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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 1O-Q

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

For the quarterly period ended October 29, 1997

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

For the transition period from ___________ to ___________

Commission file number 0-21203

DIEDRICH COFFEE, INC.
(Exact name of registrant as specified in its charter)

Delaware 33-0086628
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)

2144 Michelson Drive
Irvine, California 92612
(Address of Principal Executive Offices including Zip Code)

(714) 260-1600
(Registrant's Telephone Number including Area Code)

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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 |_|

As of December 11, 1997, there were 5,391,650 shares of common stock of
the registrant outstanding.

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DIEDRICH COFFEE, INC.

INDEX

PART I - FINANCIAL INFORMATION Page No.

Item 1. Financial Statements

Condensed Balance Sheets..............................................................3

Condensed Statements of Operations....................................................4

Condensed Statements of Cash Flows....................................................5

Notes to Condensed Financial Statements...............................................6

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................9

PART II - OTHER INFORMATION

Item 5. Other Information....................................................................15

Item 6. Exhibits and Reports on Form 8-K.....................................................17

Signatures...........................................................................17

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DIEDRICH COFFEE, INC.
CONDENSED BALANCE SHEETS
(Unaudited)

ASSETS (Note 3) OCTOBER 29, 1997 JANUARY 29, 1997
---------------- ----------------

Current Assets:
Cash $ 1,550,276 $ 2,071,904
Accounts receivable 265,885 210,363
Inventories (Note 2) 1,480,457 1,615,145
Prepaid expenses 520,958 185,063
Other current assets 43,328 285,072
------------ ------------
Total current assets 3,860,904 4,367,547

Property and equipment, net 10,245,739 11,962,752
Costs in excess of net assets acquired, net 394,713 796,178
Other assets 339,818 344,942
------------ ------------
Total assets $ 14,841,174 $ 17,471,419
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
Accounts payable $ 1,412,472 $ 1,800,292
Accrued compensation 414,408 417,028
Accrued expenses 415,985 201,487
Current portion of obligation under capital lease 42,897 --
Restructuring liabilities 1,213,049 --
------------ ------------
Total current liabilities 3,498,811 2,418,807

Obligation under capital lease - long term 103,922 --
Long term debt 3,000,000 --
Deferred rent 160,238 154,384
------------ ------------
Total liabilities 6,762,971 2,573,191
------------ ------------

Stockholders' Equity:

Preferred stock --
Common stock 53,917 53,917
Additional paid-in capital 15,882,046 15,882,046
Accumulated deficit (7,857,760) (1,037,735)
------------ ------------
Total stockholders' equity 8,078,203 14,898,228
------------ ------------
Commitments and contingencies
Total liabilities and stockholders' equity $ 14,841,174 $ 17,471,419
============ ============

See accompanying Notes to condensed financial statements.

DIEDRICH COFFEE, INC.
CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

THIRTEEN THIRTEEN THIRTY-NINE THIRTY-NINE
WEEKS ENDED WEEKS ENDED WEEKS ENDED WEEKS ENDED
OCTOBER 29, OCTOBER 30, OCTOBER 29, OCTOBER 30,
1997 1996 1997 1996
------------ ------------ ------------ ------------

Net Sales:
Retail $ 4,989,024 $ 4,716,301 $ 15,632,429 $ 12,887,504
Wholesale and other 573,848 388,386 1,608,685 1,159,274
------------ ------------ ------------ ------------
Total 5,562,872 5,104,687 17,241,114 14,046,778
------------ ------------ ------------ ------------

Cost and Expenses:
Cost of sales and related occupancy costs 2,716,323 2,096,321 8,619,031 6,005,203
Store operating expenses 2,029,491 2,226,610 6,536,446 5,834,033
Other operating expenses 92,896 53,244 232,985 175,829
Depreciation and amortization 426,778 238,798 1,313,294 603,349
Provision for store closings and restructuring costs -- -- 4,550,068 --
General and administrative expenses 951,683 407,532 2,695,562 1,054,992
------------ ------------ ------------ ------------
Total 6,217,171 5,022,505 23,947,386 13,673,406
------------ ------------ ------------ ------------

Operating income (loss) (654,299) 82,182 (6,706,272) 373,372

Interest expense (79,954) (78,119) (101,605) (186,851)

Interest and other income (expense) (4,501) 73,182 (9,258) 75,188
------------ ------------ ------------ ------------

Income (loss) before income taxes (738,754) 77,245 (6,817,135) 261,709

Provision for income taxes -- 31,670 2,890 103,319
------------ ------------ ------------ ------------

Net income (loss) $ (738,754) $ 45,575 $ (6,820,025) $ 158,390
============ ============ ============ ============

Per share information: $ (0.14) $ 0.01 $ (1.27) $ 0.04
============ ============ ============ ============
Net income (loss) per share

Weighted average shares outstanding 5,391,650 4,764,491 5,391,650 4,190,131
============ ============ ============ ============

See accompanying Notes to condensed financial statements.

