UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

[ X ]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
        ACT OF 1934
                  For the fiscal year ended:  December 31, 1996

                                       or

[   ]   TRANSITION  REPORT  PURSUANT TO SECTION  13 OR  15(D) OF THE  SECURITIES
        EXCHANGE ACT OF 1934
            For the transition period from ___________ to ___________

                        Commission file Number:   0-21397

                               COFFEE PEOPLE, INC.
                 ----------------------------------------------
                 (Name of small business issuer in its charter)

            Oregon                                             93-1073218
-------------------------------------------------------------------------------
    (State of incorporation)                                (I.R.S. Employer
                                                            Identification No.)
                         15100 SW Koll Parkway, Suite J
                             Beaverton, Oregon 97006
                    ----------------------------------------
                    (Address of principal executive offices)

                    Issuer's telephone number: (503) 672-9603

       Securities registered under Section 12(b) of the Exchange Act: None

         Securities registered under Section 12(g) of the Exchange Act:

                         Common Stock, without par value
                                (Title of class)

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

     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of Regulation S-B contained in this Form 10-KSB,  and no disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.  /X/

     State issuer's revenues for its most recent fiscal year: $12,281,000

     State the aggregate  market value of the voting stock held by nonaffiliates
computed by reference  to the price at which the stock was sold,  or the average
bid and asked prices of such stock,  as of a specified date within 60 days prior
to the date of filing:  $16,917,290 aggregate market value as of March 14, 1997,
based on the price at which the stock was sold.

     Indicate the number of shares  outstanding of each of the issuer's  classes
of common equity, as of the latest practicable date:  3,241,591 shares of Common
Stock, without par value, on March 14, 1997.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Part III of this Form 10-KSB  incorporates  information  from the  issuer's
definitive  proxy statement for the annual meeting of shareholders to be held on
April 24, 1997.

     Transitional Small Business Disclosure Format (Check One): Yes / /; No /X/


<PAGE>

                                         PART I

ITEM 1:  BUSINESS

GENERAL

     Coffee  People,  Inc.  ("Coffee  People"  or the  "Company")  sells  coffee
beverages, coffee beans, cookies, pastries, ice cream, shakes and coffee related
merchandise.  The  Company's  objective  is to be a leading  national  specialty
coffee  retailer  and coffee  house  operator  through a program  of  geographic
expansion and consistent profitability.

     The Company distributes  products through its Company-owned  retail stores,
including neighborhood coffee houses,  drive-through espresso bars and specialty
kiosks.  Coffee People plans to open  approximately 27 retail stores during 1997
in selected  midwestern and western states,  and to continue  further  expansion
thereafter.  As of March  15,  1997,  the  Company  operated  26 stores in three
states: Oregon (23, with 22 in the Portland Metropolitan area), Denver, Colorado
(2) and Southern  California  (1). As of that date, the Company also had entered
into  leases for the opening of 7  additional  stores in Chicago  (2),  southern
California (2) and Oregon (3).

     The  specialty  coffee  retail  business  in the  United  States is growing
rapidly  and  is  disproportionately  concentrated  in  the  Pacific  Northwest,
particularly  Washington and Oregon. Industry sources estimate that total retail
sales of specialty  coffee through all  distribution  channels will grow to $5.0
billion by 1999 from an estimated  $1.5  billion in 1989 and that coffee  cafes,
including  espresso carts and kiosks,  will be the fastest growing  distribution
channel.  It is estimated  that the number of coffee  cafes,  espresso  bars and
espresso carts will increase from  approximately  3,000 in 1995 to approximately
10,000 by 1999.

     The Company  believes it can be a leading  specialty coffee retailer in its
selected markets by differentiating itself from other coffee houses. The Company
believes it can achieve this differentiation by being more customer focused than
the  competition,  by  providing  superior  coffee  and  service  and  by  being
constantly innovative.  The Company believes its stores offer an atmosphere that
welcomes  customers in a friendly and inviting  setting  designed to encourage a
feeling of customer "ownership" and provide a community focus that fosters brand
recognition and consumer  loyalty.  Central to the Coffee People approach is its
experienced  management  team, its focus on operational  excellence,  its strong
unit economics and its site selection processes.

<PAGE>

     The Company was incorporated as an Oregon  corporation on November 7, 1991.
Prior to that time,  Coffee  People was  operated  as a  partnership.  The first
Coffee People store opened in Portland, Oregon on December 1, 1983.

THE COFFEE PEOPLE STRATEGY

     The  Company's  objective  is to be a  leading  national  specialty  coffee
retailer and coffee house operator through a program of geographic expansion and
consistent profitability. The key elements of the Company's strategy include:

     CULTIVATE  CUSTOMERS'  SENSE OF OWNERSHIP.  Coffee People strives to foster
long-term loyalty and a sense of ownership in its customers by being continually
receptive to evolving  customer  desires.  The Company is dedicated to providing
its customers with the highest quality of service emphasizing speed, consistency
and courtesy in stores designed to welcome customers in a friendly, relaxing and
inviting atmosphere.

     OFFER  INNOVATIVE   PRODUCTS  AND  EXTENSIVE  MENU.  Coffee  People  offers
innovative  products  and an extensive  menu that appeals to a diverse  blend of
people.  The Company has developed  proprietary brands that foster a high degree
of market  differentiation  and customer loyalty.  For example,  the Company has
expanded  the Black Tiger  brand from an espresso  beverage to include ice cream
and shakes, a breakfast cereal and a sparkling coffee drink,  making Black Tiger
one of the Company's top-selling brands.

     ACHIEVE OPERATIONAL EXCELLENCE.  Coffee People's senior management team has
extensive experience in the specialty coffee industry,  from selecting the beans
to serving  the cup.  The  Company  believes  that its  training  and  incentive
programs  create  knowledgeable  and loyal  employees.  Coffee People strives to
achieve  exceptional  financial  results  from  each of its  stores  by  closely
managing sales, costs and customer satisfaction.

     FOCUS ON SUPERIOR  SITE  SELECTION  AND RAPID  NATIONAL  EXPANSION.  Coffee
People uses extensive  marketing and demographic  research to select store sites
it believes show a high likelihood of financial success.  The Company intends to
open  multiple  stores in new  markets  where it can  strive to become a leading
specialty retailer.

COFFEE PEOPLE PRODUCTS AND SUPPLIERS

     PRODUCTS.  The Company  offers a broad  product  line  including  specialty
coffees,  coffee  beans,  pastries and cookies,  ice cream and shakes and coffee
related  merchandise.  Caffeinated and decaffeinated  coffee and  espresso-based
drinks  are  offered  at all of  the  Company's  stores,  as are  pastries.  The
Company's   neighborhood   stores  also  sell  whole  coffee  beans,   teas  and
accessories,  mugs and other  merchandise.  Sales of coffee  beverages  comprise
approximately  two-thirds of the Company's  revenues,  with bakery and ice cream
products accounting for approximately one-fifth of the Company's revenues.

<PAGE>

SUPPLIERS

     COFFEE.  Coffee People's supplier purchases coffee from a variety of coffee
producing  countries.  The  Company  believes  that its  contacts  in the coffee
producing  countries will ensure a continued  supply of the  high-quality  beans
used in its products. The Company does not roast any of its coffee beans because
of the ready  availability  of high-quality  roasters in the United States.  The
Company  buys its  coffee  from  Coffee  Bean  International,  Inc.  ("CBI"),  a
Portland,  Oregon based roaster that uses Coffee People's  proprietary  roasting
specifications.  The Company  believes CBI has adequate  capacity to fulfill the
Company's needs for the foreseeable future.

     BAKERY GOODS AND ICE CREAM.  The Company obtains bakery goods and ice cream
from local vendors with reputations for superior quality. Cookies are made based
on recipes developed by Coffee People. By offering  alternative  selections such
as ice cream and non-coffee beverages for people who do not drink coffee, Coffee
People believes it creates an inclusive,  welcoming setting for all to enjoy its
products.

DISTRIBUTION STRATEGY AND STORE TYPES

     The Company's principal  distribution  channel is retail stores,  including
neighborhood  coffee houses,  drive-through  espresso  bars,  airport stores and
specialty  kiosks.  The objective of each of the Company's  stores is to provide
the "Coffee People Experience" to customers in a relaxed,  friendly and inviting
setting.  Coffee  People may seek to develop other  distribution  points such as
mail order catalogs,  airlines and  co-developed  stores that feature coffee and
other  complementary  products.  Coffee People also intends to enter into one or
more licensing  agreements with ice cream  manufacturers for the distribution of
ice cream under the  Company's  brand names in  supermarkets  and other  grocery
outlets.

     The Company has four store types:

     NEIGHBORHOOD  COFFEE HOUSE.  Neighborhood coffee houses are located in both
urban and suburban  neighborhoods and business  districts which offer a complete
line of Coffee People  products and roasted coffee beans.  As of March 15, 1997,
the Company had twelve neighborhood coffee houses: eight in the Portland, Oregon
area; one in Eugene,  Oregon;  one in Huntington Beach,  California;  and two in
Denver, Colorado.

<PAGE>

     DRIVE-THROUGH  ESPRESSO BAR. The second type of store is the  drive-through
espresso bar that operates under the Motor Moka(R) brand.  As of March 15, 1997,
the Company operated seven of these stores in Portland, Oregon, one of which has
indoor  seating.  The Company intends to provide indoor seating in all stores of
this type where feasible.  Drive-through stores without indoor seating generally
will have a walk-up  window.  These  stores are  designed to  maximize  customer
convenience by eliminating the need to park a car and walk into a store.

     AIRPORT STORE. The third type of store is designed for major airports.  The
Company has six of these  stores at  Portland  International  Airport  operating
under the Aero Moka(TM) brand.  These stores include quick  grab-and-go  kiosks,
coffee bars and a sit-and-relax cafe. The Company believes these types of stores
provide visibility and increase brand recognition.

     SPECIALTY  KIOSK.  The fourth  type of Coffee  People  store is a specialty
kiosk for placement in high-traffic  locations such as  supermarkets  and office
building  lobbies.  The  Company has one of these store types and intends to add
more as attractive opportunities arise.

