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                                                                   EXHIBIT 10.38



                        SEPARATION AND RELEASE AGREEMENT


               The parties to this Separation and Release Agreement (the
"Agreement") are Kerry W. Coin ("Employee") and Diedrich Coffee, Inc. (the
"Company") who agree and state that:

               (A)    Employee has been employed by the Company in the position
of Chief Operating Officer since August 26, 1996.

               (B)    Employee and the Company entered into that certain
Employment Agreement, dated August 26, 1996 and amended September 24, 1997, (the
"Employment Agreement").

               (C)    Employee desires to resign all of his positions with the
Company effective January 28, 1998 to pursue other interests (and without cause
as defined in paragraph 4(e) of his Employment Agreement). A copy of the
memorandum of understanding signed by the parties is attached as Exhibit A
hereto.

               (D)    The Company desires to accept Employee's resignation.

               (E)    Employee and Company desire to terminate the Employment
Agreement and exchange the consideration set forth below upon the terms and
conditions set forth below in full satisfaction of Employee's and the Company's
rights and obligations set forth in the Employment Agreement.

               NOW, THEREFORE, based on the following promises contained herein,
Employee and the Company hereby agree as follows:

               1.     PAYMENT. The Company agrees to pay Employee as separation
amount (the equivalent of 6 3/4 months salary), the total amount of which is
ninety thousand dollars ($90,000.00) (the "Separation Amount"). Except as
provided in Paragraph 11 below, the Separation Amount will be paid subject to
all appropriate withholdings in nine equal monthly installments on the first of
the month through October, 1998.

               Employee and the Company acknowledge that the Employee is not yet
fully vested in the stock options granted Employee pursuant to the original
Stock Option Grant, as amended. As approved by the Board, the Company agrees
that the Employee shall retain the right to purchase sixty-two thousand five
hundred (62,500) shares at an exercise price of $3.00 per share as previously
granted under the Company's 1996 Stock Incentive Plan. Unless terminated earlier
pursuant to Paragraph 11, these options are exercisable through November 1,
1998. Employee is further granted an additional right to purchase up to 17,500
shares at an exercise price of $3.00 per share. This option vests



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as of August 31, 1998. Employee may exercise any of these stock options by
"cashless exercise" until November 1, 1998, whereby capital stock of the Company
will be retained by the Company from the stock otherwise issuable upon exercise
or surrender of vested and/or exercisable option shares. Employee further
acknowledges and agrees that the option to purchase 40,000 additional shares, as
previously granted under the Company's 1996 Stock Incentive Plan, is terminated
effective the date of his termination.

               Unless terminated earlier pursuant to Paragraph 11, all exercised
option shares shall expire and terminate and not be exercisable as of January
28, 1999.

               Employee shall have the personal use of the Company's PC
presently located at Employee's personal residence for nine months or until
November 1, 1998. On or before November 1, 1998 Employee shall either return
said PC to Company in good working condition, reasonable wear and tear excepted
or purchase the PC from the Company at book value.

               Employee acknowledges that he received a final paycheck for all
wages due, including all accrued vacation, through the date of his termination.
Employee further acknowledges and agrees that the Separation Amount shall be the
sole amount paid to him, and he shall have no entitlement or claim to any
further compensation or benefits from the Company, including without
limitations, salary, bonuses, incentive compensation, vacation payments,
severance, unvested pension benefits, employer-paid health benefits or any other
employment benefits; provided, however, that if the Board of Directors of the
Company elects to award management bonuses for fiscal year 1998, the Board shall
grant an equitable bonus to Employee.

               2. RELEASE. Except for any written Indemnification Agreement
entered into by the Company with Employee, Employee on behalf of himself and his
executors, legatees, devises, administrators, successors and assigns, does
hereby knowingly and willingly forever release and absolutely and forever fully
discharge the Company and all of its current and former officers, directors,
partners, agents, servants, lawyers, employees, assigns, insurers,
predecessors-in-interest, successors-in-interest, underwriters, and all of its
parent, affiliated and subsidiary entities from any and all causes of action,
judgements, liens, indebtedness, costs, damages, obligations, attorney's fees,
losses, claims, liabilities and demands of whatever kind and character, whether
known or unknown, suspected or unsuspected (including, for example, claims for
wrongful termination, unlawful discrimination, payment of wages, vacation pay,
health benefits, business and travel expenses, life insurance, disability
insurance, pension and retirement plans, severance pay, layoff benefit or other
entitlements), arising out of or in any way related to any of the circumstances
of Employee's relationship with the Company, up to the date he signs below.

