Peets Coffee & Tea (PEET) 10-Q 2006 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

__________

FORM 10-Q

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

For the quarterly period ended October 2, 2005

OR

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

Commission file number 000-32233

PEET'S COFFEE & TEA, INC.

(Exact Name of Registrant as Specified in Its Charter)

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

1400 Park Avenue

Emeryville, California 94608-3520

(Address of Principal Executive Offices) (Zip Code)

(510) 594-2100

(Registrant's Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Securities Exchange Act Rule 12b-2). Yes [X] No [ ]

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, no par value	14,027,558
(Class)	(Outstanding at November 8, 2005)

	PEET'S COFFEE & TEA, INC.
	INDEX
PART I	Financial Information
Item 1.	Financial Statements	3
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16
Item 4.	Controls and Procedures	17
PART II	Other Information
Item 6.	Exhibits	17
	Signatures	18

2

PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PEET’S COFFEE & TEA, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except share amounts)
	October 2,			January 2,
	2005			2005
ASSETS
Current assets
Cash and cash equivalents	$	13,900		$	11,356
Short-term marketable securities		49,750			-
Accounts receivable, net		4,928			4,136
Inventories		20,751			12,614
Deferred income taxes		1,434			1,403
Prepaid expenses and other		4,715			2,280
Total current assets		95,478			31,789
Long-term marketable securities		1,767			52,057
Property and equipment, net		44,996			40,588
Intangible and other assets, net		3,718			3,455
Total assets	$	145,959		$	127,889
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable	$	5,307		$	5,710
Accrued compensation and benefits		6,116			4,266
Deferred revenue		2,259			2,394
Other accrued liabilities		2,673			3,372
Total current liabilities		16,355			15,742
Deferred income taxes		879			838
Deferred lease credits and other long-term liabilities		2,401			2,182
Total liabilities		19,635			18,762
Shareholders' equity
Common stock, no par value; authorized 50,000,000 shares;
issued and outstanding: 14,015,000 and 13,500,000 shares		102,979			93,091
Accumulated other comprehensive loss, net of tax		(90	)		(152	)
Retained earnings		23,435			16,188
Total shareholders' equity		126,324			109,127
Total liabilities and shareholders' equity	$	145,959		$	127,889
See notes to consolidated financial statements.

3

PEET’S COFFEE & TEA, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in thousands, except per share amounts)
	Thirteen weeks ended				Thirty-nine weeks ended
	October 2,		September 26,		October 2,		September 26,
	2005		2004		2005		2004
Retail stores	$	28,719	$	23,917	$	84,577	$	70,063
Specialty sales		14,135		10,549		39,988		30,550
Net revenue		42,854		34,466		124,565		100,613
Operating expenses:
Cost of sales and related occupancy expenses		19,671		16,143		56,568		46,355
Operating expenses		14,868		11,903		42,731		34,260
Marketing and advertising expenses		1,103		762		2,675		2,613
Depreciation and amortization expenses		1,864		1,487		5,365		4,166
General and administrative expenses		2,122		1,221		6,432		4,724
Total operating costs and expenses		39,628		31,516		113,771		92,118
Income from operations		3,226		2,950		10,794		8,495
Investment income, net		421		227		1,176		655
Income before income taxes		3,647		3,177		11,970		9,150
Income tax provision		1,431		1,168		4,723		3,557
Net income	$	2,216	$	2,009	$	7,247	$	5,593
Net income per share:
Basic	$	0.16	$	0.15	$	0.53	$	0.42
Diluted	$	0.15	$	0.14	$	0.50	$	0.40
Shares used in calculation of net income per share:
Basic		13,949		13,420		13,754		13,269
Diluted		14,658		14,115		14,421		13,915
See notes to consolidated financial statements.

