For the thirty-six weeks ended March 4, 2009, the Company incurred a net loss of $1.4 million and reported net cash used in operating activities of $3.2 million. The Company had a cash balance of $1.1 million with $5 million of outstanding borrowings under its credit facilities as of March 4, 2009.

A $5,000,000 Note Purchase Agreement with Sequoia Enterprises, L.P. ("Sequoia"), a limited partnership whose sole general partner also serves as the Chairman of the Company's board of directors (the "Note Purchase Agreement"), expires on March 31, 2009 and the $2 million balance on the outstanding note is due in full on that date. The Company obtained an extension on the $2.0 million note to April 30, 2009 while the Company finalizes contractual details with Sequoia of this commitment. In addition, the Company obtained a $3 million term loan from Sequoia on August 26, 2008.

On January 23, 2009 and March 27, 2009 the Company obtained commitments from the lenders Sequoia and Vessel Partners, L.P., which are limited partnerships whose general partner also serves as the Chairman of the Company's board of directors (collectively, the "Lenders") for additional borrowings of up to $5 million and to extend the maturity date of the $2 million note due under the Note Purchase Agreement to March 31, 2010. The Company and the Lenders are currently in the process of finalizing the contractual details of this commitment. See Note 11.

The Company believes that cash flow from operations, funds available from the credit agreements and additional lending commitments obtained from the Lenders will be sufficient to satisfy working capital needs at the anticipated operating levels for at least the next twelve months.

The Company's future capital requirements will depend on many factors, including the extent and timing of the rate at which the business grows, if at all, with corresponding demands for working capital. The Company may be required to seek additional funding through debt financing, equity financing or a combination of funding methods to meet capital requirements and sustain operations. However, additional funds may not be available on terms acceptable or at all.

3. ACCOUNTS RECEIVABLE

During the thirty-six weeks ended March 4, 2009, the Company provided for $585,000 of additional allowance for doubtful accounts and charged off $519,000 of accounts receivable against the reserve.

The following table details the components of net accounts receivable:

                                                  March 4, 2009       June 25, 2008
 Wholesale receivables                           $     9,797,000     $     4,814,000
 Allowance for wholesale receivables                    (326,000 )          (285,000 )

                                                       9,471,000           4,529,000

 Franchise and other receivables                         636,000             709,000
 Allowance for franchise and other receivables          (248,000 )          (223,000 )

                                                         388,000             486,000

 Total accounts receivable, net                  $     9,859,000     $     5,015,000

4. INVENTORIES


Inventories consist of the following:



                                             March 4, 2009     June 25, 2008
        Unroasted coffee                    $       649,000   $     1,608,000
        Roasted coffee                            1,590,000         1,163,000
        Accessory and specialty items               167,000           104,000
        Other food, beverage and supplies         2,440,000         1,777,000

        Total inventory                     $     4,846,000   $     4,652,000

5. NOTES RECEIVABLE


Notes receivable consists of the following:



                                                         March 4, 2009         June 25, 2008
Notes receivable bearing interest at rates from 0%
to 8.0%, payable in monthly installments varying
between $115 and $650 and due on various dates
through August 2016. Notes are secured by the
assets sold under the asset purchase and sale
agreements or general security agreement. Amounts
are net of allowance of $138,000 and $247,000,
respectively                                            $        22,000       $       177,000
Notes receivable from a corporation discounted at
an annual rate of 8.0%, payable annually in
installments varying between $1,000,000 and
$2,000,000, due between January 31, 2010 and
January 31, 2011                                              2,746,000             3,560,000
Less: current portion of notes receivable                    (2,014,000 )          (1,074,000 )

Long-term portion of notes receivable                   $       754,000       $     2,663,000

6. ACCRUED PROVISION FOR STORE CLOSURE

As required by SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"), the Company records estimated costs for store closures when they are incurred rather than at the date of a commitment to an exit or disposal plan. These costs primarily consist of the estimated cost to terminate real estate leases.

