1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

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

For the quarterly period ended April 29, 1998

|_| 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
Incorporation or Organization) Identification No.)

2144 MICHELSON DRIVE
IRVINE, CALIFORNIA 92612
(Address of Principal Executive Offices including Zip Code)

(949) 260-1600
(Registrant's Telephone Number including Area Code)

----------------------------

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 June 10, 1998, there were 5,941,650 shares of common stock of the
registrant outstanding.

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DIEDRICH COFFEE, INC.

INDEX

PAGE NO.
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PART I - FINANCIAL INFORMATION

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............................................ 11

Item 3 Quantitative and Qualitative Disclosures About Market Risk....... 15

PART II- OTHER INFORMATION

Item 1 Legal Proceedings................................................ 15

Item 6 Exhibits and Reports on Form 8-K................................. 15

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

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

DIEDRICH COFFEE, INC.
CONDENSED BALANCE SHEETS

ASSETS APRIL 29, 1998 JANUARY 28, 1998
-------------- ----------------

Current Assets:
Cash $ 1,913,609 $ 1,408,161
Accounts receivable 197,658 181,628
Inventories (Note 2) 1,201,472 1,375,119
Prepaid expenses 184,403 157,393
Income taxes receivable 19,363 42,528
-------------- -------------
Total current assets 3,516,505 3,164,829

Property and equipment, net 9,594,202 10,104,843
Costs in excess of net assets acquired, net 349,545 389,651
Other assets 260,391 289,103
-------------- -------------
Total assets $ 13,720,643 $ 13,948,426
============== =============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
Current installments of obligations under capital $ 169,488 $ 168,139
lease
Accounts payable 1,150,696 1,204,366
Accrued compensation 586,202 716,742
Accrued expenses 1,258,824 1,796,869
Restructuring charge 159,394 237,320
-------------- -------------
Total current liabilities 3,324,604 4,123,436

Obligation under capital lease - long term 349,457 317,292
Long term debt (Note 3) 2,500,000 2,500,000
Deferred rent 181,739 172,231
-------------- -------------
Total liabilities 6,355,800 7,112,959
-------------- -------------

Stockholders' Equity: (Note 4)
Common stock 59,417 57,417
Additional paid-in capital 18,204,113 16,928,546
Accumulated deficit (10,898,687) (10,150,496)
--------------- --------------
Total stockholders' equity 7,364,843 6,835,457
-------------- -------------
Commitments and contingencies
Total liabilities and stockholders' equity $ 13,720,643 $ 13,948,426
============== =============

See accompanying notes to financial statements.

DIEDRICH COFFEE, INC.
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)

THIRTEEN WEEKS THIRTEEN WEEKS
ENDED APRIL 29, ENDED APRIL 30,
1998 1997
--------------- ---------------

Net Sales:
Retail $ 5,285,060 $ 5,384,625
Wholesale and other 638,301 483,095
------------ ------------
Total 5,923,361 5,867,720
------------ ------------

Cost and Expenses:
Cost of sales and related occupancy costs 2,682,665 3,041,815
Store operating expenses 2,283,903 2,380,227
Other operating expenses 148,785 64,325
Depreciation and amortization 482,222 447,439
Provision for store closings and restructuring costs -- 4,550,068
General and administrative expenses 974,848 774,325
------------ ------------
Total 6,572,422 11,258,199
------------ ------------

Operating loss (649,061) (5,390,479)

Interest expense (97,273) --

Interest and other income 1,510 7,660
------------ ------------

Loss before income taxes (744,825) (5,382,819)

Income tax provision 800 --
------------ ------------

Net Loss (745,625) $ (5,382,819)
============ ============

Basic net loss per share: $ (0.13) $ (1.00)
============ ============
Diluted net loss per share:
$ (0.13) $ (1.00)
============ ============

Weighted average shares outstanding 5,800,991 5,391,650
============ ============

See accompanying notes to financial statements.