4

PEET’S COFFEE & TEA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
	Thirty-nine weeks ended
	October 2,	September 26,
	2005	2004
Cash flows from operating activities:
Net income	$ 7,247	$ 5,593
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization	6,327	4,983
Tax benefit from exercise of stock options	3,185	2,843
Loss on disposition of assets and asset impairment	445	7
Other	88	181
Changes in other assets and liabilities:
Accounts receivable	(792)	(277)
Inventories	(8,137)	(4,162)
Prepaid expenses and other current assets	(2,435)	(31)
Other assets	(119)	484
Accounts payable and accrued liabilities	709	(1,109)
Deferred lease credits and other long-term liabilities	219	525
Net cash provided by operating activities	6,737	9,037
Cash flows from investing activities:
Purchases of property and equipment	(11,130)	(10,576)
Proceeds from sales of property and equipment	51	9
Changes in restricted investments	(250)	(1,550)
Proceeds from sales and maturities of marketable securities	41,244	71,180
Purchases of marketable securities	(40,696)	(94,867)
Net cash used in investing activities	(10,781)	(35,804)
Cash flows from financing activities:
Net proceeds from issuance of common stock	6,684	4,935
Purchase of common stock	-	(4,631)
Bank overdrafts	(96)	-
Repayment of debt	-	(3)
Net cash provided by financing activities	6,588	301
Increase (decrease) in cash and cash equivalents	2,544	(26,466)
Cash and cash equivalents, beginning of period	11,356	30,263
Cash and cash equivalents, end of period	$ 13,900	$ 3,797
See notes to consolidated financial statements.

5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED

1. BASIS OF PRESENTATION

The accompanying consolidated financial statements of Peet’s Coffee & Tea, Inc. and its subsidiaries (collectively, the “Company”) as of October 2, 2005 and for the thirteen and thirty-nine weeks ended October 2, 2005 and September 26, 2004 are unaudited and, in the opinion of management, contain all adjustments (consisting only of normal recurring items) necessary to present fairly the financial position and results of operations for such periods. These financial statements have been prepared using the same accounting policies as, and should be read in conjunction with, the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended January 2, 2005. The January 2, 2005 balance sheet has been derived from the year end financial statements. The results of operations for the thirteen and thirty-nine weeks ended October 2, 2005 are not necessarily indicative of the results expected for the full year.

The Company has changed the classification of restricted investments on the consolidated statement of cash flows, which had the affect of increasing cash flows from operations and decreasing cash flows from investing activities by $1.6 million for the thirty-nine weeks ended September 26, 2004.

2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Stock-Based Compensation

The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principle Board No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). Accordingly, no compensation cost has been recognized for the stock option awards granted at fair market value. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), requires the disclosure of pro forma net income and net income per share as if the Company had adopted the fair value method. Had compensation cost for the Company’s stock option plans and employee stock purchase plan been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company’s net income and net income per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):

	Thirteen weeks ended						Thirty-nine weeks ended
	Oct. 2, 2005			Sept. 26, 2004			Oct. 2, 2005			Sept. 26, 2004
Net income - as reported	$	2,216		$	2,009		$	7,247		$	5,593
Stock-based employee compensation included in
reported net income, net of tax		6			15			10			46
Stock-based compensation expense determined
under fair value based method, net of tax		(772	)		(955	)		(3,257	)		(3,333	)
Net income - pro forma	$	1,450		$	1,069		$	4,000		$	2,306
Basic net income per share - as reported	$	0.16		$	0.15		$	0.53		$	0.42
Basic net income per share - pro forma	$	0.10		$	0.08		$	0.29		$	0.17
Diluted net income per share - as reported	$	0.15		$	0.14		$	0.50		$	0.40
Diluted net income per share - pro forma	$	0.10		$	0.08		$	0.28		$	0.17

During the thirteen and thirty-nine weeks ended October 2, 2005, 0 and 300,000, respectively, options vested subject to acceleration provisions based on stock price appreciation, resulting in $1.1 million of the pro forma adjustment for the thirty-nine week period. The Company has no additional outstanding options subject to acceleration provisions based on stock price appreciation.

6

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

	Options Granted for the Thirty-nine Week Period Ended
	Oct. 2,			Sept. 26,
	2005			2004
Expected dividend rate		0.00	%		0.00	%
Expected volatility
- Options		39.5	%		44.2	%
- ESPP awards		27.3	%		52.3	%
Risk-free interest rate
- Options		3.8	%		4.0	%
- ESPP awards		3.3	%		1.3	%
Expected lives (years)
- Options		3.6			5.2
- ESPP awards		0.5			1.3

Comprehensive Income

For the thirteen weeks ended October 2, 2005 and September 26, 2004, comprehensive income was $2,256,000 and $2,113,000, respectively. For the thirty-nine weeks ended October 2, 2005 and September 26, 2004, comprehensive income was $7,309,000 and $5,492,000, respectively. Comprehensive income consists of net income and net unrealized gains and losses on investments.

