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TABLE OF CONTENTS
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

For the fiscal year ended March 31, 2002

OR

For the transition period from                to               

Commission File Number 0-26829

TULLY'S COFFEE CORPORATION
(Exact name of registrant as specified in its charter)

3100 Airport Way South
Seattle, Washington 98134
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (206) 233-2070

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of each class)

        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 ý    No o

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

        As of June 20, 2002, the number of shares of the registrant's Common Stock outstanding was 16,336,114.

TABLE OF CONTENTS

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A Warning About Forward-Looking Statements

        We make forward-looking statements in this report that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of the company's operations and its financial condition, plans, objectives and performance. Additionally, when we use the words "believe," "expect," "anticipate," "estimate" or similar expressions, we are making forward-looking statements. Many possible events or factors could affect our future financial results and performance. The forward-looking statements are not guarantees of future performance and results or performance may differ materially from those expressed in our forward-looking statements. In addition to the factors discussed elsewhere in this annual report, the following possible events or factors could cause our actual results to differ materially:

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future sources of financing may not be available when needed or may not be available on terms favorable to Tully's;



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our growth strategy may not be as successful as we expect if we are unable to achieve market acceptance in new geographic areas or to locate and open stores in suitable locations;



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our marketing and new product introduction strategies may not be as successful as we expect;



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competition within the retail specialty coffee market may intensify;



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competition and consolidation within the food service and supermarket channels could result in reduced opportunities for product placement, or increase price competition among coffee suppliers, thereby adversely affecting our revenues or gross margins;



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adverse changes in the general economic climate, interest rates or other factors affecting discretionary spending by consumers could adversely affect our revenues and growth potential; and



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natural or political events could either interrupt the supply or increase the price of premium coffee beans, thereby significantly increasing our operating costs.

        In addition, this document contains forward-looking statements relating to estimates regarding the specialty coffee business. You should not place undue reliance on any of these forward-looking statements. Except to the extent required by the federal securities laws, we do not intend to update or revise the forward-looking statements contained in this report.

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PART I

ITEM 1. BUSINESS

General

        Tully's Coffee Corporation ("Tully's" or the "Company") sells high quality, premium roasted whole bean coffees, richly brewed coffees, Italian-style espresso and other hot and cold beverages, baked goods, pastries and other food products, and coffee-related accessories and equipment. As of June 20, 2002, Tully's operated 103 retail stores, all of which are located in the western United States.

        Tully's complements its retail operations with additional channels for distribution of its branded products. Tully's previously referred to this complementary distribution business as its "specialty coffee division." This part of the Tully's business has experienced significant growth in recent years, and has expanded along two paths which the Company began to manage as separate business segments during the fiscal year ended March 31, 2002: (1) its International division, which sells Tully's coffee and related products and supplies to foreign licensees and manages the relationships with these licensees, and (2) its Wholesale division, which sells Tully's whole bean coffee, related products and supplies to domestic customers for resale via supermarket, food service, restaurant, office coffee service, and institutional channels. The Wholesale division is also responsible for the Company's mail order and internet sales activities. Due to the past growth and anticipated opportunities for the International and Wholesale divisions, they are now being separately reported by the Company, and prior historical information for the former "specialty coffee division" has been segregated to reflect the new reporting perspective. See "Item 8—Financial Statements and Supplementary Data—Note 1 and Note 25 to the Consolidated Financial Statements."

        The International Division has significant relationships with two Japanese companies. Tully's has a license and supply agreement with Tully's Coffee Japan, Ltd. ("Tully's Coffee Japan") which, as of June 20, 2002, operated 49 Tully's retail stores in Japan and had franchised an additional 14 stores in Japan under its license with the Company. Tully's has licensed Ueshima Coffee Company Ltd. ("Ueshima Coffee Company" or "UCC"), a Japanese company, to operate coffee stores under the Tully's name throughout Asia, excluding Japan.

        The Company's retail store philosophy focuses on providing an upscale atmosphere, with quick, friendly service where customers can relax and enjoy some of the finest coffee and espresso drinks available, together with other tasty treats. It is management's goal to make each location a friendly, neighborhood meeting place, with employees who go out of their way to make customers feel special. The Company believes that developing customer loyalty and brand recognition on the foundation of product appeal and customer service is of the utmost importance in its business and growth strategy, and that its retail image builds product and brand credibility for its Wholesale and International divisions.

Fiscal Periods

        The Company ends its fiscal year on the Sunday closest to March 31. As a result, the Company records its revenue and expenses on a 52-53 week period. The fiscal year ended March 31, 2002 included 52 weeks ("Fiscal 2002"), the fiscal year ended April 1, 2001 included 52 weeks ("Fiscal 2001") and the fiscal year ended April 2, 2000 included 53 weeks ("Fiscal 2000"). The fiscal year ending March 30, 2003 will include 52 weeks ("Fiscal 2003").

Company Background

        Tully's was formed in July 1992 after its founder and Chairman of the Board, Tom T. O'Keefe, concluded that an opportunity to develop, own and operate a chain of specialty coffee stores existed in the greater Puget Sound, Washington area. During the early 1990s, Mr. O'Keefe's real estate company

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was approached by numerous companies inquiring about locating specialty coffee stores in the properties owned and managed by his company. As a result, Mr. O'Keefe began researching the specialty coffee industry and determined that an opportunity existed for development of a company focused on the sale of high-quality coffee beans, coffee drinks and coffee related products in an upscale atmosphere that emphasized customer service. On September 16, 1992, Tully's opened its first store in Kent, Washington.

        Tully's Coffee Corporation is a Washington corporation and is headquartered at 3100 Airport Way South, Seattle, Washington 98134. The Company's telephone number is (206) 233-2070 or 1-800-96Tully.

Strategy

General

        During its first ten years of operations, the Company's objective has been to establish Tully's as one of the most respected coffee brands in the world. Under this strategy, the Company has made significant investments in marketing and building its brand. The Company wants each Tully's retail store to provide a warm and inviting atmosphere that will attract customers and encourage those customers to stay and enjoy Tully's coffee, espresso and other beverages and food products. Tully's seeks to employ people who contribute to the "coffee experience" of its customers.

        The Company believes that it has successfully developed its brand identity and that it can modify its strategy to place greater emphasis on improving store performance and overall corporate profitability and less emphasis on brand development. Management believes that the Tully's brand and retail store model have been developed to a point where they can be leveraged for improved operating results, and then replicated to additional locations and markets.

        Tully's strives to develop customer loyalty and brand recognition by providing superior service and offering quality coffee products that are competitively priced. Management believes that the Company's staff is well trained and knowledgeable about the coffee products offered for sale. It is the Company's belief that customer service, along with product freshness and consistency, has become its hallmark, and it seeks to sustain these attributes in all three of its operating divisions- Retail, Wholesale, and International.

        The Company believes that its customers enjoy the flavor profiles and qualities of its coffee beverages and other products, and often purchase them from more than one channel. For example, customers may patronize Tully's stores and may also enjoy Tully's coffee beverages at a favorite restaurant or espresso bar, and may purchase Tully's whole bean coffee from a supermarket for home consumption. Tully's also believes that its customers will be receptive to the introduction of other complementary product categories into its stores and through its Wholesale division. Further, products that are successful in Tully's domestic stores may have opportunities for export or for license to the stores operated or franchised by Tully's licensees in Asia. In May 2002, the Company introduced Tully's Premium Softened Ice Cream™ into several Tully's stores, and will be expanding the availability of this product line into most of its Washington state stores during 2002. This product line is based upon premium soft-serve vanilla and Tully's espresso flavor ice cream, and supports an expanded menu including cones, sundaes, cold beverages and more. Tully's also believes that customers will be receptive to improved value, variety and convenience through broader distribution, and it seeks expanded market share through its Wholesale division in the supermarket, food service, and institutional channels. It is the Company's belief that expanded product mix and broader distribution will help Tully's reach prospective customers that do not currently buy the Company's products, and increase the frequency and size of customer purchases.

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        Another important element of the Company's strategy is to become an integral part of the local neighborhood served by each retail store. This is accomplished in a variety of ways, such as becoming involved in local fundraising and charitable organizations, participating in primary and secondary school programs and by providing jobs to area high school students. The Company believes that community involvement not only helps the Company by building goodwill, but also strengthens its market position.

Historical Expansion and Future Growth Strategy

        Tully's principal domestic expansion strategy has been to develop new retail stores in the Company's current geographic markets in the western United States and to introduce its Wholesale division to targeted wholesale segments (supermarket, food service and restaurants, office coffee services and institutional clients) in those same markets. Tully's also has expanded into new markets by purchasing existing retail coffee locations, with the goal of converting these into Tully's stores.

        During Fiscal 2001, Tully's acquired the assets and real property leases of four Los Angeles-area stores and one Seattle-area store from Coffee Station, Inc. ("Coffee Station"), and the Company entered the Portland, Oregon market by acquiring nine stores from Tri-Brands, Inc., dba Marsee Baking ("Marsee Baking"). No stores were acquired in Fiscal 2002.