     The Company's  expansion strategy is to open multiple stores in new markets
where it believes it can become a leading specialty coffee retailer. The Company
intends to open  approximately  27 new retail stores during 1997 and to continue
its national expansion thereafter.  In 1996, the Company opened one new store in
Oregon and two new stores in the Denver,  Colorado  area.  As of March 15, 1997,
the Company had opened four new stores in 1997, one neighborhood coffee house in
Huntington  Beach,  California,  and three Motor Mokas in the  Portland,  Oregon
metropolitan  area.  Coffee  People will also seek to acquire  specialty  coffee
retailers  as   opportunities   arise  that  satisfy  the  Company's   economic,
site-selection and other strategic criteria.

     The cost of opening a new store depends upon the type of store,  the nature
of any  improvements  that already exist at the site, the availability of tenant
improvement allowances and other factors. The Company estimates that the average
cost of opening a new  neighborhood  coffee  house  store will be  approximately
$325,000.

<PAGE>

MARKETING STRATEGY

     Coffee People's central marketing strategy is to offer quality products and
service that create customer loyalty in a satisfying environment. To effect this
strategy, Coffee People markets the Coffee People Experience.

     The Company  believes it addresses its  customers in a distinctive  tone of
voice.  For example,  the Company's  paper cups feature Coffee  People's Bill of
Rights,  which  expresses  concerns  about  the  issues  of the day,  creates  a
fictional  history  that gives the Company a sense of depth and gently pokes fun
at itself and its obsession  with coffee.  This voice forms a character that the
Company uses to create a strong sense of personality and brand recognition.

     The Company  seeks to create new brands and  products  associated  with the
brand.  Black Tiger(R),  for example,  is a name Coffee People developed in 1987
for a  high-caffeine  coffee with a rustic Italian taste. It was first served as
brewed hot coffee and as a distinctive line of espresso drinks. Later, ice cream
featuring  Black Tiger coffee was  developed.  The ice cream was  combined  with
espresso and the Black Tiger milkshake was created. The Company has expanded the
product line to include Black Tiger  Sparkling  Coffee,  Black Tiger granola,  a
breakfast cereal, and ancillary products.

     Black Tiger products now account for a significant  amount of the Company's
total revenues.  The Company  believes that this kind of branded  expansion line
has been successful in attracting the Company's customers to new products and in
building sales. The Company also seeks ways to weave its branded products themes
into the  architectural  elements  in its  stores,  creating  an  atmosphere  of
immersion into the Coffee People culture.

COMPETITION

     The specialty  coffee market is intensely  competitive and is becoming more
so. Many of the  Company's  competitors  have greater  financial  and  marketing
resources,  brand name  recognition and a larger customer base than the Company.
The specialty  coffee industry is currently  characterized  by a small number of
large,  well-capitalized  companies  and a large number of small  companies  and
single-unit  operators.  The activities of large companies such as Starbucks are
increasing  the  appreciation  and  awareness  of  specialty  coffee  across the
country.  At the same time,  the  national  press has focused  attention  on the
growth opportunities associated with operating coffee stores and espresso carts.
This  attention,  combined with relative ease of entry into this  business,  has
resulted in a rapid increase in the number of small independent specialty coffee
companies and single-unit operators.


<PAGE>

     Coffee People competes  against  virtually all coffee sellers.  A number of
nationwide  coffee  manufacturers,  such as Kraft  General  Foods,  Proctor  and
Gamble,  and Nestle,  distribute coffee products in supermarkets and convenience
stores,  which  may  serve as  substitutes  for  Coffee  People  coffees.  Other
specialty coffee companies, such as Starbucks,  Millstone Coffee, Seattle's Best
Coffee  and  Green  Mountain  Coffee  Roasters,   sell  whole  bean  coffees  in
supermarkets and variety and discount stores.

     In the retail area, the Company  competes for whole bean and beverage sales
with  national and regional  chains,  franchise  operators  and local  specialty
coffee stores. There are a large number of competing specialty coffee retailers,
many of whom  have  significantly  more  retail  outlets  than the  Company.  In
addition,  Coffee  People  competes with and will continue to compete with local
competitors in the specialty coffee business.

     The Company expects intense  competition both within its primary geographic
territory,  the Pacific  Northwest,  and in new geographic  locations across the
United States in which the Company will seek to expand. In all of these markets,
national and regional  competitors as well as local  companies have  established
themselves as strong competitors with loyal customer  followings.  The specialty
coffee  business  is  expected  to  become  even more  competitive  as local and
regional companies expand and attempt to build brand awareness in new markets.

     Coffee  People  also  competes   against  other  specialty   retailers  and
restaurants for suitable sites for new retail stores.  There can be no assurance
that management will be able to secure suitable sites at acceptable rent levels.

INTELLECTUAL PROPERTY

     The Company does not own any patents. The Company's principal United States
trademarks include Coffee People(R), Black Tiger(R), Good Coffee No Backtalk(R),
Java  Noir(R),   Black  Tiger  Sparking   Coffee(TM)  and  Human  Being  Organic
Espresso(TM).  The Company's  principal United States service mark registrations
include Coffee  People(R),  Motor Moka(R) and Motorist's  Espresso  Bar(R).  The
Company has an  application  pending in the United  States to register  the name
Aero Moka(TM). The Company has applied for trademark and service mark protection
for the name Coffee People in Canada and Japan.

<PAGE>

GOVERNMENT REGULATION

     The food service industry is subject to extensive federal,  state and local
government  regulation relating to the development and operation of food service
outlets,  including  laws and  regulations  relating  to  building  and  seating
requirements,  the  preparation  and sale of food,  cleanliness,  safety  in the
workplace,  accommodations for the disabled and the Company's  relationship with
its  employees,  such as minimum wage  requirements,  anti-discrimination  laws,
overtime and working  conditions and  citizenship  requirements.  The failure to
obtain or retain necessary food licenses,  substantial  increases in the minimum
wage or substantial  increases in payroll taxes to fund mandatory health-care or
employee  benefit  programs could have a material adverse effect on the Company.
In November 1996,  Oregon voters passed a ballot initiative to raise the State's
minimum wage law over a three year period from $4.75 per hour to $6.50 per hour.
The Company does not expect the minimum wage to have a material  adverse  effect
in 1997.  It is uncertain  what impact,  if any, the minimum wage  increase will
have on the Company's  operating  results beyond 1997; any impact is expected to
be mitigated,  however,  by the Company's planned continued expansion outside of
Oregon. See "Management's Discussion and Analysis or Plan of Operation -- Coffee
Prices and Other Expenses and Risks."

FORWARD-LOOKING INFORMATION

     Some of the information in this Form 10-KSB,  including  anticipated  store
openings,  planned  expansions  into new  markets  and  trends in the  Company's
operations,  are  forward-looking  statements which are subject to certain risks
and uncertainties.  Actual future results may differ significantly  because of a
variety of  factors,  including  the  Company's  ability to find  optimal  store
locations at favorable lease rates,  increased  competition within the specialty
coffee  industry,  the  Company's  ability to hire,  train and retain  qualified
personnel  and the Company's  continued  ability to obtain  adequate  capital to
finance  its  planned  expansion,  and other  risks  detailed  in the  Company's
Registration  Statement on Form SB-2, as amended,  filed with the Securities and
Exchange Commission.

ITEM 2:  FACILITIES

     The Company currently owns the land and buildings at which two of its Motor
Moka  facilities  are operated,  a total of  approximately  1,600 square feet of
retail  space.  In  addition,  the Company  owns the  buildings,  and leases the
underlying lands, for five additional facilities, a total of approximately 3,750
square feet of retail space. As of March 15, 1997, the Company leased facilities
for the  operation  of 30 retail  stores,  24 of which  were in  operation.  The
Company's  retail  stores  range from 150 to 2,850  square feet with lease rates
ranging from  approximately  $1,200 to $7,100 per month.  The monthly lease rate
for certain stores is based on that store's  monthly sales  revenue.  Certain of
the Company's  leases expire in the near future.  There can be no assurance that
specific leases can be renewed on terms acceptable to the Company, or at all.

<PAGE>

     One of the  Company's  stores is operated at a location  for which there is
currently no term lease in effect. The lessor at such location could at any time
demand that the Company vacate the premises on 30 days prior written notice. The
Company is negotiating  with the lessor for a long-term  lease.  There can be no
assurance,  however,  that a lease  for  such  location  will be  obtainable  on
commercially  reasonable terms, or at all. The loss of this store location would
adversely affect the Company's earnings.

     As a  requirement  of its lease with the Port of Portland  for the six Aero
Moka stores at Portland  International Airport, the Company is required to enter
into a joint venture with a certified  disadvantaged business enterprise for one
of the Company's stores at Portland  International  Airport. Upon entry into the
joint venture,  the Company will have a 49% ownership in that store. The Company
has had  continuing  discussions  with the Port of Portland  to discuss  ways in
which this requirement can be met.

     One of the Company's stores is leased from the owner by certain  affiliates
of the Company.  The Company is permitted to operate at such  location and makes
all rental  payments  under the lease  agreement.  However,  the  Company has no
written sublease relating to the store.

     The Company  occupies  approximately  9,400  square feet for its  corporate
offices under a lease which expires February 2004. The Company believes that the
terms of the office lease are favorable.

EMPLOYEES

     As of  January  28,  1997,  the  Company  had  358  employees.  None of the
Company's  employees  are  covered by a  collective  bargaining  agreement.  The
Company believes its employee relations are good.

ITEM 3: LEGAL PROCEEDINGS

     The Company is not involved in any material litigation or proceeding and is
not aware of any material litigation or proceeding threatened against it.

ITEM 4: SUBMISSION OF MATTERS TO VOTE OF SECURITIES' HOLDERS

     None.

<PAGE>

                                    PART II


ITEM 5: MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The  Company's  Common  Stock began  trading on  September  25, 1996 on the
Nasdaq National Market under the symbol "MOKA".  As reported in Nasdaq's monthly
Summary of Activity  Reports,  the following  table sets forth the range of high
and  low  closing  price  information  for the  Company's  Common  Stock.  These
quotations reflect  inter-dealer  prices,  without retail mark-up,  mark-down or
commission and may not necessarily represent actual transactions.

                                    FISCAL YEAR ENDED
        COMMON STOCK (MOKA)         DECEMBER 31, 1996
        -------------------         -----------------

                                    High       Low
                                    ----       ---

        First Quarter               N/A        N/A
        Second Quarter              N/A        N/A
        Third Quarter               9.375      7.5
        Fourth Quarter              9.125      6.25

     The closing  price of the Common  Stock on March 14,  1997 was  $7.625.  At
March 14, 1997, the approximate  number of holders of record of Common Stock was
512.

