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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

For the fiscal year ended March 28, 2004

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

Series A Convertible Preferred 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  x    No   ¨

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrants’ most recently completed second fiscal quarter. – Not Applicable (not traded on any market)

As of June 18, 2004 the number of shares of the registrant’s Common Stock outstanding was 16,491,187, and the number of shares of the registrant’s Series A Convertible Preferred Stock outstanding was 15,378,264.

Documents incorporated by reference: None.

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A Warning About Forward-Looking Statements

In this report, we refer to Tully’s Coffee Corporation as “we,” “us,” or “Tully’s.” 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 our operations and our 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 under “Risk Factors” in this report, the following possible events or factors could cause our actual results to differ materially:

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

General

Tully’s Coffee Corporation roasts and sells high quality, premium roasted whole bean coffees. Tully’s Retail division operates specialty coffee stores that offer our premium roasted whole bean coffees and serve a wide selection of hot and cold beverages that feature its coffees, teas and premium softened ice cream. The stores also sell baked goods, pastries and other food products, and coffee related supplies, accessories and equipment. As of June 18, 2004, Tully’s operated 94 retail stores, all of which are located in the western United States.

We complement our retail operations with additional channels for distribution of our branded products: (1) Tully’s Wholesale division sells Tully’s coffees and related products and supplies to domestic customers in the supermarket, food service, restaurant, office coffee service, and institutional channels; and (2) Tully’s Specialty division (formerly referred to as the “International division”) sells Tully’s coffee and related products and supplies to foreign licensees and manages the relationships with these licensees, and is responsible for the franchising and licensing of Tully’s stores in the U.S. and for developing business opportunities for complementary Tully’s-branded products. The Wholesale division is also responsible for our mail order and Internet sales activities.

During Fiscal 2004, Tully’s began developing new business opportunities related to (1) the licensing or franchising of Tully’s stores within the domestic U.S. markets and (2) extending the Tully’s brand into complementary products. Tully’s has renamed its former International division as the “Specialty division.” The Specialty division includes these new U.S. franchising and licensing activities (exclusive of any product sales to these customers, which are included in the Wholesale division) and also includes all of the international business activities of the former International division. The Specialty division has significant relationships with two Japanese companies. Tully’s has a license and supply agreement with FOODX GLOBE Co., Ltd. (“FOODX”) (formerly known as Tully’s Coffee Japan) which, as of May 31, 2004, operated 89 Tully’s retail stores in Japan and had franchised an additional 104 stores that operate under the Tully’s brand in Japan. In addition, Tully’s has licensed Ueshima Coffee Company Ltd. (“UCC”) to operate coffee stores under the Tully’s brand throughout Asia, excluding Japan, and which operates one Tully’s-branded store (in Seoul, South Korea). No U.S. franchised stores were operating in Fiscal 2004, but two franchised stores were operating as of June 18, 2004.

Our retail store philosophy focuses on providing an upscale atmosphere, with quick, friendly service where customers can relax and enjoy some of the finest hot and cold coffee, espresso, and hand-made ice cream shake drinks available, together with other tasty treats. We seek to make each location a comfortable neighborhood meeting place, with employees who go out of their way to make customers feel special. We believe that developing customer loyalty and brand recognition on the foundation of product appeal and customer service is of the utmost importance in our business and growth strategy, and that our retail image builds product and brand credibility for our Wholesale and Specialty divisions.

Fiscal Periods

We end our fiscal year on the Sunday closest to March 31. As a result, we record our revenue and expenses on a 52 or 53 week period, depending on the year. Each of the fiscal years ended March 28, 2004 (“Fiscal 2004”), March 30, 2003 (“Fiscal 2003”), March 31, 2002 (“Fiscal 2002”) and April 1, 2001 (“Fiscal 2001”) included 52 weeks. The fiscal year ending April 3, 2005 (“Fiscal 2005”) will include 53 weeks.

Company Background

Tully’s was formed in July 1992 after our 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 was approached by

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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. Our telephone number is (206) 233-2070 or 1-800-96Tully. Information contained on our website (www.tullys.com) does not constitute part of this report.

Strategy

General

From our founding through Fiscal 2001, our objective was to establish Tully’s as one of the most respected coffee brands in the world. To achieve this goal, we made significant investments in marketing and building our brand. Starting in Fiscal 2002, we decided that we had successfully developed our brand identity and that we could modify our strategy to place greater emphasis on improving store and overall corporate operating performance and less emphasis on brand development. Since Fiscal 2003, we have focused on improving overall corporate operating performance and on the conservative use of our capital. 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 replicated in 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. Tully’s seeks to employ people who contribute to the “coffee experience” of our customers. Management believes that our staff is well trained and knowledgeable about the products offered for sale. It is our belief that customer service, along with product freshness and consistency, has become our hallmark, and we seeks to sustain these attributes in all three of our operating divisions—Retail, Wholesale, and Specialty.