The following table details the components of accrued provision for store closure:

                                                       Amounts
                                        Beginning      Charged         Cash         Ending
                                         Balance      to Expense     Payments       Balance
 Fiscal Year ended June 25, 2008        $  811,000   $    806,000   $ (679,000 )   $ 938,000
 Thirty-six Weeks ended March 4, 2009   $  938,000   $    109,000   $ (268,000 )   $ 779,000

Of the $779,000 reserve balance for store closures at March 4, 2009, $745,000 and $34,000 are reserved for continuing operations and discontinued operations, respectively. For the thirty-six weeks ended March 4, 2009, $109,000 was charged to costs of sales and related occupancy costs. Of the $938,000 reserve balance for store closures at June 25, 2008, $849,000 and $89,000 are reserved for continuing operations and discontinued operations, respectively.

7. NOTE PAYABLE






                                                       March 4, 2009         June 25, 2008
Note payable amount bearing interest at a rate of
three-month LIBOR plus 9.30% (10.73% as of
March 4, 2009) is due and payable on April 30,
2009. Note is unsecured.                              $     2,000,000       $     2,000,000
Note payable amount bearing interest at a rate of
one-month LIBOR plus 9.30% (9.80% as of March 4,
2009). Note is unsecured.                                   3,000,000                    -
Discount on note payable                                     (850,000 )            (259,000 )

                                                      $     4,150,000       $     1,741,000
Less: current portion of notes payable, net of
discount                                                   (2,647,000 )          (1,741,000 )

Long-term portion of notes payable, net of
discount                                              $     1,503,000       $            -

8. EARNINGS PER SHARE


The following table sets forth the computation of basic and diluted net loss per
share from continuing operations:



                                          Twelve            Twelve            Thirty-six          Thirty-six
                                        Weeks Ended       Weeks Ended         Weeks Ended         Weeks Ended
                                       March 4, 2009     March 5, 2008       March 4, 2009       March 5, 2008
Numerator:
Net income (loss) from continuing
operations                            $     1,358,000   $    (2,153,000 )   $    (1,420,000 )   $    (4,349,000 )

Denominator:
Basic weighted average shares
outstanding                                 5,468,000         5,454,000           5,468,000           5,462,000
Effect of dilutive securities                      -                 -                   -                   -

Diluted adjusted weighted average
shares                                      5,468,000         5,454,000           5,468,000           5,462,000

Basic and diluted net income (loss)
per share from continuing
operations                            $          0.25   $         (0.39 )   $         (0.26 )   $         (0.80 )

For the quarters ended March 4, 2009 and March 5, 2008, employee stock options of approximately 663,000, and 757,000, respectively, and warrants of 500,000 for each year, were excluded from the computation of diluted earnings per share as their impact would have been anti-dilutive. In addition, for the twelve and thirty-six weeks ended March 4, 2009 approximately 1,667,000 stock purchase warrants outstanding pursuant to the terms of the 2008 Sequoia Warrant (as discussed in Note 11), and for the twelve and thirty-six weeks ended March 5, 2008, 1,275,000 stock purchase warrants outstanding pursuant to terms of the Note Purchase Agreement (as discussed in Note 11) were excluded from the computation of diluted earnings per share as their impact would have been anti-dilutive.

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

                                          Twelve            Twelve            Thirty-six          Thirty-six
                                        Weeks Ended       Weeks Ended         Weeks Ended         Weeks Ended
                                       March 4, 2009     March 5, 2008       March 4, 2009       March 5, 2008
Numerator:
Net income (loss)                     $     1,358,000   $    (2,153,000 )   $    (1,420,000 )   $    (3,582,000 )

Denominator:
Basic weighted average shares
outstanding                                 5,468,000         5,454,000           5,468,000           5,462,000
Effect of dilutive securities                      -                 -                   -                   -

Diluted adjusted weighted average
shares                                      5,468,000         5,454,000           5,468,000           5,462,000

Basic and diluted net income (loss)
per share                             $          0.25   $         (0.39 )   $         (0.26 )   $         (0.66 )

9. SEGMENT AND RELATED INFORMATION

The Company has three reportable segments: wholesale operations, franchise operations and retail 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.