     The Company did not declare any  dividends  on its Common  Stock during the
last two fiscal years. The Company intends to retain all earnings for use in its
business and  therefore  does not  anticipate  paying any cash  dividends in the
foreseeable future. The Company's bank credit agreement prohibits the payment of
cash dividends.

<PAGE>

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

     The following  discussion  contains  forward-looking  statements within the
meaning  of the  federal  securities  laws and  involves  a number  of risks and
uncertainties.  Actual  results  and  trends  may  differ  materially  from  the
statements contained in this discussion depending on a variety of factors.  Such
factors  include  but are not limited  to, the price and  availability  of green
coffee and other raw materials,  successful execution of the Company's expansion
plans,  the ability of the Company to manage growth,  the impact of competition,
acceptance of the Company's products and image outside of Oregon and other risks
detailed in the Company's Registration Statement on Form SB-2, as amended, filed
with the Securities and Exchange Commission.

OVERVIEW

     Coffee People sells coffee beverages,  coffee beans, cookies,  pastries and
coffee related merchandise.  The first Coffee People store opened in 1983. As of
December 31, 1996, the Company operated 22 stores.

     In January 1996, the Company raised net proceeds of $3,725,000 in a private
placement of Common Stock. In September  1996, the Company  completed an initial
public  offering in which it raised net proceeds of $9,717,000  from the sale of
1,225,000  shares of Common Stock.  The Company  intends to use the net proceeds
from the public offering and the private placement to build or acquire stores.

     During  1995,  the  Company  opened  two new stores as it  concentrated  on
raising  capital and prepared for its  expansion  into new markets.  The Company
devoted  the first  three  quarters of 1996 to  building  its  management  team,
developing  its  infrastructure,  developing  its new  retail  store  prototype,
selecting new markets and identifying sites within those markets.  In the fourth
quarter of 1996, the Company opened three new stores -- one in Oregon and two in
Colorado.  The Colorado stores were the first stores outside Oregon. The Company
intends to open  approximately  27 new stores in existing or new markets  during
1997. This is a forward-looking  statement.  Actual results may differ depending
upon a variety of factors,  including  the  Company's  ability to find  optional
store locations at favorable lease rates and the ability to construct new stores
within budgeted amounts.

     New stores  typically  incur higher than normal  operating  costs and lower
than normal  revenues during the first few months of store  operation.  Based on
its overall experience,  on average the Company expects a store to break even at
the  store  level by the third  month of  operation  and to make a profit  after
allocation of corporate general and  administrative  expenses by the sixth month
of  operation.  The three  stores  opened  during  the  fourth  quarter of 1996,
however,  continue to incur operating losses at the store level. There can be no
assurance  that  future  stores  will  meet  the  Company's   expectations   for
profitability.

<PAGE>

     Store opening  costs,  including  employee  recruiting and training and new
store marketing and promotion expenses, are expensed by the Company as incurred.
The  concentration  of these costs in periods  when a large number of new stores
are being opened is expected to  significantly  affect the  Company's  operating
results for such periods.

     As new markets are developed and as new stores mature,  the Company expects
average  store  sales from stores in that market to  increase.  However,  as the
Company  strives to build overall  market share,  annual average store sales and
year-over-year  comparable store sales comparisons may decline as new stores are
built in relatively close proximity to existing stores.


RESULTS OF OPERATIONS

1996 COMPARED TO 1995

     REVENUES.  Total revenues  increased 9.1% to $12,281,000 for the year ended
December 31, 1996 from $11,257,000 for the year ended December 31, 1995.  Retail
sales increased 9.6% to $12,104,000 in 1996 from $11,045,000 in 1995.

     Comparable  store  sales  for the 17 stores  open for the full  year  ended
December 31, 1996 and 1995 increased 2.0% primarily due to increased transaction
volumes,  particularly at the Company's airport stores,  and a price increase on
coffee  beverages  effected in September 1996 which resulted in an overall price
increase  of  approximately  4.0%.  Comparable  store  sales  during  1996  were
adversely  affected by a 19.9% decline in sales at one of the  Company's  stores
located in a shopping  center that is  undergoing  redevelopment  and by a 18.3%
decline  in a store  located  in close  proximity  to one of the  Company's  top
producing  stores.  The lease on the latter  store will  expire in the spring of
1997 and is not expected to be renewed.

     The  increase in  comparable  store sales  represents  19.6% of the overall
increase  in  sales.  Incremental  sales  from the  stores  opened  during  1995
contributed 69.9% of the increase in retail sales and incremental sales from the
stores opened during 1996 contributed 10.5% of the increase.

     Wholesale and other sales decreased 16.5% to $177,000 in 1996 from $212,000
in 1995.  The decrease was expected due to the  Company's  decision to turn over
the servicing of the  Company's  wholesale  business to an outside  firm.  These
sales primarily represent sales made to the outside firm at a fixed mark-up over
cost.

<PAGE>

     COSTS AND  EXPENSES.  Cost of sales and  related  occupancy  expenses  as a
percentage  of total  revenues  remained  relatively  stable at 47.7% in 1996 as
compared  to 47.9% in 1995.  The primary  components  were a decrease of 0.5% in
cost of sales and an increase of 0.3% in occupancy  costs.  The decrease in cost
of sales as a percentage  of total  revenues was due  primarily to the effect of
the price increase  effected in September 1996 which helped absorb  increases in
the costs of milk, chocolate and pastry. The increase in occupancy expenses as a
percentage of total  revenues was due primarily to the  percentage  rent paid on
sales generated at the Company's stores at Portland International Airport and to
the effect of  occupancy  expenses at the three new stores  opened in the fourth
quarter of 1996.

     Store operating expenses as a percentage of retail sales increased to 32.0%
in 1996 from 31.2% in 1995. The increase is primarily due to operating  expenses
associated with the three new stores opened in the fourth quarter.

     Depreciation and  amortization as a percentage of total revenues  increased
to 4.3% in 1996 from 3.5% in 1995,  due primarily to the impact of higher design
and build-out  costs for the stores opened in 1995 and 1996.  These stores carry
higher depreciation expense as a percentage of total revenues than stores opened
prior to 1995.

     General and  administrative  expenses  increased to $1,868,000 in 1996 from
$1,550,000  in 1995 due primarily to the addition of key  management  personnel,
and other costs necessary to achieve the Company's growth plans. As a percentage
of total revenues,  general and  administrative  expenses  increased to 15.2% in
1996 from 13.8% in 1995.

     AVERAGE STORE SALES AND STORE CONTRIBUTION  MARGIN. For 1996, the Company's
12 neighborhood and drive-through stores open for the full year achieved average
store  sales of  $729,000  and an  average  store  contribution  margin of 20.0%
compared to $736,000 and 20.5%, respectively,  for the 11 stores open during the
full year of 1995.  The six airport stores and one kiosk store open for the full
year achieved average store sales of $464,000 and an average store  contribution
margin of 13.1%,  respectively,  compared to $417,000 and 13.9% for five airport
stores and one kiosk open for the full year of 1995. The difference  between the
contribution  margins realized on the Company's  neighborhood stores compared to
its airport stores is primarily a result of the percentage rent paid at Portland
International  Airport on sales generated at the airport stores.  The decline in
store  contribution  margins at the Company's airport stores is due primarily to
higher labor costs and depreciation expenses incurred at these airport stores.

<PAGE>

     OTHER INCOME.  Other income as a percentage of total revenues  increased to
2.4% for the year ended  December 31, 1996 from 0.4% for the same period in 1995
due to  interest  earned  on the  proceeds  from the  Company's  initial  public
offering in September 1996 and the private placement completed in January 1996.

     INTEREST  EXPENSE.  Interest  expense  as a  percentage  of total  revenues
decreased  to 0.6% for the year ended  December  31, 1996 from 1.2% for the same
period in 1995, primarily as a result of utilizing portions of the proceeds from
the Company's private placement to reduce interest-bearing obligations.


1995 COMPARED TO 1994

     REVENUES.  Revenues  increased  46.0% to  $11,257,000  for the  year  ended
December 31, 1995 from  $7,708,000 for the year ended December 31, 1994.  Retail
sales increased 45.6% to $11,045,000 in 1995 from $7,588,000 in 1994.

     Comparable  stores  sales for the seven  stores  open for the full years of
1995 and 1994 decreased 8.7% due to the Company's decision to open new stores in
close proximity to existing units. Although this decision resulted in a decrease
in  comparable  store sales,  the Company  believes that it was able to increase
market share,  enhance its brand  recognition  and better serve customers in the
Portland, Oregon metropolitan area. Incremental sales from the new stores opened
in 1994 and 1995  accounted  for the entire  increase in retail  sales which was
partially offset by the decline in comparable store sales.

     COSTS  AND  EXPENSES.  Cost of  sales  and  related  occupancy  costs  as a
percentage of total  revenues  decreased to 47.9% in 1995 from 49.1% in 1994 due
primarily  to a decrease in cost of sales  offset by an  increase  in  occupancy
expenses.  The decrease in cost of sales was due to lower coffee prices achieved
in 1995 as a result of a new supply  contract  negotiated in October  1994.  The
increase  in  occupancy  expenses  as a  percentage  of total  revenues  was due
primarily to the percentage rent paid on sales generated at the Company's stores
at Portland International Airport.

<PAGE>

     Store operating expenses as a percentage of retail sales increased to 31.2%
in 1995 from 30.5% in 1994 primarily because of the impact of higher labor costs
incurred at the Company's units at Portland International Airport.

     Depreciation  and  amortization  as a percentage of net sales  increased to
3.5% in 1995 from 2.3% in 1994 due to the impact of higher  build-out  costs for
stores opened in 1994 and 1995. These stores carry higher  depreciation  expense
as a percentage of sales than stores opened before 1994.

     General and  administrative  expenses  as a  percentage  of total  revenues
decreased  to 13.8% in 1995 from  15.7% in 1994 as a result of  increased  total
revenues without a proportionate increase in overhead.

     AVERAGE STORE SALES AND STORE CONTRIBUTION  MARGIN. For 1995, the Company's
neighborhood and drive-through  stores open for the full period achieved average
store  sales of  $736,000  and an  average  store  contribution  margin of 20.5%
compared to $934,000 and 20.6%,  respectively,  for 1994. The Company's  airport
and kiosk  stores  open for the full  period  achieved  average  store  sales of
$417,000  and an  average  store  contribution  margin of 13.9% as  compared  to
$222,000 and 22.7%, respectively,  for 1994. The increase in average store sales
for the Company's  airport and kiosk stores resulted from the opening of several
higher-volume   airport  stores  in  late  1994.  The  difference   between  the
contribution  margins realized on the Company's  neighborhood stores compared to
its airport stores is primarily a result of the percentage rent paid at Portland
International  Airport on sales generated at the airport stores.  The decline in
store  contribution  margins at the Company's airport stores is due primarily to
higher labor costs and depreciation expenses at these airport stores.