DIEDRICH COFFEE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

THIRTY-NINE THIRTY-NINE
WEEKS ENDED WEEKS ENDED
OCTOBER 29, OCTOBER 30,
1997 1996
----------- -----------

Cash flows from operating activities:
Net income (loss) $(6,820,025) $ 112,815
Adjustments to reconcile net income (loss) to cash (used in)
provided by operating activities:
Depreciation and amortization 1,313,294 364,551
Restructuring charge 1,682,325 --
Impairment on long-lived assets 2,220,955 --
Increase (decrease) from changes in:
Accounts receivable (55,522) (16,580)
Inventories 45,466 (307,143)
Prepaid expenses (335,895) (64,634)
Other current assets 241,744 (118,387)
Other assets 5,124 (316,668)
Accounts payable (387,820) 1,059,666
Accrued compensation (115,363) 100,990
Accrued expenses 214,498 99,422
Income taxes payable -- (24,916)
Deferred rent 5,854 6,546
----------- -----------
Net cash provided by (used in) operating activities (1,985,365) 895,662
----------- -----------

Cash flows from investing activities:
Capital expenditures for property and equipment (1,536,263) (3,609,893)
Acquisition of coffeehouses -- (1,800,000)
=========== ===========
Net cash provided by (used in) investing activities $(1,536,263) $(5,409,893)
=========== ===========

Cash flows from financing activities:
Checks issued against future deposits -- 204,145
Proceeds from notes payable -- 10,000
Payments on notes payable -- --
Proceeds from line of credit -- 3,386,530
Payments on line of credit -- --
Proceeds from long-term debt 3,000,000 1,422,520
Principal payments on long-term debt -- (546,565)
Proceeds from issuance of common stock, net of fees paid -- --
Proceeds from sale of preferred stock -- --
Repurchase of common stock -- --
----------- -----------
Net cash provided by financing activities 3,000,000 4,476,630
----------- -----------
Net increase (decrease) in cash (521,628) (37,601)
----------- -----------
Cash at beginning of period 2,071,904 94,659
----------- -----------
Cash at end of period $ 1,550,276 $ 57,058
=========== ===========

Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 64,729 $ 86,021
Income taxes $ 2,890 $ 62,500
Non-cash transactions
Equipment purchased under capital lease $ 146,819 $ --

See accompanying Notes to condensed financial statements.

DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
OCTOBER 29, 1997
(Unaudited)

1. Summary of Significant Accounting Policies

Basis of Presentation

The unaudited condensed financial statements of Diedrich
Coffee, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial
information. In the opinion of management, all adjustments (consisting
of normal, recurring adjustments and accruals) considered necessary for
a fair presentation of the Company's financial position at October 29,
1997 and the results of operations and cash flows for the thirty-nine
weeks ended October 29, 1997 and October 30, 1996 have been included.
Results for the interim periods are not necessarily indicative of the
results for an entire year. This information should be read in
conjunction with the financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
January 29, 1997.

In June 1997, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards ("SFAS")
No. 130, Reporting Comprehensive Income, which establishes standards
for reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general-purpose
financial statements. SFAS No. 130 is effective for financial
statements issued for periods beginning after December 15, 1997. The
Company has not determined the impact of SFAS No. 130 on its
consolidated financial statements.

In June 1997, the FASB issued SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131
establishes standards for the way that public business enterprises
report information about operating segments in annual financial
statements and requires that those enterprises report information about
operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments
in interim financial reports issued to shareholders. SFAS No. 131 is
effective for financial statements issued for periods beginning after
December 15, 1997. The Company has not determined the impact of SFAS
No. 131 on its consolidated financial statements.

Net Income (Loss) per Common Share

The calculation of net income (loss) per share was determined
by dividing the net income (loss) by the weighted average common and
common equivalent shares outstanding when dilutive. In accordance with
Securities and Exchange Commission Staff Accounting Bulletin No. 83,
shares issued and share options granted within one year of the
Company's initial public offering ("IPO") have been included in the
calculation of common share equivalents, using the treasury stock
method to determine the dilutive effect of the issuances, as if they
were outstanding for all periods presented even if they were
antidilutive. The calculation of common share equivalents assumes that
the proceeds of common shares and share options issued within one year
of the IPO were used to repurchase common shares at the IPO price of
$9.50 per share. Primary earnings (loss) per share approximate fully
diluted earnings (loss) per share for all periods presented.

DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (Continued)
OCTOBER 29, 1997
(Unaudited)

In February 1997, the FASB issued SFAS No. 128, "Earnings Per
Share." SFAS No. 128 specifies new standards designed to improve the
earnings per share ("EPS") information provided in financial statements
by simplifying the existing computational guidelines, revising the
disclosure requirements and increasing the comparability of EPS data on
an international basis. SFAS No. 128 is effective for financial
statements issued for periods ending after December 15, 1997, including
interim periods. The Company does not believe the implementation of
SFAS No. 128 will have a material effect on net income (loss) per
share.

