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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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FORM 10-K/A

AMENDMENT NO. 3



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(Mark One)

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



For the fiscal year ended June 30, 2004



OR



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



Commission file number 0-21203



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DIEDRICH COFFEE, INC.

(Exact Name of Registrant as Specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 33-0086628                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)



28 Executive Park,
Suite 200

Irvine, California 92614

(Address of Principal Executive Offices)



Registrants telephone number, including area code

(949) 260-1600



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Securities registered pursuant to Section 12(b) of the Act:

None



Securities registered pursuant to Section 12(g) of the
Act:

Common Stock, $0.01 par value per share

(Title of Class)



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



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K. ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes ̈No  x



The aggregate market value of the registrants common stock held by non-affiliates of the registrant as of December 17, 2003 was
$9,696,479.



The number of shares of the registrants common stock
outstanding, as of September 21, 2004 was 5,162,757.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the
registrants definitive proxy statement for its 2004 annual meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days of June 30, 2004, are incorporated by reference into Part III of this report.



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EXPLANATORY NOTE



The purpose of this Amendment Number 3 on Form 10-K/A to the Annual Report on Form 10-K/A of Diedrich Coffee, Inc. for the fiscal year ended
June 30, 2004 is to restate our consolidated financial statements for the years ended June 30, 2004, July 2, 2003 and July 3, 2002 and related disclosures, including the selected financial data included herein as of and for the years ended June 30,
2004, July 2, 2003, July 3, 2002, as described in Note 2 to the Consolidated Financial Statements. Additional information about the decision to restate these financial statements can be found in our Current Report on Form 8-K/A, filed with the SEC
on April 8, 2005.



Generally, no attempt has been made in this Form 10-K/A to
modify or update other disclosures presented in the original report on Form 10-K, except as required to reflect the effects of the restatement. The Form 10-K/A generally does not reflect events occurring after the filing of the Form 10-K or modify
or update those disclosures, including the exhibits to the Form 10-K affected by subsequent events. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the Amendment No. 2 filing of the Form
10-K/A on October 12, 2004. Accordingly, this Form 10-K/A Amendment Number 3 should be read in conjunction with our filings made with the Securities and Exchange Commission subsequent to the filing of the Amendment No. 2 of Form 10-K/A,
including any amendments to those filings. The following items have been amended as a result of the restatement:



| |  |  | Part I  Item 1 - Business
| | - |  | --------------------------



| |  |  | Part II  Item 6 - Selected Financial Data
| | - |  | ------------------------------------------



| |  |  | Part II  Item 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | Part II  Item 8  Financial Statements and Supplementary Data
| | - |  | --------------------------------------------------------------



| |  |  | Part II  Item 9A  Controls and Procedures
| | - |  | -------------------------------------------



| |  |  | Part IV  Item 15 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
| | - |  | -----------------------------------------------------------------------------------



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TABLE OF CONTENTS



|                                           |  |                                                                                                               |  |     
|------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------- |  | ----
|                                           |  |                                                                                                               |  | Page
|A Warning About Forward-Looking Statements |  | 1                                                                                                            
|                                           |  |                                                                                                              
|                                           |  | PART I                                                                                                        |  |     
|                                           |  |                                                                                                              
|Item 1.                                    |  | Business                                                                                                      |  | 1   
|                                           |  |                                                                                                              
|Item 2.                                    |  | Properties                                                                                                    |  | 17  
|                                           |  |                                                                                                              
|Item 3.                                    |  | Legal Proceedings.                                                                                            |  | 17  
|                                           |  |                                                                                                              
|Item 4.                                    |  | Submission of Matters to a Vote of Security Holders                                                           |  | 17  
|                                           |  |                                                                                                              
|                                           |  | PART II                                                                                                       |  |     
|                                           |  |                                                                                                              
|Item 5.                                    |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |  | 18  
|                                           |  |                                                                                                              
|Item 6.                                    |  | Selected Financial Data.                                                                                      |  | 19  
|                                           |  |                                                                                                              
|Item 7.                                    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  | 20  
|                                           |  |                                                                                                              
|Item 7A.                                   |  | Quantitative and Qualitative Disclosures About Market Risk                                                    |  | 32  
|                                           |  |                                                                                                              
|Item 8.                                    |  | Financial Statements and Supplementary Data                                                                   |  | 33  
|                                           |  |                                                                                                              
|Item 9.                                    |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                          |  | 33  
|                                           |  |                                                                                                              
|Item 9A.                                   |  | Controls and Procedures                                                                                       |  | 33  
|                                           |  |                                                                                                              
|Item 9B.                                   |  | Other Information                                                                                             |  | 33  
|                                           |  |                                                                                                              
|                                           |  | PART III                                                                                                      |  |     
|                                           |  |                                                                                                              
|Item 10.                                   |  | Directors and Executive Officers of the Registrant                                                            |  | 34  
|                                           |  |                                                                                                              
|Item 11.                                   |  | Executive Compensation                                                                                        |  | 34  
|                                           |  |                                                                                                              
|Item 12.                                   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                |  | 34  
|                                           |  |                                                                                                              
|Item 13.                                   |  | Certain Relationships and Related Transactions                                                                |  | 34  
|                                           |  |                                                                                                              
|Item 14.                                   |  | Principal Accountant Fees and Services                                                                        |  | 35  
|                                           |  |                                                                                                              
|                                           |  | PART IV                                                                                                       |  |     
|                                           |  |                                                                                                              
|Item 15.                                   |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                                              |  | 35  
|                                           |  |                                                                                                              
|                                           |  | Signatures                                                                                                    |  | 36  
|                                           |  |                                                                                                              
|                                           |  | Financial Statements                                                                                          |  | F-1 
|                                           |  |                                                                                                              
|                                           |  | Index to Exhibits                                                                                             |  | S-1 



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A WARNING ABOUT FORWARD-LOOKING STATEMENTS



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



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



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



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



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



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



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



Additional risks and uncertainties are described elsewhere in this report and in detail under Item 1. Business  Risk Factors and Trends Affecting Diedrich
Coffee and Its Business. You are cautioned not to place undue reliance on these forward-looking statements, which reflect managements analysis only as of the date of this annual report. We undertake no obligation to publicly release the
results of any revision of the forward-looking statements. Unless the context requires otherwise, the terms we, us, and our refer to Diedrich Coffee, Inc., a Delaware corporation, and its predecessors and
subsidiaries.



PART I



Item 1.Business.



Overview



Diedrich Coffee, Inc. is a specialty coffee roaster,
wholesaler and retailer. We sell brewed, espresso-based and various blended beverages primarily made from our own fresh roasted premium coffee beans, as well as light food items, whole bean coffee and accessories, through our company operated and
franchised retail locations. We also sell whole bean and ground coffee on a wholesale basis through a network of distributors in the Office Coffee Service (OCS) market and to other wholesale customers, including restaurant chains and
other retailers. Our brands include Diedrich Coffee, Gloria Jeans, and Coffee People. As of June 30, 2004, we owned and operated 56 retail locations and franchised 426 other retail locations under these brands, for a total of 482 retail coffee
outlets. Although the specialty coffee industry is presently dominated by a single company, which operates or licenses over seven times the number of retail outlets we do, we are one of the nations largest specialty coffee retailers with
annual system-wide revenues in excess of $225 million. Our retail units are located in 34 states and 13 foreign countries. As of June 30, 2004, we also had over 460 wholesale accounts with OCS distributors, chain and independent restaurants, and
others. In addition, we operate a large coffee roasting facility in central California that supplies freshly roasted coffee to our retail locations and wholesale accounts.



Our Gloria Jeans coffee stores offer an extensive variety of the finest quality flavored whole bean coffees, as well as an assortment
of coffee related merchandise, accessories, porcelain novelties and gift items, in addition to coffee-based beverages. The critical components for each of our retail locations include high quality, fresh roasted coffee and superior customer service
by knowledgeable employees.



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Our Diedrich Coffee brand is differentiated from other specialty coffee companies by roasting our coffee beans with the
experience we have gained over several decades. Our roasting recipes take into account the specific variety, origin and physical characteristics of each coffee bean to maximize its unique flavor. In addition, we seek to differentiate our
coffeehouses by offering our customers a broad line of superior tasting coffee products and a high level of personalized customer service. Our coffeehouses offer a warm, friendly environment specifically designed to encourage guests to enjoy their
favorite beverages while lingering with friends and business associates, or relaxing alone in comfort. Ample seating is augmented by sofas and comfortable chairs to create intimate nooks for meeting and relaxing. Many of our coffeehouses feature
local musicians who provide live entertainment from time to time during the week.



Company Background



Our predecessor company, Carl E. Diedrich
& Sons, Inc., commenced operations in Orange County, California in 1972 and changed its name to Diedrich Coffee when its first retail store opened. We incorporated in California in 1985. We remained a small, family operated business with only
three retail locations until 1992. We grew rapidly from 1992 to 1996 through construction of new Diedrich Coffee coffeehouses in Orange County and the acquisition of coffeehouses operated under other brands in Houston, Denver and San Diego, all of
which were converted into Diedrich Coffee coffeehouses. In August 1996, we reincorporated under Delaware law as Diedrich Coffee, Inc., and completed an initial public offering of our common stock in September 1996. On July 7, 1999, we acquired
Coffee People, Inc. The Coffee People, Inc. brands included Gloria Jeans, one of the leaders in the mall coffee store market, Coffee People, based primarily in Portland, Oregon, and Coffee Plantation, based primarily in Phoenix, Arizona. The
Coffee Plantation coffeehouses have been sold or closed. We continue to operate three brands: Diedrich Coffee, Gloria Jeans and Coffee People.



Industry Overview



According to the National Coffee Association of U.S.A., Inc. (the NCA), in 2004, the percentage of the population over 18 that drank coffee daily or occasionally was essentially flat at 79%, but increased
from 166.6 million adults in 2003 to 167.1 million adults in 2004. On average, each adult drinks 3.4 cups of coffee per day. The NCA also reported that daily and occasional consumption of gourmet coffee has increased over the past five years from
9.0% of the adult population in 1999 to over 16.0% of the adult population in 2004.



The United States coffee market consists of two distinct product categories:



| |  |  | commercial ground roast, mass-merchandised coffee; and
| | - |  | ------------------------------------------------------



| |  |  | specialty coffees, which include gourmet coffees (premium grade Arabica coffees sold in whole bean and ground form) and premium coffees (upscale coffees mass-marketed by the leading
coffee companies).
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We believe that several factors have
contributed to the increase in demand for gourmet coffee including:



| |  |  | greater consumer awareness of gourmet coffee as a result of its increasing availability;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | increased quality differentiation over commercial grade coffees by consumers;
| | - |  | -----------------------------------------------------------------------------



| |  |  | increased demand for all premium food products, including gourmet coffee, where the differential in price from the commercial brands is small compared to the perceived improvement
in product quality and taste; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ease of preparation of gourmet coffees resulting from the increased use of automatic drip coffee makers and home espresso machines.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



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Our Business Model



Our business objective is a logical extension of our Mission Statement, which states: We sell great coffee. Therefore, our objective is to sell coffee,
without compromising our commitment to quality. We buy only the finest quality green coffee beans available, fresh roast them with our proprietary recipes and subject them to a rigorous internal quality control process. We ensure that care is taken
at each and every step of the production and distribution process to preserve that quality.



We principally sell our coffee through two distribution channels, and strive to target our resources to increase efficiency and profitability while growing the business within this framework. These two distribution
channels are retail outlets and wholesale distribution. While each of these channels have different customers, cost structures, overhead requirements, competitors, and other fundamental differences, we believe our commitment to quality is essential
to successful growth in both of these areas. Important financial information for each of our business segments can be found in Note 13 to our consolidated financial statements.



Retail Outlets



Our retail outlet distribution channel can be divided into two sub-channels, each with its own distinct business model, including
differences in revenue and cost structure, overhead, and capital requirements. These two retail sub-channels are company operated retail outlets and franchised retail outlets. Despite the differences noted above, we view retail outlets as a single
distribution channel primarily because our retail customers do not make any distinction between company and franchise operated locations. The critical success factors are, therefore, the same for each type of retail location, whether company
operated or franchised  quality of product, service and atmosphere. The economic model and cost structures are also the same for each type of location at the retail unit level, notwithstanding their different direct financial impacts on us in
our roles as both an operator and franchiser of retail outlets. Furthermore, the potential contribution of any given outlet, as measured by the amount of roasted coffee produced through our roasting plant, is the same.



Presently, our largest brand is Gloria Jeans, which consists of retail units located
throughout the United States and in 13 foreign countries. Over 97% of Gloria Jeans retail units are franchised. Our Diedrich Coffee brand has a higher concentration of company operated units, with 77% of retail locations operated by us.
Diedrich Coffee stores are located primarily in Orange County, California, although there are a number of Diedrich Coffee locations in Los Angeles, San Diego, Denver, and Houston. We also operate retail coffee outlets under a third brand, Coffee
People, all of which are currently company operated and located in Portland, Oregon.



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The following table summarizes the relative sizes of each of our brands on a unit count basis and changes in unit count
for each brand over the past two years.



|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|------------------------------- |  | --------------------- |  | ------ |  | ------ | - |  | --------------------------------------------------- | - |  | --------------------- |  | ------ |  | ------ | - |  | --------------------------------------------------- | - |  | ----------------------
|                                |  | Units at July 3, 2002 |  | Opened |  | Closed |   |  | Net transfers between the Company and Franchise (A) |   |  | Units at July 2, 2003 |  | Opened |  | Closed |   |  | Net transfers between the Company and Franchise (B) |   |  | Units at June 30, 2004
|Gloria Jeans Brand             |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Company Operated                |  | 18                    |  |       |  | (1     | ) |  | (6                                                  | ) |  | 11                    |  |       |  | (3     | ) |  | 2                                                   |   |  | 10                    
|Franchise  Domestic            |  | 155                   |  | 4      |  | (22    | ) |  | 6                                                   |   |  | 143                   |  | 10     |  | (14    | ) |  | (2                                                  | ) |  | 137                   
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Franchise  International       |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Australia                       |  | 76                    |  | 66     |  |       |   |  |                                                    |   |  | 142                   |  | 55     |  | (1     | ) |  |                                                    |   |  | 196                   
|Far East/Asia (C)               |  | 16                    |  | 3      |  | (1     | ) |  |                                                    |   |  | 18                    |  | 4      |  | (3     | ) |  |                                                    |   |  | 19                    
|Mexico                          |  | 12                    |  | 4      |  | (1     | ) |  |                                                    |   |  | 15                    |  | 3      |  | (1     | ) |  |                                                    |   |  | 17                    
|Other (D)                       |  | 36                    |  | 4      |  | (9     | ) |  |                                                    |   |  | 31                    |  | 21     |  | (2     | ) |  |                                                    |   |  | 50                    
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Total Franchise  International |  | 140                   |  | 77     |  | (11    | ) |  |                                                    |   |  | 206                   |  | 83     |  | (7     | ) |  |                                                    |   |  | 282                   
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Subtotal Gloria Jeans          |  | 313                   |  | 81     |  | (34    | ) |  |                                                    |   |  | 360                   |  | 93     |  | (24    | ) |  |                                                    |   |  | 429                   
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Diedrich Coffee Brand           |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Company Operated                |  | 25                    |  |       |  |       |   |  |                                                    |   |  | 25                    |  |       |  | (2     | ) |  |                                                    |   |  | 23                    
|Franchise  Domestic            |  | 12                    |  |       |  | (2     | ) |  |                                                    |   |  | 10                    |  |       |  | (3     | ) |  |                                                    |   |  | 7                     
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Subtotal Diedrich               |  | 37                    |  |       |  | (2     | ) |  |                                                    |   |  | 35                    |  |       |  | (5     | ) |  |                                                    |   |  | 30                    
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Coffee People Brand             |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Company Operated                |  | 27                    |  |       |  | (5     | ) |  |                                                    |   |  | 22                    |  | 1      |  |       |   |  |                                                    |   |  | 23                    
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       
|Total                           |  | 377                   |  | 81     |  | (41    | ) |  |                                                    |   |  | 417                   |  | 94     |  | (29    | ) |  |                                                    |   |  | 482                   
|                                |  |                       |  |        |  |        |   |  |                                                     |   |  |                       |  |        |  |        |   |  |                                                     |   |  |                       

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|(A) | Six company operated Gloria Jeans coffeehouses were transferred to a franchisee during the year.
|--- | -------------------------------------------------------------------------------------------------

|(B) | Two company operated Gloria Jeans coffeehouses were transferred to franchisees during the year, and four franchisee operated coffeehouses were transferred from franchisees to
the Company.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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



We recognize the importance of our brands to our success in both the retail and wholesale
areas of our business. We therefore devote considerable energy to maintain distinct brand identities. Our brands are differentiated by coffees offered, other product categories offered, format and type of retail location, advertising message, and
trade dress.



Gloria Jeans



Gloria Jeans is a leader in the specialty grade, flavored coffee market, with 429
coffee stores in 33 states throughout the United States and in 13 foreign countries. Many of our Gloria Jeans coffee stores are located in high traffic shopping malls. The consumer traffic pattern in our mall-based stores is driven by mall
hours and dynamics. Our mall-based stores are generally busiest on weekends and during holiday seasons. The typical



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Gloria Jeans domestic coffee store is staffed with a manager and a staff of 5 to 10 part-time hourly employees who
fill the operating shifts. The typical Gloria Jeans international store is staffed with two shift supervisors and a staff of 12 to 15 part-time hourly employees who fill operating shifts. Gloria Jeans outlets tend to open earlier than
most mall stores, but in general, operating hours coincide with mall hours. Internationally, Gloria Jeans can be found in malls, on street front locations, and in other non-traditional venues. In addition to coffee beverages and fresh roasted
whole bean coffees, Gloria Jeans carries a wide selection of gift items, coffee accessories, and a small selection of bakery items to complement beverage sales. The stores currently sell from 32 to 53 varieties of flavored and non-flavored
coffees. Currently, approximately 50% of overall sales are comprised of beverage sales.



The success of Gloria Jeans coffee stores in malls depends on three critical components: product quality, product selection, and service.



Product Quality. Gloria Jeans has been a pioneer in developing high quality, flavored, specialty coffees, and continues to be a leader in the sale of
flavored coffees. Gloria Jeans flavored coffees begin with a top quality, single-origin coffee that is roasted and then coated with proprietary flavorings.



Product Selection. For those stores in a mall environment, the shopping experience is integral to a coffee store, and sales of whole
bean coffee and coffee-related merchandise tend to represent a large percentage of sales. Offering as many as 53 varieties of flavored coffees, a wide variety of hot and cold beverages, and a wide selection of gift items is important. A major
benefit of mall retailing is its captive consumer base. The primary function of Gloria Jeans marketing is to entice consumers with eye-catching signage and window displays. A large selection of products helps to attract both new and repeat
customers. Once inside a mall, consumers are unlikely to leave to purchase coffee, refreshments or gifts similar to those offered by Gloria Jeans. Mall employees are also captive consumers and represent an important component of our customer
base.



Service. Friendly and efficient customer service is always
critical in any retail setting, and is especially important for those stores in a mall environment, where shoppers are often in a hurry and have many choices. Because of the opportunity for repeat customers, it is essential that customers receive
excellent service.



Diedrich Coffee



Our typical Diedrich Coffee neighborhood coffeehouse is staffed with one or two managers and
a staff of 12 to 25 part-time hourly employees who fill the operating shifts. Additionally, local entertainment is often offered on the weekends to enhance the neighborhood atmosphere. The hours for each coffeehouse are established based upon
location and customer demand, but typically are from 6:00 a.m. to 11:00 p.m.



In addition to coffee beverages and fresh roasted whole bean coffees, all of our Diedrich Coffee coffeehouses offer a limited selection of light food items such as bagels, croissants and pastries, and dessert items, such as cookies and
cakes, to complement beverage sales. Our coffeehouses sell more than 25 different selections of regular and decaffeinated roasted whole bean coffees, and they carry select coffee-related merchandise items. The success of a Diedrich Coffee
coffeehouse depends upon three critical components: product quality, service and ambiance.



Product Quality. Our management team includes a number of coffee experts with years of specialty coffee industry experience in purchasing and roasting coffee and in training our coffeehouse team members.
Through these key personnel, we are able to identify and purchase exceptional coffees and roast them to perfection. In addition they share their expertise with our coffeehouse team members in our training program, Coffee University.



Service. Our coffeehouses deliver specific consumer benefits that
address a wide range of otherwise unmet needs in suburban neighborhoods in the United States. As a neighborhood coffeehouse, we are the non-alcoholic counterpart to the corner pub. Our employees greet regular customers by name and acknowledge all
patrons by



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name at the point of drink pick-up. Although a large percentage of coffeehouse business is quick morning coffee pick-up,
where speed is an important aspect of our overall service, our coffeehouses place an emphasis on hospitality and customer interaction to encourage development of strong afternoon and evening business. This is complemented by our selection of
desserts, pastries and quality, non-caffeinated beverages. Surveys and customer comments indicate that patrons are treated as part of the Diedrich Coffee community and frequently visit the coffeehouse.



Ambiance. Our coffeehouses are specifically designed to encourage guests to linger
with friends and business associates, or to relax alone in comfort. Ample seating is augmented with sofas and comfortable chairs to create intimate nooks for meeting and relaxing. A weekly entertainment schedule is provided to encourage patrons to
revisit on weekend evenings. A signature element of our full size coffeehouses is a coffee bar, where customers can sit at a barstool and watch the barista prepare espresso-based drinks, similar to the way patrons in traditional pubs and taverns
interact with the bartender and other customers at the bar.



Wholesale Distribution



As of June 30, 2004, we had
over 460 coffee wholesale accounts not affiliated with our retail locations, which purchase coffee from us under both the Diedrich Coffee and Gloria Jeans brands. Our current wholesale accounts are in the OCS market, chain restaurants,
independent restaurants and other hospitality industry accounts and specialty retailers. Additionally, except for our franchisees in Australia and Mexico, our franchise agreements require both Gloria Jeans and Diedrich Coffee franchisees to
purchase substantially all of their coffee from us, and we record a wholesale gross profit on such sales.



OCS Market



We sell our premium coffees
primarily to OCS distributors in whole bean and ground coffee form for use in traditional coffee brewing equipment found in most office environments. During fiscal 2000, we entered into a licensing agreement with Keurig, Inc. whereby we utilize
Keurigs patented single-serve coffee brewing technology and its existing extensive distribution channels within the OCS market. Keurig is introducing a variation of its OCS market brewing technology for at-home use by consumers, and we intend
to participate actively if at-home use is successfully established.



Chain
Restaurants



As specialty coffee has grown in overall popularity,
restaurant customers are demanding a high quality cup of coffee as a supplement to a meal. Our chain accounts include Rubys restaurants, Ruths Chris Steakhouse (California and Arizona locations), Pat and Oscars restaurants and
Islands restaurants. We not only supply coffee to these customers, but also approve their equipment and train their employees to ensure that the quality of coffee served meets our rigorous quality standards. It is common for our chain restaurant
wholesale customers to specify in their menus that they serve Diedrich Coffee or Gloria Jeans coffee, which provides us with additional exposure to the restaurants patrons.



Other Wholesale Accounts



We also supply coffee on a wholesale basis to a number of smaller, often independent, operators in the restaurant and hospitality industries and to specialty retailers.
These wholesale accounts are typically located in the same geographic areas where our retail outlets have created brand awareness and demand. We are careful to balance the benefit of new wholesale accounts near our existing retail outlets against
the risk of cannibalization of these units. We believe that this risk can be successfully managed. Many of our wholesale accounts, such as hotels, restaurants, golf course snack bars and airport concessions have their own
captive customer base. In such cases, the risk of cannibalization is minimal, since a customer would not likely stop their activity in such locations to visit one of our coffeehouses or mall based coffee stores for a beverage, and then
return to their previous activity at those wholesale customer locations. Additionally, if sales conflicts arise as we develop new retail locations in the future, we can cease selling to then-existing wholesale accounts.



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Growth Strategy



Retail Segment Growth. We expect future growth in our retail segment to occur in two ways: via comparable store sales growth in each of our retail brands
and from new retail unit growth. We expect that new unit growth in the near term will be achieved primarily through the development of new Gloria Jeans retail locations, both domestically by us and internationally by franchisees, and in the
future through the development of new Diedrich Coffee coffeehouses in southern California by us and by franchisees. We believe that the resources we recently invested in our Gloria Jeans franchising infrastructure will facilitate continued
strong growth in our international store count and will allow us to resume net growth in our domestic store count under that brand. Diedrich Coffee franchise development will occur less rapidly relative to Gloria Jeans for two reasons. First,
we continue to evaluate a number of initiatives and programs within the Diedrich Coffee business model that are designed to make Diedrich Coffee franchises more attractive to prospective franchisees before we attempt to grow the brand further on a
franchised basis. Second, once we are comfortable franchising new Diedrich Coffee units again, we expect that new unit growth will be concentrated almost exclusively in southern California, for the reasons described below. In the near term, retail
growth under our Coffee People brand is expected to occur primarily through comparable store sales growth.



Development of new retail locations by us is undertaken on a very selective basis. For both Gloria Jeans and Diedrich Coffee, new company store development will be done primarily for the purpose of facilitating
new franchise development, rather than as part of a deliberate strategy to increase the size of the company operated retail unit portfolio. Therefore, increased development of new retail units by us will likely be accompanied by increased sales of
company operated retail units to franchisees. For a variety of reasons, retail units sold by us to franchisees in any given period may not necessarily coincide precisely with the specific new units developed by us in that same period. Development of
new retail units by us is expected to support new franchise development in a number of ways, including opportunistically obtaining control of desirable locations as they become available, increasing awareness of our specialty coffee brands by real
estate developers and landlords of prime retail properties as they develop new retail venues, and by prospective retail coffeehouse customers, improving the cost effectiveness of architectural plans for new prototypes, leveraging purchasing
efficiencies system-wide for new unit equipment and fixtures packages, and increasing awareness among prospective franchisees and their lenders.