        In light of the Company's current capital constraints and management's focus on achieving operating efficiencies and profitability, the Company anticipates opening very few new retail stores during Fiscal 2003. In Fiscal 2003, Tully's intends to focus its Retail division primarily on improving the results of its existing stores through introduction of new products, increased focus on marketing, merchandising, and advertising, operating cost savings, and closure of stores that do not meet Company expectations. During Fiscal 2003, Tully's will continue to investigate and evaluate acquisition or other expansion opportunities that fit strategically into its future growth plans, but presently expects few, if any, store acquisitions during Fiscal 2003.

        Tully's regularly evaluates store performance, and periodically closes stores not meeting Company expectations. During Fiscal 2002, the Company opened two new stores and closed 12 stores. During Fiscal 2001, the Company opened 37 new stores, closed two stores, and acquired 14 stores. During Fiscal 2000, the Company opened 10 new stores and closed four stores.

        The Company's primary international growth strategy has been to license others to (i) operate or franchise the right to operate Tully's-branded retail stores and (ii) sell Tully's-branded products in the licensed geographic markets. The Company expects continuing growth in its International division in Fiscal 2003 and the Company may pursue other international licensing and joint venture opportunities.

        In Fiscal 2003, Tully's expects to continue developing its Wholesale division, especially in the supermarket and food service channels. Growth in the wholesale segment is expected to include addition of new customers in the Company's principal market areas, and also programs to expand the volume of products sold through current customers.

Marketing

Retail Stores

        Tully's focus on consistency and quality in both its products and customer service has been a key element of its marketing program. Point of sale signage, custom bags, boxes, cups, gift sets, products and literature with the Company's distinctive name and logo, and community activities in which Tully's name and logo are featured, are intended to increase name awareness and to reinforce the Company's image.

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Wholesale

        Tully's Wholesale division provides additional opportunities for coffee consumers to experience the Company's coffee and reinforces Tully's branded logo and name. The Wholesale division makes many of the Company's branded products available through supermarkets, restaurants, espresso bars, office coffee services, mail order, and institutional food service. The Company's products generally feature branded packaging. Tully's also provides logo-bearing coffee cups, banners and point of use signage to customers of the Wholesale division. The Company believes that marketing programs that support its retail stores, such as its presence in the Seattle Mariners Safeco Field ballpark and its community programs are also beneficial to its Wholesale division.

International

        The International division expands the geographic reach of the Tully's brand and products to consumers outside the United States. Tully's Coffee Japan operates and franchises Tully's-branded stores in Japan. These stores bring the look and feel of the Tully's store, and the flavor of Tully's coffees and beverages, to the Japanese customer. The license with UCC is expected to expand this international presence to other countries in Asia. The Company believes that the tourism, media, and trade ties between the principal domestic markets served by its Retail and Wholesale divisions with other Pacific Rim nations (in particular, Japan) are beneficial to the international expansion of the Tully's brand.

Community

        Tully's commitment to the local community is another key element of its marketing strategy. Tully's supports local and national organizations focusing on children's educational and health-related issues. Each store supports events within its neighborhood and community. The Company's employees volunteer service and the Company donates product to local non-profit organizations, including schools, sports teams, food banks, charities and service organizations. The Company also provides product and resource donations to national organizations working to improve the health and development of children.

Media

        Tully's seeks to generate awareness of its brand by encouraging local and national media coverage of Tully's events, new product launches, community programs, and promotions. Tully's also does local area marketing such as advertising in neighborhood newspapers, supporting community activities, customer appreciation promotions, direct mail and targeted marketing. During Fiscal 2003, Tully's expects to periodically supplement these methods with other media such billboards, bus boards, newspapers and radio.

        The Company is a sponsor of the Seattle Mariners and is the exclusive coffee provider at Safeco Field pursuant to an agreement entered into in 1999 that is effective through December 31, 2003. This sponsorship agreement includes prominent signage at several places in the stadium, including the left field wall, and allows Tully's to use the Mariners' trademarks in advertising and in certain geographic areas. The annual fees due under this contract in Fiscal 2003 are $450,000 in each of Fiscal 2003 and the fiscal year ending March 28, 2004. The Company has a similar arrangement with the San Francisco Giants and PacBell Stadium pursuant to an agreement with China Basin Ballpark Company dated April 10, 2000 that runs through October 31, 2002. The fees due under this agreement in Fiscal 2003 are $950,000. The Company has determined that it will not extend this agreement when it terminates. In addition, Tully's has a supply partnership with PacWest Racing pursuant to which Tully's coffee and logo cups are available in the pit area and hospitality suites at PacWest Racing events. The Company

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gains exposure to potential new customers with no investment other than the cost of its coffee and cups under this informal arrangement.

International

        The Company's International division sells Tully's whole bean coffees and other proprietary merchandise, and supporting supplies, equipment and materials to its international licensee customers. Product sales to licensees located outside the United States accounted for approximately 5.6% of Tully's net sales in Fiscal 2002, 3.7% of Tully's net sales in Fiscal 2001 and approximately 2.0% of Tully's net sales in Fiscal 2000. The Company expects this percentage to decline as its international licensees establish more local sourcing of products and materials, and expects the level of royalty income to the Company to increase.

        In April 2001, the Company entered into an exclusive license agreement (the "License Agreement") with UCC, a Japanese company that is one of Asia's largest coffee purveyors. Under the terms of the License Agreement, Tully's granted UCC an exclusive, perpetual license to use Tully's business names, trademarks, and other intellectual property rights to develop and operate specialty coffee stores throughout Asia, except for Japan. In April 2001, the parties completed the transaction upon payment by UCC to Tully's of a $12,000,000 license fee. In further consideration of the license, UCC will pay Tully's a royalty and service fee, commencing in April 2009, based on the aggregate net revenues of the stores that UCC operates under the Tully's business name, and all other sales of products or services made under the Tully's business names and trademarks in Asia. UCC plans to roast coffee for the licensed stores in Asia.

        On April 26, 2001, Tully's entered into a license and a supply agreement with Tully's Coffee Japan, which, as of June 20, 2002, operated 49 retail stores in Japan as a licensee of the Company and had franchised 14 stores in Japan. In October 2001, the Company received $4,200,000 and 300 shares of Tully's Coffee Japan stock (with a market value of approximately $1,771,000 at October 1, 2001) from Tully's Coffee Japan in connection with the amendment of Tully's license and supply agreements with Tully's Coffee Japan. The amendments allow Tully's Coffee Japan to be the exclusive wholesaler of Tully's coffee in Japan and to roast Tully's coffee in Japan, which will provide more efficient delivery and a lower cost, and to acquire other supplies and equipment from sources other than the Company, subject to various product and quality requirements. Tully's Coffee Japan has contracted with UCC to roast Tully's coffee for Tully's Coffee Japan, and UCC commenced roasting in May 2002. Under the amended supply agreement, the Company receives a royalty from Tully's Coffee Japan for coffee roasted in Japan. Although Tully's expects that Tully's Coffee Japan will purchase some coffee and supplies from Tully's in Fiscal 2003, it expects that most of the coffee will be roasted in Japan, and that Tully's Coffee Japan will seek to shift much of its supplies and equipment purchasing to Japanese-based suppliers. During Fiscal 2002 and the first two months of Fiscal 2003, the Company periodically sold shares of its Tully's Coffee Japan stock investment, and on June 20, 2002, the Company's had five shares of Tully's Coffee Japan common stock remaining with a market value of approximately $20,000.

        International sales for Fiscal 2002 include $1,958,000 of revenue related to the $12,000,000 UCC license fee and the $5,971,000 license fee (reflecting the cash portion of the fee plus the fair market value, at the time received, of the stock consideration) received in connection with the roasting and wholesale agreement with Tully's Coffee Japan. This amount represented 3.8% of net sales for Fiscal 2002.

        Tully's Europe B.V. ("TEB") was a licensee of the Company that operated in Sweden, and was partially owned by Tully's. During Fiscal 2002, the Company and the other owners of TEB liquidated TEB. The Company recognized a loss of $46,000 in Fiscal 2002 and $1,036,000 in Fiscal 2001 related to the termination of TEB. The Company is engaged in negotiations with the licensee of its Spinelli brand

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in Singapore and Taiwan to sell the licensee the rights to the name in those markets and to terminate the existing license agreement.

Competition

        The specialty coffee market is highly fragmented and very competitive. A number of Tully's competitors have much greater financial and marketing resources, brand name recognition and larger customer bases than Tully's. Tully's competes with a number of specialty coffee retailers, including Starbucks Corporation, which has stores in most of the United States and around the world, and regional retailers such as Coffee Bean and Tea Leaf, Diedrich Coffee, Inc., Seattle's Best Coffee and Peet's Coffee & Tea. Coffee manufacturers including Starbucks Corporation, Kraft Foods, Inc., The Proctor & Gamble Company and Nestle, Inc. distribute premium coffee products nationally and internationally in supermarkets and convenience stores. Many of these products may be alternatives to Tully's coffees and coffee drinks. Consumers also may choose non-coffee products and beverages offered by these and other competitors as alternatives to the Company's products. Tully's coffee beverages, teas, and other beverages compete directly against all restaurant and beverage outlets that serve coffee, tea and other beverages, and the many single location specialty coffee outlets (espresso stands, carts, kiosks, drive-throughs and stores). Tully's whole bean and ground coffees and its coffee beverages compete indirectly against all other coffees available in the market. The specialty coffee industry is evolving toward a variety of retailers, wholesalers, and manufacturers, all seeking their own niche. Tully's believes that its customers choose among specialty coffee brands primarily on the basis of product quality, service, convenience, and, to a lesser extent, on price. Tully's also believes that the flavor profile of its coffee and coffee products, and the variety and quality of other food products provided by Tully's stores, serve as a point of differentiation for many customers.