DIEDRICH COFFEE, INC.
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)

THIRTEEN WEEKS THIRTEEN WEEKS
ENDED APRIL 29, ENDED APRIL 30,
1998 1997
--------------- ---------------

Cash flows from operating activities:
Net loss $ (745,625) $(5,382,819)
Adjustments to reconcile net loss to cash used
in operating activities:
Depreciation and amortization 482,222 447,439
Provision for asset impairment and
restructuring costs -- 4,287,660
Changes in assets and liabilities:
Accounts receivable (16,030) 11,274
Inventories 173,647 94,130
Prepaid expenses (27,010) (31,354)
Income taxes receivable 23,165 82,653
Other assets 430 (7,531)
Accounts payable (53,670) (715,545)
Accrued compensation (189,616) (168,751)
Accrued expenses (32,385) 78,374
Deferred rent 9,508 --
----------- -----------
Net cash used in operating activities (375,364) (1,304,470)
----------- -----------

Cash flows from investing activities:
Capital expenditures for property and equipment (373,575) (623,625)
----------- -----------
Net cash used in investing activities $ (373,575) $ (623,625)
=========== ===========

Cash flows from financing activities:
Proceeds from issuance of common stock, net fees 1,275,000 --
paid
Payment on capital lease obligation (20,613) --
----------- -----------
Net cash provided by financing activities $ 1,254,387 $ --
----------- -----------
Net increase (decrease) in cash 505,448 (1,928,095)
----------- -----------
Cash at beginning of period 1,408,161 2,071,904
----------- -----------
Cash at end of period 1,913,609 $ 143,809
=========== ===========

Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 75,000 $ --
=========== ===========
Income taxes 800 $ --
=========== ===========

Non-cash Transactions
Equipment Purchased under Capital Lease $ 54,127 $ --
=========== ===========

See accompanying notes to financial statements

DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
APRIL 29, 1998
(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 April 29, 1998 and the results of operations and cash
flows for the thirteen weeks ended April 29, 1998 and April 30, 1997 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 28, 1998.

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 determined that the impact of SFAS No. 130 on its consolidated
financial statements is not material.

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. SFAS No. 131 will be applied in the
preparation of the Company's annual financial statements for the year ending
January 27, 1999.

In April 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of
Start-up Activities". This SOP requires that costs incurred during start-up
activities, including organization costs, be expensed as incurred. SOP 98-5 is
effective for financial statements for fiscal years beginning after December 15,
1998. Initial application of the SOP should be as of the beginning of the fiscal
year in which the SOP is first adopted and should be reported as a cumulative
effect of a change in accounting principle. The Company has adopted SOP 98-5
which had an impact of $22,000 in the thirteen weeks ended April 29, 1998.

Net Loss Per Common Share

In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 specifies new

7
DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
APRIL 29, 1998
(UNAUDITED)

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. Some of the changes made to
simplify the EPS computations include: (a) eliminating the presentation of
primary EPS and replacing it with basic EPS, with the principal difference being
that the common stock equivalents are not considered in computing basic EPS, (b)
eliminating the modified treasury stock method and the three percent materiality
provision and (c) revising the contingent share provisions and the supplemental
EPS data requirements. SFAS No. 128 also makes a number of changes to existing
disclosure requirements. SFAS No. 128 is effective for financial statements
issued for periods ending after December 15, 1997, including interim periods.
Basic earnings per share are presented for the thirteen weeks ended April 29,
1998 and April 30, 1997; diluted earnings per share are not presented as losses
were incurred in those years.

2. INVENTORIES

Inventories consist of the following:

APRIL 29, 1998 JANUARY 28, 1998
-------------- ----------------

Green coffee $ 406,725 $ 535,885
Roasted coffee 91,348 67,965
Accessory and specialty items 194,843 230,502
Other food, beverage and supplies 508,556 540,767
--------------- --------------
$ 1,201,472 $ 1,375,119
=============== ==============

3. DEBT

Long-term debt consists of the following:

APRIL 29, 1998 JANUARY 28, 1998
-------------- ----------------

NUVRTY, INC.
Note payable bearing interest at prime rate
plus 3 1/2%, interest payable monthly. Note
is secured by the assets of the Company. $1,000,000 $1,000,000
Due September 30, 2002