               Company on behalf of itself, its officers, directors, affiliates
and authorized agents and representatives does hereby knowingly and willingly
forever release and absolutely forever fully discharge Employee and his
successors and assigns



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from any and all causes of action, judgments, liens, indebtedness, costs,
damages, obligations, attorney's fees, losses, claims, liabilities, and demands
of whatever kind and character, whether known or unknown, suspected or
unsuspected, arising out of or in any way related to any of the circumstances of
Company's relationship with the Employee, up to the date of this Agreement.

               4. ADEA WAIVER. Employee specifically agrees that the foregoing
release includes any and all claims, rights and/or remedies arising under the
Age Discrimination in Employment Act ("ADEA") and the Older Workers Benefit
Protection Act. Employee acknowledges that, prior to signing this Agreement, he
was provided a period of twenty-one (21) days to consider its provisions,
including this ADEA wavier. Employee further acknowledges that he is entitled to
revoke this ADEA waiver within seven (7) days after he executes this Agreement,
and this ADEA waiver is not effective or enforceable until this seven-day
revocation period has expired. Employee also acknowledges that he has been
advised to consult with an attorney prior to signing this ADEA waiver and
Agreement.

               5. ALL DISPUTES. This Agreement also extends to all disputes of
every nature and kind by employee against the Company whether known or unknown,
suspected or unsuspected, past or present, and regardless of whether they arise
out of or are attributable to the circumstances of Employee's employment or
termination of employment with Company. Specifically, Employee hereby expressly
waives any and all rights under Section 1542 of the California Civil Code, which
reads in full as follows:

               "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR
               DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF
               EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY
               AFFECCTED HIS SETTLEMENT WITH THE DEBTOR."

               Employee acknowledges that he has separately bargained for the
foregoing waiver of section 1542. Employee understands and agrees that the
provisions regarding the disputes released herein be construed as broadly as
possible, and incorporates herein similar federal, state or other laws, all of
which are similarly waived by Employee.

               6. NO OTHER CHARGES OR CLAIMS. Employee represents that he
presently has no charges or claims of any kind against the Company (including
any of the Company's current or former employees, officers, directors and
affiliates) arising out of or related to any of the circumstances of his
relationship with the Company. If, arguendo, any such charges or claims are
pending, Employee agrees that he will withdraw the same with prejudice. Employee
further covenants that he will not hereafter pursue, initiate or cause to be
instituted any claim or charge before any state, federal or other court, or
state or federal agency or other governmental entity arising out of or related
to any of the circumstances of Employee's relationship or cessation or
termination of such relationship



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with the Company, up to the date he signs this Agreement, and that if any agency
or court assumes jurisdiction of any complaint, charge or lawsuit against any of
these entities or persons on behalf of Employee, he will promptly request such
agency or court to withdraw from the matter, with prejudice, and he will not
seek or accept any damages.

               Company represents that it presently has no charges or claims of
any kind against Employee arising out of or related to any of the circumstances
of Employee's relationship with the Company. If, arguendo, any such charges or
claims are pending, Company agrees that it will withdraw the same with
prejudice. Company further covenants that it will not hereafter pursue, initiate
or cause to be instituted any claim or charge before any state, federal or other
court, or state or federal agency or other governmental entity arising out of or
related to any of the circumstances of Employee's employment or cessation or
termination of such relationship with Company, up to the date of this Agreement,
and further that if any agency or court assumes jurisdiction of any complaint,
charge or lawsuit by Company, its officers, directors, employees, authorized
agents for representatives against Employee, it will promptly request such
agency or court to withdraw from the matter, with prejudice, and it will not
seek or accept any damages.