Gloria Jeans Franchise Growth



Since the acquisition of the Gloria Jeans brand in 1999, we have made a number of modifications to the Gloria Jeans franchising business model to strengthen
the Gloria Jeans system. A new form of franchise agreement was adopted which incorporated many provisions common in other successful franchise systems. Screening of financial qualifications of franchise candidates has been improved in terms of
consistency and accuracy. Franchisees are now encouraged to obtain their own master leases directly from mall owners, rather than subleasing their locations from Gloria Jeans. Franchisees are required to hire their own architects and
contractors to develop new Gloria Jeans locations to approved specifications. Our training program has been completely redesigned in order to improve the quality of store level operations, product quality, and the consistency of brand
standards. Although we believe that these and other changes to the Gloria Jeans franchising model will ultimately result in a stronger Gloria Jeans franchise system, they may result in slower domestic franchise growth in the near term.



Another factor we must overcome in the near term to resume domestic unit
growth for Gloria Jeans is a shortage of projects in our new unit development pipeline, or inventory of new unit deals in progress. This shortage resulted from our focus on improving the foundation for future franchise development
during the past several years since we acquired the Gloria Jeans brand, rather than on opening new retail units. As part of our efforts to strengthen our existing retail base, it was necessary to allow many of the weaker performing locations
to close. Additional gaps in the flow of new franchise units resulted from several periods where our franchise registration status, which is required by law to sell new franchises, was temporarily interrupted during certain periods when our
financial position was less stable than it is today, and frequent updates of our registration were required.



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Although there were only three premature franchise unit closures (closures prior to the natural expiration of
the underlying master lease) during the most recent fiscal year, there are an average of approximately one dozen franchise units which reach their natural expiration annually, and it may not make economic sense to renew many of these
locations based on changes in the retail tenant mix, desirability of the location, increases in rent relative to sales levels, and various other factors. Therefore, it may be some time before we are able to open enough new domestic retail units to
offset the number of closures during the same time period for net growth in domestic retail unit count.



Gloria Jeans has been successful establishing coffeehouses internationally through area development agreements, and has added a net of 142 new international franchise units during the past two fiscal years.
International franchisees operated 282 Gloria Jeans retail locations in 13 countries at June 30, 2004, and we anticipate continued strong growth internationally through existing area development agreements during fiscal 2005. We also expect to
seek to enter into new area development agreements and master franchise agreements in order to expand Gloria Jeans international penetration to additional countries in the future.



Diedrich Coffee Franchise Growth



For the past several years we have temporarily suspended our prior franchise growth strategy for the Diedrich Coffee brand. In order to make Diedrich Coffee franchises
more attractive to prospective franchisees, we continue to evaluate a number of initiatives and programs within the Diedrich Coffee business model before we attempt to grow the brand further on a franchised basis. Because the Diedrich Coffee system
is relatively small in size when compared to our Gloria Jeans system and because it is concentrated geographically almost exclusively in southern California, where the locations are 100% company operated, we believe this is the optimal time to
test new programs and initiatives for the entire Diedrich Coffee system before we devote significant resources to a franchise development program.



When we are comfortable franchising new Diedrich Coffee units again, we anticipate that our strategy will be to leverage Diedrich Coffees existing brand awareness
and retail operating unit base in central and south Orange County, California to achieve a higher level of penetration of this core market with new Diedrich Coffee locations. Once this is accomplished, our plan is to develop additional
franchised retail units in new markets, expanding outwardly from the core market in concentric rings, and focusing sequentially on the next highest priority areas for expansion. Therefore, north Orange County, southern Los Angeles County and
northern San Diego County, all of which are in close geographic proximity to Diedrich Coffees existing core base of retail coffeehouses, but which presently have few Diedrich Coffee units, would be our next priority once central and south
Orange County achieves a sufficiently high level of penetration. Likewise, once a base of coffeehouses has been successfully established in these immediately adjacent markets, the next sphere of opportunity would include parts of the greater Los
Angeles and San Diego metropolitan areas. It should be noted that growth potential under such a concentric rings strategy would be significant, even though concentrated within a single region, because of the significant population of
southern California. Based upon the 2000 census, the five county metropolitan Los Angeles area (which includes Los Angeles, Orange, Riverside, San Bernardino and Ventura Counties) has a population in excess of 15 million people and San Diego County
has a population in excess of 2 million people. We believe that this strategy maximizes the likelihood of success of new retail units because of heightened brand awareness and operational efficiencies.



As will be the case for our Gloria Jeans brand, new Diedrich Coffee units we open as
company operated coffeehouses will be undertaken on a very selective basis, and primarily as a way to facilitate our franchising initiative described above. Also, as in the case of our Gloria Jeans operations, we may periodically sell certain
company operated Diedrich Coffee locations to franchisees as part of this same strategy.



As of June 30, 2004, we had one area development agreement in effect with Diedrich franchisees. This agreement is for areas outside of California.



Wholesale Distribution Growth. We have taken significant steps to build our wholesale sales organization over the past two
years, and we are actively seeking new distribution channels for our products. We intend to



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pursue continued growth within our OCS wholesale business by expanding the number of distributors that carry our Keurig
Premium Coffee Systemslines of coffees and our whole bean and ground coffee product
lines. We also offer our coffees on our internet website, and we believe that this channel of distribution has long-term growth potential.



Franchise Support Programs



We provide a variety of support services to our franchisees. These services include marketing, product sourcing, volume purchasing savings, training and business
consultation.



We have established an intensive training program for our
franchisees, which includes training on in-store operations, coffee knowledge, merchandising, buying, controls and accounting. Management works closely with franchisee representatives on issues that affect the operations of stores. Franchisees are
surveyed regularly to provide feedback on subjects that affect the operations of their stores.



Marketing



Our primary marketing
strategy is to develop the Gloria Jeans brand through penetration of new and existing markets via franchise growth. Our marketing strategy for our Diedrich Coffee brand is to support growth in same store sales and to position the brand for new
unit growth in the near future. Our wholesale sales in the OCS market, to chain restaurants, and to other customers also operates to increase the visibility of our brands. Our marketing efforts are based upon the belief that the proprietary roast
recipes and our commitment to quality and freshness deliver a distinctive advantage in our products. We use word-of-mouth, local store marketing and the inviting atmosphere of our coffeehouses and mall coffee stores to drive brand awareness and
comparable store sales growth. We also conduct in-store coffee tastings, provide brewed coffee at local neighborhood events, and donate coffee to local charities to increase brand awareness. We also conduct product trials in the communities where
our coffeehouses and mall coffee stores are located.



Product Supply and
Roasting



Sourcing



Coffee beans are an agricultural product grown commercially in over 50 countries in tropical
regions of the world. The price and supply of coffee are subject to significant volatility. There are many varieties of coffee and a range of quality grades within each variety. Although the broader coffee market generally treats coffee as a
fungible commodity, the specialty coffee industry focuses on the highest grades of coffee. We purchase premium grade Arabica coffee beans that we believe to be the best available from each producing region.



Roasting



We employ a roasting process that varies based upon the variety, quality, origin and
physical characteristics of the coffee beans being roasted. Our master roasters are responsible for the green coffee bean roasting process. They are craftsmen who employ our proprietary roasting formulas while adjusting the formula to take into
account the specific attributes of each coffee bean being roasted. Each coffee bean contains aromatic oils and flavor characteristics that develop from the soil, climate and environment where the bean is grown. The skilled roast master determines
and carefully controls the roasting conditions in an effort to maximize the flavor potential of each batch of coffee. The roast master hears how the roast pops, smells the developing aroma and identifies the right shades of color. He draws upon
experience and knowledge to properly adjust airflow, time and temperature while the roast is in progress in order to optimize each roast.



Freshness



We are committed to serving our customers beverages and whole bean products from freshly roasted coffee beans. Our coffee is delivered to our retail locations and
wholesale customers promptly to guarantee the freshness of each cup of coffee or package of whole coffee beans sold.



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Competition



The specialty coffee market is intensely competitive and highly fragmented. With low barriers to entry, competition in the industry is expected to increase from national
and regional chains, as well as from local specialty coffee stores. We compete directly against all other premium coffee roasters, wholesalers and retailers, including other brands of coffeehouses, and mall coffee stores, restaurant and beverage
outlets that serve coffee, and a growing number of espresso kiosks, stands, and carts. In addition, we compete to draw consumers of standard or commercial coffee to premium coffee. Our whole bean coffee competes directly against specialty coffees
sold at specialty retailers and a growing number of specialty coffee stores. We believe that our customers choose among retailers primarily on the basis of product quality, service, coffeehouse ambiance and convenience and, to a lesser extent, on
price.



We compete with a growing number of specialty coffee retailers
including Starbucks, Coffee Beanery Ltd., Caribou Coffee, Barnies, Tullys, New World Coffee & Bagels, Peets Coffee and many others. The attractiveness of the gourmet specialty coffeehouse market may draw additional competitors
with substantially greater financial, marketing and operating resources than we have. A number of nationwide coffee manufacturers, such as Kraft Foods, Proctor & Gamble and Nestlé, distribute coffee products in supermarkets and
convenience stores, which may serve as substitutes for our coffees. Other specialty coffee companies including Starbucks, Bucks County, Brothers Gourmet Coffees and Green Mountain Coffee Roasters, sell whole bean coffees in supermarkets and variety
and discount stores.



Foreign Operations



At June 30, 2004, there were 282 Gloria Jeans coffeehouses in 13 foreign countries.
The largest concentration of stores is in Australia where there were 196 stores at June 30, 2004. International operations, particularly those in Australia, have grown rapidly in the past three years. Total international revenues were $1,345,000 in
fiscal 2002, $1,801,000 in fiscal 2003 and $3,134,000 in fiscal 2004. Australian revenues were approximately $579,000 in fiscal 2002, $1,350,000 in fiscal 2003 and $2,068,000 in fiscal 2004.



Other Factors



The performance of individual coffeehouses or mall coffee stores may also be affected by factors such as traffic patterns and the type,
number and proximity of competing coffeehouses or mall coffee stores. In addition, factors such as inflation, increased coffee bean, food, labor and employee benefit costs and the availability of experienced management and hourly employees may also
adversely affect the specialty coffee retail business in general and our coffeehouses and mall coffee stores in particular.



Seasonality



Historically, we have experienced variations in sales from quarter-to-quarter due to the peak November-December holiday season, as well as from a variety of other factors, including, but not limited to, general
economic trends, the cost of green coffee, competition, marketing programs, weather and special or unusual events.



Intellectual Property



We own several trademarks and service marks that have been registered with the United States Patent and Trademark Office, including Diedrich Coffee®, Gloria Jeans®, Coffee People®, Motor Moka®, Aero Moka®, Wiener Melange Blend®, Harvest Peak®, and Flor de
Apanas®, as well as other slogans, product names, design marks and logos. In addition, we
have applications pending with the United States Patent and Trademark Office for a number of additional marks. We also own registrations and have applications pending in numerous foreign countries for the protection of the Diedrich Coffee and Coffee
People trademark and service mark. These trademark registrations can generally be renewed as long as we continue to use the marks protected by the



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registrations. The Gloria Jeans and Diedrich Coffee trademarks are material to our business. We also own a number
of common law service marks and trademarks in the United States including Gloria Jeans Coffee Bean. We have also received trademark and service mark protection for the name Coffee People and related marks in Canada and Japan. We
own copyrights on our promotional materials, coffeehouse graphics and operational and training materials. We do not believe that any of these copyrights, valuable as they are, are material to our business.



Employees



At June 30, 2004, we employed 807 people, 316 of whom were employed full-time. None of our employees are represented by a labor union, and
no employees are currently covered by collective bargaining agreements. We consider our relations with our employees to be good. We regularly review our employee benefits, training and other aspects of employment to attract and to retain valuable
employees and managers.



Government Regulation



In addition to the laws and regulations relating to the food service industry, we are
subject to Federal Trade Commission (FTC) regulation and state laws that regulate the offer and sale of franchises as well as the franchise relationship. The FTCs Trade Regulation Rule relating to Disclosure Requirements and
Prohibitions Concerning Franchising and Business Opportunity Ventures generally requires us to give prospective franchisees a franchise offering circular containing information prescribed by the rule. A number of states have laws that regulate the
offer and sale of franchises and the franchisor-franchisee relationship. These laws generally require registration of the franchise offering with state authorities before making offers or sales and regulate the franchise relationship by, for
example:



| |  |  | prohibiting interference with the right of free association among franchisees;
| | - |  | ------------------------------------------------------------------------------



| |  |  | prohibiting discrimination in fees and charges;
| | - |  | -----------------------------------------------



| |  |  | regulating the termination of the relationship by requiring good cause to exist as a basis for the termination, advance notice to the franchisee of the termination, and
an opportunity to cure a default;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | requiring repurchase of inventories in some circumstances;
| | - |  | ----------------------------------------------------------



| |  |  | restricting non-renewal by the franchisor;
| | - |  | ------------------------------------------



| |  |  | limiting restrictions on transfers or inheritance of the franchisees interests; and
| | - |  | ------------------------------------------------------------------------------------



| |  |  | regulating placement of competing units that might adversely affect the franchisees results.
| | - |  | ---------------------------------------------------------------------------------------------



Failure to comply with applicable franchise laws may adversely affect us. Any changes to the FTCs rules, or state franchise laws, or
future court or administrative decisions, could affect our franchise business. There are also extensive federal, state and local government regulations relating to the development and operation of food service outlets, including laws and regulations
relating to: building and seating requirements; the preparation and sale of food; cleanliness; safety in the workplace; and accommodations for the disabled. Our relationship with our employees is also subject to regulation, such as: minimum wage
requirements; anti-discrimination laws; overtime and working conditions; and citizenship requirements.



Available Information



Our Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and other documents that we may file with or furnish to the SEC from time to time are available on our Internet website, free of charge, as soon as reasonably
practicable after the reports are electronically filed with or furnished to the United States Securities and Exchange Commission. These reports are available at www.diedrich.com under the heading Investor Services.



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RISK FACTORS AND TRENDS AFFECTING DIEDRICH COFFEE AND ITS BUSINESS



Historical losses may continue and, as a result, the price of our common stock may be
negatively affected.



For five years ended June 30, 2004, we had net
income of $251,000 for the fiscal year ended June 30, 2004, a net loss of $1,358,000 for the fiscal year ended July 2, 2003, net income of $952,000 for the fiscal year ended July 3, 2002, a net loss of $3,988,000 for the fiscal year ended July 27,
2001 and a net loss of $22,423,000 for the fiscal year ended June 28, 2000. We could suffer losses in the future.



If we are not able to grow our business, the results of our operations and our financial condition may be adversely impacted.



As of June 30, 2004, we operated 46 Diedrich Coffee and Coffee People retail locations,
which we managed on a day-to-day basis, and had seven franchised Diedrich Coffee coffeehouse locations. We also had 429 Gloria Jeans retail locations, of which 419 were franchised. To grow, we must:



| |  |  | attract single and multi-store franchisees for our Gloria Jeans brand in the United States, and multi-store franchisees and franchise area developers internationally;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | continue to upgrade Gloria Jeans products and programs;
| | - |  | --------------------------------------------------------



| |  |  | expand Diedrich Coffee and Gloria Jeans wholesale sales;
| | - |  | ---------------------------------------------------------



| |  |  | attract franchise area developers for Diedrich Coffee in the United States and internationally;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | obtain (or have our franchise area developers obtain) suitable sites at acceptable costs in highly competitive real estate markets;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | hire, train and retain qualified personnel;
| | - |  | -------------------------------------------



| |  |  | integrate newly franchised or corporate locations into existing product distribution;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | continue to upgrade inventory control, marketing and information systems; and
| | - |  | -----------------------------------------------------------------------------



| |  |  | impose and maintain strict quality control from green coffee acquisition to the fresh cup of brewed coffee in a customers hand.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



Implementation of our growth strategy may divert managements attention from other
aspects of our business and place a strain on management, operational and financial resources, and accounting systems. Future inability to grow our business may adversely affect the results of our operations and our financial condition.



Our franchisees could take actions that could harm our business.



Franchisees are independent contractors and are not our employees. We provide training and
support to our franchisees, and the terms of our franchise agreements require our franchisees to maintain certain minimum operating standards; however, the quality of franchised operations may be diminished by any number of factors beyond our
control. For example, franchisees may not successfully operate coffeehouses in a manner consistent with our standards and requirements, or may not hire and train qualified managers or other personnel. In other instances, franchisees may operate
their units in conformity with our operating standards and specifications, but may fail to meet their financial obligations to us under a franchise agreement or a sublease for a location, or to vendors, lenders or other creditors. While we have
certain contractual remedies in such instances of default, enforcing our remedies typically requires litigation, and therefore our image and reputation, and the image and reputation of other franchisees, may suffer until such litigation is
successfully concluded. If a significant number of franchisees were to be in default simultaneously, a larger number of franchise units could be terminated in a given time period than we would be able to re-franchise, or absorb into our company
operated unit base, and system-wide sales could significantly decline. If this were to occur, we might also be unable to meet our obligations to mall landlords for early termination of the 98 master leases for which we are currently liable.



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Our growth through franchise area development may not occur as rapidly as we currently anticipate.



Our ability to recruit, retain and contract with qualified franchise area developers has
become, and will continue to be, increasingly important to our operations as we expand. In addition, the coffeehouses contemplated in existing franchise area development agreements may not open on the anticipated development schedule. Our
franchisees are dependent upon the availability of adequate sources of financing on acceptable terms in order to meet their development obligations, and the credit markets for such franchise financing have historically been somewhat volatile.
Prospective franchise lenders have historically been cautious in their approach to financing smaller or newer, less established retail brands vis-à-vis larger and more established franchised systems. Such financing may not be available to our
franchised area developers, or only available upon disadvantageous terms. Our franchise development strategy may not enhance our results of operations. Failure to execute on our strategy to grow through franchise area development would harm our
business, financial condition and results of operations.



Our operating
results may fluctuate significantly, which could have a negative effect on the price of our common stock.



Our operating results will fluctuate from quarter to quarter as the result of a number of factors, including:



| |  |  | comparable store sales results;
| | - |  | -------------------------------



| |  |  | the number, timing, mix and cost of coffeehouse and mall coffee store openings, franchises, acquisitions or closings;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | the level of competition from existing or new competitors in the specialty coffee industry;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | labor costs for our hourly and management personnel, including increases in federal or state minimum wage requirements;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | changes in consumer preferences; and
| | - |  | ------------------------------------



| |  |  | fluctuations in prices of unroasted coffee.
| | - |  | -------------------------------------------



From time to time in the future, our operating results likely will fall below the expectations of investors and public market securities analysts. Quarterly fluctuations,
for any reason, could cause our stock price to decline. Also, our business is subject to seasonal fluctuations. The November - December holiday season generally experiences the highest sales. In contrast, hot weather tends to depress sales of hot
coffee and espresso drinks, especially unseasonably warm weather. Consequently, we will continue to experience significant fluctuations in quarterly results.



In addition, if we were to open additional company owned coffeehouses in the future, we would incur significant pre-opening expenses, and the new coffeehouses would
likely experience an initial period of operating losses. As a result, the opening of a significant number of company owned coffeehouses in a single period would have an adverse effect on our results of operations. Accordingly, we believe that
period-to-period comparisons of our historical or future operating results are not necessarily meaningful, and such comparisons should not be relied upon as indicators of future performance.



Because we have only one roasting facility, a significant interruption in the operation of
this facility could potentially disrupt our operations.



We have only one
coffee roasting and distribution facility. A significant interruption in the operation of this facility, whether as a result of a natural disaster or other causes, could significantly impair our ability to operate our business on a day-to-day basis.



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Future changes in minimum wage requirements could adversely affect our business, financial condition, results of
operations or cash flows.



A number of our employees are subject to
minimum wage requirements. Many of our employees work in retail locations located in California and Oregon, and receive salaries equal to those states minimum wage laws, which salaries currently exceed the federal minimum wage. There can be no
assurance that further increases will not be implemented in these or other jurisdictions in which we operate or seek to operate. There can be no assurance that we will be able to pass additional increases in labor costs through to our customers in
the form of price adjustments and, accordingly, such minimum wage increases could have a material adverse effect on our business, financial condition, results of operations or cash flows.



We may not be able to renew leases or control rent increases at our retail locations.



All of our 56 company operated coffeehouses are presently on leased premises. Gloria
Jeans stores are generally leased by an indirect subsidiary of Coffee People, although in most cases, the franchisees pay their rent directly to their landlord. Upon the expiration of some of these leases, there is no automatic renewal or
option to renew. Consequently, these leases may not be renewed. If they are renewed, rents may increase substantially. Either of these events could adversely affect us. Other leases are subject to renewal at fair market value, which could involve
substantial rent increases, or are subject to renewal with scheduled rent increases, which could result in rents being above fair market value.



Our industry is highly competitive and we may not have the resources to compete effectively.



With low barriers to entry, competition in our industry is expected to increase from national and regional chains, franchise operators and
local specialty coffee stores. Our whole bean coffees compete directly against specialty coffees sold at specialty retailers, variety and discount stores, and a growing number of specialty coffee stores. Many specialty coffee companies, including
Starbucks, Seattles Best Coffee, Bucks County, Brothers Gourmet Coffees and Green Mountain Coffee Roasters sell whole bean coffees through these channels. In our sale of coffee beverages and espresso drinks, we compete directly against all
other specialty grade coffee roasters, coffeehouses, espresso/coffee bars and mall coffee stores, as well as against restaurant and beverage outlets that serve coffee, and a growing number of espresso stands, carts, and stores. Our competition at
this level includes a growing number of specialty coffee retailers, including Starbucks, Barnies, Coffee Beanery Ltd., Caribou Coffee, Peets Coffee, Tullys Coffee and many others. The attractiveness of the gourmet specialty
coffeehouse market may draw additional competitors with substantially greater financial, marketing and operating resources than we have. In addition, we compete to draw customers of standard or commercial coffee, and consumers of substitute coffee
products manufactured by a number of nationwide coffee manufacturers, such as Kraft Foods, Proctor & Gamble and Nestlé, to specialty grade coffee.



We believe that our customers choose among retailers primarily on the basis of product quality, service, coffeehouse ambiance, convenience, and to a lesser extent, on
price. The performance of individual coffeehouses or mall coffee stores may also be affected by factors such as traffic patterns and the type, number and proximity of competing coffeehouses or mall coffee stores. In addition, factors such as
inflation, increased coffee bean, food, labor and employee benefit costs, and the availability of experienced management and hourly employees may also adversely affect the specialty coffee retail business in general and our coffeehouses and mall
coffee stores in particular.



Growth of our international operations may be
adversely affected by factors outside of our control.



We have 282 Gloria
Jeans franchised stores located outside of the United States and its territories. As part of our growth strategy, we expect to seek franchise developers internationally for Gloria Jeans stores. As a result, our business and operations
will be increasingly subject to the risk of changes in economic conditions and, to a lesser extent, changes in social and political conditions inherent in foreign operations, including changes in U.S. laws and regulations relating to foreign trade
and investment. In addition, consumer tastes vary from region to region, and consumers located in the regions in which we may expand our retail operations may not be as receptive to specialty coffees as consumers in existing markets.



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Our company operated retail locations are concentrated in the western region of the United States, and therefore our
business is subject to fluctuations if adverse business conditions occur in that region.



Our company operated retail locations are primarily located in the western region of the United States. Accordingly, we are susceptible to fluctuations in our business caused by adverse economic or other conditions in
this region, including natural or other disasters. In addition, some of our competitors have many more retail locations than we do. Consequently, adverse economic or other conditions in a region, a decline in the profitability of several existing
retail locations or the introduction of several unsuccessful new retail locations in a geographic area could have a more significant effect on our results of operations than would be the case for a company with a larger number of retail locations or
with more geographically dispersed retail locations.



Our supply costs may
be higher than we expect because of fluctuations in availability and cost of unroasted coffee.



Increases in the price of green coffee, or the unavailability of adequate supplies of green coffee of the quality we seek, whether due to the failure of our suppliers to perform, conditions in coffee-producing
countries, or otherwise, could have a material adverse effect on our results of operations. We depend upon both outside brokers and our direct contacts with exporters and growers in countries of origin for our supply of green coffee. Coffee supply
and price are subject to significant volatility beyond our control. Although most coffee trades in the commodity market, coffee of the quality we seek tends to trade on a negotiated basis at a substantial premium above commodity coffee pricing,
depending upon the origin, supply and demand at the time of purchase. Supply and price can be affected by a number of factors in the producing countries, including weather, political and economic conditions. In addition, green coffee prices have
been affected in the past, and may be affected in the future, by the actions of certain organizations and associations, such as the International Coffee Organization or the Association of Coffee Producing Countries. These organizations have
historically attempted to establish commodity price controls of green coffee through agreements that establish export quotas or by restricting coffee supplies worldwide. These organizations, or others, may succeed in raising green coffee prices.
Should this happen, we may not be able to maintain our gross margins by raising prices without affecting demand.



Compliance with health, franchising and other government regulations applicable to us could have a material adverse affect on our business, financial condition and
results of operations.



Each retail location and roasting facility is and
will be subject to licensing and reporting requirements by a number of governmental authorities. These governmental authorities include federal, state and local health, environmental, labor relations, sanitation, building, zoning, fire, safety and
other departments that have jurisdiction over the development and operation of our retail locations. Our activities are also subject to the Americans with Disabilities Act and related regulations, which prohibit discrimination on the basis of
disability in public accommodations and employment. Changes in any of these laws or regulations could have a material adverse affect on our business, financial condition and results of operations. Delays or failures in obtaining or maintaining
required construction and operating licenses, permits or approvals could delay or prevent the opening of new retail locations, or could materially and adversely affect the operation of existing retail locations. In addition, we may not be able to
obtain necessary variances or amendments to required licenses, permits or other approvals on a cost-effective or timely basis in order to construct and develop retail locations in the future.



We are also subject to federal regulation and certain foreign and state laws that govern the
offer and sale of franchises and the franchisor-franchisee relationship. Many foreign and state franchise laws impose substantive requirements on franchise agreements, including limitations on non-competition provisions and on provisions concerning
the termination or non-renewal of a franchise. Some foreign countries and states require companies to register certain materials before franchises can be offered or sold in that country or state. The failure to obtain or retain licenses or
registration approvals to sell franchises could delay or preclude franchise sales and otherwise adversely affect our business, financial condition and results of operations. Additionally, any franchise law violations may give existing and future
franchisees a basis to bring claims against us. Franchise law violation claims could include unfair business practices, negligent misrepresentation, fraud, or statutory franchise investment or relationship violations. Remedies may include damages or
rescission of the franchise agreement by the franchisee. These claims may already exist and their assertion against us could adversely affect our business, financial condition, and results of operations.