2. Inventories

Inventories consist of the following:

October 29, January 29,
1997 1997
---------- ----------

Green coffee $ 562,715 $ 357,255
Roasted coffee 75,487 90,536
Accessory and specialty items 270,248 454,946
Other food, beverage and supplies 572,007 712,408
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$1,480,457 $1,615,145
========== ==========

3. Debt

On May 27, 1997, the Company made a promissory note (the
"Note") for the benefit of the Palm Trust of which Paul Heeschen, a
director, is a trustee. Mr. Heeschen has no beneficial interest in the
Palm Trust. The Note provides for borrowings by the Company up to
$1,500,000 with interest accruing at the prime rate plus 3 1/2%. All
outstanding principal and accrued interest was due and payable on
January 27, 1998 or promptly after the closing of any new debt or
equity financing in an amount exceeding $1,500,000. This indebtedness
was fully paid and discharged on October 20, 1997 with the proceeds of
borrowings from the Ocean and Grandview Trusts described below.

On August 19, 1997, the Company entered into a promissory
note, term loan agreement, and security agreement with the Virginia R.
Cirica Trust (the "Cirica Trust") (collectively the "Cirica Trust Loan
Documents"). That trust is controlled by Ms. Cirica, who is the spouse
of Lawrence Goelman, Chairman and Interim Chief Executive Officer of
the Company.

Shortly before the Cirica Trust entered into the Cirica Trust
Loan Documents, Mr. Goelman loaned Ms. Cirica approximately $250,000.
Some of those funds were transferred by Ms. Cirica to the Cirica Trust
and advanced to the Company pursuant to the Cirica Trust Loan
Documents. The loan is secured by the assets of the Company and
provides for borrowings up to $500,000 with interest accruing at the
prime rate plus 3 1/2 %. As of October 29, 1997 the Company borrowed
the entire $500,000 available. All outstanding principal and accrued
interest is due and payable on August 19, 2002.

In connection with the Cirica Trust Loan Documents, the
Company issued a warrant to the Cirica Trust to purchase up to 85,000
shares of the Company's common stock if the loan is repaid in full in
120 days of closing, or up to 170,000 shares of the Company's common
stock if the loan is not repaid within 120 days, all at a price of
$2.25 a share. The warrants are exercisable immediately and expire on
the later of August 19, 2003 or one year following payment in full of
the loan. Mr. Goelman disclaims any pecuniary interest in the loan to
the Company and any

beneficial interest in the Cirica Trust, except to the extent to which
Mr. Goelman is a contingent beneficiary under the terms of the Cirica
Trust.

On September 30, 1997 the Company entered into a promissory
note, term loan agreement and security agreement with Nuvrty, Inc., a
Colorado corporation controlled by Amre Youness, a former director of
the Company (the "Nuvrty Loan Documents"). The loan is secured by the
assets of the Company and provides for borrowings up to $1,000,000 with
interest accruing and paid monthly at the prime rate plus 3 1/2%. The
Company borrowed the full amount under the loan.

In connection with the Nuvrty Loan Documents, the Company
issued a warrant to Nuvrty to purchase up to 170,000 shares of the
Company's common stock if the Loan is repaid in full within 120 days of
closing and up to 340,000 shares of the Company's common stock if the
loan is not repaid within 120 days, all at a price of $2.25 per share.
The warrants are exercisable immediately and expire on the later of
September 30, 2003 or one year following payment in full of the loan.

On October 16, 1997 the Company entered into parallel
promissory notes, term loan agreements and security agreements with the
Ocean and Grandview Trusts on terms identical to those entered into
with the Cirica Trust and Nuvrty, Inc. (the "Ocean Trust Loan
Documents" and the "Grandview Trust Loan Documents", respectively). The
Ocean Trust Loan Documents and the Grandview Trust Loan Documents
provide for borrowing up to $750,000 from each Trust. Each loan is
secured by the assets of the Company. Interest on advances is accrued
and payable monthly at the prime rate plus 3 1/2%. The Company borrowed
$750,000 under each facility. All outstanding principal and accrued
interest is due and payable to each of the Ocean and Grandview Trusts
on October 16, 2002.

In connection with the Ocean Trust Loan Documents and the
Grandview Trust Loan Documents the Company issued warrants to each
Trust respectively to purchase up to 127,500 shares each of the
Company's common stock if the loan is repaid in full within 120 days of
closing, or up to 255,000 shares respectively of the Company's common
stock if the loan is not repaid in full within 120 days of closing, all
at a price of $2.25 per share. The warrants are exercisable immediately
and expire on the later of October 16, 2003 or one year following
payment in full of the respective loans. The Company used the proceeds
from the Ocean Trust and Grandview Trusts Loans to pay off and
discharge the outstanding indebtedness to the Palm Trust.

4. Restructuring Charge

On March 12, 1997, the Company announced that it was reviewing
the performance of all of the Company's coffeehouses to determine which
units were meeting or not meeting management's long-term operational
expectations. As a result of this review, twelve stores were identified
to be closed. In connection with the planned store closures, the
Company recorded an impairment provision and a restructuring charge
totaling approximately $4,600,000 in the first quarter of fiscal 1998.
The store closures, which were undertaken to streamline operations and
improve profitability, began in late March 1997 and are expected to be
completed during fiscal 1998. The Company believes that the reserve of
$1,213,000 as of October 29, 1997 will be sufficient to cover the
actual losses arising from final resolution of the terminated leases.

