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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



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FORM 10-K



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



| | for the fiscal year ended December 31, 2006
| | -------------------------------------------

OR



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

Commission file number 0-32233

PEETS COFFEE & TEA, INC.

(Exact Name of Registrant as Specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Washington                                                     |  | 91-0863396                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

1400 Park Avenue

Emeryville, California 94608-3520

(Address of Principal Executive Offices) (Zip Code)

(510) 594-2100

(Registrants telephone number, including area code)

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

Common Stock, no par value

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

None



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Indicate by check mark whether the
registrant is well-known, seasoned filer (as defined in Rule 405 under the Securities Act).    Yes ̈No  x

Indicate by check mark whether the registrant is not
required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.    Yes ̈No  x

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

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

Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Exchange Act Rule 12b-2).

Large Accelerated Filer ̈Accelerated
Filer   x        Non-Accelerated Filer ̈

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

The approximate aggregate market value of the voting stock held by non-affiliates of the registrant based on the closing price and shares of the Common Stock outstanding on July 2, 2006 (the registrants
most recently completed second quarter), as reported by the Nasdaq National Market, was $417,639,433. Shares of Common Stock held by each officer, director and each person known to the Company to hold 5% or more of the outstanding Common Stock have
been excluded as such persons may be deemed to be affiliates of the Company. Such determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 14, 2007, 13,516,180 shares of registrants Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement related to
the registrants 2006 annual meeting of shareholders, which proxy statement will be filed under the Securities Exchange Act of 1934 within 120 days of the end of the registrants fiscal year ended December 31, 2006, are incorporated
by reference into Part III of this annual report on Form 10-K.



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TABLE OF CONTENTS



|         |  |                                                                                                              |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                              |  | Page
|         |  | PART I                                                                                                       |  |     
|         |  |                                                                                                             
|Item 1.  |  | Business                                                                                                     |  | 7   
|         |  |                                                                                                             
|Item 1A. |  | Risk Factors                                                                                                 |  | 12  
|         |  |                                                                                                             
|Item 1B. |  | Unresolved Staff Comments                                                                                    |  | 17  
|         |  |                                                                                                             
|Item 2.  |  | Properties                                                                                                   |  | 17  
|         |  |                                                                                                             
|Item 3.  |  | Legal Proceedings                                                                                            |  | 18  
|         |  |                                                                                                             
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 18  
|         |  |                                                                                                             
|         |  | PART II                                                                                                      |  |     
|         |  |                                                                                                             
|Item 5.  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 19  
|         |  |                                                                                                             
|Item 6.  |  | Selected Financial Data                                                                                      |  | 20  
|         |  |                                                                                                             
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 24  
|         |  |                                                                                                             
|Item 7A. |  | Quantitative and Qualitative Disclosure About Market Risk                                                    |  | 32  
|         |  |                                                                                                             
|Item 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 33  
|         |  |                                                                                                             
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 33  
|         |  |                                                                                                             
|Item 9A. |  | Controls and Procedures                                                                                      |  | 33  
|         |  |                                                                                                             
|Item 9B. |  | Other Information                                                                                            |  | 35  
|         |  |                                                                                                             
|         |  | PART III                                                                                                     |  |     
|         |  |                                                                                                             
|Item 10. |  | Directors, Executive Officers and Corporate Governance                                                       |  | 36  
|         |  |                                                                                                             
|Item 11. |  | Executive Compensation                                                                                       |  | 36  
|         |  |                                                                                                             
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 36  
|         |  |                                                                                                             
|Item 13. |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 36  
|         |  |                                                                                                             
|Item 14. |  | Principal Accountant Fees and Services                                                                       |  | 36  
|         |  |                                                                                                             
|         |  | PART IV                                                                                                      |  |     
|         |  |                                                                                                             
|Item 15. |  | Exhibits and Financial Statement Schedules                                                                   |  | 37  
|         |  |                                                                                                             
|         |  | Signatures                                                                                                   |  | 39  





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References to we, us, our, Peets, and the
Company in this annual report on Form 10-K refer to Peets Coffee & Tea, Inc.

FORWARD-LOOKING STATEMENTS

Some of the matters discussed under the captions Risk Factors, Managements Discussion and Analysis of
Financial Condition and Results of Operation, Business and elsewhere in this report include forward-looking statements. We have based these forward-looking statements on our current expectations and assumptions about future events,
including, among other things:



| |  |  | Implementing our business strategy;
| | - |  | -----------------------------------



| |  |  | Attracting and retaining customers;
| | - |  | -----------------------------------



| |  |  | Establishing and expanding our market presence in new geographic regions;
| | - |  | -------------------------------------------------------------------------



| |  |  | The availability and pricing of high quality Arabica coffee beans;
| | - |  | ------------------------------------------------------------------



| |  |  | Consumers tastes and preferences; and
| | - |  | --------------------------------------



| |  |  | Competition in our markets.
| | - |  | ---------------------------

In some
cases, you can identify forward-looking statements by terminology such as may, should, could, predict, potential, continue, expect, anticipate,
future, intend, plan, believe, estimate and similar expressions (or the negative of such expressions). These statements are based on our current beliefs, expectations and assumptions and
are subject to a number of risks and uncertainties. Actual results, levels of activity, performance, achievements and events may vary significantly from those implied by the forward-looking statements. A description of risks that could cause our
results to vary appears under the caption Risk Factors and elsewhere in this annual report on Form 10-K (report). Forward-looking statements speak only as of the date of this report.

EXPLANATORY NOTE

Restatement of
Consolidated Financial Results

This annual report on Form 10-K for the fiscal year ended December 31, 2006
(Form 10-K) includes the restatement of our consolidated financial statements and the related disclosures as of January 1, 2006 and for the two fiscals year ended January 1, 2006 resulting from the (i) previously
disclosed voluntary review of historical stock option grant practices and (ii) incorrect methodology used to allocate procurement and production costs into inventory. In this Form 10-K, we have restated our consolidated balance sheet as of
January 1, 2006 and the related consolidated statements of income, shareholders equity, and cash flows for the years ended January 1, 2006 (fiscal 2005) and January 2, 2005 (fiscal 2004) and quarterly data for fiscal years 2006
and 2005. In addition, the following items of this Form 10-K include restated financial data: (i) Part II, Item 6Selected Financial Data; (ii) Part II, Item 7  Managements Discussion and Analysis of
Financial Condition and Results of Operations; and (iii) Part II, Item 8  Financial Statements and Supplementary Data.

We
have not amended our previously-filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for any fiscal year or quarter affected by the restatement. Instead, the financial information that has been previously filed or otherwise
reported for these periods is superseded by the information in this 2006 Form 10-K, and the financial information contained in such previously-filed reports should no longer be relied upon.



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Stock Option Grants

As previously disclosed, on October 20, 2006, our Board of Directors appointed an Option Review Committee (the Special Committee) consisting of two independent directors to oversee a review of the
Companys past stock option granting practices. This voluntary review was initiated in light of the media coverage regarding stock option granting practices of other publicly traded companies. The Special Committees review covered the
period from the Companys 2001 initial public offering to August 2006. The Company also reviewed all options granted beginning in 1996. The review was conducted with the assistance of independent legal counsel and accounting experts (the
Review Team).

Special Committee Findings

The Review Team reviewed the facts and circumstances surrounding stock option grants made during the review period, which included grants made on 80 dates. The Review Team conducted an extensive investigation
including the review of physical and electronic documents and interviews with current and former directors, officers, employees and advisors. Documents reviewed included final versions and electronically stored drafts of board and committee meeting
minutes and unanimous written consents, communication records with the Companys Board of Directors and its Compensation Committee, grant lists and other documents. As part of its investigation, the Special Committee evaluated whether the
correct measurement dates had been used under applicable accounting principles for the options granted. The measurement date as defined under Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB
25) and related interpretations, is the first date where there is evidence of proper approval and on which all of the following are known: (1) the individual employee who is entitled to receive the option grant, (2) the number of
options that an individual employee is entitled to receive, and (3) the options exercise price.

The Special Committee concluded
its review and reported its findings to the Board of Directors on March 6, 2007. The Special Committee reported that based on their review of data and interviews, the Review Team did not find evidence that there was any deliberate attempt to
manipulate the price at which any stock option was granted nor the date of the grant in order to benefit the grant recipient or Peets. The Review Team also reported that they did not discover evidence of intentional wrongdoing by any
Peets employee or Board member. The Review Team did, however, discover a lack of documentation and internal controls in connection with our stock administration system, particularly in the 2001-2003 period.

Based on the work of the Special Committee and the Review Team, we have determined that we used an incorrect measurement date for financial accounting
purposes for a number of stock option grants. These errors resulted primarily from misapplication of accounting standards related to the determination of certain measurement dates, as discussed below, which on a number of occasions resulted in
employees receiving options with stated exercise prices higher or lower than the market prices on the revised measurement dates as determined by the applicable accounting standards. Accordingly, we sought to determine, based on the available
evidence for each of the grants, when all prerequisites had been met in order to establish a revised measurement date for the granted options. In addition, we found instances in which the measurement dates for option grants were determined
appropriately but the options were accounted for incorrectly. Based on these conclusions, we have restated the accompanying fiscal 2005 and 2004 consolidated financial statements to record additional non-cash stock-based compensation expense and
related tax effects with regard to past stock option grants. The cumulative effect of these stock-based compensation adjustments, after tax, aggregate $1.0 million for fiscal years 1998 through 2005. The adjustments, after tax, for fiscal years 2005
and 2004 are $15,000 and $74,000, respectively.



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The principal components of the restatement are as follows (in thousands):



|                                                                                     |  |                        |    
|------------------------------------------------------------------------------------ |  | ---------------------- | ---
|                                                                                     |  | Adjustments,net of tax
|Revised Measurement Dates:                                                           |  |                        |    
|All Employee Grants                                                                  |  | $                      | 266
|Bonus Grants                                                                         |  |                        | 420
|Other Grants                                                                         |  |                        | 28 
|Incorrect Accounting for Grants to Consultants, Modifications and Discounted Options |  |                        | 265
|Misapplication of Non-Employee Director Stock Option Plan                            |  |                        | 9  
|                                                                                     |  |                        |    
|                                                                                     |  | $                      | 988
|                                                                                     |  |                        |    

Revised Measurement Dates.Based on available evidence, the Company applied the
methodologies described below to determine the revised measurement dates under APB No. 25 for grants in the following categories: (1) annual grants to all Company employees (All Employee Grants); (2) bonus award option
grants to directors and officers (Bonus Grants); and (3) grants in connection with the hiring and promotion of employees and other discretionary grants (Other Grants).



| |  |  | All Employee GrantsSince the Companys initial public offering in 2001, the Company has made an annual grant of stock options to all
employees of the Company. These grants require approval by the Board of Directors or the Compensation Committee of the Board of Directors (Compensation Committee). The number of shares to be granted to each individual is based upon job
level in the organization and years of service.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We determined that the fiscal 2001 grant was not approved at a Board of
Directors or Compensation Committee meeting, but instead we used a unanimous written consent (UWC) to obtain Board of Director approval. However, the UWC relating to the grant was not fully executed by the grant date. We have determined
the appropriate measurement date of this award to be the date the final Board member signature was obtained on the UWC.

We also determined
that we used the incorrect measurement date for the fiscal 2002 grant. While Board of Directors approval was received for the shares to be issued and documented in a regularly scheduled board meeting, there was no evidence that the exercise price
was determined on the stated date. We have determined the revised measurement date for this grant using our judgment of when the grant details were likely finalized, based on review of available evidence, such as e-mail communications, interviews
and supporting facts and circumstances.



| |  |  | Bonus GrantsIn 2001, the Company began to grant stock options to director-level employees and above as incentive compensation. The number
of options to be granted was determined using a predefined formula that utilizes the exercise price to determine the number of shares to be granted. For the 2001 and 2002 bonus grants, we determined we used an incorrect measurement date for
accounting purposes because the list containing the names of grantees, the options awarded to each grantee, and/or the grant date was not evidenced to be approved and determined with finality until a date subsequent to the measurement dates we
previously used. We determined the revised measurement dates for the 2001 and 2002 bonus grants based on the date when the formula used to compute the number of options granted to each employee was approved by the Board of Directors and there was
evidence that the grant price was established.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other GrantsThe Company also awarded options to key new hires, for promotions and in select situations to reward and retain key
individuals. The Companys general practice has been to grant stock options on the date the employee started work, was promoted or was notified of a discretionary grant. The Company would obtain approval for these grants in two different ways:
(1) for grants over 10,000 shares the Company required Board of Directors or Compensation Committee approval, and (2) beginning in February 2003, the Compensation Committee delegated authority to the Chief Executive
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | Officer in his capacity as a member of the Board of Directors to approve grants up to 10,000 shares, as prior to that date the delegation was implied. In
certain instances, the available documentation for the grants did not support the original measurement date as all the terms of the grant were not approved and known with finality at the stated grant date. We used the methodology described below
for: 1) grants requiring Board of Directors or Compensation Committee approval and 2) grants where granting authority was delegated to the Chief Executive Officer.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Other Grants requiring Board of Directors or Compensation Committee approvalWe determined the revised measurement date for each stock option
grant that requires Board of Directors or Compensation Committee approval to be the Approval Date (as defined below) for the stock option, provided the criteria set forth below were met. If there was not clear documentation supporting the Approval
Date, we used the evidence described below to determine the most likely measurement date.



| |  |  | Approval DateThe Approval Date was the date of approval set forth in executed minutes or a fully-executed UWC of the Board of Directors or
Compensation Committee documenting the grant of the stock option (i.e. employee, number of options, and exercise price.) When we did not have evidence of the approvals through either the minutes or signed UWC, we used other available evidence of
approval by the Board of Directors or Compensation Committee, including email communications.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Most Likely Measurement DateIf the Approval Date criteria was not evidenced (i.e. all signed UWCs were not returned), we used the earlier
of the following dates to determine the revised measurement date as we believe approval of the grant would have occurred prior to this date:
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The date the employee was notified of the terms of the option grant,
| | - |  | --------------------------------------------------------------------



| |  |  | The signature date of management approvals on the Companys grant approval form,
| | - |  | --------------------------------------------------------------------------------



| |  |  | The date the grant approval form was received by our human resources department,
| | - |  | --------------------------------------------------------------------------------



| |  |  | Print date or metadata creation date on notice of grant of stock form, or
| | - |  | -------------------------------------------------------------------------



| |  |  | The date the option was entered into our stock option database application.
| | - |  | ---------------------------------------------------------------------------

Other Grants where granting authority was delegated to the Chief Executive Officer:



| |  |  | New Hire GrantsThe Companys Chief Executive Officer has been directly involved in determining the stock options to be granted to new hires.
Generally, the terms of these stock options were included in the employees offer letter. Therefore, we determined the measurement date for new hire option grants to be the employees start date if all of the terms of the option grant were
documented in the employees offer letter. Where we have determined that new hire option terms had not been determined and approved with finality prior to the employees start date, we have used the methodology defined above under
Most Likely Measurement Date, to determine the revised measurement date.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Promotion and Discretionary GrantsWe did not follow a consistent practice in granting, approving or documenting promotion and discretionary grants
throughout the years. In many of our promotion and discretionary grants, the available documentation for the grants did not support the original measurement date as all the terms of the grant were not approved and known with finality at the stated
grant date. In such instances, we have used the methodology defined above under Most Likely Measurement Date, to determine the revised measurement date.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Incorrect Accounting for Grants to Consultants, Modifications and Discounted Options.We also identified other accounting errors
related to option grants. We identified one Company-wide grant from 1998, before Peets became a public company that was intentionally granted with an exercise price equal to 85% of fair value, consistent with the operative stock plan and the
Companys practice at the time, with respect to which we did not correctly account for the discount to fair value. We also identified two options granted to consultants that



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were incorrectly accounted for as grants to employees. In addition, we found several instances in which we incorrectly accounted for modifications to
outstanding options, including one employee option that was accelerated upon termination of employment outside the provisions of the original grant and 11 instances in which employees periods to exercise options were extended.

Misapplication of Non-Employee Director Stock Option Plan.The Non-Employee Director Plan provides for non-discretionary,
automatic option grants to non-employee directors (including both initial grants and annual grants), requiring no independent action of the Board or any committee of the Board. The plan stipulates that each director automatically receives an
initial grant and a prorated annual grant on the day of initial election or appointment to the Board of Directors and an ongoing annual grant on the day following each annual meeting of shareholders. Prior to May 2005 the plan specified that options
would have an exercise price equal to the market value of the option grant, which was defined as the closing price of the stock on the day prior to the grant. The plan was amended in May 2005 to define the market value as the closing price of the
stock on the day of the option grant. The Company incorrectly administered three annual grants to all directors and one initial grant by applying a measurement date that was incorrect by one day. In addition, in two instances, the Company did not
record the proper prorated grant upon a new director being named to the Board. The Company intends to correct these two administrative errors on the prorated grants in accordance with the plan. Of the three annual grants to all directors, two were
recorded at an exercise price higher than the market price on the revised measurement date, and therefore no additional expense has been recognized in respect to these grants.

Total Financial Impact of Stock Option Related Restatement

The total stock-based compensation expense and incremental impact, to correct these errors in our historical stock option grants is as follows, net of related income tax expenses (in thousands):



|          |  |                          |       |                                   |   |                         |  |   |     |  |   |     |  |   |    
|--------- |  | ------------------------ | ----- | --------------------------------- | - | ----------------------- |  | - | --- |  | - | --- |  | - | ---
|          |  | Stock-based Compensation
|          |  | Adjustments              |       | As previouslyreported, net of tax |   | As restated, net of tax
|          |  | pre-tax                  |       | tax effect                        |   | net of tax              |  |  
|1998      |  | $                        | 26    |                                   | $ | 11                      |  | $ | 15  |  | $ |    |  | $ | 15 
|1999      |  |                          | 48    |                                   |   | 20                      |  |   | 28  |  |   | 9   |  |   | 37 
|2000      |  |                          | 51    |                                   |   | 21                      |  |   | 30  |  |   | 143 |  |   | 173
|2001      |  |                          | 291   |                                   |   | 119                     |  |   | 172 |  |   | 183 |  |   | 355
|2002      |  |                          | 953   |                                   |   | 389                     |  |   | 564 |  |   | 174 |  |   | 738
|2003      |  |                          | 152   |                                   |   | 62                      |  |   | 90  |  |   | 115 |  |   | 205
|          |  |                          |       |                                   |   |                         |  |   |     |  |   |     |  |   |    
|1998-2003 |  |                          |       |                                   |   |                         |  |   | 899 |  |   |     |  |   |    
|2004      |  |                          | 125   |                                   |   | 51                      |  |   | 74  |  |   | 54  |  |   | 128
|2005      |  |                          | 26    |                                   |   | 11                      |  |   | 15  |  |   | 10  |  |   | 25 
|          |  |                          |       |                                   |   |                         |  |   |     |  |   |     |  |   |    
|          |  | $                        | 1,672 |                                   | $ | 684                     |  | $ | 988 |  |   |     |  |   |    
|          |  |                          |       |                                   |   |                         |  |   |     |  |   |     |  |   |    

As of January 2, 2006 (the first day of the Companys 2006 fiscal year), the aggregate
amount of unamortized compensation expense related to these option grants totaled approximately $57,000.

Additionally, we have restated
the related pro forma expense for the years ended January 1, 2006 and January 2, 2005 under Statement of Financial Accounting Standards (SFAS) No. 123 in Note 1, Summary of Significant Accounting Policies of
the Notes to Consolidated Financial Statements of this 2006 Form 10-K to reflect the impact of these adjustments.

With
respect to the matters discussed above, it is conceivable that others viewing the same evidence might have selected different measurement dates and that a higher or lower compensation charge would have resulted. Solely for purposes of assessing the
possible effect on compensation expense that using different measurement



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dates could have had, we selected the earliest and latest measurement dates (if any) that had any substantial support, and calculated compensation expense
using the highest and lowest stock price during that range of dates. Based on this data, the resulting additional pre-tax compensation expense could have been as low as $1.0 million or as high as $2.7 million instead of the $1.7 million we have
recorded. However, we believe that our methodology provides for the most likely measurement date based on all available information.

We
are in the process of continuing to develop more formal procedures and controls to provide reasonable assurance that the measurement date for stock option grants is appropriately determined. Effective March 26, 2007, the Compensation Committee
of the Board of Directors adopted a stock option granting policy and specified Company procedures. The policy set forth policies and procedures relating to stock option granting practices, including (a) the review of stock option grant
documentation prior to a grant to ensure proper support for the measurement date including the appropriate Board of Directors, Compensation Committee or Chief Executive Officer approval, (b) eliminating the use of unanimous written consents by
the Board of Directors and its Compensation Committee, and (c) the use of predetermined effective dates for all grants.

Procurement and Production
Costs

Subsequent to the Companys 2006 year-end, we determined that our methodology for allocating production and procurement cost
to inventory was incorrect and resulted in understating inventory balances and misstated net income. The Companys restated consolidated balance sheet as of January 1, 2006 includes an increase to inventory balances of $0.9
million and a cumulative net effect on retained earnings of $0.6 million. The pre-tax impact on the consolidated statements of income for fiscal 2005 and 2004 is approximately a $174,000 increase and a $2,000 decrease.



Restatement Reconciliation

The reconciliation of the cumulative effect of the above adjustments to beginning retained earnings as reported is as follows (in thousands):



|                                                            |  |   |      |  
|----------------------------------------------------------- |  | - | ---- | -
|Cumulative Stock Options Adjustment                         |  | $ | 899  |  
|Cumulative Inventory Adjustment                             |  |   | (403 | )
|                                                            |  |   |      |  
|Cumulative effect on Retained Earnings at December 28, 2003 |  | $ | 496  |  
|                                                            |  |   |      |  



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PART I

Item 1. Business

Peets Coffee & Tea is a specialty coffee roaster and marketer of fresh roasted whole bean coffee. We sell our coffee under strict freshness standards through multiple channels of distribution including
grocery stores, home delivery, office, restaurant and food service accounts and Company-owned and operated stores in six states.

Since we
believe that roasted coffee is a perishable product, we pursue distribution channels that are consistent with our strict freshness standards. For instance, our distribution to grocery stores emphasizes the use of a direct store delivery
(DSD) system whereby our employees or agents deliver fresh goods to our grocery partners. We roast to order and ship coffee directly from our roasting facility to our home delivery customers. Our goal is to ensure that customers receive
coffee within days of roasting.

We have expanded from a retailer that operates its own outlets to a premium coffee brand available through
multiple channels of distribution. We signed our first office coffee distribution agreement in 1997 and have since added a number of restaurants, food service accounts and office coffee distributors in select markets. We added online ordering
capability to our website in 1997 to complement our existing mail order home delivery business and have since invested in marketing programs designed to support our home delivery channel. In 1998, we initiated a strategic expansion into specialty
grocery and gourmet food stores. This expansion was further developed to include distribution to mainstream grocers as we expanded our grocery accounts from 130 to 4,400 stores. We believe our expansion strategy emphasizes disciplined growth and
enhancement of our brands image and quality reputation. We operate our business through two reportable segments: retail and specialty sales. See Note 11, Segment Information to the Notes to Consolidated Financial
Statements included elsewhere in this report.

Our website is located at peets.com. Our annual report on Form 10-K, quarterly reports
on Form 10-Q and current reports on Form 8-K, as well as any amendments or exhibits to those reports, are available free of charge through our website at peets.com as soon as reasonably practicable after we file them with, or furnish them to, the
Securities and Exchange Commission (SEC). The Company was organized as a Washington corporation in 1971.

Company Retail Stores

At December 31, 2006 we operated 136 retail stores in six states through which we sell whole bean coffee, beverages and pastries,
tea, and other related items. Our stores are designed to facilitate the sale of fresh whole bean coffee and to encourage customer trial of our coffee through coffee beverages. Each store has a dedicated staff person at the bean counter to take
orders and assist customers with questions on coffee origins and on home brewing. Upon order, beans are scooped and ground to the customers specific requirements. At our beverage counter, we rotate and sell freshly-brewed coffees and
coffee-based beverages to promote customer familiarity, sampling, and sales of whole-bean coffees. To ensure that our freshness standards are consistently met, it is our policy not to serve brewed coffee that is more than 30 minutes old and
every espresso based drink is made to order using freshly pulled shots of espresso and freshly steamed milk. See Item 2. Properties for further discussion about our retail stores.

Specialty Sales

Grocery

In addition to sales through our retail stores, we have expanded the availability of our products through a network of grocery stores, including Safeway,
Albertsons, Ralphs and Whole Foods Market. To support this expansion, we have developed a DSD sales and distribution system. Peets DSD route sales representatives



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deliver directly to their stores anywhere between one to three times per week, properly shelve the product, resolve pricing discrepancies, rotate to ensure
freshness, sell and erect free-standing displays and forge store-level selling relationships. We currently have 42 company-operated DSD route sales representatives, and approximately 100 independent distributors or multi-liners who will continue to
support the expansion into new grocery accounts in the western United States and our existing grocery customers.

Home Delivery

In the home delivery channel, we have a dedicated website and customer service representatives who provide points of contact to our
customers for coffee ordering and coffee knowledge. Our website features an Express Buy function for registered customers for speed and ease, special coffee and tea programs and a coffee and tea selector to assist the customer in choosing a product
based upon certain characteristics. Peets.com also features a proprietary tool that allows customers to manage the timing and delivery of their recurring orders. In 2004, we implemented our Peetnik Loyalty Program to reward our most loyal home
delivery customers who maintain regular, ongoing deliveries of coffee or tea. This program has proven to be successful in growing our home delivery business online by engaging our most loyal customers to establish regular deliveries of fresh roasted
coffee or tea. In addition to our website, we have a team of customer service representatives who assist customers in placing customer orders, choosing a gift item, providing product information and resolving customer issues. Customer service
representatives are regularly trained on Peets product offerings through weekly coffee and tea tastings.

Food Service and Office

In the food service and office business, we have a staff of sales and account managers who make sales calls to potential and existing
accounts and manage our distributor network. Additionally, we have established relationships with office, restaurant and food service distributors to expand our account base in select markets. These distributors have their own sales and account
management resources.

Our Coffee

Coffee Beans

Coffee is an agricultural crop that undergoes quality changes and price fluctuation depending on weather,
economic and political conditions in coffee producing countries. We purchase only Arabica coffee beans, which are considered superior to beans traded in the commodity market. Thus, the arabicabeans purchased by us tend to trade on a
negotiated basis at a substantial premium above commodity coffee prices, depending upon the supply and demand at the time of purchase. Our access to high quality arabica beans depends on our relationships with coffee brokers, exporters and
growers, with whom we have built long-term relationships to ensure a steady supply of coffee beans. We believe that, as a result of our reputation that has been built over 40 years, we have access to some of the highest quality coffee beans from the
finest estates and growing regions around the world and we are occasionally presented with opportunities to purchase unique and special coffees.

Unlike roasted coffee beans, green coffee beans are not highly perishable. We generally turn our inventory of green coffee beans two to three times per year. We typically carry approximately $10 million to $14 million worth of green coffee
beans in our inventory. We mitigate the risks associated with fluctuations in coffee prices by entering into fixed price commitments and in the past, hedging agreements, for a portion of our green coffee bean requirements.

Our Roasting Method

Our roasting
method was first developed by Alfred Peet and further honed by our talented and skilled roasting personnel who make a long-term commitment to our artisan craft. We roast by hand in small batches, and we rely on the skills and training of each
roaster to maximize the flavor and potential in our beans. Our



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roasters undergo an extensive apprenticeship program to learn our roasting method and to gain the skills necessary to roast coffee at Peets.

