Peets Coffee & Tea (PEET) 10-Q 2008 Q2 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 July 1, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

Commission file number 0-32233

PEET’S COFFEE & TEA, INC.

(Exact Name of Registrant as Specified in Its Charter)

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

1400 Park Avenue

Emeryville, California 94608-3520

(Address of Principal Executive Offices)(Zip Code)

(510) 594-2100

(Registrant’s telephone number, including area code)

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

Common Stock, no par value

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

None

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 o.

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

Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o

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

As of August 5, 2007, 13,764,154 shares of registrant’s Common Stock were outstanding.

	INDEX
		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	17
Item 4.	Controls and Procedures	18
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	18
Item 4.	Submission of Matters to a Vote of Security Holders	19
Item 6.	Exhibits	19
	Signatures	19

2

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PEET’S COFFEE & TEA, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share amounts)

	July 1,			December 31,
	2007			2006
ASSETS
Current assets
Cash and cash equivalents	$	2,297		$	7,692
Short-term marketable securities		14,103			19,511
Accounts receivable, net		6,757			6,838
Inventories		25,164			19,533
Deferred income taxes - current		1,888			1,888
Prepaid expenses and other		5,972			3,852
Total current assets		56,181			59,314
Long-term marketable securities		6,387			5,989
Property and equipment, net		93,234			82,447
Deferred income taxes - non current		1,315			1,315
Other assets, net		3,824			3,940
Total assets	$	160,941		$	153,005
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and other accrued liabilities	$	8,436		$	11,046
Accrued compensation and benefits		7,580			6,389
Deferred revenue		3,848			4,625
Total current liabilities		19,864			22,060
Deferred lease credits and other long-term liabilities		4,109			3,506
Total liabilities		23,973			25,566
Shareholders' equity
Common stock, no par value; authorized 50,000,000 shares;
issued and outstanding:13,757,000 and 13,516,000 shares		99,566			93,246
Accumulated other comprehensive loss, net of tax		(24	)		(15	)
Retained earnings		37,426			34,208
Total shareholders' equity		136,968			127,439
Total liabilities and shareholders' equity	$	160,941		$	153,005

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				Twenty-six weeks ended
	July 1,		July 2,		July 1,		July 2,
	2007		2006		2007		2006
			(As restated, see Note 1)				(As restated, see Note 1)
Retail stores	$	40,963	$	33,581	$	79,986	$	66,981
Specialty sales		19,140		16,108		37,630		32,415
Net revenue		60,103		49,689		117,616		99,396
Cost of sales and related occupancy expenses		28,374		23,093		55,564		45,908
Operating expenses		21,366		17,581		41,179		34,687
General and administrative expenses		5,357		4,575		11,300		9,412
Depreciation and amortization expenses		2,586		2,095		5,316		4,077
Total costs and expenses from operations		57,683		47,344		113,359		94,084
Income from operations		2,420		2,345		4,257		5,312
Interest income		463		702		888		1,379
Income before income taxes		2,883		3,047		5,145		6,691
Income tax provision		1,081		1,140		1,927		2,532
Net income	$	1,802	$	1,907	$	3,218	$	4,159
Net income per share:
Basic	$	0.13	$	0.14	$	0.24	$	0.30
Diluted	$	0.13	$	0.13	$	0.23	$	0.29
Shares used in calculation of net income per share:
Basic		13,663		13,840		13,589		13,866
Diluted		14,077		14,549		14,003		14,579

See notes to consolidated financial statements.

4

PEET’S COFFEE & TEA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

	Twenty-six weeks ended
	July 1,			July 2,
	2007			2006
				(As restated, see Note 1)
Cash flows from operating activities:
Net income	$	3,218		$	4,160
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization		6,336			5,155
Stock-based compensation		1,445			2,251
Excess tax benefit from exercise of stock options		(887	)		(50	)
Tax benefit from exercise of stock options		842			606
Loss on disposition of assets and asset impairment		113			42
Changes in other assets and liabilities:
Accounts receivable, net		81			(53	)
Inventories		(5,631	)		(3,732	)
Prepaid expenses and other current assets		(2,120	)		(1,910	)
Other assets		59			(181	)
Accounts payable, accrued liabilities and deferred revenue		(1,116	)		(1,443	)
Deferred lease credits and other long-term liabilities		603			327
Net cash provided by operating activities		2,943			5,172
Cash flows from investing activities:
Purchases of property and equipment		(18,160	)		(10,905	)
Proceeds from sales of property and equipment		-			16
Changes in restricted investments		-			(1,969	)
Proceeds from sales and maturities of marketable securities		22,863			24,480
Purchases of marketable securities		(17,961	)		(20,129	)
Net cash used in investing activities		(13,258	)		(8,507	)
Cash flows from financing activities:
Net proceeds from issuance of common stock		4,033			2,908
Purchase of common stock		-			(6,448	)
Excess tax benefit from exercise of stock options		887			50
Net cash provided by (used in) financing activities		4,920			(3,490	)
Decrease in cash and cash equivalents		(5,395	)		(6,825	)
Cash and cash equivalents, beginning of period		7,692			20,623
Cash and cash equivalents, end of period	$	2,297		$	13,798

See notes to consolidated financial statements.