We believe that our customers enjoy the flavor profiles and qualities of our coffee beverages and other products, and often purchase them from more than one channel. For example, customers may patronize Tully’s stores and also may 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 our customers will be receptive to the introduction of other complementary products into our stores and through our 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. We introduced Tully’s Premium Softened Ice Cream^™ into 63 of our Tully’s stores in Fiscal 2003 and into most of the other stores in Fiscal 2004. This product line is based upon premium soft-serve vanilla ice cream and Tully’s coffee flavor ice cream, and supports an expanded menu including ice cream shakes, cones, and sundaes that complements our other cold beverages, Spin^™ and Tango^®.

We believe that customer interest is increased, and incremental sales will occur, when customers are informed about new Company products and special offers, and about the qualities of our product offerings. Accordingly, our strategies include advertising and marketing inside and outside of our stores.

We also believe that customers will be receptive to improved value, variety and convenience through broader distribution, and we seek expanded market share through our Wholesale division in the supermarket, food service, and institutional channels. It is our belief that expanded product mix and broader distribution help Tully’s reach prospective customers that do not currently buy our products, and increase the frequency and size of customer purchases.

Another important element of our strategy is to be 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

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charitable organizations, participating in primary and secondary school programs and by providing jobs to area high school and college students. We believe that community involvement not only helps Tully’s by building goodwill, but also strengthens our market position.

Historical Expansion and Future Growth Strategy

Tully’s principal domestic expansion strategy has been to develop new retail stores in our current geographic markets in the western United States and to introduce our 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. As our focus has shifted from brand development and revenue growth toward improving overall corporate operating performance, and in response to the local economies of our markets, our rate of new store openings has decreased. In each of Fiscal 2004 and Fiscal 2003, Tully’s opened one new store. During Fiscal 2002, we opened two new stores and in Fiscal 2001, we opened 37 new stores and acquired 14 stores.

In Fiscal 2005 we expect to give more attention to growth of the business, with continued focus on improving overall corporate operating performance and the conservative use of our capital. Subject to the availability of capital, we expect to open between two and twelve new retail stores in Fiscal 2005. The number and location of new stores will depend upon the timing and amount of capital (if any) that we may raise in Fiscal 2005 and the amount of cashflow provided from operations that may be used for such new stores, the amounts of which are not presently determined. The primary focus for the Retail division in Fiscal 2005 will be improving the results of our existing stores through introduction of new products, targeted marketing, merchandising, and advertising initiatives, and operating cost savings.

Since inception, our domestic retail strategy has been based upon retail stores that are operated by Tully’s, and this continues to be our primary retail strategy for the United States. However, we believe we have sufficiently developed our brand, products and operating systems so that targeted licensed or franchised locations (together, these are referred to as “franchises” in this report) can be established in those markets and venues that meet our criteria for franchising. Accordingly, our Specialty division will now evaluate and develop licensing and franchising opportunities meeting Tully’s specific criteria. These criteria include geographic, marketplace, branding, venue, strategic and financial considerations. Certain real estate and facilities may not typically be available for Tully’s-owned stores but may be available and appropriate for a franchised location. Further, certain geographic markets may not be targeted for new Tully’s-owned stores in the near future, but may be good markets for possible franchising. Franchisees must have financial and operating capacity, and their Tully’s stores must be consistent with our business standards and strategic objectives. During Fiscal 2004, Tully’s has evaluated possible franchising opportunities against these criteria and has approved some of these opportunities for further development. In April 2004 a franchised Tully’s store opened at the airport in Burbank, CA and in June 2004, a franchised Tully’s store opened at the Seattle-Tacoma International Airport. Franchising stores in the domestic market offers the potential for growth in these particular venues with minimal capital investment from Tully’s. Franchising also offers challenges, including additional regulatory burdens, sharing of financial rewards with the franchisee and maintaining brand and operating standards in stores that are not operated by Tully’s employees. In the future, we expect to open additional franchised stores in targeted domestic markets and venues, as a complement to our primary strategy of operating Tully’s-owned stores.