Coffee Types and Blends

Beyond sourcing and roasting, we have developed a reputation for expert coffee blending. Our blends, such as Major Dickasons Blend®, are well regarded by our customers for their uniqueness, consistency and special flavor characteristics. We sell approximately 32 types of coffee as
regular menu items, including approximately 21 blends and 11 single origin coffees such as Colombia, Guatemala, Sumatra and Kenya. We also offer a line of high-end reserve coffees including JR Reserve Blend® and Kona, and we have also featured seasonal reserve coffees such as Jamaica Blue
Mountain and Aged Sulawesi Peaberry. We are active in seeking, roasting and selling unique special lot and one-time coffees. On average, we offer four to six such coffees every year, including our Anniversary Blend and Holiday Blend.

Tea, Food and Merchandise

Peets offers a line
of hand selected whole leaf and bagged tea. Our quality standards for tea are very high. We purchase tea directly from importers and brokers and store and pack the tea at our facility in Emeryville. We offer a limited line of specialty food items,
such as jellies, jams and candies. These products are carefully selected for quality and uniqueness.

Our merchandise program consists of
items such as brewing equipment for coffee and tea, paper filters and brewing accessories and branded and non-branded cups, saucers, travel mugs and serveware. We do not emphasize these items, but we carry them in retail stores and offer them
through home delivery as a means to reinforce our commitment to premium home-brewed coffee and tea.

Competitive Positioning

The specialty coffee market can be characterized as highly fragmented. Our primary competitors in whole bean specialty coffee sales include Gevalia (Kraft
Foods), Green Mountain Coffee, Illy Caffé, Millstone (Procter & Gamble), Seattles Best (Starbucks) and Starbucks. There are numerous smaller, regional brands that also compete in this category. Premium coffee brands may serve
as substitutes for our whole bean coffee and we also compete indirectly against all other coffee brands on the market.

In addition to
competing with other distributors of whole bean coffee, we compete with retailers of prepared beverages, including coffee house chains, particularly Starbucks, and to a lesser degree, Coffee Bean and Tea Leaf, Dunkin Donuts and Caribou Coffee,
numerous convenience stores, restaurants, coffee shops and street vendors.

We believe that our customers choose among specialty coffee
brands based upon quality, variety, convenience, and to a lesser extent, price. Although consumers may differentiate coffee brands based on freshness (as an element of coffee quality), to our knowledge, few significant competitors focus on product
freshness and roast-dating in the same manner as Peets. We believe that our market share in the specialty category is based on a solidly differentiated position built on our freshness standards and artisan-roasting style. Because of the
fragmented nature of the specialty coffee market, we cannot accurately estimate our market share. However, many of our existing competitors have significantly greater financial, marketing and operating resources.

Our roasted coffee is priced in tiers. Our regular menu coffees are currently priced in our retail locations within a range of $9.95 to $18.95 per pound.
Our line of high-end reserve coffees introduced in 2001 is priced between $49.90 and $79.90 per pound. In the grocery channel, we sell our coffee in 12 ounce packages at prices established by the grocery store. Most grocery stores sell our product
at a price between $9.99 and $11.99 for a 12 ounce bag.



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Intellectual Property

We regard intellectual property and other proprietary rights as important to our success. We place high value on our Peets trade name, and we own several trademarks and service marks that have been registered
with the United States Patent and Trademark Office, including Peets®, Peets Coffee & Tea®, peets.com®, Blend
101®, Espresso Forte®, Fresh Fridays®, Gaia Organic Blend®, Garuda Blend®, JR Reserve Blend®, Maduro Blend®, Major Dickasons Blend®, Pride of the Port®, Pumphreys Blend®, Sierra Dorada Blend®, Summer House®, Snow
Leopard®, Top Blend® and Vine Street Blend®. We also have registered trademarks on our stylized logo. In addition, we have
applications pending with the United States Patent and Trademark Office for a number of additional marks including Freddo, Blended Freddo, eCup and A Cup Is Worth A Thousand Words.

We own registered trademarks for
our name and logo in Argentina, Australia, Canada, Chile, China, the European Union, Hong Kong, Japan, Paraguay, Singapore, South Korea, Taiwan and Thailand. We have filed additional applications for trademark protection in Brazil and the
Philippines. In addition to peets.com and coffee.com, we own several other domain names relating to coffee, Peets and our roasting process.

In addition to registered and pending trademarks, we consider the packaging for our coffee beans (consisting of dark brown coloring with African-style motif and lettering with a white band running around the lower
quarter of the bag) and the design of the interior of our stores (consisting of dark wood fixtures, classic lighting, granite countertops and understated color) to be strong identifiers of our brand. Although we consider our packaging and store
design to be essential to our brand identity, we have not applied to register these trademarks and trade dress, and thus cannot rely on the legal protections afforded by trademark registration.

Our ability to differentiate our brand from those of our competitors depends, in part, on the strength and enforcement of our trademarks. We must
constantly protect against any infringement by competitors. If a competitor infringes on our trademark rights, we may have to litigate to protect our rights, in which case, we may incur significant expenses and divert significant attention from our
business operations.

Information Systems

The information systems installed at Peets are used to manage our operations and increase the productivity of our workforce. We believe our point-of-sale system increases store productivity, provides a higher level of service to our
customers and maintains timely information for performance evaluation. Our registers have touch screen components and full point-of-sale capability. In 2002, during the rollout of our DSD system in the grocery channel, we implemented a grocery order
entry and invoice system with handheld capability that allows our route sales representatives to provide service and information on the spot. In 2003, we implemented business intelligence software to better support and analyze our business in all
channels. In 2004, we deployed an integrated labor and scheduling system in our retail stores to improve productivity and customer service.

Our website, peets.com, is hosted at our corporate headquarters in Emeryville, California. All website applications are built on Microsoft ASP with in-house development. We offer full-functioning e-commerce and our website is integrated
with our call center for access to orders placed at both locations. Online delivery confirmation is provided by United Parcel Service and the United States Postal Service. Our website contains several customer-centered functions. Manage Deliveries
is an application which enables consumers to schedule recurring deliveries including choosing specific coffees and teas to be delivered at the frequency of their choice. Other important customer functions include a coffee and tea selector, Express
Buy and multiple ship-to capability on a single bill. Additionally, customers with Peets cards can check their balance as well as reload their card online. We designed our website to provide fast, easy and effective operation when
navigating and shopping on our website. We have dedicated information technology employees and marketing staffers for website maintenance, improvement, development and performance.



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Employees

As of March 14, 2007, we employed a workforce of 3,169 people, approximately 621 of whom work approximately 40 hours per week and are considered full-time employees. We consider our relationship with our employees to be good. Since
1979, we have provided full benefits to all employees who work at least 21 hours per week and have worked at least 500 total hours for the Company. We believe we offer competitive benefits packages to attract and retain valuable employees.

Government Regulation

Our coffee
roasting operations and our retail stores are subject to various governmental laws, regulations, and licenses relating to customs, health and safety, building and land use, and environmental protection. Our roasting facility is subject to state and
local air-quality and emissions regulations. If we encounter difficulties in obtaining any necessary licenses or complying with these laws and regulations, then:



| |  |  | The opening of new retail locations could be delayed;
| | - |  | -----------------------------------------------------



| |  |  | The operation of existing retail locations or our coffee roasting operations could be interrupted; or
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | Our product offerings could be limited.
| | - |  | ---------------------------------------

We believe that we are in compliance in all material respects with all such laws and regulations and that we have obtained all material licenses that are required for the operation of our business. We are not aware of any environmental
regulations that have or that we believe will have a material adverse effect on our operations.

Executive Officers of the Registrant

Set forth below is information with respect to the names, ages, positions and offices of our executive officers as of March 14, 2007.



|                 |  |     |  |                                                      
|---------------- |  | --- |  | -----------------------------------------------------
|Name             |  | Age |  | Position                                             
|Patrick J. ODea |  | 45  |  | Chief Executive Officer, President and Director      
|Thomas P. Cawley |  | 46  |  | Chief Financial Officer, Vice President and Secretary
|James E. Grimes  |  | 51  |  | Vice President, Operations and Information Systems   

Patrick J. ODeahas served as Chief Executive Officer, President and as a director
since May 2002. From April 1997 to March 2001, he was CEO of Archway/Mothers Cookies and Mothers Cake & Cookie Company. From 1995 to 1997, Mr. ODea was the Vice President and General Manager of the Specialty Cheese
Division of Stella Foods. From 1984 to 1995, he was with Procter & Gamble, where he marketed several of the companys snack and beverage brands.

Thomas P. Cawley has served as Chief Financial Officer since July 2003. From August 2000 to June 2003, he was at Gap, Inc. serving as Chief Financial Officer, Gap Brand. From 1986 to August 2000,
Mr. Cawley was at PepsiCo/Yum Brands (formerly Tricon Global Restaurants), holding various positions such as Director of Finance, Vice PresidentController, and Chief Financial Officer; Pizza Hut. Previous to 1986, Mr. Cawley was with
The Quaker Oats Company and General Foods.

James E. Grimes has served as Vice President of Operations and Information Systems since
July 2002. In August 2001, Mr. Grimes founded Supply Chain Consulting, where he provided supply chain management expertise. From 1998 to 2001, he was Senior Vice President of Operations at Archway/Mothers Cookies. Previously,
Mr. Grimes held various positions at Mothers Cake and Cookie Company, Frito Lay and Procter & Gamble.



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|I
tem 1A. | Risk Factors
|--------- | ------------

We may not be successful in the implementation of
our business strategy or our business strategy may not be successful, either of which will impede our growth and operating results.

Our
business strategy emphasizes expansion through multiple channels of distribution. Currently, our retail stores, which generated over 67% of our 2006 net revenue, continue to be an important element of our business. We do not know whether we will be
able to successfully implement our business strategy or whether our business strategy will be successful. Our ability to implement this business strategy is dependent on our ability to:



| |  |  | Market our products on a national scale and over the internet;
| | - |  | --------------------------------------------------------------



| |  |  | Enter into distribution and other strategic arrangements with third party retailers and other potential distributors of our coffee;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increase our brand recognition on a national scale;
| | - |  | ---------------------------------------------------



| |  |  | Identify and lease strategic locations suitable for new stores; and
| | - |  | -------------------------------------------------------------------



| |  |  | Manage growth in administrative overhead and distribution costs likely to result from the planned expansion of our retail and non-retail distribution channels.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

Our revenue may be adversely affected if we fail to implement our business strategy or if we divert resources to a
business strategy that ultimately proves unsuccessful.

Because our business is highly dependent on a single product, specialty coffee, if the demand
for specialty coffee decreases, our business could suffer.

Sales of specialty coffee constituted nearly 84% of our 2006 net revenue.
Demand for specialty coffee is affected by many factors, including:



| |  |  | Consumer tastes and preferences;
| | - |  | --------------------------------



| |  |  | National, regional and local economic conditions;
| | - |  | -------------------------------------------------



| |  |  | Demographic trends; and
| | - |  | -----------------------



| |  |  | Perceived or actual health benefits or risks.
| | - |  | ---------------------------------------------

Because we are highly dependent on consumer demand for specialty coffee, a shift in consumer preferences away from specialty coffee would harm our business more than if we had more diversified product offerings. If
customer demand for specialty coffee decreases, our sales would decrease accordingly.

If we fail to continue to develop and maintain our brand, our
business could suffer.

We believe that maintaining and developing our brand is critical to our success and that the importance of brand
recognition may increase as a result of competitors offering products similar to ours. Because the majority of our retail stores are located on the West Coast, primarily in California, our brand recognition remains largely regional. Our brand
building initiative involves increasing the availability of our products and opening new stores to increase awareness of our brand and create and maintain brand loyalty. If our brand building initiative is unsuccessful, we may never recover the
expenses incurred in connection with these efforts and we may be unable to increase our future revenue or implement our business strategy.

Our success in promoting and enhancing the Peets brand will also depend on our ability to provide customers with high quality products and customer service. Although we take measures to ensure that we sell only fresh roasted whole
bean coffee and that our retail employees properly prepare our coffee beverages, we have no control over our whole bean coffee products once purchased by customers. Accordingly, customers may



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prepare coffee from our whole bean coffee inconsistent with our standards, store our whole bean coffee for long periods of time or resell our whole bean
coffee without our consent, which in each case, potentially affects the quality of the coffee prepared from our products. If customers do not perceive our products and service to be of high quality, then the value of our brand may be diminished and,
consequently, our ability to implement our business strategy may be adversely affected.

Increases in the cost and decreases in availability of high
quality Arabica coffee beans could impact our profitability and growth of our business.

Green coffee is our largest single cost of
sales. We do not purchase coffee on the commodity markets, but price movements in the trading of coffee do impact the price we pay. Over the past two years, the commodity cost for coffee has risen above the range it was trading in for the prior
three to four years. Coffee is a trade commodity and, in general, its price can fluctuate depending on:



| |  |  | Weather patterns in coffee-producing countries;
| | - |  | -----------------------------------------------



| |  |  | Economic and political conditions affecting coffee-producing countries;
| | - |  | -----------------------------------------------------------------------



| |  |  | Foreign currency fluctuations;
| | - |  | ------------------------------



| |  |  | The ability of coffee-producing countries to agree to export quotas; and
| | - |  | ------------------------------------------------------------------------



| |  |  | General economic conditions that make commodities more or less attractive investment options.
| | - |  | ---------------------------------------------------------------------------------------------

If the cost of our green coffee beans increases due to any of these or other factors impacting us negatively, we many not be able to pass along those
costs to our customers because of the competitive nature of the specialty coffee industry. If we are unable to pass along increased coffee costs, our margin will decrease and our profitability will suffer accordingly. If we are not able to purchase
sufficient quantities of high quality Arabica beans due to any of the above factors, we many not be able to fulfill the demand for our coffee, our revenue may decrease and our ability to expand our business may also suffer.

We cannot be certain of the future effectiveness of our internal control over financial reporting or the impact of the same on our operations or the market price for
our common stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our Annual Report on
Form 10-K our assessment of the effectiveness of our internal control over financial reporting. Our management identified certain material weaknesses relating to our historical stock option granting practices and our methodology for allocating
procurement and production costs during its assessment of the effectiveness of internal control over financial reporting as of December 31, 2006. As a result, management concluded that we did not maintain effective internal control over
financial reporting as of December 31, 2006 based on the control criteria established in a report entitled Internal ControlIntegrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Although we believe we have corrected the methodology to allocate procurement and production costs and we are in process of developing more formal procedures and controls relating to our stock option granting practices, we cannot assure
you that we have or will be able to successfully remediate these material weaknesses. We cannot be certain that future material changes to our internal controls over financial reporting will be effective. If we cannot adequately maintain the
effectiveness of our internal control over financial reporting, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC. Any such action could adversely affect our financial results and the market price of our
common stock. In addition, the inability to maintain effective internal control over financial reporting could adversely impact our operations.



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Civil litigation relating to our stock option granting practices could have a material adverse effect on the Company.

We and certain of our directors and current and former officers are defendants in three shareholder derivative actions relating to our
stock option granting practices. See Note 10, Commitments and Contingencies, Legal Proceedings in the Notes to Consolidated Financial Statements for a more detailed description of these proceedings. These actions are in their
preliminary stages, and we intend to take all appropriate steps in the defense of these cases. These lawsuits could divert management time and attention from day-to-day operations, result in significant legal expenses, and result in an outcome that
could have a material adverse effect on our business, financial condition, results of operations and cash flows.

As a result of the delayed filing of
our Form 10-Q for the quarter ended October 1, 2006, we are ineligible to use Form S-3 to register securities with the SEC, which may adversely affect our ability to raise future capital or complete acquisitions.

As a result of our delayed filing of our Form 10-Q for the quarter ended October 1, 2006, we are ineligible to register our securities on Form S-3
for sale by us or resale by other security holders until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for at least 12 full calendar months from the date our Form 10-Q for the quarter ended October 1, 2006 was
due. In the meantime, we would need to use Form S-1 to register securities with the SEC, which could increase the transaction costs and adversely affect our ability to raise capital or complete acquisitions of other companies during this
period.

Because our business is based primarily in California, a worsening of economic conditions, a decrease in consumer spending or a change in the
competitive conditions in this market may substantially decrease our revenue and may adversely impact our ability to implement our business strategy.

Our California retail stores generated 60% of our 2006 net revenue and a substantial portion of the revenue from our other distribution channels is generated in California. We expect that our California operations
will continue to generate a substantial portion of our revenue. In addition, our California retail stores provide us with means for increasing brand awareness, building customer loyalty and creating a premium specialty coffee brand. As a result, an
economic downturn or other decrease in consumer spending in California may not only lead to a substantial decrease in revenue, but may also adversely impact our ability to market our brand, build customer loyalty, or otherwise implement our business
strategy.

Labor conditions in the grocery business could negatively impact our grocery business.

There have been grocery strikes in the past that have negatively impacted our grocery business and it is possible that future grocery strikes in places
where we have large distribution may adversely impact our grocery business.

Government mandatory healthcare requirements could adversely affect
our profits.

The Company offers healthcare benefits to all employees who work at least 21 hours a week and meet service eligibility
requirements. In the past, some states, including California, have unsuccessfully proposed legislation mandating that employers pay healthcare premiums into a state run fund for all employees immediately upon hiring. If legislation similar to this
were to be enacted in the states we do business, it could have an adverse affect on the Companys profits.

If we are unable to continue leasing
our retail locations or obtain leases for new stores, our existing operations and our ability to expand may be adversely affected.

All
of our 136 retail locations at year-end are on leased premises. If we are unable to renew these leases, our revenue and profits could suffer. In addition, we intend to lease other premises in connection with the planned



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expansion of our retail operations. Because we compete with other retailers and restaurants for store sites and some landlords may grant exclusive locations
to our competitors, we may not be able to obtain new leases or renew existing leases on acceptable terms. This could adversely impact our revenue growth and brand building initiatives.

Because we rely heavily on common carriers to ship our coffee on a daily basis, any disruption in their services or increase in shipping costs could adversely affect our business.

We rely on a number of common carriers to deliver coffee to our customers and retail stores. We consider roasted coffee a perishable product and we rely
on these common carriers to deliver fresh roasted coffee on a daily basis. We have no control over these common carriers and the services provided by them may be interrupted as a result of labor shortages, contract disputes or other factors. If we
experience an interruption in these services, we may be unable to ship our coffee in a timely manner. A delay in shipping could:



| |  |  | Have an adverse impact on the quality of the coffee shipped, and thereby adversely affect our brand and reputation;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | Result in the disposal of an amount of coffee that could not be shipped in a timely manner; and
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | Require us to contract with alternative, and possibly more expensive, common carriers.
| | - |  | --------------------------------------------------------------------------------------

Any significant increase in shipping costs could lower our profit margins or force us to raise prices, which could cause our revenue and profits to
suffer.

We depend on the expertise of key personnel. If these individuals leave or change their role within our Company without effective replacements,
our operations may suffer.

The success of our business is dependent to a large degree on our management and our coffee roasters and
purchasers. If members of our management leave without effective replacements, our ability to implement our business strategy could be impaired. If we lost the services of our coffee roasters and purchasers, our ability to source and purchase a
sufficient supply of high quality coffee beans and roast coffee beans consistent with our quality standards could suffer. In either case, our business and operations could be adversely affected.

We may not be able to hire or retain additional management and other personnel and our recruiting and training costs may increase as a result of turnover, both of
which may increase our costs and reduce our profits and may adversely impact our ability to implement our business strategy.

The
success of our business depends upon our ability to attract and retain highly motivated, well-qualified management and other personnel, including technical personnel and retail employees. We face significant competition in the recruitment of
qualified employees. Our ability to execute our business strategy may suffer if:



| |  |  | We are unable to recruit or retain a sufficient number of qualified employees;
| | - |  | ------------------------------------------------------------------------------



| |  |  | The costs of employee compensation or benefits increase substantially; or
| | - |  | -------------------------------------------------------------------------



| |  |  | The costs of outsourcing certain tasks to third party providers increase substantially.
| | - |  | ---------------------------------------------------------------------------------------

A significant interruption in the operation of our roasting and distribution facilities could potentially disrupt our operations.

We are currently in the process of transitioning our roasting and distribution operations to a new facility, after which we intend to convert our existing
roasting and distribution facility to office space. A significant interruption in the operation of either facility during the transition process or the new facility thereafter, whether as a result of a natural disaster or other causes, could
significantly impair our ability to operate our business. Since we only roast our coffee to order, we do not carry inventory of roasted coffee in our roasting plant.



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Therefore, a disruption in service in our roasting facility would impact our sales in our retail and specialty channels almost immediately. Moreover, our
roasting and distribution facilities and most of our stores are located near several major earthquake faults. The impact of a major earthquake on our facilities, infrastructure and overall operations is difficult to predict and an earthquake could
seriously disrupt our entire business.

Our earthquake insurance covers net income, continuing normal operating expenses and extra expenses
incurred during the period of restoration once the large deductible has been exceeded. However, in the event of a catastrophic earthquake, our coverage is limited and we would incur additional expenses.

We have a high deductible workers compensation insurance program and more claims and higher costs from these claims may adversely affect our profits.

Our current workers compensation insurance program is a modified self-insured program with a high deductible with an overall
program ceiling to limit exposure. The California workers compensation environment has been unpredictable with continually increasing costs in the past five years. The majority of our business is in California; therefore, we are exposed to the
same increased costs. Additionally, we have had to estimate our liability for existing claims whose outcome is uncertain. While we believe our reserve methodology on these claims is appropriate today, unfavorable legislative developments in this
area may also affect any open claims that were filed beginning March 2002, the date we transitioned to a high deductible program. Should a greater amount of claims occur or the settlement costs increase beyond what was anticipated, our expenses
could increase and our profitability may decrease.

Our roasting methods are not proprietary, so competitors may be able to duplicate them, which could
harm our competitive position.

We consider our roasting methods essential to the flavor and richness of our roasted whole bean coffee
and, therefore, essential to our brand. Because we do not hold any patents for our roasting methods, it may be difficult for us to prevent competitors from copying our roasting methods. If our competitors copy our roasting methods, the value of our
brand may be diminished, and we may lose customers to our competitors. In addition, competitors may be able to develop roasting methods that are more advanced than our roasting methods, which may also harm our competitive position.

Competition in the specialty coffee market is intense and could affect our profits.

The specialty coffee market can be characterized as highly fragmented. Our primary competitors in whole bean specialty coffee sales include Gevalia (Kraft Foods), Green Mountain Coffee, Illy Caffé, Millstone
(Procter & Gamble), Seattles Best (Starbucks) and Starbucks. There are numerous smaller, regional brands that also compete in this category. Premium coffee brands may serve as substitutes for our whole bean coffee and we also compete
indirectly against all other coffee brands on the market. In addition to competing with other distributors of whole bean coffee, we compete with retailers of prepared beverages, including coffee house chains, particularly Starbucks, and to a lesser
degree, Coffee Bean and Tea Leaf, Dunkin Donuts and Caribou Coffee, numerous convenience stores, restaurants, coffee shops and street vendors.

Despite competing in a fragmented product category, whole bean specialty coffee brands are being established across multiple distribution channels. Several competitors have been aggressive in obtaining distribution in specialty grocery and
gourmet food stores, through online, and in office, restaurant and food service locations. Other competitors may have an advantage over us based on their earlier entry into these distribution channels.

Many of these new market entrants may have substantially greater financial, marketing and operating resources than we do. In addition, many of our
existing competitors have substantially greater financial, marketing and operating resources than we do.



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Adverse public or medical opinion about caffeine may harm our business.

Our specialty coffee contains significant amounts of caffeine and other active compounds, the health effects of some of which are not fully understood. A
number of research studies conclude or suggest that excessive consumption of caffeine may lead to increased heart rate, nausea and vomiting, restlessness and anxiety, depression, headaches, tremors, sleeplessness and other adverse health effects. An
unfavorable report on the health effects of caffeine or other compounds present in coffee could significantly reduce the demand for coffee, which could harm our business and reduce our sales and profits.

Adverse publicity regarding customer complaints may harm our business.

We may be the subject of complaints or litigation from customers alleging beverage and food-related illnesses, injuries suffered on the premises or other quality, health or operational concerns. Adverse publicity
resulting from such allegations may materially adversely affect us, regardless of whether such allegations are true or whether we are ultimately held liable.



|Item 1B. | Unresolved Staff Comments
|-------- | -------------------------

Not Applicable.



|Item 2. | Properties
|------- | ----------

Peets headquarters are located in
Emeryville, California, where the Company leases approximately 103,000 square feet of office and production space in four locations. Within these facilities, we have 31,000 square feet devoted to general corporate and retail overhead and a call
center for the home delivery business. Our current lease for our roasting, distribution and main office location of 72,000 square feet extends to October 2015 with two five year extension options, subject to our right to terminate early if needed
before August 2007. The leases of our other office location in Emeryville expire December 31, 2007.

In December 2006 we purchased
approximately 460,000 square feet of land and a 138,000 square foot building with related site improvements in Alameda for the purpose of operating a new roasting and distribution facility. The final purchase price of the facility and the land was
$18.6 million. We are currently in the process of transitioning our roasting and distribution operations to this new facility, after which we intend to convert our existing roasting and distribution facility to office space. We anticipate the new
facility to be at full production capability by April 2007.

In June 2006, we purchased 131,000 square feet of land for $2.3 million
adjacent to the new roasting facility.

In 2006, we opened 25 new stores. Our retail locations are all company-owned and operated in leased
facilities. Our stores are typically located in urban neighborhoods, suburban shopping centers (usually consisting of grocery, specialty and service stores) and on high-traffic streets.



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The following table lists the number of retail locations as of December 31, 2006:



|                    |  |       
|------------------- |  | ------
|Location            |  | Number
|Northern California |  | 85    
|Southern California |  | 29    
|Illinois            |  | 2     
|Oregon              |  | 7     
|Massachusetts       |  | 6     
|Washington          |  | 3     
|Colorado            |  | 4     
|                    |  |       
|Total               |  | 136   
|                    |  |       



|Item 3. | Legal Proceedings
|------- | -----------------

In November 2006, a complaint
styled as a shareholder derivative action was filed, purportedly on behalf of Peets, against certain of our present and former directors and officers. The complaint alleges that the defendants caused or allowed improprieties in connection with
certain stock option grants since at least 2001 and thereby breached their fiduciary duties to Peets and violated specified provisions of the California Corporations Code. The complaint also alleges that certain of our present and former
directors and officers were unjustly enriched as a result. Purportedly on behalf of Peets, the complaint seeks, among other things, damages, restitution and corporate governance reforms. This complaint and a similar one have been filed in the
Superior Court for Alameda County, California and a third was filed in February 2007 in the United States District Court for the Northern District of California.

These actions could result in substantial costs and divert managements attention and resources. These actions are at a preliminary stage, and we are not in a position to determine whether a loss is probable or
estimate a range of amount of loss.

We may from time to time become involved in certain legal proceedings in the ordinary course of
business. Currently, the Company is not a party to any other legal proceedings that management believes would have a material adverse effect on the financial position or results of operations of the Company.



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

No matters were submitted to a vote of our shareholders during the quarter ended December 31, 2006.