     INCOME TAXES.  For the period from January 1, 1994 through August 22, 1994,
the Company  elected to be taxed under the  provisions  of  Subchapter  S of the
Internal Revenue Code. Under those  provisions,  the Company did not pay federal
or state corporate income tax on its taxable income.  Accordingly,  no provision
for income taxes was made for that period.

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

     The Company plans to open  approximately  27 new retail stores during 1997.
The Company  estimates that the cost of constructing a new  neighborhood  coffee
house based on its new prototype design,  including site selection costs,  lease
negotiation,   store  design,   permitting,   architectural  fees,  construction
supervision,   leasehold  improvements  and  equipment,  will  be  approximately
$325,000.  There can be no assurance,  however,  that costs of constructing  new
stores will not substantially exceed this estimate.

     As  of  December  31,  1996  the  Company  had   $10,274,000  in  cash  and
equivalents.

     Working capital as of December 31, 1996 totaled $9,472,000 as compared to a
working capital deficiency of $690,000 at December 31, 1995.

     For the year ended  December  31,  1996,  and for 1995,  cash  provided  by
operating activities was $458,000 and $416,000, respectively.

     Historically,  the Company has  financed its growth  primarily  through the
sale of equity securities, the issuance of notes payable and the periodic use of
bank  debt.  For the year  ended  December  31,  1996 the  Company  had net cash
provided by financing  activities  of  $13,229,000  primarily as a result of the
initial public offering completed in September 1996 which resulted in $9,717,000
in net proceeds and $3,725,000 in net proceeds received from a private placement
of Common Stock completed in January 1996. For the year ended December 31, 1995,
net cash provided by financing activities totaled $232,000.

     The  Company has a bank line of credit  providing  for  borrowings  through
August 1, 1997 of up to $500,000.  Borrowings  bear interest at the rate of 0.5%
over the bank's  prime rate (8.25% as of December  31,  1996) and are secured by
substantially  all of  the  Company's  assets,  including  accounts  receivable,
inventories, trade fixtures and equipment. As of December 31, 1996 there were no
borrowings  outstanding under the line of credit;  however,  $73,000 of the line
was  reserved for a letter of credit dated  September  1996.  The line of credit
agreement contains restrictive covenants relating to certain financial ratios as
well as the bank's standard covenants and restrictions. As of December 31, 1996,
the Company was in compliance with all such debt covenants.

     For the years ended  December 31, 1996 and 1995, net cash used in investing
activities was $3,673,000 and $860,000 respectively. The primary use of net cash
used in investing  activities is capital expenditures for new retail stores. The
Company  currently  estimates  that  capital   expenditures  for  1997  will  be
approximately  $9.0 million,  substantially all of which will be used to develop
or acquire stores.

<PAGE>

     The  Company  believes  that  anticipated  cash  flow from  operations  and
existing  cash will be  sufficient  to meet the  Company's  anticipated  capital
requirements for planned expansion through the end of 1997.

COFFEE PRICES AND OTHER EXPENSES AND RISKS

     The Company believes that it has adequate sources of supply of high-quality
specialty coffee to meet its expansion needs for the foreseeable future.

     Coffee  prices  are  volatile  and  the  Company  has   experienced   price
fluctuations  for  purchased  coffee.   During  the  first  part  of  1997,  the
commodities markets have witnessed a significant  increase in the price of green
coffee,  with  prices  for coffee  climbing  from a level in the $1.15 per pound
range  in  December  1996 to over  $2.00  per  pound in early  March  1997.  The
Company's supply agreement  provides for the Company to purchase its coffee at a
fixed amount over green cost.  As a result,  the  Company's  cost of coffee will
fluctuate with the price of green coffee. The Company believes that its supplier
has  sufficient  inventories  and purchase  commitments  to maintain  some price
stability in the short term.  However,  if coffee prices remain at their current
levels,  the Company will incur  substantially  higher costs for coffee which it
purchases  after existing  inventories  and  commitments are used. The Company's
ability to raise  prices in response to rising  coffee  prices may be limited by
competitive  pressures if other major  specialty  coffee  retailers do not raise
prices. The Company's inability to pass through higher coffee prices in the form
of higher retail prices for beans and  beverages  could have a material  adverse
effect on the Company's earnings.

     On November 5, 1996,  Oregon voters passed a ballot  initiative  which will
raise the state  minimum  wage over a  three-year  period from $4.75 per hour to
$6.50 per hour. In 1996, the Company paid all employees,  other than newly hired
employees participating in a 20-hour training program, above the minimum wage in
effect in 1997. Accordingly, the Company does not expect the new minimum wage to
have a material adverse effect on earnings in 1997. It is uncertain what impact,
if any, the minimum wage increase will have on the Company's  operating  results
beyond 1997; any impact is expected to be mitigated to some extent,  however, by
the Company's planned expansion outside Oregon.

     The  Company's  future  results of  operations  and earnings  could also be
significantly  affected by other factors,  such as the Company's ability to find
optimal store locations at favorable lease rates,  increased  competition within
the specialty coffee industry,  the Company's  continued ability to hire, train,
and retain  qualified  personnel and the Company's  continued  ability to obtain
adequate capital to finance its planned expansion.

<PAGE>

ITEM 7:  FINANCIAL STATEMENTS

     See pages 25 through 40.


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

     None.


<PAGE>

                                    PART III


ITEM 9:  DIRECTORS AND EXECUTIVE OFFICERS

     There is hereby incorporated by reference the information under the caption
"Election of  Directors"  in the Company's  definitive  Proxy  Statement for the
Company's  annual  meeting of  shareholders  to be held on April 24, 1997, to be
filed with the Securities and Exchange  Commission within 120 days after the end
of the Company's  fiscal year. The required  information  concerning  compliance
with  Section  16(a) of the  Securities  Exchange  Act of 1934,  as amended,  is
incorporated   herein  by  reference  to  the  information   under  the  caption
"Compliance  with Section  16(a) of  Securities  Exchange  Act" in the Company's
definitive  Proxy  Statement  to be filed  within  120 days after the end of the
Company's fiscal year.

ITEM 10:  EXECUTIVE COMPENSATION

     There is hereby incorporated by reference the information under the caption
"Executive Compensation" in the Company's definitive Proxy Statement to be filed
with the  Securities  Exchange  Commission  within 120 days after the end of the
Company's fiscal year.

ITEMS 11: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     There is hereby incorporated by reference the information under the caption
"Principal Shareholders" in the Company's definitive Proxy Statement to be filed
with the Securities and Exchange Commission within 120 days after the end of the
Company's fiscal year.

ITEM 12:  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     There is hereby incorporated by reference the information under the caption
"Certain  Transactions" in the Company's  definitive Proxy Statement to be filed
with the Securities and Exchange Commission within 120 days after the end of the
Company's fiscal year.

ITEM 13:  EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

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

3.1            Registrant's Restated Articles of Incorporation  (Incorporated by
               reference to Exhibit 3.1 to the Company's  Registration Statement
               on Form SB-2,  effective  September  25, 1996  (Registration  No.
               333-5376-LA)).

<PAGE>

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

3.2            Registrants'  Bylaws,  as amended  (Incorporated  by reference to
               Exhibit 3.2 to the Company's Registration Statement on Form SB-2,
               effective September 25, 1996 (Registration No. 333-5376-LA)).

4              See Article 2 of Exhibit 3(i) and Article II of Exhibit 3(ii)

10.1*          Registrant's 1993 Stock Option Plan (Incorporated by reference to
               Exhibit  10.1 to the  Company's  Registration  Statement  on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.2*          Registrant's 1994 Stock Option Plan (Incorporated by reference to
               Exhibit  10.2 to the  Company's  Registration  Statement  on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.3*          Registrant's 1995 Stock Option Plan (Incorporated by reference to
               Exhibit  10.3 to the  Company's  Registration  Statement  on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.4*          Registrant's 1996 Stock Option Plan (Incorporated by reference to
               Exhibit  10.4 to the  Company's  Registration  Statement  on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.5*          Form of Incentive Stock Option  Agreement  related to 1993, 1994,
               1995 and 1996 Stock  Option Plans  (Incorporated  by reference to
               Exhibit  10.5 to the  Company's  Registration  Statement  on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.6*          Form of  Nonstatutory  Stock  Option  Agreement  related to 1993,
               1994, 1995 and 1996 Stock Option Plans (Incorporated by reference
               to Exhibit 10.6 to the Company's  Registration  Statement on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.7*          Registrant's   Employee  Stock  Purchase  Plan  (Incorporated  by
               reference to Exhibit 10.7 to the Company's Registration Statement
               on Form SB-2,  effective  September  25, 1996  (Registration  No.
               333-5376-LA)).

10.8           Supply  Agreement dated February 17, 1997 between  Registrant and
               Coffee Bean International, Inc.**

<PAGE>



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


10.9           Form of Indemnity Agreement (Incorporated by reference to Exhibit
               10.9  to the  Company's  Registration  Statement  on  Form  SB-2,
               effective September 25, 1996 (Registration No. 333-5376-LA)).

10.10          Business  Loan  Agreement  with Bank of  America  NT & SA,  dated
               August 3, 1995, as amended  (Incorporated by reference to Exhibit
               10.10  to the  Company's  Registration  Statement  on Form  SB-2,
               effective September 25, 1996 (Registration No. 333-5376-LA)).

10.10(a)       Security  Agreement with Bank of America NT & SA, dated August 3,
               1995  (Incorporated  by  reference  to Exhibit  10.10(a))  to the
               Company's   Registration   Statement  on  Form  SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.11*         Employment Agreement with James L. Roberts, Chairman of the Board
               and Chief Executive Officer (Incorporated by reference to Exhibit
               10.11  to the  Company's  Registration  Statement  on Form  SB-2,
               effective September 25, 1996 (Registration No. 333-5376-LA)).

10.12*         Employment  Agreement with Taylor H. Devine,  President and Chief
               Operating Officer  (Incorporated by reference to Exhibit 10.12 to
               the  Company's  Registration  Statement  on Form SB-2,  effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.13*         Employment  Agreement  with Matthew J. Kimble,  Vice  President--
               Human Relations.