GRANDVIEW TRUST
Note payable bearing interest at prime rate
plus 31/2%, interest payable monthly. Note 750,000 750,000
is secured by the assets of the Company.
Due October 15, 2002

OCEAN TRUST
Note payable bearing interest at prime rate
plus 31/2%, interest payable monthly. Note 750,000 $750,000
is secured by the assets of the Company.
Due October 16, 2002
---------- ----------
$2,500,000 $2,500,000
========== ==========

In March 1997, the Company received a commitment for a $1 million line
of credit on arms-length terms from a significant stockholder of the Company.

DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
APRIL 29, 1998
(UNAUDITED)

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 provided 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 borrowing 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, then 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 was secured by the
assets of the Company and provided 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.

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 was repaid in full within 120 days of closing, or up to
170,000 shares of the Company's common stock if the loan was 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. The loan was repaid in full and discharged on December 17,
1997.

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"). All outstanding principal and accrued interest is due and payable
on September 30, 2002. 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 was repaid in full within 120 days of closing and up to 340,000
shares of the Company's common stock if the loan was 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.

DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
APRIL 29, 1998
(UNAUDITED)

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 loans
were repaid in full within 120 days of closing, or up to 255,000 shares
respectively of the Company's common stock if the loans were 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 warrants associated with all the above debt were accounted for in
accordance with the provisions of APB 14, "Accounting for Convertible Debt and
Debt Issued Stock Purchase Warrants." In accordance with APB 14, none of the
proceeds from issuance of the debt was allocated to the warrants based on their
relative fair value calculated using both a Cost of Replacement Model and the
Monte Carlo simulation of possible warrant exercise and no expense was
recognized.

4. STOCKHOLDERS' EQUITY

On April 25, 1997, the Company's Board of Directors approved the 1997
Non-Employee Director's Stock Option Plan under which options for 10,000 shares
each were granted to two non-employee directors. These options have an exercise
price of $2.75, became vested on April 25, 1998 and expire on April 25, 2007.

On November 18, 1997, Mr. John E. Martin joined 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. The Company and Mr. Martin also entered into an
agreement under which Mr. Martin would be granted the option to purchase up to
850,000 shares of the common stock of the Company subject to stockholder
approval. Mr. Martin and the Company also agreed to terms under which Mr. Martin
would purchase 333,333 shares of the Company's common stock at $3.00 per share,
following stockholder approval of the Martin Option Agreement.

On November 18, 1997, Mr. Timothy J. Ryan joined the Company 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 would be granted the option to purchase up to 600,000 shares of the common
stock of the Company and Mr. Ryan would purchase 16,667 shares at $3.00 per
share in the Company pursuant to a private sale of restricted stock.

On January 22, 1998 the stockholders of the Company approved the stock
option plans and agreements with John Martin and Timothy Ryan. On January 28,
1998 Messrs. Martin and Ryan completed their respective private purchases of
Company stock of $1,000,000 and $50,000, respectively.

On March 30, 1998 the Company agreed to a private placement of 200,000
shares of the Company's common stock to Franchise Mortgage Acceptance Company
("FMAC") at a price of $6.375 (the stock's closing sale price for that day on
the Nasdaq National Stock Market). In addition, FMAC also received an option to
purchase 100,000 additional shares of the Company's common stock; this option
may be exercised in increments of 25,000 shares or more and expires on April 3,
2000. The exercise prices of this option are as follows: 50,000 shares are
exercisable at $10.00 per share and $12.50 per share, respectively.

10
DIEDRICH COFFEE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
APRIL 29, 1998
(UNAUDITED)

The fair value of this option is estimated to be $72,042. The estimated fair
value of the option has been charged to equity and will be amortized ratably
over the two year life of the option. Amortization for the period ended April
29, 1998 totaled $2,566. This transaction was completed on April 3, 1998.