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The loss of key personnel or our inability to attract and retain qualified personnel could significantly disrupt our
business.



Our continued success largely will depend on the efforts and
abilities of our executive officers and other key employees. The loss of services of these individuals could disrupt operations. Although we have employment agreements with each of our executive officers, any of our executive officers can terminate
their employment if he or she chooses to do so. In addition, our success and the success of our franchisees will depend upon our and their ability to attract and retain highly motivated, well-qualified retail operators and other management
personnel, as well as a sufficient number of qualified employees. Qualified individuals needed to fill these positions are in short supply in some geographic areas. Our inability to recruit and retain such individuals may delay the planned openings
of new retail locations or result in higher employee turnover in existing retail locations, which could have a material adverse effect on our business or results of operations.



We could be subject to adverse publicity or claims from our customers.



We may be the subject of complaints from or litigation by customers who allege beverage or food-related illness, injuries suffered on the
premises or other quality, health or operational concerns. Adverse publicity resulting from such allegations may materially adversely affect us, regardless of whether such allegations are true or whether we are ultimately held liable. We may also be
the subject of complaints or allegations from current, former or prospective employees from time-to-time. A lawsuit or claim could result in an adverse decision against us that could have a material adverse effect on our business, financial
condition and results of operations.



Changes in consumer preferences or
discretionary spending could negatively affect our results.



Our retail
locations offer specialty coffee beans, brewed coffee beverages, espresso-based beverages, blended drinks and light food items served in a casual setting. Our continued success depends, in part, upon the popularity of these types of coffee-based
beverages and this style of casual dining. Shifts in consumer preferences away from our coffee-based beverages or casual setting could materially adversely affect our future profitability. Also, our success depends to a significant extent on a
number of factors that affect discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce guest traffic or impose practical limits on pricing,
either of which could adversely affect our business, financial condition, operating results and cash flows.



Our lack of diversification may affect business if demand is reduced.



Our business is primarily centered on one product: fresh specialty grade coffee. To date, our operations have been limited to primarily the purchase and roasting of green coffee beans and the sale of whole bean
coffee, coffee beverages and espresso drinks through our franchise coffee stores, coffeehouses, and wholesale coffee and mail order businesses. Any decrease in demand for coffee would have a material adverse effect on our business, operating results
and financial condition.



Our failure or inability to enforce our trademarks
or trade names could adversely affect our efforts to establish brand equity.



Our ability to successfully expand our business will depend in part on our ability to maintain brand equity through the use of our trademarks, service marks, trade dress and other proprietary intellectual property, including our
name and logos. We currently hold a number of trademarks and service marks related to our brands. Some or all of our rights related to our intellectual property may not be enforceable, even if registered, against any prior users of similar
intellectual property or our competitors who seek or intend to utilize similar



16



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intellectual property in areas where we operate or intend to conduct operations. If we are unable to successfully enforce
our intellectual property rights, we may be unable to capitalize on our efforts to maintain brand equity. It is possible that we will encounter claims from prior users of similar intellectual property in areas where we operate or intend to conduct
operations, including foreign countries. Claims from prior users could limit our operations or cause us to pay damages or licensing fees to a prior user or registrant of similar intellectual property.



Item 2.Properties.



Office Space and Plant



We currently lease approximately
17,620 square feet of office space in Irvine, California and approximately 6,192 square feet of warehouse space in Irvine, California. The lease for the office space will expire in January 2011 and the lease for the warehouse space will expire in
October 2006. We also lease a 66,237 square foot roasting facility located in Castroville, California. The term of the current lease expires on December 31, 2005, and is renewable, at our option, for a term of seven additional years. We believe that
our facilities are generally adequate for our current needs, and that suitable additional production and administrative space will be available as needed for the foreseeable future.



Company Owned Locations



As of June 30, 2004, we were a party to leases for a total of 56 company operated retail locations. During fiscal year 2004, we closed five locations. Our company
operated retail locations on leased premises are subject to varying arrangements specified in property specific leases. For example, some of the leases require a flat rent, subject to regional cost-of-living increases, while others are based upon a
percentage of gross sales. In addition, certain of these leases expire in the near future, and there is no automatic renewal or option to renew. No assurance can be given that leases can be renewed, or if renewed, that rents will not increase
substantially, either of which would adversely affect us. Other leases are subject to renewal at fair market value, which could involve substantial increases or are subject to renewal with a scheduled rent increase, which could result in rents being
above fair market value.



Franchised Stores



All of our Gloria Jeans locations are operated on leased premises, 137 of which are
located in the United States and 282 of which are located in foreign countries. A majority of the leased premises presently occupied by domestic Gloria Jeans franchised outlets are leased by us, and we have entered into sublease agreements
with the franchisees on a cost pass-through basis. Gloria Jeans, however, remains obligated under the lease in all such cases. As further discussed below under the heading Financial Condition and Liquidity and Capital Resources 
Commitments and Contractual Obligations, our maximum theoretical future exposure under these leases at June 30, 2004, computed as the sum of all remaining lease payments through the expiration dates of the respective leases, was $15,337,000.
In the future, new franchisees will generally be required to enter into master leases directly with the landlord. This will also be the case when current leases are up for renewal. Gloria Jeans stores are designed to accommodate locations in
various sizes, ranging from 170 square foot kiosk outlets (which sell principally coffee drinks and other beverages) to 2,000 square foot full service stores.



Item 3.Legal Proceedings.



In the ordinary course of our business, we may become involved in legal proceedings from time to time. As of September 28, 2004, we were not a party to any material pending legal proceedings.



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



None.



17



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##### Table of Contents

PART II



Item 5.Market For Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.



Our common stock is reported on the Nasdaq National Market under the symbol DDRX. The following table sets forth, for the
periods indicated, the high and low trading prices for our common stock as reported on the Nasdaq National Market.



|                                      |  |             |      |     |   |     
|------------------------------------- |  | ----------- | ---- | --- | - | ----
|                                      |  | Price Range
|Period                                |  | High        |      | Low
|Fiscal Year Ended July 2, 2003        |  |             |      |     |   |     
|Twelve Weeks Ended September 25, 2002 |  | $           | 4.88 |     | $ | 1.50
|Twelve Weeks Ended December 18, 2002  |  |             | 5.25 |     |   | 3.35
|Twelve Weeks Ended March 12, 2003     |  |             | 4.25 |     |   | 2.35
|Sixteen Weeks Ended July 2, 2003      |  |             | 3.62 |     |   | 2.10
|                                      |  |            
|Fiscal Year Ended June 30, 2004       |  |             |      |     |   |     
|Twelve Weeks Ended September 24, 2003 |  |             | 3.65 |     |   | 2.85
|Twelve Weeks Ended December 17, 2003  |  |             | 4.86 |     |   | 3.25
|Twelve Weeks Ended March 10, 2004     |  |             | 3.89 |     |   | 3.17
|Sixteen Weeks Ended June 30, 2004     |  |             | 5.88 |     |   | 3.20



At September 21, 2004, there were
5,162,757 shares of our common stock outstanding and 703 stockholders of record. We have not paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.



18



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Item 6.Selected Financial Data.



Our fiscal year ends on the Wednesday closest to June 30. This reporting schedule generally results in three 12-week quarters and one 16-week quarter during the fourth fiscal quarter, for a total of 52 weeks. However, due to the alignment
of the calendar in 2002, the fiscal year ended July 3, 2002 contains 17 weeks during the fourth fiscal quarter, for a total of 53 weeks. The following selected financial data may not be indicative of our future results of operations and should be
read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations beginning on page 20, and should be read in conjunction with our consolidated financial statements and related notes.



The information set forth below should be read in conjunction with the
consolidated financial statements and related Notes and Managements Discussion and analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K/A.



|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|------------------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------------------------ | - | ------ | --------------------------------- |  | - | ------------------------------- | - |  | ------------------------------- | ------ | - |  | - | ------- | -
|                                                                          |  | Fiscal Year ended June 30, 2004       |        |   | Fiscal Year ended July 2, 2003 |   |        | Fiscal Year ended July 3, 2002(A) |  |   | Fiscal Year ended June 27, 2001 |   |  | Fiscal Year ended June 28, 2000 |       
|                                                                          |  | (as restated)                         |        |   | (as restated)                  |   |        | (as restated)                     |  |   |                                 |   |  |                                 |       
|                                                                          |  | (in thousands, except per share data) |       
|Statement of Operations Data:                                             |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Net revenue:                                                              |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Retail sales                                                              |  | $                                     | 31,617 |   |                                | $ | 33,034 |                                   |  | $ | 38,658                          |   |  | $                               | 46,925 |   |  | $ | 48,308  |  
|Wholesale and other                                                       |  |                                       | 15,466 |   |                                |   | 15,336 |                                   |  |   | 16,681                          |   |  |                                 | 18,545 |   |  |   | 19,081  |  
|Franchise revenue                                                         |  |                                       | 7,542  |   |                                |   | 6,611  |                                   |  |   | 6,666                           |   |  |                                 | 6,742  |   |  |   | 6,592   |  
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Total revenue                                                             |  |                                       | 54,625 |   |                                |   | 54,981 |                                   |  |   | 62,005                          |   |  |                                 | 72,212 |   |  |   | 73,981  |  
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Costs and expenses:                                                       |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Cost of sales and related occupancy costs                                 |  |                                       | 25,144 |   |                                |   | 26,262 |                                   |  |   | 30,423                          |   |  |                                 | 36,152 |   |  |   | 38,240  |  
|Operating expenses                                                        |  |                                       | 16,707 |   |                                |   | 16,944 |                                   |  |   | 17,821                          |   |  |                                 | 20,907 |   |  |   | 20,646  |  
|Depreciation and amortization                                             |  |                                       | 2,315  |   |                                |   | 2,169  |                                   |  |   | 2,474                           |   |  |                                 | 4,445  |   |  |   | 4,331   |  
|General and administrative expenses                                       |  |                                       | 9,770  |   |                                |   | 9,346  |                                   |  |   | 9,587                           |   |  |                                 | 10,676 |   |  |   | 15,734  |  
|Provision for asset impairment and restructuring costs                    |  |                                       | 94     |   |                                |   | 2,176  |                                   |  |   | 542                             |   |  |                                 | 2,867  |   |  |   | 16,370  |  
|Gain on asset disposals                                                   |  |                                       | (2     | ) |                                |   | (868   | )                                 |  |   | (423                            | ) |  |                                 | (173   | ) |  |   | (24     | )
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Total costs and expenses                                                  |  |                                       | 54,028 |   |                                |   | 56,029 |                                   |  |   | 60,424                          |   |  |                                 | 74,874 |   |  |   | 95,297  |  
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Operating income (loss)                                                   |  |                                       | 597    |   |                                |   | (1,048 | )                                 |  |   | 1,581                           |   |  |                                 | (2,662 | ) |  |   | (21,316 | )
|                                                                          |  |                                       |        |   |                               
|Interest expense and other, net                                           |  |                                       | (318   | ) |                                |   | (256   | )                                 |  |   | (537                            | ) |  |                                 | (1,290 | ) |  |   | (1,088  | )
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Income (loss) before income tax provision                                 |  |                                       | 279    |   |                                |   | (1,304 | )                                 |  |   | 1,044                           |   |  |                                 | (3,952 | ) |  |   | (22,404 | )
|Income tax provision                                                      |  |                                       | 28     |   |                                |   | 54     |                                   |  |   | 92                              |   |  |                                 | 36     |   |  |   | 19      |  
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Net income (loss)                                                         |  | $                                     | 251    |   |                                | $ | (1,358 | )                                 |  | $ | 952                             |   |  | $                               | (3,988 | ) |  | $ | (22,423 | )
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Basic and diluted net income (loss) per common share (B)                  |  | $                                     | 0.05   |   |                                | $ | (0.26  | )                                 |  | $ | 0.18                            |   |  | $                               | (1.16  | ) |  | $ | (7.19   | )
|                                                                          |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Balance Sheet Data:                                                       |  |                                       |        |   |                                |   |        |                                   |  |   |                                 |   |  |                                 |        |   |  |   |         |  
|Working capital (deficiency)                                              |  | $                                     | 641    |   |                                | $ | 1,207  |                                   |  | $ | 809                             |   |  | $                               | (819   | ) |  | $ | (4,216  | )
|Total assets                                                              |  |                                       | 25,218 |   |                                |   | 26,101 |                                   |  |   | 27,806                          |   |  |                                 | 31,891 |   |  |   | 40,330  |  
|Long-term debt and obligations under capital leases, less current portion |  |                                       | 1,173  |   |                                |   | 2,033  |                                   |  |   | 2,832                           |   |  |                                 | 4,219  |   |  |   | 10,252  |  
|Total stockholders equity (C)                                            |  | $                                     | 16,475 |   |                                | $ | 16,202 |                                   |  | $ | 17,492                          |   |  | $                               | 16,678 |   |  | $ | 15,122  |  

---

See Note 2 of the Notes to Consolidated Financial
Statements for discussion of our restatement of previously issued financial statements.



|(A) | Includes 53 weeks of operation.
|--- | -------------------------------

|(B) | All per share information has been adjusted to reflect our one-for-four reverse stock split, which was effective May 9, 2001.
|--- | -----------------------------------------------------------------------------------------------------------------------------

|(C) | Stockholders equity for fiscal year ended June 27, 2001 has been restated. See Note 2 of the Notes to Consolidated Financial Statements for further explanation.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations.



INTRODUCTION



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



| |  |  | Overview. This section provides a general description of our business, as well as recent significant transactions that we believe are important in understanding the results
of operations, as well as to anticipate future trends in those operations.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Results of operations. This section provides an analysis of our results of operations presented in the accompanying consolidated statements of operations by comparing the
restated results for fiscal 2004 to fiscal 2003 and comparing the restated results for fiscal 2003 to fiscal 2002.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Financial condition and liquidity and capital resources. This section provides an analysis of our cash flows, as well as a discussion of our outstanding debt and commitments,
both firm and contingent, that existed as of June 30, 2004. Included in the discussion of outstanding debt is a discussion of the amount of financial capacity available to fund our future commitments, as well as a discussion of other financing
arrangements.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical accounting policies. This section discusses those accounting policies that both are considered important to our financial condition and results, and require
significant judgment and estimates on the part of management in their application. In addition, all of our significant accounting policies, including the critical accounting policies, are summarized in Note 1 to the accompanying consolidated
financial statements.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | New accounting pronouncements. This section discusses new accounting pronouncements, dates of implementation and impact on our accompanying consolidated financial statements,
if any.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



OVERVIEW



Business



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



Our brands include Diedrich
Coffee, Gloria Jeans, and Coffee People. The Diedrich Coffee and Coffee People brands are primarily company store operations and the Gloria Jeans brand is primarily a franchised store operation. As of June 30, 2004, we owned and operated
56 retail locations and franchised 426 other retail locations under these brands, for a total of 482 retail coffee outlets. Our retail units are located in 34 states and 13 foreign countries. As of June 30, 2004, we had over 460 wholesale accounts
with Office Coffee Service distributors, chain and independent restaurants, and others. Although the specialty coffee industry is dominated by a single company with more than 8,000 locations, we are one of the nations largest specialty coffee
retailers and a significant competitor in the international market. Our system-wide revenues are more than $225 million.



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



Key Performance Indicators



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



Same-store sales growth, or comparative sales growth, is a primary
statistic used in the retail industry to measure core revenues. This measure compares sales for all units open for one year or more to the comparable prior year period. We use this measure to evaluate single coffeehouse, total brand, and total
company sales performance. Until recently, comparable sales of our company operated stores and domestic franchised stores had declined, primarily as a result of aging stores, a lack of capital to fund store improvements, and no new store openings.
New stores typically achieve relatively strong comparative sales growth in their early years. Franchised units that are located in malls have also experienced declining sales due to aging stores and overall declines in mall traffic. Our ability to
open new company operated and franchise stores depends on our process in raising capital and selling franchises. Continuing declines in same-store sales could result in store closures, make sales of franchises more difficult and have a material
adverse impact on our future performance.



The number of operating units opened
and closed is also a measure of the health of our brands and our business, although it is affected by a number of factors, including the availability of capital to finance growth. In recent years the number of domestic units has declined because the
number of aging units closing exceeded the number of new units opening. International unit growth has been robust in recent years, particularly in Australia. Also, company operated stores have declined and franchised stores have increased. Unlike
new company operated stores, new franchised stores do not require our capital. In addition, franchised stores typically make an immediate profit contribution, whereas company stores generally are not profitable in the first year. Domestic franchises
generate more profit than international franchises because the domestic royalty fees are higher and because all domestic franchisees are required to purchase their coffee from us. Our near-term growth plans focus primarily on franchising new
domestic stores. Failure to successfully expand our franchise operations would materially adversely impact our future performance.



We use the relationship between cost of sales and related occupancy costs and operating expenses to sales to measure the operating efficiency of our individual
coffeehouses and to measure the relationship between general and administrative expenses to sales to monitor and control the level of corporate overhead. Cost of sales and related occupancy costs have declined, and gross margins have improved, in
recent years primarily as a result of the sale of high cost, low margin retail units and due to our exiting the unprofitable wholesale grocery chain distribution channel. There is no assurance that the trend of declining cost of sales and occupancy
costs will continue. Operating expenses have increased in the past two years as a result of dedicating more in-store labor and supervision to the retail stores. General and administrative expenses have increased as a percentage of sales due to
staffing for accelerated growth and due to the effect of continuing declines in sales on a relatively fixed expense base.



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RESULTS OF OPERATIONS



The following table sets forth the percentage relationship to total revenue of certain items included in our statements of income for the
years indicated:



|                                                       |  |                          |   |  |                         |    |  |                         |  
|------------------------------------------------------ |  | ------------------------ | - |  | ----------------------- | -- |  | ----------------------- | -
|                                                       |  | Year Ended June 30, 2004 |   |  | Year Ended July 2, 2003 |    |  | Year Ended July 3, 2002 |  
|                                                       |  | (as restated)            |   |  | (as restated)           |    |  | (as restated)           |  
|Net revenue:                                           |  |                          |   |  |                         |    |  |                         |  
|Retail sales                                           |  | 57.9                     | % |  | 60.1                    | %  |  | 62.3                    | %
|Wholesale and other                                    |  | 28.3                     |   |  | 27.9                    |    |  | 26.9                    |  
|Franchise revenue                                      |  | 13.8                     |   |  | 12.0                    |    |  | 10.8                    |  
|                                                       |  |                          |   |  |                         |    |  |                         |  
|Total revenue                                          |  | 100.0                    | % |  | 100.0                   | %  |  | 100.0                   | %
|                                                       |  |                          |   |  |                         |    |  |                         |  
|Costs and expenses:                                    |  |                          |   |  |                         |    |  |                         |  
|Cost of sales and related occupancy costs              |  | 46.0                     | % |  | 47.8                    | %  |  | 49.1                    | %
|Operating expenses                                     |  | 30.6                     |   |  | 30.8                    |    |  | 28.7                    |  
|Depreciation and amortization                          |  | 4.2                      |   |  | 3.9                     |    |  | 4.0                     |  
|General and administrative expenses                    |  | 17.9                     |   |  | 17.1                    |    |  | 15.5                    |  
|Provision for asset impairment and restructuring costs |  | 0.2                      |   |  | 3.9                     |    |  | 0.9                     |  
|Gain on asset disposals                                |  | 0.0                      |   |  | (1.6                    | )  |  | (0.7                    | )
|                                                       |  |                          |   |  |                         |    |  |                         |  
|Total costs and expenses                               |  | 98.9                     | % |  | 101.9                   | %  |  | 97.5                    | %
|                                                       |  |                          |   |  |                         |    |  |                         |  
|Operating income (loss)                                |  | 1.1                      | % |  | (1.9                    | )% |  | 2.5                     | %
|Interest expense and other, net                        |  | (0.5                     | ) |  | (0.5                    | )  |  | (0.9                    | )
|                                                       |  |                          |   |  |                         |    |  |                         |  
|Income (loss) before income tax provision              |  | 0.6                      |   |  | (2.4                    | )  |  | 1.6                     |  
|Income tax provision                                   |  | 0.1                      |   |  | 0.1                     |    |  | 0.1                     |  
|                                                       |  |                          |   |  |                         |    |  |                         |  
|Net income (loss)                                      |  | 0.5                      | % |  | (2.5                    | )% |  | 1.5                     | %
|                                                       |  |                          |   |  |                         |    |  |                         |  



Restatement of Previously Issued
Financial Statements



In the third quarter of fiscal 2005 we completed
a review of our procedures in accounting for leases and determined that these procedures were incorrect and previously issued financial statements required restatement. We have corrected our accounting treatment for amortization of leasehold
improvements, tenant improvement allowances, and rent holidays for leased facilities restating previously issued financial statements for the fiscal years 2004, 2003 and 2002. The cumulative effect of these corrections was a $402,000 reduction of
previously reported earnings. We historically calculated straight-line rent expense and amortized some of its leasehold improvements over a period that included both the initial term of the lease and the option periods. We determined that our method
of accounting for the lease term used in establishing the straight-line rent and amortization period was not in accordance with the applicable accounting literature. Accordingly, we corrected our accounting for leasehold improvements and
straight-line rent expense. For leases with renewal periods at our option, we now generally use the lesser of useful life or original lease term, excluding renewal option periods to determine useful lives. If failure to exercise a renewal option
imposes an economic penalty to us, we may determine that renewal is reasonably assured and include that renewal option period in the determination of the lease term and the appropriate estimated useful lives. Our policy requires lease term
consistency when estimating useful lives, classifying a lease as capital or operating, and computing straight-line rent expense. The correction of this accounting required us to record additional amortization expense and to decrease both deferred
rent and the amount of rent expense previously recorded.



Additionally, we
identified instances in which property and equipment was not retired in a timely manner. During fiscal 2003 and fiscal 2004, we remodeled 14 coffeehouse locations and did not retire certain leasehold improvements. We corrected this error through our
restatement.



We historically accounted for tenant improvement allowances as
reductions to the related leasehold improvement asset on the consolidated balance sheets and capital expenditures in investing activities on the consolidated statements of cash flows. We have now determined that Financial Accounting Standards Board
(FASB) Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases, requires these allowances to be recorded as deferred rent on the consolidated balance sheets and as a component of operating activities
on the consolidated statements of cash flows.



In the course of our review of
lease accounting procedures, we also noted additional unrelated errors affecting reported results for prior periods. Royalty income of $202,000 earned in fiscal year 2003 was incorrectly reported as income in fiscal year 2002. Also, income related
to construction services provided to franchisees in fiscal years prior to fiscal year 2002 was not recorded until fiscal year 2002, in which $120,000 was improperly reported as income and fiscal year 2003 in which $109,000 was improperly reported as
income. Also, we determined that our allowance for doubtful accounts was overstated by $74,000 in fiscal 2002 and understated by approximately the same amount in fiscal 2003. We have corrected all of these errors through our restatement.



Year Ended June 30, 2004 Compared to Year Ended July 2, 2003



Total Revenue. Our total revenue for the year ended
June 30, 2004 decreased by $356,000, to $54,625,000 from $54,981,000 for the year ended July 2, 2003. This result was the net effect of a decrease in retail sales, offset by increases in wholesale sales and franchise revenue. Each component of total
revenue is discussed below.



Retail Sales. Our retail sales revenue for
the year ended June 30, 2004 decreased by $1,417,000, or 4.3%, to $31,617,000 from $33,034,000 for the year ended July 2, 2003. This decrease was primarily related to a lower number of company stores partially offset by higher same store sales.
During the year, five company stores were closed and a net of two stores were transferred to us by franchisees. The retail sales decrease is attributable to sales lost from the year over year company store count decline of approximately $2,206,000,
which was partially offset by the 1.4% increase in comparable store sales for company operated units, approximately $646,000. Retail sales from our internet website also increased by $185,000 in fiscal 2004.



Wholesale and Other. Our wholesale revenue for the year ended June 30, 2004 increased
by $130,000, or 0.8%, to $15,466,000 from $15,336,000 for the year ended July 2, 2003. This increase was primarily the net result of the following factors:



Keurig K-cup and other Office Coffee Service sales. Keurig K-cup and other Office Coffee Service sales, along with other non-contract
sales, achieved 17.2% sales growth in fiscal 2004, increasing $1,053,000 to $7,163,000.



Roasted coffee sales to franchisees. Sales of roasted coffee to our franchisees decreased $760,000 for the year ended June 30, 2004 because of a decrease in the number of domestic franchise stores in the current fiscal year. This
resulted from the closure of 14 Gloria Jeans domestic franchise locations. The decrease in domestic store count was compounded by a decrease of 0.8% in Gloria Jeans domestic system comparable sales that also reduced roasted coffee usage.



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Coffee sales to restaurants and specialty retailers. Wholesale coffee sales to restaurants and specialty retailers
decreased $114,000, or 6.7%, from the prior year. This segment is being de-emphasized due to its relatively low profitability.



Coffee sales to grocery retailers. The grocery retail segment proved to be unprofitable and we exited this distribution channel early in fiscal 2004. Sales for the
year were $38,000, a decrease of $55,000 from the prior year.



Franchise
Revenue. We increased our franchise revenue by $931,000, or 14.1%, to $7,542,000 for the year ended June 30, 2004 from $6,611,000 for the year ended July 2, 2003. Our franchise revenue consists of initial franchise fees, franchise renewal fees,
area development fees, royalties received on sales at franchised locations, and miscellaneous other franchise revenue, including coordination fees received from product suppliers. The increase in franchise revenue was primarily due to the net impact
of an increase in international royalties and initial franchise fees partially offset by a reduction in domestic franchise royalties. International royalties increased by $878,000 as a result of the 76 store net increase in the number of
international outlets compared to the prior year. International initial franchise fees increased by $546,000, of which $263,000 resulted from the termination of an area development agreement with Malaysia and $283,000 resulted from the 76 store net
increase in international units. Domestic royalties declined by $479,000 primarily due to the six store net decrease in the number of Gloria Jeans domestic franchise locations compared to the prior year 2004 and the 0.8% decrease in Gloria
Jeans franchise comparable store sales.