10.14*         Employment  Agreement  with Steven P.  Crantz,  Vice  President--
               Development  (Incorporated  by reference to Exhibit  10.14 to the
               Company's   Registration   Statement  on  Form  SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.15          Redemption   agreement,   dated   January  4,  1993  between  the
               Registrant  and Gary G.  Talboy  (Incorporated  by  reference  to
               Exhibit  10.15 to the  Company's  Registration  Statement on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.15(a)       Promissory Note, dated January 4, 1993, payable to Gary G. Talboy
               in  original  principal  amount  of  $245,000   (Incorporated  by
               reference  to Exhibit  10.15(a))  to the  Company's  Registration
               Statement   on  Form   SB-2,   effective   September   25,   1996
               (Registration No. 333-5376-LA)).

<PAGE>

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

10.16          Redemption   Agreement,   dated  January  4,  1993,  between  the
               Registrant and Jeffrey M. Ferguson  (Incorporated by reference to
               Exhibit  10.16 to the  Company's  Registration  Statement on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.16(a)       Promissory  Note,  dated  January 4, 1993,  payable to Jeffrey M.
               Ferguson in original  principal amount of $245,000  (Incorporated
               by reference to Exhibit  10.16(a)) to the Company's  Registration
               Statement   on  Form   SB-2,   effective   September   25,   1996
               (Registration No. 333-5376-LA)).

10.17          Security Agreement,  dated January 4, 1993, among the Registrant,
               Jeffrey M. Ferguson and Gary G. Talboy (Incorporated by reference
               to Exhibit 10.17 to the Company's  Registration Statement on Form
               SB-2,    effective   September   25,   1996   (Registration   No.
               333-5376-LA)).

10.18          Food and  Beverage  Concession  Lease  Agreement;  dated June 10,
               1994,   between   the   Registrant   and  the  Port  of  Portland
               (Incorporated  by  reference  to Exhibit  10.18 to the  Company's
               Registration Statement on Form SB-2, effective September 25, 1996
               (Registration No. 333-5376-LA)).

10.19          Common Stock  Purchase  Agreement,  dated as of January 11, 1996,
               among the  Registrant  and certain  purchasers  (Incorporated  by
               reference  to  Exhibit  10.19  to  the   Company's   Registration
               Statement   on  Form   SB-2,   effective   September   25,   1996
               (Registration No. 333-5376-LA)).

10.20          Warrant  Agreement,  dated as of January  23,  1996,  between the
               Registrant and International Capital Partners, Inc. (Incorporated
               by  reference  to  Exhibit  10.20 to the  Company's  Registration
               Statement   on  Form   SB-2,   effective   September   25,   1996
               (Registration No. 333-5376-LA)).

<PAGE>


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

11             Statement Regarding Computation of Per Share Earnings.

23             Consent of Arthur Andersen LLP, Independent Public Accountants.

27             Financial Data Schedule


---------------------------------
  *  Management contract or compensatory plan or arrangement.
  ** Confidential treatment requested.


(b)  Reports on Form 8-K

     None.


<PAGE>

                         INDEX TO FINANCIAL STATEMENTS


                                                                      Page
                                                                      ----

Report of Independent Public Accountants                               26

Balance Sheets at December 31, 1996 and 1995                           27

Statements of Income for Three Years Ended                             28
     December 31, 1996

Statements of Changes in Stockholders' Equity                          29
     (Deficit) for Three Years Ended
     December 31, 1996

Statement of Cash Flow for Three Years Ended                           30
     December 31, 1996

Notes to Financial Statements                                          31


<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Stockholders and Board of Directors of Coffee People, Inc.:

We have  audited the  accompanying  balance  sheets of Coffee  People,  Inc. (an
Oregon corporation) as of December 31, 1996 and 1995, and the related statements
of income,  changes in stockholders' equity (deficit) and cash flows for each of
the  three  years  in the  period  ended  December  31,  1996.  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  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the  financial  position of Coffee  People,  Inc. as of
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.


                                        /s/ Arthur Andersen LLP


Portland, Oregon,
February 6, 1997


<PAGE>



                               COFFEE PEOPLE, INC.


                                 BALANCE SHEETS

                        AS OF DECEMBER 31, 1996 AND 1995

                             (Dollars in thousands)


                                     ASSETS
                                                       1996         1995
                                                       ----         ----
CURRENT ASSETS:
  Cash and cash equivalents (Note 1)                 $10,274      $  260
  Accounts receivable                                     26           9
  Inventories (Note 1)                                   205         264
  Prepaid expenses                                       141         112
  Deferred tax assets (Notes 1 and 5)                     28          13
  Other current assets                                    96           -
                                                     -------      ------
          Total current assets                        10,770         658

  Property and equipment, net (Notes 1 and 2)          5,513       2,155
  Other assets                                           129          23
                                                     -------      ------
          Total assets                               $16,412      $2,836
                                                     =======      ======

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Current portion of long-term debt and capital
    lease obligations (Note 4)                      $   115      $  112
  Current portion of long-term debt to related
    parties (Note 4)                                     20          35
  Line of credit (Note 3)                                 -         175
  Accounts payable                                      533         775
  Construction accounts payable                         321           -
  Accrued liabilities                                   262         196
  Income taxes payable (Notes 1 and 5)                   47          55
                                                     ------      ------
          Total current liabilities                   1,298       1,348

DEFERRED TAX LIABILITY (Notes 1 and 5)                   86          66

LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
  (Note 4)                                              267         370

LONG-TERM DEBT TO RELATED PARTIES (Note 4)              159         197

COMMITMENTS (Note 7)

STOCKHOLDERS' EQUITY (Notes 8, 9, 12 and 14):
  Preferred Stock, no par value; authorized
    10,000,000 shares, none issued or outstanding         -           -
  Common Stock, no par value; authorized,
    50,000,000 shares; issued, 3,237,432 and
    1,936,233 shares; outstanding, 3,237,432
    and 1,405,054 shares                             14,492       1,476
  Stock subscription notes receivable (Note 9)         (281)       (341)
  Warrants outstanding (Note 12)                          -           -
  Treasury Stock, at cost; 0 and 531,189 shares           -        (467)
  Retained earnings                                     391         187
                                                    -------      ------
          Total stockholders' equity                 14,602         855
                                                    -------      ------
          Total liabilities and stockholders'
            equity                                  $16,412      $2,836
                                                    =======      ======


The accompanying notes are an integral part of these financial statements.


<PAGE>


                               COFFEE PEOPLE, INC.


                              STATEMENTS OF INCOME

              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

                  (Dollars in thousands, except per share data)



                                               1996          1995          1994
                                             ---------     ---------      -----
REVENUES:
  Retail sales                               $  12,104     $  11,045     $7,588
  Wholesale and other                              177           212        120
                                             ---------     ---------     ------
          Total revenues                        12,281        11,257      7,708

COST OF SALES and related occupancy
  expenses (cost of sales and occupancy
  expenses paid to related parties of
  $239, $187 and $93)                            5,860         5,388      3,788

STORE OPERATING EXPENSES                         3,873         3,451      2,314

OTHER OPERATING EXPENSES                            44            63         40

DEPRECIATION AND AMORTIZATION                      530           391        175

GENERAL AND ADMINISTRATIVE EXPENSES              1,868         1,550      1,210
                                             ---------     ---------     ------
          Income from operations                   106           414        181

OTHER INCOME, net                                  298            43         39

INTEREST EXPENSE (interest expense to
  related parties of $20, $35 and $38)             (73)         (134)       (88)
                                             ---------     ---------     ------
          Income before provision for
            income taxes                           331           323        132

PROVISION FOR INCOME TAXES (Notes 1 and 5)        (127)         (112)       (16)
                                             ---------     ---------     ------
NET INCOME                                   $     204     $     211     $  116
                                             =========     =========     ======

EARNINGS PER SHARE (Note 1)                  $   0.09      $   0.14
                                             =========     =========

SHARES USED IN COMPUTING EARNINGS
  PER SHARE (Note 1)                         2,349,702     1,500,975


The accompanying notes are an integral part of these financial statements.


<PAGE>

<TABLE>
<CAPTION>


                                                         COFFEE PEOPLE, INC.


                                       STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

                                        FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

                                                       (Dollars in Thousands)


                                                                                        Stock            Retained
                                               Common Stock                         Subscription         Earnings
                                            -------------------      Treasury           Notes          (Accumulated
                                            Shares       Amount       Stock          Receivable          Deficit)       Total
                                            ------       ------      --------       ------------       ------------     -----

<S>                                         <C>          <C>         <C>            <C>                 <C>             <C>

BALANCE, December 31, 1993                 1,200,000     $   434     $(501)            $(167)            $  36         $  (198)

  Issuance of Treasury
    Stock                                     33,000          98        34                 -                 -             132
  Exercise of stock
    options
    (Notes 8 and 9)                           37,500          83         -               (83)                -               -
  Interest income on stock
    subscription notes at
    8.5% per annum, net
    (Note 9)                                       -           -         -                (7)                -              (7)
  Direct Public Offering
    (Note 12)                                107,704         802         -                 -                 -             802
  Net income                                       -           -         -                 -               116             116
  Dividends                                        -           -         -                 -              (176)           (176)
                                           ---------      ------     -----             -----             -----          ------
BALANCE, December 31, 1994                 1,378,204       1,417      (467)             (257)              (24)            669

  Exercise of stock
    options
    (Notes 8 and 9)                           26,850          59         -               (58)                -               1
  Interest income on stock
    subscription notes at
    8.5% per annum
    (Note 9)                                       -           -         -               (26)                -             (26)
  Net income                                       -           -         -                 -               211             211
                                           ---------      ------     -----             -----             -----          ------
BALANCE, December 31, 1995                 1,405,054       1,476      (467)             (341)              187             855

  Private Placement
    (Note 12)                                596,250       3,258       467                 -                 -           3,725
  Initial public offering
    (Note 12)                              1,225,000       9,717         -                 -                 -           9,717
  Exercise of stock
    options (Note 8)                          11,128          25         -                 -                 -              25
  Repayment of stock
    subscription note and
    accrued interest
    (Note 9)                                       -           -         -                84                 -              84
  Income tax benefit of
    disqualifying
    dispositions                                   -          16         -                 -                 -              16
  Interest income on stock
    subscription notes at
    8.5% per annum
    (Note 9)                                       -           -         -               (24)                -             (24)
  Net income                                       -           -         -                 -               204             204
                                           ---------     -------     -----             -----             -----         -------
BALANCE, December 31, 1996                 3,237,432     $14,492       $ -             $(281)            $ 391         $14,602
                                           =========     =======     =====             =====             =====         =======


</TABLE>

The accompanying notes are an integral part of these financial statements.