During Fiscal 2003, supermarket distribution of our pre-packaged premium ground and whole bean coffees expanded into more stores, primarily in the Pacific Northwest. In Fiscal 2004, this growth continued into other states in the West, and approximately 2,000 supermarkets currently offer our coffee for sale. In Fiscal 2005, we expect further growth in the number of U.S. supermarkets offering Tully’s premium coffees, primarily in the western U.S. and potentially into other U.S. markets. During Fiscal 2004, we shifted our primary food service distributor relationship in the Pacific Northwest to Food Services of America, a leading regional distributor. In California and other western states, two major beverage distribution companies, Dispenser Juice, Inc. and Quick

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Dispense, Inc., now distribute Tully’s products. These distributors provide food service channel customers with Tully’s products, equipment and service. Growth in the wholesale segment is expected to include the addition of new customers in the western United States, and also programs to expand the volume of products sold to current customers.

The Company’s primary international growth strategy has been to license others to operate or franchise the right to operate Tully’s-branded retail stores and sell Tully’s coffees in the foreign markets (see “Description of Our Business- Specialty”). The Company expects continuing international growth in its Specialty division in Fiscal 2005, primarily from the expected growth of the FOODX business, and we may pursue other international licensing and joint venture opportunities.

Marketing

Retail Stores

Tully’s focus on consistency and quality in our products and customer service has been a key element of our marketing program. Point of sale signage, custom bags, boxes, cups, gift sets, products and literature with our 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 our image. Since Fiscal 2003, we are making increased use of outdoor signage, direct mail and newspaper advertisements, coupons and special offer books, special and seasonal product offerings, promotional and community events, and joint promotions with other companies. In Fiscal 2004, we refurbished our retail store menu boards to provide a fresh look, more clearly describing product offerings and providing greater flexibility for new products, promotions, and pricing changes.

We believe that product quality and selection are very important factors to maintain the loyalty of our current customers. We also believe these factors will appeal to prospective customers. Therefore, our development efforts and marketing messages focus on the improvement of our current offerings and the addition of new products that will complement our existing offerings. New products may be available for only a limited season, or they may become a recurring offering. The introduction of Tully’s premium softened ice cream in Fiscal 2003 has provided us with a more flexible platform to prepare new beverages, desserts and snacks compared to the previous hard pack ice cream. In Fiscal 2004, we added the Dean & Deluca “Snacks on the Run” (gourmet nuts, candies and snacks) to our stores, and we introduced the Tully’s Limited Reserve Coffee Series, a periodic offering of specially selected and roasted coffees available in our stores only for a limited time while supplies last. In Fiscal 2005, we are introducing our improved Spin^™ blended beverage with a broader flavor selection.

Convenience is another important factor for our retail store customers. In Fiscal 2003, we introduced the Tully’s Coffee Card^™, a stored-value payment card. Customers can use this card like a gift certificate for gift giving, or they can use it as a convenient personal purchase card at Tully’s coffee stores, instead of cash or credit card. The Tully’s Coffee Card encourages customer visits to Tully’s stores, and is periodically incorporated into our promotional activities. In Fiscal 2004, we introduced high-speed wireless Internet access (“Wi-Fi”) into most of our Washington state Tully’s stores. We are currently transitioning to a new Wi-Fi network provider and we expect to have Wi-Fi access available in most of our Tully’s coffee stores in Fiscal 2005. Wi-Fi offers our customers an economical and convenient way to check email and “surf the web” while enjoying our products in the comfort of a Tully’s store.

Wholesale

Tully’s Wholesale division provides additional opportunities for coffee consumers to experience our coffee and reinforces Tully’s branded logo and name. The Wholesale division makes many of our branded products available through supermarkets, restaurants, espresso bars, office coffee services, and institutional food service. Tully’s offers logo-bearing coffee cups, banners and point of use signage to Wholesale division customers (subject to Tully’s usage requirements and standards). We believe marketing programs that support our brand and our retail stores also benefit our Wholesale division. In the supermarket channel, Tully’s provides marketing support through promotional allowances and discounts in support of special price offerings to the grocers’

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customers and through cooperative advertising and other marketing funds. We also make use of other marketing approaches such as direct mail to support wholesale customers, co-sponsoring of trade shows and consumer events with our distributors and in-store demonstrations.

Our Wholesale division also includes our mail order and Internet sales channel. Through these efforts, we make our coffee available to consumers who cannot yet buy it in their own neighborhood. Customers can order our coffee directly from our roasting plant and have it ground to their specification. In Fiscal 2004, we moved our Internet sales and ordering from our own web site to the new Amazon.com gourmet foods site, to take advantage of the greater functionality and market presence of Amazon.com.

