000gain on the sale of a closed coffeehouse, resulted in a net gain of$117,000.  In the current year quarter therewas a loss of $5,000 on asset disposals.

 

***InterestExpense and Other, Net.**** *Interest expense and other, net increased $12,000 from$46,000 in last year’s third quarter to $58,000 in the current year quarter,primarily due to increased loan fee amortization.

 

***Income Tax Provision.***  Net operating losses generated in previousyears resulted in no federal income tax liability and only a nominal amount ofstate income tax expense for the twelve weeks ended March 10, 2004 and theprior year period. Due to the uncertainty of future taxable income, deferredtax assets resulting from these net operating losses have been fully reserved.The slight fluctuation in expense between the twelve weeks ended March 10,2004 versus the prior year period is due to changes in state income taxes owedin conjunction with the portfolio of Company operated Gloria Jean’s units,which are located in a variety of states. As of March 10, 2004 netoperating loss carryforwards for federal and state income tax purposes of$30,305,000 and $19,340,000, respectively, are available to be utilized againstfuture taxable income for years through fiscal 2024 for federal and fiscal 2014for state, subject to possible annual limitations pertaining to change inownership rules under the Internal Revenue Code.  For the twelve weeks ended March 10, 2004, our valuationallowance decreased $931,000.

 

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*Thirty-sixWeeks Ended March 10, 2004 Compared with the Thirty-six Weeks EndedMarch 12, 2003*

 

***TotalRevenue.*** Total revenue for the thirty-six weeks ended March 10, 2004decreased by $1,310,000, or 3.3%, to $38,062,000 from $39,372,000 for thethirty-six weeks ended March 12, 2003. This decline was attributable to decreases in retail and wholesale sales,partially offset by an increase in franchise revenue.  Each component is discussed below.

 

The mix of Company owned and franchisedstores and the mix of domestic and international stores continues tochange.  Since the beginning of theprior fiscal year, Company stores have declined by a net of 12 units andfranchised stores have increased by a net of 108 units.  Domestic stores have declined by a net of 33units and international stores have grown by a net of 129 units.  These changes impact our retail sales andfranchise revenue results because, among other matters, sales and operatingexpenses are reported for Company stores, but only fees earned under franchiseagreements are reported for franchise units. In addition, domestic franchise fees are at higher rates thaninternational franchise fees, and coffee is sold to domestic franchise stores,but generally not to international stores. Therefore, although the new store growth is much stronger ininternational franchises, per store franchise fees increase more slowly thandomestic per store franchise fees and manufacturing sales and profitability isgenerally not affected by the new international store growth.

 

Retail sales for the thirty-sixweeks ended March 10, 2004 decreased by $1,936,000, or 8.2%, to$21,725,000 from $23,661,000 for the prior year period.  This decrease primarily represented thecombined impact of two factors.  First,the number of Company stores decreased in the current year because of the saleor closure of 14 Company operated locations since the beginning of the priorfiscal year. The reduction in retail sales from the sale or closure of these 14coffeehouses was approximately $2,426,000. This decrease was partially offsetby a $249,000 increase in newly opened or transferred store sales, a $138,000increase in sales from our internet website, and a 0.1% increase in comparablestore sales for Company operated units increased retail sales by $103,000.

 

Wholesale revenue decreased$136,000, or 1.2%, to $11,114,000 for the thirty-six weeks ended March 10,2004 from $11,250,000 for the prior year period.  This decrease was primarily the combined result of the followingfactors:

 

*Wholesalerevenue from franchisees*.  Sales of roasted coffee to our franchisees decreased $699,000, or12.0%, for the thirty-six weeks ended March 10, 2004 primarily because ofa net 21 unit reduction in the number of domestic franchises compared to theprior year, along with negative year-to-year same store sales for Gloria Jean’sdomestic franchise units of 0.6%.  Thesedecreases were partially offset by a barter transaction that we entered intoduring the third quarter of our current fiscal year.  At the end of the 2003 holiday period, in our second fiscalquarter, we recorded an impairment charge reducing holiday gift pack inventoryto its net realizable value.  During thecurrent quarter, we exchanged $67,000 of this impaired inventory foradvertising barter credits valued by the barter provider in excess of theimpaired inventory value.  We recordedthe advertising credits as a prepaid expense at the $67,000 impaired netrealizable value of the inventory exchanged. Additionally, we accounted for this transaction as a sale, recordingrevenue and cost of sales of $67,000, leaving no net impact to earnings.

 

*Keurig“K-cup” and other OCS sales*.  Keurig and other office coffee service sales increased by$648,000 to $4,900,000 for the thirty-six weeks ended March 10, 2004, from$4,252,000 in the prior year period, a 15.2% increase.   This increase is primarily due to anincrease in the number of Keurig K-cup customers.

 

*Coffee salesto independent and chain restaurants and specialty retailers*.  Wholesale coffee sales to independent andchain restaurants and other specialty retailers decreased by $80,000, or 6.8%,versus the prior year period because of our decreased focus on this lessprofitable segment.