<PAGE>

                               COFFEE PEOPLE, INC.


                            STATEMENTS OF CASH FLOWS

              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

                             (Dollars in thousands)

                                               1996          1995          1994
                                             ---------     ---------      -----

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income                                 $   204     $ 211       $   116
  Adjustments to reconcile net income
    to net cash provided by operating
    activities-
      Depreciation and amortization              530       391           175
      Deferred provision for income
        taxes                                      5        49             4
      Interest income on stock
        subscriptions                            (14)      (26)          (21)
      Changes in operating assets and
        liabilities:
        Accounts receivable                      (17)        3            (8)
        Inventories                               59       (60)          (45)
        Prepaid expenses                         (29)      (26)          (57)
        Other current assets                     (96)       14           (14)
        Accounts payable                        (242)     (166)          639
        Accrued liabilities                       66        16            49
        Income taxes payable                      (8)       43            12
        Other current liabilities                  -       (33)           18
                                             -------     -----       -------
          Net cash provided by operating
            activities                           458       416           868

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of property and equipment, net     (3,888)     (933)       (1,368)
  (Increase) decrease in other assets           (106)       73           (81)
  Construction accounts payable                  321         -             -
                                             -------     -----       -------
          Net cash used in investing
            activities                        (3,673)     (860)       (1,449)

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from long-term debt and
    capital lease obligations                      -       682           204
  Repayment of debt and capital lease
    obligations                                 (275)     (168)            -
  Repayment of debt to related parties           (53)     (227)          (70)
  Repayment of stock subscription note
    receivable and interest                       74         -             -
  Proceeds from private placement, net         3,725         -             -
  Proceeds from initial public offering,
    net                                        9,717         -             -
  Issuance of Common Stock, net                   25         1           801
  Income tax benefit of disqualifying
    dispositions                                  16         -             -
  Dividends                                        -       (56)         (135)
                                             -------     -----       -------
          Net cash provided by financing
            activities                        13,229       232           800
                                             -------     -----       -------
INCREASE (DECREASE) IN CASH AND CASH    
  EQUIVALENTS                                 10,014      (212)          219

CASH AND CASH EQUIVALENTS, beginning of
  the period                                     260       472           253
                                             -------     -----       -------
CASH AND CASH EQUIVALENTS, end of the
  period                                     $10,274     $ 260       $   472
                                             =======     =====       =======

The accompanying notes are an integral part of these financial statements.

<PAGE>


                               COFFEE PEOPLE, INC.
                               -------------------

                         NOTES TO FINANCIAL STATEMENTS
                         ------------------------------
                  (Dollars in thousands, except per share data)


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
    ------------------------------------------

The Company
-----------

Coffee  People,  Inc.  (the  Company),  an  Oregon  corporation,   sells  coffee
beverages, coffee beans, cookies, pastries, ice cream, shakes and coffee related
merchandise.  Nineteen  of  the  Company's  twenty-two  stores  are  located  in
Portland,  Oregon with one located in Eugene,  Oregon and two located in Denver,
Colorado.  A downturn in  economic  conditions  in Oregon  could have a material
adverse effect on the Company.

Use of Estimates
----------------

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  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.

Fair Value of Financial Instruments
-----------------------------------

The Company's  financial  instruments  consist of accounts  receivable  and debt
instruments.  At  December  31, 1996 and 1995,  the fair value of the  Company's
receivables and debt under loans approximated the carrying value.

Advertising
-----------

Advertising  costs are  expensed as incurred.  For the years ended  December 31,
1996, 1995 and 1994, advertising costs were $144, $49 and $69, respectively.

Cash and Cash Equivalents
-------------------------

Cash and cash equivalents include cash and short-term  investments with original
maturity dates of three months or less.

Inventories
-----------

Inventories are stated at the lower of cost (first-in,  first-out) or market and
consist of roasted coffee beans, food, beverages, supplies and other merchandise
held for sale.

Property and Equipment
----------------------

Property and equipment is stated at cost.  Depreciation on equipment is computed
on the straight-line basis over the estimated useful lives of the assets ranging
from three to seven years.  Leasehold improvements are capitalized and amortized
on a  straight-line  basis  over the  shorter of the  initial  lease term or the
estimated useful lives of the assets, generally three to ten years.

Maintenance  and repairs are charged to expense as incurred.  Major  repairs and
improvements are capitalized and depreciated.


<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


Store Opening Costs
-------------------

Costs  incurred in  connection  with  start-up  and  promotion of new stores are
expensed as incurred.

Income Taxes
------------

For the period from January 1, 1994 through August 22, 1994, the Company elected
to be taxed under the  provisions of Subchapter S of the Internal  Revenue Code.
Under those  provisions,  the  Company  did not pay  federal or state  corporate
income taxes on its taxable income.  Instead, the stockholders were individually
responsible  for federal and state income taxes.  Accordingly,  no provision for
income  taxes was made for the period from  January 1, 1994  through  August 22,
1994.

Subsequent  to August 22,  1994,  the  Company  was subject to federal and state
corporate income taxes.  Income taxes were provided for on the basis of earnings
reported for financial  reporting  purposes.  Deferred income taxes are provided
for in  accordance  with  Statement of Financial  Accounting  Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). Deferred taxes are determined based on
the estimated future tax effects of differences  between the financial statement
and tax bases of assets and liabilities given the provisions of enacted tax laws
and tax rates.  Deferred income tax expenses or credits are based on the changes
in the financial statement basis versus the tax basis in the Company's assets or
liabilities from year to year.

Earnings Per Share
------------------

The year ended  December  31,  1995 was the first full year that the Company was
subject to federal and state  corporate  income taxes (see Income Taxes  above).
The Securities and Exchange Commission (SEC) guidelines allow earnings per share
data  to be  presented  only  when  a  company  converts  to a  taxable  status.
Accordingly, earnings per share data has been presented only for the years ended
December 31, 1996 and 1995.

Earnings per share  amounts are based on the average  number of shares of Common
Stock and dilutive  Common  Stock  equivalents  outstanding,  using the treasury
stock method, during the year after giving retroactive effect of a 3-for-2 stock
split declared on July 26, 1996 (see Note 14). Common stock equivalents  include
shares issuable upon exercise of outstanding stock options.

Stock-Based Compensation Plans
------------------------------

The Company  accounts for its stock-based  compensation  plans under  Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25).  Effective in 1996, the Company adopted the disclosure  option of Statement
of  Financial   Accounting   Standards  No.  123,  "Accounting  for  Stock-Based
Compensation (SFAS 123). SFAS 123 requires that companies which do not choose to
account for  stock-based  compensation  as prescribed by this  statement,  shall
disclose the pro forma effects on earnings and earnings per share as if SFAS 123
had been  adopted.  Additionally,  certain other  disclosures  are required with
respect to stock  compensation  and the  assumptions  used to determine  the pro
forma effects of SFAS 123.


<PAGE>
                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


2.  PROPERTY AND EQUIPMENT:
    ----------------------

Property and equipment at December 31, consists of the following:

                                                        1996        1995
                                                       ------      ------

Land                                                   $  868      $    -
Leasehold improvements                                  2,634       1,764
Machinery and equipment                                 1,842       1,156
Capital leases                                            116         116
Construction in progress                                1,492          28
                                                       ------      ------
                                                        6,952       3,064
Less- Accumulated depreciation                         (1,439)       (909)
                                                       ------      ------
                                                       $5,513      $2,155
                                                       ======      ======

3.  LINE OF CREDIT:
    --------------

In September 1996, the Company renewed its line of credit  agreement with a bank
in the amount of $500.  The  interest  rate for amounts  drawn under the line is
0.5% over the  prime  rate  (8.75% at  December  31,  1996).  There is no amount
outstanding  under the line of  credit at  December  31,  1996.  Out of the $500
credit  line,  the sum of $73 is reserved for use under a letter of credit dated
September 1996. The line expires in August 1997.

4.  DEBT:
    ----

Debt consists of the following at December 31:

                                                             1996      1995
                                                            -----     -----

Note payable to bank, payable in monthly
  installments of $6 each, plus interest at 9%,
  commencing September 1, 1995, due August 1, 1998          $ 115     $ 184

Note payable to stockholder, payable in monthly
  installments of $3, including interest at 2% over
  the prime rate (10.25% at December 31, 1996),
  due December 1, 2002                                        179       197

Note payable to the Port of Portland, payable in
  monthly installments of $5, commencing April 8,
  1995, including interest at 12%, due March 8, 2003          244       268
                                                            -----     -----
                                                              538       649
Less- Current portion                                        (117)     (110)
                                                            -----     -----
                                                            $ 421     $ 539
                                                            =====     =====



<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


The bank note and line of credit (Note 3) is secured by substantially all of the
Company's assets including accounts receivable,  inventories, trade fixtures and
equipment.  These debt  agreements  contain  restrictions  relating to specified
financial ratios as well as the lender's standard covenants and restrictions. As
of December 31, 1996, the Company was in compliance with all debt covenants. The
proceeds from the bank note were used to pay off a note to a stockholder.

The stockholder note is secured by substantially all of the Company's assets and
is subordinated to the bank note.