PART I - FINANCIAL INFORMATION

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

In addition to historical information, management's discussion and
analysis includes certain forward-looking statements, including those related to
the Company's growth and strategies, that involve risks and uncertainties. These
projections or forward looking statements fall under the safe harbors of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The Company's actual results and financial
position could differ materially from those anticipated in the forward-looking
statements as a result of a number of factors, such as unexpected delays in
implementing the new management and information systems, weaknesses in store
operations and management, working capital limits, failure of the wholesale
business to meet targets, the Company's ability to hire, train and retain
optimum store and area management and volatile world coffee prices. The need for
additional financing and other risks and uncertainties are described elsewhere
in this report and in detail under "Certain Factors and Trends Affecting
Diedrich Coffee and Its Business" in the Company's annual report on Form 10-K
for the fiscal year ended January 29, 1997 and in reports filed by the Company
with the Securities and Exchange Commission.

GENERAL

The Company commenced operations in 1972 as a private company and
completed its initial public offering in September 1996. The Company, a custom
roaster of specialty coffee, sells coffee and a broad range of espresso drinks
through its own coffeehouses. To complement beverage sales, the Company sells
light food items and whole bean coffee through its coffeehouses. The Company
also sells roasted coffee and a broad range of equipment through a wholesale
sales force. At the conclusion of fiscal 1997 (January 29, 1997), the Company
operated forty-seven coffeehouses or carts located in California, Colorado and
Texas. As of October 29, 1997, the Company operated a total of thirty-six
coffeehouses and one cart after closing eleven of the twelve locations
identified for closure under the previously announced restructuring plan (see
Note 4 of Notes to Condensed Financial Statements) and the opening of a new
coffeehouse in Houston, Texas in July, 1997.

In the first three-quarters of the current fiscal year the Company
experienced losses related to underperforming stores and as a consequence,
recorded a restructuring charge of approximately $4,600,000. Management is
committed to both grow the Company and return the Company to profitability, with
the primary goal of positive cash flow by the end of fiscal 1998 (January 28,
1998). In order to achieve this goal, the Company must increase sales in several
markets, add new channels of distribution and reduce expenses. Achieving these
goals depends upon, among other things, maintaining sufficient working capital,
successful implementation of new operational systems, execution of new store
management systems and improved store management and customer satisfaction.
Results were according to plan in the second quarter. While management continues
to believe that the Company can return to profitability by year-end, the Company
experienced lower than expected retail sales in the third quarter due to
unusually warm weather in the Company's core Southern California markets, delays
in establishing certain new wholesale business relationships, and green coffee
inventory expense that exceeded average historical costs.

Business plan. At the direction of the Board of Directors, the
Company's new management team is implementing a business plan to
strengthen the Company operationally in order to position it for growth and
profitability. As previously announced, this business plan includes: (1) closing
stores which do not meet the Company's performance standards; (2) developing
carts and kiosks as well as new channels of distribution such as "co-branding",
franchising, and office coffee service; (3) accelerating growth in wholesale
sales; (4) improved cost controls through centralized purchasing and installing
upgraded software and new management information and point-of-sale systems; (5)
rolling out a more comprehensive training program and human resources systems
designed to strengthen and build the Company's operating management and staff;
and (6) concentrating on building brand awareness and brand equity.

Progress against the plan. Eleven of the twelve stores targeted for
closure were closed by October 29, 1997. Management remains confident that the
remaining store identified for closure will be closed before the end of the
fiscal year. The Company's projects operating losses to steadily diminish and
end in the fourth quarter if all targets are met. While retail revenues for the
third quarter increased 8.2% over the same quarter last year, the increase in
the third quarter did not meet management's expectations. Controllable operating
expenses at the store level are decreasing. The Company believes that further
decreases are achievable. The Company believes that controllable operating
expenses should stabilize in the first quarter of next year. Wholesale sales are
continuing to grow. Wholesale sales increased 47.8% in the third quarter. The
Company anticipates that seven pending transactions will close in the fourth
quarter and the Company expects the wholesale division to record revenues
for the year-end by that time. This expectation is based on the wholesale
division's performance to date and projects in progress.

Area Development. In September the Company informed its franchisee in
Singapore that the franchisee was in default under the agreed development
schedule under the applicable Master Development Agreement. No stores have
opened in Singapore. A new understanding may be reached as to Singapore,
Malaysia, and Indonesia only. The Company is engaged in preliminary discussions
with possible area developers for several US and foreign markets. No forecasts
can be made as to if and when such negotiations will lead to binding agreements,
or how much revenue can be anticipated from any such agreement.

Green coffee prices. In the third quarter of fiscal 1998, worldwide
coffee commodity prices moderated from the levels reached earlier in the year
but remained within the range of the highest levels experienced during the past
nine years. The Company usually pays a premium over the commodity price for the
select grade coffee beans that it purchases. As worldwide demand for coffee of
all types remains strong, the Company expects the prices that it pays to remain
comparatively high into the foreseeable future. Earlier this year, the Company
mitigated the effect of the green coffee price increases by increasing the
wholesale and retail sales prices of its roasted coffee beans, brewed coffee and
related products, but there can be no assurance that any future price increases
can be so integrated. Demand for the Company's coffee was not adversely affected
by the price increase.

