<PAGE>   1
                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                   FORM 10-KSB


              [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1997

                                       OR

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


               For the transition period from ________ to ________


                        Commission File No. 33-960-70-LA


                        THANKSGIVING COFFEE COMPANY, INC.
                      (Exact name of small business issuer
                          as specified in its charter)

             California                              94-2823626
   (State or other jurisdiction of                 (IRS Employer
    incorporation or organization)             Identification Number)



        19100 South Harbor Drive
          Fort Bragg, California                         95437
 (Address of principal executive officers)             (Zip Code)

         Issuer's telephone number, including area code: (707) 964-0118


              (Former name, former address and former fiscal year,
                          if changed since last report)


        Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 [ ]

        Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any


<PAGE>   2
amendment to this Form 10-KSB.  [X]

        State issuer's revenues for its most recent fiscal year: $6,222,128

        State the aggregate market value of the voting stock held by
nonaffiliates computed by reference to the price at which the stock was sold, or
the average bid and asked prices of such stock, as of a specified date within 60
days prior to the date of filing: $1,320,938 as of February 6, 1998.

        As of December 31, 1997, there were issued and outstanding 1,236,744
shares of common stock of the issuer.

                       DOCUMENTS INCORPORATED BY REFERENCE

        List hereunder the documents if incorporated by reference and the Part
of this Form 10-KSB into which the document is incorporated: None.


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                        THANKSGIVING COFFEE COMPANY, INC.

                                      INDEX


<TABLE>
<CAPTION>
                                                                                    Page No.
<S>                                                                                 <C>
PART I.

  Item 1.      Description of Business......................................           1

  Item 2.      Description of Property......................................           9

  Item 3.      Legal Proceedings..............................................         10

  Item 4.      Submission of Matters to a Vote of
               Security Holders...............................................         10

PART II.

  Item 5.      Market for Common Equity and Related
               Stockholder Matters............................................         10

  Item 6.      Management's Discussion and Analysis or
               Plan of Operation..............................................         11

  Item 7.      Financial Statements...........................................         15

  Item 8.      Changes in and Disagreements With
               Accountants on Accounting and Financial
               Disclosure.....................................................         15

PART III.

  Item 9.      Directors and Executive Officers of the
               Registrant.....................................................         15

  Item 10.     Executive Compensation.........................................         17

  Item 11.     Security Ownership of Management and
               Certain Others.................................................         17

  Item 12.     Certain Relationships and Related
               Transactions...................................................         18

  Item 13.     Exhibits and Reports on Form 8-K...............................         19
</TABLE>


<PAGE>   4
                                     PART I

ITEM 1: BUSINESS

FORWARD LOOKING INFORMATION

     Certain information in this Form 10-KSB, including planned expansions into
new and existing markets and trends in the operations of Thanksgiving Coffee
Company, Inc. (the "Company"), may be perceived to be forward looking
statements. Any such statements should be considered in light of various risks
and uncertainties that could cause results to differ materially from
expectations, estimates or forecasts expressed. The various risks and
uncertainties include, but are not limited to: changes in general economic
conditions, changes in business conditions in the coffee industry, fluctuations
in consumer demand for coffee products and in the availability and costs of
green coffee beans, increased competition within the Company's businesses, the
management challenges of rapid growth, variances from budgeted sales mix and
growth rate, consumer acceptance of the Company's new products, inability to
secure adequate capital to fund its operating losses and working capital
requirements, inability to hire, train and retain qualified personnel,
concentration of production and sales in Northern California, the loss of one or
more major customers, inability to successfully implement its business plan,
weather and other risks identified herein. The Company does not undertake to
update any forward looking statement that may be made from time to time by or on
its behalf.

GENERAL

     For more than twenty-five years, Thanksgiving Coffee Company, Inc. (the
"Company") has purchased, roasted and marketed high quality coffee beans to the
specialty coffee market. The Company buys green coffee beans through Sustainable
Harvest, Inc.("Sustainable Harvest"), a supplier of shade grown, arabica coffee
beans which was a wholly-owned subsidiary of the Company in fiscal 1997, and
through six other importers. At the end of fiscal 1997, the Company sold
Sustainable Harvest but has an agreement to purchase beans from Sustainable
Harvest for five years. See "Green Bean Coffee Supply and Availability."

     The Company was incorporated as a California corporation on May 10, 1982.
Prior to that time, the Company was operated as a partnership.

     The Company retails over 100 varieties of its coffee and tea through its
own distribution system in the Northern California market.  In other parts of
the nation the Company distributes either direct to retailers or through
brokers.  The Company also


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markets directly to consumers through both the print and electronic media. It
publishes a mail order catalogue which features most of the Company's coffee and
tea products, in addition to complementary products and accessories of third
parties. The same product offerings are made on the Company's web site on the
internet. The Company also markets its coffee and tea products in its retail
bakery (the "Bakery"), located on the north Mendocino coast of California. At
the end of February 1998, the Company closed its retail coffee shop (the
"Cafe"), which had previously marketed the Company's coffee and tea products.

     In October 1996, the Company completed its offering of shares of Common
Stock. During the subsequent twelve months, the Company added a division
director and two fulfillment clerks to the direct marketing department, hired a
new controller, increased its sales staff by five in its direct sales division
and by one in its national sales distribution and added a designer responsible
for graphic art, web site design and maintenance, and marketing. As of December
31, 1997, 1,341 shareholders held shares of the Company's Common Stock which
represents approximately 21% of the outstanding shares.

SOCIAL RESPONSIBILITY

     It has been the hallmark of the Company to not only provide an excellent
cup of quality coffee but also procure, roast, package and market its products
in a fair manner to all its customers. The Company's motto, "Not Just a Cup, but
a Just Cup,"(TM) reflects the Company's commitment to local coffee growers in
developing nations. It donates $0.15 per package of selected organic coffees for
the benefit of local coffee co-operatives to help diversify their economies and
improve their economic future.

     The clear cutting of the rain forests to provide land for sun- grown coffee
has destroyed the habitat of neo-tropical song birds. To assist the preservation
of this bird habitat in coffee growing nations and to support the promotion of
public awareness of this destruction, the Company provides cash rebates to the
American Birding Association. It provides a $0.15 rebate for every Song Bird
coffee package sold and a $0.15 rebate for every pound of bulk Song Bird coffee
sold.

     The Company also contributes coffee, money and employee time to a number of
causes aligned with its commitment to social and environmental responsibility.

PRODUCTS

     COFFEE.  The Company roasts a wide variety of whole bean caffeinated,
decaffeinated, flavored, blended and unblended


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coffees. With the exception of its high-caffeinated coffees, the Company roasts
only high quality arabica beans with a focus on organics and shade grown beans.
Arabica beans are grown at high altitudes where the cooler climate results in
slow growth and high quality. Packages have been custom-designed for retailers'
particular products. Currently, the Company is producing custom products for the
American Birding Association under an exclusive ten-year contract and
private-label products for over 100 retail and serving accounts, in addition to
its full line of classic specialty and estate coffees from over 20 countries.

     TEA. The Company's Royal Gardens Tea Company ("Royal Gardens") division
currently offers eleven traditional teas from China, India, Sri Lanka and Japan.
Royal Gardens packages its tea in gauze fabric bags which can expand to
accommodate whole leaf teas and allow proper infusion, unlike most teas which
are packaged in paper bags. Since the ability of paper to expand on immersion is
limited compared to gauze fabric, paper tea bags contain crushed leaves of
lower quality teas. The Company believes that Royal Gardens tea is the only tea
product that is packaged in fabric tea bags, and that this distinction is a
competitive advantage for the Company.

        Supplies of tea are secured from traditional sources which are readily
available in the marketplace. Royal Gardens is a founding member of
the American Premium Tea Institute.

     COMPLEMENTARY PRODUCTS. The Company sells a wide variety of complementary
coffee and tea products and accessories, such as coffee and espresso makers,
grinders, thermal carafes, books, T- shirts, mugs, CD's and chocolate covered
espresso beans. The Company's complementary products are purchased in quantities
for its mail order catalog and can be discontinued if no longer available.

     The Company sells its coffees and teas through a multi-channel distribution
network consisting of wholesale operations, a Company- owned Bakery and direct
marketing operations. The Company offers its complementary products through its
Bakery and direct mail operations. The Company generally provides its wholesale
customers with brewing, grinding and related equipment (leased from
manufacturers) and product displays (designed and manufactured by the Company)
at no charge if predetermined sales volumes are reached. The Company believes
that its ability to construct its own display fixtures gives it a competitive
advantage because supermarkets, which constitute a significant portion of the
target market, require custom design fixture programs at low cost, with
accelerated delivery times. The Company believes that its major competitors
outsource the manufacture of their displays, and that such outsourcing
makes it more difficult for competitors


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to meet the supermarkets' quick delivery requirements.

     In fiscal 1997, coffee and tea sales comprised approximately 95% and 2%,
respectively, of the Company's core revenues (exclusive of revenues from the
Cafe, Bakery and Sustainable Harvest), with complementary products accounting
for approximately 3% of the Company's core revenues.

COFFEE INDUSTRY

     Specialty coffee is one of the fastest growing segments of the coffee
industry. According to the Specialty Coffee Association of America, the
production of mild arabica coffees, which are the basis of specialty coffee
sales, represents approximately $6.7 billion or 47% of the estimated total world
coffee trade valued at $14 billion in 1997. In 1997, the U.S. specialty coffee
industry purchased over 2.5 million bags of arabica coffees, which represent
$396 million or approximately 5% of the world's output. In the United States
during the past five years, specialty coffee beverage retailers have become the
fastest growing distribution channel in the specialty coffee industry. The
industry is expected to continue to be fragmented with only a few specialty
coffee companies possessing a nationally distributed brand. Costs of green
specialty coffee increased greatly in fiscal 1997 due to the inability of green
coffee suppliers to meet the growing world wide demand for coffee, the
unfavorable weather conditions in certain growing regions and the limited
inventories of high quality and organic coffee beans in the consuming nations.