Cost of Sales and Related
Occupancy Costs. As a percentage of total revenue, these costs declined from 47.8% in fiscal 2003 to 46.0% in fiscal 2004. Because none of these costs relate to franchise revenue, the most relevant benchmark of these costs is their
relationship to total retail and wholesale sales. Using that measure, cost of sales and related occupancy costs declined as a percentage of total retail and wholesale sales from 54.3% in fiscal 2003 to 53.4% in fiscal 2004. Overall cost of sales
remained relatively stable, although wholesale cost of sales declined by $106,000 primarily due to our exiting the high cost retail grocery distribution channel early in fiscal 2004. Retail cost of sales declined by $605,000 primarily due to the
closure of five company stores. Occupancy costs declined by $562,000 primarily due to the retail stores with high occupancy costs that were closed in the past year.



Market prices for coffee beans increased significantly during fiscal 2004, although the market prices for specialty coffee beans rose at a
lower rate. Because we typically have commitments for approximately 50% of our coffee bean requirements, the increase did not affect fiscal 2004 cost of goods sold and margins significantly. Dairy prices also increased approximately 20% in the
fourth quarter of fiscal 2004. If commodity prices remain at the increased levels, an upward adjustment in our retail prices may be necessary.



Operating Expenses. Operating expenses for the year ended June 30, 2004 remained relatively flat, decreasing by 1.4% to $16,707,000 from $16,944,000 for the
year ended July 2, 2003. On a margin basis, operating expenses declined slightly to 30.6% of total revenue from 30.8% in the prior year. The decline was the net result of a number of factors. Retail operating expenses increased overall by $122,000
primarily as a result of increased staffing in the coffeehouses and additional supervision of these units. Wholesale operating expenses decreased overall by $358,000 primarily as a result of our exiting the retail grocery distribution channel in
fiscal 2004 and as a result of improved collection experience that reduced bad debt expense.



Depreciation and Amortization. Depreciation and amortization increased by $146,000, or 6.7%, to $2,315,000 for the year ended June 30, 2004. This increase is primarily due to the store re-imaging and
improvement program conducted during fiscal 2004 and as a result of acquiring additional machinery and equipment for our Castroville roasting facility.



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General and Administrative Expenses. Our general and administrative expense increased by $424,000, or 4.5%,
to $9,770,000 for the year ended June 30, 2004. On a margin basis, general and administrative expenses increased to 17.9% of total revenue for the year ended June 30, 2004 from 17.0% of total revenue for the year ended July 2, 2003. This 0.9
unfavorable margin basis point change for the current year was primarily the result of a $400,000 increase in salaries due to additional staffing in the franchise development and construction areas in preparation for a planned acceleration of unit
growth.



Provision for Asset Impairment and Restructuring Costs.
Asset impairment and restructuring costs declined from $2,176,000 in fiscal year 2003 to $94,000 in fiscal year 2004. Provisions for asset impairment and restructuring costs arise as a result of regular reviews of long-lived assets in accordance
with SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. Provisions for asset impairment and restructuring costs may also arise as a result of our regular reviews of purchased goodwill and certain other
intangible assets in accordance with SFAS No. 142 Goodwill and Other Intangible Assets, which requires, among other things, the use of a non-amortization approach for purchased goodwill and certain other intangible assets, and provides
for a review for possible impairment of these assets at least annually. SFAS No. 142 also provides for a review of possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.



Gain on Asset Disposals. Gain on asset disposals declined from
$868,000 for the year ended July 2, 2003 to $2,000 for the year ended June 30, 2004. This fiscal 2003 gain was primarily related to a net gain of $984,000 from the sales and closures of nine locations partially offset by the write-off of equipment
from other closed locations.



Interest Expense and Other, Net.
Interest expense and other, net increased to $318,000 for the year ended June 30, 2004 from $256,000 for the year ended July 2, 2003. This increase is primarily due to a write-off of $68,000 of deferred financing costs incurred in securing loan
facilities that were refinanced with proceeds of a new financing completed during fiscal 2004.



Income Tax Expense. Net operating losses generated in previous years resulted in no federal income tax liability and only a nominal amount of state income tax expense for the years ended June 30, 2004
and July 2, 2003. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved. The slight fluctuation in expense between fiscal 2004 versus fiscal 2003 is due to changes in
state income taxes owed in conjunction with the portfolio of company operated Gloria Jeans units, which are located in a variety of states. As of June 30, 2004, net operating loss carryforwards for federal and state income tax purposes of
$30,546,000 and $19,228,000, respectively, are available to be utilized against future taxable income for years through fiscal 2024 for federal and fiscal 2014 for state, subject to possible annual limitations pertaining to change in ownership rules
under the Internal Revenue Code.



Year Ended July 2, 2003 Compared To Year
Ended July 3, 2002



Total Revenue. Our total revenue for the
year ended July 2, 2003 decreased by $7,024,000, or 11.3%, to $54,981,000 from $62,005,000 for the year ended July 3, 2002. This decrease consisted of decreases in retail sales, wholesale and other sales, and franchise revenue. Each component of
total revenue is discussed below.



Retail Sales. Retail sales revenue
for the year ended July 2, 2003 decreased by $5,624,000, or 14.5%, to $33,034,000 from $38,658,000 for the year ended July 3, 2002. This decrease was primarily related to the net impact of several factors. First, the number of company operated
stores decreased in fiscal year 2003 versus fiscal year 2002 because of the closure of three poorly performing company operated locations, the closure of three company operated kiosks, and the sale of six other company operated locations to
franchisees since the beginning of fiscal year 2003. The reduction in retail sales from the unit divestitures noted above amounted to approximately $4,801,000. A summary of company operated and franchise retail unit activity for both fiscal year
2003 and 2002 can be found above under the caption Business  Our Business Model  Retail Outlets. Second, retail sales declined by 3.4%, or $1,076,000, due to lower comparable store sales for company operated units.



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Approximately $636,000 of this decrease was due to an unfavorable match up to fiscal year 2002, which contained one
additional fiscal week versus fiscal year 2003. Fiscal year 2002 contained 53 weeks, whereas fiscal year 2003 contained only 52 weeks. These decreases were partially offset by a $253,000 increase in retail sales from our internet website.



Wholesale and Other. Our wholesale revenue for the year ended July 2,
2003 decreased by $1,345,000, or 8.1%, to $15,336,000 from $16,681,000 for the year ended July 3, 2002. This decrease was primarily the net result of the following factors:



Roasted coffee sales to franchisees. Sales of roasted coffee to our franchisees decreased $1,131,000 for the year ended July 2, 2003
because of a decrease in the number of domestic franchise stores in the current fiscal year. This resulted from the closure of 24 domestic franchise locations. The decrease in domestic store count was compounded by lower sales volumes at open
stores. Gloria Jeans system comparable sales decreased 0.9% for the year ended July 2, 2003 versus the year ended July 3, 2002, further reducing roasted coffee usage.



Coffee sales to restaurants and specialty retailers. Wholesale coffee sales to restaurants and specialty retailers decreased
$267,000, or 13.6%, for the year ended July 2, 2003. This decrease primarily resulted from our reduced focus on independent and specialty retailer accounts because many of these accounts represent only a single or few retail locations and require
proportionately more resources to support.



Coffee sales to grocery
retailers. Although we began selling coffee through the grocery distribution channel during the second fiscal quarter of 2003, revenue on our initial coffee shipments netted to zero because the wholesale selling value of such shipments was
applied against our slotting fee obligations to a grocery store chain. It is customary to pay grocery chains such fees to set up the initial distribution of product in their retail store system. During the third quarter of fiscal year
2003, slotting fees were fully covered by our cumulative shipments, and we recognized $93,000 in net revenue on subsequent shipments during the balance of fiscal year 2003.



Keurig K-cup and other Office Coffee Service sales. Keurig K-cup and other Office Coffee Service sales
decreased by $40,000 for the year ended July 2, 2003, a 0.7% decrease over the prior year. The decrease was primarily due to lower sales to two large OCS distributor wholesale customers.



Franchise Revenue. Franchise revenue decreased by $55,000, or 0.8%, to $6,611,000 for the year ended July 2, 2003 from $6,666,000 for
the year ended July 3, 2002. Our franchise revenue consists of initial franchise fees, franchise renewal fees, area development fees, royalties received on sales at franchised locations, and miscellaneous other franchise revenue, including
coordination fees received from product suppliers. The decrease in franchise revenue is the net impact of several factors. Initial franchise fees and franchise renewal fees increased by approximately $190,000 for fiscal year 2003 versus the prior
year, as a result of an increase in franchise agreements sold or renewed. Franchise royalties decreased $164,000 versus the prior year period. This was the net impact of a reduction in domestic franchise royalties and an increase in international
royalties. Domestic royalties decreased primarily because of the 20-unit net reduction in domestic franchise stores from the prior year, and a decrease in franchise comparable store sales. International royalties increased because of a 66-unit net
increase in the number of international outlets compared to the prior year, although international franchise units pay a lower average royalty rate compared to domestic franchises. Miscellaneous other franchise revenue, including vendor coordination
fees, decreased by approximately $81,000 compared to the prior fiscal year.



Cost of Sales and Related Occupancy Costs. Our cost of sales and related occupancy costs for the year ended July 2, 2003 decreased 13.7% to $26,262,000 from $30,423,000 for the year ended July 3, 2002. On a margin basis, cost
of sales and related occupancy costs decreased to 47.8% of total revenue during fiscal 2003 versus 49.1% during fiscal 2002. This 1.3 favorable margin basis point change was solely due to a 0.9 favorable cost of sales margin basis point change, as
the occupancy cost margin basis remained consistent in current and prior years. This margin basis point improvement resulted primarily from two factors. First, during fiscal year 2003, we sold 12 company operated units with high cost of sales as a
percentage of sales, as discussed above. Second, we had a $178,000 increase in the cost of sales during the prior year, due to a recall of Keurig K-cups, as discussed below.



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Operating Expenses. Our operating expenses for the year ended July 2, 2003 decreased by 4.9% to $16,944,000
from $17,821,000 for the year ended July 3, 2002. On a margin basis, operating expenses increased to 30.8% of total revenue during fiscal year 2003 from 28.7% for fiscal year 2002. This unfavorable 2.1 margin basis point change resulted from several
factors. First, bad debt expense increased $638,000 during fiscal year 2003. This increase was primarily due to $315,000 of expense recognized in fiscal year 2003, which was comprised of $395,000 of bad debt expense recognized that was partially
offset by $80,000 in collections of previously reserved for amounts. In comparison, we reversed $471,000 of expense in fiscal year 2002, which was comprised of $214,000 in bad debt expense recognized that was offset by $685,000 in collections of
previously reserved for amounts. Advertising expense also increased versus the prior year as part of an overall effort to increase comparable store sales in retail units and to add new accounts at the wholesale level. We also incurred $384,000 of
new selling expenses in fiscal year 2003, which are classified as operating expenses, as we launched our grocery store sales program. As described in the discussion of revenue above, this program resulted in nominal new revenue during
fiscal year 2003 because of our accounting for slotting fees and the impact of these new expenses, when analyzed as a percentage of revenue, resulted in an erosion of reported margins. Finally, we experienced an increase in our workers
compensation insurance rates in our retail coffeehouses compared to the fiscal year 2002, resulting in an increase in operating expenses as a percentage of revenue. These increases were offset by decreases in labor costs and entertainment expenses
due to the sale or closure of the 12 stores noted above, combined with a strategic goal to reduce coffeehouse labor expenses.



Depreciation and Amortization. Depreciation and amortization decreased by $305,000, or 12.3%, to $2,169,000 for the year ended July 2, 2003 from $2,474,000
for the year ended July 3, 2002. This decrease is primarily due to the closure of six locations and the sale of six locations discussed above. Depreciation also decreased as certain assets at our Castroville roasting facility were fully depreciated,
combined with the fact that eight capital leases expired during the year ended July 2, 2003.



General and Administrative Expenses. Our general and administrative expenses decreased by $241,000, or 2.5%, to $9,346,000 for the year ended July 2, 2003 from $9,587,000 for the year ended July 3, 2002.
On a margin basis, general and administrative expenses increased to 17.0% of total revenue for the year ended July 2, 2003 from 15.5% of total revenue for the year ended July 3, 2002. This 1.5 unfavorable margin basis point change for the year ended
July 2, 2003 resulted because many of our general and administrative expenses are relatively fixed, and therefore, on a margin basis, represent a higher percentage of revenue when our revenue declines. The reduction in general and administrative
expenses dollars was the net impact of reductions in management bonuses and related benefits, rent expense, and accrued store closure expense versus fiscal year 2002. These decreases were partially offset by higher spending during fiscal year 2003
in the areas of franchise sales, real estate, construction and franchise operations, in order to increase our ability to support new franchise store development. We also incurred recruitment fees in connection with hiring an executive search firm to
find a new chief executive officer, and incurred increased directors and officers liability insurance premiums versus fiscal year 2002.



Asset Impairment and Restructuring Costs. Asset impairment and restructuring costs increased to $2,176,000 for the year ended July 2, 2003 from $542,000 for
the year ended July 3, 2002. This increase is primarily due to a review of our goodwill, in accordance with SFAS No. 142 Goodwill and Other Intangible Assets, which requires, among other things, the use of a nonamortization approach for
purchased goodwill and certain other intangible assets. Goodwill and certain other intangible assets with indefinite lives are not amortized, but instead are reviewed for impairment at least annually. As a result of our recent changes in executive
management, we reviewed our competitive position in certain markets in order to better align our resources with our growth strategy. As a result of this review, we modified certain assumptions used in our goodwill impairment test, which led to an
impairment charge of $1,900,000 that was recorded during fiscal year 2003. It is possible that our assumptions with respect to asset impairment may change or that actual results may



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vary significantly from our current estimates. As a result, additional impairment charges may occur. In addition, we
recorded asset impairment charges of $345,000 due to the reduction of the carrying values associated with four of our coffeehouses. A charge of $35,000 was recorded to reflect the net present value of the remaining lease obligation on a closed
coffeehouse in Arizona. These charges were partially offset by a reversal of $49,000 in closed store lease reserves associated with a closed coffeehouse in Arizona for which a full pass-through sublease was obtained. During fiscal 2002, we recorded
asset impairment charges of $195,000, associated with five company operated locations. This charge was partially offset by an asset impairment reversal of $58,000 to write up the book value of a parcel of land based on proceeds received from its
subsequent sale. At the end of fiscal 2002, we agreed to resume operation of four Arizona locations, which we had sold in fiscal 2001. A charge of $89,000 was recorded to reflect the net present value of the remaining lease obligations on these four
locations. In addition, we recorded severance costs and related employee benefits of $321,000 associated with the elimination of ten support center positions.



Gain on Asset Disposals. Gain on asset disposals increased to $868,000 for the year ended July 2, 2003 from $423,000 for the year ended July 3, 2002.
This increase is primarily related to a net gain of $984,000 from the sales and closures of nine locations partially offset by the write-off of equipment from other closed locations. During fiscal year 2002, we recognized a net gain of $400,000 on
the sale of three locations, partially offset by losses on the closure of several locations and the sale of related equipment.



Interest Expense and Other, Net. Interest expense and other, net decreased to $256,000 for the year ended July 2, 2003 from $537,000 for the year ended July
3, 2002. This decrease is primarily due to a reduction in one of our bank notes payable from $3,226,000 at July 3, 2002 to $2,000,000 at July 2, 2003, and, to a lesser degree, to a reduction in our floating interest rate and the expiration of eight
capital leases. This decrease was partially offset by interest related to a new note payable agreement for $950,000, which commenced on April 10, 2003.



Income Tax Expense. Net operating losses generated in fiscal year 2003 and in previous years resulted in no federal income tax liability and only a nominal
amount of state income tax expense for the years ended July 2, 2003 and July 3, 2002. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved. The slight fluctuation in
expense between fiscal 2003 versus fiscal 2002 is due to changes in state income taxes owed in conjunction with the portfolio of company operated Gloria Jeans units, which are located in a number of states. As of July 2, 2003, net operating
loss carry-forwards for federal and state income tax purposes of $32,757,000 and $18,064,000, respectively, are available to be utilized against future taxable income for years through fiscal 2022 for federal and fiscal 2007 for state, subject to
annual limitations pertaining to change in ownership rules under the Internal Revenue Code.



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FINANCIAL CONDITION AND LIQUIDITY AND CAPITAL RESOURCES



Current Financial Condition



At June 30, 2004, we had working capital of $641,000, total long-term debt and capital lease
obligations of $1,533,000 and $16,475,000 of stockholders equity, compared to a working capital of $1,207,000, total long-term debt and capital lease obligations of $3,677,000 and $16,202,000 of stockholders equity at July 2, 2003. As a
result of our restructuring our credit agreements as described in Outstanding Debt and Financing Arrangements below, available credit under our credit agreements increased from approximately $500,000 at July 2, 2003 to
approximately $4,600,000 at June 30, 2004.



Cash Flows



The following is a summary of our cash flows for the three years ended June 30, 2004:



|                                                      |  |                    |            |   |               |    |            |               |  |   |            |  
|----------------------------------------------------- |  | ------------------ | ---------- | - | ------------- | -- | ---------- | ------------- |  | - | ---------- | -
|                                                      |  | Fiscal Years Ended |           
|                                                      |  | June 30, 2004      |            |   | July 2, 2003  |    |            | July 3, 2002  | 
|                                                      |  | (as restated)      |            |   | (as restated) |    |            | (as restated) | 
|Cash flows provided by operating activities:          |  |                    |            |   |               |    |            |               |  |   |            |  
|Net income (loss)                                     |  | $                  | 251,000    |   |               | ($ | 1,358,000  | )             |  | $ | 952,000    |  
|Net non-cash charges to income                        |  |                    | 2,952,000  |   |               |    | 4,065,000  |               |  |   | 2,415,000  |  
|Net increase in operating assets                      |  |                    | (135,000   | ) |               |    | (1,173,000 | )             |  |   | (247,000   | )
|Net increase (decrease) in operating liabilities      |  |                    | 688,000    |   |               |    | 18,000     |               |  |   | (2,674,000 | )
|                                                      |  |                    |            |   |               |    |            |               |  |   |            |  
|Cash flows provided by operating activities           |  | $                  | 3,756,000  |   |               | $  | 1,552,000  |               |  | $ | 446,000    |  
|Cash flows provided by (used in) investing activities |  |                    | (2,438,000 | ) |               |    | (690,000   | )             |  |   | 1,471,000  |  
|Cash flows used in financing activities               |  |                    | (2,144,000 | ) |               |    | (470,000   | )             |  |   | (2,747,000 | )
|                                                      |  |                    |            |   |               |    |            |               |  |   |            |  
|Net increase (decrease) in cash                       |  |                    | (826,000   | ) |               |    | 392,000    |               |  |   | (830,000   | )
|Cash at beginning of fiscal year                      |  |                    | 2,625,000  |   |               |    | 2,233,000  |               |  |   | 3,063,000  |  
|                                                      |  |                    |            |   |               |    |            |               |  |   |            |  
|Cash at end of fiscal year                            |  | $                  | 1,799,000  |   |               | $  | 2,625,000  |               |  | $ | 2,233,000  |  
|                                                      |  |                    |            |   |               |    |            |               |  |   |            |  
|Capital commitments at end of fiscal year             |  | $                  | 514,000    |   |               | $  | 194,000    |               |  | $ |           |  



The improvement in cash provided by
operating activities for the fiscal years ended June 30, 2004, July 2, 2003 and July 3, 2002 is more fully enumerated in the consolidated statements of cash flows in the accompanying consolidated financial statements.



Working capital requirements tend to be seasonal, with inventories and receivables increasing
before the holiday season and declining in the post holiday period. Planned new store growth will initially have the effect of increasing working capital requirements and decreasing cash flows provided by operating activities.



Cash used in investing activities increased for the fiscal years ended June 30, 2004 and July
2, 2003 as proceeds from sales of property and equipment declined from $2,187,000 in fiscal 2002 to $1,209,000 in fiscal 2003 and $64,000 in fiscal 2004. Capital expenditures increased late in fiscal 2003 and throughout fiscal 2004 due to a store
improvement program and as a result of equipment additions at the Castroville roasting facility.



Cash flows used in financing activities are the result of a net reduction of long-term debt and capital lease obligations in each of the fiscal years.



Capital commitments at the end of the fiscal year June 30, 2004 are primarily for equipment and leasehold improvements in company-operated
retail units and the Castroville roasting facility and one new company store.



Outstanding Debt and Financing Arrangements



On May 10, 2004,
we entered into a $5,000,000 Contingent Convertible Note Purchase Agreement. The agreement provides for us to, at our election, issue notes up to an aggregate principal amount of $5,000,000. Issued notes will be amortized on a monthly basis at a
rate that will repay 60% of the principal amount of each note by May 10, 2007. The remaining 40% will mature on that date. Interest is payable at LIBOR plus 3.30%, and a facility fee of 1.00% annually is payable on the unused portion of the
facility. The agreement contains covenants that limit the amount of indebtedness that we may have outstanding in relation to our tangible net worth and that require us to maintain a specified minimum dollar value of earnings before interest, tax,
depreciation and amortization for the trailing four fiscal quarters. Notes are convertible into our common stock only upon certain changes of control. For notes issued and repaid, warrants to purchase shares will be issued with the same rights and
restrictions for exercise as existed for convertibility of the notes at the time of their issuance. Warrants are exercisable only in the event of a change of control and expire on May 10, 2008. The lender under this agreement is a limited
partnership of which the chairman of our board of directors serves as the sole general partner. On May 10, 2004, upon entering into the agreement, we immediately issued a $1,000,000 note under the facility, and used the proceeds from that note and
other available cash to repay all outstanding debt with Bank of the West. As of June 30, 2004, $983,000 was outstanding under the facility. The applicable interest rate at June 30, 2004 was 4.64%.



On May 10, 2004, we also entered into an Amended and Restated Credit Agreement with Bank of
the West. The agreement provides for a working capital facility of $250,000 and a letter of credit facility of $750,000. At June 30, 2004, no debt was outstanding under the working capital facility and $426,000 of letters of credit were outstanding
under the letter of credit facility.



Based upon the terms of our credit
agreements, as amended, our recent operating performance and business outlook, and status of our balance sheet, we believe that cash from operations, cash and cash equivalents, and funds available under our credit agreements will be sufficient to
satisfy our working capital needs at the anticipated operating levels for at least the next twelve months.



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Commitments and Contractual Obligations



The following is a summary of our contractual obligations and commitments as of June 30, 2004:



|                                                             |  |                        |        |                  |   |           |  |           |        |                   |   |       |  |   |      
|------------------------------------------------------------ |  | ---------------------- | ------ | ---------------- | - | --------- |  | --------- | ------ | ----------------- | - | ----- |  | - | -----
|                                                             |  | Payments Due By Period
|                                                             |  | Total                  |        | Less than 1 year |   | 1-3 years |  | 3-5 years |        | More than 5 years
|                                                             |  | (In thousands)        
|Note payable                                                 |  | $                      | 983    |                  | $ | 200       |  | $         | 783    |                   | $ |      |  | $ |     
|Interest on note payable                                     |  |                        | 172    |                  |   | 75        |  |           | 97     |                   |   |      |  |   |     
|Capital leases (including interest)                          |  |                        | 746    |                  |   | 206       |  |           | 149    |                   |   | 88    |  |   | 303  
|Company operated retail locations and other operating leases |  |                        | 14,582 |                  |   | 3,780     |  |           | 5,134  |                   |   | 3,056 |  |   | 2,612
|Franchise operated retail locations operating leases         |  |                        | 15,337 |                  |   | 4,495     |  |           | 5,706  |                   |   | 3,104 |  |   | 2,032
|Green coffee commitments                                     |  |                        | 2,795  |                  |   | 2,494     |  |           | 301    |                   |   |      |  |   |     
|                                                             |  |                        |        |                  |   |           |  |           |        |                   |   |       |  |   |      
|                                                             |  | $                      | 34,615 |                  | $ | 11,250    |  | $         | 12,170 |                   | $ | 6,248 |  | $ | 4,947
|                                                             |  |                        |        |                  |   |           |  |           |        |                   |   |       |  |   |      



The Company also has entered into
employment agreements with its President and Chief Executive Officer and three other senior executive officers that provide for severance payments in the event that these individuals are terminated without cause or that they terminate their
employment as a result of a constructive termination. These severance payments range from six months to one years salary. The Companys maximum liability for severance under the contracts is currently $857,500. Because such amounts are
contingent they have not been included in the above table.



We have obligations
under non-cancelable operating leases for our coffee houses, roasting facility and administrative offices. Lease terms are generally for 10 to 20 years with renewal options and generally require us to pay a proportionate share of real estate taxes,
insurance, common area and other operating costs. Some retail leases provide for contingent rental payments based on sales thresholds. In addition, we are liable on the master leases for 98 franchise locations. Under our historical franchising
business model, we executed the master leases for these locations, and entered into subleases on the same terms with our franchisees, which typically pay their rent directly to the landlords. Should any of these franchisees default on their
subleases, we would be responsible for making payments thereunder. Our maximum theoretical future exposure at June 30, 2004, computed as the sum of all remaining lease payments through the expiration dates of the respective leases, was $15,337,000.
This amount does not take into consideration any mitigating measures that we could take to reduce this exposure in the event of default, including re-leasing the locations or terminating the master lease by negotiating a lump sum payment to the
landlord that is less than the sum of all remaining future rents and other amounts payable.



Critical Accounting Estimates



The
preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts. The estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and on
various other factors that are believed to be reasonable. Accounts significantly impacted by estimates and assumptions include, but are not limited to, franchise receivables, allowance for bad debt reserves, fixed asset lives, goodwill, intangible
assets, income taxes, self-insurance and workers compensation reserves, store closure reserves, stock-based compensation, the valuation allowance for net deferred tax assets and contingencies. We believe that the following represent our
critical accounting policies and estimates used in the preparation of our condensed consolidated financial statements. The following discussion, however, does not list all of our accounting policies and estimates.