        Tully's Retail division faces intense competition for suitable new store sites and for qualified personnel to operate both new and existing stores. Due to this competition, Tully's may not be able to continue to secure sites at acceptable rent levels or to attract a sufficient number of qualified workers.

Store Operations And Management / Employees

        As of June 20, 2002, Tully's employed approximately 1,000 people, approximately 900 of whom were employed in retail stores or regional operations. The balance of the employees work in the Company's administrative, wholesale, roasting and warehouse operations. All employees are non-union and management anticipates this will continue to be the case. Approximately 800 of the Company's employees work 20 hours or more per week.

        Tully's believes that its employees are an integral part of its business, and has structured its benefit programs accordingly. Full time employees are eligible for vacation, holidays, medical and dental insurance, maternity leave and sick leave. To promote product loyalty and enhance expertise, all employees receive discounts on beverages and merchandise items. Tully's believes that its current relations with employees are excellent.

        To maintain Tully's high standards of quality products and customer service, new store employees complete a two-day training course, plus on-site training while working in a store. Training hours are devoted to orientation, Company philosophy, cash register and paperwork procedures, store equipment use, cash handling, retail product knowledge, sales techniques, customer service and thorough familiarization with Tully's Employee Handbook. Training also covers coffee history, roasting, decaffeinating processes, tasting ("cuppings") of Tully's proprietary blends, and hands-on beverage preparation. Employees who will serve in the Wholesale and International divisions, and those who serve in administrative support roles, receive much of the same training in order to build their specialty coffee industry expertise.

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        Tully's is committed to attracting and retaining excellent employees through its corporate culture, employee ownership and quality employee benefits. In addition to the benefits described above, Tully's offers a Stock Option Plan and a 401k savings plan.

Suppliers And Equipment Vendors

        Tully's roasts its own coffees to its own specifications. This enables the Company to develop distinctive coffee beverages and unique ground or whole bean coffees, to modify products to better fit the needs of particular customer segments, and to control more elements of this aspect of its product mix. Other materials such as dairy products, juices, and accessories are purchased from various vendors and are generally less specialized, although some materials and products are made to the Company's proprietary recipes, or packaged to the Company's proprietary specifications.

Coffee Markets

        The Company purchases unroasted, or "green" coffee beans. There are many varieties of green coffee beans and a range of quality grades within each variety. Tully's purchases only premium grade arabica coffee beans and believes these beans are the best available from each producing region. Tully's seeks to purchase the finest qualities and varieties of coffee beans by identifying the unique characteristics and flavors of the varieties available from each region of the world.

        Coffee is the world's second largest agricultural product and is grown commercially in over fifty countries in tropical regions of the world. The price and supply of coffee are subject to significant volatility. While most coffee trades in the commodity market, coffee beans of the quality sought by the Company tend to trade on a negotiated basis at a substantial premium above commodity coffee bean prices, depending upon the supply and demand at the time of purchase. Supply and price can be affected by multiple factors in the producing countries including weather and 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. The Company's ability to raise sales prices in response to rising coffee bean prices may be limited, and the Company's future profitability could be adversely affected if coffee bean prices were to rise substantially.

        During the buying season, Tully's often enters into forward commitments for the purchase of green coffee beans that may only be available in small quantities. Rotating the coffee bean selection enables the Company to provide its customers with a wider variety of coffees, as well as certain coffees that are available only on a seasonal basis. Tully's enters into contracts for future delivery of green coffee beans to help ensure adequacy of supply. As of June 20, 2002, the Company had approximately $2,700,000 in fixed-price purchase commitments for Fiscal 2003 which, together with existing inventory, are expected to provide an adequate supply of green coffee beans through Fiscal 2003 (except for supplies of certain varietals that will need to be replenished). Tully's believes, based on relationships established with its suppliers, that the risk of non-delivery on such purchase commitments is remote. However, if coffee spot market prices are attractive, or if Company sales volumes increase beyond the levels anticipated for Fiscal 2003, the Company may elect to, or be required to, purchase coffee on the spot market, which might be at prices greater or less than the fixed contract pricing.

Roasting

        Tully's procures and roasts green coffee beans to its exacting specifications at its roasting plant in Seattle. Tully's employs a roasting process that varies based upon the variety, quality, origin and physical characteristics of the coffee beans being roasted. Each batch is craft roasted to maximize the flavor characteristics.

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        The Company's roasting process produces coffee in "small batches." Coffee is roasted daily and sealed in bags. Production and inventory levels are carefully monitored to minimize the time between roasting and delivery to the customer as coffee or a beverage, and coffee date codes are monitored to maintain fresh coffee stocks.

        Tully's has authorized its licensees, Tully's Coffee Japan and UCC, to roast coffee under the Tully's brand for sale in the stores operated or franchised by these licensees in their respective territories. The Company's amended supply agreement with Tully's Coffee Japan provides for UCC to be the preferred contract coffee roaster for Tully's Coffee Japan, and in May 2002, UCC commenced roasting coffee in Japan for Tully's Coffee Japan. The Company's agreements with its licensees require that they roast to Tully's specifications, recipes and quality standards, which will be periodically audited by Tully's.

Equipment and Store Supplies

        Tully's purchases non-coffee merchandise, and the equipment, fixtures and supplies for its retail store locations from a number of vendors. The materials are purchased through purchase orders on an as needed basis. Some materials and items are distributed through Tully's roasting plant and warehouse facility, while the suppliers deliver other items directly to the Company's retail stores. Shipments to Wholesale division and International division customers are generally distributed from the same roasting plant and warehouse facility. In the past Tully's has used different vendors for the same type of equipment and supplies. During Fiscal 2002, Tully's increased its effort to standardize and consolidate its vendors and suppliers to improve the cost of purchases and simplify operations. Tully's believes that its relationships with vendors are currently satisfactory. However, if a particular supplier or vendor is unable to meet Tully's needs, begins to deliver unsatisfactory materials or is not price competitive, Tully's believes that there are a number of alternative sources to meet all of its merchandise, equipment, store supplies and other materials needs.

Trademarks

        The Company owns several trademarks that are registered with the United States Patent and Trademark Office, including Swirkle® and Tullini®. In addition, Tully's has applied for federal trademark registration in the United States and for trademark registration in several foreign countries for Tully's™. The duration of trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained, and they have not been found to become generic.

        Since Tully's filed its application for federal trademark registration for Tully's™, another company has applied to register the mark "Tully's" in a somewhat different form. This claimant filed an opposition to the issuance of a trademark registration to the Company. It is claiming use of a Tully's trademark prior to the Company. If it can successfully support its claim, it may be able to exclude the Company's use of the Tully's name in certain markets. That claimant currently operates a chain of four restaurants in the greater Syracuse, New York area. On January 31, 2001, the Trademark Trial and Appeal Board of the U.S. Patent and Trademark Office issued its opinion sustaining the claimant's opposition to Tully's trademark registration application and refusing registration of the Tully's mark. In response, Tully's filed a complaint against the claimant in the U.S. District Court for the Northern District of New York on April 2, 2001. The Company intends to pursue this case vigorously or, if appropriate, to seek an out-of-court settlement. During Fiscal 2002, the Company and another party settled a dispute regarding the other party's use of a commercial designation that the Company believed was confusingly similar to the Tully's trademark and trade name, and the other party agreed to discontinue use of that commercial designation.

        In addition to registered and pending trademarks, Tully's considers the overall design and visual language of its trade dress to be a valuable asset. The design of its stores, including but not limited to

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the use of materials, furniture, signage, layout and overall aesthetics, developed in conjunction with packaged goods and marketing collateral, create a distinctive "look and feel" as well as a unique visual language. This "look and feel" and visual language continues to build its brand exposure and deliver "The Tully's Experience" through all channels of its business. Although Tully's considers store design, packaging and marketing collateral to be essential to brand identity, Tully's has not applied to register these trademarks and trade dress, and thus cannot rely on the legal protections afforded by trademark registration.

        The ability to differentiate the Tully's brand from its competitors depends, in part, on the strength and enforcement of its trademarks. If a competitor infringes on Tully's trademark rights, the Company may have to litigate to protect its rights, in which case Tully's may incur significant expenses and management's attention may be diverted from the Company's business operations.

        Tully's does not hold any patents.

Seasonality

        The Company's business is subject to seasonal fluctuations. Greater portions of Tully's net sales are generally realized during the third quarter of Tully's fiscal year, which includes the December holiday season. Seasonal patterns are generally applicable to all three divisions, Retail, Wholesale and International. In addition, quarterly results are affected by the timing of the opening of new stores or the closure of stores not meeting Company expectations. Because of the seasonality of Tully's business, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Risk Factors

        In this section "Risk Factors," the terms "we," "us," and "our" refer to Tully's Coffee Corporation. The following factors may affect our future results and financial condition and should be considered in evaluating our business, operations and prospects.