5

Peet’s Coffee & Tea, Inc.

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” or “Peet’s”) as of July 1, 2007 and for the thirteen and twenty-six weeks ended July 1, 2007 and July 2, 2006 are unaudited and, in the opinion of management, contain all adjustments, consisting only of normal recurring items, except as discussed below, necessary to present fairly the financial position and results of operations for such periods. The information included in this Quarterly Report on Form 10-Q (this “Form 10-Q”) should be read in conjunction with the Company’s annual consolidated financial statements in Peet’s Annual Report on Form 10-K for the year ended December 31, 2006 (the “2006 Form 10-K”).

The results of operations for the thirteen and twenty-six weeks ended July 1, 2007 are not necessarily indicative of the results expected for the full year.

Restatement of Unaudited Consolidated Financial Statements and Reclassifications for the 13 and 26 Weeks Ended July 2, 2006

Stock Option Grants

On October 20, 2006, the Company’s Board of Directors appointed an Option Review Committee (the “Special Committee”) consisting of two independent directors to oversee a review of the Company’s past stock option granting practices. Based on this review, the Company has determined that it used an incorrect measurement date for financial accounting purposes for a number of stock option grants. These errors resulted primarily from misapplication of accounting standards related to the determination of certain measurement dates, as discussed below, which on a number of occasions resulted in employees receiving options with stated exercise prices lower than the market prices on the appropriate measurement dates as determined by the applicable accounting standards. For purposes of accounting for option grants, Accounting Principles Board Opinion (“APB”) No. 25 provides that the measurement date occurs when both the number of shares that the employee is entitled to receive is fixed and the exercise price associated with the grant is known. For certain stock options grants, the documentation related to the grant indicated that all prerequisites for establishing an accounting measurement date had not been met as of the original grant date selected by the Company. Accordingly, the Company sought to determine, based on the available evidence for each of the grants, when all prerequisites had been met in order to establish a revised measurement date for the granted options. In addition, the Company found instances in which the measurement dates for option grants were determined appropriately but the options were accounted for incorrectly. Based on these conclusions, the Company has restated the accompanying consolidated financial statements for the thirteen and twenty-six week periods ended July 2, 2006 to record additional non-cash stock-based compensation expense and related tax effects with regard to past stock option grants.

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

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

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

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

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

6

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

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

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

· The date the employee was notified of the terms of the option grant,

· The signature date of management approvals on the Company’s grant approval form,

· The date the grant approval form was received by the Company’s human resources department,

· Print date or metadata creation date on notice of grant of stock form, or

· The date the option was entered into the Company’s stock option database application.

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

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

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

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

Procurement and Production Costs

Subsequent to the Company’s 2006 year-end, the Company determined that its methodology for allocating production and procurement costs to inventory was incorrect and resulted in understating inventory balances and misstated net income. 

7

Reclassifications

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

Summary of the Effect of Adjustments and Reclassifications on the Consolidated Financial Statements

The following tables set forth the effect of the adjustments and reclassifications on the Company’s Consolidated Statements of Income for the thirteen week and twenty-six week periods ended July 2, 2006 and Consolidated Statement of Cash Flows for the twenty-six week period ended July 2, 2006 (in thousands except per share amounts):

CONSOLIDATED STATEMENTS OF INCOME DATA

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

	For the 26 Weeks Ended July 2, 2006
	As Previously		Adjustments
	Reported		Inventory			Stock Options			Reclassifications			As Restated
Net revenue	$	99,396										$	99,396
Expenses:
Cost of sales and related occupancy expenses		45,576	$	(155	)				$	487			45,908
Operating expenses		35,326				$	3			(642	)		34,687
General and administrative expenses		9,223					32			157			9,412
Depreciation and amortization expenses		4,079					-			(2	)		4,077
Total costs and expenses from operations		94,204		(155	)		35						94,084
Income from operations		5,192		155			(35	)					5,312
Income before income taxes		6,571		155			(35	)					6,691
Income tax provision		2,482		64			(14	)					2,532
Net income		4,089		91			(21	)					4,159
Net income per share - basic	$	0.29	$	0.01		$	-		$	-		$	0.30
Net income per share - diluted	$	0.28	$	0.01		$	-		$	-		$	0.29
Shares used in per share calculation -basic		13,866		-			-			-			13,866
Shares used in per share calculation - diluted		14,579		-			-			-			14,579

8

CONSOLIDATED STATEMENT OF CASH FLOWS DATA
	For the 26 Weeks Ended July 2, 2006
	As Previously			Adjustments
	Reported			Inventory			Options			As Restated
Cash flows from operating activities:
Net income	$	4,089		$	91		$	(21	)	$	4,159
Stock-based compensation		2,216			-			35			2,251
Inventories		(3,576	)		(155	)		-			(3,731	)
Deferred lease credits and other long-term liabilities		277			64			(14	)		327
Net cash provided by operating activities		5,172			-			-			5,172

2. Summary of Significant Accounting Policies

Stock-Based Compensation

Effective January 2, 2006, the beginning of the Company’s first fiscal quarter of 2006, the Company adopted Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based Payment” (“SFAS 123(R)”), using the modified-prospective transition method. Compensation expense recognized included the estimated expense for stock options granted on and subsequent to January 2, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R), and the estimated compensation expense for the portion vesting in the period for options granted prior to, but not vested as of, January 2, 2006, based on the grant date fair value estimated in accordance with the original disclosure provisions of SFAS 123.