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##### Table of Contents

PART II



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

Market for the Registrants Stock

The
Companys common stock is traded on the Nasdaq National Market under the symbol PEET. The following table sets forth, for the periods indicated, the high and low closing prices for our common stock as reported on the Nasdaq National
Market for each quarter during the last two fiscal years.



|                                    |  |      |       |     |   |      
|----------------------------------- |  | ---- | ----- | --- | - | -----
|                                    |  | High |       | Low
|Fiscal Year Ended December 31, 2006 |  |      |       |     |   |      
|Fourth Quarter                      |  | $    | 27.87 |     | $ | 24.29
|Third Quarter                       |  |      | 30.90 |     |   | 24.43
|Second Quarter                      |  |      | 32.76 |     |   | 28.21
|First Quarter                       |  |      | 31.91 |     |   | 28.19
|Fiscal Year Ended January 1, 2006   |  |      |       |     |   |      
|Fourth Quarter                      |  | $    | 33.27 |     | $ | 28.12
|Third Quarter                       |  |      | 36.80 |     |   | 29.40
|Second Quarter                      |  |      | 34.00 |     |   | 25.13
|First Quarter                       |  |      | 26.40 |     |   | 23.26

As of March 14, 2007, there were approximately 345 registered holders of record of the
Companys common stock. On March 14, 2007, the last sale price reported on the Nasdaq National Market for the common stock was $26.48 per share.

Dividend Policy

We have not declared or paid any dividends on our capital stock since 1990. We expect to retain any future
earnings to fund the development and expansion of our business. Therefore, we do not anticipate paying cash dividends on our common stock in the foreseeable future.

Use of Proceeds from Sales of Registered Securities

We completed our initial public offering of our
common stock in 2001. The total net proceeds from the offering of $17.8 million have since been applied to the uses described in the prospectus for the offering.

Issuer Purchases of Equity Securities

On September 6, 2006, the Companys Board of Directors authorized the
Company to purchase up to 1.0 million shares of Peets common stock, with no expiration, and the Company announced its plan on September 12, 2006 on Form 8-K. As of December 31, 2006, no shares had been purchased under this
program. The Company expects to make purchases from time to time on the open market at prevailing market prices or in negotiated transactions off the market.

Performance Graph*

The following graph depicts the Companys total return to shareholders from December 30, 2001
through December 31, 2006, relative to the performance of the NASDAQ Composite Index, and the Standard & Poors Smallcap 600 Consumer Goods Sector, Processed and Packaged Foods Industry, a peer group that includes Peets. All
indices shown in the graph have been reset to a base of 100 as of December 30, 2001, assume an investment of $100 on that date and the reinvestment of dividends paid since that date, calculated on a monthly



19



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##### Table of Contents

basis. The Company has never paid cash dividends on its Common Stock. The points represent index levels based on the last trading day of the Companys
fiscal year. The chart set forth below was prepared by Research Data Group, Inc., which holds a license to provide the indices used herein. The stock price performance shown in the graph is not necessarily indicative of future price performance.

LOGO

---

|* | This section is not soliciting material, is not deemed filed with the SEC and is not to be incorporated by reference in any of our filings under the
Securities Act or the Securities Exchange Act made before or after the date hereof and irrespective of any general incorporation language in any such filing.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 6. | Selected Financial Data
|------- | -----------------------

The Companys
financial statements as of and for the year ended December 31, 2006, and its restated financial statements as of January 1, 2006 and for each of the two fiscal years in the period ended January 1, 2006 are included in Item 8,
Financial Statements and Supplementary Data of this Form 10-K. The operating results data for the fiscal years ended December 28, 2003 and December 29, 2002 and balance sheet data as of January 2,
2005, December 28, 2003 and December 29, 2002 are derived from restated financial statements of the Company not included herein. The information set forth below should be read in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto of the Company included elsewhere in this document. The financial statements for fiscal years 2002 through 2005 have been restated herein
to reflect adjustments related to non-cash compensation expense associated with the issuance of options granted from fiscal year 1998 through fiscal 2005 and certain inventory adjustments and expense reclassifications. See Item 7,
Managements Discussion and Analysis of Financial Condition and Results of OperationsRestatement of Financial Statements and Note 2, Restatement of Consolidated Financial Statements in the Notes to
Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K.



20



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##### Table of Contents

The table below shows selected consolidated financial data for our last five fiscal years. Our fiscal
year is based on a 52 or 53 week year and ends on the Sunday closest to the last day in December.

The following selected consolidated
financial data should be read in conjunction with our consolidated financial statements and related notes and Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this report.

Selected Consolidated Financial Data

(in thousands, except per share data)



|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|--------------------------------------------------- |  | --------------- | ------- | - | --------------- | - | ------- | --------------- |  | - | --------------- | - |  | --------------- | ------- | - |  | - | ------- | -
|                                                    |  | Year            |        
|                                                    |  | 2006 (52 weeks) |         |   | 2005 (52 weeks) |   |         | 2004 (53 weeks) |  |   | 2003 (52 weeks) |   |  | 2002 (52 weeks) |        
|                                                    |  |                 |         |   | As Restated     |   |         | As Restated     |  |   | As Restated     |   |  | As Restated     |        
|Statement of Income Data:                           |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Net revenue                                         |  | $               | 210,493 |   |                 | $ | 175,198 |                 |  | $ | 145,683         |   |  | $               | 119,816 |   |  | $ | 104,073 |  
|Cost of sales and related occupancy expenses        |  |                 | 98,928  |   |                 |   | 80,837  |                 |  |   | 67,806          |   |  |                 | 55,694  |   |  |   | 48,996  |  
|Operating expenses                                  |  |                 | 72,272  |   |                 |   | 57,879  |                 |  |   | 47,645          |   |  |                 | 37,746  |   |  |   | 32,786  |  
|General and administrative expenses                 |  |                 | 20,634  |   |                 |   | 13,341  |                 |  |   | 11,439          |   |  |                 | 14,087  |   |  |   | 12,042  |  
|Depreciation and amortization expenses              |  |                 | 8,609   |   |                 |   | 7,293   |                 |  |   | 5,787           |   |  |                 | 4,883   |   |  |   | 4,561   |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Income from operations                              |  |                 | 10,050  |   |                 |   | 15,848  |                 |  |   | 13,006          |   |  |                 | 7,406   |   |  |   | 5,688   |  
|Interest income, net                                |  |                 | 2,456   |   |                 |   | 1,769   |                 |  |   | 922             |   |  |                 | 1,163   |   |  |   | 540     |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Income before income taxes                          |  |                 | 12,506  |   |                 |   | 17,617  |                 |  |   | 13,928          |   |  |                 | 8,569   |   |  |   | 6,228   |  
|Income tax provision                                |  |                 | (4,690  | ) |                 |   | (6,842  | )               |  |   | (5,218          | ) |  |                 | (3,444  | ) |  |   | (2,260  | )
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Net income                                          |  | $               | 7,816   |   |                 | $ | 10,775  |                 |  | $ | 8,710           |   |  | $               | 5,125   |   |  | $ | 3,968   |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Net income per share:                               |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Basic                                               |  | $               | 0.57    |   |                 | $ | 0.78    |                 |  | $ | 0.65            |   |  | $               | 0.41    |   |  | $ | 0.36    |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Diluted                                             |  | $               | 0.55    |   |                 | $ | 0.74    |                 |  | $ | 0.62            |   |  | $               | 0.39    |   |  | $ | 0.34    |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Shares used in calculation of net income per share: |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Basic                                               |  |                 | 13,733  |   |                 |   | 13,801  |                 |  |   | 13,308          |   |  |                 | 12,589  |   |  |   | 10,919  |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Diluted                                             |  |                 | 14,202  |   |                 |   | 14,469  |                 |  |   | 13,949          |   |  |                 | 13,228  |   |  |   | 11,587  |  
|                                                    |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Balance Sheet Data:                                 |  |                 |         |   |                 |   |         |                 |  |   |                 |   |  |                 |         |   |  |   |         |  
|Cash and cash equivalents                           |  | $               | 7,692   |   |                 | $ | 20,623  |                 |  | $ | 11,356          |   |  | $               | 30,263  |   |  | $ | 7,572   |  
|Working capital                                     |  |                 | 37,254  |   |                 |   | 62,584  |                 |  |   | 16,726          |   |  |                 | 45,166  |   |  |   | 23,118  |  
|Total assets                                        |  |                 | 153,005 |   |                 |   | 148,752 |                 |  |   | 128,944         |   |  |                 | 111,319 |   |  |   | 95,990  |  
|Borrowings under line of credit                     |  |                 |        |   |                 |   |        |                 |  |   |                |   |  |                 |        |   |  |   |        |  
|Current portion of long-term borrowings             |  |                 |        |   |                 |   |        |                 |  |   |                |   |  |                 | 3       |   |  |   | 468     |  
|Long-term borrowings, less current portion          |  |                 |        |   |                 |   |        |                 |  |   |                |   |  |                 |        |   |  |   | 424     |  
|Total shareholders equity                          |  |                 | 127,439 |   |                 |   | 126,878 |                 |  |   | 109,905         |   |  |                 | 96,098  |   |  |   | 81,349  |  



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The table below reflects the impact of the restatement adjustments on our fiscal 2003 and 2002
consolidated statements of income and fiscal 2004, 2003 and 2002 balance sheet data.



|                                             |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|-------------------------------------------- |  | ----------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ------ | - |  | - | -------
|                                             |  | As of December 28, 2003
|                                             |  | As Previously Reported  |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                         | Inventory |             |   | Stock Options |                   |  |  
|Statements of Income:                        |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Net revenue                                  |  | $                       | 119,816   |             |   |              |                   |  |   |            |   |  |   |       |   |  | $ | 119,816
|Cost of sales and related occupancy expenses |  |                         | 54,961    |             | $ | (62           | )                 |  | $ | 18          |   |  | $ | 777    |   |  |   | 55,694 
|Operating expenses                           |  |                         | 38,751    |             |   |              |                   |  |   | 86          |   |  |   | (1,091 | ) |  |   | 37,746 
|General and administrative expenses          |  |                         | 13,718    |             |   |              |                   |  |   | 48          |   |  |   | 321    |   |  |   | 14,087 
|Depreciation and amortization expenses       |  |                         | 4,890     |             |   |              |                   |  |   |            |   |  |   | (7     | ) |  |   | 4,883  
|Income from operations                       |  |                         | 7,496     |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 7,406  
|Interest income, net                         |  |                         | 1,163     |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 1,163  
|Income before income taxes                   |  |                         | 8,659     |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 8,569  
|Income tax provision                         |  |                         | 3,481     |             |   | 25            |                   |  |   | (62         | ) |  |   |       |   |  |   | 3,444  
|Net income                                   |  |                         | 5,178     |             |   | (37           | )                 |  |   | 90          |   |  |   |       |   |  |   | 5,125  
|Net income per sharebasic                   |  | $                       | 0.41      |             | $ |              |                   |  | $ | 0.01        |   |  | $ |       |   |  | $ | 0.41   
|                                             |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Net income per sharediluted                 |  | $                       | 0.39      |             | $ |              |                   |  | $ | 0.01        |   |  | $ |       |   |  | $ | 0.39   
|                                             |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Shares used in per share calculationbasic   |  |                         | 12,589    |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 12,589 
|Shares used in per share calculationdiluted |  |                         | 13,236    |             |   |              |                   |  |   | (8          | ) |  |   |       |   |  |   | 13,228 
|                                             | 
|                                             |  | As of December 29, 2002
|                                             |  | As Previously Reported  |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                         | Inventory |             |   | Stock Options |                   |  |  
|Statements of Income:                        |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Net revenue                                  |  | $                       | 104,073   |             |   |              |                   |  |   |            |   |  |   |       |   |  | $ | 104,073
|Cost of sales and related occupancy expenses |  |                         | 48,146    |             | $ | 211           |                   |  | $ | 122         |   |  | $ | 517    |   |  |   | 48,996 
|Operating expenses                           |  |                         | 33,221    |             |   |              |                   |  |   | 342         |   |  |   | (777   | ) |  |   | 32,786 
|General and administrative expenses          |  |                         | 11,286    |             |   |              |                   |  |   | 489         |   |  |   | 267    |   |  |   | 12,042 
|Depreciation and amortization expenses       |  |                         | 4,568     |             |   |              |                   |  |   |            |   |  |   | (7     | ) |  |   | 4,561  
|Income from operations                       |  |                         | 6,852     |             |   | (211          | )                 |  |   | (953        | ) |  |   |       |   |  |   | 5,688  
|Interest income, net                         |  |                         | 540       |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 540    
|Income before income taxes                   |  |                         | 7,392     |             |   | (211          | )                 |  |   | (953        | ) |  |   |       |   |  |   | 6,228  
|Income tax provision                         |  |                         | 2,735     |             |   | (86           | )                 |  |   | (389        | ) |  |   |       |   |  |   | 2,260  
|Net income                                   |  |                         | 4,657     |             |   | (125          | )                 |  |   | (564        | ) |  |   |       |   |  |   | 3,968  
|Net income per sharebasic                   |  | $                       | 0.43      |             | $ | (0.01         | )                 |  | $ | (0.05       | ) |  | $ |       |   |  | $ | 0.36   
|                                             |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Net income per sharediluted                 |  | $                       | 0.40      |             | $ | (0.01         | )                 |  | $ | (0.05       | ) |  | $ |       |   |  | $ | 0.34   
|                                             |  |                         |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Shares used in per share calculationbasic   |  |                         | 10,919    |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 10,919 
|Shares used in per share calculationdiluted |  |                         | 11,627    |             |   |              |                   |  |   | (40         | ) |  |   |       |   |  |   | 11,587 



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|                                           |  |                         |           |             |               |             |  |   |     |  |   |        
|------------------------------------------ |  | ----------------------- | --------- | ----------- | ------------- | ----------- |  | - | --- |  | - | -------
|                                           |  | As of January 2, 2005  
|                                           |  | As Previously Reported  |           | Adjustments |               | As Restated
|                                           |  |                         | Inventory |             | Stock Options |            
|Balance Sheet Data:                        |  |                         |           |             |               |             |  |   |     |  |   |        
|Cash and cash equivalents                  |  | $                       | 11,356    |             |               |            |  |   |    |  | $ | 11,356 
|Working capital                            |  |                         | 16,047    |             | $             | 679         |  |   |    |  |   | 16,726 
|Total assets                               |  |                         | 127,889   |             |               | 679         |  | $ | 376 |  |   | 128,944
|Borrowings under line of credit            |  |                         |          |             |               |            |  |   |    |  |   |       
|Current portion of long-term borrowings    |  |                         |          |             |               |            |  |   |    |  |   |       
|Long-term borrowings, less current portion |  |                         |          |             |               |            |  |   |    |  |   |       
|Total shareholders equity                 |  |                         | 109,127   |             |               | 402         |  |   | 376 |  |   | 109,905
|                                           | 
|                                           |  | As of December 28, 2003
|                                           |  | As Previously Reported  |           | Adjustments |               | As Restated
|                                           |  |                         | Inventory |             | Stock Options |            
|Balance Sheet Data:                        |  |                         |           |             |               |             |  |   |     |  |   |        
|Cash and cash equivalents                  |  | $                       | 30,263    |             |               |            |  |   |    |  | $ | 30,263 
|Working capital                            |  |                         | 44,485    |             | $             | 681         |  |   |    |  |   | 45,166 
|Total assets                               |  |                         | 110,455   |             |               | 403         |  | $ | 461 |  |   | 111,319
|Borrowings under line of credit            |  |                         |          |             |               |            |  |   |    |  |   |       
|Current portion of long-term borrowings    |  |                         | 3         |             |               |            |  |   |    |  |   | 3      
|Long-term borrowings, less current portion |  |                         |          |             |               |            |  |   |    |  |   |       
|Total shareholders equity                 |  |                         | 95,234    |             |               | 403         |  |   | 461 |  |   | 96,098 
|                                           | 
|                                           |  | As of December 29, 2002
|                                           |  | As Previously Reported  |           | Adjustments |               | As Restated
|                                           |  |                         | Inventory |             | Stock Options |            
|Balance Sheet Data:                        |  |                         |           |             |               |             |  |   |     |  |   |        
|Cash and cash equivalents                  |  | $                       | 7,572     |             |               |            |  |   |    |  | $ | 7,572  
|Working capital                            |  |                         | 22,499    |             | $             | 619         |  |   |    |  |   | 23,118 
|Total assets                               |  |                         | 95,145    |             |               | 366         |  | $ | 479 |  |   | 95,990 
|Borrowings under line of credit            |  |                         |          |             |               |            |  |   |    |  |   |       
|Current portion of long-term borrowings    |  |                         | 468       |             |               |            |  |   |    |  |   | 468    
|Long-term borrowings, less current portion |  |                         | 424       |             |               |            |  |   |    |  |   | 424    
|Total shareholders equity                 |  |                         | 80,504    |             |               | 366         |  |   | 479 |  |   | 81,349 

See the impact of the restatement adjustments and reclassifications on our fiscal 2005 and 2004
consolidated statements of income and our fiscal 2005 consolidated balance sheet in Note 2 of the accompanying Notes to Consolidated Financial Statements.



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

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in
this report. Except for historical information, the discussion below contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. The fiscal year ended December 31, 2006 (fiscal 2006)
included 52 weeks, fiscal year ended January 1, 2006 (fiscal 2005) included 52 weeks, and the fiscal year ended January 2, 2005 (fiscal 2004) included 53 weeks.

Restatement of Financial Statements

The fiscal 2005 and 2004 financial statements have been restated
as more fully described in the Explanatory Note immediately preceding Part I, Item 1 and in Note 2, Restatement of Consolidated Financial Statements in Notes to Consolidated Financial Statements of this
annual report on Form 10-K. The after tax net income impact of the adjustments for fiscal years 2005 and 2004 was approximately $15,000 and $74,000, respectively.

In addition, options determined to have been granted with an exercise price below the fair market value of our common stock on the actual grant date and vesting subsequent to December 2004 may result in
nonqualified deferred compensation for purposes of Section 409A of the Internal Revenue Code, subjecting the holders of such options to an excise tax on the value of the options in the year in which they vest. We believe that options to
purchase approximately 46,000 shares of our common stock held by current and former employees may be subject to unfavorable personal income tax consequences under Section 409A. We have not determined what actions, if any, we may take in order
to mitigate these tax consequences, but we do not expect the financial or accounting consequences of any such action to be material.

Company Overview
and Industry Outlook

Peets is a specialty coffee roaster and marketer of fresh, deep-roasted whole bean coffee sold through
multiple channels of distribution for home and away-from-home enjoyment. Founded in Berkeley, California in 1966, Peets has established a loyal customer base with strong brand awareness in California. Our growth strategy is based on the sale
of whole bean coffee and high-quality beverages in multiple channels of distribution including our own retail stores, grocery, home delivery, and office and restaurant accounts throughout the United States. Our current expansion strategy is focused
in the western United States, where we have strong customer awareness, loyalty and brand affinity.

In 2006, the Company pursued its
strategy to build out its multiple channels in the western United States. The results of the efforts in 2006 include:



| |  |  | opening 25 new retail locations, 19 of which were in California, three in Colorado and the remaining three in the Pacific Northwest;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | expanding our grocery network to now include virtually all the grocery stores west of the Rockies and select markets on the East Coast. This helped drive 32%
revenue growth in our grocery business;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | purchasing a new roasting facility in Alameda, California, which will enable our future growth needs for our west coast business;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | continuing the investment in the people and systems to prepare for the continued expansion of the brand; and
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | delivering consistent net revenue results, as we have since we became a public company in 2001.
| | - |  | -----------------------------------------------------------------------------------------------

All of these results have been achieved while continuing to provide our customers with the uncompromised quality of our coffee offerings.

We expect the specialty coffee industry to continue to grow. We believe that this growth will be fueled by continued consumer interest in high
quality coffee and related products. We believe that by offering high-quality



24



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##### Table of Contents

products to consumers throughout the country, we will attract the same loyal customer base that we have attracted in California.

As we grow, our operations will continue to be vertically integrated, allowing us to control the quality of our product at all stages. We purchase
high quality Arabica coffee beans from countries around the world, and we utilize our artisan-roasting technique to bring out the distinctive flavor of our coffees. Because roasted coffee is perishable, we are committed to delivering our coffee
under the strictest freshness standards. As a result, we do not stock or inventory roasted coffee. We roast to order and ship fresh coffee daily to our stores and customers. Control of purchasing, roasting, packaging and distribution of our
coffee allows us to maintain our commitment to freshness, is cost effective, and enhances our margins and profit potential.

Business Segments

Our coffee and related items are sold through multiple channels of distribution that provide broad market exposure to potential
purchasers of fresh roasted whole bean coffee. We are indifferent as to where consumers purchase our coffees and teas, and believe that our specialty and retail segments are synergistic. However, we also recognize that the economics of our retail
stores and other distribution channels are different enough that we have chosen to report them as separate segments under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Therefore, we currently
have two reportable segments, consisting of:



| |  |  | Our retail stores; and
| | - |  | ----------------------



| |  |  | Specialty sales, which consist of sales to home delivery customers, sales to grocery stores, restaurant and food service companies and office accounts.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

We believe growth opportunities exist in all of our distribution channels. Our expansion is focused geographically, not
by segment. Our first priority is to develop primarily in the western U.S. markets where we already have a presence and have higher customer awareness. We will continue to open new stores in strategic locations that meet our demographic profile in
these markets, make our coffees more broadly and conveniently located in grocery stores, and partner with distributors and companies who share our passion for quality and freshness and are willing and able to execute accordingly in the food service
and office environment.

Business Categories

In addition to our reportable segments, we measure our business by monitoring the volume and revenue growth of two distinct business categories:



| |  |  | Whole bean coffee and related products, consisting of products for home brewing, tea and packaged foods; and
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Beverages and pastries.
| | - |  | -----------------------

We believe
these business categories are useful in understanding our results of operations for the periods presented because we operate our stores and record sales through these two categories. Our stores are primarily designed to facilitate the sale of fresh
whole bean coffee and hand-crafted coffee beverages. The format of our stores replicates that of a specialty grocer. Beans are freshly scooped from bins under the counter, weighed on counter top scales and hand packed into branded bags. In addition,
our stores are also designed to encourage customer trial of our coffee through coffee beverages. Each store has a beverage bar that is dedicated to the sale of prepared beverages and artisan baked pastries.



25



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##### Table of Contents

Results of Operations

The following discussion on results of operations should be read in conjunction with Item 6. Selected Consolidated Financial Data, the consolidated financial statements and accompanying notes and the other
financial data included elsewhere in this report.

Our fiscal year is based on a 52 or 53 week year. The fiscal year ends on the Sunday
closest to the last day of December.



|                                                                              |  |       |   |  |               |   |  |               |  
|----------------------------------------------------------------------------- |  | ----- | - |  | ------------- | - |  | ------------- | -
|                                                                              |  | 2006  |   |  | 2005          |   |  | 2004          |  
|                                                                              |  |       |   |  | (As Restated) |   |  | (As Restated) |  
|Statement of operations as a percent of net revenue:                          |  |       |   |  |               |   |  |               |  
|Net revenue                                                                   |  | 100.0 | % |  | 100.0         | % |  | 100.0         | %
|Cost of sales and related occupancy expenses                                  |  | 47.0  |   |  | 46.1          |   |  | 46.5          |  
|Operating expenses                                                            |  | 34.3  |   |  | 33.0          |   |  | 32.7          |  
|General and administrative expenses                                           |  | 9.8   |   |  | 7.6           |   |  | 7.9           |  
|Depreciation and amortization expenses                                        |  | 4.1   |   |  | 4.2           |   |  | 4.0           |  
|                                                                              |  |       |   |  |               |   |  |               |  
|Income from operations                                                        |  | 4.8   |   |  | 9.1           |   |  | 8.9           |  
|Interest income                                                               |  | 1.2   |   |  | 1.0           |   |  | 0.7           |  
|Interest expense                                                              |  |      |   |  |              |   |  | (0.1          | )
|                                                                              |  |       |   |  |               |   |  |               |  
|Income before income taxes                                                    |  | 6.0   |   |  | 10.1          |   |  | 9.5           |  
|Income tax provision                                                          |  | 2.2   |   |  | 3.9           |   |  | 3.6           |  
|                                                                              |  |       |   |  |               |   |  |               |  
|Net income                                                                    |  | 3.8   | % |  | 6.2           | % |  | 5.9           | %
|                                                                              |  |       |   |  |               |   |  |               |  
|Percent of net revenue by business segment:                                   |  |       |   |  |               |   |  |               |  
|Retail Stores                                                                 |  | 67.2  | % |  | 67.4          | % |  | 68.9          | %
|Specialty Stores                                                              |  | 32.8  |   |  | 32.6          |   |  | 31.1          |  
|Percent of net revenue by business category:                                  |  |       |   |  |               |   |  |               |  
|Whole bean coffee and related products                                        |  | 55.8  | % |  | 57.7          | % |  | 59.2          | %
|Beverages and pastries                                                        |  | 44.2  |   |  | 42.3          |   |  | 40.8          |  
|Cost of sales and related occupancy expenses as a percent of segment revenue: |  |       |   |  |               |   |  |               |  
|Retail Stores                                                                 |  | 46.2  | % |  | 45.0          | % |  | 45.3          | %
|Specialty Stores                                                              |  | 48.6  |   |  | 48.5          |   |  | 49.4          |  
|Operating expenses as a percent of segment revenue:                           |  |       |   |  |               |   |  |               |  
|Retail Stores                                                                 |  | 42.6  | % |  | 40.7          | % |  | 38.7          | %
|Specialty Stores                                                              |  | 17.5  |   |  | 17.3          |   |  | 19.3          |  
|Percent increase from prior year:                                             |  |       |   |  |               |   |  |               |  
|Net Revenue                                                                   |  | 20.1  | % |  | 20.3          | % |  | 21.6          | %
|Retail Stores                                                                 |  | 19.8  |   |  | 17.5          |   |  | 17.1          |  
|Specialty Stores                                                              |  | 20.9  |   |  | 26.4          |   |  | 32.9          |  
|Cost of sales and related occupancy expenses                                  |  | 22.4  |   |  | 19.2          |   |  | 21.7          |  
|Operating expenses                                                            |  | 24.9  |   |  | 21.5          |   |  | 26.2          |  
|General and administrative expenses                                           |  | 54.7  |   |  | 16.6          |   |  | 19.6          |  
|Depreciation and amortization expenses                                        |  | 18.0  |   |  | 26.0          |   |  | 18.5          |  
|                                                                              |  |       |  
|Selected operating data:                                                      |  |       |   |  |               |   |  |               |  
|Number of retail stores in operation                                          |  |       |   |  |               |   |  |               |  
|Beginning of the year                                                         |  | 111   |   |  | 92            |   |  | 75            |  
|Store openings                                                                |  | 25    |   |  | 20            |   |  | 17            |  
|Store closures                                                                |  |      |   |  | (1            | ) |  |              |  
|                                                                              |  |       |   |  |               |   |  |               |  
|End of the year                                                               |  | 136   |   |  | 111           |   |  | 92            |  
|                                                                              |  |       |   |  |               |   |  |               |  



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##### Table of Contents

2006 (52 weeks) Compared with 2005 (52 weeks)

Net revenue

Net revenue for 2006
increased 20.1% versus 2005 as a result of continued expansion of our retail and specialty sales segments. Sales of whole bean and related products increased 16.4% to $117.5 million. Sales from beverages and pastries increased 25.3% to $92.9
million.

In the retail segment, net revenue increased 19.8% compared to 2005 primarily as a result of increased sales from new stores we
opened in the last two years and growth in the existing stores. We opened 25 new stores in 2006 and 20 stores in 2005. Sales of whole bean coffee and related products in the retail segment increased by 9.2% to $49.1 million, while sales of beverages
and pastries increased by 26.3% to $92.3 million. The increase in beverage and pastry sales was primarily related to sales at the stores we opened in 2005 and 2006 and increased traffic in our existing stores. The slower growth in whole bean and
related products was primarily due to continuing cannibalization of bean sales in retail stores as we increased the availability of Peets coffee in grocery stores. As part of our goal of achieving sales growth of at least 20% for 2007 and
beyond, we expect to open approximately 30 stores in 2007, all of them in the western United States.