 

Franchise revenue increased by$762,000, or 17.1%, to $5,223,000 for the thirty-six weeks ended March 10,2004 from $4,461,000 for the prior year period.  The increase in franchise revenue is due to several factors.Initial franchise fees and franchise renewal and transfer fees increasedapproximately $371,000 for the thirty-six weeks ended March 10, 2004versus the prior year, primarily as a result of strong international growth anda dissolution settlement of $150,000 for the Malaysia franchise agreement.International franchise royalties increased $567,000 and coordination feesincreased $11,000 over the prior year period, due to strong internationalgrowth.  Domestic royalties decreased$187,000 primarily because of the net 21 unit reduction in domestic franchisestores and negative same store sales for Gloria Jean’s franchise units of 0.9%in the current year.  Negative year-to-yearsame store sales were primarily due to the weak sales of the holiday gift packinventories.

 

***Costof Sales and Related Occupancy Costs*.**  Cost of sales and related occupancy costsfor the thirty-six weeks ended March 10, 2004 were $17,601,000, a decreaseof 6.9% on a 5.9% decline in retail and wholesale sales.   On a margin basis, cost of sales andrelated occupancy costs decreased from 54.2% of total retail and wholesalesales to 53.6% in the current year.  This0.6 favorable margin basis point change was due to the net impact of a favorable0.3 margin basis point change in cost of sales, in addition to a favorable 0.3margin basis point change in occupancy costs. Both cost of sales and occupancy costs experienced a margin basis pointimprovement primarily due to the sale or closure of 14 Company stores since thebeginning of last the last fiscal year. The closed stores’ cost of sales and occupancy costs were higher thanthe remaining store group.  Additionally,cost of sales also improved in the wholesale segment as a result of our exitingthe unprofitable grocery channel this year.

 

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***OperatingExpenses.**** *Operatingexpenses for the thirty-six weeks ended March 10, 2004 declined by$542,000, or 4.5%, to $11,550,000 from $12,092,000 in the prior yearperiod.  Retail operating expenses as apercentage of retail sales increased from 44.2% in the prior year to 46.9% inthe current year.  This was largely dueto planned additional in-store and supervisory labor, as well as increases inutility and insurance costs.   Wholesaleoperating expenses, as a percentage of wholesale sales, declined from 13.4% inthe prior year to 10.2% in the current fiscal year. Year to year wholesale baddebt expense decreased $149,000, due to a bad debt charge in the prior year of$186,000 related to the bankruptcy of a major wholesale distributor.  Wholesale operating expenses also decreasedin the current year by $189,000 as a result of our withdrawal from theunprofitable grocery store distribution channel.  Franchise operating expense increased $110,000 in the currentyear, due to an increase in franchise bad debt expense, as prior year franchisebad debt reserves were reduced due to favorable collections on reservedaccounts.  Effective October 1,2003, we became self-insured for workers compensation with a $250,000deductible per occurrence and a program maximum for all claims of$750,000.  This change had no materialimpact in the current year periods.

 

***Depreciationand Amortization*.** Depreciation and amortization increased by $214,000 to $1,541,000 forthe thirty-six weeks ended March 10, 2004.  This increase was primarily due to the depreciation of the Keurigpackaging equipment purchased during fiscal 2003 and the facility improvementprogram underway in the current year.

 

***Generaland Administrative Expenses*.**  General and administrative expensesincreased by $494,000, or 7.7%, to $6,891,000 for the thirty-six weeks endedMarch 10, 2004.  On a margin basis,general and administrative expenses increased to 18.1% of total revenue in thefirst three quarters of fiscal 2004 from 16.2% in the prior year period.  This 1.9 unfavorable margin basis pointchange was primarily due to $431,000 of increased salary and bonus costs.  The salary and bonus increases included the additionof an Executive Vice President of Development, a Director of Operations and thefact that the Chief Executive Officer position was not filled for part of theprior year period.

 

***Provisionfor Asset Impairment and Restructuring Costs.***  The thirty-six weeks ended March 10,2004 included a $90,000 charge as a result of the early termination of aDiedrich Coffee coffeehouse lease and a $4,000 provision related to the closureof one coffeehouse.  Prior year resultsincluded a $106,000 provision to reduce the carrying value of one coffeehouse,partially offset by a $49,000 reversal of closed store lease reservesassociated with a closed coffeehouse in Arizona.

 

***Gain (Loss) on AssetDisposals***. Gain (loss) on asset disposals changed by $124,000 in the current yearperiod resulting in a $5,000 loss on asset disposals, compared to a $119,000gain on the sale of a coffee house in the prior year period.

 

***InterestExpense and Other, Net.***  Interest expense and other, net increased from $184,000 in theprior year to $186,000 for the thirty-six weeks ended March 10, 2004.  Interest expense decreased $14,000,primarily due to a $408,000 reduction in our long term debt principle balance,which was partially offset by increased loan fee amortization during thecurrent year.  Interest and other incomedecreased $16,000, primarily due to the revision of our outstanding notereceivable agreements in the current year.