Net Income per Share

The following table summarizes the differences between basic weighted average shares outstanding and diluted weighted average shares outstanding used to compute diluted net income per share (in thousands):

	Thirteen weeks ended				Thirty-nine weeks ended
	Oct. 2, 2005		Sept. 26, 2004		Oct. 2, 2005		Sept. 26, 2004
Basic weighted average shares outstanding		13,949		13,420		13,754		13,269
Incremental shares from assumed exercise
of stock options		709		695		667		646
Diluted weighted average shares outstanding		14,658		14,115		14,421		13,915

The number of incremental shares from the assumed exercise of stock options was calculated by applying the treasury stock method.

For the thirteen weeks ended October 2, 2005 and September 26, 2004, 5,063 and 0 anti-dilutive options, respectively, and for the thirty-nine weeks ended October 2, 2005 and September 26, 2004, 1,688 and 211,495 anti-dilutive options, respectively, were excluded from the computation of diluted weighted average shares outstanding.

7

Recently Issued Accounting Standards

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires companies to (1) use fair value to measure stock-based compensation awards and (2) cease using the intrinsic value method of accounting used by the Company. Compensation cost based on the fair value of the award will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). The Company will adopt SFAS 123(R) beginning January 2, 2006, as required, and expects to adopt the standard using the modified prospective method requiring the Company to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards outstanding as of the date of adoption. Until a final decision is made, however, the Company will continue to review alternatives and might ultimately choose another reporting method. Management is currently evaluating its valuation methodology and forfeiture rates, as well as various compensation strategies, and has not determined the effect that the new standard will have on future period financial statements. The Company believes that the adoption of SFAS 123(R) will have a significant impact on its financial statements.

3.MARKETABLE SECURITIES

The Company’s short and long-term marketable securities balances include U.S. government, agency, municipal and guaranteed student loan obligations, and are classified as available-for-sale. Gains and losses are due to fluctuations in interest rates and are considered temporary impairments as management has the intent and ability to hold the securities to recovery.

As of October 2, 2005, the Company reclassified marketable securities with remaining maturities of less than one year to short-term marketable securities as they are available for current operations.  Previously all marketable securities were classified as long-term.

4.    INVENTORIES

The Company’s inventories consist of the following:

	Oct. 2,		Jan. 2,
	2005		2005
Raw materials	$	14,283	$	7,416
Finished goods		6,468		5,198
Total	$	20,751	$	12,614

5.SEGMENT INFORMATION

The Company operates in two reportable segments: retail and specialty sales. Retail store operations consist of sales of whole bean coffee, beverages, tea and related products through Company-operated retail stores. Specialty sales consists of whole bean coffee and related product sales through grocery, home delivery, foodservice and office coffee accounts.

8

The following table presents certain financial information for each segment. Segment income before taxes excludes unallocated marketing expenses, general and administrative expenses, and investment income, net. Unallocated assets include cash and cash equivalents, coffee inventory in the warehouse, corporate headquarter, roasting plant, intangible and other assets.