Specialty

The Specialty division expands the geographic reach of the Tully’s brand and products to consumers outside the United States. FOODX 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 eventually expand this international presence to other countries in Asia (beyond the one store currently operated by UCC in South Korea). We believe the tourism, media, and trade ties between the principal domestic markets served by its Retail and Wholesale divisions and Pacific Rim nations (in particular, Japan) are beneficial to the international expansion of the Tully’s brand. Tully’s views other foreign markets as opportunities for growth through licensing or joint venture, but is not presently focused on developing these other markets.

Through franchised and licensed U.S. stores, Tully’s also expects its Specialty division to make Tully’s retail experience and products available to consumers in geographic markets outside Tully’s retail market areas, and in specialized venues that might otherwise be difficult for us to penetrate, like airports, colleges and other “captive” locations. Tully’s also expects its Specialty division to evaluate and pursue opportunities to extend the qualities of Tully’s brand and products into complementary products and markets.

Community

Tully’s commitment to the local community is another key element of our 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. Our employees volunteer services and we donate product to local non-profit organizations, including schools, youth athletics, food banks, charities and service organizations. We also provide product and resource donations to national organizations working to improve the health and development of children.

Specialty

Our Specialty division (formerly known as the International division) makes Tully’s whole bean coffees and other proprietary merchandise available to consumers outside of the United States. The Specialty division administers the licensing relationships for our foreign licensees, and provides our products and supporting supplies, equipment and materials to our foreign licensees, as required.

FOODX is the exclusive operator and franchisor of Tully’s stores in Japan, and is the exclusive wholesaler of Tully’s coffee in Japan. FOODX also is authorized to have Tully’s coffee roasted in Japan, and to sell Tully’s branded ready-to-drink (“RTD”) beverages in Japan. Tully’s receives license royalties in connection with sales of the Tully’s stores franchised by FOODX and will receive a license fee on the RTD beverages starting in November 2004. Additionally, Tully’s receives a fee from FOODX based upon the amount of coffee roasted in Japan. In its early years and through Fiscal 2003, FOODX purchased most of its coffee and supplies from Tully’s, but as its volumes grew to sufficient levels, FOODX is able to source most of its coffee, supplies and equipment from local suppliers, as permitted by the supply agreement. As of May 31, 2004, FOODX operated 89 Tully’s retail stores in Japan and had franchised another 104 Tully’s stores in Japan (FOODX also operates “Koot’s Green Tea” stores in Japan).

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UCC, a Japanese company that is one of Asia’s largest coffee purveyors, has 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. 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 operates one Tully’s store, which it opened in Seoul, South Korea in Fiscal 2003. UCC purchases some coffee and supplies from Tully’s, but most of its requirements are sourced locally.

As the result of the FOODX shift to local sourcing of products and supplies, product sales to licensees located outside the United States accounted for approximately 0.6% of our net sales for Fiscal 2004 as compared to 4.0% in Fiscal 2003 and 5.6% in Fiscal 2002. Net sales from international licenses, royalties and fees were approximately 2.4% of Tully’s net sales for Fiscal 2004 as compared to 1.3% in Fiscal 2003 and 0.1% in Fiscal 2002.

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 recognition and customer bases than Tully’s. We compete with a number of specialty coffee roasters and retailers, including Starbucks Corporation (which acquired Seattle’s Best Coffee and Torrefazione Italia Coffee in Fiscal 2004) which has stores in many nations, and regional companies such as Coffee Bean and Tea Leaf, Diedrich Coffee, Inc., and Peet’s Coffee & Tea, as well as smaller local chains and independent operators.

Coffee roasters and distributors including Starbucks Corporation, Kraft Foods, Inc., The Proctor & Gamble Company and Nestle, Inc. distribute premium coffee products nationally and internationally in supermarkets and other wholesale channels. 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 our 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). Restaurant and wholesale customers of our Wholesale division, and U.S. operations franchised through our Specialty division, serve products (including Tully’s-branded products) that compete directly or indirectly with the offerings of our retail stores.

Premium specialty coffees have grown in popularity in the United States, and are being given additional selling space within supermarkets and increased attention from distributors in the food services channel. Tully’s must compete with other premium coffee roasters and distributors (including those providing branded and private label coffees) for space on the supermarket shelves and for distribution by wholesale food service distributors. In Fiscal 2004 our primary distributor in the wholesale food service distributor channel established a national relationship with Starbucks Corporation. Tully’s has shifted its primary relationships to other distributors, including Food Services of America in the Pacific Northwest, and we have established or expanded our relationships with other wholesale food service distributors outside the Pacific Northwest.