Company Risks

Our history of losses may continue in the future and this could have an adverse affect on our ability to grow.

        To date, we have not made a profit from operations. We expect to continue to incur losses in Fiscal 2003 and cannot assure you that we will ever become or remain profitable.

Our rapid growth may make it difficult to effectively allocate our resources and manage our business.

        During Fiscal 2000 and 2001, the Company greatly expanded its retail store base, which placed strain on our management, production, financial and other resources. In Fiscal 2001 and 2002, both the Wholesale and International divisions grew substantially. Tully's expects to continue to grow its Wholesale and International divisions in Fiscal 2003 and beyond. Although Retail division operations will focus primarily on improving operating results in existing stores in Fiscal 2003 rather than opening new stores, we expect to increase the number of stores in future years. We cannot assure you that we will be able to manage any future growth effectively. Continued growth could further strain our management, production, financial and other resources. To manage our growth effectively, we must:

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improve the productivity of the average store and lower the average capital investment required to establish a new store,



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evolve the retail concept to be more differentiated from our competition, without losing the key elements of the Tully's store concept,

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provide consumer-focused initiatives to improve the movement of our products through the food service and supermarket sectors,



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add production capacity while maintaining high levels of quality and efficiency,



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continue to enhance our operational, financial and management systems, and



•

successfully attract, train, manage and retain our employees.

        Any failure to manage our growth effectively could have an adverse effect on our business, financial condition and results of operations.

We may not be able to obtain additional capital when needed.

        To date, we have not generated sufficient cash to fully fund operations. We historically have financed this cash shortfall through the issuance of debt and equity securities, through borrowings, and through cash provided under our international licensing relationships. We will need to raise additional capital in the future to fund operations and planned growth. Any equity or debt financing may not be available on favorable terms, if at all. Such a financing might provide lenders with a security interest in Company assets or other liens that would be senior in position to current investors and creditors. If financing is unavailable to us or is available only on a limited basis, we may be unable to take advantage of business opportunities or respond to competitive pressures that could have an adverse effect on our business, operating results and financial condition. In such event, the Company would need to modify or discontinue its growth plans and its investments in store improvements, new customers and new products, and substantially reduce operating, marketing, general and administrative costs related to its continuing operations, and might be required to sell stores or other assets.

New senior management has only recently joined the Company

        During Fiscal 2002, the Company's chief executive officer (CEO) and chief financial officer (CFO) left the Company, and the Company operated under interim executive leadership. In February 2002, Tully's hired a new CFO, and in May 2002 the new CEO joined the Company. Because these new executives may not concur with the Company's previous management's strategies, they may implement changes in Company strategy. Further, even if they agree with such strategy, their unfamiliarity with the Company could cause delays in implementing our strategy, which could cause our business and results of operations to suffer.

Our international licensees may not be successful in their operations and growth.

        The Company has significant relationships with its Asian licensees, Tully's Coffee Japan and UCC. Tully's expects to enjoy continued growth in the revenues and profits from its International division. If these licensees experience business difficulties or modify their business strategies, Tully's results of operations could suffer. Because these licensees are located outside of the United States, the factors that contribute to their success may be different than those affecting companies in the United States. This makes it more difficult for the Company to predict the prospects for continued growth in its revenues and profits from these relationships.

If we are unable to successfully integrate future acquisitions, our business could be negatively impacted.

        We may consider future strategic acquisitions similar to our acquisitions of the Coffee Station and Marsee Baking stores in Fiscal 2001. Integrating newly-acquired businesses is expensive and time-consuming. Due to capital limitations, Tully's has not yet fully conformed all of the Coffee Station and Marsee Baking stores to the Tully's standards. If we acquire a business, we may not manage these integration efforts successfully, and our business and results of operations could suffer.

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If we are required to relocate our offices and roasting plant, our business could be negatively impacted.

        The Company and the lessor for the Company's roasting plant and warehouse and administrative and executive office facility have agreed that, in the event of the sale of the property by the lessor or the lessor's decision to lease to a third party, the lease will terminate upon 150 days notice, and the Company would be required to relocate its operations. If we were required to relocate, we might experience an interruption to our business, or incur extra costs related to the relocation or to the replacement facility.

Our two largest stockholders have significant influence over matters subject to stockholder vote and may support corporate actions that conflict with other stockholders' interests.

        As of June 20, 2002, Mr. Tom T. O'Keefe, our founder and chairman, beneficially owned approximately 32% of our common stock and Mr. Keith McCaw, a former director beneficially owned approximately 23% of our common stock. This ownership position gives each of them individually, and on a combined basis if acting in unison, the ability to significantly influence the election of our directors and other matters brought before the stockholders for a vote, including any potential sale or merger of our Company or a sale of its assets. This voting power could prevent or significantly delay another company from acquiring or merging with us, even if the acquisition or merger was in the best interests of our stockholders.

Industry Risks

We cannot be certain that the specialty coffee industry will be accepted in new markets. Failure to achieve market acceptance will adversely affect our revenues.

        Although the specialty coffee industry has gained substantial market acceptance throughout the United States over the last several years through the operation of a variety of specialty coffee shops, there is a risk that our brand or products may not be accepted in new markets. Consumer tastes and brand loyalties vary from one location or region of the country to another. Consumers in areas other than the Pacific Northwest, San Francisco, Los Angeles and Japanese markets may not embrace specialty coffee or the Tully's brand if Tully's were to expand its domestic or international operations into new geographic areas.

We cannot be certain that expanded product variety will be accepted in current or new markets. Failure to achieve market acceptance will adversely affect our revenues.

        Tully's retail store operations, and to a lesser extent, its Wholesale and International divisions, sell various foodstuffs and products other than coffee and coffee beverages. The Company believes that growth of these complementary product categories is important to the growth of the Company's revenues from existing stores, and for growth in total net revenues and profits. Customers may not embrace these complementary product offerings, or may substitute them for products currently purchased from Tully's.

We compete with a number of companies for customers. The success of these companies could have an adverse effect us.

        Our Retail division and our Wholesale division operate in highly competitive markets in the Pacific Northwest, San Francisco and Los Angeles. Our specialty coffees compete directly against all restaurant and beverage outlets that serve coffee and the large number of independent espresso stands, carts and stores. Companies that compete directly with us in the retail and wholesale channels include, among others, Starbucks Corporation, Coffee Bean and Tea Leaf, Diedrich Coffee, Inc., Peet's Coffee and Tea, Kraft Foods, Inc., The Proctor & Gamble Company, Nestle, Inc., and Seattle's Best Coffee. Some of these companies compete with our International division and we also face competition from companies

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local to those international markets that may better understand those markets, or be better established in those markets. We must spend significant resources to differentiate our product from the products offered by these companies, but our competitors still may be successful in attracting our Retail, Wholesale and International customers. Our failure to compete successfully against current or future competitors would have an adverse effect on our business, including loss of customers, declining revenues and loss of market share.

Our whole bean coffee sales must compete with supermarkets and warehouse clubs, and with other companies selling through those channels.

        Supermarkets and warehouse clubs pose both an opportunity and a competitive challenge in the whole bean coffee market. A number of global coffee suppliers, such as Starbucks Corporation, Kraft Foods, Inc., The Procter & Gamble Company, and Nestle Inc., distribute premium coffee products in supermarkets and warehouse clubs that may serve as substitutes for our whole bean coffees, and compete with the Tully's whole bean and ground coffees sold in our stores and through our supermarket customers.

Competition for store locations and qualified workers could adversely affect our growth plans.

        We face intense competition from both restaurants and other specialty retailers for suitable sites for new stores and for qualified personnel to operate both new and existing stores. We may not be able to continue to secure adequate sites at acceptable rent levels or attract a sufficient number of qualified workers. These factors could impact our plans for expansion and our ability to operate existing stores. Similar factors could impact our Wholesale customers and our International customers, and could adversely impact our plans to grow revenues from those customers.

A shortage in the supply or an increase in price of coffee beans could adversely affect our revenues.

        Our future success depends to a large extent upon the availability of premium quality unroasted, or green, coffee beans at reasonable prices. The world coffee bean market is largely a commodity market, although purchases of premium Arabica coffee beans are typically negotiated on a per sale basis with growers. Natural or political events, or disruption of shipping and port channels could interrupt the supply of these premium beans, or impact the cost. In addition, green coffee bean prices have been affected in the past, and could be affected in the future, by the actions of organizations such as the International Coffee Organization and the Association of Coffee Producing Countries, which have attempted to influence commodity prices of green coffee beans through agreements establishing export quotas or restricting coffee supplies worldwide. Price increases for whole bean coffee result in increases in the costs of coffee beverages served in our stores. These cost increases may force us to increase the retail and wholesale prices for our coffee products, which could adversely affect our revenues.

Changes in economic climates could adversely affect our revenues.

        Our business is not diversified. Our revenues are derived predominantly from the sale of coffee, coffee beverages, baked goods and pastries and coffee-related accessories and equipment. Given that many of these items are discretionary items in our customers' budgets, our business depends upon a healthy economic climate for the coffee industry as well as the economy generally. The Company believes that the weak economy during Fiscal 2002 has adversely impacted its revenues. If the economic climate does not improve, or if it worsens, there could be further adverse impact on the Company's revenues.