	Retail					Specialty					Unallocated			Total
			Percent of					Percent of								Percent of
	Amount		Net Revenue			Amount		Net Revenue						Amount		Net Revenue
Thirteen weeks ended October 2, 2005:
Net revenue	$	28,719		100.0	%	$	14,135		100.0	%				$	42,854		100.0	%
Cost of sales and occupancy		13,002		45.3	%		6,669		47.2	%					19,671		45.9	%
Operating expenses		12,110		42.2	%		2,758		19.5	%					14,868		34.7	%
Depreciation and amortization		1,311		4.6	%		386		2.7	%	$	167			1,864		4.3	%
Segment operating income		2,296		8.0	%		4,322		30.6	%		(3,392	)		3,226		7.5	%
Investment income, net												421			421
Income before income taxes															3,647
Total assets		35,105					11,063					99,791			145,959
Capital expenditures		4,128					226					292			4,646
Thirteen weeks ended September 26, 2004:
Net revenue	$	23,917		100.0	%	$	10,549		100.0	%				$	34,466		100.0	%
Cost of sales and occupancy		11,095		46.4	%		5,048		47.9	%					16,143		46.9	%
Operating expenses		9,672		40.4	%		2,231		21.1	%					11,903		34.5	%
Depreciation and amortization		1,065		4.5	%		270		2.6	%	$	152			1,487		4.3	%
Segment operating income		2,085		8.7	%		3,000		28.4	%		(2,135	)		2,950		8.6	%
Investment income, net												227			227
Income before income taxes															3,177
Total assets		27,079					8,169					83,249			118,497
Capital expenditures		3,332					964					478			4,774
Thirty-nine weeks ended October 2, 2005:
Net revenue	$	84,577		100.0	%	$	39,988		100.0	%				$	124,565		100.0	%
Cost of sales and occupancy		37,645		44.5	%		18,923		47.3	%					56,568		45.4	%
Operating expenses		34,837		41.2	%		7,894		19.7	%					42,731		34.3	%
Depreciation and amortization		3,750		4.4	%		1,129		2.8	%	$	486			5,365		4.3	%
Segment operating income		8,345		9.9	%		12,042		30.1	%		(9,593	)		10,794		8.7	%
Investment income, net												1,176			1,176
Income before income taxes															11,970
Total assets		35,105					11,063					99,791			145,959
Capital expenditures		8,986					1,067					1,077			11,130
Thirty-nine weeks ended September 26, 2004:
Net revenue	$	70,063		100.0	%	$	30,550		100.0	%				$	100,613		100.0	%
Cost of sales and occupancy		31,598		45.1	%		14,757		48.3	%					46,355		46.1	%
Operating expenses		27,354		39.0	%		6,906		22.6	%					34,260		34.1	%
Depreciation and amortization		2,945		4.2	%		779		2.5	%	$	442			4,166		4.1	%
Segment operating income		8,166		11.7	%		8,108		26.5	%		(7,779	)		8,495		8.4	%
Investment income, net												655			655
Income before income taxes															9,150
Total assets		27,079					8,169					83,249			118,497
Capital expenditures		7,712					1,365					1,499			10,576

9

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

                        RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our financial statements and related notes included elsewhere in this report. Except for historical information, the discussion in this report contains certain forward-looking statements that involve risks and uncertainties. We have based these forward-looking statements on our current expectations and assumptions about future events. In some cases, you can identify forward-looking statements by terminology, such as “may,”“should,”“could,”“predict,”“potential,”“continue, “expect,”“anticipate,”“future,”“intend,”“plan,”“believe,”“estimate,”“forecast” and similar expressions (or the negative of such expressions). These statements are based on our current beliefs, expectations and assumptions and are subject to a number of risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors including but not limited to, coffee and other raw material prices and availability, successful execution of business strategies and plans for expansion, competition, general economic conditions, the popularity of specialty coffee due to consumer trends, labor relations, health factors or other issues, as well as other risk factors as described more fully in our Annual Report on Form 10-K for the year ended January 2, 2005. Forward-looking statements speak only as of the date of this report.

COMPANY OVERVIEW AND INDUSTRY OUTLOOK

Peet’s is a specialty coffee roaster and marketer of fresh, deep-roasted whole bean coffee sold through multiple channels of distribution for home and office enjoyment.  Founded in Berkeley, California in 1966, Peet’s has established a loyal customer base with strong brand awareness in California.  Our national expansion strategy is based on the sale of whole bean coffee in multiple channels of distribution including grocery, home delivery, office and food service accounts and Company-owned stores throughout the United States.  Our current expansion strategy is focused in the western United States, where we have strong customer awareness, loyalty and brand affinity.    

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

Our operations are vertically integrated.  We purchase high quality Arabica coffee beans from countries around the world and use our artisan-roasting technique to bring out the distinctive flavor of our coffees. Because roasted coffee is perishable, we are committed to delivering our coffee under the strictest freshness standards. We roast to order and ship fresh coffee daily to our stores and customers.  Control of purchasing, roasting, packaging and distribution of our coffee allows us to maintain our commitment to freshness, is cost effective, and enhances our margins and profit potential.