               7. COOPERATION AND ASSISTANCE. Employee agrees to provide
reasonable assistance to the Company as requested by and at the expense of the
Company to affect a smooth and orderly transition and continuation of the
business of the Company.

               Employee will reasonably cooperate with and assist the Company,
its agents, owners, employee, and attorneys in the preparation and/or defense
and/or pursuit of any litigation involving the Company, and, in addition, with
respect to any issues related to his employment by the Company, his performance
as an employee/officer of the Company, or any related matters, except as he may
be prevented by law.

               Employee further agrees that he will not voluntary aid, assist,
cooperate with or encourage any current, former or future employee or
independent contractor of the Company in connection with the pursuit of any
claim or dispute against the Company, unless compelled by deposition or other
legal process. Employee further agrees that, unless expressly requested in
writing to do so by the Company, he will not voluntarily involve himself in any
way with respect to any claim or dispute by any current, former or future
employee, officer, director or independent contractor of the Company, or by
other third party, against the Company. This paragraph is intended to preclude
the voluntary aid or involvement of Employee as described above, and nothing in
this paragraph is intended to influence the substance of such aid or involvement
which is properly compelled by legal process. The provisions of this paragraph
shall be continuing.

               8. NON-SOLICITATION OF EMPLOYEES. Employee agrees not to solicit
or encourage employees of the Company to leave employment of the Company before
October 31, 1998. During such period, if Employee is contacted by employees of
the



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Company with regard to employment opportunities with Employee, Employee agrees
to inform such employees at the first discussion thereof that Employee cannot
encourage, follow up on, hire or promote the hiring of such employees unless
consent is provided to Employee by the Board of Directors of the Company to
continue such discussions.

               9. TRADE SECRETS AND CONFIDENTIAL INFORMATION. During the term of
Employee's employment with the Company, Employee had access to and became
familiar with various secrets and other confidential information including, but
not limited to, coffee roasting recipes and processes, proposals, computer
software or programming, budgets or other financial information, product
pricing, growth strategies, contracts, and compilations of confidential
information, data and records which are owned by the Company and which are
regularly used in the operation of the business of the Company (the "Proprietary
Information"). Employee agrees not to disclose any of the Proprietary
Information directly or indirectly, nor use it in any way, except as required by
order of a court of competent jurisdiction or a federal governmental agency. All
files, records, document, data, and similar items relating to the Proprietary
Information or to the business of the Company, whether prepared by Employee or
otherwise coming into his possession, shall remain the exclusive property of the
Company. Employee agrees not to remove from the premises or otherwise take,
procure, or copy this property of the Company under any circumstances whatsoever
without authorization of an officer of the Company. Employee represents and
warrants that prior to or concurrently with the execution of this Agreement, he
will return to the Company any of said property in his possession.

               10. NON-DISPARAGEMENT. Employee agrees that he shall not make any
untruthful or derogatory statements about, or otherwise disrupt, interfere,
impair or damage the business of the Company. This paragraph is not intended to
prohibit Employee from testifying truthfully about the Company when compelled to
testify by law. Company agrees that neither it nor its officers or directors
will make any untruthful or derogatory statements about, or otherwise disrupt,
interfere, impair or damage the business or reputation of Employee. This
paragraph is not intended to prohibit Company, its officers or directors from
testifying truthfully about Employee when compelled to testify by law.

               11. TERMINATION OF PAYMENT OBLIGATIONS. Employee acknowledges and
agrees that all of the Company's obligations under Paragraph 1 of this Agreement
will terminate immediately if Employee breaches any provision if this Agreement.
The termination provisions of this Paragraph do not limit in any way the
Company's remedies provided in other provisions of this Agreement, all such
remedies being cumulative. The Company's decision to discontinue benefits to
Employee under this Paragraph shall not affect the remaining obligations and
benefits under this Agreement.

               12. NO TRANSFER. Employee represents and warrants that he has not
heretofore assigned or transferred, or purported to have assigned or
transferred, to any firm, corporation, entity or person, any dispute released
herein. Employee agrees to



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indemnify, defend and hold the Company's harmless from and against any and all
claims based on or arising out of any such assignment or transfer, or purported
assignment or transfer of any claims or any portion thereof or interest therein.