The principal payments on long-term debt are as follows at December 31, 1996:

   1997                                        $117
   1998                                          99
   1999                                          60
   2000                                          67
   2001                                          75
Thereafter                                      120
                                               ----
                                               $538
                                               ====

The Company has capital leases for certain  equipment.  Future minimum  payments
under the capital leases are as follows at December 31, 1996:

     1997                                                $ 20
     1998                                                   6
                                                         ----
                                                           26
     Less- Portion representing interest                   (3)
                                                         ----
     Present value of net minimum lease payments           23

     Less- Current portion                                (18)
                                                         ----
     Long-term obligations under capital leases          $  5
                                                         ====

5.  INCOME TAXES:
    ------------

The components of the provision for income taxes consist of the following:

                                               1996     1995     1994
                                               ----     ----     ----
Current:
  Federal                                      $100     $ 59     $  9
  State                                          22        4        3
                                               ----     ----     ----
                                                122       63       12
Deferred                                          5       49        4
                                               ----     ----     ----
          Total provision                      $127     $112     $ 16
                                               ====     ====     ====



<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


The  reconciliation  of the statutory  federal income tax rates to the Company's
effective income tax rates is as follows:

                                                  1996        1995       1994
                                                 ------      ------     -----

Federal statutory rate                            34.0%       34.0%      34.0%
State income taxes, net of federal benefit         2.3         2.6        5.9
Effect of graduated tax rates                      -          (1.3)      (7.7)
Effect of change in tax status (Note 1)            -           -        (18.2)
Other                                              2.1        (0.6)      (1.9)
                                                  ----        ----      -----
                                                  38.4%       34.7%      12.1%

The components of the net deferred tax assets and liabilities consist of the
following at December 31:

                                                      1996      1995
                                                      ----      ----

Current deferred tax assets-
  Basis difference in accrued liabilities             $ 17      $  3
  Tax deduction carryforwards                           11        10
                                                      ----      ----
          Total current deferred tax asset            $ 28      $ 13
                                                      ====      ====
Long-term deferred tax asset-
  Tax credit carryforwards                             $ -      $ 32
Long-term deferred tax liability-
  Basis difference in property, plant and
    equipment                                          (86)      (98)
                                                      ----      ----
          Net long-term deferred tax liability        $(86)     $(66)
                                                      ====      ====

The Company  believes that deferred tax assets will be fully realized based upon
future reversals of existing taxable temporary  differences,  future earnings or
available  tax  strategies.  Accordingly,  there was no  valuation  allowance on
deferred tax assets at December 31, 1996 and 1995.

6.  OPERATING LEASES:
    ----------------

The Company leases certain retail store,  office and warehouse  facilities under
operating leases expiring  through the year 2013. Most lease agreements  contain
renewal  options  and  rent  escalation  clauses.  Certain  leases  provide  for
contingent rentals based upon gross sales.

Rental  expense  under these lease  agreements  for the years ended  December 31
1996, 1995 and 1994 was as follows:

                                   1996      1995     1994
                                  ------     ----     ----

Minimum rentals                   $1,051     $828     $460
Contingent rentals                    69       84       28
                                  ------     ----     ----
                                  $1,120     $912     $488
                                  ======     ====     ====



<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


Minimum future rental payments under these agreements as of December 31, 1996
are as follows:

   1997                                      $1,040
   1998                                         991
   1999                                         971
   2000                                         877
   2001                                         806
Thereafter                                    2,926
                                             ------
                                             $7,611
                                             ======

7.  COMMITMENTS:
    -----------

The Company has an agreement  with a supplier to purchase  substantially  all of
the Company's coffee  requirements  through November 1997.  Management  believes
that other suppliers could provide similar products.  Any supplier from whom the
Company might  purchase  coffee is subject to volatility in the supply and price
of  coffee  beans.  A change  in  suppliers,  however,  could  impact  the terms
currently received by the Company. Such a change could have a negative impact on
operating results.

As a  requirement  of the  lease  with  the Port of  Portland,  the  Company  is
committed  to  enter  into a joint  venture  with a third  party  for one of the
Company's  stores at  Portland  International  Airport.  Once the  agreement  is
finalized, the Company will have a 49% ownership interest in that store.

8.  INCENTIVE PLANS:
    ---------------

Authorized Stock
----------------

In June 1995, the Company  restated its Articles of  Incorporation  to authorize
50,000,000  shares of no par value Common Stock and 10,000,000  shares of no par
value Preferred Stock.

Stock Option Plans
------------------

At December 31,  1996,  the Company had four Stock Option Plans - the 1993 Stock
Option Plan  adopted in December  1993,  the 1994 Stock  Option Plan  adopted in
March 1994,  the 1995 Stock Option Plan adopted in June 1995, and the 1996 Stock
Option Plan adopted in May 1996 (collectively,  the Plans). Under the Plans, key
employees  and  consultants  may be granted  either  incentive  stock options or
nonqualified  stock  options.  Incentive  stock  options  must  comply  with the
requirements  of the Internal  Revenue  Code (the Code),  may be granted only to
employees and may be granted at not less than the fair market value of the stock
at the date of grant.  Nonqualified  options  may be  granted to  employees  and
consultants  at not less than 85% of the fair  market  value of the stock at the
date of grant. Canceled options are available for future grant.



<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


The following table summarizes the activity for the aforementioned  stock option
plans:

                                                Number of        Price per
                                                 Shares            Share
                                                --------       --------------

Outstanding at December 31, 1993                 150,000       $    2.22
  Granted                                        105,000         4.00 -  8.00
  Exercised                                      (37,500)           2.22
  Canceled                                       (12,900)           2.22
                                                --------       --------------
Outstanding at December 31, 1994                 204,600         2.22 -  8.00
  Granted                                        196,500         2.22 - 10.00
  Exercised                                      (26,850)           2.22
  Canceled                                       (22,237)        2.22 -  8.00
                                                --------       --------------
Outstanding at December 31, 1995                 352,013         2.22 - 10.00
  Granted                                        197,225         9.00 - 10.00
  Exercised                                      (11,128)           2.22
  Canceled                                      (115,547)        2.22 - 10.00
                                                --------       --------------
Outstanding at December 31, 1996                 422,563       $ 2.22 - 10.00
                                                ========       ==============

For all four plans,  there were 214,459 shares of unissued Common Stock reserved
for issuance at December 31, 1996.  Options to purchase  89,177 shares of Common
Stock were exercisable at December 31, 1996.

Employee Stock Purchase Plan
----------------------------

In June 1994, the Board of Directors  adopted and the  shareholders  approved an
Employee  Stock  Purchase  Plan (the ESPP).  Under the ESPP,  150,000  shares of
Common Stock have been reserved for issuance to and purchase by employees of the
Company.  All  employees  with over four months of service who work more than 20
hours per week and who do not own stock  and stock  options  for more than 5% of
the  Company's  stock are  eligible  to  participate  in the  ESPP.  The ESPP is
intended to qualify as an "employee  stock  purchase  plan" under Section 423 of
the Internal Revenue Code (the Code). Under that section of the Code,  employees
may not be granted options if,  immediately after the grant, such employee would
own stock or hold options to purchase stock  possessing 5% or more of the voting
power or value of all stock of the  Company,  nor may any  participant  purchase
Common Stock having a fair market value exceeding  $25,000 in any calendar year.
As of December 31, 1996, no shares had been issued or purchased under the ESPP.

Statement Financial Accounting Standards No. 123
------------------------------------------------

During 1995,  the  Financial  Accounting  Standards  Board  issued  Statement of
Financial  Accounting  Standards  No.  123  (SFAS  123),  which  defines  a fair
value-based  method of accounting for an employee stock option or similar equity
instrument  and  encourages  all entities to adopt that method of accounting for
all of their  employee  stock  compensation  plans.  However,  it also allows an
entity to continue to measure compensation cost for those plans using the method
of accounting  prescribed by APB 25. Entities  electing to retain the accounting
treatment  in APB 25 must make pro  forma  disclosures  of net  income  and,  if
presented,  earnings per share, as if the fair value-based  method of accounting
defined in SFAS 123 had been applied.


<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


The Company has elected to account for its stock-based  compensation plans under
APB 25; however,  the Company has computed for pro forma disclosure purposes the
value of all  options  granted  during  1996 and 1995  using  the  Black-Scholes
option-pricing  model as  prescribed  by SFAS 123 using the  following  weighted
average assumptions for grants:

                                             1996         1995
                                           -------      -------

     Average risk-free interest rate         6.36%        6.45%
     Expected dividend yield                 0.00%        0.00%
     Expected lives                        5 years      5 years
     Expected volatility                    63.13%       63.13%

The  total  value of  options  granted  during  1996 and  1995 was  computed  as
approximately $994 and $1,025,  respectively,  which would be amortized on a pro
forma basis over the five-year vesting period of the options. If the Company had
accounted for these plans in accordance  with SFAS 123, the Company's net income
and pro forma net income (loss) per share would have been as follows:

                                  1996                          1995
                       -------------------------     ---------------------------
                       As Reported     Pro Forma     As Reported       Pro Forma
                       -----------     ---------     -----------       ---------

Net income (loss)         $204           $(200)          $211            $ 6
Net income (loss)
  per share                .09            (.09)           .14            .00


9.  STOCK SUBSCRIPTION NOTES RECEIVABLE:
    -----------------------------------

During December 1993, upon exercise of incentive stock options by an officer and
by a key employee,  the Company issued 75,000 shares of Common Stock in exchange
for notes. On January 4, 1994, a key employee exercised  incentive stock options
for 37,500 shares of Common Stock in exchange for notes. The notes bear interest
at the rate of 8.5% per annum from the dates of exercise, and are due in full on
December 31, 1998.

During  January 1995, an officer  exercised  incentive  stock options for 26,250
shares of Common  Stock in exchange  for notes.  The notes bear  interest at the
rate of 8.5% per annum from the date of exercise and are due in full on December
31, 1999.

The notes  provide  that in the event any of the stock is sold  before the notes
mature,  all accrued  interest and a pro rata portion of the  principal  balance
must be paid.  During  1996,  the key  employee  sold  25,000  shares and repaid
$84,000,  which represented all accrued interest and the pro rata portion of the
principal balance.



<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


10.  RETIREMENT PLAN:
     ---------------

Effective on May 1, 1994, the Company  adopted a tax deferred  savings plan (the
401(k) Plan). All employees with over six months service and who work an average
of 30 hours per week or more are  eligible to  participate  in the 401(k)  Plan.
Participants  who choose to participate may contribute up to 20% of their pretax
compensation  to the 401(k) Plan subject to the  statutorily  prescribed  annual
limits. All contributions to the 401(k) Plan,  including Company  contributions,
are fully vested and nonforfeitable at all times. The Company made contributions
of $16, $10 and $3 during 1996, 1995 and 1994, respectively.

11.  STATEMENTS OF CASH FLOWS:
     ------------------------

The Company made the following cash payments:

                                                  1996     1995     1994
                                                  ----     ----     ----

Interest (includes $20, $35 and $40
  paid to related parties)                        $ 75     $134      $71
Taxes                                              128       32        -

Noncash investing and financing activities are as follows:

                                                  1996     1995     1994
                                                  ----     ----     ----

Issuance of Common Stock                          $  -     $ 58     $ 83
Stock subscription note receivable, net             14       84       89
Issuance of treasury stock to related
  parties in satisfaction of dividends
  payable and long-term debt obligations             -        -      132
Reduction of other assets and stock
  subscription note receivable interest
  in lieu of dividend payments                       -        -       22


12.  STOCKHOLDERS' EQUITY:
     --------------------

Initial Public Offering
-----------------------

On September  25, 1996,  the Company  completed its initial  public  offering in
which it raised $11,025 through the issuance of 1,225,000 shares of Common Stock
at $9.00 per share.  The  Company's  proceeds from the initial  public  offering
included in the financial statements are net of offering costs.