Summarized financial information concerning the Company's reportable segments is shown in the following tables. Corporate identifiable assets consist of corporate cash, corporate notes receivable, corporate prepaid expenses, and corporate property and equipment. The corporate component of segment loss before tax includes corporate general and administrative expenses, depreciation and amortization expense, interest income and interest expense.

                                                 TWELVE WEEKS ENDED                    THIRTY-SIX WEEKS ENDED
                                          March 4, 2009       March 5, 2008       March 4, 2009       March 5, 2008
Net revenue:
Wholesale                                $    17,384,000     $     9,663,000     $    41,361,000     $    26,497,000
Franchise                                        580,000             658,000           1,649,000           2,090,000
Retail                                         1,545,000           1,001,000           3,833,000           3,343,000

Total net revenue                        $    19,509,000     $    11,322,000     $    46,843,000     $    31,930,000

Interest expense:
Wholesale                                $            -      $            -      $            -      $            -
Franchise                                             -                   -                   -                   -
Corporate                                        227,000              11,000             794,000              34,000

Total interest expense                   $       227,000     $        11,000     $       794,000     $        34,000

Depreciation and amortization:
Wholesale                                $       346,000     $       190,000     $       940,000     $       510,000
Retail                                            20,000              43,000              38,000             102,000
Corporate                                         63,000              70,000             195,000             223,000

Total depreciation and amortization      $       429,000     $       303,000     $     1,173,000     $       835,000

Segment income (loss) from continuing
operations before income tax benefit:
Wholesale                                $     3,049,000     $       442,000     $     4,676,000     $     1,435,000
Franchise                                        (37,000 )          (206,000 )          (350,000 )        (1,106,000 )
Retail                                           145,000              43,000             214,000             272,000
Corporate                                     (1,791,000 )        (2,363,000 )        (5,948,000 )        (5,421,000 )

Total segment income (loss) from
continuing operations before income
tax provision (benefit)                  $     1,366,000     $    (2,084,000 )   $    (1,408,000 )   $    (4,820,000 )

                                       March 4, 2009     June 25, 2008
               Identifiable assets:
               Wholesale              $    19,554,000   $    15,008,000
               Franchise                      864,000         1,084,000
               Retail                         541,000           170,000
               Corporate                    6,480,000         6,474,000

               Total assets           $    27,439,000   $    22,736,000

10. LEASE CONTINGENCIES

In addition to the corporate office, warehouse and store leases, the Company is liable on the master real property leases for 31 franchise locations. Under the Company's historical franchising business model, the Company executed the master lease for these locations and entered 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 March 4, 2009, computed as the sum of all remaining lease payments through the expiration dates of the respective leases, was $8,259,000. 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 location or terminating the master lease by negotiating a lump sum payment to the landlord in an amount that is less than the sum of all remaining future rents and related payables. In addition, the Company also leases equipment with various expiration dates. On March 27, 2009, the Company entered into an agreement to sell its United States franchise operations of Gloria Jean's (See Note 15).

11. OUTSTANDING DEBT, FINANCING ARRANGEMENTS AND RESTRICTED CASH

Note Purchase Agreement:

On May 10, 2004, the Company entered into the Note Purchase Agreement with Sequoia, which provided, at the Company's election, the ability to issue notes with up to an aggregate principal amount of $5,000,000. The Company has amended the Note Purchase Agreement from time to time and has agreed to refrain from further borrowings under the Note Purchase Agreement in connection with the entry into the Loan Agreement (as defined below) entered into on August 26, 2008. As amended, the notes issued under the Note Purchase Agreement are due in full on April 30, 2009, and the Company is only required to make monthly payments of interest and the monthly commitment fee, but not principal, until such date. On the maturity date, all outstanding principal, interest and other amounts payable under the Note Purchase Agreement will be due unless due earlier pursuant to the terms of the Note Purchase Agreement upon a change in control of the Company or an event of default. Interest is payable at three-month LIBOR plus 9.3% for any period during which the ratio of Indebtedness (as defined in the Note Purchase Agreement) of the Company on a consolidated basis to Effective Tangible Net Worth (as defined in the Note Purchase Agreement) is greater than 1.75:1.00 or the three-month LIBOR plus 6.30% for any other period, in each case reset on a periodic basis as provided in the Loan Agreement. The Note Purchase Agreement contains covenants, among others, that limit the amount of indebtedness that the Company may have outstanding in relation to its tangible net worth. As of March 4, 2009, the Company was in compliance with all covenants under the Note Purchase Agreement. As of March 4, 2009, $2,000,000 is outstanding under the Note Purchase Agreement.