GREEN COFFEE AVAILABILITY

The Company believes that it has adequate sources of supply of high
quality, green arabica coffee to meet its projected needs for the foreseeable
future. While the Company seeks to carefully anticipate its green coffee needs,
there can be no assurance that supplies and prices will not be affected by
political and social events, the weather in the coffee growing regions of the
world, unexpected demand or other market forces. Green coffee is an
international agricultural commodity product subject to considerable price
fluctuations.

SEASONALITY AND QUARTERLY RESULTS

The Company's business is subject to seasonal fluctuations as well as
economic trends that affect retailers in general. Historically, the Company's
net sales have not been realized proportionately in each quarter, with net sales
being the highest during the last fiscal quarter which includes the December
holiday

11
season. Hot weather tends to reduce sales. Quarterly results are affected by the
timing of the opening of new stores, which may not occur as anticipated due to
events outside the Company's 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. Due to all of the foregoing
and variables, the Company's future earnings and the market price of the
Company's securities are subject to change. There can be no assurance that the
Company will return to profitability when targeted nor of future growth rate.

Roast capacity, packaging, shipping and distribution. The Company is
actively seeking cost effective ways to expand its coffee roasting capacity and
upgrade its packaging, shipping and distribution capabilities. These
improvements are needed to enable the Company to expand and diversify its
wholesale business.

RESULTS OF OPERATIONS

Thirteen Weeks Ended October 29, 1997 Compared with the Thirteen Weeks Ended
October 30, 1996

Net sales. Net sales for the thirteen weeks ended October 29, 1997
increased 9.0% to $5,563,000 from $5,105,000 for the thirteen weeks ended
October 30, 1996, despite having fewer stores in operation. During this most
recent quarter, the Company derived 89.7% of net sales from its retail
coffeehouse operations. The Company's wholesale and mail order sales accounted
for the remainder of net sales. Net retail sales for the thirteen weeks ended
October 29, 1997 increased 5.8% to $4,989,000 from $4,716,000 in the thirteen
weeks ended October 30, 1996 primarily due to higher per-store average sales. As
of October 29, 1997, the Company operated 36 coffeehouses and one cart; as of
October 30, 1996, the Company operated 40 coffeehouses and one cart. There can
be no assurance that the Company's net sales will continue to increase. The
Company's ability to continue to increase net sales depends upon many factors,
including existing and emerging competition. The percentage decrease in third
quarter of fiscal 1998 comparable store sales was 0.2%. Comparable store sales
were adversely affected in the latter half of the current quarter as a result of
rolling over the "80th Anniversary" promotion in the prior year, which increased
unit average sales by approximately 10% for the six weeks that it ran.

Wholesale and mail order sales combined increased 47.8% to $574,000 in
the thirteen weeks ended October 29, 1997 from $388,000 in the thirteen weeks
ended October 30, 1996. The increase was due to a more active sales effort,
under the leadership of the new director of wholesale sales and continued
favorable customer response from new and existing wholesale accounts. Although
the Company anticipates continued improvement in wholesale sales there can be
no assurance that this will happen.

Net sales for the thirty-nine weeks ended October 29, 1997 increased
22.7% to $17,241,000 from $14,047,000 for the thirty-nine weeks ended October
30, 1996. Net retail sales for the thirty-nine weeks ended October 29, 1997
increased 21.3% to $15,632,000 from $12,888,000 for the thirty-nine weeks ended
October 30, 1996 due to an increase in the number of average coffeehouses open
and in coffeehouse sales. Wholesale and mail order sales for the thirty-nine
weeks ended October 29, 1997 increased 38.8% to $1,609,000 from $1,159,000 for
the thirty-nine weeks ended October 30, 1996.

Cost of sales and related occupancy costs. Cost of roasted coffee,
dairy, food, paper and bar supplies, accessories and clothing (cost of sales)
and rent (related occupancy costs) for the thirteen weeks ended October 29, 1997
increased to $2,716,000 from $2,096,000 for the thirteen weeks ended October 30,
1996. As a percentage of retail net sales, cost of sales and related occupancy
costs increased to 54.4% in the third quarter of fiscal 1998 from 44.4% for the
third quarter of fiscal 1997. These figures include non-recurring expenses of
closing stores, such as continuing lease payments.

Cost of sales and related occupancy costs for the thirty-nine weeks
ended October 29, 1997 increased to $8,619,000 from $6,005,000 for the
thirty-nine weeks ended October 30, 1996. As a percentage of retail net sales,
cost of sales and related occupancy costs increased to 55.1% for the first
three-quarters in fiscal 1998 from 46.6% for the first three fiscal quarters in
fiscal 1997. This increase

stems from the result of higher green coffee costs that were not entirely offset
by the menu price increase implemented in the second quarter of fiscal 1998.
Additionally, the increase was also attributable to some increases in related
occupancy costs. The Company is actively working to control and reduce green
coffee costs, cost of sales and occupancy costs through several means. The
Company's Director of Purchasing, hired in the second quarter, is focused on
reducing the cost of goods purchased. The Company is evaluating and testing
"co-branding" relationships at some locations and implementing new management
and staff training and procedures. The Company believes that it will see the
benefits of cost savings in the fourth quarter and the next fiscal year
beginning January 29, 1998.