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



Each quarter, or upon the occurrence of a triggering event as
defined in SFAS No. 144, we evaluate the carrying value of individual stores when the operating results have reasonably progressed to a point to adequately evaluate the probability of continuing operating losses or a current expectation that a store
will be sold or otherwise disposed of before the end of its previously estimated useful life. In making these judgments, we consider the period of time since the store was opened or remodeled, and the trend of operations and expectations for future
sales growth. For stores selected for review, we estimate the future cash flows from operating the store over its estimated useful life. We make judgments about future same-store sales and the operating expenses and estimated useful life that we
would expect with such level of same-store sales.



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



Impairment of Goodwill



At the reporting unit level, goodwill is tested for impairment annually or whenever an event
or circumstance indicates that impairment has likely occurred. We consider the reporting unit level to be the segment level since the components within each segment have similar economic characteristics, including products and services, production
processes, types or classes of customers and distribution methods. The impairment, if any, is measured based on the estimated fair value of the segment. Fair value can be determined based on discounted cash flows or valuations of similar businesses.
Impairment occurs when the carrying amount of goodwill exceeds its estimated fair value.



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



If our assumptions used in performing the impairment test prove inaccurate, the fair value of the segments may ultimately prove to be
significantly higher or lower, thereby causing the carrying value to be less than or to exceed the fair value and indicating impairment has or has not occurred. If our assumptions are incorrect, the carrying value of our goodwill may be understated
or overstated. Our annual impairment measurement date is our fiscal year end.



Estimated Liability for Closing Stores



We make
decisions to close stores based on prospects for estimated future profitability and sometimes we are forced to close stores due to circumstances beyond our control (e.g., a landlords refusal to negotiate a new lease). Our management team
evaluates each stores performance every period. When stores continue to perform poorly, we consider the demographics of the location, as well as the likelihood of being able to improve the performance of an unprofitable store. Based on the
management teams judgment, we estimate the future cash flows. If we determine that the store will not, within a reasonable period of time, operate at break-even cash flow or be profitable, and we are not contractually obligated to continue
operating the store, we may close the store. Additionally, franchisees may close stores for which we are the primary lessee. If the franchisee cannot make payments on the lease, we continue making the lease payments and establish an estimated
liability for the closed store if we decide not to operate it as a company operated store. Effective January 1, 2003, we establish the estimated liability on the actual closure date which is generally the date on which we cease to receive economic
benefit from the unit. Prior to the adoption of SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, on January 1, 2003, we established the estimated liability when we identified a store for closure, which may
or may not have been the actual closure date.



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



A significant assumption used in determining the amount of the estimated liability for closing stores is the amount of the estimated
liability for future lease payments on vacant stores, which we determine based on our assessment of our ability to successfully negotiate early terminations of our lease agreements with the lessors or



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to sublease the property. Additionally, we estimate the cost to maintain leased and owned vacant properties until the
lease has been abated. If the costs to maintain properties increase, or it takes longer than anticipated to sell properties or sublease or terminate leases, we may need to record additional estimated liabilities. If the leases on the vacant stores
are not terminated or subleased on the terms we used to estimate the liabilities, we may be required to record losses in future periods. Conversely, if the leases on the vacant stores are terminated or subleased on more favorable terms than we used
to estimate the liabilities, we reverse previously established estimated liabilities through the line item in which it was originally recorded, resulting in an increase in operating income.



Estimated Liability for Self-Insurance and Workers Compensation



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



Franchised Operations



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



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



In accordance with SFAS No. 146, which we adopted on January 1, 2003, an estimated liability for future lease obligations on stores operated
by franchisees for which we are the primary or secondary obligee is established on the date the franchisee closes the store. Also, we record an estimated liability for subsidized lease payments when we sign a sublease agreement committing us to the
subsidy.



The amount of the estimated liability is established using the
methodology described in Estimated Liability for Closing Stores above. Consistent with SFAS No. 146, we have not established an additional estimated liability for potential losses not yet incurred. If sales trends or economic conditions
worsen for our franchisees, their financial health may worsen, our collection rates may decline and we may be required to assume the responsibility for additional lease payments on franchised stores. In addition, entering into restructured franchise
agreements may result in reduced franchise royalty rates in the future.



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Stock-Based Compensation



As discussed in the notes to consolidated financial statements, we have various stock-based compensation plans that provide options for
certain employees and outside directors to purchase common shares of stock. We have elected to account for stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, which utilizes the intrinsic value method of accounting for stock-based compensation, as opposed to using the fair-value method prescribed in SFAS No. 123, Accounting for Stock-Based Compensation. Because of this
election, we are required to make certain disclosures of pro forma net income assuming we had adopted SFAS No. 123. We determine the estimated fair value of stock-based compensation on the date of the grant using the Black-Scholes option-pricing
model. The Black-Scholes option-pricing model requires us to apply highly subjective assumptions, including our historical stock price volatility, expected life of the option and the risk-free interest rate. A change in one or more of the
assumptions used in the Black-Scholes option-pricing model may result in a material change to the estimated fair value of the stock-based compensation. See Note 1 of Notes to Consolidated Financial Statements for analysis of the effect of certain
changes in assumptions used to determine the fair value of stock-based compensation.



Valuation Allowance for Net Deferred Tax Assets and Contingencies



As discussed above, we have recorded a 100% valuation allowance against our net deferred tax assets. If we have been profitable for a number of years and our prospects for the realization of our deferred tax assets
are more likely than not, we would then reverse our valuation allowance and credit income tax expense. In assessing the prospects for future profitability, many of the assessments of same-store sales and cash flows discussed above become relevant.
When circumstances warrant, we assess the likelihood that our net deferred tax assets will more likely than not be realized from future taxable income. As of June 30, 2004, our net deferred tax assets and related valuation allowance totaled
approximately $14,742,000.



OTHER MATTERS



Seasonality and Quarterly Results



Our business is subject to seasonal fluctuations as well as economic trends that affect
retailers in general. Historically, our net sales have not been realized proportionately in each quarter, with net sales being the highest during the second fiscal quarter, which includes the November-December holiday season. Hot weather tends to
negatively impact sales. Quarterly results are also affected by the timing of the opening of new stores, which may not occur as anticipated due to events outside our control. As a result of these factors, and of the other contingencies and risk
factors described elsewhere in this report, the financial results for any individual quarter may not be indicative of the results that may be achieved in a full fiscal year.



Item 7A.Quantitative and Qualitative Disclosures About Market Risk.



Market Risk Sensitive Items Entered Into for Trading Purposes



None.



Market Risk Sensitive Items Entered Into for Other Than Trading Purposes



We have exposure to market risk from two primary sources  interest rate risk and commodity price risk.



Interest Rate Risk



We are exposed to market risk from changes in interest rates on our outstanding bank debt.
At June 30, 2004, we had a $5,000,000 loan facility with an outstanding balance of $983,000 and a $250,000 working capital facility with no outstanding balance, each of which could be affected by changes in short term interest rates. At



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fiscal year-end, the interest rates ranged from 4.46% to 4.63%. These rates can be fixed over periods ranging from one to
six months, at our discretion. At June 30, 2004, a hypothetical 100 basis point increase in the adjusted rates would result in additional interest expense of $9,830 on an annualized basis. The current loan approximates the fair value.



Commodity Price Risk



Green coffee, the principal raw material for our products, is subject to significant price
fluctuations caused by a number of factors, including weather, political, and economic conditions. To date, we have not used commodity-based financial instruments to hedge against fluctuations in the price of green coffee. To ensure that we have an
adequate supply of green coffee, however, we enter into agreements to purchase green coffee in the future that may or may not be fixed as to price. At June 30, 2004, we had commitments to purchase coffee through fiscal year 2006, totaling $2,795,000
for 2,249,000 pounds of green coffee, the majority of which were fixed as to price. The coffee scheduled to be delivered to us in fiscal year 2005 pursuant to these commitments will satisfy approximately 47% of our anticipated green coffee
requirements for the fiscal year. Assuming we require approximately 2,201,000 additional pounds of green coffee during fiscal 2005 for which no price has yet been fixed, each $0.01 per pound increase in the price of green coffee could result in
$22,000 of additional cost. However, because the price we pay for green coffee is negotiated with suppliers, we believe that the commodity market price for green coffee would have to increase significantly, by as much as $0.25 per pound, before
suppliers would increase the price they charge us.



Item 8.Financial Statements and Supplementary Data.



The financial statements and supplementary data required by this item are set forth at the end of this Annual Report on Form 10-K beginning on page F-1.



Item 9.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.



None.



Item 9A.Controls and Procedures.



The Companys management, with the participation of the Companys Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures (as
such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), as of the end of the period covered by this report. The Companys management, with the participation of
the Companys Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of the Companys internal control over financial reporting to determine whether any changes occurred during the period covered by this report
that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



As was initially reported in the Form 10-K for the fiscal year ended June 30, 2004, the Companys management, including the Companys Chief
Executive Officer and Chief Financial Officer, determined that our disclosure controls and procedures were effective as of the end of the period covered by that report and that no change in our internal control over financial reporting had occurred
during the period covered by that report. Subsequent to such evaluations, the Companys management became aware that the Companys accounting policies for leases may not have been consistent with United States generally accepted accounting
principles (GAAP). After investigating such matter, the Companys management and the Audit Committee of the Board of Directors concluded that the Companys disclosure controls and procedures were not effective as of June 30,
2004 because there was a material weakness in the Companys controls over the selection, monitoring, implementation and review of the Companys lease accounting policies, specifically amortization of leasehold improvements, tenant
improvement allowances, and rent holidays for leased facilities. As a result, on April 1, 2005, the Audit Committee concluded that it concurred with the Companys management recommendation to restate the financial statements for the fiscal
years ended July 3, 2002, July 2, 2003 and June 30, 2004, and for the first and second quarters of fiscal year 2005 to correct errors in lease accounting, as reported in our Current Report on Form 8-K, filed on April 1, 2005, and amended on April 8,
2005.



During the third quarter of fiscal 2005, the Company
remediated the material weakness in internal control over financial reporting and the ineffectiveness of its disclosure controls and procedures by conducting a review of its accounting related to amortization of leasehold improvements, tenant
improvement allowances, and rent holidays for leased facilities by changing the Companys accounting policies for leases to conform to GAAP, trained the accounting staff regarding the policy changes and increased management oversight of
compliance.



Item 9B.Other Information.



None.



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PART III



Item 10.Directors and Executive Officers of the Registrant.



The information required by this item is incorporated herein by reference to our definitive proxy statement for our 2004 annual meeting of stockholders, which will be
filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended June 30, 2004.



Item 11.Executive Compensation.



The information required by this item is incorporated herein by reference to our definitive proxy statement for our 2004 annual meeting of stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days
after the close of the fiscal year ended June 30, 2004.



Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.



The information required by this item is incorporated herein by reference to our definitive proxy statement for our 2004 annual meeting of stockholders, which will be
filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended June 30, 2004.



Equity Compensation Plan Information



The following table summarizes the equity compensation plans under which our common stock may be issued as of June 30, 2004.



|                                                       |  |                                                                                           |     |  |                                                                           |      |                                                                                                                                         |         |    
|------------------------------------------------------ |  | ----------------------------------------------------------------------------------------- | --- |  | ------------------------------------------------------------------------- | ---- | --------------------------------------------------------------------------------------------------------------------------------------- | ------- | ---
|                                                       |  | (a)                                                                                       |     |  | (b)                                                                       |      | (c)                                                                                                                                     |        
|Plan category                                          |  | Number of securities to be issuedupon exercise of outstandingoptions, warrants and rights |     |  | Weighted-average exercise priceof outstanding options,warrants and rights |      | Number of securities remainingavailable for future issuanceunder equity compensationplans (excluding securitiesreflected in column
(a)) |        
|Equity compensation plans approved by security holders |  | 969,242                                                                                   | (1) |  | $                                                                         | 5.27 |                                                                                                                                         | 452,750 | (2)
|                                                       |  |                                                                                           |     |  |                                                                           |      |                                                                                                                                         |         |    
|Total                                                  |  | 969,242                                                                                   |     |  | $                                                                         | 5.27 |                                                                                                                                         | 452,750 |    
|                                                       |  |                                                                                           |     |  |                                                                           |      |                                                                                                                                         |         |    

---

|(1) | Represents options to purchase shares of our common stock issued under: the Diedrich Coffee, Inc. 2000 Equity Incentive Plan; the Stock Option Plan and Agreement with Roger M.
Laverty; the Diedrich Coffee, Inc. 2000 Non-Employee Directors Stock Option Plan; and the Amended and Restated Diedrich Coffee, Inc. 1996 Stock Incentive Plan.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Represents securities available for issuance under the Diedrich Coffee, Inc. 2000 Equity Incentive Plan.
|--- | --------------------------------------------------------------------------------------------------------



Item 13.Certain Relationships and Related Transactions.



The information required by this item is incorporated herein by reference to our definitive proxy statement for our 2004 annual meeting of stockholders, which will be filed with the Securities and Exchange Commission
no later than 120 days after the close of the fiscal year ended June 30, 2004.



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Item 14.Principal Accountant Fees and Services



The information required by this item is incorporated herein by reference to our definitive proxy statement for our 2004 annual meeting of stockholders, which will be filed with the Securities and Exchange Commission
no later than 120 days after the close of the fiscal year ended June 30, 2004.



PART IV



Item 15.Exhibits, Financial Statement Schedules, and Reports on Form 8-K.



(a) and (d) Financial Statements and Schedules.



The financial statements and schedules required to be filed hereunder are set forth at the end of this Annual Report on Form 10-K beginning on page F-1.



(b) Reports on Form 8-K.



On April 21, 2004, we filed a current report on Form 8-K pursuant to which
we furnished a press release, dated April 21, 2004, reporting the financial results of Diedrich Coffee, Inc. for our third fiscal quarter of the fiscal year ending June 30, 2004.



On May 13, 2004, we filed a current report on Form 8-K pursuant to which we furnished a press release, dated May 13, 2004,
announcing that we had entered into a $5,000,000 credit facility.



(c) Exhibits.



The Exhibit Index attached
hereto is incorporated herein by reference.



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SIGNATURES



Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                   |  |                       |  |                                      
|------------------ |  | --------------------- |  | -------------------------------------
|                   |  | DIEDRICH COFFEE, INC.
|                   |  |                      
|September 26, 2005 |  | By:                   |  | /s/ ROGER M. LAVERTY                 
|                   |  |                       |  | Roger M. Laverty                     
|                   |  |                       |  | President and Chief Executive Officer
|                   |  |                       |  | (Principal Executive Officer)        



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DIEDRICH COFFEE, INC. AND SUBSIDIARIES



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                        |  |     
|------------------------------------------------------- |  | ----
|                                                        |  | Page
|Report of Independent Registered Public Accounting Firm |  | F-2 
|                                                        | 
|Consolidated Balance Sheets                             |  | F-3 
|                                                        | 
|Consolidated Statements of Operations                   |  | F-4 
|                                                        | 
|Consolidated Statements of Stockholders Equity         |  | F-5 
|                                                        | 
|Consolidated Statements of Cash Flows                   |  | F-6 
|                                                        | 
|Notes to Consolidated Financial Statements              |  | F-7 
|                                                        | 
|Schedule II  Valuation and Qualifying Accounts         |  | F-23





F-1



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders

Diedrich Coffee, Inc.:



We have audited the accompanying consolidated balance sheets of Diedrich Coffee, Inc. and subsidiaries as of June 30, 2004 and July 2, 2003,
and the related consolidated statements of operations, stockholders equity and cash flows for each of the years in the three-year period ended June 30, 2004. In connection with our audits of the consolidated financial statements, we have also
audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Diedrich Coffee, Inc. and subsidiaries as of June 30, 2004 and July 2, 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2004, in conformity with U.S. generally accepted
accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth
therein.



As discussed in note 2 of the notes to consolidated financial
statements, the consolidated financial statements for all periods presented have been restated.



/s/ KPMG LLP



Costa Mesa, California

August 20, 2004, except as

to note 2 which is as of

September 22, 2005



F-2



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                     |  |               |             |   |               |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ----------- | - | ------------- | - | ----------- | -
|                                                                                                                                     |  | June 30, 2004 |             |   | July 2, 2003  |  
|                                                                                                                                     |  | (as restated) |             |   | (as restated) |  
|Assets                                                                                                                               |  |               |             |   |               |   |             |  
|Current assets:                                                                                                                      |  |               |             |   |               |   |             |  
|Cash                                                                                                                                 |  | $             | 1,799,000   |   |               | $ | 2,625,000   |  
|Accounts receivable, less allowance for doubtful accounts of $1,155,000 at June 30, 2004 and $1,375,000 at July 2, 2003              |  |               | 2,337,000   |   |               |   | 2,454,000   |  
|Inventories                                                                                                                          |  |               | 2,815,000   |   |               |   | 2,611,000   |  
|Current portion of notes receivable                                                                                                  |  |               | 81,000      |   |               |   | 58,000      |  
|Advertising fund assets, restricted                                                                                                  |  |               | 370,000     |   |               |   |            |  
|Prepaid expenses                                                                                                                     |  |               | 341,000     |   |               |   | 901,000     |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Total current assets                                                                                                                 |  |               | 7,743,000   |   |               |   | 8,649,000   |  
|Property and equipment, net                                                                                                          |  |               | 6,687,000   |   |               |   | 6,611,000   |  
|Goodwill                                                                                                                             |  |               | 10,190,000  |   |               |   | 10,190,000  |  
|Notes receivable                                                                                                                     |  |               | 153,000     |   |               |   | 182,000     |  
|Other assets                                                                                                                         |  |               | 445,000     |   |               |   | 469,000     |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Total assets                                                                                                                         |  | $             | 25,218,000  |   |               | $ | 26,101,000  |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Liabilities and Stockholders Equity                                                                                                 |  |               |             |   |               |   |             |  
|Current liabilities:                                                                                                                 |  |               |             |   |               |   |             |  
|Current installments of obligations under capital leases                                                                             |  | $             | 160,000     |   |               | $ | 185,000     |  
|Current installments of long-term debt                                                                                               |  |               | 200,000     |   |               |   | 1,459,000   |  
|Accounts payable                                                                                                                     |  |               | 2,144,000   |   |               |   | 2,108,000   |  
|Accrued compensation                                                                                                                 |  |               | 2,074,000   |   |               |   | 1,307,000   |  
|Accrued expenses                                                                                                                     |  |               | 732,000     |   |               |   | 738,000     |  
|Franchisee deposits                                                                                                                  |  |               | 611,000     |   |               |   | 671,000     |  
|Deferred franchise fee income                                                                                                        |  |               | 702,000     |   |               |   | 549,000     |  
|Advertising fund liabilities                                                                                                         |  |               | 370,000     |   |               |   |            |  
|Accrued provision for store closure                                                                                                  |  |               | 109,000     |   |               |   | 425,000     |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Total current liabilities                                                                                                            |  |               | 7,102,000   |   |               |   | 7,442,000   |  
|Obligations under capital leases, excluding current installments                                                                     |  |               | 390,000     |   |               |   | 542,000     |  
|Long term debt, excluding current installments                                                                                       |  |               | 783,000     |   |               |   | 1,491,000   |  
|Deferred rent                                                                                                                        |  |               | 468,000     |   |               |   | 424,000     |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Total liabilities                                                                                                                    |  |               | 8,743,000   |   |               |   | 9,899,000   |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Stockholders equity:                                                                                                                |  |               |             |   |               |   |             |  
|Common stock, $.01 par value; authorized 8,750,000 shares; issued and outstanding 5,161,000 shares at June 30, 2004 and July 2,
2003 |  |               | 52,000      |   |               |   | 52,000      |  
|Additional paid-in capital                                                                                                           |  |               | 58,058,000  |   |               |   | 58,036,000  |  
|Accumulated deficit                                                                                                                  |  |               | (41,635,000 | ) |               |   | (41,886,000 | )
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Total stockholders equity                                                                                                           |  |               | 16,475,000  |   |               |   | 16,202,000  |  
|Commitments and contingencies (Notes 7, 8 and 11)                                                                                    |  |               |             |   |               |   |             |  
|                                                                                                                                     |  |               |             |   |               |   |             |  
|Total liabilities and stockholders equity                                                                                           |  | $             | 25,218,000  |   |               | $ | 26,101,000  |  
|                                                                                                                                     |  |               |             |   |               |   |             |  



See accompanying
notes to consolidated financial statements.



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|------------------------------------------------------ |  | ------------------------ | ---------- | - | ----------------------- | - | ---------- | ----------------------- |  | - | ---------- | -
|                                                       |  | Year Ended June 30, 2004 |            |   | Year Ended July 2, 2003 |   |            | Year Ended July 3, 2002 | 
|                                                       |  | (as restated)            |            |   | (as restated)           |   |            | (as restated)           | 
|Net revenue:                                           |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Retail sales                                           |  | $                        | 31,617,000 |   |                         | $ | 33,034,000 |                         |  | $ | 38,658,000 |  
|Wholesale and other                                    |  |                          | 15,466,000 |   |                         |   | 15,336,000 |                         |  |   | 16,681,000 |  
|Franchise revenue                                      |  |                          | 7,542,000  |   |                         |   | 6,611,000  |                         |  |   | 6,666,000  |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Total revenue                                          |  |                          | 54,625,000 |   |                         |   | 54,981,000 |                         |  |   | 62,005,000 |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Costs and expenses:                                    |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Cost of sales and related occupancy costs              |  |                          | 25,144,000 |   |                         |   | 26,262,000 |                         |  |   | 30,423,000 |  
|Operating expenses                                     |  |                          | 16,707,000 |   |                         |   | 16,944,000 |                         |  |   | 17,821,000 |  
|Depreciation and amortization                          |  |                          | 2,315,000  |   |                         |   | 2,169,000  |                         |  |   | 2,474,000  |  
|General and administrative expenses                    |  |                          | 9,770,000  |   |                         |   | 9,346,000  |                         |  |   | 9,587,000  |  
|Provision for asset impairment and restructuring costs |  |                          | 94,000     |   |                         |   | 2,176,000  |                         |  |   | 542,000    |  
|Gain on asset disposals                                |  |                          | (2,000     | ) |                         |   | (868,000   | )                       |  |   | (423,000   | )
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Total costs and expenses                               |  |                          | 54,028,000 |   |                         |   | 56,029,000 |                         |  |   | 60,424,000 |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Operating income (loss)                                |  |                          | 597,000    |   |                         |   | (1,048,000 | )                       |  |   | 1,581,000  |  
|Interest expense                                       |  |                          | (348,000   | ) |                         |   | (305,000   | )                       |  |   | (600,000   | )
|Interest and other income, net                         |  |                          | 30,000     |   |                         |   | 49,000     |                         |  |   | 63,000     |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Income (loss) before income tax provision              |  |                          | 279,000    |   |                         |   | (1,304,000 | )                       |  |   | 1,044,000  |  
|Income tax provision                                   |  |                          | 28,000     |   |                         |   | 54,000     |                         |  |   | 92,000     |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Net income (loss)                                      |  | $                        | 251,000    |   |                         | $ | (1,358,000 | )                       |  | $ | 952,000    |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Net income (loss) per share  basic and diluted        |  | $                        | 0.05       |   |                         | $ | (0.26      | )                       |  | $ | 0.18       |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Weighted average shares outstanding:                   |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Basic                                                  |  |                          | 5,161,000  |   |                         |   | 5,161,000  |                         |  |   | 5,161,000  |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  
|Diluted                                                |  |                          | 5,197,000  |   |                         |   | 5,161,000  |                         |  |   | 5,165,000  |  
|                                                       |  |                          |            |   |                         |   |            |                         |  |   |            |  



See accompanying
notes to consolidated financial statements.



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  
|----------------------------------------------- | ------ | ------------ | ------ | ------------------------ | ------ |  | ------------------ | ---------- | - | ------------------------ | - | ----------- | - |  | - | ---------- | -
|                                                |        | Common Stock |        | AdditionalPaid-InCapital |        |  | AccumulatedDeficit |            |   | TotalStockholdersEquity |  
|                                                | Shares |              | Amount |                          |        | 
|Balance, June 27, 2001 (as previously reported) |        | 5,161,000    |        | $                        | 52,000 |  | $                  | 58,106,000 |   |                          | $ | (41,545,000 | ) |  | $ | 16,613,000 |  
|Restatement adjustments (See Note 2)            |        |              |        |                          |        |  |                    |            |   |                          |   | 65,000      |   |  |   | 65,000     |  
|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  
|Balance, June 27, 2001 (as restated)            |        | 5,161,000    |        |                          | 52,000 |  |                    | 58,106,000 |   |                          |   | (41,480,000 | ) |  |   | 16,678,000 |  
|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  
|Stock issuance costs                            |        |             |        |                          |       |  |                    | (138,000   | ) |                          |   |            |   |  |   | (138,000   | )
|Net income (as restated)                        |        |             |        |                          |       |  |                    |           |   |                          |   | 952,000     |   |  |   | 952,000    |  
|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  
|Balance, July 3, 2002 (as restated)             |        | 5,161,000    |        |                          | 52,000 |  |                    | 57,968,000 |   |                          |   | (40,528,000 | ) |  |   | 17,492,000 |  
|Stock compensation expense                      |        |             |        |                          |       |  |                    | 68,000     |   |                          |   |            |   |  |   | 68,000     |  
|Net loss (as restated)                          |        |             |        |                          |       |  |                    |           |   |                          |   | (1,358,000  | ) |  |   | (1,358,000 | )
|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  
|Balance, July 2, 2003 (as restated)             |        | 5,161,000    |        |                          | 52,000 |  |                    | 58,036,000 |   |                          |   | (41,886,000 | ) |  |   | 16,202,000 |  
|Stock compensation expense                      |        |             |        |                          |       |  |                    | 22,000     |   |                          |   |            |   |  |   | 22,000     |  
|Net income (as restated)                        |        |             |        |                          |       |  |                    |           |   |                          |   | 251,000     |   |  |   | 251,000    |  
|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  
|Balance, June 30, 2004 (as restated)            |        | 5,161,000    |        | $                        | 52,000 |  | $                  | 58,058,000 |   |                          | $ | (41,635,000 | ) |  | $ | 16,475,000 |  
|                                                |        |              |        |                          |        |  |                    |            |   |                          |   |             |   |  |   |            |  



See accompanying
notes to consolidated financial statements.