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Investment Risks

We may need additional capital, which if raised, could dilute your interest in our Company.

        If we raise additional funds through the issuance of equity, convertible debt or other securities, current stockholders may experience dilution and the securities issued to the new investors may have rights or preferences senior to those of common stock. In addition, prior to October 1999, holders of our capital stock were entitled to preemptive rights pursuant to our Articles of Incorporation and the Washington Business Corporation Act. Some of our stockholders may be entitled to purchase additional shares of our common stock pursuant to these preemptive rights. We intend to either satisfy or seek waivers of these rights from such stockholders. If we were not able to obtain waivers from all the necessary stockholders, non-waiving stockholders may be entitled to purchase additional shares of our capital stock at the price or prices at which those shares were historically offered. Any such issuances could further dilute current stockholders.

The lack of a public market for Tully's capital stock and restrictions on transfer substantially limit the liquidity of an investment in our capital stock.

        There is currently no public market for our common stock or our preferred stock, and consequently liquidity of an investment in our capital stock currently is limited.

ITEM 2. PROPERTIES

        As of June 20, 2002, Tully's operated 103 retail stores in the United States, all of which are located on property leased by The Company. The Company regularly reviews the operating results of its stores, and from time to time will identify stores that do not meet its expectations. Such stores are evaluated for possible closure, lease termination or sublease. Through June 10, 2002, sixteen of the 19 leases identified by the Company in Fiscal 2001 for termination had been terminated, two were unresolved, and one is expected to be developed into a new retail store in Fiscal 2003.

        The Company leases approximately 220,000 square feet in a building located in Seattle, Washington, which currently houses its roasting, warehousing, administrative and executive offices. The lease has a ten-year term with two five-year options to renew. In February 2001, the Company received $1,000,000 from the lessor of the property as reimbursement for Company-paid tenant improvements, which is being repaid to the lessor in the form of increased rents over the remaining life of the lease. Annual rent payments under the lease are approximately $792,000 for fiscal years 2003 through 2005, $911,000 for fiscal years 2006 through 2010 and $114,000 during fiscal year 2011. On March 19, 2002, the Company signed an early termination letter agreement ("Termination Letter") with the lessor. The Termination Letter provides that, in event that the lessor finds a replacement tenant or buyer to occupy the premises the lease will terminate upon 150 days notice, and the Company would be required to relocate its operations. In this event, the unamortized balance of the tenant improvement reimbursement will continue to be an obligation of Tully's, and will be converted to an installment note payable with monthly payments of $14,994 through May 2010. The installment note will bear interest at the rate of twelve percent (12%) per annum.

ITEM 3. LEGAL PROCEEDINGS

        The Company is a party to various legal proceedings arising in the ordinary course of its business, including the trademark-related proceeding described at "Trademarks" in Item 1 on page 11, but is not currently a party to any legal proceeding which the Company believes will have a material adverse effect on the financial position or results of operations of the Company.

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

        No matters were submitted for a vote of stockholders of the Company during the fourth quarter of Fiscal 2002.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information, Holders and Dividends

        Currently there is no public market for Tully's common stock. As of June 20, 2002, there were 4,905 holders of Tully's common stock.

        The Company has not paid dividends in the past and Tully's presently does not plan to pay dividends in the foreseeable future. The Company intends to retain and use earnings to finance the growth of its business for an indefinite period. Any determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon the Company's financial condition, results of operations, capital requirements and such other factors as the Board of Directors deems relevant.

Securities Authorized for Issuance Under Equity Compensation Plans

        Equity Compensation Plan Information
(As of March 31, 2002)

*

These options were granted by the Company's chairman to employees and third parties and may be exercised to purchase shares of the Company's common stock owned by the chairman. We refer to these options as being granted under the "Founder's Stock Option Plan." The Company does not expect any additional options to be granted under the Founder's Stock Option Plan.

        For a description of the Company's equity compensation plans, see Note 21 to the Consolidated Financial Statements.

Recent Sales of Unregistered Securities

        The Company issued and sold securities in the transactions described below during Fiscal 2002. The offer and sale of these securities were made in reliance on the exemptions from registration provided by Section 4(2) of the Securities Act of 1933, as amended, as offers and sales not involving a public offering, based on the limited number of purchasers and their pre-existing relationship with the Company.

•

The Company granted options to purchase an aggregate of 69,750 shares of its common stock to 12 directors pursuant to the Company's Amended and Restated 1994 Stock Option Plan in consideration for their service during Fiscal 2002 on the board of directors and, in certain cases, on committees thereof. The options have an exercise price of $.01 per share, are vested and fully exercisable upon grant, and have a ten year term.

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•

The Company granted options to purchase an aggregate of 105,112 shares of its common stock to its Chairman of the Board and to a director in consideration for their personal guarantees of the Company's bank line of credit. The options have an exercise price of $.01 per share, are vested and fully exercisable upon grant, and have a ten year term.



•

The Company issued 12,000 shares of its common stock to one vendor for goods and services provided to the Company.



•

The Company issued an aggregate of 10,076 shares of its common stock to one director and four employees upon exercise of their options with aggregate consideration to the Company of approximately $3,000.



•

The Company issued 125,000 shares of its common stock to a grocery store chain as settlement for the termination of a grocery store agreement.



•

The Company issued 7,500 shares of its common stock to one warrant holder upon exercise of warrants for aggregate consideration to the Company of approximately $2,000.



•

The Company issued warrants to purchase 240,000 shares of its common stock to a company owned by a former director of the Company in accordance with the terms of a convertible promissory note held by such company. The warrants were issued in lieu of interest on the promissory note, have an exercise price of $0.01 and are exercisable for ten years from the issuance date thereof.

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ITEM 6. SELECTED FINANCIAL DATA

        The following selected financial data have been derived from the consolidated financial statements of the Company. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K.

(1)

Fiscal 2002 and 2001 include significant charges as follows:

(2)

During Fiscal 2002, the Company received a $12,000,000 license fee from UCC. In addition, the Company received $4,200,000 and 300 shares of Tully's Coffee Japan stock (with a market value of approximately $1,771,000 at October 1, 2001) in connection with the amendment of its license and supply agreements with Tully's Coffee Japan. As of June 20, 2002, Tully's owned five shares of Tully's Coffee Japan stock with a market value of approximately $20,000.

(3)

The additional week during Fiscal 2000 accounted for $503,000 in net sales.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion and analysis provides information that Tully's believes is relevant to an assessment and understanding of its results of operations and financial condition for the fiscal years ended March 31, 2002, April 1, 2001 and April 2, 2000. The following discussion should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this report. The Company believes that certain statements herein, including statements concerning anticipated store openings, planned capital expenditures, and trends in or expectations regarding Tully's operations, constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based on currently available operating, financial and competitive information, and are subject to 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 materials prices and availability, successful execution of internal performance and expansion plans, the impact of competition, the effect of legal proceedings, and other risks summarized at "Item 1—Business—Risk Factors."

Overview

        Tully's derives its revenues from sales from (1) its Retail division, which operates retail stores in Washington, Oregon, California and Idaho,(2) its Wholesale division, which sells Tully's-branded products to domestic supermarkets, food service distributors, restaurants, institutions, and office coffee services, and through direct mail order sales, and (3) its International division, which sells Tully's-branded products to its foreign licensees and receives royalty and licensing fees from those licensees. For Fiscal 2002, Tully's derived approximately 80.6% of net sales from its Retail division.

        The Company's cash flow from operations has not been sufficient to cover operating expenses and the Company has not made a profit from operations in any year since inception. These losses are primarily due to costs associated with the Company's significant growth, especially opening new stores and expansion into new markets, and its significant investment in building the Tully's brand, and were exacerbated in Fiscal 2002 by the weak economy in its principal geographic markets. During Fiscal 2003, the Company intends to focus primarily on improving the operations of its existing retail stores including expansion of the merchandise offered in the stores, expanding its Wholesale division sales and International division licensee opportunities, and managing its costs more effectively. Tully's expects to open few, if any, new stores in Fiscal 2003, and expects to close two or more stores not meeting Company expectations.

        The Company has historically funded its cash flow shortfalls through the issuance of debt and equity securities, through borrowings, and with proceeds from its licensing agreements with UCC and Tully's Coffee Japan.

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Results of Operations

        The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of sales.

Fiscal Year Ended March 31, 2002 Compared To Fiscal Year Ended April 1, 2001

Net Sales

        The Company's net sales for Fiscal 2002 increased $9,356,000 or 22.2% to $51,458,000 as compared to net sales of $42,102,000 for Fiscal 2001. During the same period, Retail division sales increased 16% to $41,477,000 from $35,759,000. This $5,718,000 increase in Retail division sales resulted from the opening during Fiscal 2002of two new retail stores ($390,000); and stores opened or acquired during Fiscal 2001 and operating for the full year in Fiscal 2002 contributed $8,178,000. These amounts were partially offset by a comparable store sales decrease of (6.1%) which represented a $1,662,000 decrease, and $1,235,000 of sales declines from twelve stores closed during Fiscal 2002. Management believes that the comparable store sales decrease was caused by (i) the weak economy, exacerbated by consumer uncertainty following the events of September 11, 2001, (ii) cannibalization of, or diversion of customers from, comparable stores by new Tully's stores opened during Fiscal 2001, (iii) customers purchasing Tully's ground coffee through supermarkets instead of Tully's retail stores, and (iv) limited product innovation and marketing during Fiscal 2002. Comparable store sales are defined as sales generated in stores open for at least 12 months in each of the periods. At March 31, 2002, the Company operated 103 retail stores.