Total stock-based compensation expense recognized in the consolidated statement of income for the thirteen weeks ended July 1, 2007 was $730,000 and consisted of stock option and ESPP expense of $659,000 and $71,000, respectively. Total stock-based compensation expense recognized in the consolidated statement of income for the twenty-six weeks ended July 1, 2007 was $1,445,000 and consisted of stock option and ESPP expense of $1,303,000 and $142,000, respectively. The related total tax benefit was $298,000 and $590,000 for the thirteen and twenty-six weeks ended July 1, 2007, respectively. Stock-based compensation expense recognized in the consolidated statement of income for the thirteen weeks ended July 2, 2006 was $1,204,000 and consisted of stock option and ESPP expense of $1,127,000 and $77,000, respectively. Stock-based compensation expense recognized in the consolidated statement of income for the twenty-six weeks ended July 2, 2006 was $2,251,000 and consisted of stock option and ESPP expense of $2,104,000 and $147,000, respectively. The related total tax benefit was $491,000 and $918,000 for the thirteen and twenty-six weeks ended July 2, 2006, respectively. Stock-based compensation expense was recognized as follows in the statements of income (in thousands):

	13 weeks ended				26 weeks ended
	July 1, 2007		July 2, 2006		July 1, 2007		July 2, 2006
			(As restated)				(As restated)
Cost of sales and related occupancy expenses	$	61	$	160	$	114	$	297
Operating expenses		241		373		479		720
General and administrative expenses		428		671		852		1,234
Total	$	730	$	1,204	$	1,445	$	2,251

The fair value of each option grant and ESPP award is estimated on the date of grant using the Black-Scholes-Merton (“Black-Scholes”) option-pricing model with the following assumptions for the twenty-six week periods ended July 1, 2007 and July 2, 2006:

	Stock Options						ESPP
	July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Expected term (in years)		5.3			5.3			0.5			0.5
Expected stock price volatility		30.0	%		34.1	%		27.8	%		26.8	%
Risk-free interest rate		5.0	%		5.0	%		5.1	%		4.7	%
Expected dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Estimated fair value per option granted	$	9.78		$	11.96		$	6.13		$	6.97

 

The expected term of the options represents the estimated period of time from date of option grant until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Expected stock price volatility is based on a combination of historical volatility and the implied volatility of the Company’s traded options. For grants prior to July 3, 2006, expected stock price volatility was estimated using only the historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent term. The Company has not paid dividends in the past and does not plan to pay dividends in the near future.

9

Comprehensive Income

For the thirteen weeks ended July 1, 2007 and July 2, 2006, comprehensive income was $1,770,000 and $1,882,000, respectively. For the twenty-six weeks ended July 1, 2007 and July 2, 2006, comprehensive income was $3,209,000 and $4,147,000, respectively. Comprehensive income consists of net income and net unrealized gains and losses on investments.

Net Income per Share

Basic net income per share is computed as net income divided by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur from common shares issued through stock options. Anti-dilutive shares of 796,904 and 560,023 have been excluded from diluted weighted average shares outstanding for the thirteen week periods ended July 1, 2007 and July 2, 2006, respectively, and 911,850 and 433,585 for the twenty-six week periods, respectively.

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

	13 weeks ended				26 weeks ended
	July 1, 2007		July 2, 2006		July 1, 2007		July 2, 2006
Basic weighted average shares outstanding		13,663		13,840		13,589		13,866
Incremental shares from assumed exercise of stock options		414		709		414		713
Diluted weighted average shares outstanding		14,077		14,549		14,003		14,579

Recently Issued Accounting Standards

In July 2006, the FASB issued Financial Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The Company’s federal income tax returns for the years 2002 through 2004 were effectively settled with the Internal Revenue Service. The Company’s federal income tax returns for 2005 and 2006 are open tax years. The Company’s state of California tax returns for 2004 through 2006 are open tax years. The state of California is the Company’s only significant tax jurisdiction and it also files in numerous state jurisdictions with varying statutes of limitations. The Company’s policy is to classify estimated interest and penalties in its provision for income taxes. Accrued interest and penalties are insignificant at July 1, 2007. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

The Company adopted the provisions of FIN 48 on January 1, 2007. The adoption of FIN 48 did not impact the consolidated financial condition, results of operations or cash flows. At January 1, 2007 and July 1, 2007, the Company did not have any unrecognized tax benefits.