MARKETING STRATEGY

     The Company's sales and marketing efforts are organized in three different
segments:

       1. Wholesale, direct delivery -- This segment includes customers in
northern California counties contiguous to the Company plant in Fort Bragg, CA,
and serviced by Company trucks. The Company owns or leases trucks and delivers
coffee within a 200 mile radius of Fort Bragg, California.

       2. Wholesale, delivery by other means -- This segment includes accounts
which are serviced by UPS or other common carriers. Delivery is made to over 500
loyal accounts which span all 50 states of the United States.

       3. Direct Marketing -- This segment includes accounts serviced through
catalogue or online programs.

     During fiscal 1997, the Company made a dramatic shift in its blend of
product sales.  This shift, which is expected to continue
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through fiscal 1998, is based on the introduction of Song Bird Coffee(TM) to the
marketplace. The Company has embarked on a campaign to market coffees to bird
lovers under an exclusive ten-year agreement with the American Birding
Association ("ABA") to produce and market Song Bird Coffee(TM) worldwide. Song
Bird Coffee(TM) is a registered trademark of the American Birding Association
("ABA"), one of America's most active and prestigious birding membership
associations with over 19,000 members.

        The Company's strategy of "repositioning" its coffee products by
targeting bird lovers instead of coffee lovers is predicated on the fact that
migratory birds are in population decline due to loss of habitat, which results
from the clearing of shade tree canopy to allow coffee to grow in the sun. The
Smithsonian Migratory Bird Center's landmark 1996 study reported that as much as
60% of the migratory bird population of North America has disappeared since
1972, and traced this disappearance to the reduction of forest habitat in
Central and South America caused by the "technification" of coffee agriculture.
The Company's environmental concerns have meshed perfectly with the birding
community, and the Company's marketing efforts have been extremely successful to
date. Between April and December 1997, the Company opened over 250 new accounts
to exclusively retail Song Bird Coffee(TM).

     In fiscal 1997, the Company pioneered the sale of the Song Bird Coffee(TM)
in bird stores, home and garden centers and drug stores. It also began to offer
Song Bird Coffee(TM) through more traditional retail venues such as
supermarkets, restaurants and cafes, and in its direct marketing catalogue.
This effort is intended to increase the awareness of the coffee drinking public
and the birding community that production of sun grown coffee on previously
forested lands was a major factor in the deterioration of the world's rain
forests and habitat of migratory song birds. By educating consumers through
packaging and special venue sales, such as bird stores, the Company's aim is
the creation of a strong market for shade grown coffees which preserves bird
habitat. Support by consumers could influence coffee farms to be replanted to
limited or natural shade, and thus, help stop the destruction of the
environment before additional losses occur in the song bird population.

        The Company believes that its relationship with the ABA has
distinguished the Company's role and image in the marketplace. Since the
inception and introduction of Song Bird Coffee(TM), several significant changes
in the coffee industry have occurred:

        1. The Specialty Coffee Association of America ("SCAA") has changed its
        14-year old mission statement to include the words: "social
        responsibility", "environmental sensitivity", and "sustainability".


<PAGE>   9
        2. A Second National Conference on Coffee and the Environment, which is
        co-sponsored by the SCAA and the Smithsonian Migratory Bird Center, will
        be held on April 17, 1998, in Denver, Colorado. The Company's Chief
        Executive Officer, Paul Katzeff, is co-chairman of the conference.

        3. The international community of coffee producers has accepted the goal
        of "sustainability" as the economic direction of choice.

        4. Shade grown coffee now appears on the "offer" lists of  most
        coffee brokers and importers and is offered by a majority of small to
        mid-size coffee roasters of specialty coffee.

        5. Coffee producing countries, such as Costa Rica, have begun shade
        replantings on their sun coffee farms to improve the quality of their
        coffee beans and to benefit from premium prices paid for shade coffee.

     The Company believes these positive developments are attributable in part
to the presence of Song Bird Coffee(TM) in the marketplace. The devotion of
more of the Company's resources to the production of Song Bird Coffee(TM) has
resulted in a corresponding increase in the percentage of the Company's
packaged and bulk roasted shade grown and organic coffee varieties, from
approximately 30% of sales in fiscal 1996 to just over 33% of sales in fiscal
1997. On an annualized basis, sales of Song Bird Coffee(TM), which was first
introduced to the market in April 1997, represented 10% of the Company's
packaged and bulk roasted coffee sales in fiscal 1997.

        This rapid shift in the Company's product mix had an adverse impact on
the Company's gross margins in fiscal 1997, because cost of sales for shade
grown and organic coffee beans generally cost up to 41% more than sun grown
coffee. The Company's management recognized this problem late in the fourth
quarter of fiscal 1997, and has revised the Company's pricing structure to
enable sales to become profitable.

     In fiscal 1997, in addition to its marketing emphasis on shade grown and
organic coffee, the Company embarked on an aggressive prospecting campaign to
increase the number of names in its direct mail marketing list. This effort
required significant cash outlays for purchasing and renting lists, advertising
and mailing. In addition, significant outlays were needed for catalogue
designing and printing which generated higher sales. As a result, over 25,000
names were added to the Company's mailing list and annual mail order sales
volume increased by 40% in fiscal 1997. Sales from the


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internet catalogue continue to increase with the addition of two new web sites
for Song Bird Coffee (TM) and "Zip" coffee.

COMPETITION

     The specialty coffee market is highly competitive, and the Company competes
against all sellers of specialty coffee. At the wholesale level, the Company
competes with several nationally known premium coffee brands, such as Proctor &
Gamble's Millstone label and Nestle's Sarks label, as well as other lesser known
brands and store brands. The Company also competes regionally in Northern
California with small regional specialty roasters for retail shelf space and
with large regional roasters for food service trade. In the direct mail area,
the Company competes with established suppliers such as Gevalia, a division of
General Foods Corporation, as well as with other direct mail companies,
including Starbuck's, a leading independent specialty coffee retailer with a
limited wholesale operation.

     The Company competes primarily on the basis of the quality of its products,
the superiority of its graphics, and its social and environmental philosophies.
While the Company believes it competes favorably with respect to these factors,
many of the Company's competitors are larger than the Company and have
significantly greater financial, marketing and other resources than the Company,
and there can be no assurance that it will be able to compete or maintain or
expand sales successfully in the future.

        The Company's philosophy on competition is to lead rather than follow.
The Company attempts to cooperate with retailers in introducing novel products
which face little or no competition and to place its products in markets where
such products have not previously been sold. For example, Song Bird Coffee(TM)
is marketed in stores where bird lovers purchase birdseed and bird houses. The
Company calls this strategy "repositioning". See "Marketing Strategy."

        Similarly, the Company sells organic coffee in the socially responsible
marketplace, repositioning its products as carriers of issues as well as flavor.
In fiscal 1997, the Company's coffee products were served and sold by
prestigious environmental organizations such as The World Wildlife Fund, Natural
Resource Defense Council, Monterey Bay Aquarium, the Cape May Bird Observatory
and by several other national institutions where social and environmental action
can be achieved through earmarked spending policies.

        The Company cannot guarantee successful competition against more highly
funded coffee companies. The Company believes its focus on repositioning and
partnering has enabled it to find a


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niche in the coffee market, however there can be no assurance that the Company's
marketing efforts will be successful.

GREEN BEAN COFFEE SUPPLY AND AVAILABILITY

     The Company purchases green beans from a number of importers as well as
from farmer representatives and small producer cooperatives. Although most
coffee trades in the worldwide commodities markets, coffee of the quality sought
by the Company tends to trade on a negotiated basis at a substantial premium or
"differential" above commodity coffee pricing, depending upon the supply and
demand at the time of purchase. Supply and price can be affected by multiple
factors, such as weather, politics and economics in the producing countries.

        In addition, in its attempt to reduce the cost risk resulting from
market fluctuations in the cost of coffee beans, the Company does from time to
time purchase coffee option contracts when it is not able to enter into coffee
purchase commitments. Changes in the market value of option contracts are
reported by the Company in the period in which the change occurs and are
included as part of cost of sales.

     With respect to organic and shade grown coffee, the Company has entered
into a five-year agreement with Sustainable Harvest to secure a supply of
organic and shade grown coffee beans. Under this agreement, the Company must
purchase and Sustainable Harvest must provide a minimum annual amount of beans
at a fixed mark-up above cost. This agreement is intended to ensure a supply of
organic and shade grown coffee for the Company's production of Song Bird
Coffee(TM).

    The Company believes its long-term relationships with coffee bean brokers,
including Sustainable Harvest, provide adequate sources of supply of
high-quality green beans to meet its needs for the foreseeable future. However,
a worldwide supply shortage of the high quality arabica coffees the Company
purchases, and a shortage of organic and shade grown beans in particular, could
have an adverse impact on the Company. The Company is pursuing long-term
contracts with its Nicaraguan, Costa Rican and Mexican producers.

SUMMARY OF RECENT DEVELOPMENTS

     In the fiscal quarter ended March 31, 1997, the Company commenced
operations of its wholly-owned subsidiary, Sustainable Harvest, which imports
green coffee beans for resale. Sustainable Harvest's operations were intended to
provide the Company with a supply of shade coffees that would meet the standards
set by the Company's 5-year market plan. Effective December 31, 1997, the


<PAGE>   12
Company sold all the outstanding stock of Sustainable Harvest to Mr. David
Griswold, an officer of Sustainable Harvest, and entered into a five-year
agreement with Sustainable Harvest for the purchase of organic and shade grown
coffee beans. These transactions were intended to establish and secure for the
Company a source of supply without the risks associated with the operations a
green coffee importing company and without the need for large capital outlays to
finance purchases of container loads of coffee, which could impact negatively on
the cash flow of the Company. In fiscal 1997, the Company recorded a loss of
$29,471 from the sale of Sustainable Harvest.