 

***Income Tax Provision.***  Net operating losses generated in previousyears resulted in no federal income tax liability and only a nominal amount ofstate income tax expense for the thirty-six weeks ended March 10, 2004 andthe prior year period. Due to the uncertainty of future taxable income,deferred tax assets resulting from these net operating losses have been fullyreserved. The slight fluctuation in expense between the thirty-six weeks endedMarch 10, 2004 versus the prior year period is due to changes in stateincome taxes owed in conjunction with the portfolio of Company operated GloriaJean’s units, which are located in a variety of states. As of March 10,2004, net operating loss carryforwards for federal and state income taxpurposes of $30,305,000 and $19,340,000, respectively, are available to beutilized against future taxable income for years through fiscal 2024 forfederal and fiscal 2014 for state, subject to possible annual limitationspertaining to change in ownership rules under the Internal Revenue Code.  For the thirty-six weeks endedMarch 10, 2004, our valuation allowance decreased $1,032,000.

 

**Financial Condition,Liquidity and Capital Resources.**

 

***Current Financial Condition. ***AtMarch 10, 2004, we had negative working capital of $736,000, compared toworking capital of $1,207,000 at July 2, 2003.  This decrease was primarily due to a $792,000 restricted cashrequirement imposed by the third amendment to our Credit Agreement with Bank ofthe West, in addition to the $165,000 restricted cash requirement related toour outstanding letter of credit facility, as discussed in more detail in Note 3to the Condensed Consolidated Financial Statements.

 

On December 2, 2003, at the annualmeeting of stockholders, the stockholders approved a proposal to enter into atransaction pursuant to which we may borrow up to $5 million from SequoiaEnterprises, LP (the “Lender”).  OurChairman, Paul Heeschen, is the sole general partner of the Lender.  The Company is currently documenting theterms of a Contingent Convertible Note Purchase Agreement (the “Agreement”)which will provide for the issuance of one or more unsecured contingentconvertible promissory notes (the “Notes”) with an aggregate principal amountnot to exceed $5 million.  At ourelection, for a period of three years, we may issue to the Lender on theeffective date of the Agreement, or on the first day of any fiscal quarter, oneor more Notes having a minimum principal amount of $300,000 up to an aggregateprincipal amount of $5 million. Interest on the Notes will accrue at a rate equal to LIBOR plus 3.30% perannum calculated on the basis of a 360 day year and actual days elapsed.  We will be required to make payments to theLender monthly on the first day of each month. Each monthly payment will be equal to the sum of (a) all accruedinterest on each of the outstanding Notes for the prior month, plus (b) 1.67%of the outstanding aggregate principal amount of the Notes, plus (c) acommitment fee equal to 0.0833% of the difference between $5 million and theprincipal amount of all issued Notes. The principal amount of the Notes plus any accrued and unpaid interestwill be due on the earlier of a change in control or the third

 

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anniversary of the effective date of the Agreement.  The Agreement will contain customaryfinancial covenants, including a restriction regarding the amount of additionaldebt we may incur, and customary events of default.

 

The Notes will be convertible into our commonstock upon the occurrence of a change in control.  In addition, upon repayment of the amount of indebtedness evidencedby the Notes, we will be obligated to issue the Lender warrants to purchaseshares of our common stock, which warrants will be exercisable upon theoccurrence of a change in control.  Anywarrants issued by us will only be exercisable immediately prior to a change ofcontrol and will expire and no longer be exercisable on the fourth

 

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anniversary of the effective date of the Agreement.  Additional details regarding the terms ofthe proposed facility can be found in the proxy statement for our 2003 annualmeeting of stockholders.

 

Based upon theterms of the contingent convertible note purchase agreement, the existing BOWCredit Agreement, our recent operating performance and business outlook, and statusof our balance sheet, we believe that cash on hand, cash from operations, andfunds available under our current and expected credit facilities will besufficient to satisfy our working capital requirements for at least the nexttwelve months.

 

***Cash Flows. ***Cash provided by operating activities forthe thirty-six weeks ended March 10, 2004 totaled $2,470,000 as comparedwith $1,081,000 for the thirty-six weeks ended March 12, 2003.  This improvement is the net result of manyfactors more fully enumerated in the Unaudited Condensed Consolidated Statementof Cash Flows in the accompanying financial statements.

 

Net cash usedin investing activities for the thirty-six weeks ended March 10, 2004totaled $1,672,000 as compared with $304,000 used for the thirty-six weeksended March 12, 2003. During the thirty-six weeks ended March 10,2004, $1,706,000 was used to invest in property and equipment in our storeremodel project, our Castroville roasting facility and our home officefacility. These expenditures were partially offset by $26,000 of paymentsreceived on notes receivable and $8,000 in proceeds from disposal of propertyand equipment.

 

Net cash usedin financing activities for the thirty-six weeks ended March 10, 2004totaled $2,031,000 as compared to $954,000 in net cash used in financingactivities for the thirty-six weeks ended March 12, 2003. During thethirty-six weeks ended March 10, 2004, $957,000 of cash was restricted inaccordance with the $792,000 restricted cash requirement imposed by the thirdBOW amendment, in addition to the $165,000 restricted cash requirement relatedto our outstanding letter of credit facility, as discussed above. For bothperiods, the net cash used in financing activities consisted of repayment oflong-term debt and capital leases.