In the specialty sales segment, net
revenue increased 20.9% compared to 2005. The $11.9 million increase consisted of an $8.3 million increase in grocery sales, a $2.0 million increase in home delivery sales, and a $1.6 million increase in sales to food service and office
accounts. Grocery continued to have the highest growth rate in the segment with a 31.7% increase compared to last year, primarily due to continued strong growth in our existing accounts and secondarily due to new accounts we added during the year.
In grocery, we added 500 new stores during the year, bringing the number of grocery stores selling Peets coffee to approximately 4,400. Net revenue to the home delivery channel grew 13.1% compared to 2005 due primarily to three online only
special offerings held during the year. In addition, food service and office coffee revenue increased 10.5% primarily due to our effort to expand distributorships, partially offset by the forced closure of six Company operated Peets kiosks in
Larrys Markets in the Seattle area due to the bankruptcy and closure of Larrys Markets.

Cost of sales and related occupancy
expenses

Cost of sales and related occupancy expenses consist of product costs, including manufacturing costs, rent and other occupancy
costs. As a percent of net revenue, cost of sales increased from 46.1% in 2005 to 47.0% in 2006 due to higher green coffee costs and the impact of expensing stock-based compensation, partially offset by the price increase taken in our grocery
channel. Higher coffee cost resulted in a 1.0% increase in cost of sales as a percentage of net revenue. Expensing stock-based compensation resulted in a 0.2% increase in cost of sales. The increases were partially offset by the price increase we
took in our grocery channel in October 2005 that improved our cost of sales percentage by 0.5%.

We expect cost of sales to increase in
2007 due to further increases in coffee costs, which lags behind the commodity market price due to future fixed price purchase commitments, and due to incremental depreciation, operating costs and moving costs related to the new roasting facility
that is expected to become operational in April 2007.

Operating expenses

Operating expenses consist of both retail store and specialty operating costs, such as employee labor and benefits, repairs and maintenance, supplies,
training, travel and banking and card processing fees. Operating expenses as a percent of net revenue for 2006 increased compared to 2005 primarily due to the opening of new stores, higher expenses in existing stores and the impact of expensing
stock options.

In the retail segment, operating expenses as a percent of net revenue increased by 1.9% to 42.6%. Of the increase, 0.7% was
due to opening 45 new stores in the last two years, a 48.0% increase in the number of stores



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since 2004. New stores generally have higher operating expenses due to lower sales volume and startup costs. Stores opened prior to 2005 had a 0.5% increase
in operating expenses due to higher supplies and repairs and maintenance expense. The impact of the change to stock-based compensation accounted for the remaining 0.7% of the increase.

As a percent of net revenue, specialty operating expenses increased 0.2% to 17.5%. Stock-based compensation changes accounted for approximately 0.5% of
the increase. This was offset by the price increase taken in October 2005 in our grocery channel.

General and administrative expenses

General and administrative expenses in 2006 were $20.6 million, or 9.8% of net revenue, compared to $13.3 million, or 7.6% for the
same period last year. Of the 2.2% increase in expenses as a percent of net revenues, 1.1%, or $2.2 million, was attributable to the impact of stock-based compensation, 0.8%, or $1.8 million, was related to the legal and other professional fees
incurred for the stock option review and the remainder was due to increases in headcount, as well as recruiting, audit and accounting related and other professional services.

Depreciation and amortization expenses

Depreciation and amortization expenses increased in 2006 primarily due to the 45 stores we opened during 2006 and 2005.

Investment income, net

We currently invest in U.S. government, agency, municipal and guaranteed student loan obligations.
Investment income includes interest income and gains or losses from the sale of these instruments. We earned $2.5 million in interest income in 2006, compared to $1.8 million last year, primarily due to higher interest rates on our investments.

Income tax provision

This years effective income tax rate was 37.5% versus 38.8% in the prior year. Our effective rate decreased 1.3% primarily due to increased interest income from tax-exempt marketable securities during 2006.

2005 (52 weeks) Compared with 2004 (53 weeks)

Net
revenue

Net revenue for 2005 increased 20.3% versus 2004 as a result of continued expansion of our retail and specialty sales segments.
The increase from the same 52 weeks was 22.5% as the extra week accounted for 2.2%. Sales of whole bean and related products increased 17.1% to $101.0 million. Sales from beverages and pastries increased 24.8% to $74.2 million.

In the retail segment, net revenue increased 17.5% compared to 2004, or 19.8% without the
53rdweek in 2004, primarily as a result of increased sales from the 37 new stores we opened in the last two years
and growth in the existing stores. Sales of whole bean coffee and related products in the retail segment increased by 6.6% to $44.9 million, while sales of beverages and pastries increased by 25.4% to $73.1 million. The increase in beverage and
pastry sales was primarily caused by sales at the stores we opened in 2004 and 2005, increased traffic in our existing stores, and a price increase in October 2004. The slower growth in whole bean and related products was due to continuing
cannibalization of bean sales in retail stores as we increased the availability of Peets coffee in grocery stores and the lower mix of whole bean sales in our new stores. During 2005, we opened a total of 20 stores compared to 17 in 2004.



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In the specialty sales segment, net revenue
increased 26.4% compared to 2004, or 28.3% without the 53rdweek in 2004. The $11.9 million increase consisted
primarily of a $7.8 million increase in grocery sales and a $1.7 million increase in sales to restaurants and food service companies. The increase in both grocery and food service channel sales was primarily due to continued strong growth in our
existing accounts and secondarily due to new accounts we added during the year. In grocery, we added 400 new stores during the year, bringing the number of grocery stores selling Peets coffee to approximately 4,000. In the food service area,
we selectively added new accounts such as the University of California Berkeley. Net revenue to the home delivery channel grew 10.2% compared to 2004 as we continued to emphasize loyalty programs that reward customers who subscribe to our recurring
order programs. In addition, office coffee sales increased 30.3% primarily due to our effort to expand distributorships.

Cost of sales
and related occupancy expenses

Cost of sales and related occupancy expenses consist of product costs, including manufacturing costs,
rent and other occupancy and hedging costs. As a percent of net revenue, cost of sales decreased from 46.5% in 2004 to 46.1% in 2005 due to the price increase taken in October 2004 and the adjustment of $0.8 million related to lease accounting in
December of 2004. The price increase, which affected coffee, beverages, and tea in our retail stores and home delivery channel, lowered cost as a percent of net revenue by 1.1%. In addition, 2005 cost as a percentage of net revenue was lower than
2004 by 0.4% due to the prior year lease accounting adjustment.

These cost decreases were partially offset by higher coffee and
manufacturing costs and the opening of more new stores. New stores increased cost as a percent of net revenue by 0.4% because of their higher occupancy cost on a lower sales base. In addition, increased manufacturing and packaging costs had a
greater impact on costs as specialty became a larger part of the business. Lastly, higher coffee cost resulted in an additional 0.2% increase in cost of sales as a percentage of net revenue.

Operating expenses

Operating
expenses as a percent of net revenue for 2005 increased compared to 2004 primarily due to the opening of new stores, partially offset by leverage gained in the specialty segment.

In the retail segment, operating expenses as a percent of net revenue increased by 2.0% to 40.7%. The increase was due to a 1.6% increase from opening 37
new stores in the last two years. New stores generally have higher operating expenses due to lower sales volume and startup costs. The remaining increase was due to investments made in retail management to support store growth. The increase was
partially offset by the October 2004 price increase.

As a percent of net revenue, specialty operating expenses decreased 2.0% to 17.3% as
we leveraged the relatively fixed operating structure in grocery, foodservice, office and home delivery channels.

General and
administrative expenses

As a percent of net revenue, general and administrative expenses were mostly consistent with 2004, a 0.3%
decrease, as we continued to invest in headcount to support our growth.

Depreciation and amortization expenses

Depreciation and amortization expenses increased in 2005 primarily due to the 37 stores we opened during 2005 and 2004.



29



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##### Table of Contents

Investment income, net

We currently invest in U.S. government, agency, municipal and guaranteed student loan obligations. Investment income includes interest income and gains or
losses from the sale of these instruments. We earned $1.8 million in interest income in 2005, compared to $1.0 million last year, primarily due to higher interest rates on our investments and a higher average investment balance.

Income tax provision

The effective
income tax rate was 38.8% in 2005 versus 37.5% in the prior year. Our effective rate increased 1.0% as we entered into a higher statutory income tax bracket. The impact in 2005 of the benefits we realized from the new domestic production deduction
and state enterprise zone credits were offset by the adjustment in 2004 from the removal of the valuation allowance on federal and state charitable contribution carryforwards.

Liquidity and Capital Resources



At December 31, 2006, we had $7.7 million in cash and cash equivalents and $25.5 million in short-term and long-term marketable securities for a total of $33.2 million. Working capital was $37.3 million as of December 31, 2006
compared to $62.6 million at January 1, 2006. The decrease in working capital was primarily due to managements decision to invest in a new roasting facility and to repurchase our own stock under a stock repurchase program approved by our
Board of Directors in 2004.

Net cash provided by operations was $17.8 million in 2006 compared to $19.5 million in 2005. Operating cash
flows were positively impacted in 2006 by net income net of stock-based compensation expense, offset by increases in net deferred tax assets associated with stock-based compensation expense and decreased tax depreciation and other changes in working
capital.

Net cash used in investing activities was $19.4 million in 2006. Investing activities primarily relate to purchases of property
and equipment, and maturities and purchases of marketable securities. During 2006, maturities net of purchases totaled $23.5 million as we used funds to invest in property and equipment and repurchase our stock, as noted above. Cash paid for
property and equipment totaling $44.4 million included:



| |  |  | $18.6 million to acquire the new Alameda roasting facility;
| | - |  | -----------------------------------------------------------



| |  |  | $2.3 million to acquire land adjacent to the Alameda roasting facility;
| | - |  | -----------------------------------------------------------------------



| |  |  | $17.9 million to build-out new stores and remodel existing ones;
| | - |  | ----------------------------------------------------------------



| |  |  | $1.0 million used for food service kiosks, grocery displays and other equipment for specialty sales;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | $3.7 million used for additional machinery for the current and new roasting facilities; and
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | $0.9 million used for information technology support systems and other software and hardware to support our growing infrastructure.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------

Net cash used in financing activities was $11.3 million in 2006. Financing activities in 2006 consisted primarily of the Companys purchase of its
common stock for $15.9 million, partially offset by $3.9 million from the exercise of stock options by employees.

Our 2007 capital
expenditures are expected to be between $27.0 and $28.0 million. Approximately $14.0 million is expected to be used for the opening of 30 new retail stores scheduled for 2007 and $2.5 to $3.0 million is expected to be used for remodeling
existing stores. Another $4.0 to $5.0 million is expected for purchases of equipment for the new roasting facility in Alameda. The balance is expected to be used for converting our existing plant into office space, for information technology
enhancements, and for equipment for the food service and grocery channels. We expect to finance these capital expenditures with our cash and marketable securities and with operating cash flows.



30



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##### Table of Contents

The following table summarizes the Companys contractual obligations and the timing and effect that
such commitments are expected to have on the Companys liquidity and capital requirements in future periods as of December 31, 2006 (in thousands):



|                                        |  |                                       |         |                  |   |           |  |           |        |              |   |        |  |   |       
|--------------------------------------- |  | ------------------------------------- | ------- | ---------------- | - | --------- |  | --------- | ------ | ------------ | - | ------ |  | - | ------
|                                        |  | Payments Due by Period (in thousands)
|Contractual obligations                 |  | Total                                 |         | Less than 1 year |   | 1-3 years |  | 4-5 years |        | After 5years
|Equipment operating leases              |  | $                                     | 537     |                  | $ | 185       |  | $         | 270    |              | $ | 82     |  | $ |      
|Retail store operating leases (1)       |  |                                       | 74,771  |                  |   | 11,154    |  |           | 13,942 |              |   | 16,082 |  |   | 28,193
|Fixed-price coffee purchase commitments |  |                                       | 32,800  |                  |   | 26,611    |  |           | 4,310  |              |   | 1,879  |  |   |      
|Development commitments (2)             |  |                                       | 3,375   |                  |   | 3,375     |  |           |       |              |   |       |  |   |      
|                                        |  |                                       |         |                  |   |           |  |           |        |              |   |        |  |   |       
|Total contractual cash obligations      |  | $                                     | 111,483 |                  | $ | 41,325    |  | $         | 23,922 |              | $ | 18,043 |  | $ | 20,193
|                                        |  |                                       |         |                  |   |           |  |           |        |              |   |        |  |   |       

---

|(1) | Payments for maintenance, insurance, taxes and contingent rent for which we are obligated are excluded. In fiscal 2006 these charges totaled approximately $1.9 million.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Contractual obligations for purchases of equipment and leasehold improvements for retail locations and equipment and building improvements for our roasting facility.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

For the next twelve months, we expect our cash flows from operations and cash and marketable securities to be sufficient for
our operating and capital requirements, our new share purchase program and our contractual obligations as they come due.

Inflation

We do not believe that inflation has had a material impact on our results of operation in recent years. However, we cannot predict what effect inflation
may have on our results of operations in the future.

Critical Accounting Policies, Judgments and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain
accounting policies and judgments, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be
determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.

We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated, and adjustments are made when
facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our accounting policies are more fully described in Note 1 Summary of Significant Accounting Policies in the Notes to the Consolidated
Financial Statements, included elsewhere in this report. We have identified the following critical accounting policies:



| |  |  | Inventory.Raw materials consist primarily of green bean coffee. Finished goods include roasted coffee, tea, accessory products, spices and packaged foods.
All products are valued at the lower of cost or market using the first-in, first-out method, except green bean and roasted coffee, which is valued at the average cost. We continually evaluate the composition of our coffee related merchandise and
mark down such inventory as needed. Our historical inventory write-offs have been immaterial.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Impairment of long-lived assets.When facts and circumstances indicate that the carrying of long-lived assets may be impaired, an evaluation of
recoverability is performed by comparing the carrying values
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | of the assets to projected future cash flows in addition to other quantitative and qualitative analyses. Upon indication that the carrying values of such
assets may not be recoverable, the Company recognizes an impairment loss by a charge against current operations for an amount equal to the difference between the carrying value and the assets fair value. The fair value of the retail net asset
is estimated using the discounted cash flows of the assets. Property, plant and equipment assets are grouped at the lowest level for which there are identifiable cash flows when assessing impairment. Cash flows for retail net assets are identified
at the individual store level.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accrued workers compensation.We record an estimated liability for the self-insured portion of workers compensation claims. The liability of $2.6
million recorded as of December 31, 2006 is determined based on information received from our insurance carrier including claims paid, filed and reserved for and historical experience. Should a greater amount of claims occur compared to what is
estimated or the settlement costs increase beyond what was anticipated, the recorded liability may not be sufficient.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Income taxes. In establishing deferred income tax assets and liabilities, we make judgments and interpretations based on enacted tax laws and published tax
guidance applicable to our operations. We record deferred tax assets and liabilities and evaluate the need for valuation allowances to reduce deferred tax assets to realizable amounts. Changes in our valuation of the deferred tax assets or changes
in the income tax provision and reserves may affect our annual effective income tax rate.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based compensation. On January 2, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No.
123(R), Share-Based Payment (SFAS 123(R)). We use the Black-Scholes-Merton option-pricing model, which requires assumptions requiring a high degree of judgment. These assumptions include estimating the length of time
employees will retain their vested stock options before exercising them, the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements. Changes in the
subjective assumptions can materially affect the estimate of fair value of share-based payments and, consequently, the related amount recognized in the consolidated statements of income.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Recent Accounting Pronouncements

In July 2006, the
FASB issued Financial Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that
we recognize in our financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. We will adopt FIN 48 as required beginning January 1,
2007. The Company is currently evaluating the provisions of FIN 48 and has not yet completed its determination of the impact of adoption on our financial position or results of operations.



|Item 7A. | Quantitative and Qualitative Disclosures about Market Risk
|-------- | ----------------------------------------------------------

We invest excess cash in interest-bearing, U.S. government, agency, municipal and guaranteed student loan obligations. These financial instruments are all subject to fluctuations of daily interest rates. Therefore our investment portfolio
is exposed to market risk from these changes.

The supply and price of coffee are subject to significant volatility and can be affected by
multiple factors in the producing countries, including weather, political and economic conditions. In addition, green coffee bean prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and
associations that have historically attempted to influence commodity prices of green coffee beans through agreements establishing export quotas or restricting coffee supplies worldwide.



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We currently use fixed-price purchase commitments, but in the past have used and may potentially in the
future use coffee futures and coffee futures options to manage coffee supply and price risk.

Fixed-Price and Not-Yet-Priced Purchase
Commitments

We enter into fixed-price purchase commitments in order to secure an adequate supply of quality green coffee beans
and fix our cost of green coffee beans. These commitments are made with established coffee brokers and are denominated in U.S. dollars. We also enter into not-yet-priced commitments based on a fixed premium over the New York
C market with the option to fix the price at any time. As of December 31, 2006, we had approximately $26.8 million in open fixed-priced purchase commitments and approximately $6.0 million in not-yet-priced commitments for a total of
approximately $32.8 million with delivery dates ranging from January 2007 through September 2010. We believe, based on relationships established with our suppliers, that the risk of non-delivery on such purchase commitments is low.



|Item 8. | Financial Statements and Supplementary Data
|------- | -------------------------------------------

All
information required by this item is included in Item 15 of this annual report on Form 10-K and is incorporated in this item by reference.



|Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
|------- | ------------------------------------------------------------------------------------

None.



|Item 9A. | Controls and Procedures
|-------- | -----------------------

Disclosure Controls and Procedures

Definition and limitations of disclosure controls. Our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) are controls and other procedures that are designed to ensure that information required to be disclosed in our reports
filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls and procedures are also designed to ensure that such
information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our management evaluates these controls and
procedures on an ongoing basis to determine if improvements or modifications are necessary.

There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures. These limitations include the possibility of human error, the circumvention or overriding of the controls and procedures and reasonable resource constraints. In addition, because we
have designed our system of controls based on certain assumptions, which we believe are reasonable, about the likelihood of future events, our system of controls may not achieve its desired purpose under all possible future conditions. Accordingly,
our disclosure controls and procedures provide reasonable assurance, but not absolute assurance, of achieving their objectives.

Evaluation of disclosure controls and procedures. Taking into account the restatement of our previously issued consolidated financial statements, as described in the Explanatory Note immediately preceding Part I,
Item 1 and in Note 2, Restatement of Consolidated Financial Statements in Notes to Consolidated Financial Statements of this Form 10-K, management has evaluated the effectiveness of our disclosure controls and
procedures and our internal control over financial reporting as of December 31, 2006 and determined that there were two material weaknesses, as more fully described below in Managements Report on Internal Control Over Financial
Reporting. For these reasons, we have concluded that our disclosure controls and procedures and our internal control over financial reporting were not effective as of December 31, 2006. We have disclosed this conclusion to the Audit
Committee and to our independent registered public accountants.



33



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Management Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act
Rule 13a-15(f). The Companys internal control system was designed to provide reasonable assurance to the Companys management and board of directors regarding the preparation and fair presentation of published financial statements. All
internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Under
the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, as directed by our board of directors, we conducted an evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2006 based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). A material weakness is a
control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

The following is a summary of the material weaknesses identified by management as of December 31, 2006:



| |  |  | We did not design and implement controls necessary to provide reasonable assurance that the measurement date for stock option grants was appropriately determined.
In particular, the procedures used to approve and process stock option grants were insufficient to ensure that all option grants complied with our stock option plans and the selection of measurement dates conformed to the requirements of applicable
accounting rules. As a result, the measurement date used for certain option grants was not appropriate and such grants were not accounted for in accordance with GAAP; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We failed to properly examine and test our methodology for allocating procurement and production costs to inventory. As a result, we understated inventory balances
and misstated cost of goods sold.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Because of the existence of the material weaknesses, management concluded that the
Company did not maintain effective internal control over financial reporting as of December 31, 2006 based on the criteria described in the COSO Integrated Framework.

The registered independent public accounting firm of Deloitte & Touche LLP, as auditors of the Companys consolidated financial statements,
has issued a report on managements assessment of the Companys internal control over financial reporting.

Managements Remediation
Plans

Stock option grants. The Company is in the process of continuing to develop more formal procedures and controls to provide
reasonable assurance that the measurement date for stock option grants is appropriately determined. Effective March 26, 2007, the Compensation Committee of the Board of Directors adopted a stock option granting policy and specified Company
procedures. The policy set forth policies and procedures relating to stock option granting practices, including (a) the review of stock option grant documentation prior to a grant to ensure proper support for the measurement date including the
appropriate Board of Directors, Compensation Committee or Chief Executive Officer approval, (b) eliminating the use of unanimous written consents by the Board of Directors and its Compensation Committee, and (c) the use of predetermined
effective dates for all grants.

Allocation of procurement and production costs.Subsequent to the 2006 year-end, the Company
critically examined its methodology used to allocate production and procurement costs to inventory. The Company has corrected this methodology to more accurately reflect inventory balances as of December 31, 2006 and January 1, 2005 and
will continue to review and ensure the correct methodology and calculation in future periods.



34



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##### Table of Contents

Changes in Internal Control over Financial Reporting

There were no changes in the Companys internal control over financial reporting identified in connection with the evaluation required by paragraph
(d) of Exchange Act Rules 13a-15(e) or 15d-15(e) that was conducted during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. The
changes described above under Managements Remediation Plans with respect to the allocation of procurement and production costs have been implemented subsequent to the end of the fiscal year and have materially affected the
Companys internal control over financial reporting.



|Item 9B. | Other Information
|-------- | -----------------

Not applicable.



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##### Table of Contents

PART III



|Item 10. | Directors, Executive Officers and Corporate Governance
|-------- | ------------------------------------------------------

Information with respect to continuing directors and nominees of the Company, committees of the Board of Directors and the Companys Code of Business Conduct and Ethics is set forth under the caption Proposal 1Election of
Directors in the Companys proxy statement relating to its 2007 Annual Meeting of Shareholders (the Proxy Statement) and is incorporated by reference into this Form 10-K. The Proxy Statement will be filed with the SEC in
accordance with Rule 14a-6(c) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act.). With the exception of the foregoing information and other information specifically incorporated by reference into this
Form 10-K, the Proxy Statement is not being filed as a part hereof. Information respecting executive officers of the Company is set forth at Part I of this Form 10-K under the caption BusinessExecutive Officers of the Registrant.

Information with respect to compliance with Section 16(a) of the Exchange Act is set forth under the caption Section 16(a)
Beneficial Ownership Reporting Compliance in the Proxy Statement and is incorporated by reference into this Form 10-K.



|Item 11. | Executive Compensation
|-------- | ----------------------

Information concerning
executive and director compensation required by Item 11 is set forth under the caption Executive Compensation in the Proxy Statement and is incorporated by reference into this Form 10-K.





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

Information concerning security ownership of certain beneficial owners and management and equity compensation plans required by Item 12 is set forth
under the caption Security Ownership of Certain Beneficial Owners and Management and Executive CompensationEquity Compensation Plan Information in the Proxy Statement and is incorporated by reference into this Form
10-K.



|Item 13. | Certain Relationships and Related Transactions, and Director Independence
|-------- | -------------------------------------------------------------------------

Information concerning certain relationships and related transactions required by Item 13 is set forth under the caption Certain Transactions in the Proxy Statement and is incorporated by reference
into this Form 10-K. Information concerning director independence required by Item 13 is set forth under the caption Proposal 1Election of DirectorsIndependence of the Board of Directors in the Proxy Statement and is
incorporated by reference into this Form 10-K.



|Item 14. | Principal Accountant Fees and Services
|-------- | --------------------------------------

Information
concerning principal accounting fees and services required by Item 14 is set forth under the caption Proposal 2Ratification of Selection of Independent Registered Public Accounting Firm in the Proxy Statement and is
incorporated by reference into this Form 10-K.



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##### Table of Contents

PART IV



|Item 15. | Exhibits and Financial Statement Schedules
|-------- | ------------------------------------------

The
following documents are filed as part of this Form 10-K.

(a)(1) Index to Consolidated Financial Statements.

The following Consolidated Financial Statements of Peets Coffee & Tea, Inc. and its subsidiaries are filed as part of this Form 10-K:



|                                                                                                                                                        |  |     
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                                                        |  | Page
|Report of Independent Registered Public Accounting Firm                                                                                                 |  | F-2 
|                                                                                                                                                        | 
|Report of Independent Registered Public Accounting Firm on Internal Controls Over Financial Reporting                                                   |  | F-3 
|                                                                                                                                                        | 
|Consolidated Balance Sheets as of December 31, 2006 and January 1, 2006 (As Restated)                                                                   |  | F-4 
|                                                                                                                                                        | 
|Consolidated Statements of Income for the Years Ended December 31, 2006, January 1, 2006 (As Restated), and January 2, 2005 (As Restated)               |  | F-5 
|                                                                                                                                                        | 
|Consolidated Statements of Shareholders Equity for the Years Ended December 31, 2006, January 1, 2006 (As Restated), and January 2, 2005 (As Restated) |  | F-6 
|                                                                                                                                                        | 
|Consolidated Statements of Cash Flows for the Years December 31, 2006, January 1, 2006 (As Restated), and January 2, 2005 (As Restated)                 |  | F-7 
|                                                                                                                                                        | 
|Notes to Consolidated Financial Statements                                                                                                              |  | F-8 

(a)(2) Index to Financial Statement Schedule.

Schedules are omitted because they are not applicable, not required or because the required information is included in the Consolidated Financial
Statements or Notes thereto.