Store operating expenses. Store operating expenses decreased to
$2,029,000 for the thirteen weeks ended October 29, 1997 from $2,227,000 for the
thirteen weeks ended October 30, 1996. As a percentage of retail net sales,
store operating expenses decreased to 40.7% in the third quarter of fiscal 1998
from 47.2% in the prior fiscal year's third quarter. For the thirty-nine weeks
ended July 31, 1997, store operating expenses, as a percentage of retail net
sales, similarly decreased to 41.8% from 45.3% for the thirty-nine weeks ended
October 30, 1996. These decreases were primarily due to improved labor
scheduling methods. The Company plans to achieve further reductions in store
operating expenses.

Other operating expenses. Other operating expenses (those associated
with wholesale and mail order sales) increased to $93,000 for the third quarter
of fiscal 1998 from $53,000 in the third quarter of fiscal 1997. These expenses,
as a percentage of the net sales from the wholesale division, increased to 16.2%
from 13.7%. This increase reflects the cost of additional management and sales
staff recruited to further develop the sales of the wholesale division. As a
percentage of net sales these costs should go down as wholesale sales increase.
For the thirty-nine weeks ended October 29, 1997, other operating expenses, as a
percentage of wholesale net sales, decreased to 14.5% from 15.2% for the
thirty-nine weeks ended October 30, 1996. This decrease is a result of an
increase in sales volume on a year-to-date basis.

Depreciation and Amortization. Depreciation and amortization increased
to $427,000 for the thirteen weeks ended October 29, 1997 from $239,000 for the
thirteen weeks ended October 30, 1996. As a percentage of net sales,
depreciation and amortization increased to 7.7% from 4.7% for the same period in
the prior year, principally due to depreciable assets related to the addition of
new stores and the conversion costs for the acquired locations. Depreciation and
amortization increased to $1,313,000 for the thirty-nine weeks ended October 29,
1997 from $603,000 for the thirty-nine weeks ended October 30, 1996.

General and administrative expenses. General and administrative
expenses increased to $952,000 for the third quarter of fiscal 1998 from
$408,000 for the third quarter of fiscal 1997. As a percentage of net sales,
general and administrative expenses increased to 17.1% from 8.0% due to the
adding of selected resources and personnel in order to implement the revenue
building and cost saving elements of the Company's business plan. Similarly, as
a percentage of net sales, general and administrative expenses increased to
15.6% in the thirty-nine weeks ended October 29, 1997 from 7.5% for the
thirty-nine weeks ended October 30, 1996. The Company believes that it will see
a reduction in general and administrative expenses relative to sales over the
next several quarters as revenue flows increase and cost controls and other
savings are realized, assuming continued successful execution of the new
business plan.

Provision for store closings and restructuring costs. In response to
lower than expected profitability in certain of its operations, the Company
commenced a restructuring program which includes store closures, lease
terminations and the write off of fixed assets. The $4.6 million, or $.84 per
share provision for store closings and restructuring costs reflects anticipated
expenses related to the program. The restructuring charge primarily includes
lease termination and other costs associated with store closures as well as a
provision for the impairment of long-lived assets in accordance with SFAS No.
121.

Interest expense. Interest expense increased to $82,000 for the
thirteen weeks ended October 29, 1997 from $78,000 for the thirteen weeks ended
October 30, 1996. Interest expense for the 39 weeks ended October 29, 1997 was
$104,000 compared to $187,000 for the 39 weeks ended October 30, 1996.

Income (loss) before taxes. Loss before taxes for the thirteen weeks
ended October 29, 1997 was $739,000 compared to income before taxes of $77,000
for the thirteen weeks ended October 30, 1996. This change was primarily the
result of increases in cost of sales and related occupancy, depreciation and
amortization, and general and administrative costs as a percentage of sales.

Operating loss for the thirty-nine weeks ended October 29, 1997 was
$6,820,000 (including the restructuring charge of $4,200,000) compared to
operating income of $262,000 for the thirty-nine weeks ended October 30, 1996.
This change was principally the result of the restructuring provision discussed
above as well as increases in cost of sales and related occupancy, depreciation
and amortization, and general and administrative costs as a percentage of sales.

LIQUIDITY AND CAPITAL RESOURCES

The Company had working capital of $362,000 as of October 29, 1997
compared to working capital of $1,949,000 as of January 29, 1997. The current
period working capital includes remaining restructuring liabilities of
$1,213,000. Cash used by operating activities for the thirty-nine weeks ended
July 30, 1997 totaled $1,985,000.

On May 27, 1997, the Company made a promissory note (the "Note") for
the benefit of the Palm Trust of which Paul Heeschen, a director, is a trustee.
Mr. Heeschen has no beneficial interest in the Palm Trust. The Note provides for
borrowings by the Company up to $1,500,000 with interest accruing at the prime
rate plus 3 1/2%. All outstanding principal and accrued interest was due and
payable on January 27, 1998 or promptly after the closing of any new debt or
equity financing in an amount exceeding $1,500,000. This indebtedness was fully
paid and discharged on October 20, 1997 with the proceeds of borrowings from the
Ocean and Grandview Trusts described below.