 

***OutstandingDebt and Financing Arrangements.***  We have a $675,000 revolving working capitaland letter of credit facility.  Thetotal borrowings under the working capital facility and letters of credit arelimited to a combined maximum of $675,000 outstanding at any time.  Letters of credit are subject to a sub-limitof $250,000.  We also have an additional$250,000 letter of credit facility.  AtMarch 10, 2004, there were two letters of credit in the amounts of$179,000 and $165,000 outstanding under the two letter of credit facilities,and no draws against the working capital facility.

 

For additional information regarding ourbanking relationship and further details of the revolving working capital andletter of credit facility please refer to the accompanying Unaudited CondensedConsolidated Financial Statements and related notes.

 

***OtherCommitments. ***Thefollowing represents a comprehensive list of our contractual obligations andcommitments as of March 10, 2004:

 
|                                                          |   | **Payments Due by Period** |       |
|---------------------------------------------------------------|--------|----------------------------|------------|
|                                                          |   | **Total**                  |       | **12  months** |   | **13-24  months** |   | **25-36  months** |   | **37-48  months** |   | **49-60  months** |   | **Thereafter** |   |
|                                                          |   | **(In  thousands)**        | ** ** |
| Note payable                                                  |   | $                          | 1,992      |   | $ | 1,517 |   | $ | 317 |   | $ | 158 |   | $ | — |   | $ | — |   | $ | — |   |
| Capital  leases                                               |   | 611                        |       | 171 |   | 122 |   | 22 |   | 23 |   | 25 |   | 248 |   |
| Company  operated retail locations and other operating leases |   | 15,708                     |       | 3,968 |   | 3,193 |   | 2,265 |   | 1,757 |   | 1,476 |   | 3,049 |   |
| Franchise  operated retail locations operating leases         |   | 20,900                     |       | 5,515 |   | 4,231 |   | 3,237 |   | 2,611 |   | 1,810 |   | 3,496 |   |
| Green coffee  commitments                                     |   | 2,575                      |       | 1,230 |   | 1,345 |   | — |   | — |   | — |   | — |   |
|                                                          |   | $                          | 41,786     |   | $ | 12,401 |   | $ | 9,208 |   | $ | 5,682 |   | $ | 4,391 |   | $ | 3,311 |   | $ | 6,793 |   |

 

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We have obligations under non-cancelableoperating leases for our coffee houses, roasting facility and administrativeoffices.  Lease terms are generally forperiods of 10 to 20 years with renewal options, and generally require us to paya proportionate share of real estate taxes, insurance, common area, and otheroperating costs.  Some retail leasesprovide for contingent rental payments based on sales thresholds. In addition,we are liable on the master leases for 118 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,which typically pay their rent directly to the landlords. If any of thesefranchisees default on their subleases, we would be required to make allpayments under the master leases. Our maximum theoretical future exposure atMarch 10, 2004, computed as the sum of all remaining lease paymentsthrough the expiration dates of the respective leases, was $20,900,000. Thisamount does not take into consideration any mitigating measures that we couldtake to reduce this exposure in the event of default, including re-leasing thelocations or terminating the master lease by negotiating a lump sum payment tothe landlord in an amount that is less than the sum of all remaining futurerents.

 

**Critical Accounting Estimates.**

 

The preparation of our condensed consolidatedfinancial statements requires us to make estimates and assumptions that affectthe reported 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, fixedasset lives, goodwill, intangible assets, income taxes, self-insurance andworkers’ compensation reserves, store closure reserves, stock-basedcompensation, the valuation allowance for net deferred tax assets andcontingencies. We believe that the following represent our critical accountingpolicies and estimates used in the preparation of our condensed consolidatedfinancial statements. The following discussion, however, does not list all ofour accounting policies and estimates.

 

***Impairment of Property and Equipment and Other Amortizable Long-LivedAssets Held and Used***

 

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

 

The most significant assumptions in ouranalysis are 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, the carrying value of our operating unitassets may be overstated or understated.

 

***Impairment of Goodwill***

 

At the reporting unit level, goodwill istested for impairment annually or whenever an event or circumstance indicatesthat it is more likely than not an impairment may have occurred. We considerthe reporting unit level to be the segment level since the components withineach segment have similar economic characteristics, including products andservices, production processes, types or classes of customers and distributionmethods. The impairment, if any, is measured based on the estimated fair valueof the segment. Fair value can be determined based on discounted cash flows orvaluations of similar businesses. Impairment occurs when the carrying amount ofgoodwill exceeds its estimated fair value.

 

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

 

If our assumptions used in performing theimpairment test prove inaccurate, the fair value of the segments may ultimatelyprove to be significantly lower, thereby causing the carrying value to exceedthe fair value and indicating an impairment has occurred. If our assumptionsare incorrect, the carrying value of our goodwill may be understated oroverstated. Our annual impairment measurement date is our fiscal year end.