(a)(3) Listing of Exhibits



|        |  |                                                                                             
|------- |  | --------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                 
|3.1     |  | Amended and Restated Articles of Incorporation.*                                            
|        | 
|3.2     |  | Amended and Restated Bylaws.*                                                               
|        | 
|4.1     |  | Form of common stock certificate.*                                                          
|        | 
|10.1    |  | Amended and Restated 1993 Stock Option Plan. (1)*                                           
|        | 
|10.2    |  | 1994 California Stock Option Plan. (1)*                                                     
|        | 
|10.3    |  | 1997 Equity Incentive Plan and form of Stock Option Agreement. (1)*                         
|        | 
|10.4    |  | Peets Operating Company, Inc. Savings and Retirement Plan. (1)*                            
|        | 
|10.5    |  | 2000 Equity Incentive Plan and form of Stock Option Agreement as restated March 30, 2007 (1)
|        | 
|10.6    |  | 2000 Employee Stock Purchase Plan and form of Offering. (1)*                                
|        | 
|10.7    |  | Peets Operating Company, Inc. Key Employee Severance Benefit Plan. (2)*                    
|        | 
|10.8    |  | Change of Control Option Acceleration Plan. (1)*                                            



37



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##### Table of Contents

|        |  |                                                                                                                                                                                                                                                                            
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                                                                
|10.9    |  | Peets Operating Company, Inc. Key Employment Agreement for James E. Grimes, Vice President, Operations and Information Systems, dated as of June 24, 2002. Incorporated by reference to
the Companys annual report on Form 10-K for the year ended December 28, 2003. (2)
|        | 
|10.10   |  | Form of Indemnity Agreement between the registrant and each of its directors and officers. Incorporated by reference to Exhibit 10.21 to the Companys annual report on Form 10-K for the
year ended December 31, 2000. (2)                                                
|        | 
|10.11   |  | Peets Coffee & Tea, Inc. Key Employment Agreement for Patrick J. ODea, Chief Executive Officer, dated as of May 6, 2002. Incorporated by reference to Exhibit 10.17 to the
Companys quarterly report on Form 10-Q for the quarter ended June 30, 2002. (2)              
|        | 
|10.12   |  | Peets Coffee & Tea, Inc. Amended and Restated 2000 Non-Employee Director Stock Option Plan and Form of Stock Option Agreement. Incorporated by reference to Exhibit 10.10 to the
Companys quarterly report on Form 10-Q for the quarter ended September 29, 2002. (1)    
|        | 
|10.13   |  | Peets Coffee & Tea, Inc. Key Employment Agreement for Thomas P. Cawley, Chief Financial Officer, dated as of June 25, 2003. Incorporated by reference to Exhibit 10.17 to the
Companys quarterly report on Form 10-Q for the quarter ended September 28, 2003. (2)       
|        | 
|10.14   |  | Nonqualified Deferred Compensation Plan dated December 1, 2003. Incorporated by reference to Exhibit 10.30 to the Companys quarterly report on Form 10-Q for the quarter ended March 28,
2004. (2)                                                                        
|        | 
|10.15   |  | Agreement for Purchase and Sale of Property, dated as of November 29, 2005, by the Company and Harbor Bay Acquisition LLC.*                                                                                                                                                
|        | 
|21.1    |  | Subsidiaries of the registrant.*                                                                                                                                                                                                                                           
|        | 
|23.1    |  | Consent of Deloitte & Touche LLP.                                                                                                                                                                                                                                          
|        | 
|31.1    |  | Certification of the Companys Chief Executive Officer, Patrick ODea, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                                   
|        | 
|31.2    |  | Certification of the Companys Chief Financial Officer, Thomas Cawley, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.                                                                                                                   
|        | 
|32.1    |  | Certification of the Companys Chief Executive Officer, Patrick ODea, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                              
|        | 
|32.2    |  | Certification of the Companys Chief Financial Officer, Thomas Cawley, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                              

---

|* | Incorporated by reference to the Registrants Information Statement on Form S-1 (File No. 333-47957) filed on October 13, 2000, as subsequently amended.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(1) | Compensatory plan or arrangement.
|--- | ---------------------------------

|(2) | Management contract.
|--- | --------------------



38



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##### Table of Contents

SIGNATURES

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



|                     |  |  |  |                           |  |     |  |                                                       
|-------------------- |  |  |  | ------------------------- |  | --- |  | ------------------------------------------------------
|Date: March 30, 2007 |  |  |  | PEETS COFFEE & TEA,
INC.
|                     |  |  |  |                          
|                     |  |  |  |                           |  | By: |  | /S/    PATRICK J.
ODEA                               
|                     |  |  |  |                           |  |     |  | Patrick J. ODea President and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Patrick J. ODea and Thomas P. Cawley
and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this report and to
file the same, with all granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents
and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.



|                                                   |  |                                                                                                    |  |               
|-------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                          |  | Title                                                                                              |  | Date          
|                                                   |  |                                                                                                   
|/S/    PATRICK J.
ODEA Patrick J. ODea           |  | President, Chief Executive Officer and Director (Principal Executive Officer)                      |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    THOMAS P.
CAWLEY Thomas P. Cawley           |  | Vice President, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer) |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    JEAN-MICHEL
VALETTE Jean-Michel Valette     |  | Chairman                                                                                           |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    GERALD
BALDWIN Gerald Baldwin               |  | Director                                                                                           |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    HILARY
BILLINGS Hilary Billings             |  | Director                                                                                           |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    GORDON A.
BOWKER Gordon A. Bowker           |  | Director                                                                                           |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    DAVID
DENO David Deno                       |  | Director                                                                                           |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    H. WILLIAM JESSE,
JR. H. William Jesse, Jr. |  | Director                                                                                           |  | March 30, 2007
|                                                   |  |                                                                                                   
|/S/    MICHAEL
LINTON Michael Linton               |  | Director                                                                                           |  | March 30, 2007



39



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##### Table of Contents

INDEX TO FINANCIAL STATEMENTS



|                                                                                                                                                        |  |     
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                                                        |  | Page
|Report of Independent Registered Public Accounting Firm                                                                                                 |  | F-2 
|                                                                                                                                                        | 
|Report of Independent Registered Public Accounting Firm on Internal Controls Over Financial Reporting                                                   |  | F-3 
|                                                                                                                                                        | 
|Consolidated Balance Sheets as of December 31, 2006 and January 1, 2006 (As Restated)                                                                   |  | F-4 
|                                                                                                                                                        | 
|Consolidated Statements of Income for the Years Ended December 31, 2006, January 1, 2006 (As Restated), and January 2, 2005 (As Restated)               |  | F-5 
|                                                                                                                                                        | 
|Consolidated Statements of Shareholders Equity for the Years Ended December 31, 2006, January 1, 2006 (As Restated), and January 2, 2005 (As Restated) |  | F-6 
|                                                                                                                                                        | 
|Consolidated Statements of Cash Flows for the Years December 31, 2006, January 1, 2006 (As Restated), and January 2, 2005 (As Restated)                 |  | F-7 
|                                                                                                                                                        | 
|Notes to Consolidated Financial Statements                                                                                                              |  | F-8 



F-1



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
of Peets Coffee & Tea, Inc.:

We have audited the accompanying consolidated balance sheets of Peets Coffee &
Tea, Inc. and subsidiaries (the Company) as of December 31, 2006 and January 1, 2006, and the related consolidated statements of income, shareholders equity, and cash flows for each of the three fiscal years in the period
ended December 31, 2006. 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 audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the
financial position of the Company as of December 31, 2006 and January 1, 2006, and the results of their operations and their cash flows for each of the three fiscal years in the period ended December 31, 2006, in conformity with
accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements,
the Company adopted Statement of Financial Accounting Standards No. 123 (R), Share-Based Payment, on January 2, 2006.

As discussed in Note 2 to the consolidated financial statements, the accompanying fiscal 2005 and 2004 consolidated financial statements have been restated.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as of
December 31, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 30, 2007 expressed an
unqualified opinion on managements assessment of the effectiveness of the Companys internal control over financial reporting and an adverse opinion on the effectiveness of the Companys internal control over financial reporting
because of material weaknesses.

/s/    DELOITTE & TOUCHE LLP

San Francisco, California

March 30, 2007



F-2



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Board of Directors and Shareholders of Peets Coffee & Tea, Inc.:

We have audited managements assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that
Peets Coffee & Tea, Inc. and subsidiaries (the Company) did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of the material weaknesses identified in
managements assessment based on criteria established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Companys management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion
on the effectiveness of the Companys internal control over financial reporting based on our audit.

We conducted our audit in
accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A companys internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive
and principal financial officers, or persons performing similar functions, and effected by the companys board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override
of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are
subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in managements assessment: (1) The Company did not design and implement
controls necessary to provide reasonable assurance that the measurement date for stock option grants was appropriately determined. In particular, the procedures used to approve and process stock option grants were insufficient to ensure that all
option grants complied with the Companys stock option plans and the selection of measurement dates conformed to the requirements of applicable accounting rules. As a result, the measurement date used for certain option grants was not
appropriate and such grants were not accounted for in accordance with GAAP; and (2) The Company failed to properly examine and test its methodology for allocating procurement and production costs to inventory. As a result, the Company
understated inventory balances and misstated cost of goods sold. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for the
fiscal year ended December 31, 2006, of the Company and this report does not affect our report on such financial statements.

In our
opinion, managements assessment that the Company did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of
the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial statements as of and for the fiscal year ended December 31, 2006, of the Company and our report dated March 30, 2007 expressed an unqualified opinion on those financial
statements and included an explanatory paragraph related to the Companys adoption of a new accounting standard.

/s/    DELOITTE & TOUCHE LLP

San Francisco, California

March 30, 2007



F-3



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##### Table of Contents

PART IFINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

PEETS
COFFEE & TEA, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)



|                                                                                                                   |  |                  |         |   |                           |   |         |  
|------------------------------------------------------------------------------------------------------------------ |  | ---------------- | ------- | - | ------------------------- | - | ------- | -
|                                                                                                                   |  | December 31,2006 |         |   | January 1,2006            |  
|                                                                                                                   |  |                  |         |   | (As Restated, See Note 2) |  
|ASSETS                                                                                                             |  |                  |         |   |                           |   |         |  
|                                                                                                                   |  |                 
|Current assets                                                                                                     |  |                  |         |   |                           |   |         |  
|Cash and cash equivalents                                                                                          |  | $                | 7,692   |   |                           | $ | 20,623  |  
|Short-term marketable securities                                                                                   |  |                  | 19,511  |   |                           |   | 32,453  |  
|Accounts receivable, net                                                                                           |  |                  | 6,838   |   |                           |   | 5,152   |  
|Inventories                                                                                                        |  |                  | 19,533  |   |                           |   | 17,001  |  
|Deferred income taxescurrent                                                                                      |  |                  | 1,888   |   |                           |   | 1,514   |  
|Prepaid expenses and other                                                                                         |  |                  | 3,852   |   |                           |   | 3,372   |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|Total current assets                                                                                               |  |                  | 59,314  |   |                           |   | 80,115  |  
|Long-term marketable securities                                                                                    |  |                  | 5,989   |   |                           |   | 16,890  |  
|Property and equipment, net                                                                                        |  |                  | 82,447  |   |                           |   | 46,313  |  
|Deferred income taxesnon-current                                                                                  |  |                  | 1,315   |   |                           |   |        |  
|Other assets, net                                                                                                  |  |                  | 3,940   |   |                           |   | 5,434   |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|Total assets                                                                                                       |  | $                | 153,005 |   |                           | $ | 148,752 |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                               |  |                  |         |   |                           |   |         |  
|                                                                                                                   |  |                 
|Current liabilities                                                                                                |  |                  |         |   |                           |   |         |  
|Accounts payable and other accrued liabilities                                                                     |  | $                | 11,046  |   |                           | $ | 8,553   |  
|Accrued compensation and benefits                                                                                  |  |                  | 6,389   |   |                           |   | 5,563   |  
|Deferred revenue                                                                                                   |  |                  | 4,625   |   |                           |   | 3,415   |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|Total current liabilities                                                                                          |  |                  | 22,060  |   |                           |   | 17,531  |  
|Deferred income taxesnon-current                                                                                  |  |                  |        |   |                           |   | 1,806   |  
|Deferred lease credits and other long-term liabilities                                                             |  |                  | 3,506   |   |                           |   | 2,537   |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|Total liabilities                                                                                                  |  |                  | 25,566  |   |                           |   | 21,874  |  
|                                                                                                                   |  |                 
|Shareholders equity                                                                                               |  |                  |         |   |                           |   |         |  
|Common stock, no par value; authorized 50,000,000 shares; issued and outstanding: 13,516,000 and 13,902,000 shares |  |                  | 93,246  |   |                           |   | 100,562 |  
|Accumulated other comprehensive loss, net of tax                                                                   |  |                  | (15     | ) |                           |   | (76     | )
|Retained earnings                                                                                                  |  |                  | 34,208  |   |                           |   | 26,392  |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|Total shareholders equity                                                                                         |  |                  | 127,439 |   |                           |   | 126,878 |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  
|Total liabilities and shareholders equity                                                                         |  | $                | 153,005 |   |                           | $ | 148,752 |  
|                                                                                                                   |  |                  |         |   |                           |   |         |  

See notes to consolidated financial statements.



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##### Table of Contents

PEETS COFFEE & TEA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)



|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|--------------------------------------------------- |  | ---- | ------- | - | ------------------------ | - | ------- | ------------------------ |  | - | ------- | -
|                                                    |  | 2006 |         |   | 2005                     |   |         | 2004                     | 
|                                                    |  |      |         |   | (As Restated,See Note 2) |   |         | (As Restated,See Note 2) | 
|Retail stores                                       |  | $    | 141,377 |   |                          | $ | 118,030 |                          |  | $ | 100,444 |  
|Specialty sales                                     |  |      | 69,116  |   |                          |   | 57,168  |                          |  |   | 45,239  |  
|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net revenue                                         |  |      | 210,493 |   |                          |   | 175,198 |                          |  |   | 145,683 |  
|                                                    |  |      |        
|Cost of sales and related occupancy expenses        |  |      | 98,928  |   |                          |   | 80,837  |                          |  |   | 67,806  |  
|Operating expenses                                  |  |      | 72,272  |   |                          |   | 57,879  |                          |  |   | 47,645  |  
|General and administrative expenses                 |  |      | 20,634  |   |                          |   | 13,341  |                          |  |   | 11,439  |  
|Depreciation and amortization expenses              |  |      | 8,609   |   |                          |   | 7,293   |                          |  |   | 5,787   |  
|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Total costs and expenses from operations            |  |      | 200,443 |   |                          |   | 159,350 |                          |  |   | 132,677 |  
|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Income from operations                              |  |      | 10,050  |   |                          |   | 15,848  |                          |  |   | 13,006  |  
|Interest income                                     |  |      | 2,458   |   |                          |   | 1,771   |                          |  |   | 1,009   |  
|Interest expense                                    |  |      | (2      | ) |                          |   | (2      | )                        |  |   | (87     | )
|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Income before income taxes                          |  |      | 12,506  |   |                          |   | 17,617  |                          |  |   | 13,928  |  
|Income tax provision                                |  |      | 4,690   |   |                          |   | 6,842   |                          |  |   | 5,218   |  
|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net income                                          |  | $    | 7,816   |   |                          | $ | 10,775  |                          |  | $ | 8,710   |  
|                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net income per share:                               |  |      |         |   |                          |   |         |                          |  |   |         |  
|Basic                                               |  | $    | 0.57    |   |                          | $ | 0.78    |                          |  | $ | 0.65    |  
|Diluted                                             |  | $    | 0.55    |   |                          | $ | 0.74    |                          |  | $ | 0.62    |  
|                                                    |  |      |        
|Shares used in calculation of net income per share: |  |      |         |   |                          |   |         |                          |  |   |         |  
|Basic                                               |  |      | 13,733  |   |                          |   | 13,801  |                          |  |   | 13,308  |  
|Diluted                                             |  |      | 14,202  |   |                          |   | 14,469  |                          |  |   | 13,949  |  



See notes to consolidated
financial statements.



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##### Table of Contents

PEETS COFFEE & TEA, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

(In thousands)



|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|------------------------------------------------------------------------------------- |  | ----------------- | - |  | ---------------- | ------- | - | --------------------------------------------- | - | ------ | ------------------------- |  | - | ------------------------ | - |  | ------------------------ | ------- | - |  | - | ------ | -
|                                                                                      |  | Common Stock      |   |  | RetainedEarnings |         |   | Accumulated Other ComprehensiveIncome/
(Loss) |   |        | Total ShareholdersEquity |  |   | ComprehensiveIncome      |  
|                                                                                      |  | SharesOutstanding |   |  | Amount           |         |   |                                               |   |       
|                                                                                      |  |                   |   |  |                  |         |   | (As Restated,see Note 2)                      |   |        | (As Restated,see Note 2)  |  |   | (As Restated,see Note 2) |   |  | (As Restated,see Note 2) |        
|Balance at December 28, 2003, as previously reported                                  |  | 12,983            |   |  | $                | 87,808  |   |                                               | $ | 7,403  |                           |  | $ | 23                       |   |  | $                        | 95,234  |   |  |   |        |  
|Adjustment (see Note 2)                                                               |  |                   |   |  |                  | 1,360   |   |                                               |   | (496   | )                         |  |   |                          |   |  |                          | 864     |   |  |   |        |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Balance at December 28, 2003, as restated                                             |  | 12,983            |   |  |                  | 89,168  |   |                                               |   | 6,907  |                           |  |   | 23                       |   |  |                          | 96,098  |   |  |   |        |  
|Stock options exercised, including tax benefit                                        |  | 669               |   |  |                  | 9,198   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 9,198   |   |  |   |        |  
|Stock sold in Employee Stock Purchase Program                                         |  | 84                |   |  |                  | 1,139   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 1,139   |   |  |   |        |  
|Amortization of stock compensation                                                    |  |                   |   |  |                  | 212     |   |                                               |   |        |                           |  |   |                          |   |  |                          | 212     |   |  |   |        |  
|Stock purchased in accordance with share purchase program                             |  | (236              | ) |  |                  | (5,277  | ) |                                               |   |        |                           |  |   |                          |   |  |                          | (5,277  | ) |  |   |        |  
|Reclassification of net losses on cash flow hedges to cost of sales, net of tax of $2 |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | 3                        |   |  |                          |         |   |  |   |        |  
|Net unrealized loss on marketable securities, net of tax of $117                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | (178                     | ) |  |                          |         |   |  |   |        |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Other comprehensive loss                                                              |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | (175                     | ) |  |                          | (175    | ) |  | $ | (175   | )
|Net income                                                                            |  |                   |   |  |                  |         |   |                                               |   | 8,710  |                           |  |   |                          |   |  |                          | 8,710   |   |  |   | 8,710  |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Balance at January 2, 2005 (As restated, see Note 2)                                  |  | 13,500            |   |  | $                | 94,440  |   |                                               | $ | 15,617 |                           |  | $ | (152                     | ) |  | $                        | 109,905 |   |  | $ | 8,535  |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Stock options exercised, including tax benefit                                        |  | 536               |   |  |                  | 9,991   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 9,991   |   |  |   |        |  
|Stock sold in Employee Stock Purchase Program                                         |  | 40                |   |  |                  | 1,019   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 1,019   |   |  |   |        |  
|Amortization of stock compensation                                                    |  |                   |   |  |                  | 44      |   |                                               |   |        |                           |  |   |                          |   |  |                          | 44      |   |  |   |        |  
|Stock purchased in accordance with share purchase program                             |  | (174              | ) |  |                  | (4,932  | ) |                                               |   |        |                           |  |   |                          |   |  |                          | (4,932  | ) |  |   |        |  
|Net unrealized gain on marketable securities, net of tax of $48                       |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | 76                       |   |  |                          |         |   |  |   |        |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Other comprehensive income                                                            |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | 76                       |   |  |                          | 76      |   |  | $ | 76     |  
|Net income                                                                            |  |                   |   |  |                  |         |   |                                               |   | 10,775 |                           |  |   |                          |   |  |                          | 10,775  |   |  |   | 10,775 |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Balance at January 1, 2006 (As restated, see Note 2)                                  |  | 13,902            |   |  | $                | 100,562 |   |                                               | $ | 26,392 |                           |  | $ | (76                      | ) |  | $                        | 126,878 |   |  | $ | 10,851 |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Stock options exercised, including tax benefit                                        |  | 160               |   |  |                  | 3,531   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 3,531   |   |  |   |        |  
|Stock sold in Employee Stock Purchase Program                                         |  | 44                |   |  |                  | 1,065   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 1,065   |   |  |   |        |  
|Amortization of stock compensation                                                    |  |                   |   |  |                  | 4,022   |   |                                               |   |        |                           |  |   |                          |   |  |                          | 4,022   |   |  |   |        |  
|Stock purchased in accordance with share purchase program                             |  | (590              | ) |  |                  | (15,934 | ) |                                               |   |        |                           |  |   |                          |   |  |                          | (15,934 | ) |  |   |        |  
|Net unrealized gain on marketable securities, net of tax of $59                       |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | 61                       |   |  |                          |         |   |  |   |        |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Other comprehensive income                                                            |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   | 61                       |   |  |                          | 61      |   |  | $ | 61     |  
|Net income                                                                            |  |                   |   |  |                  |         |   |                                               |   | 7,816  |                           |  |   |                          |   |  |                          | 7,816   |   |  |   | 7,816  |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  
|Balance at December 31, 2006                                                          |  | 13,516            |   |  | $                | 93,246  |   |                                               | $ | 34,208 |                           |  | $ | (15                      | ) |  | $                        | 127,439 |   |  | $ | 7,877  |  
|                                                                                      |  |                   |   |  |                  |         |   |                                               |   |        |                           |  |   |                          |   |  |                          |         |   |  |   |        |  

See notes to consolidated financial statements.



F-6



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##### Table of Contents

PEETS COFFEE & TEA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ------------------------ | - | ------- | ------------------------ |  | - | ------- | -
|                                                                                  |  | 2006 |         |   | 2005                     |   |         | 2004                     | 
|                                                                                  |  |      |         |   | (As Restated,See Note 2) |   |         | (As Restated,See Note 2) | 
|Cash flows from operating activities:                                             |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net income                                                                        |  | $    | 7,816   |   |                          | $ | 10,775  |                          |  | $ | 8,710   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |         |   |                          |   |         |                          |  |   |         |  
|Depreciation and amortization                                                     |  |      | 10,244  |   |                          |   | 8,643   |                          |  |   | 6,899   |  
|Amortization of interest purchased                                                |  |      | 415     |   |                          |   | 139     |                          |  |   | 247     |  
|Stock-based compensation                                                          |  |      | 4,022   |   |                          |   | 44      |                          |  |   | 212     |  
|Excess tax benefit from exercise of stock options                                 |  |      | (724    | ) |                          |   |        |                          |  |   |        |  
|Tax benefit from exercise of stock options                                        |  |      | 708     |   |                          |   | 3,262   |                          |  |   | 3,413   |  
|Loss on disposition of assets and asset impairment                                |  |      | 288     |   |                          |   | 437     |                          |  |   | 280     |  
|Deferred income taxes                                                             |  |      | (3,495  | ) |                          |   | 908     |                          |  |   | 189     |  
|Changes in other assets and liabilities:                                          |  |      |         |   |                          |   |         |                          |  |   |         |  
|Accounts receivable, net                                                          |  |      | (1,686  | ) |                          |   | (1,016  | )                        |  |   | (906    | )
|Inventories                                                                       |  |      | (2,532  | ) |                          |   | (3,708  | )                        |  |   | (1,892  | )
|Prepaid expenses and other current assets                                         |  |      | (480    | ) |                          |   | (1,092  | )                        |  |   | (507    | )
|Other assets                                                                      |  |      | (244    | ) |                          |   | (373    | )                        |  |   | 622     |  
|Accounts payable and accrued liabilities                                          |  |      | 2,473   |   |                          |   | 1,129   |                          |  |   | 953     |  
|Deferred lease credits and other long-term liabilities                            |  |      | 969     |   |                          |   | 355     |                          |  |   | 1,366   |  
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net cash provided by operating activities                                         |  |      | 17,774  |   |                          |   | 19,503  |                          |  |   | 19,586  |  
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|Cash flows from investing activities:                                             |  |      |         |   |                          |   |         |                          |  |   |         |  
|Purchases of property, plant and equipment                                        |  |      | (44,443 | ) |                          |   | (14,020 | )                        |  |   | (15,004 | )
|Proceeds from sales of property and equipment                                     |  |      | 28      |   |                          |   | 104     |                          |  |   | 9       |  
|Changes in restricted investments                                                 |  |      | 1,500   |   |                          |   | (1,750  | )                        |  |   | (1,550  | )
|Proceeds from sales and maturities of marketable securities                       |  |      | 49,888  |   |                          |   | 89,154  |                          |  |   | 71,180  |  
|Purchases of marketable securities                                                |  |      | (26,356 | ) |                          |   | (86,444 | )                        |  |   | (94,868 | )
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net cash used in investing activities                                             |  |      | (19,383 | ) |                          |   | (12,956 | )                        |  |   | (40,233 | )
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|Cash flows from financing activities:                                             |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net proceeds from issuance of common stock                                        |  |      | 3,888   |   |                          |   | 7,748   |                          |  |   | 6,924   |  
|Purchase of common stock                                                          |  |      | (15,934 | ) |                          |   | (4,932  | )                        |  |   | (5,277  | )
|Excess tax benefit from exercise of stock options                                 |  |      | 724     |   |                          |   |        |                          |  |   |        |  
|Bank overdrafts                                                                   |  |      |        |   |                          |   | (96     | )                        |  |   | 93      |  
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|Net cash provided by (used in) financing activities                               |  |      | (11,322 | ) |                          |   | 2,720   |                          |  |   | 1,740   |  
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|(Decrease) Increase in cash and cash equivalents                                  |  |      | (12,931 | ) |                          |   | 9,267   |                          |  |   | (18,907 | )
|Cash and cash equivalents, beginning of year                                      |  |      | 20,623  |   |                          |   | 11,356  |                          |  |   | 30,263  |  
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|Cash and cash equivalents, end of year                                            |  | $    | 7,692   |   |                          | $ | 20,623  |                          |  | $ | 11,356  |  
|                                                                                  |  |      |         |   |                          |   |         |                          |  |   |         |  
|                                                                                  |  |      |        
|Non-cash investing activities:                                                    |  |      |         |   |                          |   |         |                          |  |   |         |  
|Capital expenditures incurred, but not yet paid                                   |  | $    | 1,995   |   |                          | $ | 756     |                          |  | $ | 301     |  
|Other cash flow information:                                                      |  |      |         |   |                          |   |         |                          |  |   |         |  
|Cash paid for interest                                                            |  |      |        |   |                          |   |        |                          |  |   | 22      |  
|Cash paid for income taxes                                                        |  |      | 7,890   |   |                          |   | 3,146   |                          |  |   | 440     |  

See notes to consolidated financial statements.



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.    Summary of Significant Accounting Policies

Organization

Peets Coffee & Tea, Inc., a Washington corporation (the Company), sells fresh roasted coffee, hand selected tea, and related merchandise in several distribution channels, including grocery, home delivery, food
service and office accounts and company-operated retail stores. At December 31, 2006 and January 1, 2006, the Company operated 136 and 111 retail stores, respectively, in California, Colorado, Illinois, Oregon, Massachusetts and
Washington.

Principles of ConsolidationThe consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Year EndThe
Companys fiscal year end is the Sunday closest to December 31. The fiscal year ended December 31, 2006 included 52 weeks. The fiscal year ended January 1, 2006 included 52 weeks and the fiscal year ended January 2, 2005
included 53 weeks.

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

ReclassificationsCertain reclassifications have been made to prior years financial statements in order to conform with the current years presentation. See Note 2, Restatement of
Consolidated Financial Statements and Reclassifications.

Cash and Cash EquivalentsThe Company considers all
liquid investments with original maturities of three months or less to be cash equivalents.

InventoriesRaw materials
consist primarily of green bean coffee. Finished goods include roasted coffee, tea, accessory products, spices, and packaged foods. All products are valued at the lower of cost or market using the first-in, first-out method, except green bean and
roasted coffee, which is valued at the average cost.

Property, plant and equipmentProperty, plant and equipment are
stated at cost. Depreciation and amortization are recorded on the straight-line method over the estimated useful lives of the property and equipment, which range from 3 to 10 years. Leasehold improvements are amortized using the straight-line method
over the lesser of the estimated useful life or the term of the related lease, consistent with the period used for recognizing rent expense and deferred lease credits, which range from 3 to 10 years.