        Wholesale division net sales increased $333,000 or 7.0% to $5,116,000 for Fiscal 2002 from $4,783,000 for Fiscal 2001. The increase was due primarily to new supermarket and food service accounts, partially offset by declines in the office coffee service sales.

        Net sales for the International division increased by $3,297,000 or 211.3% for Fiscal 2002 from $1,560,000 for Fiscal 2001. International licensing fees, on an amortized basis, accounted for $1,958,000 of the increase and sales of coffee and supplies to Tully's Coffee Japan represented $1,339,000 of the increase.

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Operating Expenses

        Cost of goods sold and related occupancy costs increased $3,400,000 or 15.1% to $25,905,000 in Fiscal 2002 from $22,505,000 in Fiscal 2001. This increase was largely the result of higher sales volumes and the impact of stores open only part of Fiscal 2001 but open all of Fiscal 2002. As a percentage of net sales, cost of goods sold and related occupancy costs decreased to 50.3% for Fiscal 2002 compared with 53.5% for Fiscal 2001, primarily as a result of (i) the consolidation of the Company's bakery vendors and improved pricing, (ii) reduced costs of green coffee and improved inventory controls and (iii) awareness of cost savings, including more careful management of perishable inventories and supplies.

        Store operating expenses increased $2,154,000 or 14.1% to $17,390,000 in Fiscal 2002 from $15,236,000 in Fiscal 2001. Labor and other expenses from new stores operated during part of Fiscal 2001 but all of Fiscal 2002 generated $1,423,000 of the increase, two new stores opened in Fiscal 2002 represented $175,000 of the increase, and costs associated with stores closed in Fiscal 2002 accounted for $555,000 of the increase. As a percentage of net sales, store operating expenses decreased to 33.8% for Fiscal 2002 from 36.2% for Fiscal 2001. This decrease resulted from the closing of stores that did not meet Company expectations offset by an increase in labor and related costs.

        Other operating expenses (expenses associated with all operations other than retail stores) decreased $1,430,000 or 47.5% to $1,581,000 in Fiscal 2002 from $3,011,000 in Fiscal 2001. The expense decrease is primarily due to factors in Fiscal 2001 including the write-down of the Company's investment in TEB and related trade receivables totaling approximately $1,036,000 and the remaining decrease is due to the reduction in labor and overhead costs.

        Marketing, general and administrative costs (excluding non-cash stock option compensation expense) decreased $1,446,000 or 11.7% to $10,900,000 in Fiscal 2002 from $12,346,000 in Fiscal 2001 reflecting Company efforts to reduce costs to levels appropriate for its revenue base. The decrease reflects reduced spending on community relations and donations ($715,000), a reduction in professional fees and services of approximately $373,000, and reduced bad debt expense by $390,000. As a percentage of net sales, marketing, general and administrative costs decreased to 21.2% in Fiscal 2002 from 29.3% in Fiscal 2001.

        Non-cash stock option compensation expense decreased $523,000 or 66.9% to $259,000 in Fiscal 2002 from $782,000 in Fiscal 2001. As a percentage of net sales, stock option expense decreased to 0.5% for Fiscal 2002 from 1.9% for Fiscal 2001. Non-cash stock compensation expense is a non-cash charge representing the difference between the exercise price and fair market value of the stock at the date of grant and is recognized as expense over the vesting period.

        Depreciation and amortization expense increased $207,000 or 4.7% to $4,600,000 in Fiscal 2002 from $4,393,000 in Fiscal 2001, reflecting a full year of depreciation and amortization on stores added during Fiscal 2001. As a percentage of net sales, depreciation and amortization expense decreased to 8.9% for Fiscal 2002 from 10.4% for Fiscal 2001. Retail sales grew faster than depreciation and amortization (primarily due to a full year of sales in Fiscal 2002 at stores opened during Fiscal 2001) and, to a lesser extent, due to the reduced depreciable value of the assets impaired in Fiscal 2001 (described below).

Impairment of Long-Lived Assets

        A non-cash charge of $2,350,000 for the impairment of long-lived assets was recognized during Fiscal 2002 compared to $5,006,000 during Fiscal 2001 under the application of FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). See Note 10 to the Consolidated Financial Statements. The charge consists of a non-cash write-off of the goodwill, leasehold improvements and other long term assets

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determined to be impaired. As a result of the Fiscal 2002 impairment charge, depreciation and amortization expense for Fiscal 2003 on these assets will decline by approximately $350,000.

Store Closure and Lease Termination Costs

        Store closure and lease termination costs of $1,583,000 for Fiscal 2002 reflect the Company's estimate of write-offs to be made and costs to be incurred in connection with the closure of twelve retail stores (and the termination of the related leases), the termination of one lease (for an unopened store) and additional costs (in excess of the Fiscal 2001 estimate of costs) related to the termination of four leases identified for termination during Fiscal 2001. During Fiscal 2001, store closure and lease termination costs of $2,620,000 reflected the Company's estimate of write-offs to be made and costs to be incurred in connection with the closure of the four retail stores (and termination of the related leases) and termination of 18 leases (for unopened stores, including the four leases eventually terminated in Fiscal 2002). Lease termination costs include rent, brokers fees, and other anticipated lease settlement costs, and were determined using management's best estimate. During Fiscal 2002, the Company reached negotiated settlements for most of the store closures and lease terminations recognized in Fiscal 2002 and Fiscal 2001, however, accrued liabilities at March 31, 2002, include an accrual of approximately $852,000 with respect to those leases for which the Company has not yet reached a negotiated settlement. See Note 19 to the Consolidated Financial Statements.

Other Expenses (Income)

        Interest expense was essentially unchanged at $812,000 in Fiscal 2002 compared to $778,000 for Fiscal 2001. During Fiscal 2001 the Company repaid its bank line of credit, but incurred a full year of interest on the convertible promissory note in Fiscal 2002 compared to only a partial year in Fiscal 2001. See Note 15 to the Consolidated Financial Statements.

        Gain on sale of investments of $2,887,000 in Fiscal 2002 reflects the recognized gain from the sale of the Company's holdings of Tully's Coffee Japan stock.

        Miscellaneous income decreased $89,000 or 47.1% to $100,000 for Fiscal 2002 from $189,000 for Fiscal 2001. The decrease is due to the following losses that offset other income in Fiscal 2002: (i) the loss on the liquidation of TEB of $46,000 and (ii) the $39,000 loss on the sale of Company equipment that offset other income in Fiscal 2002.

        Loan guarantee fee expense decreased $455,000 or 67.8% to $216,000 in Fiscal 2002 from $671,000 for Fiscal 2001. The bank line of credit was repaid on October 1, 2001. This non-cash expense is for options to purchase common stock of the Company granted to two directors in consideration of their guarantees of the Company's bank line of credit, with the number of options based on the amount outstanding on the line of credit.

Net Loss

        Net loss decreased $13,905,000 or 55.5% to $11,152,000 in Fiscal 2002 from $25,057,000 for Fiscal 2001. The smaller net loss in Fiscal 2002 reflects the $3,693,000 reduction in charges relating to the impairment of long-lived assets and store closure and lease termination costs, and the $2,887,000 recognized gain on the Fiscal 2002 sale of the Company's Tully's Coffee Japan stock. The remaining $7 million improvement in net loss resulted from the increase in net sales (including the international license fee revenue), improved gross margins, cost management efforts, and lower financing costs in Fiscal 2002 as compared to Fiscal 2001. The Company recognized no income tax benefit from its net loss in Fiscal 2002 or Fiscal 2001. Net loss applicable to common stockholders decreased $13,905,000 or 55.5% to $11,152,000 from $25,057,000 for Fiscal 2001. There was no preferred stock dividend/accretion in Fiscal 2002 or Fiscal 2001. Net loss applicable to common stockholders per share decreased by $0.90 or 56.6% to $0.69 per share in Fiscal 2002 from $1.59 per share in Fiscal 2001.

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Fiscal Year Ended April 1, 2001 Compared To Fiscal Year Ended April 2, 2000

Net Sales

        The Company's net sales for Fiscal 2001 increased $14,404,000 to $42,102,000 from $27,698,000 for Fiscal 2000, which represents a 52.0% increase. During the same period, Retail division sales increased $11,697,000 to $35,759,000 from $24,062,000, a 48.6% increase. The increase in Retail division sales resulted from: a) the opening of 37 new retail stores which contributed $8,523,000, b) the acquisition of 14 retail stores which contributed $2,413,000 and c) comparable store sales growth of 3.5% which accounted for the remaining $761,000 of the increase. At Fiscal 2001 year-end, Tully's operated 114 retail stores, all located in the western United States compared to 65 at April 2, 2000.

        Wholesale division net sales increased $1,589,000 or 49.7% to $4,783,000 for Fiscal 2001 from $3,194,000 for Fiscal 2000. The increase was due to new domestic wholesale and office coffee service customer accounts.