 

***Estimated Liability for Closing Stores***

 

We make decisions to close stores based onprospects for estimated future profitability and sometimes we are forced toclose stores due to circumstances beyond our control (e.g., a landlord’srefusal to negotiate a new lease). Our management team evaluates each store’sperformance every period. When stores continue to perform poorly, we considerthe demographics of the location, as well as the likelihood of being able toimprove the performance of an unprofitable store. Based on the managementteam’s judgment, we estimate the future cash flows. If we determine that thestore will not, within a reasonable period of time, operate at break-even cashflow or be profitable, and we are not contractually obligated to continueoperating the store, we may close the store. Additionally, franchisees mayclose

 

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stores for which we are the primary lessee. If the franchisee cannotmake payments on the lease, we continue making the lease payments and establishan estimated liability for the closed store if we decide not to operate it as aCompany operated store. Effective January 1, 2003, we establish the estimatedliability on the actual closure date. Prior to the adoption of Statement ofFinancial Accounting Standards No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*(“SFAS 146”)on January 1, 2003, we established the estimated liability when we identified astore for closure, which may or may not have been the actual closure date.

 

The estimated liability for closing stores onproperties vacated is generally based on the term of the lease and the leasetermination fee we expect to pay, as well as estimated maintenance costs untilthe lease has been abated. The amount of the estimated liability established isgenerally the present value of these estimated future payments. The interestrate used to calculate the present value of these liabilities is based on ourincremental borrowing rate at the time the liability is established. Therelated discount is amortized and shown in provision for asset impairment andrestructuring costs, net in our condensed consolidated statements of earnings.

 

A significant assumption used in determiningthe amount of the estimated liability for closing stores is the amount of theestimated liability for future lease payments on vacant stores, which wedetermine based on our assessment of our ability to successfully negotiateearly terminations of our lease agreements with the lessors or sublease theproperty. Additionally, we estimate the cost to maintain leased and owned vacantproperties until the lease has been abated. If the costs to maintain propertiesincrease, or it takes longer than anticipated to sell properties or sublease orterminate leases, we may need to record additional estimated liabilities. Ifthe leases on the vacant stores are not terminated or subleased on the terms weused to estimate the liabilities, we may be required to record losses in futureperiods. Conversely, if the leases on the vacant stores are terminated orsubleased on more favorable terms than we used to estimate the liabilities, wereverse previously established estimated liabilities, resulting in an increasein operating income.

 

***EstimatedLiability for Self-Insurance***

 

Effective October 1, 2003, we becameself-insured for a portion of our current years’ losses related to workers’compensation insurance. We have obtained stop loss insurance for individualworkers’ compensation claims with a $250,000 deductible per occurrence and aprogram maximum for all claims of $750,000. Insurance liabilities and reservesare accounted for based on the present value of actuarial estimates of theamount of incurred and unpaid losses, based approximately on a risk-freeinterest rate. These estimates rely on actuarial observations of historicalclaim loss development. The actuary, in determining the estimated liability,bases the assumptions on the average historical losses on claims we haveincurred. The actual loss development may be better or worse than thedevelopment we estimated in conjunction with the actuary. In that event,we will modify the reserve. As such, if we experience a higher than expectednumber of claims or the costs of claims rise more than expected, then we may,in conjunction with the actuary, adjust the expected losses upward and ourfuture self-insurance expenses will rise.

 

***Franchised Operations***

 

We monitor the financial condition of certainfranchisees and record provisions for estimated losses on receivables when webelieve that our franchisees are unable to make their required payments to us.Each period we perform an analysis to develop estimated bad debts for eachfranchisee. We then compare the aggregate result of that analysis to the amountrecorded in our condensed consolidated financial statements as the allowancefor doubtful accounts and adjust the allowance as appropriate.  Over time, our assessment of individualfranchisees may change. For instance, we have had some franchisees, who in thepast we had determined required an estimated loss equal to the total amount ofthe receivable, who have paid us in full or established a consistent record ofpayments (generally one year) such that we determined an allowance was nolonger required.

 

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

 

In accordance with SFAS 146, which weadopted on January 1, 2003, an estimated liability for future lease obligationson stores operated by franchisees for which we are the primary or secondaryobligee is established on the date the franchisee closes the store. Also, werecord an estimated liability for subsidized lease payments when we sign asublease agreement committing us to the subsidy.

 

The amount of the estimated liability isestablished using the methodology described in “Estimated Liability for ClosingStores” above. Consistent with SFAS 146, we have not established anadditional estimated liability for potential losses not yet incurred.  If sales trends/economic conditions worsenfor our franchisees, their financial health may worsen, our collection ratesmay decline and we may be required to assume the responsibility for additionallease payments on franchised stores. Entering into restructured franchiseagreements may result in reduced franchise royalty rates in the future (seediscussion above).

 

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***Stock-Based Compensation***

 

As discussed in the Notes to CondensedConsolidated Financial Statements, we have various stock-based compensationplans that provide options for certain employees and outside directors topurchase common shares of stock. We have elected to account for stock-basedcompensation in accordance with APB Opinion No. 25, “Accounting for StockIssued to Employees,” which utilizes the intrinsic value method of accountingfor stock-based compensation, as opposed to using the fair-value methodprescribed in SFAS No. 123, “Accounting for Stock-Based Compensation”(“SFAS No. 123”). Because of this election, we are required to makecertain disclosures of pro forma net income assuming we had adopted SFAS No.123. We determine the estimated fair value of stock-based compensation on thedate of the grant using the Black-Scholes option-pricing model. TheBlack-Scholes option-pricing model requires the input of highly subjectiveassumptions, including the historical stock price volatility, expected life ofthe option and the risk-free interest rate. A change in one or more of theassumptions used in the Black-Scholes option-pricing model may result in amaterial change to the estimated fair value of the stock-based compensation(see Note 1 of Notes to Condensed Consolidated Financial Statements foranalysis of the effect of certain changes in assumptions used to determine thefair value of stock-based compensation).