As part of the initial public  offering,  the Company also issued warrants which
entitles  the holders to purchase  122,500  shares of Common Stock at $10.80 per
share.  The warrants are  exercisable  for a period of four years  beginning one
year from the date of the initial public offering.  The warrants are callable by
the Company upon 90 days notice  following the first time when the closing price
of the Common Stock exceeds $15.12 per share for 30 consecutive days.



<PAGE>

                              COFFEE PEOPLE, INC.
                              -------------------

                   NOTES TO FINANCIAL STATEMENTS (continued)
                   -----------------------------------------
                 (Dollars in thousands, except per share data)


Private Placement
-----------------

In January 1996, the Company  completed a private placement of equity securities
in which it raised $3,975 through the issuance of 596,250 shares of Common Stock
at $6.67 per share. The Company's  proceeds from the private placement of equity
securities  included in the financial  statements are net of offering  costs. As
part of the private placement,  the Company also issued a warrant which entitles
the holder to purchase  135,000  shares of the Company's  Common Stock at $8 per
share any time within 10 years; however, the warrant will lapse if not exercised
within one year of the closing date of the Company's initial public offering.

Direct Public Offering
----------------------

During 1994, the Company  completed a direct public offering under  Regulation A
of the  Securities  Act of 1933,  as amended,  in which the Company sold 107,704
shares of Common Stock at $8 per share.  The Company's  proceeds from the direct
public offering included in the financial statements are net of offering costs.

13.  RELATED PARTY TRANSACTIONS:
     --------------------------

As of December 31, 1996,  the Company had a lease with a  stockholder,  who is a
director of the Company.

During 1996, the Company purchased  approximately $133 of product from a company
that is 50% owned by a  stockholder,  who is a  director  and an  officer of the
Company.

14.  STOCK SPLIT:
     -----------

On July 26, 1996,  the Board of Directors  approved a 3-for-2  stock split.  The
effect of this stock split has been  retroactively  reflected in these financial
statements and notes for all periods presented.

15.  SUBSEQUENT EVENTS:
     -----------------

In January 1997, the Company opened a new store in Huntington Beach, California.


<PAGE>

                                   SIGNATURES


     In accordance  with Section 13 or 15(d) of the  Securities  Exchange Act of
1934,  the  Registrant  caused  this  report to be  signed on its  behalf by the
undersigned, thereunto duly authorized.


                                   COFFEE PEOPLE, INC.



Dated March 26, 1997               By: /s/ James L. Roberts
                                      ----------------------------
                                      James L. Roberts, Chairman
                                      and Chief Executive Officer



     In accordance  with 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.


                                   /s/ James L. Roberts
Dated March 26, 1997               ------------------------------------
                                   James L. Roberts, Chairman and
                                   Chief Executive Officer and Director


                                   /s/ Taylor H. Devine
Dated March 26, 1997               ------------------------------------
                                   Taylor H. Devine, President and
                                   Chief Operating Officer and Director


                                   /s/ Kenneth B. Ross
Dated March 26, 1997               ------------------------------------
                                   Kenneth B. Ross, Chief Financial
                                   Officer (Principal Financial and
                                   Accounting Officer)



Dated March ___, 1997              ------------------------------------
                                   Douglas L. Ayer, Director


                                   /s/ Jeffrey M. Ferguson
Dated March 26, 1997               ------------------------------------
                                   Jeffrey M. Ferguson, Director


                                   /s/ Gary G. Talboy
Dated March 26, 1997               ------------------------------------
                                   Gary G. Talboy, Director


<PAGE>


                                  EXHIBIT INDEX


(a)  Exhibits

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

3.1            Registrant's   Restated   Articles   of   Incorporation
               (Incorporated  by  reference  to  Exhibit  3.1  to  the
               Company's   Registration   Statement   on  Form   SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

3.2            Registrants'   Bylaws,  as  amended   (Incorporated  by
               reference to Exhibit 3.2 to the Company's  Registration
               Statement on Form SB-2,  effective  September  25, 1996
               (Registration No. 333-5376-LA)).

4              See Article 2 of Exhibit 3(i) and Article II of Exhibit
               3(ii)

10.1*          Registrant's  1993 Stock Option Plan  (Incorporated  by
               reference to Exhibit 10.1 to the Company's Registration
               Statement on Form SB-2,  effective  September  25, 1996
               (Registration No. 333-5376-LA)).

10.2*          Registrant's  1994 Stock Option Plan  (Incorporated  by
               reference to Exhibit 10.2 to the Company's Registration
               Statement on Form SB-2,  effective  September  25, 1996
               (Registration No. 333-5376-LA)).

10.3*          Registrant's  1995 Stock Option Plan  (Incorporated  by
               reference to Exhibit 10.3 to the Company's Registration
               Statement on Form SB-2,  effective  September  25, 1996
               (Registration No. 333-5376-LA)).

10.4*          Registrant's  1996 Stock Option Plan  (Incorporated  by
               reference to Exhibit 10.4 to the Company's Registration
               Statement on Form SB-2,  effective  September  25, 1996
               (Registration No. 333-5376-LA)).

10.5*          Form of  Incentive  Stock Option  Agreement  related to
               1993,   1994,   1995  and  1996  Stock   Option   Plans
               (Incorporated  by  reference  to  Exhibit  10.5  to the
               Company's   Registration   Statement   on  Form   SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

<PAGE>


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


10.6*          Form of Nonstatutory  Stock Option Agreement related to
               1993,   1994,   1995  and  1996  Stock   Option   Plans
               (Incorporated  by  reference  to  Exhibit  10.6  to the
               Company's   Registration   Statement   on  Form   SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

10.7*          Registrant's Employee Stock Purchase Plan (Incorporated
               by  reference   to  Exhibit   10.7  to  the   Company's
               Registration   Statement   on  Form   SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.8           Supply   Agreement  dated  February  17,  1997  between
               Registrant and Coffee Bean International, Inc.**

10.9           Form of Indemnity Agreement  (Incorporated by reference
               to Exhibit 10.9 to the Company's Registration Statement
               on   Form   SB-2,    effective   September   25,   1996
               (Registration No. 333-5376-LA)).

10.10          Business Loan  Agreement  with Bank of America NT & SA,
               dated  August 3,  1995,  as  amended  (Incorporated  by
               reference   to   Exhibit   10.10   to   the   Company's
               Registration   Statement   on  Form   SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.10(a)       Security  Agreement with Bank of America NT & SA, dated
               August 3, 1995  (Incorporated  by  reference to Exhibit
               10.10(a)) to the  Company's  Registration  Statement on
               Form SB-2,  effective  September 25, 1996 (Registration
               No. 333-5376-LA)).

10.11*         Employment Agreement with James L. Roberts, Chairman of
               the Board and Chief Executive Officer  (Incorporated by
               reference   to   Exhibit   10.11   to   the   Company's
               Registration   Statement   on  Form   SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.12*         Employment  Agreement with Taylor H. Devine,  President
               and Chief Operating Officer  (Incorporated by reference
               to  Exhibit   10.12  to  the   Company's   Registration
               Statement on Form SB-2,  effective  September  25, 1996
               (Registration No. 333-5376-LA)).

10.13*         Employment  Agreement  with  Matthew  J.  Kimble,  Vice
               President--Human Relations.

<PAGE>

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

10.14*         Employment   Agreement  with  Steven  P.  Crantz,  Vice
               President--Development  (Incorporated  by  reference to
               Exhibit 10.14 to the Company's  Registration  Statement
               on   Form   SB-2,    effective   September   25,   1996
               (Registration No. 333-5376-LA)).

10.15          Redemption agreement, dated January 4, 1993 between the
               Registrant   and  Gary  G.  Talboy   (Incorporated   by
               reference   to   Exhibit   10.15   to   the   Company's
               Registration   Statement   on  Form   SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.15(a)       Promissory Note, dated January 4, 1993, payable to Gary
               G.  Talboy in  original  principal  amount of  $245,000
               (Incorporated by reference to Exhibit  10.15(a)) to the
               Company's   Registration   Statement   on  Form   SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

10.16          Redemption  Agreement,  dated January 4, 1993,  between
               the Registrant and Jeffrey M. Ferguson (Incorporated by
               reference   to   Exhibit   10.16   to   the   Company's
               Registration   Statement   on  Form   SB-2,   effective
               September 25, 1996 (Registration No. 333-5376-LA)).

10.16(a)       Promissory  Note,  dated  January 4,  1993,  payable to
               Jeffrey M.  Ferguson  in original  principal  amount of
               $245,000   (Incorporated   by   reference   to  Exhibit
               10.16(a)) to the  Company's  Registration  Statement on
               Form SB-2,  effective  September 25, 1996 (Registration
               No. 333-5376-LA)).

10.17          Security  Agreement,  dated January 4, 1993,  among the
               Registrant,  Jeffrey  M.  Ferguson  and Gary G.  Talboy
               (Incorporated  by  reference  to  Exhibit  10.17 to the
               Company's   Registration   Statement   on  Form   SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

10.18          Food and Beverage  Concession  Lease  Agreement;  dated
               June 10, 1994,  between the  Registrant and the Port of
               Portland (Incorporated by reference to Exhibit 10.18 to
               the  Company's  Registration  Statement  on Form  SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

<PAGE>


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

10.19          Common Stock  Purchase  Agreement,  dated as of January
               11, 1996,  among the Registrant and certain  purchasers
               (Incorporated  by  reference  to  Exhibit  10.19 to the
               Company's   Registration   Statement   on  Form   SB-2,
               effective   September   25,  1996   (Registration   No.
               333-5376-LA)).

10.20          Warrant  Agreement,  dated  as  of  January  23,  1996,
               between  the  Registrant  and   International   Capital
               Partners,  Inc.  (Incorporated  by reference to Exhibit
               10.20 to the Company's  Registration  Statement on Form
               SB-2,  effective  September 25, 1996  (Registration No.
               333-5376-LA)).

11             Statement Regarding Computation of Per Share Earnings.

23             Consent  of Arthur  Andersen  LLP,  Independent  Public
               Accountants.

27             Financial Data Schedule