Our coffee and related items are sold through two segments as defined under SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information.  These segments are Company-operated retail outlets and specialty sales, consisting of home delivery (on-line and mail order), grocery, food service and office.  We evaluate segment performance primarily based on revenue and segment operating income. 

The Company’s adoption of SFAS No. 123(R) beginning January 2, 2006 is expected to have a significant effect on our 2006 financial statements. See the discussion under Recently Issued Accounting Standards in Note 2 of the “Notes to Consolidated Financial Statements”. Management is currently evaluating the methodology and assumptions for valuing share-based payments. The amount of expense that will be recognized in our financial statements will depend on these decisions.  Since the Company has used share-based payments broadly across all employees, these expenses will be reported in cost of sales, operating, and general and administrative expenses.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

10

We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change.

Our accounting policies are more fully described in Note 2 of the “Notes to the Consolidated Financial Statements,” included in our Annual Report on Form 10-K for the year ended January 2, 2005. These accounting policies are applied consistently for all periods presented. We have identified the following critical accounting policies:

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

§   Long-lived assets. We evaluate the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount might not be recoverable. If the fair value is less than the carrying amount of the asset, a loss is recognized for the difference. We believe at this time that the long-lived assets’ carrying values and useful lives continue to be appropriate.

§   Accrued workers’ compensation. We record an estimated liability for the self-insured portion of our workers’ compensation insurance program. The liability of $1.9 million recorded as of October 2, 2005 is determined based on information received from our insurance carrier including claims paid, filed and reserved for, historical experience, as well as an estimate for claims incurred but not reported. Should a greater or lesser amount of claims occur compared to what is estimated or the settlement costs increase or decrease beyond what was anticipated, the recorded liability may need to be adjusted.

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

§   Stock-based compensation. The Company has chosen to account for stock-based awards to employees using the intrinsic value method in accordance with APB No. 25. Information about the impact on our operating results of using the alternative of SFAS No. 123 is included in Note 2 of the “Notes to Consolidated Financial Statements”. As discussed above, the Company’s adoption of SFAS 123(R) beginning January 2, 2006 is expected to have a significant effect on our 2006 financial statements.

§   Lease accounting. Certain of the Company’s lease agreements provide for stated scheduled rent increases during the term of the lease. Rent is expensed on a straight-line basis over the lease term, beginning with the Company’s right to occupy the space, which may or may not coincide with the commencement date of the lease. If the original lease term is less than the Company’s anticipated rental period, one or more stated option terms are included in the straight-line computation.

11

RESULTS OF OPERATIONS

The following discussion of results of operations should be read in conjunction with our financial statements and accompanying notes and other financial data included elsewhere in this report. The following table sets forth certain financial data for the periods indicated.

	Thirteen weeks ended						Thirty-nine weeks ended
	Oct 2,			Sep 26,			Oct 2,			Sep 26,
	2005			2004			2005			2004
Statement of operations data as a percent of net revenue:
Net revenue		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales and related occupancy expenses		45.9			46.9			45.4			46.1
Operating expenses		34.7			34.5			34.3			34.1
Marketing and advertising expenses		2.6			2.2			2.1			2.6
General and administrative expenses		5.0			3.5			5.2			4.7
Depreciation and amortization expenses		4.3			4.3			4.3			4.1
Income from operations		7.5			8.6			8.7			8.4
Investment income, net		1.0			0.6			0.9			0.7
Income before income taxes		8.5			9.2			9.6			9.1
Income tax provision		(3.4	)		(3.4	)		(3.8	)		(3.5	)
Net income		5.1	%		5.8	%		5.8	%		5.6	%
Percent of net revenue by business segment:
Retail stores		67.0	%		69.4	%		67.9	%		69.6	%
Specialty sales		33.0			30.6			32.1			30.4
Percent of net revenue by business category:
Whole bean coffee and related products		56.2	%		57.1	%		56.6	%		58.1	%
Beverages and pastries		43.8			42.9			43.4			41.9
Cost of sales and related occupancy expenses as a percent of segment revenue:
Retail stores		45.3	%		46.4	%		44.5	%		45.1	%
Specialty sales		47.2			47.9			47.3			48.3
Operating expenses as a percent of segment revenue:
Retail stores		42.2	%		40.4	%		41.2	%		39.0	%
Specialty sales		19.5			21.1			19.7			22.6
Percent increase (decrease) from prior year:
Net revenue		24.3	%		19.5	%		23.8	%		17.9	%
Retail stores		20.1			15.5			20.7			13.4
Specialty sales		34.0			29.8			30.9			29.9
Cost of sales and related occupancy expenses		21.9			21.3			22.0			18.0
Operating expenses		24.9			26.3			24.7			21.6
Marketing and advertising expenses		44.8			(20.5	)		2.4			(22.2	)
General and administrative expenses		73.8			(74.9	)		36.2			(38.8	)
Depreciation and amortization expenses		25.4			21.1			28.8			17.5