 

***Valuation Allowance for Net Deferred TaxAssets***

 

As discussed above, we have recorded a 100%valuation allowance against our net deferred tax assets. If we have beenprofitable for a number of years and our prospects for the realization of ourdeferred tax assets are more likely than not, we would then reverse ourvaluation allowance and credit income tax expense. In assessing the prospectsfor future profitability, many of the assessments of same-store sales and cashflows discussed above become relevant. When circumstances warrant, we assessthe likelihood that our net deferred tax assets will more likely than not berealized from future taxable income. As of March 10, 2004, our netdeferred tax assets and related valuation allowance totaled approximately$13,608,000.

 

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

 

**Market Risk Sensitive Items Entered Into forTrading Purposes.**

 

None.

 

**Market Risk Sensitive Items Entered Into forOther Than Trading Purposes.**

 

*Interest Rate Risk.*  We are exposed to market risk from changes in interest rates onour outstanding bank debt.  AtMarch 10, 2004, we had $1,200,000 in bank debt that was tied to changes inshort term interest rates. At the end of our third fiscal quarter of fiscal2004, the interest rate was the LIBOR rate plus 3.25%, or 4.45%.  The rate can be fixed over periods rangingfrom one to six months, at our discretion. At March 10, 2004, a hypothetical 100 basis point increase in theadjusted LIBOR rate would result in additional interest expense of $12,000 onan 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, we have not used commodity basedfinancial instruments to hedge against fluctuations in the price of coffee.  To ensure that we have an adequate supply ofcoffee, however, we enter into agreements to purchase green coffee in thefuture that may or may not be fixed as to price.  At March 10, 2004, we had commitments to purchase coffeethrough fiscal year 2005 totaling $2,575,000 for 2,134,000 pounds of greencoffee, some of which commitments were fixed as to price.  The coffee scheduled to be delivered to usin this fiscal year pursuant to these commitments will satisfy approximately93% of our anticipated green coffee requirements for this fiscal year.  Assuming we require approximately 85,000additional pounds of green coffee during 2004 for which no price has yet beenfixed, each $0.01 per pound increase in the price of green coffee could resultin approximately $9,000 of additional cost. However, because the price we pay for green coffee is negotiated withsuppliers, we believe that the commodity market price for green coffee wouldhave to increase significantly, by as much as $0.25 per pound, before supplierswould increase the price they charge us.

 

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**Item 4.****           Controls andProcedures.**

 

(a) As of the end of the period covered by this quarterly report, we carriedout an evaluation, under the supervision and with the participation of ourmanagement, including our Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures.  Based on that evaluation,our Chief Executive Officer and Chief Financial Officer have concluded thatthese disclosure controls and procedures are effective in timely alerting themto material information relating to Diedrich Coffee (including oursubsidiaries) required to be included in our periodic SEC filings.

 

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

 

**PARTII - OTHER INFORMATION**

 

**Item1.****           Legal Proceedings.**

 

In theordinary course of our business, we may become involved in legal proceedingsfrom time to time. During the thirty-six week period ending March 10,2004, we were not a party to any material legal proceedings.

 

## **Item 6.**           Exhibits and Reports on Form8-K.

 

(a)          *Exhibits.*

 

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

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                                                            |
|-----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1             |   | Agreement and Plan of Merger, dated  March 16, 1999, among Diedrich Coffee, Inc., CP Acquisition Corp., a  wholly owned subsidiary of Diedrich Coffee, Inc., and Coffee People, Inc.(1)                               |
|            |   |                                                                                                                                                                                                                       |
| 3.1             |   | Restated Certificate of Incorporation of  the Company, dated May 11, 2001(2)                                                                                                                                               |
|            |   |                                                                                                                                                                                                                       |
| 3.2             |   | Bylaws of the Company(3)                                                                                                                                                                                                   |
|            |   |                                                                                                                                                                                                                       |
| 4.1             |   | Specimen Stock Certificate(4)                                                                                                                                                                                              |
|            |   |                                                                                                                                                                                                                       |
| 4.2             |   | Purchase Agreement for Series A Preferred  Stock dated as of December 11, 1992 by and among Diedrich Coffee, Inc.,  Martin R. Diedrich, Donald M. Holly, SNV Enterprises, and D.C.H., LP(5)                           |
|            |   |                                                                                                                                                                                                                       |
| 4.3             |   | Purchase Agreement for Series B Preferred  Stock dated as of June 29, 1995 by and among Diedrich Coffee, Inc.,  Martin R. Diedrich, Steven A. Lupinacci, Redwood Enterprises VII, LP, and  Diedrich Partners I, LP(5) |
|            |   |                                                                                                                                                                                                                       |
| 4.4             |   | Form of Conversion Agreement in connection  with the conversion of Series A and Series B Preferred Stock into Common Stock(3)                                                                                              |
|            |   |                                                                                                                                                                                                                       |
| 4.5             |   | Common Stock and Warrant Purchase  Agreement, dated March 14, 2001(6)                                                                                                                                                 |
|            |   |                                                                                                                                                                                                                       |
| 4.6             |   | Form of Warrant, dated May 8, 2001(2)                                                                                                                                                                                      |
|            |   |                                                                                                                                                                                                                       |
| 4.7             |   | Registration Rights Agreement, dated May 8,  2001(2)                                                                                                                                                                       |
|            |   |                                                                                                                                                                                                                       |
| 4.8             |   | Form of Warrant Agreement with Nuvrty,  Inc., Ocean Trust, and Grandview Trust(7)                                                                                                                                          |
|            |   |                                                                                                                                                                                                                       |
| 4.9             |   | Form of Common Stock and Option Purchase  Agreement with Franchise Mortgage Acceptance Company, dated as of  April 3, 1998(8)                                                                                         |