On August 19, 1997, the Company entered into a promissory note, term
loan agreement, and security agreement with the Virginia R. Cirica Trust (the
"Cirica Trust Loan Documents"). That trust is controlled by Ms. Cirica, who is
the spouse of Lawrence Goelman, Chairman and Interim Chief Executive Officer of
the Company.

Shortly before the Cirica Trust entered into the Cirica Trust Loan
Documents, Mr. Goelman loaned Ms. Cirica approximately $250,000. Some of those
funds were transferred by Ms. Cirica to the Cirica Trust and advanced to the
Company pursuant to the Cirica Trust Loan Documents. The loan is secured by the
assets of the Company and provides for borrowings up to $500,000 with interest
accruing at the prime rate plus 3 1/2 %. All outstanding principal and accrued
interest is due and payable on August 19, 2002.

In connection with the Cirica Trust Loan Documents, the Company issued
a warrant to the Cirica Trust to purchase up to 85,000 shares of the Company's
common stock if the loan is repaid in full in 120 days of closing, or up to
170,000 shares of the Company's common stock if the loan is not repaid within
120 days, all at a price of $2.25 a share. The warrants are exercisable
immediately and expire on the later of August 19, 2003 or one year following
payment in full of the loan. Mr. Goelman disclaims any pecuniary interest in the
loan to the Company, and any beneficial interest in the Cirica Trust, except to
the extent to which Mr. Goelman is a contingent beneficiary under the terms of
the Cirica Trust.

On September 30, 1997 the Company entered into a promissory note, term
loan agreement and security agreement with Nuvrty, Inc., a Colorado corporation
controlled by Amre Youness, a former director of the Company (the "Nuvrty Loan
Documents"). The loan is secured by the assets of the Company and provides for
borrowings up to $1,000,000 with interest accruing and paid monthly at the prime
rate plus 3 1/2 %. The Company borrowed the full amount under the loan.

In connection with the Nuvrty Loan Documents, the Company issued a
warrant to Nuvrty, Inc. to purchase up to 170,000 shares of the Company's common
stock if the Loan is repaid in full within 120

days of closing and up to 340,000 shares of the Company's common stock if the
loan is not repaid within 120 days, all at a price of $2.25 per share. The
warrants are exercisable immediately and expire on the later of September 30,
2003 or one year following payment in full of the loan.

On October 16, 1997 the Company entered into parallel promissory notes,
term loan agreements and security agreements with the Ocean and Grandview Trusts
on terms identical to those entered into with the Virginia R. Cirica Trust and
Nuvrty, Inc. (the "Ocean Trust Loan Documents" and the "Grandview Trust Loan
Documents", respectively). The Ocean Trust Loan Documents and the Grandview
Trust Loan Documents provide for borrowing up to $750,000 from each Trust. Each
loan is secured by the assets of the Company. Interest on advances is accrued
and payable monthly at the prime rate plus 3 1/2%. The Company borrowed $750,000
under each facility. All outstanding principal and accrued interest is due and
payable on October 16, 2002.

In connection with the Ocean Trust Loan Documents and the Grandview
Trust Loan Documents the Company issued warrants to each Trust respectively to
purchase up to 127,500 shares each of the Company's common stock if the loan is
repaid in full within 120 days of closing, or up to 255,000 shares each of the
Company's common stock if the loan is not repaid in full within 120 days of
closing, all at a price of $2.25 per share. The warrants are exercisable
immediately and expire on the later of October 16, 2003 or one year following
payment in full of the respective loans. The Company used the proceeds from the
Ocean Trust and Grandview Trusts Loans to pay off and discharge the outstanding
indebtedness to the Palm Trust.

The Company believes that cash from operations and the aforementioned
financing activities will be sufficient to satisfy the Company's working capital
needs for the remainder of the fiscal year. The Company anticipates that it will
need to seek additional debt or equity financing to fund development of new
retail locations and additional capital expenditures currently projected for
fiscal 1999, which begins as of January 29, 1998.

PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION

NEW CHAIRMAN OF THE BOARD AND NEW PRESIDENT AND CHIEF EXECUTIVE OFFICER

On November 18, 1997, the Company announced that former Taco Bell
Worldwide Chairman and Chief Executive Officer Mr. John E. Martin had agreed to
join the Company's Board of Directors as Chairman replacing Lawrence Goelman. On
November 17, 1997, Mr. Martin entered into a letter agreement with the Company
appointing him Chairman of the Board of the Company. Subject to stockholder
approval, the Company entered into a performance-based Stock Option Plan and
Agreement under which Mr. Martin will be granted the option to purchase up to
850,000 shares of the common stock of the Company. Mr. Martin and the Company
also agreed to terms under which Mr. Martin will purchase 333,333 shares of the
Company's common stock at $3.00 per share.