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|---------------------------------------------------------------------------------------- |  | ----------------------- | ---------- | - | ---------------------- | - | ---------- | ---------------------- |  | - | ---------- | -
|                                                                                         |  | Year EndedJune 30, 2004 |            |   | Year EndedJuly 2, 2003 |   |            | Year EndedJuly 3, 2002 | 
|                                                                                         |  | (as restated)           |            |   | (as restated)          |   |            | (as restated)          | 
|Cash flows from operating activities:                                                    |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Net income (loss)                                                                        |  | $                       | 251,000    |   |                        | $ | (1,358,000 | )                      |  | $ | 952,000    |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Depreciation and amortization                                                            |  |                         | 2,315,000  |   |                        |   | 2,169,000  |                        |  |   | 2,474,000  |  
|Amortization and write off of loan fees                                                  |  |                         | 152,000    |   |                        |   | 79,000     |                        |  |   | 189,000    |  
|Provision for (recovery of) bad debt                                                     |  |                         | 253,000    |   |                        |   | 315,000    |                        |  |   | (471,000   | )
|Provision for inventory obsolescence                                                     |  |                         | 210,000    |   |                        |   | 34,000     |                        |  |   | 83,000     |  
|Provision for asset impairment and restructuring                                         |  |                         | 94,000     |   |                        |   | 2,176,000  |                        |  |   | 542,000    |  
|Provision for (reversal of) store closure                                                |  |                         | (70,000    | ) |                        |   | 92,000     |                        |  |   | 21,000     |  
|Stock compensation expense                                                               |  |                         | 22,000     |   |                        |   | 68,000     |                        |  |   |           |  
|Notes receivable issued for franchise fees                                               |  |                         | (22,000    | ) |                        |   |           |                        |  |   |           |  
|Gain on disposal of assets                                                               |  |                         | (2,000     | ) |                        |   | (868,000   | )                      |  |   | (423,000   | )
|Changes in operating assets and liabilities:                                             |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Accounts receivable                                                                      |  |                         | (136,000   | ) |                        |   | (756,000   | )                      |  |   | 176,000    |  
|Inventories                                                                              |  |                         | (414,000   | ) |                        |   | (47,000    | )                      |  |   | (36,000    | )
|Prepaid expenses                                                                         |  |                         | 560,000    |   |                        |   | (229,000   | )                      |  |   | (438,000   | )
|Other assets                                                                             |  |                         | (145,000   | ) |                        |   | (141,000   | )                      |  |   | 51,000     |  
|Accounts payable                                                                         |  |                         | 36,000     |   |                        |   | 18,000     |                        |  |   | (146,000   | )
|Accrued compensation                                                                     |  |                         | 767,000    |   |                        |   | (30,000    | )                      |  |   | (920,000   | )
|Accrued expenses                                                                         |  |                         | (6,000     | ) |                        |   | 150,000    |                        |  |   | (396,000   | )
|Accrued provision for store closure                                                      |  |                         | (246,000   | ) |                        |   | (233,000   | )                      |  |   | (932,000   | )
|Deferred franchise fees income and franchisee deposits                                   |  |                         | 93,000     |   |                        |   | 73,000     |                        |  |   | (219,000   | )
|Deferred rent                                                                            |  |                         | 44,000     |   |                        |   | 40,000     |                        |  |   | (61,000    | )
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Net cash provided by operating activities                                                |  |                         | 3,756,000  |   |                        |   | 1,552,000  |                        |  |   | 446,000    |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Cash flows from investing activities:                                                    |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Capital expenditures for property and equipment                                          |  |                         | (2,530,000 | ) |                        |   | (1,947,000 | )                      |  |   | (943,000   | )
|Proceeds from disposal of property and equipment                                         |  |                         | 64,000     |   |                        |   | 1,209,000  |                        |  |   | 2,187,000  |  
|Issuance of notes receivable                                                             |  |                         | (20,000    | ) |                        |   |           |                        |  |   |           |  
|Payments received on notes receivable                                                    |  |                         | 48,000     |   |                        |   | 48,000     |                        |  |   | 227,000    |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Net cash provided by (used in) investing activities                                      |  |                         | (2,438,000 | ) |                        |   | (690,000   | )                      |  |   | 1,471,000  |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Cash flows from financing activities:                                                    |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Payments on long-term debt                                                               |  |                         | (2,967,000 | ) |                        |   | (1,226,000 | )                      |  |   | (2,317,000 | )
|Payments on capital lease obligations                                                    |  |                         | (177,000   | ) |                        |   | (194,000   | )                      |  |   | (292,000   | )
|Proceeds from issuance of common stock, net of fees paid                                 |  |                         |           |   |                        |   |           |                        |  |   | (138,000   | )
|Borrowings under credit agreement                                                        |  |                         | 1,000,000  |   |                        |   | 950,000    |                        |  |   |           |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Net cash used in financing activities                                                    |  |                         | (2,144,000 | ) |                        |   | (470,000   | )                      |  |   | (2,747,000 | )
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Net increase (decrease) in cash                                                          |  |                         | (826,000   | ) |                        |   | 392,000    |                        |  |   | (830,000   | )
|Cash at beginning of year                                                                |  |                         | 2,625,000  |   |                        |   | 2,233,000  |                        |  |   | 3,063,000  |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Cash at end of year                                                                      |  | $                       | 1,799,000  |   |                        | $ | 2,625,000  |                        |  | $ | 2,233,000  |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Supplemental disclosure of cash flow information:                                        |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Cash paid during the period for:                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Interest                                                                                 |  | $                       | 153,000    |   |                        | $ | 194,000    |                        |  | $ | 435,000    |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Income taxes                                                                             |  | $                       | 37,000     |   |                        | $ | 60,000     |                        |  | $ | 94,000     |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Non-cash transactions:                                                                   |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Issuance of notes receivable                                                             |  | $                       | 42,000     |   |                        | $ |           |                        |  | $ | 515,000    |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  
|Assets purchased under capital leases                                                    |  | $                       |           |   |                        | $ |           |                        |  | $ | 225,000    |  
|                                                                                         |  |                         |            |   |                        |   |            |                        |  |   |            |  



See accompanying
notes to consolidated financial statements.



F-6



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1. Summary of Significant Accounting Policies and Practices



Business



Diedrich Coffee, Inc. is a specialty coffee roaster, wholesaler, retailer and franchiser
whose brands include Diedrich Coffee, Gloria Jeans, and Coffee People. The Company owns and operates 56 retail locations and is the franchiser of 426 retail locations as of June 30, 2004. The retail units are located in 34 states and 13
foreign countries. The Company also has over 460 wholesale accounts with businesses and restaurant chains. In addition, the Company operates a coffee roasting facility in central California that supplies freshly roasted coffee beans to its retail
locations and to its wholesale customers.



Basis
of Presentation and Fiscal Year End



The consolidated financial
statements include the accounts of Diedrich Coffee, Inc. and its wholly owned subsidiaries (the Company). All significant intercompany transactions are eliminated. The Companys fiscal year end is the Wednesday closest to June 30.
In fiscal years 2003 and 2004, this resulted in a 52-week year. In fiscal year 2002, this resulted in a 53-week year.



Cash and Cash Equivalents



The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. There were no cash equivalents at
June 30, 2004 or July 2, 2003.



Inventories



Inventories are stated at
the lower of cost or market. The cost for inventories is determined using the first-in, first-out method.



Property and Depreciation



Property and equipment, including assets under capital leases, are recorded at cost. Depreciation is calculated using the straight-line method over estimated useful lives
of three to seven years. Property and equipment held under capital leases and leasehold improvements are generally amortized using the straight-line method over the shorter of their estimated useful lives or the term of the related leases.



Major remodels and improvements are capitalized. Maintenance and repairs that
do not improve or extend the life of the respective assets are charged to expense as incurred.



Deferred Financing Costs



Costs related to the issuance of debt are deferred and amortized using a method that approximates the effective interest method as a component of interest expense over the terms of the respective debt issues.



Store Pre-opening Costs



Direct and incremental costs incurred prior to the opening of a retail coffeehouse location
are expensed as incurred.



Fair Value of Financial
Instruments



The carrying amounts of cash, accounts receivable,
inventories, prepaid expenses, other assets, notes receivable, accounts payable, accrued compensation, accrued expenses, and franchisee deposits approximate fair



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



value because of the short-term maturity of these financial instruments. The Company believes the carrying amounts of the Companys long-term debt approximates fair
value because the interest rate on this instrument is subject to change with market interest rates and other terms and conditions are consistent with terms currently available to the Company.



Cost of Sales and Related Occupancy Costs



Cost of sales and related occupancy costs include cost of
purchased products, inbound freight charges, purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs and all other costs of our distribution network and retail store occupancy costs. Certain lease agreements
provide for scheduled rent increases during the lease terms or for rental payments commencing on a date other than the date of initial occupancy. Rent expense is recorded on a straight-line basis over the respective terms of the leases.



Operating Expenses



Operating expenses include compensation costs that account for over 70% of
the total. Other operating expenses include utilities, advertising and marketing, business insurance, taxes, licenses, fees and bank charges.



General and Administrative Expenses



General and administrative expenses include compensation costs that represent approximately 60% of the total. Other costs include legal, office rent,
telephone, consulting and outside services, and Directors and Officers insurance.



Income Taxes



Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and for operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date.



Net Income (Loss) Per Common Share



Basic earnings per share represents net earnings divided by the weighted average
shares outstanding, excluding all potentially dilutive common shares. Diluted earnings per-share reflects the dilutive effect of all potentially dilutive common shares.



Goodwill



In July 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards
(SFAS) Nos. 141 and 142, Business Combinations, and Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30,
2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger
an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of acquired assets or the strategy for the overall business, and significant
negative industry or economic trends. The Company has performed annual evaluations of its goodwill since June 30, 2001, and recorded a provision for impairment of $1,900,000 in fiscal 2003 in order to properly state its goodwill (see notes 5 and
10). No provision for impairment was recorded in fiscal 2004.



Stock Option Plans



The Company applies
the intrinsic value-method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for employee stock options. As
such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock- Based Compensation, as amended, established
accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. The Company has adopted the disclosure provisions of SFAS No. 123 and continues to follow APB No. 25 for stock-based
employee compensation.



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



Pro forma net income (loss) and pro forma net income (loss) per share, as if the fair value-based method of SFAS No. 123 had been applied in measuring compensation cost
for stock-based awards, is as follows:



|                                                                                                                                          |  |                         |          |   |                        |   |            |                        |  |   |          
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---------------------- | - | ---------- | ---------------------- |  | - | ---------
|                                                                                                                                          |  | Year EndedJune 30, 2004 |          |   | Year EndedJuly 2, 2003 |   |            | Year EndedJuly 3, 2002
|                                                                                                                                          |  | (as restated)           |          |   | (as restated)          |   |            | (as restated)         
|Net income (loss) as reported                                                                                                             |  | $                       | 251,000  |   |                        | $ | (1,358,000 | )                      |  | $ | 952,000  
|Add: Stock based employee compensation expense included in reported net income (loss), net of related tax effects                         |  |                         | 22,000   |   |                        |   | 68,000     |                        |  |   |         
|Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax
effects |  |                         | (926,000 | ) |                        |   | (573,000   | )                      |  |   | 633,000  
|                                                                                                                                          |  |                         |          |   |                        |   |            |                        |  |   |          
|Pro forma net income (loss)                                                                                                               |  | $                       | (653,000 | ) |                        | $ | (1,863,000 | )                      |  | $ | 1,585,000
|                                                                                                                                          |  |                         |          |   |                        |   |            |                        |  |   |          
|Basic and diluted net income (loss) per share as reported                                                                                 |  | $                       | 0.05     |   |                        | $ | (0.26      | )                      |  | $ | 0.18     
|Basic and diluted net income (loss) per share - Pro forma                                                                                 |  | $                       | (0.13    | ) |                        | $ | (0.36      | )                      |  | $ | 0.31     



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



|                        |  |                         |   |  |                         |   |  |                        |  
|----------------------- |  | ----------------------- | - |  | ----------------------- | - |  | ---------------------- | -
|                        |  | Year EndedJune 30, 2004 |   |  | Year Ended July 2, 2003 |   |  | Year EndedJuly 3, 2002 |  
|                        |  | (as restated)           |   |  | (as restated)           |   |  |                        |  
|Risk free interest rate |  | 3.81                    | % |  | 2.57                    | % |  | 4.00                   | %
|Expected life           |  | 6 years                 |   |  | 6 years                 |   |  | 6 years                |  
|Expected volatility     |  | 57                      | % |  | 92                      | % |  | 86                     | %
|Expected dividend yield |  | 0                       | % |  | 0                       | % |  | 0                      | %



Long-Lived Assets



The Company accounts
for long-lived assets in accordance with the provisions of SFAS No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.



Revenue Recognition



Retail and wholesale
sales are recorded when payment is tendered at point of sale for retail, and upon shipment of product for wholesale, respectively. Initial franchise fees are recognized when a franchised coffeehouse begins operations, at which time the Company has
performed its obligations related to such fees. Fees received pursuant to area development agreements, which grant the right to develop franchised coffeehouses in future periods in specific geographic areas, are deferred and recognized on a pro rata
basis as the franchised



F-9



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



coffeehouses subject to the development agreements begin operations. Should the Company or a franchisee terminate a development agreement, fees are recognized when the
agreement has been terminated. Both initial franchise fees and area development fees are collectively referred to as Front end fees in the table below because each is collected (if applicable) before the franchised location begins
operation, and both types of fees are nonrefundable. Area development fees typically apply in the case of international franchise development, whereas initial franchise fees apply primarily in the case of domestic franchise development. Franchise
royalties are recognized as earned, based upon a percentage of a franchise coffeehouse sales over time.



The following table details the various components included in franchise revenue:



|               |  |               |           |               |   |               |  |   |          
|-------------- |  | ------------- | --------- | ------------- | - | ------------- |  | - | ---------
|               |  | June 30, 2004 |           | July 2, 2003  |   | July 3, 2002 
|               |  |               |           | (as restated) |   | (as restated)
|Royalties      |  | $             | 5,950,000 |               | $ | 5,493,000     |  | $ | 5,667,000
|Front end fees |  |               | 1,271,000 |               |   | 756,000       |  |   | 566,000  
|Other          |  |               | 321,000   |               |   | 362,000       |  |   | 433,000  
|               |  |               |           |               |   |               |  |   |          
|Total          |  | $             | 7,542,000 |               | $ | 6,611,000     |  | $ | 6,666,000
|               |  |               |           |               |   |               |  |   |          



Barter
Transaction



In fiscal year 2004, the Company recorded a charge
reducing holiday gift pack inventory to its net realizable value and exchanged $67,000 of this impaired inventory for advertising barter credits valued by the barter provider in excess of the impaired inventory value. The Company recorded the
advertising credits as a prepaid expense at the $67,000 net realizable value of the inventory exchanged. Additionally, in accordance with Emerging Issues Task Force No. 99-17, Accounting for Advertising Barter Transactions, the Company
accounted for this transaction as a sale, recording revenue and cost of sales of $67,000, leaving no net impact to income (loss).



Shipping and Handling Costs



Shipping and handling costs are included as a component of cost of sales and related occupancy costs. A corresponding amount is billed to the Companys wholesale
customers, and is included as a component of wholesale and other revenue.



Advertising and Promotion Costs



The following table details the components of advertising and promotion costs:



|                                               |  |                    |           |              |   |              |  |   |          
|---------------------------------------------- |  | ------------------ | --------- | ------------ | - | ------------ |  | - | ---------
|                                               |  | Fiscal Years Ended
|                                               |  | June 30, 2004      |           | July 2, 2003 |   | July 3, 2002
|Advertising and Promotion Costs:               |  |                    |           |              |   |              |  |   |          
|Advertising and promotion payments             |  | $                  | 1,926,000 |              | $ | 1,396,000    |  | $ | 1,615,000
|Less franchisee ad fund contributions          |  |                    | 1,060,000 |              |   | 884,000      |  |   | 955,000  
|                                               |  |                    |           |              |   |              |  |   |          
|Net advertising and promotion payments         |  | $                  | 866,000   |              | $ | 512,000      |  | $ | 660,000  
|                                               |  |                    |           |              |   |              |  |   |          
|Included in general and administrative expense |  | $                  | 140,000   |              | $ | 204,000      |  | $ | 210,000  
|Included in operating expenses                 |  |                    | 726,000   |              |   | 308,000      |  |   | 450,000  
|                                               |  |                    |           |              |   |              |  |   |          
|Total advertising and promotion expense        |  | $                  | 866,000   |              | $ | 512,000      |  | $ | 660,000  
|                                               |  |                    |           |              |   |              |  |   |          



Total advertising and promotion costs
are for all Company brands sold in company-operated and franchise units. Franchisees are required to contribute 2% of sales to an advertising fund that is segregated and designated for advertising. The Company acts as an agent for the franchisees
with regard to these contributions. The Company consolidates the fund into its financial statements on a net basis, whereby contributions from franchisees, when received, are recorded as offsets to the Companys reported advertising expenses,
in accordance with SFAS 45, Accounting for Franchisee Fee Revenue.As discussed in this Note 1 below, in Variable Interest Entities, the Company began to consolidate the advertising fund as of June 30, 2004, also on a net basis,
as required for accounting periods ending after March 15, 2004.



Store Closures



Prior to January 1, 2003,
the estimated cost associated with closing under-performing stores was accrued in the period in which the store was identified for closure by management under a plan of termination. Effective January 1, 2003, the Company adopted SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



Activities, and now records these estimated costs when they are incurred rather than at the date of a commitment to an exit or disposal plan. Such costs primarily
consist of the estimated cost to terminate real estate leases.



|                                    |  |                  |         |                          |   |             |  |   |              |   |  |               |          |   |  |   |        
|----------------------------------- |  | ---------------- | ------- | ------------------------ | - | ----------- |  | - | ------------ | - |  | ------------- | -------- | - |  | - | -------
|                                    |  | BeginningBalance |         | AmountsChargedto Expense |   | Adjustments |  |   | CashPayments |   |  | EndingBalance
|Accrued provision for store closure |  |                  |         |                          |   |             |  |   |              |   |  |               |          |   |  |   |        
|Year ended July 2, 2003             |  | $                | 581,000 |                          | $ | 193,000     |  | $ | (116,000     | ) |  | $             | (233,000 | ) |  | $ | 425,000
|Year ended June 30, 2004            |  | $                | 425,000 |                          | $ | 36,000      |  | $ | (106,000     | ) |  | $             | (246,000 | ) |  | $ | 109,000



For the year ended June 30, 2004, the
$36,000 charged to expense was comprised of a $31,000 charge to cost of sales and related occupancy costs, a $4,000 charge for additional store closure costs expensed in fiscal 2004, and a $1,000 charge to general and administrative expense. These
charges primarily related to negotiated lease settlements finalized during the first quarter of fiscal 2004. Also included in the provision for store closure as an adjustment was a benefit of $106,000, which reduced cost of sales and related
occupancy costs due to a favorable lease settlement of a closed location.



For
the year ended July 2, 2003, the $193,000 charged to expense was comprised of a $93,000 charge for additional store closure costs expensed in fiscal 2003 and a $100,000 charge in additional amounts accrued to reflect the net present value of future
cash flows the Company expects to incur for the remaining lease obligations on two locations. Also included was a benefit of $115,000 resulting from the sale of three locations where the remaining lease obligations had been previously accrued as
well as a $1,000 decrease in expense due to negotiated legal settlements finalized at amounts lower than expected.



Variable Interest Entities



On June 30, 2004 the Company adopted FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entitiesan interpretation of Accounting Research
Bulletin (ARB) No. 51 (FIN 46R) which addresses the consolidation of entities in which a reporting enterprise has an economic interest but for which the traditional voting interest approach to consolidation, based on
voting rights, is ineffective in identifying where control of the entity lies, or in which the equity investors do not bear the economic risks and rewards of the entity. FIN 46R refers to those entities as variable interest entities
(VIEs). FIN 46R requires the consolidation of VIEs by the primary beneficiary that absorbs a majority of the economic risks and rewards from the VIEs activities.



The Company acquired its franchise operations in 1999. At June 30, 2004, there were 137 domestic franchise units and 282 international
franchise units. All franchise units are owned by the franchisees. The Company, as the franchisor, receives royalty fees on franchise sales, but has no equity interest and does not share in profits or losses of the franchise operation. The
franchisees make the key decisions that impact the success of their operations. The Companys rights are protective in nature and are designed to preserve the value of the brand that it licenses to the franchisee through the franchise
agreement. The Company provides no financial support of any kind to the international franchisees. Of the 137 domestic franchise locations the Company provides subordinated financial support to the extent that it is the primary lessee on 96 of the
coffeehouse leases and subleases the premises to the franchisees on a pass-through basis on the same terms as the primary lease. The franchisees generally pay rent directly to the primary lease landlord.



The Company calculated the present value of the subordinated financial support provided to
each of the franchisees by the lease arrangements and compared it to the overall subordinated financing support as defined by FIN 46R and determined that for all but four stores the Company was providing less than 50% of the franchisees total
subordinated financial support. For three of these remaining stores a further quantitative test of the franchisees equity indicated that it was well above the 10% minimum and that the franchisee would not be considered a VIE. The remaining one
store may be considered a VIE, however, the consolidation of this franchisee would be immaterial.



The Company believes its risk of loss is not significant. As a condition to acquire a franchise, the prospective franchisee is required to have a personal net worth of at least $500,000, an amount believed to be
sufficient to absorb possible franchise losses. Each franchisee is personally liable, either through direct ownership of the franchise or by a personal guarantee if the franchise is operated as a company. The Company looks to the franchisees
personal assets to satisfy the franchises obligations, including the lease on which the Company is the primary lessee. This arrangement has historically insulated the Company from loss. In the rare situation where the franchisees
personal assets have been insufficient to meet the obligations of the franchise, the Company has been able to accomplish an early termination of the lease at a substantial discount to the present value of the rentals for the remaining primary lease
term.



The Companys franchise agreements require that the franchisees pay
an advertising fund contribution of 2% of franchise sales. These funds are maintained in a segregated fund and used to pay for franchise brand marketing. All contributions are used solely for brand advertising and none are revenue or income to the
Company. The fund is administered by an employee of the Company and is subject to audit by a franchisee committee. In the event that the advertising fund in not sufficient to pay all outstanding invoices, the Company could be contingently liable for
their payment. Accordingly, the Company determined that consolidation of the fund is appropriate under FIN 46R and adopted it in the quarter ended June 30, 2004. The Company included $370,000 of advertising fund assets, restricted, and advertising
fund liabilities in the consolidated balance sheet as of June 30, 2004. Advertising fund assets are primarily cash, which is segregated and restricted to use for franchise brand advertising. Advertising fund liabilities consist mainly of accounts
payable, accrued expenses and deferred obligations. As noted in Advertising and Promotion Costs above, the advertising contributions and disbursements are reported in the consolidated statement of operations on a net basis
whereby contributions are recorded as offsets to the Companys reported operating and general and administrative expenses.



Use of Estimates



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



F-11



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



Reclassifications



Certain reclassifications have been made to prior periods to conform to the 2004 presentation.



2. Restatement of Previously Issued Consolidated Financial Statements



In the third quarter of fiscal 2005 the Company completed a review of its procedures in accounting for leases and determined that these
procedures were incorrect and previously issued financial statements required restatement. The Company has corrected its accounting treatment for amortization of leasehold improvements, tenant improvement allowances, and rent holidays for leased
facilities restating previously issued financial statements for the fiscal years 2004, 2003 and 2002. The cumulative effect of these corrections was a $402,000 reduction of previously reported earnings. The Company historically calculated
straight-line rent expense and amortized some of its leasehold improvements over a period that included both the initial term of the lease and the option periods. The Company determined that its method of accounting for the lease term used in
establishing the straight-line rent and amortization period was not in accordance with the applicable accounting literature. Accordingly, the Company corrected its accounting for leasehold improvements and straight-line rent expense. For leases with
renewal periods at the Companys option, the Company now generally uses the lesser of useful life or original lease term, excluding renewal option periods to determine useful lives. If failure to exercise a renewal option imposes an economic
penalty to the Company, management may determine that renewal is reasonably assured and include that renewal option period in the determination of the lease term and the appropriate estimated useful lives. The Companys policy requires lease
term consistency when estimating useful lives, classifying a lease as capital or operating, and computing straight-line rent expense. The correction of this accounting required the Company to record additional amortization expense and to decrease
both deferred rent and the amount of rent expense previously recorded.



Additionally, the Company identified instances in which property and equipment was not retired in a timely manner. During fiscal 2003 and fiscal 2004, the Company remodeled 14 coffeehouse locations and did not retire some leasehold
improvements. The Company has corrected this error through its restatement.



The Company historically accounted for tenant improvement allowances as reductions to the related leasehold improvement asset on the consolidated balance sheets and capital expenditures in investing activities on the consolidated statements
of cash flows. The Company has now determined that Financial Accounting Standards Board (FASB) Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases, requires these allowances to be recorded as Deferred
rent on the consolidated balance sheets and as a component of operating activities on the consolidated statements of cash flows.



In the course of its review of lease accounting procedures, the Company also noted additional unrelated errors affecting reported results for prior periods. Royalty
income of $202,000 earned in fiscal year 2003 was incorrectly reported as income in fiscal year 2002. Also, income related to construction services provided to franchisees in fiscal years prior to fiscal year 2002 was not recorded until fiscal year
2002, in which $120,000 was improperly reported as income and fiscal year 2003 in which $109,000 was improperly reported as income. Also the Company determined that its allowance for doubtful accounts was overstated by $74,000 in fiscal 2002 and
understated by a like amount in fiscal 2003. The Company has corrected all of these errors through its restatement.