 

22

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| 10.1   |   | Form of Indemnification Agreement(5)                                                                                                            |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                            |
| 10.2   |   | Diedrich Coffee, Inc. 2000 Equity Incentive  Plan(21)*                                                                                          |
|   |   |                                                                                                                                            |
| 10.3   |   | Diedrich Coffee, Inc. 2000 Non-Employee  Directors Stock Option Plan(10)*                                                                       |
|   |   |                                                                                                                                            |
| 10.4   |   | Amended and Restated Diedrich Coffee, Inc.  1996 Stock Incentive Plan(11)*                                                                      |
|   |   |                                                                                                                                            |
| 10.5   |   | Diedrich Coffee, Inc. 1996 Non-Employee  Directors Stock Option Plan(12)*                                                                       |
|   |   |                                                                                                                                            |
| 10.6   |   | Reserved.                                                                                                                                       |
|   |   |                                                                                                                                            |
| 10.7   |   | Form of Diedrich Coffee Franchise  Agreement(20)                                                                                                |
|   |   |                                                                                                                                            |
| 10.8   |   | Form of Gloria Jean’s Franchise  Agreement(20)                                                                                             |
|   |   |                                                                                                                                            |
| 10.9   |   | Form of Area Development Agreement(20)                                                                                                          |
|   |   |                                                                                                                                            |
| 10.10  |   | Credit Agreement, dated September 3,  2002, by and between Diedrich Coffee, Inc. and Bank of the West d/b/a/ United  California Bank(13)   |
|   |   |                                                                                                                                            |
| 10.11  |   | Form of Guaranty(13)                                                                                                                            |
|   |   |                                                                                                                                            |
| 10.12  |   | Form of Guarantor Security Agreement(13)                                                                                                        |
|   |   |                                                                                                                                            |
| 10.13  |   | Form of Supplemental Security Agreement  (Trademarks)(13)                                                                                       |
|   |   |                                                                                                                                            |
| 10.14  |   | Security Agreement, dated September 3,  2002, by and between Diedrich Coffee, Inc. and Bank of the West d/b/a/ United  California Bank(13) |
|   |   |                                                                                                                                            |
| 10.15  |   | First Amendment to Credit Agreement by and  between Diedrich Coffee, Inc. and Bank of the West, effective  December 17, 2002(14)           |
|   |   |                                                                                                                                            |
| 10.16  |   | Second Amendment to Credit Agreement by and  between Diedrich Coffee, Inc. and Bank of the West, effective March 11,  2003(15)             |
|   |   |                                                                                                                                            |
| 10.17  |   | Third Amendment to Credit Agreement by and  between Diedrich Coffee, Inc. and Bank of the West, effective July 1,  2003(16)                |
|   |   |                                                                                                                                            |
| 10.18  |   | Fourth Amendment to Credit Agreement by and  between Diedrich Coffee, Inc. and Bank of the West, effective October 1,  2003 (20)           |
|   |   |                                                                                                                                            |
| 10.19  |   | Reserved.                                                                                                                                       |
|   |   |                                                                                                                                            |
| 10.20  |   | Employment Agreement with Roger M. Laverty,  dated April 24, 2003(15)*                                                                     |
|   |   |                                                                                                                                            |
| 10.21  |   | Stock Option Plan and Agreement with Roger  M. Laverty, dated April 24, 2003(15)*                                                          |
|   |   |                                                                                                                                            |
| 10.22  |   | Employment Agreement with Martin A. Lynch,  dated March 26, 2004*                                                                          |
|   |   |                                                                                                                                            |
| 10.23  |   | Form of Employment Agreement with Martin R.  Diedrich, dated June 29, 2001(17)*                                                            |

 