The Stock Option Plan and Agreement grants Mr. Martin the option to
purchase up to 850,000 shares of the common stock of the Company subject to
stockholder approval. The options granted to Mr. Martin become exercisable at
the following exercise prices: 450,000 shares of common stock at an exercise
price of $4.00 per share; 100,000 shares of common stock at an exercise price of
$5.00 per share; 150,000 shares of common stock at an exercise price of $8.00
and 150,000 shares of common stock at an exercise price of $10.00. All of the
options granted to Mr. Martin become exercisable on the earlier of May 15, 2002
or as soon as the closing price of the Company's common stock exceeds the
respective price for at least seven (7) trading days in any period of ten (10)
consecutive trading days. All options are to terminate if unexercised on
November 17, 2002. The Stock Option Plan and Agreement with Mr. Martin is
attached hereto as Exhibit 10.22.

The Company also entered into a Common Stock Purchase Agreement with
Mr. Martin under which it has agreed to issue and sell 333,333 restricted shares
of Common Stock of the Company to Mr. Martin at $3.00 per share, such price
representing the fair market value of the Common Stock, as of November 17, 1997.
The Common Stock Purchase Agreement is attached hereto as Exhibit 10.23.

Lawrence Goelman will continue to serve as a Director. The authorized
number of directors was increased, in accordance with the Bylaws, from four to
six.

NEW CHIEF EXECUTIVE OFFICER

On November 18, 1997, the Company announced that it named experienced
restaurant industry executive Timothy J. Ryan, former president of Sizzler USA,
and a former colleague of Mr. Martin's at Taco Bell Worldwide, as Diedrich
Coffee's President and Chief Executive Officer to replace Lawrence Goelman,
Interim Chief Executive Officer. Subject to stockholder approval, the Company
entered into a performance based Stock Option Plan and Agreement under which Mr.
Ryan will be granted the option to purchase up to 600,000 shares of the common
stock of the Company. Mr. Ryan will also invest $50,000 in the Company pursuant
to a private sale of restricted stock.

On November 17, 1997, Mr. Ryan entered into an employment agreement
with the Company to serve as Chief Executive Officer. The term of Mr. Ryan's
agreement is two years. The agreement provides for an annual salary of $200,000
per year and a discretionary performance bonus.

The Stock Option Plan and Agreement with Mr. Ryan grants Mr. Ryan the
option to purchase an aggregate of 600,000 shares of the Common Stock of the
Company, contingent upon the approval of the stockholders. The options granted
to Mr. Ryan become exercisable at the following exercise prices: 50,000 shares
of Common Stock at an exercise price of $3.50 per share; 75,000 shares of Common
Stock at an

exercise price of $4.50 per share; 125,000 shares of Common Stock at an exercise
price of $5.00 per share; 175,000 shares of Common Stock at an exercise price of
$8.00 per share and 175,000 shares of Common Stock at an exercise price of
$10.00 per share. The shares become exercisable on the earlier of (i) May 15,
2002 or (ii) upon the satisfaction of two conditions: (x) the options having
vested pursuant to a vesting schedule set forth in the agreement, and (y) after
the date of the agreement, the closing price of the Common Stock shall have
exceeded the option price per share for at least seven trading days in any
period of ten consecutive trading days. The agreement is attached hereto as
Exhibit 10.25.

The Company entered into a Common Stock Purchase Agreement with Mr.
Ryan under which it has agreed to issue and sell 16,667 restricted shares of the
Common Stock of the Company to Mr. Ryan at $3.00 per share, such price
representing the fair market value of the Common Stock, on the date of the Ryan
Employment Agreement. The Common Stock Purchase Agreement with Mr. Ryan is
attached hereto as Exhibit 10.26.

Mr. Kerry Coin, formerly President and Chief Operating Officer,
continues as Chief Operating Officer.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Set forth below is a list of the exhibits included as part of this
Quarterly Report:

Exhibit No. Description
----------- -----------

3.1 Certificate of Incorporation of the Company (1)

3.2 Bylaws of the Company (1)

10.27 Form of Promissory Note made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust

10.28 Form of Term Loan Agreement entered into with Nuvrty,
Inc., the Ocean Trust and the Grandview Trust

10.29 Form of Security Agreement entered into with Nuvrty,
Inc., the Ocean Trust and the Grandview Trust

10.30 Form of Warrant Agreement entered into with Nuvrty,
Inc., the Ocean Trust and the Grandview Trust

10.31 Form of Inter Creditor Agreement among Nuvrty, Inc.,
the Ocean Trust, the Grandview Trust and the Cirica
Trust.

10.32 Amendment to Kerry Coin's employment agreement dated
September 24, 1997

10.33 Form of Indemnification Agreement - John Bayley

10.34 Form of Indemnification Agreement - Jonathan Eddison

10.35 Form of Indemnification Agreement - John Martin

10.36 Form of Indemnification Agreement - Timothy J. Ryan

27 Financial data schedule

(1) Incorporated by reference to the exhibit of the same
number to the Company's Registration Statement on Form
S-1 ( No. 333-08633), as amended, as declared effective
by the Securities and Exchange Commission on September
11, 1996.

(b) Reports on Form 8-K

None.

SIGNATURES

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

Dated: December __, 1997 DIEDRICH COFFEE, INC.

/s/ Timothy J. Ryan
----------------------------------------
Timothy J. Ryan,
Chief Executive Officer

/s/ John Bayley
----------------------------------------
John Bayley,
Vice President of Finance and
Controller (principal financial officer)