Intangible and other assetsIntangible and other assets include lease rights, contract acquisition costs, deposits, and restricted
cash. Lease rights represent payments made to lessors and others to secure retail locations and are amortized on the straight-line method over the life of the related lease from 5 to 10 years. Intangible assets, primarily lease rights, subject to
amortization were $358,000 and $614,000, net of accumulated amortization, at December 31, 2006 and January 1, 2006, respectively. The related accumulated amortization was $2,103,000 and $2,117,000 at December 31, 2006 and
January 1, 2006, respectively. Amortization expense for 2006, 2005, and 2004 was $121,000, $135,000, and $156,000, respectively. Future amortization expense for 2007 through 2011 is estimated at $96,000, $96,000, $96,000, $70,000 and $0,
respectively. Restricted cash of $3,085,000 and $2,941,000 as of December 31, 2006 and January 1, 2006, respectively, represents collateral for



F-8



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



the Companys high deductible workers compensation policy and is classified in intangible and other assets, net on the consolidated balance
sheets.

InvestmentsMarketable securities are classified as available-for-sale and are recorded at fair value. Any
unrealized gains and losses are recorded in other comprehensive income (loss). Gains and losses are due to fluctuations in interest rates and are considered temporary impairments as management has the intent and ability to hold the securities to
recovery.

Impairment of Long-Lived AssetsWhen facts and circumstances indicate that the carrying of long-lived assets
may be impaired, an evaluation of recoverability is performed by comparing the carrying values of the assets to projected future cash flows in addition to other quantitative and qualitative analyses. Upon indication that the carrying values of such
assets may not be recoverable, the Company recognizes an impairment loss by a charge against current operations for an amount equal to the difference between the carrying value and the assets fair value. The fair value of the retail net asset
is estimated using the discounted cash flows of the assets. Property, plant and equipment assets are grouped at the lowest level for which there are identifiable cash flows when assessing impairment. Cash flows for retail net assets are identified
at the individual store level. Impairment losses for underperforming stores of $0, $311,000 and $280,000 were recorded during 2006, 2005 and 2004, respectively, which were classified as operating expenses on the consolidated statements of income.

Accrued Compensation and BenefitsThe Company records an estimated liability for the self-insured portion of
workers compensation claims. The liability is determined based on information received from the Companys insurance adjuster including claims paid, filed and reserved for, as well as using historical experience and other actuarial
assumptions. As of December 31, 2006 and January 1, 2006, we had $2,616,000 and $2,048,000 accrued for workers compensation.

Revenue RecognitionNet revenue is recognized at the point of sale at our Company-operated retail stores. Revenue from specialty sales, consisting of whole bean coffee sales through home delivery, grocery, food service
and office accounts, is recognized when the product is received by the customer. Revenue from stored value cards, gift certificates and home delivery advanced payments is recognized upon redemption or receipt of product by the customer. Cash
received in advance of product delivery is recorded in Deferred revenue on the accompanying consolidated balance sheets. All revenues are recognized net of any discounts. Sales returns are insignificant. The Company establishes an
allowance for estimated doubtful accounts based on historical experience and current trends.

A summary of the allowance for doubtful
accounts is as follows (in thousands):



|                                 |  |                            |     |                            |   |                     |  |   |                      |   |  |   |    
|-------------------------------- |  | -------------------------- | --- | -------------------------- | - | ------------------- |  | - | -------------------- | - |  | - | ---
|                                 |  | Balance atBeginningof Year |     | AdditionsCharged toExpense |   | Write-offsand Other |  |   | Balanceat endof Year
|Allowance for doubtful accounts: |  |                            |     |                            |   |                     |  |   |                      |   |  |   |    
|Year ended December 31, 2006     |  | $                          | 145 |                            | $ |                    |  | $ | (78                  | ) |  | $ | 67 
|Year ended January 1, 2006       |  |                            | 89  |                            |   | 57                  |  |   | (1                   | ) |  |   | 145
|Year ended January 2, 2005       |  |                            | 54  |                            |   | 37                  |  |   | (2                   | ) |  |   | 89 

The Company records shipping revenue in net revenue. The Company recorded shipping revenue of
$2,532,000, $2,090,000, and $2,029,000 related to home delivery sales in 2006, 2005, and 2004, respectively.

Cost of sales and
related occupancy expensesCost of sales and related occupancy expenses consist primarily of coffee and other product costs. It also includes plant manufacturing (including depreciation), freight and distribution costs. Occupancy
expenses include rent and related expenses such as utilities.



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Operating expensesOperating expenses consist of both retail store and specialty
operating costs, such as employee labor and benefits, repairs and maintenance, supplies, training, travel and banking and card processing fees.

Preopening costsCosts incurred in connection with the start-up and promotion of new store openings are expensed as incurred.

Fair Value of Financial InstrumentsThe carrying value of cash and equivalents, receivables and accounts payable approximates fair value. Marketable securities are recorded at fair value.

Advertising costsAdvertising costs are expensed as incurred. Advertising expense was $2,237,000, $1,793,000, and
$1,546,000 in 2006, 2005, and 2004, respectively.

Operating leasesCertain of the Companys lease agreements
provide for tenant improvement allowances, rent holidays, scheduled rent increases and/or contingent rent provisions during the term of the lease. For purposes of recognizing incentives and minimum rental expenses, rent is expensed on a
straight-line basis, and we record the difference between the recognized rental expense and accounts payable under the lease to deferred lease credits and other long-term liabilities, over the lease term, which may or may not coincide with the
commencement of the lease. Tenant improvement allowances are amortized as a reduction in rent expense over the term of the lease. If the original lease term is less than the Companys anticipated rental period, one or more stated option terms
are included in the straight-line computation. Certain leases provide for contingent rents, which are determined as a percentage of gross sales in excess of specified levels. The Company records a contingent rent liability in accounts payable on the
consolidated balance sheets and the corresponding rent expense when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable. During 2004, the Company corrected certain
errors with respect to its interpretation of GAAP resulting in additional cost of sales and occupancy expense of $768,000, of which the amount related to prior years, $719,000, was determined to be immaterial and previously reported financial
statements have not been restated. The error resulted primarily from the use of the lease commencement date, rather than the date the Company had the right to occupy the space, and the original lease term, without renewals, in computing the period
over which to straight-line rent payments.

Gift CardsWe sell gift cards to our customers in our retail stores and
through our Web sites. Our gift cards do not have an expiration date. We recognize income from gift cards when: (i) the gift card is redeemed by the customer: or (ii) the likelihood of the gift card being redeemed by the customer is remote
(gift card breakage) and we determine that we do not have a legal obligation to remit the unredeemed gift cards to the relevant jurisdictions. We determine the gift card breakage rate based upon our historical redemption patterns. We apply an
estimated gift card breakage rate after the card has been dormant for 24 months, when based on historical information, we determine the likelihood of redemption becomes remote. Gift card breakage income is included in operating expenses in the
consolidated statements of income.

Income TaxesIncome taxes are accounted for using the asset and liability method,
under which deferred tax assets and liabilities are determined based on the difference between the financial statements and tax bases of assets and liabilities using enacted tax rates currently in effect.

Stock-Based CompensationOn January 2, 2006, we adopted the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment, (SFAS 123(R)), using the modified-prospective-transition method. Under this transition method, compensation cost recognized for the year ended December 31, 2006
includes: (a) compensation cost for all stock-based payments granted, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, and (b) compensation cost
for all stock-based payments granted subsequent to January 2, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Such amounts have been reduced by our estimate of forfeitures of all unvested
awards. Results for prior periods have not been restated. The fair value of each stock award is estimated on the grant date using the Black-Scholes option-pricing model based on assumptions for volatility, risk-free interest rates, expected life of
the option, and dividends (if any). The expected term of the options represents the estimated period of time from date of option grant until exercise and is based on historical experience of similar awards, giving consideration to the contractual
terms, vesting schedules and expectations of future employee behavior. For grants prior to July 3, 2006 expected stock price volatility was estimated using only the historical volatility of the Companys stock. Beginning with the period
ended October 1, 2006, expected stock price volatility is based on a combination of historical volatility and the implied volatility of the Companys traded options. The risk-free interest rate is based on the implied yield available on
U.S. Treasury zero-coupon issues with an equivalent term. The Company has not paid dividends in the past and does not plan to pay dividends in the near future. Additional disclosure requirements of SFAS 123(R) are set forth in Note 9, Stock
Options, Employee Purchase and Deferred Compensation Plans.

Stock-based compensation expense recognized in the consolidated
statements of income related to stock options was $4,022,000, $44,000, and $212,000 for 2006, 2005 and 2004, respectively. The related total tax benefit was $1,641,000, $19,000, and $84,000 for 2006, 2005 and 2004, respectively. Stock-based
compensation expense was recognized as follows in the statements of income (in thousands):



|                                             |  |      |       |      |   |      |  |   |    
|-------------------------------------------- |  | ---- | ----- | ---- | - | ---- |  | - | ---
|                                             |  | 2006 |       | 2005 |   | 2004
|Cost of sales and related occupancy expenses |  | $    | 466   |      | $ | 2    |  | $ | 12 
|Operating expenses                           |  |      | 1,292 |      |   | 19   |  |   | 82 
|General and administrative expenses          |  |      | 2,264 |      |   | 23   |  |   | 118
|                                             |  |      |       |      |   |      |  |   |    
|Total                                        |  | $    | 4,022 |      | $ | 44   |  | $ | 212
|                                             |  |      |       |      |   |      |  |   |    

The net effect of the adoption of SFAS 123(R) on net income was $2,381,000, or $0.17 per basic
share and $0.17 per diluted share, for 2006. The adoption of SFAS 123(R) resulted in a decrease of cash flows from operations and an increase in cash flows from financing activities of $724,000 for 2006. Prior to January 1, 2006, the Company
accounted for stock-based awards to employees and non-employee directors using the intrinsic value method in accordance with Accounting Principles Board, (APB) No. 25, Accounting for Stock Issued to Employees. The following table
shows the effect on net income and net income per share for 2005 and 2004 had compensation cost been recognized based upon the estimated fair value on the grant date of stock options and ESPP awards (in thousands, except net income per share):



|                                                                                      |  |                          |        |   |                          |   |        |  
|------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ------------------------ | - | ------ | -
|                                                                                      |  | 2005                     |        |   | 2004                     |  
|                                                                                      |  | (As restated,See Note 2) |        |   | (As restated,See Note 2) |  
|Net incomeas reported                                                                |  | $                        | 10,775 |   |                          | $ | 8,710  |  
|Stock-based employee compensation included in reported net income, net of tax         |  |                          | 25     |   |                          |   | 128    |  
|Stock-based compensation expense determined under fair value based method, net of tax |  |                          | (4,085 | ) |                          |   | (4,411 | )
|                                                                                      |  |                          |        |   |                          |   |        |  
|Net incomepro forma                                                                  |  | $                        | 6,715  |   |                          | $ | 4,427  |  
|                                                                                      |  |                          |        |   |                          |   |        |  
|Basic net income per shareas reported                                                |  | $                        | 0.78   |   |                          | $ | 0.65   |  
|Basic net income per sharepro forma                                                  |  | $                        | 0.49   |   |                          | $ | 0.33   |  
|Diluted net income per shareas reported                                              |  | $                        | 0.74   |   |                          | $ | 0.62   |  
|Diluted net income per sharepro forma                                                |  | $                        | 0.46   |   |                          | $ | 0.32   |  



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The fair value of each option grant and ESPP award is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:



|                                        |  |               |       |   |      |   |      |      |  |   |      |   |  |      |      |   |      |   |      |   |  |   |      |  
|--------------------------------------- |  | ------------- | ----- | - | ---- | - | ---- | ---- |  | - | ---- | - |  | ---- | ---- | - | ---- | - | ---- | - |  | - | ---- | -
|                                        |  | Stock Options |       |   | ESPP |  
|                                        |  | 2006          |       |   | 2005 |   |      | 2004 |  |   | 2006 |   |  | 2005 |      |   | 2004 |  
|Expected term (in years)                |  |               | 5.4   |   |      |   | 3.8  |      |  |   | 3.2  |   |  |      | 0.5  |   |      |   | 0.5  |   |  |   | 1.2  |  
|Expected stock price volatility         |  |               | 34.1  | % |      |   | 37.8 | %    |  |   | 42.8 | % |  |      | 27.8 | % |      |   | 26.6 | % |  |   | 45.8 | %
|Risk-free interest rate                 |  |               | 5.0   | % |      |   | 3.9  | %    |  |   | 3.3  | % |  |      | 5.0  | % |      |   | 3.3  | % |  |   | 1.6  | %
|Expected dividend yield                 |  |               | 0     | % |      |   | 0    | %    |  |   | 0    | % |  |      | 0    | % |      |   | 0    | % |  |   | 0    | %
|Estimated fair value per option granted |  | $             | 11.83 |   |      | $ | 9.03 |      |  | $ | 7.56 |   |  | $    | 7.16 |   |      | $ | 6.86 |   |  | $ | 5.93 |  

Net Income per ShareBasic net income per share is computed as net income
divided by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur from common shares issued through stock options. Anti-dilutive shares of 578,424,
28,828, and 268,606 have been excluded from diluted weighted average shares outstanding in 2006, 2005, and 2004, respectively.

The number
of incremental shares from the assumed exercise of stock options was calculated by applying the treasury stock method. The following table summarizes the differences between basic weighted average shares outstanding and diluted weighted average
shares outstanding used to compute diluted net income per share (in thousands):



|                                                          |  |        |  |        |  |              
|--------------------------------------------------------- |  | ------ |  | ------ |  | -------------
|                                                          |  | 2006   |  | 2005   |  | 2004         
|                                                          |  |        |  |        |  | (As Restated)
|Basic weighted average shares outstanding                 |  | 13,733 |  | 13,801 |  | 13,308       
|Incremental shares from assumed exercise of stock options |  | 469    |  | 668    |  | 641          
|                                                          |  |        |  |        |  |              
|Diluted weighted average shares outstanding               |  | 14,202 |  | 14,469 |  | 13,949       
|                                                          |  |        |  |        |  |              

Recently Issued Accounting Standards

In July 2006, the FASB issued Financial Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of
FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that we recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on
audit, based on the technical merits of the position. The Company is currently evaluating the provisions of FIN 48 and has not yet completed its determination of the impact of adoption on our financial position or results of operations.

2.    Restatement of Consolidated Financial Statements and Reclassifications

Stock Option Grants

On October 20, 2006, the Companys Board of Directors appointed
an Option Review Committee (the Special Committee) consisting of two independent directors to oversee a review of the Companys past stock option granting practices. Based on this review, the Company has determined that it used an
incorrect measurement date for financial accounting purposes for a number of stock option grants. These errors resulted primarily from misapplication of accounting standards related to the determination of certain measurement dates, as discussed
below, which on a number of occasions resulted in employees receiving options with stated exercise prices lower than the market prices on the appropriate measurement dates as determined by the applicable accounting standards. For purposes of
accounting for option grants, APB 25 provides that the measurement date



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



occurs when both the number of shares that the employee is entitled to receive is fixed and the exercise price associated with the grant is known. For
certain stock options grants, the documentation related to the grant indicated that all prerequisites for establishing an accounting measurement date had not been met as of the original grant date selected by the Company. Accordingly, the Company
sought to determine, based on the available evidence for each of the grants, when all prerequisites had been met in order to establish a revised measurement date for the granted options. In addition, the Company found instances in which the
measurement dates for option grants were determined appropriately but the options were accounted for incorrectly. Based on these conclusions, the Company has restated the accompanying fiscal 2005 and 2004 consolidated financial statements to record
additional non-cash stock-based compensation expense and related tax effects with regard to past stock option grants. The cumulative effect of these stock-based compensation adjustments, after tax, aggregate $1.0 million for fiscal years 1998
through 2005. The adjustments, after tax, for fiscal years 2005 and 2004 are $15,000 and $74,000, respectively.

The principal components
of the restatement are as follows (in thousands):



|                                                          |  |                        |    
|--------------------------------------------------------- |  | ---------------------- | ---
|                                                          |  | Adjustments,net of tax
|Revised Measurement Dates:                                |  |                        |    
|All Employee Grants                                       |  | $                      | 266
|Bonus Grants                                              |  |                        | 420
|Other Grants                                              |  |                        | 28 
|Incorrect Accounting for Grants to Consultants,           |  |                        |    
|Modifications and Discounted Options                      |  |                        | 265
|Misapplication of Non-Employee Director Stock Option Plan |  |                        | 9  
|                                                          |  |                        |    
|                                                          |  | $                      | 988
|                                                          |  |                        |    

Revised Measurement Dates.Based on available evidence, the Company applied the
methodologies described below to determine the revised measurement dates under APB No. 25 for grants in the following categories: (1) annual grants to all Company employees (All Employee Grants); (2) bonus award option
grants to directors and officers (Bonus Grants); and (3) grants in connection with the hiring and promotion of employees and other discretionary grants (Other Grants).



| |  |  | All Employee GrantsSince the Companys initial public offering in 2001, the Company has made an annual grant of stock options to all
employees of the Company. These grants require approval by the Board of Directors or the Compensation Committee of the Board of Directors (Compensation Committee). The number of shares to be granted to each individual is based upon job
level in the organization and years of service.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Company determined that the fiscal 2001 grant was not approved at a
Board of Directors or Compensation Committee meeting, but instead it used a unanimous written consent (UWC) to obtain Board of Director approval. However, the UWC relating to the grant was not fully executed by the grant date. The
Company has determined the appropriate measurement date of this award to be the date the final Board member signature was obtained on the UWC. The Company also determined that it used the incorrect measurement date for the fiscal 2002 grant. While
Board of Directors approval was received for the shares to be issued and documented in a regularly scheduled board meeting, there was no evidence that the exercise price was determined on the stated date. The Company has determined the revised
measurement date for this grant using managements judgment of when the grant details were likely finalized, based on review of available evidence, such as e-mail communications, interviews and supporting facts and circumstances.



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



| |  |  | Bonus GrantsIn 2001, the Company began to grant stock options to director-level employees and above as incentive compensation. The number
of options to be granted was determined using a predefined formula that utilizes the exercise price to determine the number of shares to be granted.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For the 2001 and 2002 bonus grants, the Company determined it used an incorrect measurement date for accounting purposes because the list containing the names of grantees, the options awarded to each grantee, and/or
the grant date was not evidenced to be approved and determined with finality until a date subsequent to the measurement dates it previously used. The Company determined the revised measurement dates for the 2001 and 2002 bonus grants based on the
date when the formula used to compute the number of options granted to each employee was approved by the Board of Directors and there was evidence that the grant price was established.



| |  |  | Other GrantsThe Company also awarded options to key new hires, for promotions and in select situations to reward and retain key
individuals. The Companys general practice has been to grant stock options on the date the employee started work, was promoted or was notified of a discretionary grant. The Company would obtain approval for these grants in two different ways:
(1) for grants over 10,000 shares, the Company required Board of Directors or Compensation Committee approval, and (2) beginning in February 2003, the Compensation Committee delegated authority to the Chief Executive Officer in his capacity as a
member of the Board of Directors to approve grants up to 10,000 shares, as prior to that date the delegation was implied. In certain instances, the available documentation for the grants did not support the original measurement date as all the terms
of the grant were not approved and known with finality at the stated grant date. The Company used the methodology described below for (1) grants requiring Board of Directors or Compensation Committee approval and (2) grants where granting
authority was delegated to the Chief Executive Officer.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Other Grants requiring Board of Directors or Compensation
Committee approvalThe Company determined the revised measurement date for each stock option grant that requires Board of Directors or Compensation Committee approval to be the Approval Date (as defined below) for the stock option, provided
the criteria set forth below were met. If there was not clear documentation supporting the Approval Date, management used the evidence described below to determine the most likely measurement date.



| |  |  | Approval DateThe Approval Date was the date of approval set forth in executed minutes or a fully-executed UWC of the Board of Directors or
Compensation Committee documenting the grant of the stock option (i.e. employee, number of options, and exercise price.) When the Company did not have evidence of the approvals through either the minutes or signed UWC, management used other
available evidence of approval by the Board of Directors or Compensation Committee, including email communications.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Most Likely Measurement DateIf the Approval Date criteria was not evidenced (i.e. all signed UWCs were not returned), the Company used the
earlier of the following dates to determine the revised measurement date as management believes approval of the grant occurred prior to this date:
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The date the employee was notified of the terms of the option grant,
| | - |  | --------------------------------------------------------------------



| |  |  | The signature date of management approvals on the Companys grant approval form,
| | - |  | --------------------------------------------------------------------------------



| |  |  | The date the grant approval form was received by the Companys human resources department,
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | Print date or metadata creation date on notice of grant of stock form, or
| | - |  | -------------------------------------------------------------------------



| |  |  | The date the option was entered into the Companys stock option database application.
| | - |  | -------------------------------------------------------------------------------------



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Other Grants where granting authority was delegated to the Chief Executive Officer:



| |  |  | New Hire GrantsThe Companys Chief Executive Officer has been directly involved in determining the stock options to be granted to new hires.
Generally, the terms of these stock options were included in the employees offer letter. Therefore, the Company determined the measurement date for new hire option grants to be the employees start date if all of the terms of the option
grant were documented in the employees offer letter. Where the Company has determined that new hire option terms had not been determined and approved with finality prior to the employees start date, management used the methodology
defined above under Most Likely Measurement Date, to determine the revised measurement date.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Promotion and Discretionary GrantsThe Company did not follow a consistent practice in granting, approving or documenting promotion and discretionary
grants throughout the years. In many of the Companys promotion and discretionary grants, the available documentation for the grants did not support the original measurement date as all the terms of the grant were not approved and known with
finality at the stated grant date. In such instances, the Company used the methodology defined above under Most Likely Measurement Date, to determine the revised measurement date.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Incorrect Accounting for Grants to Consultants, Modifications and Discounted Options.The Company also identified other accounting
errors related to option grants. The Company identified one Company-wide grant from 1998, before Peets became a public company that was intentionally granted with an exercise price equal to 85% of fair value, consistent with the operative
stock plan and the Companys practice at the time, with respect to which it did not correctly account for the discount to fair value. The Company also identified two options granted to consultants that were incorrectly accounted for as grants
to employees. In addition, the Company found several instances in which it incorrectly accounted for modifications to outstanding options, including one employee option that was accelerated upon termination of employment outside the provisions of
the original grant and 11 instances in which employees periods to exercise options were extended.

Misapplication of
Non-Employee Director Stock Option Plan.The Non-Employee Director Plan provides for non-discretionary, automatic option grants to non-employee directors (including both initial grants and annual grants), requiring no independent
action of the Board or any committee of the Board. The plan stipulates that each director automatically receives an initial grant and a prorated annual grant on the day of initial election or appointment to the Board of Directors and an ongoing
annual grant on the day following each annual meeting of shareholders. Prior to May 2005 the plan specified that options would have an exercise price equal to the market value of the option grant, which was defined as the closing price of the stock
on the day prior to the grant. The plan was amended in May 2005 to define the market value as the closing price of the stock on the day of the option grant. The Company incorrectly administered three annual grants to all directors and one initial
grant by applying a measurement date that was incorrect by one day. In addition, in two instances, the Company did not record the proper prorated grant upon a new director being named to the Board. The Company intends to correct these two
administrative errors on the prorated grants in accordance with the plan. Of the three annual grants to all directors, two were recorded at an exercise price higher than the market price on the revised measurement date, and therefore no additional
expense has been recognized in respect to these grants.



F-15



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Total Financial Impact of Stock Option Related Restatement

The total stock-based compensation expense and incremental impact, to correct these errors in the Companys historical stock option grants is as
follows, net of related income tax expenses (in thousands):



|          |  |                          |       |                                    |   |                         |  |   |     |  |   |     |  |   |    
|--------- |  | ------------------------ | ----- | ---------------------------------- | - | ----------------------- |  | - | --- |  | - | --- |  | - | ---
|          |  | Stock-based Compensation
|          |  | Adjustments              |       | As previously reported, net of
tax |   | As restated, net of tax
|          |  | pre-tax                  |       | tax effect                         |   | net of tax              |  |  
|1998      |  | $                        | 26    |                                    | $ | 11                      |  | $ | 15  |  | $ |    |  | $ | 15 
|1999      |  |                          | 48    |                                    |   | 20                      |  |   | 28  |  |   | 9   |  |   | 37 
|2000      |  |                          | 51    |                                    |   | 21                      |  |   | 30  |  |   | 143 |  |   | 173
|2001      |  |                          | 291   |                                    |   | 119                     |  |   | 172 |  |   | 183 |  |   | 355
|2002      |  |                          | 953   |                                    |   | 389                     |  |   | 564 |  |   | 174 |  |   | 738
|2003      |  |                          | 152   |                                    |   | 62                      |  |   | 90  |  |   | 115 |  |   | 205
|          |  |                          |       |                                    |   |                         |  |   |     |  |   |     |  |   |    
|1998-2003 |  |                          |       |                                    |   |                         |  |   | 899 |  |   |     |  |   |    
|2004      |  |                          | 125   |                                    |   | 51                      |  |   | 74  |  |   | 54  |  |   | 128
|2005      |  |                          | 26    |                                    |   | 11                      |  |   | 15  |  |   | 10  |  |   | 25 
|          |  |                          |       |                                    |   |                         |  |   |     |  |   |     |  |   |    
|          |  | $                        | 1,672 |                                    | $ | 684                     |  | $ | 988 |  |   |     |  |   |    
|          |  |                          |       |                                    |   |                         |  |   |     |  |   |     |  |   |    

As of January 2, 2006 (the first day of the Companys 2006 fiscal year), the aggregate
amount of unamortized compensation expense related to these option grants totaled approximately $57,000.

Additionally, the Company
restated the related pro forma expense for the years ended January 1, 2006 and January 2, 2005 under Statement of Financial Accounting Standards (SFAS) No. 123 in Note 1 to reflect the impact of these adjustments.

Procurement and Production Costs

Subsequent to the Companys 2006 year-end, the Company determined that its methodology for allocating production and procurement cost to inventory was incorrect and resulted in understating inventory balances and misstated net
income. The Companys restated consolidated balance sheet as of January 1, 2006 includes an increase to inventory balances of $0.9 million and a cumulative net effect on retained earnings of $0.6 million. The pre-tax
impact on the consolidated statements of income for fiscal 2005 and 2004 is approximately a $174,000 increase and a $2,000 decrease.

Restatement Reconciliation

The reconciliation of the cumulative effect of the above adjustments to beginning retained
earnings as reported is as follows (in thousands):



|                                                            |  |   |      |  
|----------------------------------------------------------- |  | - | ---- | -
|Cumulative Stock Options Adjustment                         |  | $ | 899  |  
|Cumulative Inventory Adjustment                             |  |   | (403 | )
|                                                            |  |   |      |  
|Cumulative effect on Retained Earnings at December 28, 2003 |  | $ | 496  |  
|                                                            |  |   |      |  



F-16



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Reclassifications

The Company has reclassified certain expenses in its prior consolidated financial statements to conform to the current year presentation, including the combining of marketing expenses with general and administrative
expenses; classifying home delivery fulfillment expenses, previously included in operating expenses, as cost of sales and related occupancy costs; classifying website maintenance, previously included in operating expenses, as general and
administrative expenses; and classifying the office portion of our lease expenses, previously included in cost of sales and related occupancy costs, as general and administrative expenses. These adjustments had no effect on the previously reported
income from operations or net income.

Statement of Cash Flows Restatement



For the year ended January 2, 2005, the Company included certain un-paid
liabilities as part of purchases of property, plant and equipment and in the change in accounts payable and accrued liabilities line items in the Statement of Cash Flows, rather than as capital expenditures incurred, but not yet paid in non-cash
investing activities. The correction of this error decreased net cash provided by operating activities and decreased net cash used in investing activities by $0.3 million.