PART I - FINANCIAL INFORMATION

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

FORWARD LOOKING STATEMENTS

From time to time, in both written reports and oral statements, the
Company makes "forward-looking statements" within the meaning of Federal and
state securities laws. Disclosures that use words such as the Company
"believes," "anticipates," "expects," "may" or "plans" and similar expressions
are intended to identify forward-looking statements. These forward-looking
statements reflect the Company's current expectations and are based upon data
available at the time of the statements. Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from expectations. Any such forward-looking statements, whether made in this
report or elsewhere, should be considered in context with the various
disclosures made by the Company about its business, including the factors
discussed below. 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. Foreseeable
risks and uncertainties are described elsewhere in this report and in detail
under "Risk 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 28,
1998 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. The Company's objective is to be the leading
national chain of neighborhood coffeehouses serving the best coffee
possible-technically and by consumer choice. To complement beverage sales, the
Company sells light food items and whole bean coffee through its coffeehouses.
The Company also sells roasted coffee as well as coffee brewing and espresso
equipment through a wholesale sales force. As of April 29, 1998, the Company
operated thirty-six coffeehouses and seven coffee carts located in California,
Colorado and Texas.

First Quarter. In the first quarter of the current fiscal year the
Company experienced losses of approximately $740,000 principally related to an
increase in interest expense and general and administrative expense. The level
of general and administrative expense is directly related to management's
commitment to grow the Company through retail coffeehouse development, new
wholesale channels, and franchise area development. Achieving this goal depends
upon, among other things, obtaining and maintaining sufficient working capital,
aggressive growth in the wholesale division, execution of new store management
systems, successful negotiation of franchise area development agreements and
improved store management and customer satisfaction.

Developments in the First Quarter. Pursuant to the Company's strategic
plan, the roasting facility in Denver, Colorado was closed in the first quarter
and the roasting was consolidated in Southern California. The Company also
closed an under-performing store in San Diego and one in Denver, Colorado. Four
coffee cart locations at premium Irvine Office Company locations were opened in
the first quarter. Additional coffee cart locations are under

consideration and in discussion with the Irvine Office Company and similar
commercial property managers, but no assurances can be given as to when or how
many more coffee carts may be installed.

Area Development Objectives. Management's franchise area development
goals are to enter into fifteen to seventeen franchise area development
agreements covering most major U. S. markets by the end of fiscal year 2000.
Although the Company is engaged in preliminary discussions with potential area
developers, there can be no assurances given as to when or at what rate area
development agreements are entered into. Successful area development depends
significantly upon the expertise, staff and capital of the area developer as
well as all of the contingencies and uncertainties to which the Company and its
business are subject.

Management plans to continue to develop, over the next five years,
Company-owned coffee houses, kiosks and mobile carts in Orange County,
California and in two to four other major U. S. markets. Outside of Orange
County, Company-owned store development will depend upon franchise area
development revenues and continued growth and improvements in Company operations
and coffee house-level execution.

Franchise Area Development Financing. On April 14, 1998 the Company
announced a strategic relationship with the Franchise Mortgage Acceptance
Company ("FMAC") located in Los Angeles. FMAC stated its willingness to finance,
through secured lending, franchise area developers selected by the Company. FMAC
is a leading company in multi-unit restaurant franchise financing. The Company
believes that this relationship will facilitate the Company's planned program of
franchise area development, but no assurances can be given as to actual
financing commitments or the effects of any such commitment. The Company does
not anticipate entering into any franchise area development agreement before the
latter half of the fiscal year. Area development agreements commit the area
developer to build and open coffeehouses in the agreed-upon territory according
to an agreed-upon schedule covering several years. No assurances can be given as
to the rate of new coffeehouse construction, much less related franchise
revenues.

Private Placement. On April 3, 1998 the Company closed a private
placement with Franchise Mortgage Acceptance Company ("FMAC"). FMAC purchased
200,000 shares of restricted stock at a price of $6.675 per share and received
50,000 options exercisable at $10 per share and 50,000 options exercisable at
$12.50 per share. FMAC is the leading mortgage lender to the multi-unit
restaurant industry.