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Selected operating data:
Number of retail stores in operation:
Beginning of the period	100	82	92	75
Store openings	5	5	13	12
Store closures	0	0	0	0
End of the period	105	87	105	87

Thirteen Weeks Ended October 2, 2005 Compared to Thirteen Weeks Ended September 26, 2004

Net revenue

Net revenue for the thirteen weeks ended October 2, 2005 increased 24.3% versus the same prior year period primarily as a result of the continued expansion of our retail and specialty sales segments. Whole bean and related sales increased 22.3% to $24.1 million, mostly due to specialty sales, while beverage and pastry sales increased 27.0% to $18.8 million.

In the retail segment, revenue increased by $4.8 million primarily as a result of increased sales from the 18 stores we opened in the last 12 months and secondarily from existing stores. We opened five new stores during this quarter, all in California. Sales of whole bean coffee and related products in the retail segment increased by 8.6% to $10.2 million, while sales of beverages and pastries increased by 27.5% to $18.5 million. The growth in whole bean and related products was driven by stores we opened since last year, partially offset by declining whole bean sales in existing stores caused by the increase of availability of Peet’s coffee in grocery and new retail stores. The increase in beverage and pastry sales was primarily due to sales at the stores we opened since last year, higher traffic in existing stores, and a price increase we implemented in October 2004.

In the specialty sales segment, revenue increased $3.6 million primarily due to a $2.3 million increase in grocery sales. Grocery sales increased 53.2% over last year as we increased our volume with existing accounts and increased the number of grocery stores selling our products. We believe we continue to benefit from consumer awareness of Peet’s at neighborhood grocery stores and from our direct store delivery (“DSD”) system by having better product displays, rotation, and special offerings. In addition, we are currently in more than 3,800 grocery stores, or approximately 300 more than this time last year. In the food service channel, sales increased 35.6% primarily due to the addition of selected new accounts, such as new licensed locations at the San Francisco International Airport. In office coffee, sales increased 33.4% due to new accounts added over the last 12 months. In home delivery, sales increased 10.6% as we continued to emphasize loyalty programs that reward customers who subscribe to our recurring order programs.

Cost of sales and related occupancy expenses

Cost of sales as a percent of net revenue decreased 1.0% primarily due to the price increase in October 2004. In the retail segment, cost of sales as a percent of sales decreased by 1.1% as a result of the price increase, partially offset by the impact of new stores, where lower volumes result in higher occupancy and product costs as a percent of sales. In the specialty segment, cost of sales as a percent of net revenue decreased by 0.7% primarily due to the absence of amortization related to the Safeway slotting fee paid in 2002 that was fully amortized as of September 2004. This fee was previously recorded as a reduction of revenue, which had a negative impact on margins last year.

Operating expenses

Operating expenses were $14.9 million, or 34.7% of net revenue, compared to $11.9 million, or 34.5% of net revenue, for the same period last year. Retail operating expenses as a percent of retail revenue increased from 40.4% to 42.2% due to investments in headcount to support our growing retail operations and new store expansion, partially offset by the price increase. Specialty sales operating expenses decreased from 21.1% to 19.5% as we continued to leverage higher sales growth on a more fixed cost operating structure.

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Marketing and advertising expenses

Marketing and advertising expenses were $1.1 million, or 2.6% of net revenue, compared to $0.8 million, or 2.2% of net revenue, for the same period last year. Marketing expenses were higher as a percent of revenue primarily due incremental investments in research and the development of new promotions.