Summary of the Effect of Adjustments and Reclassifications on the Companys Financial Statements

The following tables set forth the effect of the adjustments and reclassifications on the Companys Consolidated Balance Sheets as of January 1, 2006 and its Consolidated Statements of Income and Consolidated Statements of Cash
Flows for the years ended January 1, 2006 and January 2, 2005 (in thousands):

Consolidated Balance Sheet



|                                            |  |                        |           |             |               |     |             |   |       |   |  |   |        
|------------------------------------------- |  | ---------------------- | --------- | ----------- | ------------- | --- | ----------- | - | ----- | - |  | - | -------
|                                            |  | As of January 1, 2006 
|                                            |  | As Previously Reported |           | Adjustments |               |     | As Restated
|                                            |  |                        | Inventory |             | Stock Options |     |            
|Inventories                                 |  | $                      | 16,148    |             | $             | 853 |             |   |       |   |  | $ | 17,001 
|Total current assets                        |  |                        | 79,262    |             |               | 853 |             |   |       |   |  |   | 80,115 
|Total assets                                |  |                        | 147,899   |             |               | 853 |             |   |       |   |  |   | 148,752
|Deferred income tax liabilitiesnon-current |  |                        | 1,759     |             |               | 348 |             | $ | (301  | ) |  |   | 1,806  
|Total liabilities                           |  |                        | 21,827    |             |               | 348 |             |   | (301  | ) |  |   | 21,874 
|Common stock                                |  |                        | 99,273    |             |               |     |             |   | 1,289 |   |  |   | 100,562
|Retained earnings                           |  |                        | 26,875    |             |               | 505 |             |   | (988  | ) |  |   | 26,392 
|Total shareholders equity                  |  |                        | 126,072   |             |               | 505 |             |   | 301   |   |  |   | 126,878
|Total liabilities and shareholders equity  |  |                        | 147,899   |             |               | 853 |             |   |       |   |  |   | 148,752



F-17



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Consolidated Statements Of Income



|                                             |  |                        |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|-------------------------------------------- |  | ---------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ------ | - |  | - | -------
|                                             |  | As of January 1, 2006 
|                                             |  | As Previously Reported |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                        | Inventory |             |   | Stock Options |                   |  |  
|Cost of sales and related occupancy expenses |  | $                      | 80,374    |             | $ | (174          | )                 |  | $ | 2           |   |  | $ | 635    |   |  | $ | 80,837 
|Operating expenses                           |  |                        | 59,060    |             |   |               |                   |  |   | 20          |   |  |   | (1,201 | ) |  |   | 57,879 
|Depreciation and amortization expenses       |  |                        | 7,299     |             |   |               |                   |  |   |             |   |  |   | (6     | ) |  |   | 7,293  
|General and administrative expenses          |  |                        | 12,765    |             |   |               |                   |  |   | 4           |   |  |   | 572    |   |  |   | 13,341 
|Total costs and expenses from operations     |  |                        | 159,498   |             |   | (174          | )                 |  |   | 26          |   |  |   |        |   |  |   | 159,350
|Income from operations                       |  |                        | 15,700    |             |   | 174           |                   |  |   | (26         | ) |  |   |        |   |  |   | 15,848 
|Income before income taxes                   |  |                        | 17,469    |             |   | 174           |                   |  |   | (26         | ) |  |   |        |   |  |   | 17,617 
|Income tax provision                         |  |                        | 6,782     |             |   | 71            |                   |  |   | (11         | ) |  |   |        |   |  |   | 6,842  
|Net income                                   |  |                        | 10,687    |             |   | 103           |                   |  |   | (15         | ) |  |   |        |   |  |   | 10,775 
|Net income per sharebasic                   |  | $                      | 0.77      |             | $ | 0.01          |                   |  | $ |            |   |  | $ |       |   |  | $ | 0.78   
|                                             |  |                        |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Net income per sharediluted                 |  | $                      | 0.74      |             | $ |              |                   |  | $ |            |   |  | $ |       |   |  | $ | 0.74   
|                                             |  |                        |           |             |   |               |                   |  |   |             |   |  |   |        |   |  |   |        
|Shares used in per share calculationbasic   |  |                        | 13,801    |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 13,801 
|Shares used in per share calculationdiluted |  |                        | 14,469    |             |   |              |                   |  |   |            |   |  |   |       |   |  |   | 14,469 



|                                             |  |                        |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |        
|-------------------------------------------- |  | ---------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | -------
|                                             |  | As of January 2, 2005 
|                                             |  | As Previously Reported |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                        | Inventory |             |   | Stock Options |                   |  |  
|Cost of sales and related occupancy expenses |  | $                      | 67,189    |             | $ | 2             |                   |  | $ | 12          |   |  | $ | 603  |   |  | $ | 67,806 
|Operating expenses                           |  |                        | 48,530    |             |   |               |                   |  |   | 82          |   |  |   | (967 | ) |  |   | 47,645 
|Depreciation and amortization expenses       |  |                        | 5,794     |             |   |               |                   |  |   |             |   |  |   | (7   | ) |  |   | 5,787  
|General and administrative expenses          |  |                        | 11,037    |             |   |               |                   |  |   | 31          |   |  |   | 371  |   |  |   | 11,439 
|Total costs and expenses from operations     |  |                        | 132,550   |             |   | 2             |                   |  |   | 125         |   |  |   |      |   |  |   | 132,677
|Income from operations                       |  |                        | 13,133    |             |   | (2            | )                 |  |   | (125        | ) |  |   |      |   |  |   | 13,006 
|Income before income taxes                   |  |                        | 14,055    |             |   | (2            | )                 |  |   | (125        | ) |  |   |      |   |  |   | 13,928 
|Income tax provision                         |  |                        | 5,270     |             |   | (1            | )                 |  |   | (51         | ) |  |   |      |   |  |   | 5,218  
|Net income                                   |  |                        | 8,785     |             |   | (1            | )                 |  |   | (74         | ) |  |   |      |   |  |   | 8,710  
|Net income per sharebasic                   |  | $                      | 0.66      |             | $ |              |                   |  | $ | (0.01       | ) |  | $ |     |   |  | $ | 0.65   
|                                             |  |                        |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |        
|Net income per sharediluted                 |  | $                      | 0.63      |             | $ |              |                   |  | $ | (0.01       | ) |  | $ |     |   |  | $ | 0.62   
|                                             |  |                        |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |        
|Shares used in per share calculationbasic   |  |                        | 13,308    |             |   |              |                   |  |   |            |   |  |   |     |   |  |   | 13,308 
|Shares used in per share calculationdiluted |  |                        | 13,951    |             |   |              |                   |  |   | (2          | ) |  |   |     |   |  |   | 13,949 



F-18



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Consolidated Statements Of Cash Flows



|                                           |  |                                   |        |   |           |   |      |               |  |   |             |   |  |   |        |  
|------------------------------------------ |  | --------------------------------- | ------ | - | --------- | - | ---- | ------------- |  | - | ----------- | - |  | - | ------ | -
|                                           |  | Fiscal Year Ended January 1, 2006 |       
|                                           |  | As PreviouslyReported             |        |   | Inventory |   |      | Stock Options |  |   | As Restated |  
|Cash flows from operating activities:      |  |                                   |        |   |           |   |      |               |  |   |             |   |  |   |        |  
|Net income                                 |  | $                                 | 10,687 |   |           | $ | 103  |               |  | $ | (15         | ) |  | $ | 10,775 |  
|Stock-based compensation                   |  |                                   | 18     |   |           |   |      |               |  |   | 26          |   |  |   | 44     |  
|Tax benefit from exercise of stock options |  |                                   | 3,348  |   |           |   |      |               |  |   | (86         | ) |  |   | 3,262  |  
|Deferred income taxes                      |  |                                   | 762    |   |           |   | 71   |               |  |   | 75          |   |  |   | 908    |  
|Inventories                                |  |                                   | (3,534 | ) |           |   | (174 | )             |  |   |             |   |  |   | (3,708 | )
|Net cash provided by operating activities  |  |                                   | 19,503 |   |           |   |      |               |  |   |             |   |  |   | 19,503 |  



|                                           |  |                                   |         |   |           |   |    |               |  |   |                    |   |  |             |      |   |  |   |         |  
|------------------------------------------ |  | --------------------------------- | ------- | - | --------- | - | -- | ------------- |  | - | ------------------ | - |  | ----------- | ---- | - |  | - | ------- | -
|                                           |  | Fiscal Year Ended January 2, 2005 |        
|                                           |  | As PreviouslyReported             |         |   | Inventory |   |    | Stock Options |  |   | Cash FlowStatement |   |  | As Restated |     
|Cash flows from operating activities:      |  |                                   |         |   |           |   |    |               |  |   |                    |   |  |             |      |   |  |   |         |  
|Net income                                 |  | $                                 | 8,785   |   |           | $ | (1 | )             |  | $ | (74                | ) |  |             |      |   |  | $ | 8,710   |  
|Stock-based compensation                   |  |                                   | 87      |   |           |   |    |               |  |   | 125                |   |  |             |      |   |  |   | 212     |  
|Tax benefit from exercise of stock options |  |                                   | 3,549   |   |           |   |    |               |  |   | (136               | ) |  |             |      |   |  |   | 3,413   |  
|Deferred income taxes                      |  |                                   | 105     |   |           |   | (1 | )             |  |   | 85                 |   |  |             |      |   |  |   | 189     |  
|Inventories                                |  |                                   | (1,894  | ) |           |   | 2  |               |  |   |                    |   |  |             |      |   |  |   | (1,892  | )
|Accounts payable and accrued liabilities   |  |                                   | 1,254   |   |           |   |    |               |  |   |                    |   |  | $           | (301 | ) |  |   | 953     |  
|Net cash provided by operating activities  |  |                                   | 19,887  |   |           |   |    |               |  |   |                    |   |  |             | (301 | ) |  |   | 19,586  |  
|Cash flows from investing activities:      |  |                                   |         |   |           |   |    |               |  |   |                    |   |  |             |      |   |  |   |         |  
|Purchases of property, plant and equipment |  |                                   | (15,305 | ) |           |   |    |               |  |   |                    |   |  |             | 301  |   |  |   | (15,004 | )
|Net cash used in investing activities      |  |                                   | (40,534 | ) |           |   |    |               |  |   |                    |   |  |             | 301  |   |  |   | (40,233 | )

3.    Inventories

The Companys inventories consist of the following at year end 2006 and 2005 (in thousands):



|                |  |      |        |                           |   |       
|--------------- |  | ---- | ------ | ------------------------- | - | ------
|                |  | 2006 |        | 2005                     
|                |  |      |        | (As Restated, See Note 2)
|Green coffee    |  | $    | 11,535 |                           | $ | 10,263
|Other inventory |  |      | 7,998  |                           |   | 6,738 
|                |  |      |        |                           |   |       
|Total           |  | $    | 19,533 |                           | $ | 17,001
|                |  |      |        |                           |   |       



F-19



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



4.    Property, Plant and Equipment

Property, plant and equipment consist of the following at year end 2006 and 2005 (in thousands):



|                                   |  |      |         |   |      |   |         |  
|---------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                   |  | 2006 |         |   | 2005 |  
|Leasehold Improvements             |  | $    | 46,791  |   |      | $ | 40,195  |  
|Furniture, fixtures and equipment  |  |      | 52,950  |   |      |   | 42,194  |  
|Plant equipment                    |  |      | 11,601  |   |      |   | 11,748  |  
|Construction in progress           |  |      | 9,745   |   |      |   | 2,652   |  
|Building                           |  |      | 12,752  |   |      |   |        |  
|Land                               |  |      | 8,209   |   |      |   |        |  
|                                   |  |      |         |   |      |   |         |  
|Total                              |  |      | 142,048 |   |      |   | 96,789  |  
|Less: Accumulated depreciation     |  |      | (59,601 | ) |      |   | (50,476 | )
|                                   |  |      |         |   |      |   |         |  
|Property, Plant and Equipment, net |  | $    | 82,447  |   |      | $ | 46,313  |  
|                                   |  |      |         |   |      |   |         |  

Depreciation expense was $10,128,000 in 2006, $8,508,000 in 2005 and $6,741,000 in 2004.
Construction in progress includes retail stores under construction and related fixtures, manufacturing plant equipment, and other capital projects not yet placed in service.

On November 29, 2005, we entered into an agreement with Harbor Bay Acquisition LLC to purchase property in Alameda, California for the purpose of
operating a new roasting facility. In December, 2006, in accordance with the agreement, the Company acquired approximately 460,000 square feet of land and a 138,000 square foot building with related site improvements as specified. The final purchase
price of the facility and the land was $18.6 million. The Company anticipates the plant to be at full production capability by April 2007.

5.    Marketable securities

At December 31, 2006 and January 1, 2006, the Company maintained
marketable securities classified as available-for-sale as follows (in thousands):



|                                       |  |               |        |                                |   |           |  |   |       
|-------------------------------------- |  | ------------- | ------ | ------------------------------ | - | --------- |  | - | ------
|                                       |  | AmortizedCost |        | Gross UnrealizedHolding Losses |   | FairValue
|December 31, 2006                      |  |               |        |                                |   |           |  |   |       
|U.S. government and agency obligations |  | $             | 3,000  |                                | $ | 7         |  | $ | 2,993 
|State and local government obligations |  |               | 16,534 |                                |   | 16        |  |   | 16,518
|                                       |  |               |        |                                |   |           |  |   |       
|Total marketable securitiesshort-term |  | $             | 19,534 |                                | $ | 23        |  | $ | 19,511
|                                       |  |               |        |                                |   |           |  |   |       
|U.S. government and agency obligations |  | $             | 6,000  |                                | $ | 11        |  | $ | 5,989 
|State and local government obligations |  |               |       |                                |   |          |  |   |      
|                                       |  |               |        |                                |   |           |  |   |       
|Total marketable securitieslong-term  |  | $             | 6,000  |                                | $ | 11        |  | $ | 5,989 
|                                       |  |               |        |                                |   |           |  |   |       



F-20



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|                                       |  |               |        |                                |   |           |  |   |       
|-------------------------------------- |  | ------------- | ------ | ------------------------------ | - | --------- |  | - | ------
|                                       |  | AmortizedCost |        | Gross UnrealizedHolding Losses |   | FairValue
|January 1, 2006                        |  |               |        |                                |   |           |  |   |       
|U.S. government and agency obligations |  | $             | 17,676 |                                | $ | 77        |  | $ | 17,599
|State and local government obligations |  |               | 14,900 |                                |   | 46        |  |   | 14,854
|                                       |  |               |        |                                |   |           |  |   |       
|Total marketable securitiesshort-term |  | $             | 32,576 |                                | $ | 123       |  | $ | 32,453
|                                       |  |               |        |                                |   |           |  |   |       
|U.S. government and agency obligations |  | $             | 3,000  |                                | $ | 13        |  | $ | 2,987 
|State and local government obligations |  |               | 13,905 |                                |   | 2         |  |   | 13,903
|                                       |  |               |        |                                |   |           |  |   |       
|Total marketable securitieslong-term  |  | $             | 16,905 |                                | $ | 15        |  | $ | 16,890
|                                       |  |               |        |                                |   |           |  |   |       

Gross unrealized holding losses at December 31, 2006 are due to fluctuations in interest
rates and are considered temporary impairments as management has the intent and ability to hold the securities to recovery. At December 31, 2006, all long-term marketable securities have maturities ranging from one to two years.

During 2006 and 2005, the Company sold available-for-sale securities for net proceeds from marketable securities of $49,888,000 and $89,154,000, and
realized gains of $0 and $2,000, respectively. Realized gains and losses are determined on the specific identification method. For the period ended December 31, 2006, the Company had unrealized gains of $119,000 (net of $59,000 tax) and for the
period ended January 1, 2006, the Company had net unrealized gains of $76,000 (net of $48,000 tax), respectively, included in accumulated other comprehensive income (loss).

6.    Income Taxes

The income tax provision consists of the following (in
thousands):



|          |  |      |        |   |                          |   |       |                          |  |   |       |  
|--------- |  | ---- | ------ | - | ------------------------ | - | ----- | ------------------------ |  | - | ----- | -
|          |  | 2006 |        |   | 2005                     |   |       | 2004                     | 
|          |  |      |        |   | (As Restated,see Note 2) |   |       | (As Restated,see Note 2) | 
|Current:  |  |      |        |   |                          |   |       |                          |  |   |       |  
|Federal   |  | $    | 6,639  |   |                          | $ | 4,464 |                          |  | $ | 4,345 |  
|State     |  |      | 1,662  |   |                          |   | 1,567 |                          |  |   | 820   |  
|          |  |      |        |   |                          |   |       |                          |  |   |       |  
|Total     |  |      | 8,301  |   |                          |   | 6,031 |                          |  |   | 5,165 |  
|          |  |      |        |   |                          |   |       |                          |  |   |       |  
|Deferred: |  |      |        |   |                          |   |       |                          |  |   |       |  
|Federal   |  |      | (3,266 | ) |                          |   | 908   |                          |  |   | (382  | )
|State     |  |      | (345   | ) |                          |   | (97   | )                        |  |   | 435   |  
|          |  |      |        |   |                          |   |       |                          |  |   |       |  
|Total     |  |      | (3,611 | ) |                          |   | 811   |                          |  |   | 53    |  
|          |  |      |        |   |                          |   |       |                          |  |   |       |  
|Total     |  | $    | 4,690  |   |                          | $ | 6,842 |                          |  | $ | 5,218 |  
|          |  |      |        |   |                          |   |       |                          |  |   |       |  



F-21



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The difference between the effective income tax rate and the United States federal income tax rate is
summarized as follows:



|                                        |  |      |   |  |      |   |  |      |  
|--------------------------------------- |  | ---- | - |  | ---- | - |  | ---- | -
|                                        |  | 2006 |   |  | 2005 |   |  | 2004 |  
|Statutory Federal rate                  |  | 35.0 | % |  | 35.0 | % |  | 34.0 | %
|State income taxes less federal benefit |  | 5.9  |   |  | 5.8  |   |  | 5.8  |  
|Change in valuation allowance           |  | 0.0  |   |  | 0.0  |   |  | (1.6 | )
|Tax-exempt interest                     |  | (2.4 | ) |  | (0.5 | ) |  | (0.6 | )
|Domestic production deduction           |  | (1.6 | ) |  | (1.2 | ) |  | 0.0  |  
|Other, net                              |  | 0.6  |   |  | (0.3 | ) |  | (0.1 | )
|                                        |  |      |   |  |      |   |  |      |  
|Total                                   |  | 37.5 | % |  | 38.8 | % |  | 37.5 | %
|                                        |  |      |   |  |      |   |  |      |  

Deferred tax assets (liabilities) consist of the following at year end 2006 and 2005 (in
thousands):



|                                      |  |      |        |   |                          |   |        |  
|------------------------------------- |  | ---- | ------ | - | ------------------------ | - | ------ | -
|                                      |  | 2006 |        |   | 2005                     |  
|                                      |  |      |        |   | (As Restated,See Note 2) |  
|Charitable contributions              |  | $    | 33     |   |                          | $ | 88     |  
|Credit carryforwards                  |  |      | 106    |   |                          |   | 108    |  
|Scheduled rent                        |  |      | 1,308  |   |                          |   | 938    |  
|Accrued reserves                      |  |      | 1,222  |   |                          |   | 1,024  |  
|Accrued compensation                  |  |      | 498    |   |                          |   | 435    |  
|State taxes                           |  |      | 450    |   |                          |   | 182    |  
|Stock options                         |  |      | 1,748  |   |                          |   | 301    |  
|Other                                 |  |      | 11     |   |                          |   | 58     |  
|                                      |  |      |        |   |                          |   |        |  
|Gross deferred tax assets             |  |      | 5,376  |   |                          |   | 3,134  |  
|                                      |  |      |        |   |                          |   |        |  
|Property and equipment                |  |      | (1,677 | ) |                          |   | (2,992 | )
|Other                                 |  |      | (496   | ) |                          |   | (434   | )
|                                      |  |      |        |   |                          |   |        |  
|Gross deferred tax liabilities        |  |      | (2,173 | ) |                          |   | (3,426 | )
|                                      |  |      |        |   |                          |   |        |  
|Net deferred tax assets (liabilities) |  | $    | 3,203  |   |                          | $ | (292   | )
|                                      |  |      |        |   |                          |   |        |  

The Company will establish a valuation allowance when it is more likely than not that some portion
or all of the deferred tax assets will not be realized. Periodically, the valuation allowance is reviewed and adjusted based on managements assessment of realizable deferred tax assets. The Company anticipates that it will be able to realize
all its deferred tax assets. The Company has California Enterprise Zone credit carryforwards of $106,000 that do not expire.

7.    Employee Benefit Plan

The Companys 401(k) plan covers substantially all employees.
Employees may contribute up to 60% of their annual salary up to a maximum of $15,000. The Company matches 50% of amounts contributed by its employees, subject to a maximum of 5% of the employees eligible compensation contributed to the plan. The
Companys contribution was $251,000, $323,000, and $288,000 in 2006, 2005, and 2004, respectively. The plan does not offer investments in Company stock.



F-22



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



8.    Stock Purchase Program

In February 2004, the Board of Directors approved the purchase of up to one million shares of the Companys common stock, with no expiration. During
the years ended December 31, 2006 and January 1, 2006, the Company purchased and retired 589,504 and 174,000 shares of common stock, respectively, at an average price of $26.99 and $28.30, respectively, in accordance with the share
purchase program.

9.    Stock Option, Employee Purchase and Deferred Compensation Plans

Effective in 2001, the Company adopted a new stock option plan for which the Company has reserved 1,500,000 shares of common stock for issuance pursuant
to the plan. As of each annual meeting of the Companys shareholders, beginning in 2002, and continuing through and including the annual meeting of the Companys shareholders in 2010, the number of shares of common stock reserved for
issuance under the 2000 plan will be increased automatically by the lesser of (i) five percent (5%) of the total number of shares of common stock outstanding on such date, (ii) five hundred thousand (500,000) shares, or
(iii) a number of shares determined by the Board prior to such date, which number shall be less than (i) and (ii) above. The purchase price of the common stock issuable under this plan is determined by the Board of Directors, however
may not be less than 85% of the fair market value of common stock at the grant date. The term of a granted stock option is 10 years from the grant date. Stock options vest according to a pre-determined vest schedule set at grant date.

Also effective in 2001, the Company adopted the 2000 Non-Employee Director Plan that provides for the automatic grant of nonstatutory stock options to
purchase shares of common stock to non-employee directors, which is administered by the Board of Directors. The aggregate number of shares of common stock that may be issued under the plan is 330,000. As of each annual meeting of the Companys
shareholders, beginning in 2002, and continuing through and including the annual meeting of the Companys shareholders in 2020, the number of shares of common stock reserved for issuance under the 2000 plan will be increased automatically by
the lesser of (i) three quarters of one percent (0.75%) of the total number of shares of common stock outstanding on such date, (ii) sixty thousand (60,000) shares, or (iii) a number of shares determined by the Board prior to
such date, which number shall be less than (i) and (ii) above. The exercise price of options granted will be equal to the fair market value of the common stock on the date of grant and have a term no more than ten years from the date
granted. Stock options vest according to a pre-determined vest schedule set at grant date. In 2006, 2005, and 2004, the Company granted non-employee director options to purchase an aggregate of 68,125, 56,089, and 45,000 shares of common stock,
respectively.

The aggregate intrinsic value in the table below is before applicable income taxes, based on the Companys closing
stock price as of the last business day of the year, which would have been received by the optionees had all options been exercised on that date. As of December 31, 2006, total unrecognized stock-based compensation expense related to nonvested
stock options was approximately $4.2 million, which is expected to be recognized over a weighted average period of approximately 30 months. During the year ended December 31, 2006, the total intrinsic value of stock options exercised was $1.9
million.



F-23



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



As of December 31, 2006, there were 602,447 shares available for grant under the 2000 stock
option plan and 173,911 shares available for grant under the 2000 Non-Employee Director stock option plan. Changes in stock options were as follows:



|                                 |  |                    |   |  |                                         |       |                                                  |      |                                        |   |       
|-------------------------------- |  | ------------------ | - |  | --------------------------------------- | ----- | ------------------------------------------------ | ---- | -------------------------------------- | - | ------
|                                 |  | OptionsOutstanding |   |  | Weighted AverageExercise Price PerShare |       | Weighted AverageRemainingContractual Life(Years) |      | AggregateIntrinsic Value(in thousands)
|Outstanding at December 28, 2003 |  | 2,898,034          |   |  | $                                       | 12.75 |                                                  | 5.84 |                                        | $ | 12,613
|Granted                          |  | 576,754            |   |  |                                         | 22.68 |                                                  |      |                                        |   |       
|Canceled                         |  | (156,593           | ) |  |                                         | 17.16 |                                                  |      |                                        |   |       
|Exercised                        |  | (669,122           | ) |  |                                         | 8.72  |                                                  |      |                                        |   |       
|                                 |  |                    |   |  |                                         |       |                                                  |      |                                        |   |       
|Outstanding at January 2, 2005   |  | 2,649,073          |   |  |                                         | 15.69 |                                                  | 5.96 |                                        |   | 28,503
|Granted                          |  | 600,440            |   |  |                                         | 26.77 |                                                  |      |                                        |   |       
|Canceled                         |  | (161,812           | ) |  |                                         | 19.74 |                                                  |      |                                        |   |       
|Exercised                        |  | (536,395           | ) |  |                                         | 12.65 |                                                  |      |                                        |   |       
|                                 |  |                    |   |  |                                         |       |                                                  |      |                                        |   |       
|Outstanding at January 1, 2006   |  | 2,551,306          |   |  |                                         | 18.68 |                                                  | 6.71 |                                        |   | 29,790
|Granted                          |  | 461,089            |   |  |                                         | 29.54 |                                                  |      |                                        |   |       
|Canceled                         |  | (119,464           | ) |  |                                         | 25.13 |                                                  |      |                                        |   |       
|Exercised                        |  | (160,250           | ) |  |                                         | 17.79 |                                                  |      |                                        |   |       
|                                 |  |                    |   |  |                                         |       |                                                  |      |                                        |   |       
|Outstanding at December 31, 2006 |  | 2,732,711          |   |  | $                                       | 20.33 |                                                  | 6.55 |                                        | $ | 18,147
|                                 |  |                    |   |  |                                         |       |                                                  |      |                                        |   |       
|Exercisable at December 31, 2006 |  | 1,981,944          |   |  | $                                       | 17.60 |                                                  | 5.74 |                                        | $ | 17,429
|                                 |  |                    |   |  |                                         |       |                                                  |      |                                        |   |       

The following table summarizes stock option information at year end 2006:



|                         |  |                     |  |                                                   |  |                                |       |                  |           |                                |   |      
|------------------------ |  | ------------------- |  | ------------------------------------------------- |  | ------------------------------ | ----- | ---------------- | --------- | ------------------------------ | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                              
|Range of Exercise Prices |  | Number ofOptions    |  | Weighted-AverageRemainingContractual Life (Years) |  | Weighted-AverageExercise Price |       | Number ofOptions |           | Weighted-AverageExercise Price
|$6.00 to $13.47          |  | 354,001             |  | 4.84                                              |  | $                              | 10.68 |                  | 351,219   |                                | $ | 10.66
|$15.49 to $15.49         |  | 653,839             |  | 5.40                                              |  |                                | 15.49 |                  | 653,839   |                                |   | 15.49
|$16.00 to $22.84         |  | 774,668             |  | 5.77                                              |  |                                | 19.45 |                  | 693,184   |                                |   | 19.32
|$23.26 to $28.91         |  | 615,897             |  | 8.39                                              |  |                                | 26.50 |                  | 228,169   |                                |   | 25.90
|$29.20 to $35.87         |  | 334,306             |  | 9.05                                              |  |                                | 30.67 |                  | 55,533    |                                |   | 30.68
|                         |  |                     |  |                                                   |  |                                |       |                  |           |                                |   |      
|$6.00 to $35.87          |  | 2,732,711           |  | 6.55                                              |  | $                              | 20.33 |                  | 1,981,944 |                                | $ | 17.60
|                         |  |                     |  |                                                   |  |                                |       |                  |           |                                |   |      

During 2001, the Company adopted the 2000 Employee Stock Purchase Plan (ESPP), where
eligible employees can choose to have up to 15% of their annual earnings withheld to purchase the Companys common stock. The purchase price of stock is 85% of the lower of the beginning of the offering period or end of the offering period
market price. The Company authorized 200,000 shares of common stock available for issuance under the plan, which will be increased as of each annual meeting of the Companys shareholders, beginning 2002 until 2020, by the least of 200,000
shares or 1.5% of the number of shares of common stock outstanding on that date. However, the Board of Directors has the authority to designate a smaller number of shares by which the authorized number of shares of common stock will be increased on
that date. During 2006, 2005, and 2004, employees purchased 43,474, 39,957 and 83,585 shares, respectively, of the Companys common stock under the plan at a weighted-average per share price of $26.99, 24.07 and $13.14, respectively. At
December 31, 2006 797,268 shares remain available for future issuance.