        The results of the Company's Cafe, which previously retailed the
Company's coffee and tea products, did not meet expectations, and accordingly,
in an effort to reduce operating costs and overhead, management closed the Cafe
effective February 1998.

CUSTOMERS

    In fiscal 1997, no customer accounted for more than 8% of the Company's
revenue from coffee sales. However, significant reduction in sales to any of the
Company's principal customers, or the loss of one or more major customers, may
have an adverse impact on the Company. In fiscal 1997, the Company continued its
efforts to expand its customer base and added over 250 new accounts to its
wholesale business by introducing Song Bird Coffee(TM) to birding stores, lawn
and garden centers and national park gift shops. See "Marketing Strategy."

INTELLECTUAL PROPERTY

     The Company holds various federal registrations in the United States for
the following trademarks and service marks: Thanksgiving Coffee Company, Royal
Gardens Tea Company, Pony Express, Time Bandits, Grand Slam Coffee, "Not Just a
Cup...But a Just Cup," "Many Beans are Picked, Few are Chosen," Mayan Harvest,
and Inca Harvest. Federal trademark and service mark registrations must be
renewed every 10 years. Some of the Company's registered marks may require
renewal in the near future. The Company also has several applications pending
for registration of additional trademarks and service marks including the
Zapotec Powerline mark. The Company does not hold any patents.

GOVERNMENT REGULATION

     The Company's roasting plant has been certified by the Organic Crop
Improvement Association (OCIA). The OCIA has also certified the organic
practices of several farms from which the Company receives green beans. The
certification criteria of the OCIA, an independent organization, meet the
standards promulgated under the


<PAGE>   13
Organic Foods Production Act of 1990 (OFPA). The Company believes that new
federal regulations regarding organic and natural food products will not
adversely affect the Company because it already adheres to OCIA standards that
are as stringent as the new regulations.

EMPLOYEES

     As of December 31, 1997, the Company had approximately fifty-eight
full-time employees and seventeen part-time employees. Subsequent to the sale of
Sustainable Harvest effective December 31, 1997, and the closing of the
Company's Cafe in February 1998, the Company had approximately fifty-four
full-time employees and fifteen part-time employees. None of the Company's
employees are covered by a collective bargaining agreement. The Company has
never suffered a work stoppage due to adverse labor conditions with its
employees. The Company believes that it maintains good relations with its
employees.

ITEM 2: PROPERTIES

     The executive offices of the Company occupy approximately 14,500 square
feet at 19100 South Noyo Harbor Drive, Fort Bragg, California 95437, which also
includes a warehouse and the capacity for manufacturing operations. The Company
leases an additional 1,626 square feet of storage space on the Fort Bragg
waterfront. These facilities are currently being leased for a five-year term
expiring March 31, 2000, at a rate of approximately $8,500 per month in fiscal
1997 and $8,600 per month in fiscal 1998, from affiliates of the Company, Joan
and Paul Katzeff, who are founders, principal shareholders, officers and
directors of the Company. The Company has an option to extend this lease for
three additional five-year periods. The Company believes this lease represents
an arms-length rate and arms-length terms for comparable space in the Fort Bragg
area. See Item 12, "Certain Relationships and Related Transactions."

     The Company's Bakery in Mendocino is approximately 1,617 square feet and is
leased from an unaffiliated third party. The Company currently pays rent of
approximately $2,700 per month for the Bakery pursuant to a ten-year lease that
commenced on October 1, 1990. The Bakery has an option to extend its lease
through September 30, 2010.

     The Company believes that its current facilities are adequate for its
current and expected operations, and that suitable additional space will be
available in the Fort Bragg area when and if additional space is required. The
Company owns no real property.


<PAGE>   14
     The "month-to-month" lease for the Sustainable Harvest premises has been
assumed by the new owner of Sustainable Harvest. The Company is currently in
negotiations to sub-lease the Cafe premises to another tenant.

ITEM 3:  LEGAL PROCEEDINGS

     The Company is not currently party to any material pending legal
proceeding.

ITEM 4:  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   No matters were submitted to a vote of security holders during the fiscal
quarter ending December 31, 1997.

                                            PART II

ITEM 5:  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS

     Trades in the Company's Common Stock are made through Mutual Securities,
Inc., ("Mutual Securities") in Ukiah, California, an order matching service. No
established trading market exists for the Company's Common Stock. The Company's
Common Stock is not listed on any exchange nor the NASDAQ system, and the
Company does not currently intend to seek such listing in fiscal 1998.

     There were no trades in the Company's Common Stock prior to the second
quarter of fiscal 1997. During the second, third and fourth quarters of fiscal
1997, the Company was aware of only 29 trades of the Company's Common Stock
totaling 14,700 shares of Common Stock. Since all transactions were individually
negotiated between the buyer and seller through Mutual Securities as
intermediary, the Company was not informed of the exact purchase price for the
Common Stock sold in each of these transactions. The Company, however, was
informed by Mutual Securities that the Company's Common Stock traded at $5.25 in
the second quarter of fiscal 1997, at $5.00 in the third quarter of fiscal 1997,
and at $5.00, $5.125 and $5.25 in the fourth quarter of fiscal 1997.

     The Company has not declared nor paid any cash dividend since its
inception. The Company intends to retain all earnings for use in its business
and therefore does not anticipate paying any cash dividends in the near future.
The Company's bank credit agreement prohibits the payment of cash dividends
without the bank's consent.

     As of December 31, 1997, there were 1,341 holders of record of the Common
Stock.

ITEM 6:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS


<PAGE>   15
     The following discussion of financial condition and results of operations
should be read in conjunction with the Company's audited financial statements
and notes thereto appearing elsewhere in the Form 10KSB.

     The Company suffered a net loss of approximately $802,868 in fiscal 1997,
and the Company's current liabilities exceeded its current assets by $3,944 as
of December 31, 1997. Management recognizes that it must address this
deterioration in the Company's financial condition during fiscal 1997 to meet
future obligations. The Company has therefore developed a business plan to
modify its operations to continue operating with available resources. This plan
is designed to reduce costs and return the Company to profitability, and calls
for downsizing the Company's workforce, increasing roasted coffee prices and
introducing new food products at the Company's Bakery. However, there can be no
assurance that such business plan will adequately address the circumstances and
situations which resulted in the Company's performance in fiscal 1997, or that
the Company's efforts to implement its business plan will be successful.

RESULTS OF OPERATIONS

1997 COMPARED TO 1996

     REVENUES. Total revenues increased 43.9% to $6,222,138 for fiscal 1997
compared to $4,323,481 for fiscal 1996. Of this increase approximately 32% was
due to sales by Company's Cafe and Bakery, which did not commence operations
until the fourth quarter of fiscal 1996, approximately 36% was due to the sales
by Sustainable Harvest, which did not exist in fiscal 1996, and approximately
32% increase in wholesale and direct consumer sales over comparable sales in
fiscal 1996. The Company sold Sustainable Harvest on December 31, 1997 and
closed its Cafe in February 1998.

     GROSS MARGIN. Gross margin (gross profit as a percentage of net sales)
declined to 38.9% in fiscal 1997 from 45.9% in fiscal 1996. Gross margins
declined primarily due to the lower margins of Sustainable Harvest and the
Cafe/Bakery. An increased proportion of relatively lower margin sales
represented of organic and shade grown coffees and the higher costs of specialty
green beans (primarily organics, shade grown, Asian and African coffee beans)
which were unhedged and purchased on the spot market to meet increased green
bean demand also contributed to the decline in gross margins. These factors
driving the decline in gross margins were partially offset by the realization of
a $97,000 gain on coffee options contracts purchased by the Company. The Company
does not designate such contracts as a hedge, and accordingly, changes in the
market value of option contracts are reported by the Company in the period in
which the change occurs and are included


<PAGE>   16
as part of cost of sales.  See Note 1 to Financial Statements.

        Management expects an increase in gross margins in the first half of
fiscal 1998 due to the availability of lower cost green beans for which the
Company has already contracted.

        SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1,168,220 or 61.0% from $1,915,632 in
fiscal 1996 to $3,083,902 in fiscal 1997. As a percentage of total sales,
selling, general and administrative expenses increased from 44.3% in 1996 to
49.6% in fiscal 1997. Of the $1,168,220 increase approximately 24% reflects the
hiring of additional management personnel following the completion of the stock
offering in the third quarter of fiscal 1996, approximately 34% reflects
overhead attributable to the Company's new retail and green bean operations,
approximately 4% reflects increased promotional activity in support of the
Company's major marketing efforts (including its campaign to build its direct
mail marketing list), approximately 10% reflects higher mail order costs, and
approximately 8% reflects additional legal, accounting and shareholder related
expenses.

        Depreciation and amortization expenses as a percentage of total sales
increased to 2.7% in fiscal 1997 from 2.4% in fiscal 1996, due primarily to
depreciation for additional equipment related to sales growth, the depreciation
of start up costs and leasehold improvements of the retail outlets and the
amortization of good will related to the bakery purchase.

        OTHER INCOME. In fiscal 1997, miscellaneous income contains an audit
adjustment for $7,675 which relates to the transfer of the Bakery's accounting
records from an outside bookkeeping agency to the Company's accounting system.
The remaining $10,029 booked in miscellaneous income relates to a variety of
events, but about $8,000 relates to freight that the Company charged a third
party to make deliveries in the same geography as the Company's routes in
Northern California.

        LOSS ON SALE OF SUBSIDIARY.  The sale of Sustainable Harvest
resulted in a loss of $29,471.