               13. NO ADMISSION. Employee understands and agrees that neither
the payment or promise of consideration, nor the execution of this Agreement
shall constitute or be construed as an admission of any alleged liability or
wrongdoing whatsoever by the Company or its employees, officers, directors, and
affiliates. The Company expressly denies it has committed any alleged liability
or wrongdoing. Company understands and agrees that execution of this Agreement
by Employee shall not constitute nor be construed as an admission of any alleged
liability or wrongdoing whatsoever by the Employee. Employee expressly denies
that he committed any alleged liability or wrongdoing.

               14. ENFORCEMENT OF THIS AGREEMENT. This Agreement shall be
governed by the substantive law of the State of California. In the event of any
dispute concerning the validity, interpretation, enforcement or breach of this
Agreement or in any way related to Employee's employment or termination of
employment with the Company, the dispute shall be resolved by arbitration within
the County of Orange, California, in accordance with the then existing rules for
arbitration of employment disputes of the American Arbitration Association, and
judgement upon any arbitration award may be entered by any state or federal
court having jurisdiction thereof. The Arbitrator's decision in nay-such
arbitration shall be final and binding on the parties. The parties intend this
arbitration provision to be valid, enforceable, irrevocable and construed s
broadly as possible. The prevailing party in such arbitration shall recover its
reasonable costs and expenses (including, but not limited to arbitration fees
and expenses) and reasonable attorneys' fees.

               15. INVALID PROVISIONS. If any provision of this Agreement is
determined to be invalid or unenforceable, all of the other provisions shall
remain valid and enforceable notwithstanding, unless the provisions found to be
unenforceable is of such material effect that this Agreement cannot be performed
in accordance with the intent of the parties in the absence thereof.

               16. ENTIRE AGREEMENT. No promise, inducement or agreement other
than that expressed herein has been made by either party. This Agreement
constitutes a single integrated contract expressing the entire Agreement of the
parties hereto, and it supersedes all prior agreements and understandings
between the parties with respect to such subject matter, including the
Employment Agreement. Except for that certain Indemnification Agreement between
the parties dated as of [June 16, 1997,] there are no other agreements, written
or oral, express or implied, between the parties hereto concerning the subject
matter hereof, except the provisions set forth in this Agreement. This Agreement
may be executed in one or more counterparts, all of which shall constitute a
single original.



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               17. AMENDMENTS. This Agreement can be amended, modified or
terminated only by a writing executed by Employee and the President of the
Company.

               18. COMPETENCY. Employee represents that he is in good health and
fully competent to manage his business affairs, he has carefully read this
document, he understands all of its contents, he fully understands the final and
binding effect of this Agreement, he has been advised in writing to consult an
attorney, and he executes this Agreement freely and voluntarily. Employee
represents and acknowledges that in executing this Agreement he does not rely
and has not relied upon any representation or statement not set forth herein
made by the Company or by any of its agents, representatives or attorneys with
regard to the subject matter, basis or effect of this Agreement or otherwise.
Accordingly, the parties agree that the common-law principles of construing
ambiguities against the drafter shall have no application hereto. It should be
construed fairly and not in favor of or against one party as to the drafter
hereof.

               19. SURVIVAL OF WARRANTIES. All representations and warranties
contained in this Agreement shall survive its execution, effectiveness and
delivery. It is expressly understood and agreed by the Parties hereto that none
of the releases set forth herein are intended to or do release any claims or
rights arising out of this Agreement or the breach of it.

AGREED AND ACCEPTED:

   
                                            /s/ KERRY W. COIN
Dated:  January 28, 1998                    ------------------------------------
                                            Kerry W. Coin


Dated:  January 28, 1998                    Diedrich Coffee, Inc.

                                            By:   /s/ TIMOTHY J. RYAN
                                                --------------------------------
                                                  Timothy J. Ryan
                                                  President and
                                                  Chief Executive Officer

    


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