        International division sales increased $1,118,000 or 252.9% to $1,560,000 for Fiscal 2001 from $442,000 for Fiscal 2000. This increase was due to an increase in sales to Tully's Coffee Japan.

Operating Expenses

        Cost of goods sold and related occupancy costs increased $8,546,000 or 61.2% to $22,505,000 in Fiscal 2001 from $13,959,000 in Fiscal 2000. This increase was the result of higher sales volumes and the substantial growth in the number of stores in operation during Fiscal 2001 compared to Fiscal 2000. As a percentage of net sales, cost of goods sold and related occupancy costs increased to 53.5% for Fiscal 2001 compared with 50.4% for Fiscal 2000, primarily as a result of relatively higher rents compared to sales in the Company's new stores, increased costs of paper products and drink supplies and the roll-out of a new sandwich program at certain locations.

        Store operating expenses increased $5,550,000 or 57.3% to $15,236,000 in Fiscal 2001 from $9,686,000 in Fiscal 2000. Labor and other expenses from newly opened and acquired stores in Fiscal 2001 generated $4,233,000 of the increase. The remaining cost increases resulted primarily from ten stores added during Fiscal 2000 that were open all of Fiscal 2001. As a percentage of net sales, store operating expenses increased to 36.2% for Fiscal 2001 from 35.0% for Fiscal 2000, reflecting the fact that and increasing percentage of the Company's stores are less-mature, which the Company generally considers to be stores open less than two years. These stores typically have higher operating expenses than stores opened for a longer period.

        Other operating expenses (expenses associated with all operations other than retail stores) increased $1,849,000 or 159.1% to $3,011,000 in Fiscal 2001 from $1,162,000 in Fiscal 2000. The increase resulted from: a) the write-down of the Company's investment in Tully's Europe B.V. and related trade receivables totaling approximately $1,036,000, and 2) increased sales and distribution costs required to support the growth of Wholesale division sales.

        Marketing, general and administrative costs (excluding non-cash stock option compensation expense) increased $5,494,000 or 80.2% to $12,346,000 in Fiscal 2001 from $6,852,000 in Fiscal 2000. The $5,494,000 increase resulted from: a) an increase of $1,203,000 in marketing expenditures which consisted primarily of the new PacBell stadium sponsorship), b) an increase of $846,000 in professional fees for legal, accounting and auditing services, c) a $777,000 increase in payroll expenditures related to the general growth in the business, d) $513,000 of incremental occupancy expenses associated with the new roasting plant and corporate headquarters, and e) an increase of $606,000 in community relations and donations. As a percentage of net sales, marketing, general and administrative costs increased to 29.3% in Fiscal 2001 from 24.7% in Fiscal 2000.

        Non-cash stock option compensation expense decreased $426,000 or (35.3)% to $782,000 in Fiscal 2001 from $1,208,000 in Fiscal 2000. As a percentage of net sales, stock option expense decreased to

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1.9% for Fiscal 2001 from 4.4% for Fiscal 2000. Non-cash stock compensation expense is a non-cash charge representing the difference between the exercise price and fair market value of the stock at the date of grant and is recognized as expense over the vesting period.

        Depreciation and amortization expense increased $1,845,000 or 72.4% to $4,393,000 in Fiscal 2001 from $2,548,000 in Fiscal 2000. This increase was due to the opening of 37 new stores, the acquisition of five Coffee Station stores in September 2000 and nine Marsee Baking stores in December 2000. As a percentage of net sales, depreciation and amortization expense increased to 10.4% for Fiscal 2001 from 9.2% for Fiscal 2000.

Impairment of Long-Lived Assets

        A non-cash charge of $5,006,000 for the impairment of long-lived assets was recognized during Fiscal 2001 under the application of FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). See Note 10 to the Consolidated Financial Statements. The charge consists of a non-cash write-off of the goodwill, leasehold improvements and other long term assets determined to be impaired under the application of SFAS 121.

Store Closure and Lease Termination Costs

        Store closure and lease termination costs of $2,620,000 for Fiscal 2001 reflect the Company's estimate of write-offs to be made and costs to be incurred in connection with the closure of four retail stores and termination of leases for unopened store sites. As of April 1, 2001, the Company had 18 retail store locations for which leases had been signed but stores had not been opened. In March 2001, the Company determined that it would not build these retail stores due to capital constraints and because current financial projections for these locations did not meet management's financial criteria. Estimated lease termination costs, which include rent and broker fees, were determined using management's best estimate. See Note 18 to the Consolidated Financial Statements.

Other Expenses (Income)

        Interest expense increased $427,000 or 121.7% to $778,000 in Fiscal 2001 compared to $351,000 for Fiscal 2000 due to higher average borrowings on the Company's bank line of credit in Fiscal 2001 compared with Fiscal 2000 and due to interest from the convertible promissory note issued at the end of the third quarter of Fiscal 2001.

        Interest and miscellaneous income decreased $241,000 or 56.1% to $189,000 for Fiscal 2001 from $430,000 for Fiscal 2000. The decrease reflects less interest income due to lower average cash balances in Fiscal 2001.

        Loan guarantee fee expense increased $243,000 or 56.8% to $671,000 in Fiscal 2001 from $428,000 for Fiscal 2000. This non-cash expense is for options to purchase common stock of the Company, granted to the two directors in consideration of their guarantees of the Company's bank line of credit, with the number of options based on the amount outstanding on the line of credit. This increase is due to higher average borrowings on the bank line of credit.

Net Loss

        Net loss increased $16,991,000 or 210.6% to $25,057,000 in Fiscal 2001 from $8,066,000 for Fiscal 2000. Fiscal 2001 results include $7,626,000 of costs from the write-down for the impairment of long-lived assets and store closure and lease termination costs. The addition of 51 new retail stores in Fiscal 2001 in addition to the ten added in Fiscal 2000 greatly increased the percentage of less mature stores in operation and the rapid growth resulted in higher store operating expenses, marketing, general and administrative costs, and depreciation and amortization. The Company recognized no income tax

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benefit from its net loss in Fiscal 2001 or Fiscal 2000. Net loss applicable to common stockholders increased $8,197,000 or 48.6% to $25,057,000 from $16,860,000 for Fiscal 2000. There was no preferred stock dividend/accretion in Fiscal 2001 compared to $8,794,000 in Fiscal 2000, discussed below. Net loss applicable to common stockholders per share increased by $0.44 or 38.3% to $1.59 per share in Fiscal 2001 from $1.15 per share in Fiscal 2000.

        In connection with the issuance of Series A Preferred Stock in Fiscal 2000, the Company issued 4,580,392 warrants to purchase common stock at an exercise price of $0.33 per share. The exercise price of the warrant at the date of issuance was below management's estimation of the fair market value of the common stock and is therefore considered an "in the money" or beneficial conversion feature. Accounting for the issuance of convertible preferred stock with a nondetachable beneficial conversion feature at the date of issue requires that the conversion feature be recognized and measured in the financial statements by allocating a portion of the preferred stock offering proceeds to additional paid in capital. The discount resulting from the allocation of the proceeds to the beneficial conversion feature is conceptually similar to a dividend and is recognized as a return to preferred stockholders from the date of issuance through the date the warrants are exercisable. As a result of this accounting, the Company allocated $8,794,000 of the preferred stock proceeds to additional paid in capital.

Liquidity and Capital Resources

        Tully's ended Fiscal 2002 with $3,389,000 in cash and cash equivalents and short-term investments compared to cash of $408,000 at the end of Fiscal 2001. Tully's had a working capital deficit of $269,000 at March 31, 2002 compared to a working capital deficit of $12,006,000 at April 1, 2001, for a net improvement of $11,737,000. The increase in cash and short-term investments and decrease in working capital deficit was due primarily to cash from the licensing fees received from UCC and Tully's Coffee Japan under the license and supply agreements and the sale of stock received thereunder.

        Cash provided by operating activities was $6,963,000 in Fiscal 2002, a $13,574,000 improvement from cash used in operating activities of $6,611,000 in Fiscal 2001. The cash provided by operating activities primarily resulted from the $14,287,000 licensing and supply agreement proceeds received from UCC and Tully's Coffee Japan, and a reduction of inventories of $2,670,000. The Company used these cash sources to reduce trade accounts payable and accrued liabilities of approximately $5,024,000, which included payment of amounts that were in arrears under vendor terms. The Company incurred a loss of $11,152,000 in Fiscal 2002. The Fiscal 2002 loss and the cash provided by operating activities both reflect significant improvements as compared to Fiscal 2001, but the Company expects to incur a loss in Fiscal 2003. The Company has closed stores that did not meet its performance criteria, and is continuing to evaluate store locations and operations to determine if closing, downsizing or relocation of certain stores that do not meet performance objectives is necessary. The Company is taking other actions to reduce negative cash flows from operations, including revisions to operational procedures and expansion of its Wholesale division.

        Cash used in investing activities in Fiscal 2002 totaled approximately $11,000. This includes cash used for additions to property, plant and equipment of $3,024,000, including approximately $2,390,000 of payments for accounts payable at April 1, 2001 for Fiscal 2001 capital additions, and the Fiscal 2002 capital invested in two new retail stores and remodeling other stores. During Fiscal 2002, Tully's sold 56% of its shareholdings of Tully's Coffee Japan stock and received net proceeds of $3,025,000. During the first two months of Fiscal 2003, the Company sold all but five of its remaining shares of Tully's Coffee Japan stock and received additional net cash proceeds of $1,813,000.