        INTEREST EXPENSE. Interest expense as a percentage of total sales
increased to 2.1% for fiscal 1997, from 1.8% for the same time period in fiscal
1996, due primarily to the increase in short-term borrowings.

     NET LOSS. As a result of the foregoing, the net loss for fiscal 1997
amounted to $802,868 or 12.9% of total sales compared to a net income of $25,500
or 0.6% of total sales in fiscal 1996.


<PAGE>   17
1996 COMPARED TO 1995

        REVENUES.  Total revenues increased 5.2% to $4,323,481 for
fiscal 1996 compared to $4,111,224 for fiscal 1995.

        GROSS MARGIN. Gross Margin (gross profit as a percentage of net sales)
increased to 45.9% in fiscal 1996 from 39.3% in fiscal 1995. Gross margins
increased as a result of lower costs of specialty green beans.

        SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $288,081 or 17.7% from $1,627,551 in fiscal
1995 to $1,953,632 in fiscal 1996. As a percentage of total sales, selling,
general and administrative expenses increased from 39.6% in fiscal 1995 to 44.3%
in fiscal 1996.

        Depreciation and amortization expenses as a percentage of total sales
increased to 2.4% in fiscal 1996 from 2.1% in fiscal 1995, due primarily to
depreciation for additional equipment related to sales growth.

        INTEREST EXPENSE.  Interest expense as a percentage of total
sales decreased slightly to 1.8% for fiscal 1996, from 1.9% for
fiscal 1995.

        NET GAIN. As a result of the foregoing, the net gain for fiscal 1996
amounted to $25,500 or 0.6% of total sales compared to a net loss of $64,063 or
1.6% of total sales in fiscal 1995.

LIQUIDITY AND CAPITAL RESOURCES

    As of December 31, 1997 the Company had $78,391 in cash and short term
investments.

     Working capital as of December 31, 1997 totalled a deficiency of $3,944 as
compared to working capital of $914,715 at December 31, 1996.

     For fiscal 1997, and for fiscal 1996, cash provided by operating activities
showed a deficiency of $626,980 and $66,674, respectively.

     Net cash used in 1997 for investing activities, which primarily consisted
of expenditures for equipment to service new accounts and sales growth, was
$232,979 as compared to cash provided in 1996 of $411,431. Net cash provided by
investing activities in 1996 was primarily attributable to receipts from the
Company's public offering of stock, offset in part by cash used to purchase
equipment for $333,297, to purchase intangible assets for


<PAGE>   18
$299,882 and to an increase in prepaid stock offering costs of $234,404.

     Net cash provided by financing activities in 1997, which consisted
primarily of proceeds from notes payable, was $507,794 compared to net cash used
in 1996 of $73,979. Net cash provided by investing activities in 1997 consisted
of a $555,059 net increase of notes payable offset by a $47,265 net increase of
notes receivable. In 1996, cash used for financing activities consisted of the
net $32,243 reduction of notes payable and the $41,736 increase of notes
receivable.

        The Company maintains a revolving line of credit of up to $650,000. The
credit agreement was renewed in the third quarter of fiscal 1997 for a one-year
term and will expire on August 10, 1998. Borrowings under the line of credit are
secured by the Company's accounts receivable, inventory, equipment, fixtures and
improvements. The terms of this facility contain certain limitations of
additional indebtedness, which if violated could be used as a basis for
termination of the agreement. There were total borrowings of $1,109,507,
including $601,636, outstanding under the credit agreement at December 31, 1997.

     The Company is dependent on successfully executing its business plan to
achieve profitable operations, obtaining additional sources of borrowings
(including normal trade credit), and securing favorable financing arrangements
(including lease financing) to finance its immediate working capital needs.
There can be no assurance that the Company will be successful in this regard. If
the Company is not able to renew or replace its credit agreement on comparable
terms or at all, the Company may be unable to fund its working capital
requirements and the Company's business could be adversely affected.

YEAR 2000

     The Company has substantially completed the implementation of an
established third party package of integrated financial applications to replace
most of its existing management information systems. The new applications are
Year 2000 compliant. The Company does not expect any material adverse impact on
the Company's results from operations in connection with Year 2000 compliance.
In fiscal 1997, the Company expended approximately $5,000 to modify its software
to operate correctly for the year 2000.

SEASONALITY AND OTHER FACTORS AFFECTING PERFORMANCE

         The Company's business is seasonal in nature.  The seasonal
availability of green bean coffee in the first two quarters of the


<PAGE>   19
year and increased sales in the last quarter historically creates a high use of
cash and a build up in inventories in the first two quarters, with a
corresponding decrease in inventory and increase in cash in the last quarter.
Because of the seasonality of the Company's business, results for any quarter
are not necessarily indicative of the results that may be achieved for the full
fiscal year. Furthermore, past seasonal patterns are not necessarily indicative
of future results. The Company's future results of operations and earnings could
also be significantly affected by other factors, such as changes in general
economic conditions, changes in business conditions in the coffee industry,
fluctuations in consumer demand for coffee products and in the availability and
costs of green coffee beans, increased competition within the Company's
businesses, the management challenges of rapid growth, variances from budgeted
sales mix and growth rate, consumer acceptance of the Company's new products,
inability to secure adequate capital to fund its operating losses and working
capital requirements, inability to hire, train and retain qualified personnel,
concentration of production and sales in Northern California, the loss of one or
more major customers, inability to successfully implement its business plan and
weather. There can be no assurance that sales will increase in future quarters.

INDEMNIFICATION MATTERS

     The Company's Bylaws provide that the Company may indemnify its directors,
officers, employees and other agents to the fullest extent permitted by
California law. The Company believes that indemnification under its Bylaws also
permits the Company to secure insurance on behalf of any officer, director,
employee or other agent for any liability arising out of his or her actions in
such capacity, regardless of whether California law would permit
indemnification. The Company maintains such liability insurance for its
directors and certain officers and employees.

    At present, there is no pending litigation or proceeding involving any
director, office, employee or agent of the Company where indemnification would
be required or permitted. The Company is not aware of any pending or threatened
litigation or proceeding that might result in a claim for such indemnification.


ITEM 7:  FINANCIAL STATEMENTS

        Information in response to this item is set forth in the Financial
Statements beginning on page F-1 of this filing.


ITEM 8:  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE


<PAGE>   20
        None.

                                    PART III

ITEM 9:  DIRECTORS AND EXECUTIVE OFFICERS

        The directors, nominees, key employees and executive officers of the
Company and their ages as of the date of this Form 10-KSB are as follows:


<TABLE>
<CAPTION>
Name                                Age     Position with the Company
----                                ---     -------------------------
<S>                                 <C>     <C>
Paul Katzeff                        60      Chief Executive Officer & Director
Joan Katzeff                        49      President and Director
Roy Doughty                         48      Director
Larry Leigon                        50      Director
</TABLE>


Paul Katzeff, a co-founder of the Company, has served as Roastmaster, Chief
Executive Officer and a Director since its incorporation on May 10, 1982. Mr.
Katzeff is a co-founder of the Specialty Coffee Association of America
(S.C.A.A.) and served as its Chairman in 1985. He has served as an elected Board
member of the S.C.A.A. since 1994, and served as Chairman of the Environmental
Committee of the Board in 1994. Mr. Katzeff will co- chair the Second Annual
Sustainable Coffee Conference to be held April 17, 1998 and is an advisory Board
member of Coffee Kids, a non-profit organization concerned with social and
environmental issues as they relate to the coffee industry. Mr. Katzeff and Mrs.
Katzeff are husband and wife. Mr. Katzeff holds a Bachelors degree in
Agriculture from Cornell University and a Masters degree in Social Work from
Adelphi University.

Joan Katzeff, a co-founder of the Company, has served as President, Chief
Financial Officer and a Director of the Company since its incorporation on May
10, 1982. Her experience in the Company's early years included production,
delivery and bookkeeping. Mrs. Katzeff now has planning and administrative
responsibilities in operations, marketing and public relations.

Roy Doughty has served as a Director of the Company since September 1997, and as
an outside consultant to the Company since February 1994. Since 1992, Mr.
Doughty has served as a Principal of Global Insights, a consulting firm devoted
to assisting value-centered businesses. He was the co-founder of the
Spirituality and Worklife Project and has created and delivered programs for the
Center for Ethics and Social Policy, the Center for Eco-literacy, the California
School of Integral Studies, the California School of Professional Psychology and
the Social Investment Forum.

Larry Leigon has served as a Director of the Company since


<PAGE>   21
September 1997, and as an outside consultant to the Company since February 1994.
Since November 1993, he has served as a Principal of Global Insights. From 1985
to 1993, Mr. Leigon was the president of Ariel Winery, the world's first
exclusive nonalcoholic winery. His experience at Ariel included creating a whole
new category of product, taking it from research and development to worldwide
distribution in 20 countries. He is listed in Who's Who in Leading American
Executives and is also cited in The Successful Business Plan: Secrets and
Strategies of the PSI's Business Library.

The authorized number of directors is five. Currently there are four directors.
All directors will hold office until the next annual meeting of shareholders and
until their successors have been elected and qualified, unless they earlier
resign or are removed from office. Committees of the Board may be appointed by
resolution passed by a majority of the directors. The Company does not presently
have any standing audit, nominating or compensation committee, or any committee
performing similar functions. The executive officers of the Company are elected
annually by the Board of Directors and serve at the discretion of the Board.

ITEM 10:  EXECUTIVE COMPENSATION

        The following table provides certain information concerning the
compensation paid to the Company's Chief Executive for fiscal 1995, 1996 and
1997. All other Named Executive Officers received less than $100,000 in fiscal
1997.

SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>
                                                                   Securities
Name and Principal                  Year     Salary       Bonus    Underlying
Position                                      ($)          ($)      Options
                                    ----    -------       -----    ----------
<S>                                 <C>     <C>
Paul Katzeff                        1997    $75,000         -           -
Chief Executive Officer             1996    $75,000         -           -
and Director                        1995    $60,485         -           -
</TABLE>


STOCK OPTION GRANTS

     The Company did not grant stock options to any of the Named Executive
Officers during fiscal 1997.

COMPENSATION OF DIRECTORS

Members of the Board of Directors who are not also employees of the Company do
not receive any additional compensation for service on the Board.


<PAGE>   22
ITEM 11:  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of December 31, 1997, (i) by each
person (or group of affiliated persons) who is known by the Company to own
beneficially more than five per cent of the Company's Common Stock, (ii) by each
of the named executive officers, (iii) by each of the Company's directors and
nominees, and (iv) by all directors and executive officers as a group. The
Company believes that the person and entities named in the table have sole
voting and investment power with respect to all shares of Common Stock shown as
beneficially owned by them, subject to community property laws, where
applicable.


<TABLE>
                                         Shares
Name and Address of                   Beneficially
Beneficial Owner                          Owned                 Percentage
----------------                          -----                 ----------
<S>                                   <C>                       <C>
Joan and Paul Katzeff(1)                979,000(1)                 79.16%
(Joan Katzeff, President)
(Paul Katzeff, CEO)
c/o Thanksgiving Coffee Co., Inc.
POB 1918
Fort Bragg, CA 95437

Ray Doughty                                 200                     0.02%
Director
c/o Thanksgiving Coffee Co., Inc.
POB 1918
Fort Bragg, CA 95437

Larry Leigon                                  0                     0.00%
Director
c/o Thanksgiving Coffee Co., Inc.
POB 1918
Fort Bragg, CA 95437

All directors and
executive officers as a
group (4 persons)                       979,200                    79.18%
</TABLE>


(1) Shares are originally issued, restricted and jointly owned by Joan Katzeff
and Paul Katzeff.

ITEM 12:  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     In December 1997, the Company sold all outstanding shares of its
wholly-owned subsidiary, Sustainable Harvest, to Mr. David Griswold.  Under the
terms of the agreement, the Company is


<PAGE>   23
required to purchase a certain quantity of green coffee beans per year for a
five-year period commencing December 31, 1997, at a fixed mark-up over "landed
coffee costs".

     The Company leases its corporate headquarters, warehouse and waterfront
facilities from Joan and Paul Katzeff, who are affiliates of the Company (the
"Katzeffs"). The lease provided for monthly payments of $8,500 in fiscal 1997,
and the Company is also responsible for all real estate taxes, insurance and
maintenance costs related to the facilities. See Note 11 of "Notes to Financial
Statements".

     As of December 31, 1997, the Company held a note payable to the Katzeffs in
the amount of $66,000, payable in monthly interest installments at a rate of 12%
per annum, with the balance payable on demand after June 30, 1996. See Note 6 of
the "Notes to Financial Statements".

     As of December 31, 1997, the Company also held a note payable to the
Katzeffs in the amount of $17,452, payable in quarterly installments of $3,229
including interest at an annual rate of 10%, with the balance due on July 17,
1999. See Note 6 of the "Notes to Financial Statements".

     Global Insights, of which Messrs. Doughty and Leigon, both directors of the
Company, are principals, is party to two consulting agreements for fiscal 1998.
The first is a one-year agreement commencing January 1, 1998 for the provision
of specific business functions. Under this agreement, Global Insights is
entitled to a fee of $36,000. The second agreement is an eleven-month agreement
commencing February 1, 1998 for the provision of shareholder relation services.
Global Insights received an aggregate of $72,000 during fiscal 1997 for similar
services.

     The Company carries insurance indemnifying its directors and
certain officers and certain employees against certain liabilities
by reason of their status or service as directors or officers or
employees of the Company.  See Item 10, Executive Compensation --
Indemnification Matter."

ITEM 13:  EXHIBITS AND REPORTS ON FORM 8-K

(a)     Exhibits

        3.1    Restated Articles of Incorporation of the Company.+
        3.2    By laws of the Company.+
               3.2.1 Amendment No. 1 to Bylaws of the Company, dated
                     June 3, 1996.++
        10.1   Business Loan Agreement dated as of September 5, 1995 by and
               between the Company and Wells Fargo Bank, N.A., as


<PAGE>   24
               amended on August 11,1997.+++
        10.2   Lease Agreements for the Company's Fort Bragg facilities.
               10.2.1        Extension of Term and Further Amendment to
                             Lease Agreement dated April 1, 1992.
               10.2.2        Further Amendment to Lease Agreement dated
                             July 1, 1992.+
               10.2.3        Third Amendment to Lease Agreement dated July
                             1, 1994.+
               10.2.4        Exercise Option to Extend Lease Agreement
                             April 1, 1995.+
        10.3   Lease Agreement for the Company's Bakery in Mendocino.
        10.4   Sample Coffee Purchase Agreement.+
        10.5   Promissory Note issued by the Company to Joan and Paul
               Katzeff dated as of April 17, 1996.
        10.6   Promissory Note issued by the Company to Joan and Paul
               Katzeff dated as of December 30, 1990.
        10.7   Stock Purchase Agreement between the Company, Sustainable
               Harvest, Inc. and David Griswold as of December 31,
               1997.!
        10.8   Summary Plan Description of the Company's Profit Sharing
               Plan.*
        21.1   Subsidiaries of the Company.
        27.1   Financial Data Schedule.

(b)     Reports on 8-K

        None.
------------------------
+       Incorporated by reference to the exhibits to the Company's
        Registration Statement on Form S-1 (File No 33-96070-LA).
++      Incorporated by reference to the exhibits to the Company's
        Form 10-QSB for the quarter ended June 30,1997.
+++     Incorporated by reference to the exhibits to the Company's
        Form 10-QSB for the quarter ended September 30, 1997.

*       Management contract or compensatory plan or arrangement.

!       Portions of this Exhibit were omitted and have been filed separately
        with the Secretary of the Securities and Exchange Commission pursuant to
        the Company's Application Requesting Confidential Treatment under Rule
        24-b2 of the Securities Exchange Act of 1934, as amended, filed on March
        31, 1998.


<PAGE>   25
                                   SIGNATURES

               In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

THANKSGIVING COFFEE COMPANY, INC.


<TABLE>
<CAPTION>
          Name                               Title                              Date
<S>                                     <C>                                <C>
 /s/ Paul Katzeff                       Chief Executive                    March 31, 1998
-------------------------------         Officer (Principal
  Paul Katzeff                          Executive Officer)
                                        and Director


 /s/ Joan Katzeff                       President, Chief                   March 31, 1998
-------------------------------         Financial Officer
   Joan Katzeff                         (Principal
                                        Financial Officer)
                                        and Director


 /s/ Roger Edwards                      Controller                          March 31, 1998
-------------------------------         (Principal
    Roger Edwards                       Accounting
                                        Officer)


 /s/ Roy Doughty                        Director                           March 31, 1998
-------------------------------
   Roy Doughty

 /s/ Larry Leigon                       Director                           March 31, 1998
-------------------------------
   Larry Leigon
</TABLE>


<PAGE>   26
To The Board of Directors
Thanksgiving Coffee Company, Inc.
Fort Bragg, California


We have audited the accompanying balance sheets of Thanksgiving Coffee Company,
Inc. (a California Corporation) as of December 31, 1997 and 1996 and the related
statements of income, retained earnings and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

In our opinion, the financial statements present fairly, in all material
respects, the financial position of Thanksgiving Coffee Company, Inc. at
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997 in conformity
with generally accepted accounting principles.


SALLMANN, YANG & ALAMEDA
An Accountancy Corporation



/s/ Kathleen M. Alameda
-------------------------------
Kathleen M. Alameda
Certified Public Accountant





March 26, 1998

                                       F-1


<PAGE>   27
                        THANKSGIVING COFFEE COMPANY, INC.

                           CONSOLIDATED BALANCE SHEETS

                           DECEMBER 31, 1997 AND 1996

                                     ASSETS


<TABLE>
<CAPTION>
                                            1997               1996
                                         -----------        -----------
<S>                                      <C>                <C>
CURRENT ASSETS
    CASH                                 $    46,872        $   399,037
    SHORT TERM INVESTMENTS                    31,519                  0
    ACCOUNTS RECEIVABLE                      417,221            296,006
    NOTE RECEIVABLE                           56,973             41,735
    EMPLOYEE RECEIVABLE                        6,041              6,032
    INVENTORY                                513,303            486,797
    PREPAID EXPENSES                         144,983             84,517
    DEFERRED TAX ASSET                        35,398             32,412
                                         -----------        -----------
      TOTAL CURRENT ASSETS                 1,252,310          1,346,536
                                         -----------        -----------
PROPERTY AND EQUIPMENT
    PROPERTY AND EQUIPMENT                 2,045,464          1,806,155
    ACCUMULATED DEPRECIATION              (1,049,873)          (891,205)
                                         -----------        -----------
      TOTAL PROPERTY AND EQUIPMENT           995,591            914,950
                                         -----------        -----------
OTHER ASSETS
    DEPOSITS AND OTHER ASSETS                 35,329             30,585
    NOTE RECEIVABLE - GRISWOLD                32,027                  0
    INTANGIBLES LESS AMORTIZATION            281,192            293,111
                                         -----------        -----------
      TOTAL OTHER ASSETS                     348,548            323,696
                                         -----------        -----------
TOTAL ASSETS                             $ 2,596,449        $ 2,585,182
                                         ===========        ===========
</TABLE>


                 SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REPORT


                                      F-2


<PAGE>   28
                        THANKSGIVING COFFEE COMPANY, INC.