The following is a summary of the significant effects of these changes on the Companys condensed consolidated financial statements:



|                                           |  |                     |             |   |             |   |          |             |  |   |             |  
|------------------------------------------ |  | ------------------- | ----------- | - | ----------- | - | -------- | ----------- |  | - | ----------- | -
|                                           |  | Previously Reported |             |   | Adjustments |   |          | As Restated | 
|Fiscal 2004                                |  |                     |             |   |             |   |          |             |  |   |             |  
|Balance Sheet Data                         |  |                     |             |   |             |   |          |             |  |   |             |  
|Property and equipment, net                |  | $                   | 7,111,000   |   |             | $ | (424,000 | )           |  | $ | 6,687,000   |  
|Total assets                               |  |                     | 25,642,000  |   |             |   | (424,000 | )           |  |   | 25,218,000  |  
|                                           |  |                     |            
|Deferred rent                              |  |                     | 490,000     |   |             |   | (22,000  | )           |  |   | 468,000     |  
|Total liabilities                          |  |                     | 8,765,000   |   |             |   | (22,000  | )           |  |   | 8,743,000   |  
|                                           |  |                     |            
|Accumulated deficit                        |  |                     | (41,233,000 | ) |             |   | (402,000 | )           |  |   | (41,635,000 | )
|Total stockholders equity                 |  |                     | 16,877,000  |   |             |   | (402,000 | )           |  |   | 16,475,000  |  
|Total liabilities and stockholders equity |  |                     | 25,642,000  |   |             |   | (424,000 | )           |  |   | 25,218,000  |  
|                                           |  |                     |            
|Statement of Operations Data               |  |                     |             |   |             |   |          |             |  |   |             |  
|Cost of sales and related occupancy costs  |  | $                   | 25,112,000  |   |             | $ | 32,000   |             |  | $ | 25,144,000  |  
|Depreciation and amortization              |  |                     | 2,289,000   |   |             |   | 26,000   |             |  |   | 2,315,000   |  
|General and administrative expenses        |  |                     | 9,813,000   |   |             |   | (43,000  | )           |  |   | 9,770,000   |  
|Total costs and expenses                   |  |                     | 54,013,000  |   |             |   | 15,000   |             |  |   | 54,028,000  |  
|Operating income                           |  |                     | 612,000     |   |             |   | (15,000  | )           |  |   | 597,000     |  
|Income before income tax provision         |  |                     | 294,000     |   |             |   | (15,000  | )           |  |   | 279,000     |  
|Net income                                 |  |                     | 266,000     |   |             |   | (15,000  | )           |  |   | 251,000     |  
|Net income per share basic and diluted    |  |                     | 0.05        |   |             |   |         |             |  |   | 0.05        |  
|                                           |  |                     |            
|Statement of Cash Flows Data               |  |                     |             |   |             |   |          |             |  |   |             |  
|Net cash provided by operating activities  |  | $                   | 3,713,000   |   |             | $ | 43,000   |             |  | $ | 3,756,000   |  
|Net cash used in investing activities      |  |                     | (2,395,000  | ) |             |   | (43,000  | )           |  |   | (2,438,000  | )





|                                                       |  |                     |             |   |             |   |          |             |  |   |             |  
|------------------------------------------------------ |  | ------------------- | ----------- | - | ----------- | - | -------- | ----------- |  | - | ----------- | -
|                                                       |  | Previously Reported |             |   | Adjustments |   |          | As Restated | 
|Fiscal 2003                                            |  |                     |             |   |             |   |          |             |  |   |             |  
|Balance Sheet Data                                     |  |                     |             |   |             |   |          |             |  |   |             |  
|Property and equipment, net                            |  | $                   | 7,052,000   |   |             | $ | (441,000 | )           |  | $ | 6,611,000   |  
|Total assets                                           |  |                     | 26,542,000  |   |             |   | (441,000 | )           |  |   | 26,101,000  |  
|                                                       |  |                     |            
|Deferred rent                                          |  |                     | 478,000     |   |             |   | (54,000  | )           |  |   | 424,000     |  
|Total liabilities                                      |  |                     | 9,953,000   |   |             |   | (54,000  | )           |  |   | 9,899,000   |  
|                                                       |  |                     |            
|Accumulated deficit                                    |  |                     | (41,499,000 | ) |             |   | (387,000 | )           |  |   | (41,886,000 | )
|Total stockholders equity                             |  |                     | 16,589,000  |   |             |   | (387,000 | )           |  |   | 16,202,000  |  
|Total liabilities and stockholders equity             |  |                     | 26,542,000  |   |             |   | (441,000 | )           |  |   | 26,101,000  |  
|                                                       |  |                     |            
|Statement of Operations Data                           |  |                     |             |   |             |   |          |             |  |   |             |  
|Franchise revenue                                      |  | $                   | 6,409,000   |   |             | $ | 202,000  |             |  | $ | 6,611,000   |  
|Total revenue                                          |  |                     | 54,779,000  |   |             |   | 202,000  |             |  |   | 54,981,000  |  
|                                                       |  |                     |            
|Cost of sales and related occupancy costs              |  |                     | 26,276,000  |   |             |   | (14,000  | )           |  |   | 26,262,000  |  
|Operating expenses                                     |  |                     | 16,870,000  |   |             |   | 74,000   |             |  |   | 16,944,000  |  
|Depreciation and amortization                          |  |                     | 1,944,000   |   |             |   | 225,000  |             |  |   | 2,169,000   |  
|General and administrative expenses                    |  |                     | 9,237,000   |   |             |   | 109,000  |             |  |   | 9,346,000   |  
|Provision for asset impairment and restructuring costs |  |                     | 2,232,000   |   |             |   | (56,000  | )           |  |   | 2,176,000   |  
|Total costs and expenses                               |  |                     | 55,692,000  |   |             |   | 337,000  |             |  |   | 56,029,000  |  
|Operating loss                                         |  |                     | (913,000    | ) |             |   | (135,000 | )           |  |   | (1,048,000  | )
|Loss before income tax provision                       |  |                     | (1,169,000  | ) |             |   | (135,000 | )           |  |   | (1,304,000  | )
|Net loss                                               |  |                     | (1,223,000  | ) |             |   | (135,000 | )           |  |   | (1,358,000  | )
|Net loss per share  basic and diluted                 |  |                     | (0.24       | ) |             |   | (0.03    | )           |  |   | (0.26       | )
|                                                       |  |                     |            
|Fiscal 2002                                            |  |                     |             |   |             |   |          |             |  |   |             |  
|Statement of Operations Data                           |  |                     |             |   |             |   |          |             |  |   |             |  
|Franchise revenue                                      |  | $                   | 6,868,000   |   |             | $ | (202,000 | )           |  | $ | 6,666,000   |  
|Total revenue                                          |  |                     | 62,207,000  |   |             |   | (202,000 | )           |  |   | 62,005,000  |  
|                                                       |  |                     |            
|Cost of sales and related occupancy costs              |  |                     | 30,439,000  |   |             |   | (16,000  | )           |  |   | 30,423,000  |  
|Operating expenses                                     |  |                     | 17,895,000  |   |             |   | (74,000  | )           |  |   | 17,821,000  |  
|Depreciation and amortization                          |  |                     | 2,384,000   |   |             |   | 90,000   |             |  |   | 2,474,000   |  
|General and administrative expenses                    |  |                     | 9,467,000   |   |             |   | 120,000  |             |  |   | 9,587,000   |  
|Provision for asset impairment and restructuring costs |  |                     | 547,000     |   |             |   | (5,000   | )           |  |   | 542,000     |  
|Total costs and expenses                               |  |                     | 60,309,000  |   |             |   | 115,000  |             |  |   | 60,424,000  |  
|Operating income                                       |  |                     | 1,898,000   |   |             |   | (317,000 | )           |  |   | 1,581,000   |  
|Income before income tax provision                     |  |                     | 1,361,000   |   |             |   | (317,000 | )           |  |   | 1,044,000   |  
|Net income                                             |  |                     | 1,269,000   |   |             |   | (317,000 | )           |  |   | 952,000     |  
|Net income per share  basic and diluted               |  |                     | 0.25        |   |             |   | (0.06    | )           |  |   | 0.18        |  



Certain amounts in Notes 1, 5, 10, 12,
13, and 14 have been restated to reflect the restatement adjustments described above.



3. Inventories



Inventories consist of the following:



|                                  |  |               |           |              |   |          
|--------------------------------- |  | ------------- | --------- | ------------ | - | ---------
|                                  |  | June 30, 2004 |           | July 2, 2003
|Unroasted coffee                  |  | $             | 1,067,000 |              | $ | 1,034,000
|Roasted coffee                    |  |               | 632,000   |              |   | 572,000  
|Accessory and specialty items     |  |               | 198,000   |              |   | 163,000  
|Other food, beverage and supplies |  |               | 918,000   |              |   | 842,000  
|                                  |  |               |           |              |   |          
|                                  |  | $             | 2,815,000 |              | $ | 2,611,000
|                                  |  |               |           |              |   |          



4. Notes Receivable



In October 2001, the Company sold eight of its coffeehouses in Phoenix, Arizona for
$1,382,000 in cash and $515,000 in notes receivable.



In June 2004, the Company
sold two of its coffeehouses in Denver, Colorado for $38,500 in cash and $42,000 in notes receivable.



Notes receivable consist of the following:



|                                                                                                                                                                                                                                                                                                                        |  |               |         |   |              |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                                                                                                                                                                                                                        |  | June 30, 2004 |         |   | July 2, 2003 |  
|Notes receivable from a corporation: bearing interest at rates from 7.0% to 10.0%, payable in monthly installments varying between $1,297 and
$4,268 and due between October 3, 2005 and July 1, 2007. Notes are secured by the assets sold under the asset purchase and sale agreements or general security agreement. |  | $             | 234,000 |   |              | $ | 240,000 |  
|Less: current portion of notes receivable                                                                                                                                                                                                                                                                               |  |               | (81,000 | ) |              |   | (58,000 | )
|                                                                                                                                                                                                                                                                                                                        |  |               |         |   |              |   |         |  
|Long-term portion of notes receivable                                                                                                                                                                                                                                                                                   |  | $             | 153,000 |   |              | $ | 182,000 |  
|                                                                                                                                                                                                                                                                                                                        |  |               |         |   |              |   |         |  



F-12



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



5. Property and Equipment



Property and equipment is summarized as follows:



|                                          |  |                             |             |   |                            |   |             |  
|----------------------------------------- |  | --------------------------- | ----------- | - | -------------------------- | - | ----------- | -
|                                          |  | June 30, 2004 (as restated) |             |   | July 2, 2003 (as restated) |  
|Buildings                                 |  | $                           | 365,000     |   |                            | $ | 365,000     |  
|Leasehold improvements                    |  |                             | 6,439,000   |   |                            |   | 6,013,000   |  
|Equipment                                 |  |                             | 13,564,000  |   |                            |   | 12,981,000  |  
|Furniture and fixtures                    |  |                             | 1,097,000   |   |                            |   | 945,000     |  
|Construction in progress                  |  |                             | 391,000     |   |                            |   | 189,000     |  
|                                          |  |                             |             |   |                            |   |             |  
|                                          |  |                             | 21,856,000  |   |                            |   | 20,493,000  |  
|Accumulated depreciation and amortization |  |                             | (15,169,000 | ) |                            |   | (13,882,000 | )
|                                          |  |                             |             |   |                            |   |             |  
|                                          |  | $                           | 6,687,000   |   |                            | $ | 6,611,000   |  
|                                          |  |                             |             |   |                            |   |             |  



Property held under capitalized leases
in the amount of $958,000 at June 30, 2004 and July 2, 2003, is included in equipment. Accumulated amortization of such equipment amounted to $625,000 at June 30, 2004 and $597,000 at July 2, 2003.



6. Intangible Assets



During fiscal year 2003, the Company recorded a goodwill disposition of $74,000 related to the closure of three Coffee Plantation locations
in December 2002. The Company also recorded a goodwill impairment charge of $1,900,000 related to an evaluation of the Companys goodwill performed in the fourth quarter of fiscal year 2003. As a result of the Companys assessment at June
30, 2004, no impairment was indicated. It is possible that the assumptions used by management will change or that actual results may vary significantly from managements estimates. As a result, additional impairment charges may occur.



Goodwill by segment was as follows:



|                     |  |               |            |              |   |           
|-------------------- |  | ------------- | ---------- | ------------ | - | ----------
|                     |  | June 30, 2004 |            | July 2, 2003
|Retail Operations    |  | $             | 1,267,000  |              | $ | 1,267,000 
|Wholesale Operations |  |               | 6,311,000  |              |   | 6,311,000 
|Franchise Operations |  |               | 2,612,000  |              |   | 2,612,000 
|                     |  |               |            |              |   |           
|Goodwill             |  | $             | 10,190,000 |              | $ | 10,190,000
|                     |  |               |            |              |   |           



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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



7. Debt



Long-term debt consists of the following:



|                                                                                                                                                                                                                                     |  |               |          |   |              |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | -------- | - | ------------ | - | ---------- | -
|                                                                                                                                                                                                                                     |  | June 30, 2004 |          |   | July 2, 2003 |  
|Bank of the West                                                                                                                                                                                                                     |  |               |          |   |              |   |            |  
|Note payable bearing interest at a rate of 3% over LIBOR, or 4.34% as of July 2, 2003 and payable in monthly installments of $100,000. Due
March 31, 2005. Note was secured by the assets of the Company and its subsidiaries stock |  | $             |         |   |              | $ | 2,000,000  |  
|Bank of the West                                                                                                                                                                                                                     |  |               |          |   |              |   |            |  
|Note payable bearing interest at a rate of 4.29% as of July 2, 2003, and payable in monthly installments of $26,000. Due August 28, 2006. Note
was secured by coffee packaging equipment.                                            |  |               |         |   |              |   | 950,000    |  
|Contingent Convertible Note                                                                                                                                                                                                          |  |               |          |   |              |   |            |  
|Note payable bearing interest at a rate of LIBOR plus 3.30% (4.64% as of June 30, 2004) and payable in monthly installments of $16,667 with
balance due on May 10, 2007. Note is unsecured.                                          |  |               | 983,000  |   |              |   |           |  
|                                                                                                                                                                                                                                     |  |               |          |   |              |   |            |  
|                                                                                                                                                                                                                                     |  |               | 983,000  |   |              |   | 2,950,000  |  
|Less: current installments                                                                                                                                                                                                           |  |               | (200,000 | ) |              |   | (1,459,000 | )
|                                                                                                                                                                                                                                     |  |               |          |   |              |   |            |  
|Long-term debt, excluding current installments                                                                                                                                                                                       |  | $             | 783,000  |   |              | $ | 1,491,000  |  
|                                                                                                                                                                                                                                     |  |               |          |   |              |   |            |  



On May 10, 2004 the Company entered
into a $5,000,000 Contingent Convertible Note Purchase Agreement. The agreement provides for the Company to, at its election, issue notes with up to an aggregate principal amount of $5,000,000. The notes are to be amortized on a monthly basis at a
rate that will repay 60% of the principal amount of the note by May 10, 2007. The remaining 40% will mature on that date. Interest is payable at LIBOR plus 3.30%, and a facility fee of 1.00% annually is payable on the unused portion of the facility.
The agreement contains covenants that limit the amount of indebtedness that the Company may have outstanding in relation to its tangible net worth and that require the Company to maintain a specified minimum dollar value of EBITDA for the trailing
four fiscal quarters. Notes are convertible into the Companys common stock only upon certain changes of control. For notes issued and repaid, warrants to purchase shares are to be issued with the same rights and restrictions for exercise as
existed for convertibility of the notes at the time of their issuance. Warrants are exercisable only in the event of a change of control and expire on May 10, 2008. The fair value of warrants issued with respect to notes repaid will be recorded as a
discount to debt, at the date of issuance, which will then be amortized using the effective interest method. The lender under this agreement is a limited partnership of which the chairman of the Companys board of directors serves as the sole
general partner. On May 10, 2004, upon entering into the agreement, the Company immediately issued a $1,000,000 note under the facility, and used the proceeds of the note and other available cash to repay all outstanding debt with Bank of the West
(BOW).



On May 10, 2004 the Company also entered into an Amended
and Restated Credit Agreement with BOW. The agreement provides for a working capital facility of $250,000 and a letter of credit facility of $750,000. At June 30, 2004, no debt was outstanding under the working capital facility and $426,000 of
letters of credit were outstanding under the letter of credit facility. With respect to the working capital facility, the Company may elect to pay interest on amounts outstanding at the BOW reference rate plus 1.00% or LIBOR plus 3.25%. Borrowings
and issuance of letters of credit under the BOW facility are secured by substantially all of the Companys assets.



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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



Letters of Credit issued under the letter of credit facility are subject to an annual fee of 2.0% of the face amount. The agreement contains covenants that limit the
amount of indebtedness that the Company may have outstanding in relation to its tangible net worth and that require the Company to maintain a specified minimum dollar value of EBITDA for the trailing four fiscal quarters. The working capital and
letter of credit facility mature on October 15, 2004.



Maturities of long-term
debt for years subsequent to June 30, 2004 are as follows:



|                     |  |   |        
|-------------------- |  | - | -------
|Fiscal Year          |  |  
|2005                 |  | $ | 200,000
|2006                 |  |   | 200,000
|2007                 |  |   | 583,000
|                     |  |   |        
|Total long-term debt |  | $ | 983,000
|                     |  |   |        



8. Commitments and Contingencies



Lease Commitments



As of June 30, 2004, the Company leases warehouse and office space in Irvine, California,
and Castroville, California, as well as 56 retail locations. The leases expire at various dates through November 2016. The leases for four of the coffeehouse locations are guaranteed by an officer or director of the Company. Certain of the
coffeehouse leases require the payment of property taxes, normal maintenance and insurance on the properties and additional rents based on percentages of sales in excess of various specified retail sales levels. Contingent rent expense was
insignificant for all periods presented.



Future minimum lease payments under
non-cancelable operating leases, franchise-system operating leases and capital leases, and minimum future sublease rentals expected to be received as of June 30, 2004, are as follows:



|                                                                 |  |                |          |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|---------------------------------------------------------------- |  | -------------- | -------- | ------------------------------- | ------------------------------- | ------------------------------------- | ---------- | ---------------------------------- | - | ---------- |  | - | ---------- |  | - | ---------
|Year Ending June                                                 |  | Capital Leases |          |                                 | Non-Cancelable Operating Leases
|                                                                 |  | Total          |          | Companyoperated retaillocations |                                 | Franchiseoperated retaillocations (A) |            | Out of chainsubleasedlocations (B)
|2005                                                             |  | $              | 206,000  |                                 |                                 | $                                     | 8,275,000  |                                    | $ | 3,134,000  |  | $ | 4,495,000  |  | $ | 646,000  
|2006                                                             |  |                | 105,000  |                                 |                                 |                                       | 6,294,000  |                                    |   | 2,445,000  |  |   | 3,248,000  |  |   | 601,000  
|2007                                                             |  |                | 44,000   |                                 |                                 |                                       | 4,546,000  |                                    |   | 1,606,000  |  |   | 2,458,000  |  |   | 482,000  
|2008                                                             |  |                | 44,000   |                                 |                                 |                                       | 3,523,000  |                                    |   | 1,313,000  |  |   | 1,878,000  |  |   | 332,000  
|2009                                                             |  |                | 44,000   |                                 |                                 |                                       | 2,637,000  |                                    |   | 1,145,000  |  |   | 1,226,000  |  |   | 266,000  
|Thereafter                                                       |  |                | 303,000  |                                 |                                 |                                       | 4,644,000  |                                    |   | 2,031,000  |  |   | 2,032,000  |  |   | 581,000  
|                                                                 |  |                |          |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|                                                                 |  |                | 746,000  |                                 |                                 | $                                     | 29,919,000 |                                    | $ | 11,674,000 |  | $ | 15,337,000 |  | $ | 2,908,000
|                                                                 |  |                |          |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|Less amount representing interest (8% to 15%)                    |  |                | (196,000 | )                               |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|                                                                 |  |                |          |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|Present value of minimum lease payments                          |  |                | 550,000  |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|Less current installments                                        |  |                | (160,000 | )                               |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|                                                                 |  |                |          |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|Obligations under capital leases, excluding current installments |  | $              | 390,000  |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          
|                                                                 |  |                |          |                                 |                                 |                                       |            |                                    |   |            |  |   |            |  |   |          

---

|(A) | The Company is liable on the master leases for 98 franchise locations. Under the Companys historical franchising business model, the Company executed the master leases for
these locations, and entered
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



into subleases on the same terms with its franchisees, which typically pay their rent directly to the landlords. Should any of these franchisees default
on their subleases, the Company would be responsible for making payments under the master lease. The Companys maximum theoretical future exposure at June 30, 2004, computed as the sum of all remaining lease payments through the expiration
dates of the respective leases, was $15,337,000. This amount does not take into consideration any mitigating measures that the Company could take to reduce this exposure in the event of default, including re-leasing the locations or terminating the
master lease by negotiating a lump sum payment to the landlord less than the sum of all remaining future rents and other amounts payable.

|(B) | The Company has leased and subleased land and buildings to others. Many of these leases provide for fixed payments with contingent rents when sales exceed certain levels, while
others provide for monthly rentals based on a percentage of sales. The Company directly pays the rents on these master leases, and collects associated rent amounts directly from its sublessees.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Rent expense under operating leases approximated $4,238,000, $4,610,000, and $5,495,000 for
the years ended June 30, 2004, July 2, 2003, and July 3, 2002, respectively.



Purchase Commitments



At June 30, 2004, we had
commitments to purchase coffee through fiscal year 2006, totaling $2,795,000 for 2,249,000 pounds of green coffee, the majority of which were fixed as to price. Such contracts are generally short-term in nature, and the Company believes that their
cost approximates fair market value.



Guarantees and Indemnifications



The Company guarantees the performance of its subsidiary franchisor
obligations and also indemnifies franchisees for costs incurred in defending the Companys trademarks and tradenames.



Contingencies



In the ordinary course of its business, the Company may become involved in legal proceedings from time to time. The Company is not aware of any pending legal proceedings which in the opinion of management, based in
part on advice from legal counsel, would significantly adversely affect the Companys consolidated financial position or results of operations.



9. Stockholders Equity



Stock Options



On October 20, 2000, the Companys board of directors authorized the adoption of the Diedrich Coffee, Inc. 2000 Equity Incentive Plan (the 2000 Equity Incentive Plan) and the concurrent
discontinuation of the option grants under the Diedrich Coffee, Inc. Amended and Restated 1996 Stock Incentive Plan and the Diedrich Coffee, Inc. 1996 Non-Employee Directors Stock Option Plan. The Companys stockholders approved the 2000 Equity
Incentive Plan on October 16, 2000. A total of 1,087,500 shares of the Companys common stock may be issued under the 2000 Equity Incentive Plan, as amended.



On May 8, 2001, in connection with the sale of 2,000,000 shares of Company common stock, the Company issued warrants to Sequoia Enterprises,
L.P., of which the Companys chairman, Paul C. Heeschen, is the general partner, to purchase 250,000 shares of the Companys common stock at a price of $4.80 per share. Other investors also received warrants to purchase an additional
250,000 shares. The warrants were exercisable immediately upon issuance and expire on May 8, 2011. The fair value of the warrants is insignificant.



During the third quarter of fiscal 2003, the Company recognized $56,000 in compensation expense related to the separation and the accelerated vesting of options of a
former CEO of the Company. Prior to the execution of his separation agreement, he held options to purchase 25,000 shares of the Companys common stock, which



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



were fully vested, and an additional 120,000 options, which were not vested. The separation agreement accelerated the vesting of 35,000 of the non-vested options, causing
them to be fully vested on January 3, 2003. The remainder of the non-vested options immediately terminated upon his resignation in accordance with the terms of the option grant. His 60,000 vested options will expire on January 3, 2005.



During the fourth quarter of fiscal 2003, the Company issued Roger M. Laverty, the
Companys CEO, 200,000 options to purchase shares of the Companys common stock at a per share price of $3.44, which was below market value. The option grant was approved by stockholders in December 2003. The Company recognized $12,000 in
compensation expense related to these options in accordance with the provisions of APB 25.



During fiscal 2004, the Company issued Mr. Lynch, the Companys CFO, and Mr. McCarthy, the Companys Vice President Controller, 150,000 and 20,000, respectively, options to purchase shares of the
Companys common stock at a per share price of $3.38 and $3.69, respectively, which were below market value. The options were granted under the 2000 Equity Incentive Plan previously approved by stockholders. The Company recognized $22,000 in
compensation expense related to these options in accordance with the provisions of APB 25.