General and administrative expenses

General and administrative expenses in the current quarter were $2.1 million, or 5.0% of net revenue, compared to $1.2 million, or 3.5% for the same period last year. Last year’s amount included a $0.5 million expense reduction as a result of an adjustment to a 2003 California wage and hour lawsuit reserve. The remaining increased expense over prior year of $0.4 million was due to increases in headcount to support our growth.

Depreciation and amortization expenses

Depreciation and amortization expenses were higher compared to the same period last year due primarily to the 18 stores we opened during the last 12 months.

Investment income, net

We currently invest in U.S. government, agency, municipal and guaranteed student loan obligations. Investment income includes interest income and gains or losses from the sale of these instruments. We earned $0.4 million in interest income, compared to $0.2 million last year, primarily due to higher interest rates on our investments.

Provision for income taxes

We estimate our effective tax rate to be 39.6% for the full year, while for the quarter it was 39.2% primarily due to timing of the resolution of certain tax matters. Throughout the year, we expect variability in our quarterly tax rates as taxable events occur and exposures are re-evaluated.

Thirty-nine Weeks Ended October 2, 2005 Compared to Thirty-nine Weeks Ended September 26, 2004

Net revenue

Net revenue for the thirty-nine weeks ended October 2, 2005 increased 23.8% versus the same prior year period primarily as a result of the continued expansion of our retail and specialty sales segments. Whole bean and related sales increased 20.6% to $70.5 million, mostly due to specialty sales, while beverage and pastry sales increased 28.3% to $54.0 million.

In the retail segment, our revenue increased by $14.5 million primarily as a result of increased sales from the 18 stores we opened in the last 12 months and secondarily from existing stores. We have opened 13 new stores through the end of the period this year. Sales of whole bean coffee and related products in the retail segment increased by 9.0% to $31.3 million, while sales of beverages and pastries increased by 28.8% to $53.2 million. The growth in whole bean and related products was driven by stores we opened since last year, partially offset by declining whole bean sales in existing stores caused by the increase of availability of Peet’s coffee in grocery and new retail stores. The increase in beverage and pastry sales was primarily due to sales at the stores we opened since last year and the retail price increase in October 2004.

In the specialty sales segment, revenue increased $9.4 million primarily due to a $6.0 million increase in grocery sales. Grocery sales increased 49.4% over last year primarily as we increased our volume with existing accounts and increased the number of grocery stores selling our products. At the end of the period, Peet’s coffee was in approximately 3,800 grocery stores, or 300 more than this time last year. In the food service channel, sales increased 31.2% primarily due to the addition of selected new accounts, such as new licensed locations at the San Francisco International Airport. In office coffee, sales increased 30.4% due to new accounts added over the last 12 months. In home delivery, sales increased 11.0% as we continued to emphasize loyalty programs that reward customers who subscribe to our recurring order programs.

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Cost of sales and related occupancy expenses

Cost of sales as a percent of net revenue decreased 0.7% primarily due to the price increase in October 2004. In the retail segment, cost of sales as a percent of sales decreased by 0.6% as a result of the price increase, partially offset by the impact of new stores and increased occupancy expenses. In the specialty segment, cost of sales as a percent of net revenue decreased by 1.0% due primarily to the absence of amortization related to the Safeway slotting fee that was fully amortized as of September 2004. This fee was previously recorded as a reduction of revenue, which had a negative impact on margins.

Operating expenses

Operating expenses as a percent of net revenue for the current period were 34.3% of net revenue compared to 34.1% for the same period last year for the total company. Retail operating expenses as a percent of retail revenue increased from 39.0% to 41.2% due to investments in headcount to support our growing retail operations and new store expansion, partially offset by the price increase. Specialty sales operating expenses decreased from 22.6% to 19.7% as we continued to leverage higher sales growth on a more fixed cost operating structure.

Marketing and advertising expenses

Marketing and advertising expenses were $2.7 million, or 2.1% of net revenue, compared to $2.6 million, or 2.6% of net revenue, for the same period last year. Marketing expenses were lower as a percent of net revenue primarily due to the timing of current year spending.

General and administrative expenses

General and administrative expenses in the current period were 5.2% of net revenue, compared to 4.7% for the same period last year. The 0.5% increase over last year is due to the $0.5 million increase in income recognized last year related to the adjustment to a 2003 California wage and hour lawsuit reserve.