Loan Agreement:

On August 26, 2008, the Company entered into a loan agreement with Sequoia (the "Loan Agreement"). The Loan Agreement provides for a $3 million term loan (the "Term Loan") to the Company. The Term Loan accrues interest from the funding date at one-month LIBOR plus 5.30%, resetting on the first calendar day of each month. On November 10, 2008, the Company entered into a Waiver Agreement (as defined below). In consideration of such waiver, the interest rates under the Loan Agreement were increased to one-month LIBOR plus 9.30% for any period during which the ratio of Indebtedness (as defined in the Loan Agreement) of the Company on a consolidated basis to Effective Tangible Net Worth (as defined in the Loan Agreement) is greater than 1.75:1.00 or one-month LIBOR plus 6.30% for any other period, in each case reset on a periodic basis as provided in the Loan Agreement. The Company is required to make regular monthly payments of interest, and to cause the principal amount to be reduced to $2 million no later than August 26, 2009. All outstanding principal and interest will be due on the maturity date of August 26, 2011, unless due earlier pursuant to the terms of the Loan Agreement upon a change of control of the Company or an event of default. As of March 4, 2009, $3,000,000 is outstanding under the Loan Agreement.

The Loan Agreement requires the Company to refrain from further borrowings under the Note Purchase Agreement and contains restrictions on incurring indebtedness on par with, or senior to, the Term Loan. The Loan Agreement also contains a covenant that limits the amount of indebtedness that the Company may have outstanding in relation to tangible net worth, in addition to other standard covenants and events of default. As of March 4, 2009, the Company was in compliance with all covenants under the Loan Agreement.

The Term Loan is senior to all other indebtedness of the Company, except indebtedness pursuant to notes issued under the Note Purchase Agreement and certain permitted indebtedness identified in the Loan Agreement. Upon repayment of the notes under the Note Purchase Agreement, the Term Loan will be senior to all other indebtedness of the Company, except such permitted indebtedness.

Warrants:

In connection with the Loan Agreement and an amendment to the Note Purchase Agreement, on August 26, 2008, the Company issued to Sequoia a warrant (the "2008 Sequoia Warrant") to purchase 1,667,000 shares of common stock of the Company. On November 10, 2008 the exercise price of the 2008 Sequoia Warrant was decreased from $2.00 to $1.65 in connection with the Waiver Agreement (as defined below).

In addition, the exercise price of the 2001 Sequoia Warrants for 250,000 shares of common stock was reduced from $2.00 to $1.65 per share.

Waiver Agreement:

On November 10, 2008, the Company entered into a Waiver, Agreement, Amendment No. 1 to 2008 Warrant and Amendment No. 2 to 2001 Warrant (the "Waiver Agreement") with Sequoia. Pursuant to the Waiver Agreement, Sequoia waived the requirement set forth in the Note Purchase Agreement and the Loan Agreement with Sequoia (collectively, the "Loan Agreements") that the Company shall not permit, as of the end of any fiscal quarter, the ratio of Indebtedness of the Company on a consolidated basis to Effective Tangible Net Worth to be more than 1.75:1.00 (as such terms are defined in the Loan Agreements). Such waiver is effective until the earlier of (a) October 31, 2009 and (b) the end of any fiscal quarter at which the foregoing ratio is greater than 2.10:1.00.