3. Inventories

The Company’s inventories consist of the following (in thousands):

	July 1,		December 31,
	2007		2006
Green coffee	$	16,657	$	11,535
Other inventory		8,507		7,998
Total	$	25,164	$	19,533

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4. Stock Purchase Program

In February 2004, the Board of Directors approved the purchase of up to one million shares of the Company’s common stock, with no expiration. As of July 1, 2007, no shares remained available for purchase under the program. During the thirteen and twenty-six weeks ended July 2, 2006, the Company purchased and retired 94,867 and 219,667 shares of common stock, respectively, at an average price of $29.02 and $29.31, respectively, in accordance with the share purchase program. A second program was approved by the Board of Directors on September 6, 2006 to purchase up to one million shares, with no expiration. As of July 1, 2007, no shares have been purchased under this second program.

5. Stock Option and Employee Stock Purchase Plans

Stock Option Plans

The Company maintains several equity incentive plans under which it may currently grant non-qualified stock options to employees and non-employee directors.

Prior to the January 2, 2006 adoption of SFAS 123(R), the Company accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Through 2001, the Company granted options at 85% of fair value and recorded compensation expense equal to the intrinsic value over the vesting period. The term of a granted stock option is 10 years from the grant date. Stock options vest according to a pre-determined vest schedule set at grant date.

The aggregate intrinsic value in the table below is before applicable income taxes, based on the Company’s closing stock price of $24.63 as of the last business day of the period ended July 1, 2007. As of July 1, 2007, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $5,098,000, which is expected to be recognized over a weighted average period of approximately 42 months.

As of July 1, 2007, there were 934,818 shares available for grant under the 2000 Equity Incentive Plan and 174,350 shares available for grant under the 2000 Non-Employee Director stock option plan. Changes in stock options were as follows:

						Weighted Average		Aggregate
				Weighted Average		Remaining		Intrinsic
	Options			Exercise Price		Contractual		Value
	Outstanding			Per Share		Life (Years)		(in thousands)
Outstanding at December 31, 2006		2,732,711		$	20.33
Granted		250,632			26.44
Canceled		(22,580	)		27.57
Exercised		(215,673	)		16.26
Oustanding at July 1, 2007		2,745,090		$	21.11		6.75	$	13,276
Vested or expected to vest, July 1, 2007		2,465,484						$	13,250
Exercisable at July 1, 2007		1,893,027		$	18.17		5.80	$	13,158

The following table summarizes stock option information at July 1, 2007:  

	Options Outstanding						Options Exercisable
			Weighted Average
Range of	Number of		Remaining Contractual		Weighted Average		Number of		Weighted Average
Exercise Prices	Options		Life (Years)		Exercise Price		Options		Exercise Price
$6.00 to $12.98		306,329		4.48	$	10.79		306,329	$	10.79
$15.49 to $15.49		631,117		4.89		15.49		631,117		15.49
$15.59 to $22.84		649,793		6.20		19.77		618,212		19.63
$23.26 to $26.50		641,799		8.63		25.89		230,390		25.68
$27.32 to $35.87		516,052		8.73		29.86		106,979		30.42
$6.00 to $35.87		2,745,090		6.75	$	21.11		1,893,027	$	18.17

11

Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan where eligible employees can choose to have up to 15% of their annual earnings withheld to purchase the Company’s common stock. The purchase price of stock is 85% of the lower of the beginning of the offering period or end of the offering period market price. The Company authorized 200,000 shares of common stock available for issuance under the ESPP, which will be increased as of each annual meeting of the Company’s shareholders, beginning 2002 until 2020, by the lesser of 200,000 shares or 1.5% of the number of shares of common stock outstanding on that date. However, the Board of Directors has the authority to increase the ESPP reserve by a smaller number of shares of common stock on that date. During the period ended July 1, 2007, employees purchased 25,106 of the Company’s common stock under the ESPP. At July 1, 2007, 972,162 shares remain available for future issuance under the ESPP.