        Net cash used in financing activities for Fiscal 2002 totaled $5,676,000. These activities included the full repayment of the $5,500,000 bank line of credit, the net repayment of related party notes payable ($350,000 in the aggregate), and repayments on other notes payable ($737,000 in the aggregate). These cash uses were partially offset by $601,000 received from a stockholder in full

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payment of the note receivable from the stockholder, and by $305,000 proceeds from an installment note payable.

        As of June 20, 2002, the Company had fixed price inventory purchase commitments for green coffee totaling approximately $2,700,000 for deliveries scheduled at various dates during Fiscal 2003. The Company believes, based on relationships established with its suppliers, that the risk of loss on nondelivery on such purchase commitments is remote. Such commitments are short-term in nature.

        The lease of the facility that houses the Company's roasting plant, distribution center, administrative and executive offices in Seattle, Washington has a ten-year term with two five-year options to renew. In February 2001, the Company received $1,000,000 from the lessor for Company-paid tenant improvements, which the Company is repaying to the lessor in the form of increased rents over the remaining life of the lease. Annual rent payments under the lease are approximately $792,000 for fiscal years 2003 through 2005, $911,000 for fiscal years 2006 through 2010 and $114,000 during fiscal year 2011. On March 19, 2002, the Company signed an early termination letter agreement ("Termination Letter") with the lessor. The Termination Letter provides that, in event that the lessor finds a replacement tenant or buyer to occupy the premises, the lease will terminate upon 150 days notice, and the Company would be required to relocate its operations. In this event, the unamortized balance of the tenant improvement reimbursement will continue to be an obligation of Tully's, and will be converted to an installment note payable with monthly payments of $14,994 through May 2010. The installment note will bear interest at the rate of twelve percent (12%) per annum.

        The Company has sponsorship agreements with PacBell Stadium in San Francisco and Safeco Field in Seattle expiring on October 31, 2002 and December 31, 2003, respectively, that provide for certain advertising and marketing rights in exchange for annual fees. The annual fee remaining under the PacBell Stadium agreement is $950,000 and the Company does not plan to renew this contact beyond Fiscal 2003. The annual fees under the Safeco Field agreement are approximately $450,000 due in each of Fiscal 2003 and Fiscal 2004.

        Cash requirements for Fiscal 2003, other than normal operating expenses and the commitments described above, are expected to consist primarily of capital expenditures related to the remodeling and addition of a limited number of new retail stores, fixtures and equipment related to the introduction of other products into Tully's stores, equipment and accounts receivable related to new Wholesale division customers, and roasting plant equipment. Management expects that much of the new store and roasting plant fixtures and equipment will be funded through operating or capital leases.

        The Company has historically funded its capital requirements principally through the issuance of equity and debt securities, through borrowings and leasing, and through cash provided under its international licensing relationships. During Fiscal 2003, the Company expects to raise additional capital through debt or the sale of stock. Previously, the Company had a credit facility collateralized by substantially all Company assets and backed by personal guarantees of Company directors, but that facility was fully repaid in Fiscal 2002. The Company's assets are currently unencumbered by security interests. In June 2002 certain directors and stockholders of the Company (the "financial backers") agreed to provide financial support as may be required by the Company, up to an aggregate amount of $2,000,000. At the election of the financial backers, this support may be made through purchases of the Company's stock, by loans to the Company with a maturity no earlier than June 30, 2003, or by personal guarantees of a bank loan to the Company with a maturity no earlier than the earlier of June 30, 2003 or the successful completion of the Company's capital raising efforts in an amount not less than $3,000,000.

        The Company believes that the combination of cash and cash equivalents and short-term investments at March 31, 2002 plus the financial commitments by the financial backers will be sufficient to fund on going operations of the Company through Fiscal 2003. In order to fund any capital expenditures in 2002 in excess of these cash resources, the Company will require alternative sources of capital. Additional sources of funding are expected to include debt or equity financings. In the event

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that such financing is unavailable, or is available only on a limited basis or under unsatisfactory terms, or is inadequate in amount to meet the Company's growth requirements, the Company may be unable to take advantage of business opportunities or respond to competitive pressures that could have an adverse effect on its business, operating results and financial condition. In such event, the Company would need to modify or discontinue its growth plans and its investments in store improvements, new customers and new products, and substantially reduce operating, marketing, general and administrative costs related to its continuing operations, and might be required to sell stores or other assets.

Application of Critical Accounting Policies

        We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Consolidated Financial Statements. Note that our preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

        The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements, and should be read in conjunction with the Consolidated Financial Statements. The Company's critical accounting policies relate particularly to (1) Revenue recognition and (2) Estimating valuation allowances, specifically those related to long-lived assets and lease termination reserves.

Revenue recognition

        Sales are generally recognized at the time of the sale at retail store locations. Sales for the Wholesale and International divisions are recognized upon delivery or upon shipment of the products depending on individual terms with the customer. Royalty revenues are recognized in accordance with the license agreements, which are based primarily upon the licensee sales and pounds of coffee roasted. Revenues from advance license fees are recognized on the straight-line basis over the expected life of the agreements of seven to fifteen years.

Estimating valuation allowances and accrued liabilities

        The Company uses significant judgment and estimates in the preparation of its financial statements that affect the carrying values of its assets and liabilities. On an on-going basis, the Company reevaluates its estimates.

        We periodically review the carrying value of our long-lived assets for continued appropriateness. This review is based upon our projections of anticipated future cash flows. We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. Our cash flow estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect our evaluations. The net carrying value of assets not recoverable are reduced to their

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fair value. Our estimates of fair value represent our best estimate based on either discounted cash flows or appraised values, depending on the nature of the asset.

        Periodically, the Company will determine that certain leases will be terminated and the store or other operation will be closed. At such determination, the Company accrues for the net future minimum lease payments of the related lease agreements. Amounts accrued as net future minimum losses include the discounted estimated future rental payments and lease termination fees.

New Accounting Standards

        See Note 1 to the Consolidated Financial Statements.

ITEM 7(a). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        The Company is exposed to market risk related to changes in available-for sale security prices and foreign currency exchange rates on foreign investments.

        Short-term investments consist of available-for-sale securities, which are subject to significant risk of changes in value. The Company's investment balance consists of the common stock of Tully's Coffee Japan (See Note 6 to the Consolidated Financial Statements). The investment is recorded at fair value with unrealized gains and losses reported as a component of comprehensive income (loss). The investment is denominated in Japanese yen and is translated at the exchange rate on the balance sheet date.

        The Company currently has no foreign currency exchange rate exposure related to its licensing activities in Asia or its purchasing of coffee beans, because all transactions are denominated in U.S. dollars. At the present time, the Company does not hedge foreign currency risk, but may hedge known transaction exposure in the future.

        The supply and price of coffee beans are subject to significant volatility and can be affected by multiple factors in 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 bean supplies worldwide. In order to limit the cost exposure of the main commodity used in the Company's business, the Company enters into fixed-price purchase commitments. This allows the Company to secure an adequate supply of quality green coffee beans and fix its cost of green coffee beans. As of June 20, 2002, the Company had fixed price inventory purchase commitments for green coffee totaling approximately $2,700,000. The Company believes, based on relationships established with its suppliers, that the risk of loss on nondelivery on such purchase commitments is remote. Such commitments are short-term in nature.

        The Company currently has no significant outstanding debt (other than the convertible promissory note, which has no cash interest payment). However, it has had credit facilities in the past and expects to have borrowings in the future. Therefore, it will from time to time be subject to fluctuating interest rates in the normal course of business, primarily as a result of borrowings, which generally bear interest at variable rates.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        The following consolidated financial statements and related notes thereto, of Tully's Coffee Corporation, and the Report of Independent Accountants, are filed as a part of this Form 10-K

Index to Consolidated Financial Statements

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Report of Independent Accountants

To the Board of Directors and Stockholders of
    Tully's Coffee Corporation

        In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive loss, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Tully's Coffee Corporation at March 31, 2002 and April 1, 2001, and the results of its operations and its cash flows for each of the years ended March 31, 2002, April 1, 2001 and April 2, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        See Note 2 for discussion of the Company's recent and prospective liquidity issues.

PricewaterhouseCoopers LLP
Seattle, Washington
June 28, 2002

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Tully's Coffee Corporation Consolidated Balance Sheets

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

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Tully's Coffee Corporation Consolidated Statements of Operations

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

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Tully's Coffee Corporation

Consolidated Statements of Comprehensive Loss

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

34

Tully's Coffee Corporation

Consolidated Statements of Changes in Stockholders' Equity

Years Ended March 31, 2002, April 1, 2001 and April 2, 2000

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

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Tully's Coffee Corporation Consolidated Statements of Changes in Stockholders' Equity
Years Ended March 31, 2002, April 1, 2001 and April 2, 2000
(continued)

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

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Tully's Coffee Corporation Consolidated Statements of Changes in Stockholders' Equity
Years Ended March 31, 2002, April 1, 2001 and April 2, 2000
(continued)

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

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Tully's Coffee Corporation Consolidated Statements of Cash Flows