Secured Debt. On April 14, 1998 the Company announced FMAC's commitment,
subject to approval of final documentation by the Boards of Directors of both
companies, to make a secured revolving loan of up to $5 million to the Company.
When closed in the second quarter, management believes that this facility will
provide sufficient working capital, along with other anticipated internal
sources, for the balance of the fiscal year.

Master License Agreement with Home Savings. Home Savings notified the
Company in the first quarter that, in light of changes related to Home Savings
merger with Washington Mutual, the Master License Agreement dated January 29,
1997 between the Company and Home Savings was terminated. The termination does
not affect the existing Santa Monica coffeehouse. Although it is possible that
the successor in interest to Home Savings and the Company may enter into future
real estate and coffee house transactions, there can be no assurance as to when
or whether there will be any future agreements between the parties.

Green Coffee Prices. Worldwide coffee commodity prices moderated from
the record levels reached in the second and third quarters of fiscal 1998. In
the first quarter of fiscal year 1999, however, the Company's cost of green
coffee exceed prior year levels by approximately 7%. 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.

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 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 of when the Company will return
to profitability nor of future growth rate.

RESULTS OF OPERATIONS

Thirteen Weeks Ended April 29; 1998 Compared with the Thirteen Weeks Ended
April 30, 1997

Net sales. Net sales for the thirteen weeks ended April 29, 1998
increased 1.0% to $5,923,000 from $5,868,000 for the thirteen weeks ended April
30, 1997. During this most recent quarter, the Company derived 89.2% 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 April 29, 1998 decreased 1.9% to $5,285,000 from $5,385,000
in the thirteen weeks ended April 30, 1997. As of April 29, 1998, the Company
operated 36 coffeehouses and seven carts; as of April 30, 1997, the Company
operated 44 coffeehouses and one cart. The percentage increase in first quarter
of fiscal 1999 comparable store sales was 2.2%.

Wholesale and other sales increased 32.1% to $638,000 in the thirteen
weeks ended April 29, 1998 from $483,000 in the thirteen weeks ended April 30,
1997. The increase reflects increasing demand for the Company's wholesale coffee
products and increased sales efforts. Although the Company anticipates continued
improvement in wholesale sales, this depends upon successful acquisition,
installation and operation of new packaging equipment scheduled for the second
quarter. There can be no assurances that the anticipated wholesale sales gains
will happen.

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 April 29, 1998
decreased to $2,683,000 from $3,042,000 for the thirteen weeks ended April 30,
1997. As a percentage of net sales, cost of sales and related

occupancy costs decreased to 45.3% in the first quarter of fiscal 1999 from
51.8% for the first quarter of fiscal 1998. This decreased percentage was the
result of average unit volume efficiencies resulting from the closure of low
volume locations as well as purchasing efficiencies. These more than offset the
impact of higher green coffee prices, increased occupancy costs, and an increase
in the percentage of total revenues contributed by wholesale sales.

Store operating expenses. Store operating expenses decreased to
$2,284,000 for the thirteen weeks ended April 29, 1998 from $2,380,000 for the
thirteen weeks ended April 30, 1997. As a percentage of retail net sales, store
operating expenses decreased to 43.2% in the first quarter of fiscal 1999 from
44.2% in the prior fiscal year's first quarter.

Other Operating Expenses. Other operating expenses (those associated
with wholesale and other sales) increased to $149,000 for the first quarter of
fiscal 1999 from $64,000 in the first quarter of fiscal 1998. These expenses, as
a percentage of the net sales from the wholesale division, increased to 23.4%
from 13.3%. 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 decrease as wholesale sales increase.

Depreciation and Amortization. Depreciation and amortization increased
to $482,000 for the thirteen weeks ended April 29, 1998 from $447,000 for the
thirteen weeks ended April 30, 1997. As a percentage of net sales, depreciation
and amortization increased to 8.1% from 7.6% for the same period in the prior
year, principally due to higher average store volumes.