                           CONSOLIDATED BALANCE SHEETS

                           DECEMBER 31, 1997 AND 1996

                             LIABILITIES AND EQUITY


<TABLE>
<CAPTION>
                                               1997               1996
                                           -----------        -----------
<S>                                        <C>                <C>
CURRENT LIABILITIES
    ACCOUNTS PAYABLE                       $   426,810        $   206,417
    NOTES PAYABLE - BANKS                      621,636             50,000
    NOTES PAYABLE - SHAREHOLDER                 24,625             31,038
    CURRENT PORTION OF NOTES PAYABLE           108,459             91,414
    ACCRUED LIABILITIES                         74,724             52,952
                                           -----------        -----------
      TOTAL CURRENT LIABILITIES              1,256,254            431,821
                                           -----------        -----------
LONG-TERM LIABILITIES
    NOTES PAYABLE                              429,044            438,000
    NOTES PAYABLE - SHAREHOLDER                 58,827             77,080
    DEFERRED INCOME TAXES                       66,535             51,429
                                           -----------        -----------
      TOTAL-LONG TERM LIABILITIES              554,406            566,509
                                           -----------        -----------
      TOTAL LIABILITIES                      1,810,660            998,330
                                           -----------        -----------
STOCKHOLDERS' EQUITY
    COMMON STOCK - NO PAR VALUE
        1,960,000 SHARES AUTHORIZED,
        1,237,384 SHARES ISSUED, AND
        1,236,744 SHARES OUTSTANDING           872,816            874,666
    ADDITIONAL PAID IN CAPITAL                  24,600             24,600
    UNREALIZED GAIN ON INVESTMENTS               3,656                  0
    RETAINED EARNINGS                         (115,283)           687,586
                                           -----------        -----------
    TOTAL STOCKHOLDERS' EQUITY                 785,789          1,586,852
                                           -----------        -----------
TOTAL LIABILITIES AND EQUITY               $ 2,596,449        $ 2,585,182
                                           ===========        ===========
</TABLE>


                 SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REPORT


                                       F-3


<PAGE>   29
                       THANKSGIVING COFFEE COMPANY, INC.

                         CONSOLIDATED INCOME STATEMENTS

              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995


<TABLE>
<CAPTION>

                                            1997               1996               1995
                                         -----------        -----------        -----------
<S>                                      <C>                <C>                <C>
REVENUES
    NET SALES                            $ 6,222,138        $ 4,323,481        $ 4,111,224
    COST OF SALES                          3,800,149          2,337,648          2,496,296
                                         -----------        -----------        -----------
      GROSS PROFIT                         2,421,989          1,985,833          1,614,928
                                         -----------        -----------        -----------
OPERATING EXPENSES
    SELLING, GENERAL AND
      ADMINISTRATIVE EXPENSES              2,918,498          1,810,684          1,540,006
    DEPRECIATION AND AMORTIZATION            165,404            104,948             87,545
                                         -----------        -----------        -----------
      TOTAL OPERATING EXPENSES             3,083,902          1,915,632          1,627,551
                                         -----------        -----------        -----------
      OPERATING (LOSS) INCOME               (661,913)            70,201            (12,623)
                                         -----------        -----------        -----------
OTHER INCOME (EXPENSE)
    INTEREST INCOME                            5,357             10,080              8,447
    INTEREST EXPENSE                        (132,666)           (77,658)           (78,974)
    GAIN (LOSS) ON SALE OF ASSETS             11,785               (394)              (313)
    LOSS ON SALE OF SUBSIDIARY               (29,471)                 0                  0
    CASUALTY LOSS                               (746)                 0                  0
    MISCELLANEOUS INCOME                      17,704              5,797             15,401
                                         -----------        -----------        -----------
      TOTAL OTHER INCOME (EXPENSE)          (128,037)           (62,175)           (55,439)
                                         -----------        -----------        -----------
(LOSS) INCOME BEFORE TAXES                  (789,950)             8,026            (68,062)

PROVISION FOR INCOME TAXES                   (12,919)            17,474              3,999
                                         -----------        -----------        -----------
NET (LOSS) INCOME                        $  (802,869)       $    25,500        $   (64,063)
                                         ===========        ===========        ===========
</TABLE>


                 SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REPORT


                                       F-4



<PAGE>   30
                       THANKSGIVING COFFEE COMPANY, INC.

                  CONSOLIDATED STATEMENTS OF RETAINED EARNINGS

                        DECEMBER 31, 1997, 1996 AND 1995


<TABLE>
<CAPTION>
                                         1997             1996            1995
                                       ---------        ---------       ---------
<S>                                    <C>              <C>             <C>
RETAINED EARNINGS
    RETAINED EARNINGS, BEGINNING       $ 687,586        $ 662,086       $ 726,149
    NET (LOSS) INCOME                   (802,869)          25,500         (64,063)
                                       ---------        ---------       ---------
      RETAINED EARNINGS, ENDING        $(115,283)       $ 687,586       $ 662,086
                                       =========        =========       =========
</TABLE>


                 SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REPORT

                                       F-5


<PAGE>   31
                              THANKSGIVING COFFEE COMPANY, INC.

                            CONSOLIDATED STATEMENTS OF CASH FLOWS

                     FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995


<TABLE>
<CAPTION>
                                                     1997               1996               1995
                                                 -----------        -----------        -----------
<S>                                              <C>                <C>                <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  NET (LOSS) INCOME                              $  (802,869)       $    25,500        $   (64,063)
  NON CASH ITEMS INCLUDED IN NET LOSS
    DEPRECIATION AND AMORTIZATION                    177,848            126,761            108,115
    (GAIN) LOSS ON DISPOSAL OF ASSETS                (11,785)               394                314

    (INCREASE) DECREASE IN:
      SHORT TERM INVESTMENTS                         (31,519)             4,094              3,941
      RECEIVABLES                                   (121,225)           115,075              8,445
      INVENTORY                                      (26,506)            (2,493)           (56,181)
      PREPAID EXPENSES                               (63,452)           (57,090)           (33,240)
      DEPOSITS AND OTHER ASSETS                       (4,744)             2,464              1,742
    INCREASE (DECREASE) IN:
      ACCOUNTS PAYABLE                               220,394           (260,005)           189,229
      ACCRUED LIABILITIES                             21,772            (14,820)            18,468
      INCOME TAXES PAYABLE                                 0                  0             (5,800)
      DEFERRED INCOME TAXES                           15,106             (6,554)            31,659
                                                 -----------        -----------        -----------
        NET CASH (USED) PROVIDED BY
          OPERATING ACTIVITIES                      (626,980)           (66,674)            02,629
                                                 -----------        -----------        -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
  DECREASE IN STOCKHOLDER RECEIVABLE                       0              6,231             18,310
  PURCHASE OF EQUIPMENT                             (251,994)          (333,297)          (117,701)
  PROCEEDS FROM SALE OF EQUIPMENT                     22,000                300                  0
  PURCHASE OF INTANGIBLE ASSETS                       (4,791)          (299,882)                 0
  INCREASE IN PREPAID STOCK OFFERING COSTS                 0           (234,404)          (201,556)
  PROCEEDS FROM SALE OF COMMON STOCK                     150          1,273,445                  0
  REPURCHASE OF COMMON STOCK                          (2,000)                 0                  0
  UNREALIZED GAIN (LOSS) ON INVESTMENTS                3,656               (962)               962
                                                 -----------        -----------        -----------
      NET CASH (USED) PROVIDED BY
        INVESTING ACTIVITIES                        (232,979)           411,431           (299,985)
                                                 -----------        -----------        -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
  INCREASE IN NOTES RECEIVABLE                       (89,000)           (41,736)                 0
  PROCEEDS FROM NOTES RECEIVABLE                      41,735                  0             71,182
  PROCEEDS FROM NOTES PAYABLE                        719,901            454,375                  0
  REPAYMENT OF NOTES PAYABLE                        (164,842)          (486,618)           (52,016)
                                                 -----------        -----------        -----------
      NET CASH PROVIDED (USED) BY
        FINANCING ACTIVITIES                         507,794            (73,979)            19,166
                                                 -----------        -----------        -----------
NET (DECREASE) INCREASE IN CASH                     (352,165)           270,778            (78,190)

CASH, AS OF JANUARY 1, 1997, 1996
  AND 1995                                           399,037            128,259            206,449
                                                 -----------        -----------        -----------
CASH, AS OF DECEMBER 31, 1997, 1996
AND 1995                                         $    46,872        $   399,037        $   128,259
                                                 ===========        ===========        ===========
</TABLE>


                 SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REPORT

                                       F-6


<PAGE>   32
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995


Note 1.       Summary of Significant Accounting Policies

              Description of Business
              Thanksgiving Coffee Company, Inc. (The Company), is a corporation
              that purchases and roasts high-quality whole bean coffees and
              sells them to restaurants, grocery stores and other retail
              outlets. These products are sold primarily through its own
              distribution network in the Northern California area. Distributors
              and retailers do not have the right to return products.
              Additionally, the Company produces and sells a line of
              high-quality tea products under the trademark of Royal Gardens Tea
              Company. The Company also sells coffee, tea and related specialty
              products through mail order on a national basis. The Company also
              sells sandwiches, pastries, coffee and tea through a cafe located
              in Fort Bragg and a bakery located in Mendocino, where they
              prepare the pastries. In 1997, the Company purchased and sold a
              subsidiary, a wholesale purchaser and distributor of coffee beans
              located in Emeryville.

              Basis of Presentation
              The Company has prepared the financial statements on the accrual
              basis of accounting in accordance with generally accepted
              accounting principles. The Company grants credit to customers in
              the retail industry throughout the country. Consequently, the
              Company's ability to collect the amounts due from customers is
              affected by economic fluctuations in the retail industry.

              Inventories
              Inventories are stated at the lower of cost or market (first-in,
              first-out).