F-24



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Effective December 1, 2003, the Company adopted a Nonqualified Deferred Compensation Plan (the
Plan) for certain executive employees. The purpose of the Plan is to offer those employees an opportunity to elect to defer the receipt of compensation in order to provide termination of employment and related benefits taxable pursuant
to section 451 of the Internal Revenue Code of 1986, as amended (the Code). The Plan is intended to be a top-hat plan (i.e., an unfunded deferred compensation plan maintained for a select group of management or
highly-compensated employees) under sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974 (ERISA). The long-term liability related to compensation deferrals under the Plan was $222,000 and
$163,000 as of December 31, 2006 and January 1, 2006 respectively, which is included in deferred lease credits and other long-term liabilities. The related asset is classified in cash and cash equivalents on the consolidated balance
sheets.

10.    Commitments and Contingencies

LeasesThe Company leases its Emeryville, California coffee roasting plant, distribution center, administrative offices, and warehouse, and its retail stores and certain equipment under operating
leases that expire from 2007 through 2017. Certain leases contain renewal options for an additional five to fifteen years, and also provide for contingent rents to be paid equal to a stipulated percentage of sales. The lease agreements also provide
for periodic adjustments to the minimum lease payments based on changes in cost of living indices or other scheduled increases.

Future
minimum lease payments required under non-cancelable operating leases subsequent to December 31, 2006 are as follows (amounts in thousands):



|                             |  |            |       
|---------------------------- |  | ---------- | ------
|                             |  | Leases (1)
|Years:                       |  |            |       
|2007                         |  | $          | 11,339
|2008                         |  |            | 10,187
|2009                         |  |            | 9,425 
|2010                         |  |            | 8,399 
|2011                         |  |            | 7,765 
|Thereafter                   |  |            | 28,193
|                             |  |            |       
|Total minimum lease payments |  | $          | 75,308
|                             |  |            |       

---

|(1) | Payments for maintenance, insurance, taxes and contingent rent for which we are obligated are excluded. In fiscal 2006 these charges totaled approximately $1.9 million.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Rent expense was $9,951,000, $8,314,000 and $7,740,000 for 2006, 2005, and 2004, respectively, including contingent rents of
$130,000, $194,000, and $206,000, respectively.

As of December 31, 2006, the Company is a guarantor on a lease assigned to a third
party that has $191,000 of remaining lease payments. The Company has a security deposit of $6,000 and a guarantee from the sublessees parent for a maximum amount of $313,000. The Company expects that the assignee will make all future rent
payments required under the lease.

Purchase CommitmentsAs of December 31, 2006, the Company had approximately
$32,800,000 of outstanding coffee purchase commitments from 2007 to 2010 with fixed prices.



F-25



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Legal ProceedingsIn November 2006, a complaint styled as a shareholder derivative
action was filed, purportedly on behalf of Peets, against certain of our present and former directors and officers. The complaint alleges that the defendants caused or allowed improprieties in connection with certain stock option grants since
at least 2001 and thereby breached their fiduciary duties to Peets and violated specified provisions of the California Corporations Code. The complaint also alleges that certain of our present and former directors and officers were unjustly
enriched as a result. Purportedly on behalf of Peets, the complaint seeks, among other things, damages, restitution and corporate governance reforms. This complaint and a similar one have been filed in the Superior Court for Alameda County,
California and a third was filed in February 2007 in the United States District Court for the Northern District of California.

These
actions could result in substantial costs and divert managements attention and resources. These actions are at a preliminary stage, and we are not in a position to determine whether a loss is probable or estimate a range of amount of loss.

During 2004, the Company completed the payout to a settlement approved by the Superior Court of the State of California, County of Orange,
related to, two lawsuits filed against the Company entitled Brian Taraz, et al vs. Peets Coffee & Tea, Inc., and Tracy Coffee, et al. vs. Peets Coffee & Tea, Inc. on February 25, 2003 and March 7, 2003. These
lawsuits alleged misclassification of employment position and sought damages, restitution, reclassification and attorneys fees and costs. During 2003, the Company recorded a charge of $2.7 million for the estimated payment of claims to
eligible class members, attorneys fees and costs, costs to a third-party claims administrator, as well as applicable employer payroll taxes. During 2004, based on the final settlement, fees, and costs incurred, the Company recorded a benefit
of $565,000 to general and administrative expenses on the accompanying consolidated statements of income.

The Company may from time to
time become involved in certain legal proceedings in the ordinary course of business. Currently, the Company is not a party to any other legal proceedings that management believes would have a material adverse effect on the financial position or
results of operations of the Company.



F-26



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



11.    Segment Information

The Company operates in two reportable segments: retail and specialty sales. Retail store operations consist of sales of whole bean coffee, beverages, tea
and related products through Company-operated retail stores. Specialty sales consist of whole bean coffee sales through grocery, home delivery, food service and office coffee accounts. Management evaluates segment performance primarily based on
revenue and segment operating income. The following table presents certain financial information for each segment. Segment income before taxes excludes unallocated marketing expenses and general and administrative expenses. Unallocated assets
include cash, coffee inventory in the warehouse, corporate headquarter assets and intangible and other assets.



|                                |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   |         |  |       |  
|------------------------------- |  | ------ | ------- | --- | --------------------- | ----- | - | ----------- | - | --------------------- | ----- | ----- | - |  | - | ------- | --- | --------------------- | - | ------- |  | ----- | -
|                                |  | Retail |         |     | Specialty             |       |   | Unallocated |   |                       | Total |      
|                                |  | Amount |         |     | Percent ofNet Revenue |       |   | Amount      |   | Percent ofNet Revenue |       |       |   |  |   | Amount  |     | Percent ofNet Revenue |  
|2006                            |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   |         |  |       |  
|Net revenue                     |  | $      | 141,377 |     |                       | 100.0 | % |             | $ | 69,116                |       | 100.0 | % |  |   |         |     |                       | $ | 210,493 |  | 100.0 | %
|Cost of sales and occupancy     |  |        | 65,341  |     |                       | 46.2  | % |             |   | 33,587                |       | 48.6  | % |  |   |         |     |                       |   | 98,928  |  | 47.0  | %
|Operating expenses              |  |        | 60,201  |     |                       | 42.6  | % |             |   | 12,071                |       | 17.5  | % |  |   |         |     |                       |   | 72,272  |  | 34.3  | %
|Depreciation and amortization   |  |        | 6,269   |     |                       | 4.4   | % |             |   | 1,406                 |       | 2.0   | % |  | $ | 934     |     |                       |   | 8,609   |  | 4.1   | %
|Segment operating income (loss) |  |        | 9,566   |     |                       | 6.8   | % |             |   | 22,052                |       | 31.9  | % |  |   | (21,568 | )   |                       |   | 10,050  |  | 4.8   | %
|Investment income, net          |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   | 2,456   |     |                       |   | 2,456   |  |       |  
|Income before income taxes      |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   | 12,506  |  |       |  
|Total assets                    |  |        | 47,640  | (b) |                       |       |   |             |   | 12,673                |       |       |   |  |   | 92,692  | (a) |                       |   | 153,005 |  |       |  
|Capital expenditures            |  |        | 17,901  |     |                       |       |   |             |   | 1,045                 |       |       |   |  |   | 25,497  |     |                       |   | 44,443  |  |       |  
|2005 (As restated, see Note 2)  |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   |         |  |       |  
|Net revenue                     |  | $      | 118,030 |     |                       | 100.0 | % |             | $ | 57,168                |       | 100.0 | % |  |   |         |     |                       | $ | 175,198 |  | 100.0 | %
|Cost of sales and occupancy     |  |        | 53,089  |     |                       | 45.0  | % |             |   | 27,747                |       | 48.5  | % |  |   |         |     |                       |   | 80,837  |  | 46.1  | %
|Operating expenses              |  |        | 47,986  |     |                       | 40.7  | % |             |   | 9,893                 |       | 17.3  | % |  |   |         |     |                       |   | 57,879  |  | 33.0  | %
|Depreciation and amortization   |  |        | 5,149   |     |                       | 4.4   | % |             |   | 1,481                 |       | 2.6   | % |  | $ | 663     |     |                       |   | 7,293   |  | 4.1   | %
|Segment operating income (loss) |  |        | 11,806  |     |                       | 10.0  | % |             |   | 18,047                |       | 31.6  | % |  |   | (14,004 | )   |                       |   | 15,848  |  | 9.0   | %
|Investment income, net          |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   | 1,769   |     |                       |   | 1,769   |  |       |  
|Income before income taxes      |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   | 17,617  |  |       |  
|Total assets                    |  |        | 34,436  | (b) |                       |       |   |             |   | 11,517                |       |       |   |  |   | 102,799 | (a) |                       |   | 148,752 |  |       |  
|Capital expenditures            |  |        | 11,525  |     |                       |       |   |             |   | 1,223                 |       |       |   |  |   | 1,272   |     |                       |   | 14,020  |  |       |  
|2004 (As restated, see Note 2)  |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   |         |  |       |  
|Net revenue                     |  | $      | 100,444 |     |                       | 100.0 | % |             | $ | 45,239                |       | 100.0 | % |  |   |         |     |                       | $ | 145,683 |  | 100.0 | %
|Cost of sales and occupancy     |  |        | 45,459  |     |                       | 45.3  | % |             |   | 22,347                |       | 49.4  | % |  |   |         |     |                       |   | 67,806  |  | 46.5  | %
|Operating expenses              |  |        | 38,903  |     |                       | 38.7  | % |             |   | 8,742                 |       | 19.3  | % |  |   |         |     |                       |   | 47,645  |  | 32.7  | %
|Depreciation and amortization   |  |        | 4,094   |     |                       | 4.1   | % |             |   | 1,095                 |       | 2.4   | % |  | $ | 598     |     |                       |   | 5,787   |  | 4.0   | %
|Segment operating income (loss) |  |        | 11,988  |     |                       | 11.9  | % |             |   | 13,055                |       | 28.9  | % |  |   | (12,037 | )   |                       |   | 13,006  |  | 8.9   | %
|Investment income, net          |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   | 922     |     |                       |   | 922     |  |       |  
|Income before income taxes      |  |        |         |     |                       |       |   |             |   |                       |       |       |   |  |   |         |     |                       |   | 13,928  |  |       |  
|Total assets                    |  |        | 28,637  | (b) |                       |       |   |             |   | 10,405                |       |       |   |  |   | 89,902  | (a) |                       |   | 128,944 |  |       |  
|Capital expenditures            |  |        | 10,122  |     |                       |       |   |             |   | 2,728                 |       |       |   |  |   | 2,154   |     |                       |   | 15,004  |  |       |  

---

|(a) | Unallocated total assets includes cash and marketable securities of $31,401,000, $68,704,000, and $61,275,000 at the end of the years 2006, 2005, and 2004, respectively.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | Retail total assets includes cash of $1,791,000, $1,262,000, and $2,138,000 at the end of the years 2006, 2005, and 2004, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------



F-27



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Net revenue from external customers for the two major product lines is as follows:



|                                             |  |      |         |      |   |         |  |   |        
|-------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                             |  | 2006 |         | 2005 |   | 2004   
|Whole bean coffee, tea, and related products |  | $    | 117,549 |      | $ | 101,029 |  | $ | 86,270 
|Beverages and pastries                       |  |      | 92,944  |      |   | 74,169  |  |   | 59,413 
|                                             |  |      |         |      |   |         |  |   |        
|Total                                        |  | $    | 210,493 |      | $ | 175,198 |  | $ | 145,683
|                                             |  |      |         |      |   |         |  |   |        

12.    Quarterly Financial Information (Unaudited)

The following quarterly data are derived from the consolidated statements of income and have been restated to reflect the adjustments disclosed in Note 2
to the consolidated financial statements (in thousands, except per share amounts):

Year Ended December 31, 2006



|                                             |  |                                     |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|-------------------------------------------- |  | ----------------------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | ------
|                                             |  | For the Quarter Ended April 2, 2006
|                                             |  | As Previously Reported              |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                                     | Inventory |             |   | Stock Options |                   |  |  
|Net revenue                                  |  | $                                   | 49,707    |             |   |               |                   |  |   |             |   |  |   |      |   |  | $ | 49,707
|Expenses:                                    |  |                                     |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|Cost of sales and related occupancy expenses |  |                                     | 22,493    |             | $ | 106           |                   |  |   |             |   |  | $ | 216  |   |  |   | 22,815
|Operating expenses                           |  |                                     | 17,413    |             |   |               |                   |  |   |             |   |  |   | (307 | ) |  |   | 17,106
|General and administrative expenses          |  |                                     | 4,727     |             |   |               |                   |  | $ | 18          |   |  |   | 92   |   |  |   | 4,837 
|Depreciation and amortization expenses       |  |                                     | 1,983     |             |   |               |                   |  |   |             |   |  |   | (1   | ) |  |   | 1,982 
|Total costs and expenses from operations     |  |                                     | 46,616    |             |   | 106           |                   |  |   | 18          |   |  |   |      |   |  |   | 46,740
|Income from operations                       |  |                                     | 3,091     |             |   | (106          | )                 |  |   | (18         | ) |  |   |      |   |  |   | 2,967 
|Income before income taxes                   |  |                                     | 3,768     |             |   | (106          | )                 |  |   | (18         | ) |  |   |      |   |  |   | 3,644 
|Income tax provision                         |  |                                     | 1,442     |             |   | (43           | )                 |  |   | (7          | ) |  |   |      |   |  |   | 1,392 
|Net income                                   |  |                                     | 2,326     |             |   | (63           | )                 |  |   | (11         | ) |  |   |      |   |  |   | 2,252 
|Net income per sharebasic                   |  | $                                   | 0.17      |             | $ | (0.01         | )                 |  | $ |            |   |  | $ |     |   |  | $ | 0.16  
|Net income per sharediluted                 |  | $                                   | 0.16      |             | $ | (0.01         | )                 |  | $ |            |   |  | $ |     |   |  | $ | 0.15  
|Shares used in per share calculationbasic   |  |                                     | 13,892    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 13,892
|Shares used in per share calculationdiluted |  |                                     | 14,609    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 14,609



F-28



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|                                             |  |                                    |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|-------------------------------------------- |  | ---------------------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | ------
|                                             |  | For the Quarter Ended July 2, 2006
|                                             |  | As Previously Reported             |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                                    | Inventory |             |   | Stock Options |                   |  |  
|Net revenue                                  |  | $                                  | 49,689    |             |   |               |                   |  |   |             |   |  |   |      |   |  | $ | 49,689
|Expenses:                                    |  |                                    |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|Cost of sales and related occupancy expenses |  |                                    | 23,083    |             | $ | (261          | )                 |  |   |             |   |  | $ | 271  |   |  |   | 23,093
|Operating expenses                           |  |                                    | 17,913    |             |   |               |                   |  | $ | 3           |   |  |   | (335 | ) |  |   | 17,581
|General and administrative expenses          |  |                                    | 4,496     |             |   |               |                   |  |   | 14          |   |  |   | 65   |   |  |   | 4,575 
|Depreciation and amortization expenses       |  |                                    | 2,096     |             |   |               |                   |  |   |             |   |  |   | (1   | ) |  |   | 2,095 
|Total costs and expenses from operations     |  |                                    | 47,588    |             |   | (261          | )                 |  |   | 17          |   |  |   |      |   |  |   | 47,344
|Income from operations                       |  |                                    | 2,101     |             |   | 261           |                   |  |   | (17         | ) |  |   |      |   |  |   | 2,345 
|Income before income taxes                   |  |                                    | 2,803     |             |   | 261           |                   |  |   | (17         | ) |  |   |      |   |  |   | 3,047 
|Income tax provision                         |  |                                    | 1,040     |             |   | 107           |                   |  |   | (7          | ) |  |   |      |   |  |   | 1,140 
|Net income                                   |  |                                    | 1,763     |             |   | 154           |                   |  |   | (10         | ) |  |   |      |   |  |   | 1,907 
|Net income per sharebasic                   |  | $                                  | 0.13      |             | $ | 0.01          |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.14  
|Net income per sharediluted                 |  | $                                  | 0.12      |             | $ | 0.01          |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.13  
|Shares used in per share calculationbasic   |  |                                    | 13,840    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 13,840
|Shares used in per share calculationdiluted |  |                                    | 14,549    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 14,549



|                                             |  |                        |        |                      |   |       
|-------------------------------------------- |  | ---------------------- | ------ | -------------------- | - | ------
|                                             |  | For the Quarters Ended
|                                             |  | October 1,2006         |        | December 31,2006 (a)
|Net revenue                                  |  | $                      | 50,873 |                      | $ | 60,224
|Cost of sales and related occupancy expenses |  |                        | 24,081 |                      |   | 28,939
|Income from operations                       |  |                        | 1,841  |                      |   | 2,897 
|Net income                                   |  |                        | 1,479  |                      |   | 2,178 
|Basic income per share                       |  | $                      | 0.11   |                      | $ | 0.16  
|Diluted income per share                     |  | $                      | 0.10   |                      | $ | 0.16  

---

|(a) | The 2006 fourth quarter includes $1.8 million ($1.0 million or $.08 per share after tax) for professional fees related to the stock option granting practices review.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-29



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##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Year Ended January 1, 2006



|                                             |  |                                     |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|-------------------------------------------- |  | ----------------------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | ------
|                                             |  | For the Quarter Ended April 3, 2005
|                                             |  | As Previously Reported              |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                                     | Inventory |             |   | Stock Options |                   |  |  
|Net revenue                                  |  | $                                   | 39,988    |             |   |               |                   |  |   |             |   |  |   |      |   |  | $ | 39,988
|Expenses:                                    |  |                                     |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|Cost of sales and related occupancy expenses |  |                                     | 18,071    |             | $ | 28            |                   |  | $ | 2           |   |  | $ | 135  |   |  |   | 18,236
|Operating expenses                           |  |                                     | 13,501    |             |   |               |                   |  |   | 9           |   |  |   | (215 | ) |  |   | 13,295
|General and administrative expenses          |  |                                     | 3,025     |             |   |               |                   |  |   | 3           |   |  |   | 81   |   |  |   | 3,109 
|Depreciation and amortization expenses       |  |                                     | 1,680     |             |   |               |                   |  |   |             |   |  |   | (1   | ) |  |   | 1,679 
|Total costs and expenses from operations     |  |                                     | 36,277    |             |   | 28            |                   |  |   | 14          |   |  |   |      |   |  |   | 36,319
|Income from operations                       |  |                                     | 3,711     |             |   | (28           | )                 |  |   | (14         | ) |  |   |      |   |  |   | 3,669 
|Income before income taxes                   |  |                                     | 4,039     |             |   | (28           | )                 |  |   | (14         | ) |  |   |      |   |  |   | 3,997 
|Income tax provision                         |  |                                     | 1,611     |             |   | (12           | )                 |  |   | (6          | ) |  |   |      |   |  |   | 1,593 
|Net income                                   |  |                                     | 2,428     |             |   | (16           | )                 |  |   | (8          | ) |  |   |      |   |  |   | 2,404 
|Net income per sharebasic                   |  | $                                   | 0.18      |             | $ |              |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.18  
|Net income per sharediluted                 |  | $                                   | 0.17      |             | $ |              |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.17  
|Shares used in per share calculationbasic   |  |                                     | 13,564    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 13,564
|Shares used in per share calculationdiluted |  |                                     | 14,169    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 14,169



|                                             |  |                                     |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|-------------------------------------------- |  | ----------------------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | ------
|                                             |  | For the Quarter Ended July 13, 2005
|                                             |  | As Previously Reported              |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                                     | Inventory |             |   | Stock Options |                   |  |  
|Net revenue                                  |  | $                                   | 41,723    |             |   |               |                   |  |   |             |   |  |   |      |   |  | $ | 41,723
|Expenses:                                    |  |                                     |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|Cost of sales and related occupancy expenses |  |                                     | 18,826    |             | $ | (120          | )                 |  |   |             |   |  | $ | 136  |   |  |   | 18,842
|Operating expenses                           |  |                                     | 14,362    |             |   |               |                   |  | $ | 4           |   |  |   | (273 | ) |  |   | 14,093
|General and administrative expenses          |  |                                     | 2,857     |             |   |               |                   |  |   |             |   |  |   | 138  |   |  |   | 2,995 
|Depreciation and amortization expenses       |  |                                     | 1,821     |             |   |               |                   |  |   |             |   |  |   | (1   | ) |  |   | 1,820 
|Total costs and expenses from operations     |  |                                     | 37,866    |             |   | (120          | )                 |  |   | 4           |   |  |   |      |   |  |   | 37,750
|Income from operations                       |  |                                     | 3,857     |             |   | 120           |                   |  |   | (4          | ) |  |   |      |   |  |   | 3,973 
|Income before income taxes                   |  |                                     | 4,284     |             |   | 120           |                   |  |   | (4          | ) |  |   |      |   |  |   | 4,400 
|Income tax provision                         |  |                                     | 1,681     |             |   | 49            |                   |  |   | (2          | ) |  |   |      |   |  |   | 1,728 
|Net income                                   |  |                                     | 2,603     |             |   | 71            |                   |  |   | (2          | ) |  |   |      |   |  |   | 2,672 
|Net income per sharebasic                   |  | $                                   | 0.19      |             | $ |              |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.19  
|Net income per sharediluted                 |  | $                                   | 0.18      |             | $ |              |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.19  
|Shares used in per share calculationbasic   |  |                                     | 13,748    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 13,748
|Shares used in per share calculationdiluted |  |                                     | 14,424    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 14,424



F-30



---

##### Table of Contents

PEETS COFFEE & TEA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|                                             |  |                                       |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|-------------------------------------------- |  | ------------------------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | ------
|                                             |  | For the Quarter Ended October 2, 2005
|                                             |  | As Previously Reported                |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                                       | Inventory |             |   | Stock Options |                   |  |  
|Net revenue                                  |  | $                                     | 42,854    |             |   |               |                   |  |   |             |   |  |   |      |   |  | $ | 42,854
|Expenses:                                    |  |                                       |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|Cost of sales and related occupancy expenses |  |                                       | 19,671    |             | $ | (152          | )                 |  |   |             |   |  | $ | 151  |   |  |   | 19,670
|Operating expenses                           |  |                                       | 14,868    |             |   |               |                   |  | $ | 3           |   |  |   | (305 | ) |  |   | 14,566
|General and administrative expenses          |  |                                       | 3,225     |             |   |               |                   |  |   |             |   |  |   | 155  |   |  |   | 3,380 
|Depreciation and amortization expenses       |  |                                       | 1,864     |             |   |               |                   |  |   |             |   |  |   | (1   | ) |  |   | 1,863 
|Total costs and expenses from operations     |  |                                       | 39,628    |             |   | (152          | )                 |  |   | 3           |   |  |   |      |   |  |   | 39,479
|Income from operations                       |  |                                       | 3,226     |             |   | 152           |                   |  |   | (3          | ) |  |   |      |   |  |   | 3,375 
|Income before income taxes                   |  |                                       | 3,647     |             |   | 152           |                   |  |   | (3          | ) |  |   |      |   |  |   | 3,796 
|Income tax provision                         |  |                                       | 1,431     |             |   | 62            |                   |  |   | (1          | ) |  |   |      |   |  |   | 1,492 
|Net income                                   |  |                                       | 2,216     |             |   | 90            |                   |  |   | (2          | ) |  |   |      |   |  |   | 2,304 
|Net income per sharebasic                   |  | $                                     | 0.16      |             | $ | 0.01          |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.17  
|Net income per sharediluted                 |  | $                                     | 0.15      |             | $ | 0.01          |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.16  
|Shares used in per share calculationbasic   |  |                                       | 13,949    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 13,949
|Shares used in per share calculationdiluted |  |                                       | 14,658    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 14,658



|                                             |  |                                       |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|-------------------------------------------- |  | ------------------------------------- | --------- | ----------- | - | ------------- | ----------------- |  | - | ----------- | - |  | - | ---- | - |  | - | ------
|                                             |  | For the Quarter Ended January 1, 2006
|                                             |  | As Previously Reported                |           | Adjustments |   |               | Reclassifications |  |   | As Restated
|                                             |  |                                       | Inventory |             |   | Stock Options |                   |  |  
|Net revenue                                  |  | $                                     | 50,633    |             |   |               |                   |  |   |             |   |  |   |      |   |  | $ | 50,633
|Expenses:                                    |  |                                       |           |             |   |               |                   |  |   |             |   |  |   |      |   |  |   |       
|Cost of sales and related occupancy expenses |  |                                       | 23,806    |             | $ | 70            |                   |  |   |             |   |  | $ | 213  |   |  |   | 24,089
|Operating expenses                           |  |                                       | 16,329    |             |   |               |                   |  | $ | 4           |   |  |   | (408 | ) |  |   | 15,925
|General and administrative expenses          |  |                                       | 3,658     |             |   |               |                   |  |   | 1           |   |  |   | 198  |   |  |   | 3,857 
|Depreciation and amortization expenses       |  |                                       | 1,934     |             |   |               |                   |  |   |             |   |  |   | (3   | ) |  |   | 1,931 
|Total costs and expenses from operations     |  |                                       | 45,727    |             |   | 70            |                   |  |   | 5           |   |  |   |      |   |  |   | 45,802
|Income from operations                       |  |                                       | 4,906     |             |   | (70           | )                 |  |   | (5          | ) |  |   |      |   |  |   | 4,831 
|Income before income taxes                   |  |                                       | 5,499     |             |   | (70           | )                 |  |   | (5          | ) |  |   |      |   |  |   | 5,424 
|Income tax provision                         |  |                                       | 2,059     |             |   | (28           | )                 |  |   | (2          | ) |  |   |      |   |  |   | 2,029 
|Net income                                   |  |                                       | 3,440     |             |   | (42           | )                 |  |   | (3          | ) |  |   |      |   |  |   | 3,395 
|Net income per sharebasic                   |  | $                                     | 0.25      |             | $ |              |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.24  
|Net income per sharediluted                 |  | $                                     | 0.24      |             | $ |              |                   |  | $ |            |   |  | $ |     |   |  | $ | 0.23  
|Shares used in per share calculationbasic   |  |                                       | 13,944    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 13,944
|Shares used in per share calculationdiluted |  |                                       | 14,601    |             |   |               |                   |  |   |             |   |  |   |      |   |  |   | 14,601



F-31