Information regarding the Companys stock options is summarized below:



|                                                               |  |         |          |   |                              |   |      
|-------------------------------------------------------------- |  | ------- | -------- | - | ---------------------------- | - | -----
|                                                               |  | Options |          |   | WeightedAverageExercisePrice
|Number of options authorized for future grant at June 30, 2004 |  |         | 452,750  |   |                              |   |      
|                                                               |  |         |          |   |                              |   |      
|Outstanding at June 27, 2001                                   |  |         | 876,925  |   |                              | $ | 16.29
|Granted                                                        |  |         | 36,250   |   |                              | $ | 3.56 
|Exercised                                                      |  |         |         |   |                              |   |     
|Forfeited                                                      |  |         | (495,290 | ) |                              | $ | 20.42
|Outstanding at July 3, 2002                                    |  |         | 417,885  |   |                              | $ | 8.65 
|Granted                                                        |  |         | 515,250  |   |                              | $ | 3.28 
|Exercised                                                      |  |         |         |   |                              |   |     
|Forfeited                                                      |  |         | (184,268 | ) |                              | $ | 5.04 
|                                                               |  |         |          |   |                              |   |      
|Outstanding at July 2, 2003                                    |  |         | 748,867  |   |                              | $ | 5.85 
|Granted                                                        |  |         | 245,000  |   |                              | $ | 3.52 
|Exercised                                                      |  |         |         |   |                              |   |     
|Forfeited                                                      |  |         | (24,625  | ) |                              | $ | 5.13 
|                                                               |  |         |          |   |                              |   |      
|Outstanding at June 30, 2004                                   |  |         | 969,242  |   |                              | $ | 5.27 
|                                                               |  |         |          |   |                              |   |      
|Weighted-average fair value of options granted:                |  |         |          |   |                              |   |      
|Year ended July 3, 2002                                        |  | $       | 2.62     |   |                              |   |      
|Year ended July 2, 2003                                        |  | $       | 2.95     |   |                              |   |      
|Year ended June 30, 2004                                       |  | $       | 3.05     |   |                              |   |      
|Options exercisable:                                           |  |         |          |   |                              |   |      
|At July 3, 2002                                                |  |         | 210,762  |   |                              |   |      
|At July 2, 2003                                                |  |         | 327,152  |   |                              |   |      
|At June 30, 2004                                               |  |         | 521,239  |   |                              |   |      





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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



The following table summarizes information about stock options outstanding at June 30, 2004:



|                        |  |                                    |  |                                         |  |                              |       |                                     |         |                              |   |      
|----------------------- |  | ---------------------------------- |  | --------------------------------------- |  | ---------------------------- | ----- | ----------------------------------- | ------- | ---------------------------- | - | -----
|                        |  | Options Outstanding                |  | Options Exercisable                    
|Range of Exercise Price |  | NumberOutstanding At June 30, 2004 |  | Weighted Average Remaining Life (Years) |  | WeightedAverageExercisePrice |       | Number Exercisable At July 30, 2004 |         | WeightedAverageExercisePrice
|$ 2.16 - $ 3.38         |  | 225,000                            |  | 7.56                                    |  | $                            | 3.12  |                                     | 105,000 |                              | $ | 2.89 
|$ 3.44 - $ 3.44         |  | 200,000                            |  | 8.82                                    |  |                              | 3.44  |                                     | 50,000  |                              |   | 3.44 
|$ 3.50 - $ 3.80         |  | 272,500                            |  | 7.93                                    |  |                              | 3.75  |                                     | 172,500 |                              |   | 3.76 
|$ 3.97 - $ 11.00        |  | 196,375                            |  | 6.68                                    |  |                              | 5.97  |                                     | 118,372 |                              |   | 7.26 
|$11.12 - $ 41.00        |  | 75,367                             |  | 4.85                                    |  |                              | 20.23 |                                     | 75,367  |                              |   | 20.23
|                        |  |                                    |  |                                         |  |                              |       |                                     |         |                              |   |      
|                        |  | 969,242                            |  | 7.53                                    |  |                              | 5.27  |                                     | 521,239 |                              |   | 6.73 
|                        |  |                                    |  |                                         |  |                              |       |                                     |         |                              |   |      



Stock
Purchase Warrants



The terms of the Contingent Convertible Note
Purchase Agreement provide that outstanding Notes are convertible into shares of the Companys common stock at a price that is equal to the greater of the price of the stock on the date that Note is issued or 85% of the average price paid per
share of common stock by a person who engages in a transaction that results in a change of control, as defined in the Agreement, occurs. The Notes are convertible only if and when a change of control occurs. As Notes are paid the Agreement provides
that warrants are to be issued. The warrants are exercisable on substantially the same terms as the Notes are convertible. The warrants are also only exercisable if and when a change of control event occurs. The price of the Companys common
stock on May 10, 2004, the date that the $1,000,000 Note was issued, was $3.95 per share. A principal payment of $16,667 in June 2004 resulted in the issuance of 4,219 warrants that are exercisable at the greater of $3.95 per share or 85% of the
average price paid per share of common stock by a person who engages in a transaction that results in a change of control, as defined in the Agreement, occurs.



10. Income Taxes



The components of income tax expense are as follows:



|          |  |                         |        |   |                        |   |                        |  |   |       
|--------- |  | ----------------------- | ------ | - | ---------------------- | - | ---------------------- |  | - | ------
|          |  | Year EndedJune 30, 2004 |        |   | Year EndedJuly 2, 2003 |   | Year EndedJuly 3, 2002
|Current:  |  |                         |        |   |                        |   |                        |  |   |       
|Federal   |  | $                       |       |   |                        | $ |                       |  | $ |      
|State     |  |                         | (1,000 | ) |                        |   | 16,000                 |  |   | 57,000
|Foreign   |  |                         | 29,000 |   |                        |   | 38,000                 |  |   | 35,000
|          |  |                         |        |   |                        |   |                        |  |   |       
|          |  |                         | 28,000 |   |                        |   | 54,000                 |  |   | 92,000
|          |  |                         |        |   |                        |   |                        |  |   |       
|Deferred: |  |                         |        |   |                        |   |                        |  |   |       
|Federal   |  |                         |       |   |                        |   |                       |  |   |      
|State     |  |                         |       |   |                        |   |                       |  |   |      
|Foreign   |  |                         |       |   |                        |   |                       |  |   |      
|          |  |                         |        |   |                        |   |                        |  |   |       
|          |  | $                       | 28,000 |   |                        | $ | 54,000                 |  | $ | 92,000
|          |  |                         |        |   |                        |   |                        |  |   |       



Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. The significant components of deferred tax assets and liabilities are as follows:



|                                    |  |               |             |   |               |   |             |  
|----------------------------------- |  | ------------- | ----------- | - | ------------- | - | ----------- | -
|                                    |  | June 30, 2004 |             |   | July 2, 2003  |  
|                                    |  | (as restated) |             |   | (as restated) |  
|Deferred tax assets:                |  |               |             |   |               |   |             |  
|Net operating loss carryforwards    |  | $             | 11,347,000  |   |               | $ | 12,158,000  |  
|Intangible assets                   |  |               | (18,000     | ) |               |   | 198,000     |  
|Property and equipment              |  |               | 2,575,000   |   |               |   | 1,056,000   |  
|Accrued expenses                    |  |               | 639,000     |   |               |   | 774,000     |  
|Accrued provision for store closure |  |               | 42,000      |   |               |   | 165,000     |  
|Other                               |  |               | 157,000     |   |               |   | 73,000      |  
|                                    |  |               |             |   |               |   |             |  
|Total gross deferred tax assets     |  |               | 14,742,000  |   |               |   | 14,424,000  |  
|Less valuation allowance            |  |               | (14,742,000 | ) |               |   | (14,424,000 | )
|                                    |  |               |             |   |               |   |             |  
|Deferred tax liabilities            |  |               |            |   |               |   |            |  
|                                    |  |               |             |   |               |   |             |  
|Net deferred tax assets             |  | $             |            |   |               | $ |            |  
|                                    |  |               |             |   |               |   |             |  





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DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



A reconciliation of the statutory federal income tax rate with the Companys effective income tax expense (benefit) rate is as follows:



|                                           |  |                         |    |  |                        |    |  |                        |  
|------------------------------------------ |  | ----------------------- | -- |  | ---------------------- | -- |  | ---------------------- | -
|                                           |  | Year EndedJune 30, 2004 |    |  | Year EndedJuly 2, 2003 |    |  | Year EndedJune 3, 2002 |  
|Federal statutory rate                     |  | 34.0                    | %  |  | (34.0                  | )% |  | 34.0                   | %
|State income taxes, net of Federal benefit |  | 5.0                     |    |  | 2.0                    |    |  | 4.0                    |  
|Goodwill and other non-deductible costs    |  | 5.5                     |    |  | (7.0                   | )  |  | 18.6                   |  
|Valuation allowance                        |  | (64.8                   | )  |  | 38.0                   |    |  | (61.7                  | )
|Other                                      |  | 0.1                     |    |  | 3.0                    |    |  | 9.0                    |  
|Foreign income taxes                       |  | 13.6                    |    |  | 3.0                    |    |  | 3.0                    |  
|                                           |  |                         |    |  |                        |    |  |                        |  
|                                           |  | (6.6                    | )% |  | 5.0                    | %  |  | 6.9                    | %
|                                           |  |                         |    |  |                        |    |  |                        |  



As of June 30, 2004, the Company had
net operating loss (NOL) carry-forwards of approximately $30,546,000 and $19,228,000 for federal and state purposes, respectively. The federal NOL is available to offset future federal taxable income through 2024, and the state NOL is available to
offset future state taxable income through 2014. The utilization of certain NOL carryforwards could be limited due to the restriction imposed under federal and state laws upon a change in ownership.



In assessing the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is not more likely than not that the Company will realize the benefits of these deductible differences, and thus has recorded
a valuation allowance against the entire deferred tax asset. As of June 30, 2004 and July 2, 2003, the valuation allowance was $14,742,000 and $14,424,000, respectively. The change in the valuation allowance during 2004 was an increase of $318,000.



11. Impairment and Restructuring Charges



The Company recorded an asset impairment charge of $94,000 in fiscal 2004 to reduce the
carrying value associated with one of its coffeehouses. This was comprised of a charge of $90,000 to write down the carrying amount of one Company operated coffeehouse, and a charge of $4,000 that the Company expects to incur to terminate a lease
obligation on a subleased location that it no longer operates.



The Company
recorded asset impairment charges of $2,176,000 in fiscal 2003. These charges were comprised of a charge of $276,000 to write down the carrying value of four Company operated coffeehouses and a charge of $1,900,000 related to goodwill impairment.
The Company performed an annual review of its goodwill at July 2, 2003, in accordance with SFAS No. 142 Goodwill and Other Intangible Assets. SFAS No. 142 requires, among other things, the use of a non-amortization approach for purchased
goodwill and certain intangibles. Goodwill and certain intangibles with indefinite lives will not be amortized but instead will be reviewed for impairment at least annually (see note 6).



The Company recorded a charge of $542,000 in fiscal 2002 for asset impairment and restructuring costs. This charge was comprised of
severance and benefit costs of $336,000 associated with the elimination of 10 support center positions, plus a net charge of $211,000 to write down the carrying value of four Company operated coffeehouses and sale of a parcel of land.



F-19



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



12. Earnings Per Share



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



|                                                   |  |                          |           |                        |   |            |                        |  |   |          
|-------------------------------------------------- |  | ------------------------ | --------- | ---------------------- | - | ---------- | ---------------------- |  | - | ---------
|                                                   |  | Year Ended June 30, 2004 |           | Year EndedJuly 2, 2003 |   |            | Year EndedJuly 3, 2002
|                                                   |  | (as restated)            |           | (as restated)          |   |            | (as restated)         
|Numerator:                                         |  |                          |           |                        |   |            |                        |  |   |          
|Net income (loss)                                  |  | $                        | 251,000   |                        | $ | (1,358,000 | )                      |  | $ | 952,000  
|                                                   |  |                          |           |                        |   |            |                        |  |   |          
|Denominator:                                       |  |                          |           |                        |   |            |                        |  |   |          
|Basic weighted average common shares outstanding   |  |                          | 5,161,000 |                        |   | 5,161,000  |                        |  |   | 5,161,000
|Effect of dilutive securities                      |  |                          | 36,000    |                        |   |           |                        |  |   | 4,000    
|                                                   |  |                          |           |                        |   |            |                        |  |   |          
|Diluted weighted average common shares outstanding |  |                          | 5,197,000 |                        |   | 5,161,000  |                        |  |   | 5,165,000
|                                                   |  |                          |           |                        |   |            |                        |  |   |          
|Basic and diluted net income (loss) per share      |  | $                        | 0.05      |                        | $ | (0.26      | )                      |  | $ | 0.18     
|                                                   |  |                          |           |                        |   |            |                        |  |   |          



For the years ended June 30, 2004,
July 2, 2003 and July 3, 2002, employee stock options of 912,000, 749,000, and 418,000, respectively, and warrants of 500,000 for each year (as described in note 9), were excluded from the computation of diluted earnings per share as their impact
would have been anti-dilutive. The weighted average strike price of anti-dilutive securities for the years ended June 30, 2004, July 2, 2003 and July 3, 2002 was $6.70, $6.44 and $7.05, respectively.



The stock purchase warrants issued pursuant to terms of the Convertible Note Purchase
Agreement were excluded from the computation of diluted earnings per share for the year ended June 30, 2004 as their impact would have been anti-dilutive.



13. Segment Information



The Company has three reportable segments, retail operations, wholesale operations and franchise operations. The Company evaluates performance of its operating segments based on income before provision for asset
impairment and restructuring costs, income taxes, interest expense, depreciation and amortization, and general and administrative expenses.



The retail operations segment includes only company-operated retail units. Revenues are derived from sales of products and services by the units. Retail segment profit
before tax is net of cost of goods sold and related occupancy costs, retail-operating expenses and specifically identified general and administrative costs.



The wholesale operations segment sells coffee products to company stores, franchisees, and third parties. Reported revenues for the wholesale segment include sales to
franchisees and third parties, but sales to company-operated retail units are eliminated in consolidation. Wholesale segment profit before tax includes a manufacturing profit on all sales, including those to company-operated retail units, but
inter-company profit in retail unit inventories is eliminated at each period end. Wholesale segment profit before tax also is net of specifically identified selling, general and administrative expenses as well as costs of the Companys coffee
roasting facility.



The franchise operations segment revenues include franchise
store opening fees, franchise renewal and various service fees, roasting fees and royalty fees. Franchise segment profit before tax is net of specifically identified operating, general and administrative expenses.



F-20



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



Summarized financial information concerning the Companys reportable segments is shown in the following table. The other total assets consist of corporate cash,
corporate notes receivable, corporate prepaid expenses, and corporate property, plant and equipment. The other component of segment profit before tax includes corporate general and administrative expenses, provision for asset impairment and
restructuring costs, depreciation and amortization expense, and interest expense.



|                                 |  |                                 |            |   |                      |   |                                    |  |                     |           |  |                     |             |   |  |   |            |  
|-------------------------------- |  | ------------------------------- | ---------- | - | -------------------- | - | ---------------------------------- |  | ------------------- | --------- |  | ------------------- | ----------- | - |  | - | ---------- | -
|                                 |  | Retail Operations (as restated) |            |   | Wholesale Operations |   | Franchise Operations (as restated) |  | Other (as restated) |           |  | Total (as restated) |            
|Year ended June 30, 2004         |  |                                 |            |   |                      |   |                                    |  |                     |           |  |                     |             |   |  |   |            |  
|Total revenue                    |  | $                               | 31,617,000 |   |                      | $ | 15,466,000                         |  | $                   | 7,542,000 |  | $                   |            |   |  | $ | 54,625,000 |  
|Interest expense                 |  |                                 | 31,000     |   |                      |   |                                   |  |                     | 38,000    |  |                     | 279,000     |   |  |   | 348,000    |  
|Depreciation and amortization    |  |                                 | 1,372,000  |   |                      |   | 577,000                            |  |                     |          |  |                     | 366,000     |   |  |   | 2,315,000  |  
|Segment profit (loss) before tax |  |                                 | 926,000    |   |                      |   | 2,438,000                          |  |                     | 7,179,000 |  |                     | (10,264,000 | ) |  |   | 279,000    |  
|Total assets as of June 30, 2004 |  | $                               | 6,401,000  |   |                      | $ | 11,798,000                         |  | $                   | 3,900,000 |  | $                   | 3,119,000   |   |  | $ | 25,218,000 |  
|Year ended July 2, 2003          |  |                                 |            |   |                      |   |                                    |  |                     |           |  |                     |             |   |  |   |            |  
|Total revenue                    |  | $                               | 33,034,000 |   |                      | $ | 15,336,000                         |  | $                   | 6,611,000 |  | $                   |            |   |  | $ | 54,981,000 |  
|Interest expense                 |  |                                 | 41,000     |   |                      |   |                                   |  |                     | 54,000    |  |                     | 210,000     |   |  |   | 305,000    |  
|Depreciation and amortization    |  |                                 | 1,420,000  |   |                      |   | 479,000                            |  |                     |          |  |                     | 270,000     |   |  |   | 2,169,000  |  
|Segment profit (loss) before tax |  |                                 | (747,000   | ) |                      |   | 1,942,000                          |  |                     | 6,416,000 |  |                     | (8,915,000  | ) |  |   | (1,304,000 | )
|Total assets as of July 2, 2003  |  | $                               | 6,421,000  |   |                      | $ | 11,895,000                         |  | $                   | 3,956,000 |  | $                   | 3,829,000   |   |  | $ | 26,101,000 |  
|Year ended July 3, 2002          |  |                                 |            |   |                      |   |                                    |  |                     |           |  |                     |             |   |  |   |            |  
|Total revenue                    |  | $                               | 38,658,000 |   |                      | $ | 16,681,000                         |  | $                   | 6,666,000 |  | $                   |            |   |  | $ | 62,005,000 |  
|Interest expense                 |  |                                 | 64,000     |   |                      |   |                                   |  |                     | 70,000    |  |                     | 466,000     |   |  |   | 600,000    |  
|Depreciation and amortization    |  |                                 | 1,570,000  |   |                      |   | 581,000                            |  |                     |          |  |                     | 323,000     |   |  |   | 2,474,000  |  
|Segment profit (loss) before tax |  |                                 | 1,864,000  |   |                      |   | 2,661,000                          |  |                     | 6,759,000 |  |                     | (10,240,000 | ) |  |   | 1,044,000  |  
|Total assets as of July 3, 2002  |  | $                               | 9,735,000  |   |                      | $ | 10,937,000                         |  | $                   | 3,644,000 |  | $                   | 3,490,000   |   |  | $ | 27,806,000 |  



Intercompany sales from wholesale
operations to retail operations of $3,188,000 for fiscal 2002, $2,839,000 for fiscal 2003 and $2,607,000 for fiscal 2004 have been eliminated.



14. Selected Quarterly Financial Data (Unaudited)



The information in this footnote has been revised from the information previously reported to reflect a restatement of the Companys financial statements for the
first quarter of fiscal 2004. This change is the result a correction made to recognize $113,000 in additional franchise revenue under a terminated franchise agreement in the first quarter of fiscal 2004. In addition, see Note 2 herein for further
explanation of changes from previously reported financial statements.



The
quarterly results of operations for the years ended June 30, 2004 and July 2, 2003 were as follows:



|                                     |  |                                       |        |   |               |   |              |  |   |               |   |  |   |        |  
|------------------------------------ |  | ------------------------------------- | ------ | - | ------------- | - | ------------ |  | - | ------------- | - |  | - | ------ | -
|                                     |  | FirstQuarter                          |        |   | SecondQuarter |   | ThirdQuarter |  |   | FourthQuarter |  
|                                     |  | (in thousands, except per share data) |       
|Fiscal 2004 (as restated)            |  |                                       |        |   |               |   |              |  |   |               |   |  |   |        |  
|Total revenue                        |  | $                                     | 11,424 |   |               | $ | 14,252       |  | $ | 12,500        |   |  | $ | 16,449 |  
|Operating income (loss)              |  |                                       | (142   | ) |               |   | 592          |  |   | 9             |   |  |   | 138    |  
|Net income (loss)                    |  |                                       | (208   | ) |               |   | 524          |  |   | (59           | ) |  |   | (6     | )
|Basic income (loss) per share        |  |                                       | (0.04  | ) |               |   | 0.10         |  |   | (0.01         | ) |  |   | 0.00   |  
|Diluted income (loss) per share      |  |                                       | (0.04  | ) |               |   | 0.10         |  |   | (0.01         | ) |  |   | 0.00   |  
|                                     |  |                                       |        |  
|Fiscal 2004 (as previously reported) |  |                                       |        |   |               |   |              |  |   |               |   |  |   |        |  
|Total revenue                        |  | $                                     | 11,311 |   |               | $ | 14,252       |  | $ | 12,500        |   |  | $ | 16,449 |  
|Operating income (loss)              |  |                                       | (235   | ) |               |   | 612          |  |   | (1            | ) |  |   | 123    |  
|Net income (loss)                    |  |                                       | (301   | ) |               |   | 544          |  |   | (69           | ) |  |   | (21    | )
|Basic income (loss) per share        |  |                                       | (0.06  | ) |               |   | 0.11         |  |   | (0.01         | ) |  |   | 0.00   |  
|Diluted income (loss) per share      |  |                                       | (0.06  | ) |               |   | 0.10         |  |   | (0.01         | ) |  |   | 0.00   |  
|                                     |  |                                       |        |  
|Fiscal 2003 (as restated)            |  |                                       |        |   |               |   |              |  |   |               |   |  |   |        |  
|Total revenue                        |  | $                                     | 12,346 |   |               | $ | 15,170       |  | $ | 12,057        |   |  | $ | 15,408 |  
|Operating income (loss)              |  |                                       | 46     |   |               |   | 958          |  |   | (207          | ) |  |   | (1,845 | )
|Net income (loss)                    |  |                                       | (49    | ) |               |   | 876          |  |   | (258          | ) |  |   | (1,927 | )
|Basic income (loss) per share        |  |                                       | (0.01  | ) |               |   | 0.17         |  |   | (0.05         | ) |  |   | (0.37  | )
|Diluted income (loss) per share      |  |                                       | (0.01  | ) |               |   | 0.17         |  |   | (0.05         | ) |  |   | (0.37  | )
|                                     |  |                                       |        |  
|Fiscal 2003 (as previously reported) |  |                                       |        |   |               |   |              |  |   |               |   |  |   |        |  
|Total revenue                        |  | $                                     | 12,346 |   |               | $ | 14,968       |  | $ | 12,057        |   |  | $ | 15,408 |  
|Operating income (loss)              |  |                                       | 85     |   |               |   | 795          |  |   | (168          | ) |  |   | (1,625 | )
|Net income (loss)                    |  |                                       | (10    | ) |               |   | 712          |  |   | (219          | ) |  |   | (1,706 | )
|Basic income (loss) per share        |  |                                       | (0.00  | ) |               |   | 0.14         |  |   | (0.04         | ) |  |   | (0.33  | )
|Diluted income (loss) per share      |  |                                       | (0.00  | ) |               |   | 0.14         |  |   | (0.04         | ) |  |   | (0.33  | )



F-21



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##### Table of Contents

Quarterly operating results are not necessarily representative of operations for a full year for various reasons,
including the seasonal nature of the Companys business, which may affect sales volume and food costs. All quarters have 12-week accounting periods, except the fourth quarter, which has a 16-week accounting period.



The Company recorded asset impairment and restructuring charges of $94,000 and $2,118,000
during the fourth quarters of the years ended June 30, 2004 and July 2, 2003, respectively (see note 11).



The Company recognized $263,000 of revenue as a result of the termination of an area development agreement with a franchisee in Malaysia, all of which was recognized in the first quarter of the year ended June 30,
2004.



F-22



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##### Table of Contents

DIEDRICH COFFEE, INC. AND SUBSIDIARIES



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS



|                         |  |                                              |           |                                       |   |          |                                                |  |                      |   |  |                                        |          |   |  |   |          
|------------------------ |  | -------------------------------------------- | --------- | ------------------------------------- | - | -------- | ---------------------------------------------- |  | -------------------- | - |  | -------------------------------------- | -------- | - |  | - | ---------
|                         |  | Balance at Beginning of Period (as restated) |           | Provisions (Recoveries) (as restated) |   |          | Additional Provisions Obtained in Acquisitions |  | Accounts Written Off |   |  | Balance at End of Period (as restated)
|Allowance for Bad Debt:  |  |                                              |           |                                       |   |          |                                                |  |                      |   |  |                                        |          |   |  |   |          
|Year ended July 3, 2002  |  | $                                            | 2,007,000 |                                       | $ | (471,000 | )                                              |  | $                    | 0 |  | $                                      | (246,000 | ) |  | $ | 1,290,000
|                         |  |                                              |           |                                       |   |          |                                                |  |                      |   |  |                                        |          |   |  |   |          
|Year ended July 2, 2003  |  | $                                            | 1,290,000 |                                       | $ | 315,000  |                                                |  | $                    | 0 |  | $                                      | (230,000 | ) |  | $ | 1,375,000
|                         |  |                                              |           |                                       |   |          |                                                |  |                      |   |  |                                        |          |   |  |   |          
|Year ended June 30, 2004 |  | $                                            | 1,375,000 |                                       | $ | 253,000  |                                                |  | $                    | 0 |  | $                                      | (473,000 | ) |  | $ | 1,155,000
|                         |  |                                              |           |                                       |   |          |                                                |  |                      |   |  |                                        |          |   |  |   |          



See Note 2 herein for explanation of
changes from previously reported financial statements.



F-23



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##### Table of Contents

DIEDRICH COFFEE, INC.



INDEX TO
EXHIBITS



|            |  |                                                                                                                                                                                                                   
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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)                                                                                       
|            | 
|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)                                                                                                                                                                            





S-1



---

##### Table of Contents

|      |  |                                                                                                                                                             
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 |  | Amended and Restated Credit Agreement with Bank of the West, effective May 10, 2004                                                                       
|      | 
|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(9)*                                                                                         
|      | 
|10.23 |  | Form of Employment Agreement with Martin R. Diedrich, dated June 29, 2001(17)*                                                                              
|      | 
|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 |  | Contingent Convertible Note Purchase Agreement, dated May 10, 2004 (includes form of convertible promissory note and form of warrant)                     
|      | 
|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)                                          





S-2



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##### Table of Contents

|      |  |                                                                                                    
|----- |  | ---------------------------------------------------------------------------------------------------
|10.32 |  | Reserved.                                                                                          
|      | 
|21.1  |  | List of Subsidiaries(18)                                                                           
|      | 
|23.1  |  | Consent of Independent Registered Public Accounting Firm                                           
|      | 
|31.1  |  | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|      | 
|31.2  |  | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|      | 
|32.1  |  | Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|      | 
|32.2  |  | Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

---

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

| | Previously filed with this Annual Report on Form 10-K for the fiscal year ended June 30, 2004, filed with the Securities and Exchange Commission on September 28, 2004.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

|(7) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended October 29, 1997, filed with the Securities and Exchange Commission on
December 11, 1997.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended January 28, 1998, filed with the Securities and Exchange Commission on
April 28, 1998.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended March 10, 2004, filed with the Securities and Exchange Commission on
April 26, 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Previously filed as an exhibit to Diedrich Coffees Registration Statement on Form S-8, filed with the Securities and Exchange Commission on November 21, 2000.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended September 22, 1999, filed with the Securities and Exchange Commission on
November 5, 1999.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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##### Table of Contents

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

|(13) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended July 3, 2002, filed with the Securities and Exchange Commission on
October 1, 2002.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended December 18, 2002, filed with the Securities and Exchange Commission on
January 31, 2003.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(16) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended July 2, 2003, filed with the Securities and Exchange Commission on
September 30, 2003.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(17) | Previously filed as an exhibit to Diedrich Coffees Annual Report on Form 10-K for the fiscal year ended June 27, 2001, filed with the Securities and Exchange Commission on
September 25, 2001.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(19) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended September 20, 2000, filed with the Securities and Exchange Commission on
November 6, 2000.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(20) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended September 24, 2003, filed with the Securities and Exchange Commission on
November 7, 2003.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(21) | Previously filed as an exhibit to Diedrich Coffees Quarterly Report on Form 10-Q for the period ended December 17, 2003, filed with the Securities and Exchange Commission on
January 30, 2004.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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