In consideration of such waiver, (a) the exercise prices of the warrant to purchase 250,000 shares of the Company's common stock issued to Sequoia on May 8, 2001 and the warrant to purchase 1,667,000 shares of the Company's common stock issued to Sequoia on August 26, 2008 were decreased from $2.00 to $1.65, and (b) the per annum interest rates under the Loan Agreements were increased from the LIBOR Rate (as defined in the Loan Agreements) plus 5.30% to (i) the LIBOR Rate plus 9.30% for any period during which the ratio of Indebtedness of the Company on a consolidated basis to Effective Tangible Net Worth is greater than 1.75:1.00 or (ii) the LIBOR Rate plus 6.30% for any other period, in each case reset on a periodic basis as provided in the Loan Agreements.

Loan Commitment

On January 23, 2009 and March 27, 2009 the Company obtained commitments from the lenders for additional borrowings of up to $5 million and to extend the maturity date of the $2 million note due under the Note Purchase Agreement to March 31, 2010. The Company and the Lenders are currently in the process of finalizing the contractual details of this commitment.

Letter of Credit:

In addition, we entered into a Credit Agreement with Bank of the West on November 4, 2005. The agreement provides for a $750,000 letter of credit facility that expires on October 15, 2009. The letter of credit facility is secured by a deposit account at Bank of the West. As of March 4, 2009, this deposit account had a balance of $622,000, which is shown as restricted cash on the consolidated balance sheets. As of March 4, 2009, $472,000 of letters of credit were outstanding under the letter of credit facility. The agreement contains covenants that, among other matters, require us to submit financial statements to Bank of the West within specified time periods. As of March 4, 2009, the Company was in compliance with all Bank of the West agreement covenants.

12. LEGAL SETTLEMENT ACCRUAL

On September 21, 2006, a purported class action complaint entitled Jason Reid; Kimberly Cornia, et al. v. Diedrich Coffee., et al. was filed against the Company in United States District Court Central District of California by two former employees, who worked in the positions of team member and shift manager. A second similar purported class action complaint entitled Deborah Willems, et al. v. Diedrich Coffee., et al. was filed in Orange County, California Superior Court on February 2, 2007, on behalf of another former employee who worked in the position of general manager. These cases currently involve the issue of whether employees and former employees who worked in California stores during specified time periods were deprived of overtime pay, missed meal and rest breaks. In addition to unpaid overtime, these cases seek to recover waiting time penalties, interest, attorneys' fees and other types of relief on behalf of the current and former employees in the purported class.

The Company has entered into a settlement with the plaintiffs in the Reid v. Diedrich lawsuit. This settlement has been given preliminary approval by the court. A final approval hearing is set for April 27, 2009. As of March 4, 2009, the Company estimates the total amount to settle this claim to be $693,000 and has recorded an accrual for this amount.

Subject to court approval, the Company has entered into a tentative settlement with the plaintiffs in the Willems v. Diedrichlawsuit. As of March 4, 2009, the Company estimates the total amount to settle this claim to be $251,000 and has recorded an accrual for this amount.

Based on the Company's examination of these matters and its experience to date, the Company has recorded its best estimate of liability with respect to these matters. However, the ultimate liability cannot be determined with certainty.

13. DISCONTINUED OPERATIONS

During the fiscal year ended June 27, 2007, the Company sold leaseholds and related assets of 32 stores to Starbucks Corporation and seven stores to other third parties. As part of the asset purchase agreement with Starbucks Corporation, the Company agreed to a non-compete provision that for three years after the closing of the transaction, restricts the Company's ability to operate or have any interest in the ownership or operation of any entity operating any retail specialty coffee stores in any city where a Company Store was located at the time that the asset purchase agreement was executed. The non-compete provision applies only to stores opened after the date of the asset purchase agreement and does not apply to (1) any retail stores operated under the "Gloria Jean's" brand name, (2) wholesale sales to retail businesses that are not operated by the Company, or other non-retail businesses, or (3) the conversion . . .