General and Administrative Expenses. General and administrative expenses
increased to $975,000 for the first quarter of fiscal 1999 from $774,000 for the
first quarter of fiscal 1998. As a percentage of net sales, general and
administrative expenses increased to 16.4% from 13.2% due to the adding of
selected resources and personnel in order to implement the Company's business
plan. 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 - assuming successful execution of the new business plan.

Provision for Store Closings and Restructuring Costs. The restructuring
charge recorded in fiscal 1998 included primarily 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 $97,000 for the thirteen
weeks ended April 29, 1998 from $0 for the thirteen weeks ended April 30, 1997
reflecting the addition of the $2.5 million in long-term debt and $500,000 in
assets under capital leases.

Loss Before Taxes. Loss before taxes for the thirteen weeks ended April
29, 1998 was $739,000 compared to loss before taxes of $5,383,000 for the
thirteen weeks ended April 30, 1997.

LIQUIDITY AND CAPITAL RESOURCES

The Company had working capital of $192,000 as of April 29, 1998
compared to working capital deficit of $(959,000) as of January 28, 1998. The
current period working capital includes remaining restructuring liabilities of
$159,000. Cash used by operating activities for the thirteen weeks ended April
29, 1998 totaled $(375,364).

On April 3, 1998, the Company closed a private placement with Franchise
Mortgage Acceptance Company of Los Angeles, California ("FMAC") of 200,000
shares of Company restricted common stock at a price of $6.675 a share, or
approximately a $1,275,000 equity investment in the Company. In addition to the
private purchase, FMAC also acquired options to purchase restricted shares of
the Company's common stock, 50,000 shares at $10.00 and 50,000 shares at $12.50.
John Martin, Chairman of the Board of the Company, serves as a member of the
Board of Directors of FMAC.

On April 14, 1998 the Company announced FMAC's commitment, subject to
approval of final documentation by the Boards of Directors of both companies, to
make a secured revolving loan of up to $5 million to the Company. When closed in
the second quarter, management believes that this facility will provide
sufficient working capital, along with other anticipated internal sources, for
the balance of the fiscal year.

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.

ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

Derivative Instruments. The Company did not invest in market risk
sensitive instruments in fiscal 1998, nor in the first quarter of 1999. From
time to time, the Company enters into agreements to purchase green coffee in the
future at prices to be determined within two to twelve months of the time of
actual purchase. At April 29, 1998 these commitments totaled $987,000. These
agreements are tied to specific market prices (defined by both the origin of the
coffee and the month of delivery) but the Company has significant flexibility in
selecting the date of the market price to be used in each contract. The Company
does not use commodity based financial instruments to hedge coffee or any other
commodity as the Company believes there will continue to be a high probability
of maintaining a strong correlation between increases in green coffee prices and
the final selling prices of the Company's products.

Market Risk. The Company's market risk exposure with regard to financial
instruments is to changes in the "prime rate" in the United States. The Company
borrowed $2,500,000 at the prime rate plus 3 1/2%. At April 29, 1998, a
hypothetical 100 basis point increase in the prime rate would result in
additional interest expense of $25,278 on an annualized basis. At April 29, 1998
the prime rate was 8 1/2%.

The Company does not and has not used derivative financial instruments
for any purpose, including hedging or mitigating interest rate risk.

PART II- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of its business, the Company may become involved
in legal proceedings from time to time. As of June 8, 1998, the Company was not
a party to any material pending legal proceedings.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

None.

(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)
10.40 Employment Agreement - Ann Wride
10.41 Indemnification Agreement - Ann Wride
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: June 11, 1998 DIEDRICH COFFEE, INC.

/s/ Timothy J. Ryan
-------------------------------------------
Timothy J. Ryan,
President and Chief Executive Officer
(Principal Executive Officer)

/s/ Ann Wride
-------------------------------------------
Ann Wride
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

17
18
EXHIBIT INDEX

EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 Certificate of Incorporation of the Company (1)

3.2 Bylaws of the Company (1)

10.40 Employment Agreement - Ann Wride

10.41 Indemnification Agreement - Ann Wride

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.