6. Legal Proceedings

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

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

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

7. Segment Information

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

(Dollars in thousands)	Retail					Specialty					Unallocated			Total
			Percent of					Percent of								Percent of
	Amount		Net Revenue			Amount		Net Revenue						Amout		Net Revenue
Thirteen weeks ended July 1, 2007
Net revenue	$	40,963		100.0	%	$	19,140		100.0	%				$	60,103		100.0	%
Cost of sales and occupancy		19,060		46.5	%		9,314		48.7	%					28,374		47.2	%
Operating expenses		17,987		43.9	%		3,379		17.7	%					21,366		35.5	%
Depreciation and amortization		2,002		4.9	%		344		1.8	%	$	240			2,586		4.3	%
Segment operating income (loss)		1,914		4.7	%		6,103		31.9	%		(5,597	)		2,420		4.0	%
Interest income												463			463
Income before income taxes															2,883
Total assets		54,128					12,056					94,757			160,941
Capital expenditures		5,508					295					3,757			9,560
Thirteen weeks ended July 2, 2006, (As restated, see Note 1)
Net revenue	$	33,581		100.0	%	$	16,108		100.0	%				$	49,689		100.0	%
Cost of sales and occupancy		15,634		46.6	%		7,459		46.3	%					23,093		46.5	%
Operating expenses		14,699		43.8	%		2,882		17.9	%					17,581		35.4	%
Depreciation and amortization		1,512		4.5	%		353		2.2	%	$	230			2,095		4.1	%
Segment operating income (loss)		1,736		5.2	%		5,414		33.6	%		(4,805	)		2,345		4.7	%
Interest income												702			702
Income before income taxes															3,047
Total assets		38,112					10,739					102,713			151,564
Capital expenditures		3,833					199					2,662			6,694
Twenty-six weeks ended July 1, 2007
Net revenue	$	79,986		100.0	%	$	37,630		100.0	%				$	117,616		100.0	%
Cost of sales and occupancy		37,174		46.5	%		18,390		48.9	%					55,564		47.2	%
Operating expenses		34,408		43.0	%		6,771		18.0	%					41,179		35.0	%
Depreciation and amortization		4,143		5.2	%		671		1.8	%	$	502			5,316		4.5	%
Segment operating income (loss)		4,261		5.3	%		11,798		31.4	%		(11,802	)		4,257		3.6	%
Interest income												888			888
Income before income taxes															5,145
Total assets		54,128					12,056					94,757			160,941
Capital expenditures		11,796					466					5,898			18,160
Twenty-six weeks ended July 2, 2006, (As restated, see Note 1)
Net revenue	$	66,981		100.0	%	$	32,415		100.0	%				$	99,396		100.0	%
Cost of sales and occupancy		30,507		45.5	%		15,401		47.5	%					45,908		46.2	%
Operating expenses		28,917		43.2	%		5,770		17.8	%					34,687		34.9	%
Depreciation and amortization		2,948		4.4	%		704		2.2	%	$	425			4,077		4.0	%
Segment operating income (loss)		4,609		6.9	%		10,540		32.5	%		(9,837	)		5,312		5.3	%
Interest income												1,379			1,379
Income before income taxes															6,691
Total assets		38,112					10,739					102,713			151,564
Capital expenditures		7,139					311					3,455			10,905

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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.) Forward-looking statements include statements concerning projected new store openings, 2007 revenue growth rates and capital expenditures. Forward-looking statements are based on our beliefs as well as assumptions based on information currently available to us, including financial and operational information, the volatility of our stock price, and current competitive conditions. As a result, these statements are subject to various risks and uncertainties. For a discussion of material risks and uncertainties that the Company faces, see the discussion in the 2006 Form 10-K titled “Risk Factors”. Important factors that could cause actual results to differ materially include, but are not limited to, the following:

· Increases in the cost and decreases in availability of high quality arabica coffee beans: Although we do not purchase coffee on the commodity markets, price movements in the commodity trading of coffee impact the prices we pay. Coffee is a trade commodity and, in general, its price can fluctuate depending on: weather patterns in coffee-producing countries; economic and political conditions affecting coffee-producing countries; foreign currency fluctuations; the ability of coffee-producing countries to agree to export quotas; and general economic conditions that make commodities more or less attractive investment options. Over the past eighteen months, the commodity prices for coffee have risen above their historical range for the prior three to four years. If we are unable to pass along increased coffee costs, our margin will decrease and our profitability will decrease accordingly. In addition, if we are not able to purchase sufficient quantities of high quality arabica beans due to any of the above factors, we may not be able to fulfill the demand for our coffee, our revenue may decrease and our ability to expand our business may be negatively impacted.

· A significant interruption in the operation of our roasting and distribution facility could potentially disrupt our operations. We have completed the transition of our roasting and distribution operations to a new facility and are in the process of converting our previous roasting and distribution facility to office space. A significant interruption in the new facility, whether as a result of a natural disaster or other causes, could significantly impair our ability to operate our business. Since we only roast our coffee to order, we do not carry inventory of roasted coffee in our roasting plant. Therefore, a disruption in service in our roasting facility would impact our sales in our retail and specialty channels almost immediately. Moreover, our roasting and distribution facilities and most of our stores are located near several major earthquake faults. The impact of a major earthquake on our facilities, infrastructure and overall operations is difficult to predict and an earthquake could seriously disrupt our entire business.

Company Overview and Industry Outlook

Peet’s is a specialty coffee roaster and marketer of fresh, deep-roasted whole bean coffee sold through multiple channels of distribution for home and away-from-home enjoyment.  Founded in Berkeley, California in 1966, Peet’s has established a loyal customer base with strong brand awareness in California.  Our growth strategy is based on the sale of whole bean coffee and high-quality beverages in multiple channels of distribution including our own retail stores, grocery, home delivery, and office and restaurant accounts throughout the United States.  Our current retail 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.  We believe that by offering high-quality products to consumers throughout the country, we will attract the same loyal customer base that we have attracted in California.

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

13

Results of Operations

The following discussion on results of operations gives effect to the restatement as discussed in Note 1 to the consolidated financial statements and should be read in conjunction with the consolidated financial statements and accompanying notes and the other financial data included elsewhere in this report.