23

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| 10.24  |   | Employment Agreement with Matthew  McGuinness, effective March 13, 2000(18)*                                                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                |
| 10.25  |   | Employment Letter regarding the employment  of Pamela Britton, dated February 6, 2001(20)*                                                                     |
|   |   |                                                                                                                                                                |
| 10.26  |   | Employment Letter regarding the employment  of Michael Zorehkey, dated February 3, 2000(20)*                                                                   |
|   |   |                                                                                                                                                                |
| 10.27  |   | Employment Letter regarding the employment  of Carl Mount dated October 29, 1999(19)*                                                                          |
|   |   |                                                                                                                                                                |
| 10.28  |   | Separation Agreement by and between  Diedrich Coffee, Inc. and Philip G. Hirsch(15)*                                                                                |
|   |   |                                                                                                                                                                |
| 10.29  |   | Reserved.                                                                                                                                                           |
|   |   |                                                                                                                                                                |
| 10.30  |   | Standard Industrial/Commercial Multi-Tenant  Lease Agreement by and between The Westphal Family Trust and Diedrich Coffee,  Inc., dated September 10, 2003(16) |
|   |   |                                                                                                                                                                |
| 10.31  |   | Office Space Lease Agreement by and between  The Irvine Company and Diedrich Coffee, Inc., dated August 1, 2003(16)                                            |
|   |   |                                                                                                                                                                |
| 10.32  |   | Reserved.                                                                                                                                                           |
|   |   |                                                                                                                                                                |
| 31.1   |   | Certifications of Chief Executive Officer  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                           |
|   |   |                                                                                                                                                                |
| 31.2   |   | Certifications of Chief Financial Officer  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                           |
|   |   |                                                                                                                                                                |
| 32.1   |   | Certifications of Chief Executive Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                           |
|   |   |                                                                                                                                                                |
| 32.2   |   | Certifications of Chief Financial Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                           |

 

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*                 Managementcontract or compensatory plan or arrangement

 

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

 

(2)                      Previouslyfiled as an exhibit to Diedrich Coffee’s Current Report on Form 8-K, filed withthe Securities and Exchange Commission on May 16, 2001.

 

(3)                      Previouslyfiled as an exhibit to Diedrich Coffee’s Registration Statement on Form S-1/A(Registration No. 333-08633), filed with the Securities and Exchange Commissionon August 28, 1996 and declared effective on September 11, 1996.

 

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

 

(5)                      Previouslyfiled as an exhibit to Diedrich Coffee’s Registration Statement on Form S-1(Registration No. 333-08633), filed with the Securities and Exchange Commissionon July 24, 1996 and declared effective on September 11, 1996.

 

24

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(6)                      Previouslyfiled as Appendix B to Diedrich Coffee’ Definitive Proxy Statement, filed withthe Securities and Exchange Commission on April 12, 2001.

 

(7)                      Previouslyfiled as an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for theperiod ended October 29, 1997, filed with the Securities and ExchangeCommission on December 11, 1997.

 

(8)                      Previouslyfiled as an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for thefiscal year ended January 28, 1998, filed with the Securities and ExchangeCommission on April 28, 1998.

 

(9)                      Reserved.

 

(10)                Previously filedas an exhibit to Diedrich Coffee’s Registration Statement on Form S-8, filedwith the Securities and Exchange Commission on November 21, 2000.

 

(11)                Previously filedas an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for theperiod ended September 22, 1999, filed with the Securities and ExchangeCommission on November 5, 1999.

 

(12)                Previously filedas an exhibit to Diedrich Coffee’s Registration Statement on Form S-1/A(Registration No. 333-08633), filed with the Securities and Exchange Commissionon August 12, 1996 and declared effective on September 11, 1996.

 

(13)                Previously filedas an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscalyear ended July 3, 2002, filed with the Securities and Exchange Commissionon October 1, 2002.

 

(14)                Previously filedas an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the periodended December 18, 2002, filed with the Securities and Exchange Commissionon January 31, 2003.

 

(15)                Previously filedas an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the periodended March 12, 2003, filed with the Securities and Exchange Commission onApril 28, 2003.

 

(16)                Previously filedas an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscalyear ended July 2, 2003, filed with the Securities and Exchange Commissionon September 30, 2003.

 

(17)                Previously filedas an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscalyear ended June 27, 2001, filed with the Securities and ExchangeCommission on September 25, 2001.

 

(18)                Previously filedas an exhibit to Diedrich Coffee’s Annual Report on Form 10-K for the fiscalyear ended June 28, 2000, filed with the Securities and ExchangeCommission on September 27, 2000.

 

(19)                Previously filedas an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the periodended September 20, 2000, filed with the Securities and ExchangeCommission on November 6, 2000.

 

(20)                Previously filedas an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the periodended September 24, 2003, filed with the Securities and ExchangeCommission on November 7, 2003.

 

(21)                Previously filedas an exhibit to Diedrich Coffee’s Quarterly Report on Form 10-Q for the periodended December 17, 2003, filed with the Securities and Exchange Commissionon January 30, 2004.

 

25

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

 

On January 28, 2004 we furnished aCurrent Report on Form 8-K to report the financial results of our second fiscalquarter.

 

26

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**SIGNATURES**

 

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

 
|   | Date:  April 22, 2004                       | **DIEDRICH COFFEE, INC.** |
|--------|-------------------------------------------------------|---------------------------|
|   |                                                  |
|   |                                                  |
|   | /s/ Roger M. Laverty                                  |                      |
|   | Roger M. Laverty                                      |
|   | President and Chief Executive Officer                 |
|   | (Principal Executive Officer)                         |
|   |                                                  |
|   |                                                  |
|   | /s/ Martin A. Lynch                                   |                      |
|   | Martin A. Lynch                                       |
|   | Executive Vice President and  Chief Financial Officer |
|   | (Principal Financial and Accounting  Officer)         |

 

27

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