Depreciation and amortization expenses

Depreciation and amortization expenses were higher compared to the same period last year due primarily to the 18 stores we opened during the last 12 months.

Investment income, net

We currently invest in U.S. government, agency, municipal and guaranteed student loan obligations. Investment income includes interest income and gains or losses from the sale of these instruments. We earned $1.2 million in interest income, compared to $0.7 million last year, primarily due to higher interest rates on our investments.

LIQUIDITY AND CAPITAL RESOURCES

At October 2, 2005, we had $13.9 million in cash and cash equivalents and $51.5 million in marketable securities for a total of $65.4 million. Working capital was $79.1 million as of the end of this quarter compared to $16.0 million at January 2, 2005, largely due to the change in classification of marketable securities from long-term to short-term. 

Net cash provided by operations was $6.7 million during the first thirty-nine weeks of 2005 compared to $9.0 million in the same prior year period. Decrease in cash flow provided by operations was due to increased seasonal coffee purchases, income tax prepayments, and rent prepayments due to the timing of the end of the month. The increase in the quantity of green coffee inventory was due to business growth and increased purchases driven by the favorable market conditions at the time of commitment in 2004.

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Net cash used in investing activities was $10.8 million during 2005 compared to $35.8 million in the same prior year period. Investing activities in the current period related primarily to the purchases of property and equipment. During the prior period $23.7 million represented marketable securities net purchases from the transfer of cash.

Net cash provided by financing activities was $6.6 million during 2005 compared to $0.3 million in the same prior year period. Financing activities for the periods consisted primarily of the exercise of stock options, which was offset in the prior year period by purchases of common stock.

Our 2005 capital requirements consist primarily of expenditures relating to new store openings, remodeling of existing stores, equipment for the grocery channel, information technology enhancements and investments in our roasting plant. During the first thirty-nine weeks of 2005, we spent $11.1 million, of which $8.2 was spent on new stores. Our remaining 2005 capital expenditures are expected to be approximately $4.0 million.

The Company currently leases a facility in Emeryville, California that houses our roasting plant and corporate offices.  Due to space constraints, we are in the process of exploring alternatives to relocate the roasting plant within the San Francisco Bay Area in 2007.  Currently, our primary option is to purchase land to build a roasting plant and use our existing facility for our corporate office. Under this scenario, we estimate capital requirements to be approximately $20.0 to $25.0 million.    In anticipation of converting our existing plant to office space, we exercised our option to extend our current lease for an additional ten years, with two five year options and the ability to terminate early if needed This move will involve costs for relocation and write-offs of certain building improvements and fixtures, and will result in an increase in future depreciation and occupancy related costs.

For the next 12 months, we expect our cash flows from operations and cash and investments to be sufficient for our operating and capital requirements, our share purchase program, and our contractual obligations as they come due. Other business opportunities or store expansion rates substantially in excess of those presently planned may require outside funding.

ITEM 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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

As of October 2, 2005, we had approximately $24.4 million in open fixed-priced purchase commitments with delivery dates ranging from October 2005 through December 2007. We believe these commitments, combined with our current inventory, cover 100% of our remaining 2005 needs and 80% of our 2006 roasting requirements. We believe, based on relationships established with our suppliers that the risk of non-delivery on such purchase commitments is low.

There have been no substantial changes in the nature of our risks since January 2, 2005. Please refer to our Annual Report on Form 10-K for the year ended January 2, 2005.

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ITEM 4.          CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of October 2, 2005, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable-assurance level.

There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

PART II - OTHER INFORMATION

ITEM 6.EXHIBITS

Exhibit Number	Description
31.1	Certification of the Company's Chief Executive Officer, Patrick O'Dea, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
31.2	Certification of the Company's Chief Financial Officer, Thomas Cawley, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
32.1	Certification of the Company's Chief Executive Officer, Patrick O'Dea, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
32.2	Certification of the Company's Chief Financial Officer, Thomas Cawley, pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PEET’S COFFEE & TEA, INC.
Date: November 10, 2005	By: /s/ Thomas Cawley        Vice President, Chief Financial Officer, and Secretary

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