	Thirteen weeks ended						Twenty-six weeks ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2007
				(As restated)						(As restated)
Statement of income as a percent of net revenue:
Net revenue		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales and related occupancy expenses		47.2			46.5			47.2			46.2
Operating expenses		35.5			35.4			35.0			34.9
General and administrative expenses		8.9			9.2			9.6			9.5
Depreciation and amortization expenses		4.3			4.2			4.5			4.1
Income from operations		4.0			4.7			3.6			5.3
Interest income		0.8			1.4			0.8			1.4
Income before income taxes		4.8			6.1			4.4			6.7
Income tax provision		1.8			2.3			1.7			2.5
Net income		3.0	%		3.8	%		2.7	%		4.2	%
Percent of net revenue by business segment:
Retail stores		68.2	%		67.6	%		68.0	%		67.4	%
Specialty sales		31.8			32.4			32.0			32.6
Percent of net revenue by business category:
Whole bean coffee and related products		52.5	%		54.7	%		53.2	%		55.3	%
Beverages and pastries		47.5			45.3			46.8			44.7
Cost of sales and related occupancy expenses as a percent of segment revenue:
Retail stores		46.5	%		46.6	%		46.5	%		45.5	%
Specialty sales		48.7			46.3			48.9			47.5
Operating expenses as a percent of segment revenue:
Retail stores		43.9	%		43.7	%		43.0	%		43.2	%
Specialty sales		17.7			17.9			18.0			17.8
Percent increase from prior year:
Net revenue		21.0	%		19.1	%		18.3	%		21.6	%
Retail stores		22.0			17.5			19.4			19.9
Specialty sales		18.8			22.5			16.1			25.4
Cost of sales and related occupancy expenses		22.9			22.6			21.0			23.8
Operating expenses		21.5			24.7			18.7			26.7
General and administrative expenses		17.1			52.8			20.1			54.2
Depreciation and amortization expenses		23.4			15.1			30.4			16.5
Selected operating data:
Number of retail stores in operation
Beginning of period		144			113			136			111
Store openings		8			7			16			9
Store closures		-			-			-			-
End of period		152			120			152			120

14

Thirteen Weeks Ended July 1, 2007 Compared to Thirteen Weeks Ended July 2, 2006

Net revenue

Net revenue for the thirteen weeks ended July 1, 2007 increased 21.0% versus the same period in 2006 as a result of continued expansion of our retail and specialty sales segments. Sales of whole bean and related products increased 16.0% to $31.5 million. Net revenue from beverages and pastries increased 27.0% to $28.6 million.

In the retail segment, net revenue increased 22.0% compared to 2006 primarily as a result of increased sales from the 32 new stores we opened in the last 12 months and growth in the existing stores. During the second quarter of 2007, we opened eight new stores compared to seven during the same period in 2006. Sales of whole bean coffee and related products in the retail segment increased by 9.4% to $12.4 million, while sales of beverages and pastries increased by 28.4% to $28.6 million. The increase in beverage and pastry sales was primarily related to sales at the stores we opened in 2005 and 2006 and increased traffic in our existing stores. The slower growth in whole bean and related products was primarily due to continuing cannibalization of bean sales in retail stores as we increased the availability of Peet’s coffee in grocery stores.

In the specialty sales segment, net revenue increased 18.8% compared to the thirteen weeks ended July 2, 2006. The $3.0 million increase consisted of a $2.1 million increase in grocery sales, a $0.3 million increase in home delivery sales, and a $0.7 million increase in sales to foodservice and office accounts. The increase in grocery was primarily due to continued strong growth in our existing accounts and new accounts we added in the last 12 months. We added approximately 1,000 new grocery store accounts over the past 12 months, bringing the number of grocery stores selling Peet’s coffee to approximately 5,000. Net revenue to the home delivery channel grew 7.3% compared to the same period in 2006 primarily due to special offerings to our existing customers. In addition, foodservice and office coffee sales increased 16.1% primarily due to new foodservice accounts and efforts in expanding our office distributorships, offset by the closure of six Company operated Peet’s kiosks located within six Larry’s Markets in the Seattle area due to the bankruptcy and closure of Larry’s Markets in September 2006.

Cost of sales and related occupancy expenses

Cost of sales and related occupancy expenses consist of product costs, including manufacturing costs, rent and other occupancy costs. As a percent of net revenue, cost of sales increased from 46.5% in 2006 to 47.2% in 2007. This increase was caused by higher green coffee and milk costs, an increase in grocery promotions and an increased number of new stores, which have higher occupancy expenses on a lower sales base, partially offset by the retail price increase in November 2006. We anticipate milk prices, in particular, to continue to negatively impact gross margin for the rest of 2007.

Operating expenses

Operating expenses consist of both retail and specialty operating costs, such as employee labor and benefits, repairs and maintenance, supplies, training, travel and banking and card processing fees. Operating expenses as a percent of net revenue for the current quarter increased from 35.4% in 2006 to 35.5% in 2007.

In the retail segment, operating expenses as a percent of net revenue increased from 43.7% in 2006 to 43.9% in 2007. The impact from new stores opened in the last two years was largely offset primarily by the price increase in November 2006 and improved operating leverage.