              Property and Equipment
              Property and equipment are carried at cost less accumulated
              depreciation. Depreciation is provided on the straight-line and
              150% declining balance methods over estimated useful lives
              generally ranging from five to twelve years.

              Leasehold improvements are carried at cost and are amortized over
              the shorter of their estimated useful lives or the related lease
              term (including options), generally ranging from five to
              thirty-nine years.

              The portion of depreciation and amortization expenses related to
              production facilities is included in cost of sales.

              Expenditures for major renewals that extend useful lives of
              property, fixtures and improvements are capitalized.

              Expenditures for maintenance and repairs are charged to expense as
              incurred.

              For income tax purposes, depreciation is computed using the
              accelerated cost recovery system and the modified cost recovery
              system.


                 SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REPORT


                                       F-7


<PAGE>   33
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995



Note 1.       Summary of Significant Accounting Policies (continued)

              Investments in Unconsolidated Companies
              On January 1, 1997, the Company acquired the assets and
              liabilities of Sustainable Harvest, Inc., in a business
              combination accounted for as a purchase. The Company subsequently
              sold the subsidiary at a loss of $29,471 on November 1, 1997. The
              Company has a note receivable of $89,000 reflected on the books as
              a result of the sale. The results of operations of Sustainable
              Harvest are included in the accompanying financial statements.

              On October 31, 1996, the Company acquired the assets of Mendocino
              Bakery, Inc. in a business combination accounted for as a
              purchase.

              Profit Sharing Plan
              The Company has a profit sharing plan covering substantially all
              of its employees. Benefits are based upon years of service and the
              employee's compensation during the employment period. No
              contributions to the profit sharing plan were made for the years
              ended December 31, 1997, 1996 and 1995.

              Futures Contracts
              The Company may, from time to time, enter into exchange traded
              coffee futures contracts with the objective of minimizing cost
              risk due to market fluctuations. The Company does not designate
              futures contracts as a hedge as it applies to accounting
              principles and practices designated in Statement of Financial
              Accounting Standards No. 80, Accounting for Futures Contracts.
              Accordingly, changes in the market value of futures contracts are
              reported by the Company in the period in which the change occurs
              and are included as a component of stockholders' equity.

              Compensated Absences
              Employees of the Company are entitled to paid vacation, paid sick
              days and personal days off, depending on job classification,
              length of service, and other factors.

              Advertising
              The Company expenses costs of advertising the first time the
              advertising takes place, except direct-response advertising, which
              is capitalized and amortized over its expected period of future
              benefits. Direct-response advertising consists primarily of mail
              order catalog costs, typically mailed to customers who have
              specifically responded to this type of advertising. The mail order
              department documents whether orders come from catalogs or other
              sources when processing orders. Catalog costs are amortized over
              the period from the catalog mailing until the next catalog is
              issued.


                                       F-8


<PAGE>   34
                       THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995




Note 1.       Summary of Significant Accounting Policies (continued)

              Use of Estimates
              The preparation of financial statements in conformity with
              generally accepted accounting principles requires management to
              make estimates and assumptions that affect certain reported
              amounts and disclosures. Accordingly, actual results could differ
              from those estimates.


Note 2.       Accounts Receivable

              Accounts receivable consist of the following:


<TABLE>
<CAPTION>
                                               1997             1996
                                            ---------        ---------
<S>                                         <C>              <C>
Accounts receivable                         $ 439,564        $ 306,506
Less: Allowance for doubtful accounts         (22,343)         (10,500)
                                            ---------        ---------
Accounts receivable, net                    $ 417,221        $ 296,006
                                            =========        =========
</TABLE>

              The Company uses the allowance method for uncollectible accounts.
              Bad debt expense for the years ended December 31, 1997, 1996 and
              1995 was $14,226, $56,176 and $18,747, respectively.


Note 3.       Inventory

              Inventory consists of the following:


<TABLE>
<CAPTION>
                                      1997           1996
                                    --------       --------
<S>                                 <C>            <C>
Coffee:
  Unroasted                         $163,810       $179,691
  Roasted                            183,906        133,070
Tea                                   32,867         32,405

Packaging, supplies and other
  merchandise held for sale          132,720        141,631
                                    --------       --------

      Total inventory               $513,303       $486,797
                                    ========       ========
</TABLE>


                                       F-9


<PAGE>   35
                       THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995


Note 4.       Property and Equipment

              Property and equipment consists of the following:


<TABLE>
<CAPTION>
                                              1997               1996
                                          -----------        -----------
<S>                                       <C>                <C>
 Equipment and fixtures                   $ 1,125,832        $ 1,036,180
 Furniture and equipment                      205,114            191,125
 Leasehold improvements                       363,075            347,593
 Transportation equipment                      50,053             47,714
 Property held under capital leases           301,390            183,543
                                          -----------        -----------
 Total property and equipment               2,045,464          1,806,155
 Accumulated depreciation                  (1,049,873)          (891,205)
                                          -----------        -----------

Net property and equipment                $   995,591        $   914,950
                                          ===========        ===========
</TABLE>


Note 5.       Intangible Assets

              Intangible assets represent the costs associated with the acquired
              divisions over the fair value of their net assets at date of
              acquisition. The detail of the intangible assets are as follows:


<TABLE>
<CAPTION>
                                  1997             1996
                               ---------        ---------
<S>                            <C>              <C>
Goodwill                       $ 198,000        $ 198,000
Leasehold value                   67,000           67,000
Start-up costs                    34,882           34,882
Organizational costs              28,565           28,565
Trademark                          1,877              900
                               ---------        ---------
Total intangible assets          330,324          329,347
Accumulated amortization         (49,132)         (36,236)
                               ---------        ---------
Net intangible assets          $ 281,192        $ 293,111
                               =========        =========
</TABLE>


                                      F-10


<PAGE>   36
                       THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995




Note 6.       Notes Payable and Long-Term Debt


<TABLE>
<CAPTION>
Notes Payable                                                                            1997           1996
                                                                                       --------       --------
<S>                                                                                    <C>            <C>


              Revolving bank line of credit to Wells Fargo Bank with interest
              payable monthly at 1% over prime rate (9.5% and 9.25%,
              respectively). Expires August 10, 1998 and June 10, 1997,
              respectively. For 1997 and 1996 the maximum amount available on
              the line is $650,000 and $650,000, respectively. The line of
              credit is collateralized by a security interest of first priority
              in all accounts receivable, inventory, equipment, fixtures and
              improvements                                                             $601,636       $      0



              Note payable to Wells Fargo Bank, payable in monthly installments
              of $4,167 plus interest at 1.5% over prime rate. Final payment is
              due on July 15, 1999. The note is secured by all accounts
              receivable, inventory, equipment, fixtures and improvements                93,174        129,167

              Note payable to majority shareholders, Paul and Joan Katzeff,
              payable in monthly installments of interest only at 12%, with
              balance due on demand after June 30, 1996. The shareholders have
              subordinated this note to all notes payable including Wells Fargo
              Bank as described above                                                    66,000         80,000

              Note payable to majority shareholders, Paul and Joan Katzeff
              payable in quarterly installments of $3,229 including interest at
              10%, with balance due on July 17, 1999. The shareholders have
              subordinated this note to all notes payable including Wells Fargo
              Bank as described above                                                    17,452         28,118
</TABLE>


                                      F-11


<PAGE>   37
                               THANKSGIVING COFFEE COMPANY, INC.

                                 NOTES TO FINANCIAL STATEMENTS

                               DECEMBER 31, 1997, 1996 AND 1995


Note 6.       Notes Payable and Long-Term Debt (continued)


<TABLE>
<CAPTION>
Notes Payable                                                                            1997           1996
                                                                                       --------       --------
<S>                                                                                    <C>            <C>
              Note payable to Laoma Yaski for the purchase of Mendocino Bakery,
              payable in monthly installments of $6,594, including interest at
              10%, secured by property and equipment at the bakery, final
              payment due in August 2003                                               $246,021       $295,604

              Obligations Under Capital Lease

              Note payable to Nations Credit, payable in monthly installments of
              $833, including interest at 16.17%, secured by equipment, final
              payment due in January 2000                                                18,218         24,681

              Note payable to Colonial Pacific, payable in monthly installments
              of $313, including interest at 17.44%, secured by equipment, final
              payment due in November 1998                                                3,353          6,249

              Note payable to Commerce Security Bank, payable in monthly
              installments of $591, including interest at 17.24%, secured by
              equipment, final payment due in February 1998                               1,289          7,554

              Note payable to Commerce Security Bank, payable in monthly
              installments of $401, including interest at 19.44%, secured by
              equipment, final payment due in September 1998                              3,410          7,149

              Note payable to Manifest Group, payable in monthly installments of
              $1,030, including interest at 15.315%, secured by equipment, final
              payment due in January 2001                                                30,225         37,352

              Note payable to Imperial Capital, payable in monthly installments
              of $840, including interest at 17.263%, secured by equipment,
              final payment due in January 2001                                          23,970         29,392
</TABLE>


                                      F-12

<PAGE>   38
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995



Note 6.  Notes Payable and Long-Term Debt (continued)


<TABLE>
<CAPTION>
Obligations Under Capital Lease                                                           1997               1996
                                                                                      -----------        -----------
<S>                                                                                   <C>                <C>
Note payable to Granite Financial, payable in monthly installments of $1,139
including interest at 16.61%, secured by equipment, final payment due in June
2001                                                                                  $    35,515        $    42,266

Note payable to Imperial Bakery/Cafe, payable in monthly installments of $259
including interest at 19.00%, secured by equipment, final payment due in
December 1999                                                                               5,142                  0

Note payable to Oakmont/Heritage Pacific, payable in monthly installments of
$1,297 including interest at 14.00%, secured by equipment, final payment due in
February 2002                                                                              48,938                  0

Note payable to Oakmont/Heritage Pacific, payable in monthly installments of
$910 including interest at 15.53%, secured by equipment, final payment due in
February 2002                                                                              33,348                  0

Note payable to Centerpoint, payable
in monthly installments of $517 including interest at 19.23%, secured by
equipment, final payment due in March 2001                                                 14,900                  0
                                                                                      -----------        -----------
                                                                                        1,242,591            687,532
Less current portion                                                                     (754,720)          (172,452)
                                                                                      -----------        -----------
Total Long-term debt                                                                  $   487,871        $   515,080
                                                                                      ===========        ===========
</TABLE>


All of the above notes payable are personally guaranteed by the Company's
majority shareholders.