As a percent of net revenue, specialty operating expenses decreased 0.2% to 17.7%. The decrease was primarily due the closure of Larry’s Markets, which had high operating expenses as a percent of net revenue in the same period last year, partially offset by grocery promotions and other start up costs for our expansion in the east.

General and administrative expenses

General and administrative expenses in the current quarter were $5.4 million, or 8.9% of net revenue, compared to $4.6 million, or 9.2% for the same period last year. The increase was primarily due to increases in headcount and other investments to support our growth, partially offset by lower marketing costs compared to the prior year.

Depreciation and amortization expenses

Depreciation and amortization expenses increased in 2007 from $2.1 million to $2.6 million primarily due to the 41 stores we opened in 2006 and 2007.

Interest income

We currently invest in U.S. government, agency, municipal and guaranteed student loan obligations. Interest income includes interest income and gains or losses from the sale of these instruments. We earned $0.5 million in interest income in the second quarter of 2007, compared to $0.7 million last year. The difference was primarily due to lower investment amounts subject to higher interest rates.

15

Income tax provision

The effective income tax rate for the period is 37.5% compared to 37.4% during the second quarter 2006.

Twenty-six Weeks Ended July 1, 2007 Compared to Twenty-six Weeks Ended July 2, 2006

Net revenue

Net revenue for the twenty-six weeks ended July 1, 2007 increased 18.3% versus the same period in 2006 as a result of continued expansion of our retail and specialty sales segments. Sales of whole bean and related products increased 13.7% to $62.5 million. Net revenue from beverages and pastries increased 24.1% to $55.1 million.

In the retail segment, net revenue increased 19.4% compared to 2006 primarily as a result of increased sales from the 32 new stores we opened in the last 12 months and growth in the existing stores. During the first half of 2007, we opened sixteen new stores compared to nine during the same period in 2006. Sales of whole bean coffee and related products in the retail segment increased by 7.8% to $24.9 million, while sales of beverages and pastries increased by 25.5% to $55.1 million. The increase in beverage and pastry sales was primarily related to sales at the stores we opened in 2005 and 2006 and increased traffic in our existing stores. The slower growth in whole bean and related products was primarily due to continuing cannibalization of bean sales in retail stores as we increased the availability of Peet’s coffee in grocery stores.

In the specialty sales segment, net revenue increased 16.1% compared to the twenty-six weeks ended July 2, 2006. The $5.2 million increase consisted of a $3.1 million increase in grocery sales, a $0.7 million increase in home delivery sales, and a $1.5 million increase in sales to foodservice and office accounts. The increase in grocery was primarily due to continued strong growth in our existing accounts and new accounts we added in the last 12 months. We added approximately 1,000 new grocery store accounts over the past 12 months, bringing the number of grocery stores selling Peet’s coffee to approximately 5,000. Net revenue to the home delivery channel grew 8.7% compared to the same period in 2006 primarily due to special offerings to our existing customers such as our Valentine’s Day offering. In addition, foodservice and office coffee sales increased 18.1% primarily due to new foodservice accounts and efforts in expanding our office distributorships, offset by the closure of six Company operated Peet’s kiosks located within six Larry’s Markets in the Seattle area due to the bankruptcy and closure of Larry’s Markets in September 2006.

Cost of sales and related occupancy expenses

Cost of sales and related occupancy expenses consist of product costs, including manufacturing costs, rent and other occupancy costs. As a percent of net revenue, cost of sales increased from 46.2% in 2006 to 47.2% in 2007. This increase was caused by higher green coffee and milk costs, an increase in grocery promotions and an increased number of new stores, which have higher occupancy expenses on a lower sales base, partially offset by the retail price increase in November 2006. We anticipate milk prices, in particular, to continue to negatively impact gross margin for the rest of 2007.

Operating expenses

Operating expenses consist of both retail and specialty operating costs, such as employee labor and benefits, repairs and maintenance, supplies, training, travel and banking and card processing fees. Operating expenses as a percent of net revenue for the current quarter increased from 34.9% in 2006 to 35.0% in 2007. The favorable impact of retail pricing was offset by higher retail operating expenses due to new stores and higher start up costs in grocery as we expanded into New England.

In the retail segment, operating expenses as a percent of net revenue decreased by 0.2% to 43.0%. The decrease was primarily due to the impact from the price increase in November 2006 and from improved operating leverage and reduced store expenses, including repair and maintenance and supplies, partially offset by the impact from new stores opened in the last two years.

As a percent of net revenue, specialty operating expenses increased 0.2% to 18.0%. The increase was primarily due grocery promotions and other start up costs for our expansion in the east, partially offset by the closure of Larry’s Markets, which had high operating expenses as a percent of net revenue in the same period last year.

General and administrative expenses

General and administrative expenses in the current period were $11.3 million, or 9.6% of net revenue, compared to $9.4 million, or 9.5% for the same period last year. The increase was primarily due to $1.0 million of costs related to legal and other professional fees incurred for the stock option review and restatement of financial statements and legal fees for the related lawsuits. Additional increases are due to increases in headcount and other investments to support our growth, partially offset by lower marketing costs compared to the prior year when spending was higher on promotions such as our 40^th Anniversary Celebration.

16

Depreciation and amortization expenses

Depreciation and amortization expenses increased in 2007 from $4.1 million to $5.3 million primarily due to the 41 stores we opened in 2006 and 2007.

Interest income

We currently invest in U.S. government, agency, municipal and guaranteed student loan obligations. Interest income includes interest income and gains or losses from the sale of these instruments. We earned $0.9 million in interest income in the first half of 2007, compared to $1.4 million last year. The difference was primarily due to lower investment amounts subject to higher interest rates.

Income tax provision

The effective income tax rate for the twenty-six week period and as projected for the full-year is 37.5% compared to 37.8% for the twenty-six weeks ended July 2, 2006. The lower effective tax rate is primarily due to the increase in the anticipated deduction to 6% for qualified domestic production activities as part of the American Job Creations Act of 2004.

Liquidity and Capital Resources

At July 1, 2007, we had $2.3 million in cash and cash equivalents and $20.5 million in short-term and long-term marketable securities for a total of $22.8 million. Working capital was $36.3 million as of July 1, 2007.

Net cash provided by operations was $2.9 million for the twenty-six weeks ended July 1, 2007 compared to $5.2 million for the same prior year period. Operating cash flows were lower than the prior year period primarily due to decreased net income resulting partially from professional fees related to the stock option review, increased seasonal coffee purchases and other timing differences in working capital.

Net cash used in investing activities was $13.3 million for the twenty-six weeks ended July 1, 2007. Investing activities primarily relate to purchases of property and equipment and maturities and purchases of marketable securities. During the twenty-six week period ended July 1, 2007, we purchased property and equipment totaling $18.2 million primarily related to new stores and for our new roasting facility. Proceeds from maturities net of purchases of marketable securities totaled $4.9 million.

Net cash provided by financing activities for the twenty-six weeks ended July 1, 2007 was $4.9 million, consisting of $4.0 million in net proceeds from issuance of common stock and $0.9 million of excess tax benefit from exercise of stock options and employee stock purchase plan shares.

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

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 in the future use coffee futures and coffee futures options to manage coffee supply and price risk.

Fixed-Price and Not-Yet-Priced Purchase Commitments

We enter into fixed-price purchase commitments in order to secure an adequate supply of quality green coffee beans and fix our cost of green coffee beans. These commitments are made with established coffee brokers and are denominated in U.S. dollars. We also enter into “not-yet-priced” commitments based on a fixed premium over the New York “C” market with the option to fix the price at any time. As of July 1, 2007, we had approximately $26.3 million in open fixed-priced purchase commitments and approximately $1.0 million in not-yet-priced commitments for a total of approximately $27.3 million with delivery dates ranging from July 2007 through July 2012. We believe, based on relationships established with our suppliers, that the risk of non-delivery on such purchase commitments is low.

17

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

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

Evaluation of disclosure controls and procedures. Taking into account the restatement of our previously issued consolidated financial statements, as described in Note 1, “Restatement of Unaudited Consolidated Financial Statements and Reclassifications for the 13 and 26 Weeks Ended July 2, 2006” in “Notes to Consolidated Financial Statements” of this Form 10-Q, we have evaluated the effectiveness of our disclosure controls and procedures and our internal control over financial reporting as of July 1, 2007 and determined that we have the following material weakness based on the control criteria established in a report entitled Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission related to stock option grants:

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

For this reason, we have concluded that our disclosure controls and procedures and our internal control over financial reporting were not effective as of July 1, 2007. We have disclosed this conclusion to the Audit Committee and to our independent registered public accountants.

There have been no changes in our internal controls over financial reporting during the fiscal quarter ended July 1, 2007 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

Management’s Remediation Plans

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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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

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

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

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

The 2007 Annual Meeting of Stockholders of the Company was held on May 23, 2007. The three persons named below were elected as proposed in the proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, to serve as directors until the Company's Annual Meeting in 2010 and until their successors are elected and qualified. There were 12,620,172 votes cast in the election of directors. The voting regarding each nominee was as follows:

	For		Withheld		Non-votes
David Deno		12,497,731		122,441		899,342
Michael Linton		12,526,689		93,483		899,342
Jean-Michel Valette		11,620,976		999,196		899,342

The following directors' term of office as a director continued after the meeting: Gerald Baldwin, Hilary Billings, Gordon Bowker, H. William Jesse, and Patrick O'Dea.

Further, the selection of Deloitte & Touche LLP as independent registered public accountants for the fiscal year was ratified. The matter was approved with 12,458,858 votes for, 147,432 votes withheld, and 13,882 votes abstained. Of the total shares outstanding on the date of record, 899,342 shares were not voted.

Item 6. Exhibits

Exhibit 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.

SIGNATURES

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

	PEET’S COFFEE & TEA, INC.
Date: August 9, 2007	By:	/s/ Thomas P. Cawley
		Thomas P. Cawley
		Vice President, Chief Financial Officer and Secretary

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