                                      F-13


<PAGE>   39
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995


Note 6.       Notes Payable and Long-Term Debt (continued)

              Interest paid as of December 31, 1997, 1996 and 1995 was $122,881,
              $77,658 and $78,974, respectively.

              Maturities of notes payable and long-term debt are as follows:


<TABLE>
                <S>               <C>
                1998...........  $   601,636 (Line of Credit)
                1998...........      153,084 (Notes Payable)
                1999...........      225,624
                2000...........       95,609
                2001...........       73,695
                2002...........       48,453
                Thereafter.....       44,490
                                  -----------
                                  $ 1,242,591
                                  ===========
</TABLE>


              Based on current borrowing rates, the fair value of the notes and
              capital leases payable approximates their carrying amounts.


Note 7.       Income Taxes

              The components of the provision for income taxes for the years
              ended December 31, 1997, 1996 and 1995 are as follows:


<TABLE>
<CAPTION>
                           1997           1996            1995
                         --------       --------        --------
<S>                      <C>            <C>             <C>
Federal - current......  $      0       $  1,016        $ (9,239)
Federal - deferred.....     3,380        (10,739)         10,505
State - current........       800            800             800
State - deferred.......     8,739         (8,551)         (6,065)
                         --------       --------        --------
Total Income Taxes.....  $ 12,919       $(17,474)       $ (3,999)
                         ========       ========        ========
</TABLE>


                The Company computes income taxes using the asset and liability
                method under which deferred income taxes are provided for
                temporary differences between the financial basis of the
                Company's assets and liabilities. As of December 31, 1997, 1996
                and 1995, deferred tax liabilities recognized for taxable
                temporary differences total $66,535, $51,429 and $57,983,
                respectively. Deferred tax assets recognized for deductible
                temporary differences and loss carryforwards total $35,398,
                $32,412 and $19,674, respectively. The Company has a federal
                contribution carryforward of $39,784 and a state contribution
                carryforward of $20,729, expiring in 5 years, which may be used
                to offset taxable income in the future. The Company has a
                California manufacturer's credit carryforward of $19,714 which
                may be used to offset California income taxes in the future.


                                      F-14


<PAGE>   40
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995


Note 7.       Income Taxes (continued)

              Income taxes paid as of December 31, 1997, 1996 and 1995 were $0,
              $11,063 and $800, respectively.

Note 8.       Operating Leases

              The Company leases its delivery fleet, other vehicles and some
              office equipment under non-cancelable operating leases with terms
              ranging from three to five years.

              Minimum annual lease payments due under these agreements are as
              follows:


                        <TABLE>
                        <S>                              <C>
                        1998...........................  $    61,388
                        1999...........................       53,964
                        2000...........................       46,819
                        2001...........................       23,058
                        2002...........................        3,099
                                                         -----------
                                                         $   188,328
                                                         ===========
</TABLE>


              Total annual lease payments were $49,472, $28,632 and $38,089 as
              of December 31, 1997, 1996 and 1995, respectively.


Note 9.       Common Stock


<TABLE>
<CAPTION>
                                  Number of          No Par
                                   Shares            Value
                                 ----------        ----------
<S>                              <C>               <C>
Balance, January 1, 1995......      981,000        $   37,181
Issuance of stock.............            0                 0
                                 ----------        ----------
Balance, December 31, 1995....      981,000            37,181
Issuance of stock.............      256,039           837,485
                                 ----------        ----------
Balance, December 31, 1996....    1,237,039           874,666
Issuance of stock.............          345               150
Repurchase of stock...........         (640)           (2,000)
                                 ----------        ----------
Balance, December 31, 1997....    1,236,744        $  872,816
                                 ==========        ==========
</TABLE>

             Note: 981,000 shares originally issued are restricted.


                                      F-15
<PAGE>   41
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995

Note 10.      Stock Option Purchase Plan

              Under the terms of its stock option purchase plan, options to
              purchase shares of the Company's common stock are granted at a
              price of $5 per share. Options may be exercised until the year
              2000.  Following is a summary of transactions:


<TABLE>
<CAPTION>
                                         Shares Under Option
                                       ----------------------
                                         1997           1996
                                       -------        -------
<S>                                    <C>            <C>
Outstanding, beginning of year          26,000         32,000
Shares exercised during the year        (6,000)        (6,000)
                                       -------        -------
Outstanding, end of year                20,000         26,000
                                       =======        =======
</TABLE>


              The related compensation expense for December 31, 1997, 1996 and
              1995 is $13,500, $13,500, and $0, respectively.


Note 11.      Long-Term Lease

              The Company leases its corporate headquarters, warehouse and
              waterfront facilities from Paul and Joan Katzeff (the Company's
              majority shareholders). The lease provides for monthly rental
              payments of $8,500 and the Company is responsible for all real
              estate taxes, insurance and maintenance costs related to the
              facilities. The lease provides for periodic cost of living
              increases during the term of the lease, including the option
              periods. The Company exercised the first of four five-year options
              on March 31, 1995.

              Any deferred amounts are due based upon available cash flow as
              determined by the Company's management or upon demand of the
              Company's majority shareholders.

              Rental expense under the above lease was $102,000, $102,000, and
              $94,500 as of December 31, 1997, 1996 and 1995, respectively.

              The Company has made substantial leasehold improvements (Note 4)
              and intends to exercise all options under the terms of this lease.

              The Company leases a restaurant establishment in Mendocino. The
              lease provides for monthly rental payments of $2,375 and the lease
              term expires in September 2010.


                                      F-16


<PAGE>   42
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995


Note 11.      Long-Term Lease (continued)

              The Company leases retail space in Fort Bragg used as an espresso
              bar/cafe during 1997. The lease provides for monthly rental
              payments of $730, and the lease expires in January 2001, with an
              option to renew for another five years. The lease also provides
              for periodic cost of living increases during the term of the
              lease, including the option periods. In February 1998, the cafe
              business was terminated. The Company plans to sublease this
              facility.

              Minimum future rental payments for all leases are as follows:


<TABLE>
                <S>                             <C>
                1998                            $   139,260
                1999                                139,260
                2000                                 62,760
                2001                                 29,230
                2002 and Thereafter                 249,375
                                                -----------
                                                $   619,885
                                                ===========
</TABLE>


Note 12.      Related-Party Transactions

              The Company has an interest only note payable due on demand and a
              principal and interest note payable to Paul and Joan Katzeff at
              December 31, 1997, 1996 and 1995 (See Note 6, above). The Company
              also leases properties from its stockholders (See Note 11, above).

              The summary of these related-party transactions for the years
              ended December 31, 1997, 1996 and 1995 follows:


<TABLE>
<CAPTION>
                                 1997           1996           1995
                               --------       --------       --------
        <S>                    <C>            <C>            <C>
        Interest expense       $ 11,343       $ 11,858       $ 10,167
        Rent expense           $102,000       $102,000       $ 94,500
</TABLE>


Note 13.      Earnings Per Share

              Earnings per share amounts are based on the weighted average
              number of common stock shares outstanding. There were no common
              stock equivalents to be considered. Earnings per share for the
              years ended December 31, 1997, 1996 and 1995 were $(.65), $.02,
              and $(.07), respectively.


                                      F-17


<PAGE>   43
                        THANKSGIVING COFFEE COMPANY, INC.

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1997, 1996 AND 1995

Note 14.      Commitments

              Under the terms of an agreement with the subsidiary sold during
              the year, the Company is required to purchase coffee beans each
              year for the next five years ending December 31, 2002 at a
              predetermined price per pound over landed coffee costs.

              The Company purchased a bakery from Laoma Yaski in 1996 for
              $350,000. The Company agreed to pay an additional $25,000 to Laoma
              Yaski upon the seven year anniversary of the purchase provided she
              does not own, manage or operate a bakery within 250 miles of
              Mendocino, California.

              Under the terms of an agreement with a past officer of the
              Company, the Company may purchase 9,000 options under the
              following terms:


<TABLE>
<CAPTION>
                                     Number
                                   Of Shares             Total
                                   ---------             -----
                        <S>         <C>                <C>
                        1998        3,000              $ 9,000
                        1999        3,000                9,750
                        2000        3,000                3,500
</TABLE>


              A remaining 13,000 options may be exercised or sold at any time at
              the discretion of the past officer subject to the Company's first
              right of refusal.


Note 15.      Contingency

              As shown in the accompanying financial statements, the Company
              incurred a net loss of $802,869 during the year ended December 31,
              1997, and as of that date, the Company's current liabilities
              exceeded its current assets by $3,944. These factors, as well as
              the losses during the first two months of 1998 created trends that
              needed to be addressed regarding the Company's ability to meet
              future obligations. Management developed a business plan to
              reverse these trends in 1998 which includes increasing revenue
              through increased wholesale coffee prices for Thanksgiving Coffee
              Company, commencement of pizza sales for the bakery and subleasing
              the cafe retail space. Management has decreased expenses by
              closing the cafe division, selling Sustainable Harvest, and
              downsizing the workforce. The future prosperity of the Company is
              dependent upon the plan's success. The financial statements do not
              include any adjustments that might be necessary if the Company is
              not successful with the implementation of the business plan.


                                      F-18