The companies with which we compete are strong competitors, and may become even more formidable through continued growth and industry consolidation. These companies compete for retail and wholesale sales, for store locations, for employees and for supplies of premium coffee beans. Tully’s believes that there is opportunity for many companies to compete in the growing specialty coffee segment, and that the preferences and needs of consumers, owners of commercial store locations, coffee growers, coffee store employees, wholesale distributors and other constituents of the specialty coffee industry will support continued competition in this segment. 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, including Tully’s ice cream shakes, blended beverages, and premium softened ice cream products, serve as a point of differentiation for many customers.

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Store Operations and Management / Employees

As of May 31, 2004, Tully’s employed approximately 900 people, approximately 800 of whom were employed in retail stores or regional operations. The balance of the employees work in our administrative, wholesale, international, roasting and distribution operations. All employees are non-union and management anticipates this will continue to be the case. Most of our employees work 20 or more hours 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. Store managers, district managers, wholesale sales personnel and other managers participate in incentive pay programs tied to financial criteria. 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 training course and receive 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, tasting of Tully’s proprietary blends, and hands-on beverage preparation. Employees who serve in the Wholesale and Specialty divisions, and those who serve in administrative support roles, often receive much of the same training in order to build their specialty coffee industry expertise.

Tully’s regularly evaluates store performance, and periodically closes stores that do not meet our financial expectations. Tully’s closed seven stores in Fiscal 2004, five stores in Fiscal 2003, and 12 stores in Fiscal 2002. In Fiscal 2005, we will continue to evaluate the performance of our stores, and may close stores if they do not meet our financial criteria, though we expect the number of store closings in Fiscal 2005 to be fewer than in Fiscal 2004.

Suppliers and Equipment Vendors

Tully’s roasts its own coffees to its own specifications. This enables us to develop distinctive coffee beverages and unique ground and whole bean coffees, to modify products to better fit the needs of particular customer segments, and to control more elements of this aspect of our product mix. During Fiscal 2003, we acquired new packaging equipment and redesigned our packaging, particularly the coffee packaging used for the sale of whole bean and ground coffee within the supermarket channel and at our stores. We believe that these changes have improved the quality of the packaging while increasing our packaging capacity and reducing packaging costs.

Tully’s premium softened ice cream is produced especially for us. The coffee flavored ice cream is flavored with extract from Tully’s coffee. Other materials such as teas, dairy products, juices, bakery goods and accessories are purchased from various vendors and are generally less specialized, although some materials and products are made to our proprietary recipes, or packaged to our proprietary specifications. In Fiscal 2004, three suppliers each provided approximately ten percent of our product purchases, but we believe that there are alternative sources of supply if our relationship with any of these suppliers were to be interrupted. These suppliers are Food Services of America and Sysco Food Services (broad line food services distributors) and List & Beisler (a coffee broker).

Coffee Markets

The Company purchases unroasted (“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 among the best available from each producing region. Tully’s seeks to purchase the

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finest qualities and varieties of coffee beans by identifying the unique characteristics and flavors of the varieties available from each region of the world. Many of our coffees contain green beans from Central America and South America, but we also purchase coffees from Asia, Africa and Hawaii.

Coffee is grown commercially in the tropical and sub-tropical regions of the world. Coffee is harvested at different times each year, depending on the particular region. 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 Tully’s 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, 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. Our ability to raise sales prices in response to rising coffee bean prices may be limited, and our future operating performance could be adversely affected if coffee bean prices were to rise substantially or if sufficient quantities of high quality beans were not available when needed.

Tully’s enters into forward commitments for most of its purchases of green coffee beans, in anticipation of the future seasonal harvests. We also make periodic buys on “spot” markets and from special offerings, when coffee requirements exceed the contracted supplies and when there are special beans available that are suitable for limited supply offerings like the Tully’s Limited Reserve Series. Typically, Tully’s has entered into contracts for the next season’s delivery of green coffee beans to help ensure adequacy of supply. However, in Fiscal 2004, Tully’s also entered into contracts for part of its second year (Fiscal 2006) coffee harvest requirements, in order to provide a more stable market for the growers and to provide for more certainty of coffee bean supply and pricing in Fiscal 2006. As of March 28, 2004, we had approximately $3,600,000 in fixed-price purchase commitments for Fiscal 2005 and $1,500,000 in fixed-price purchase commitments for Fiscal 2006. These purchase commitments, together with existing inventory, are expected to provide an adequate supply of green coffee beans through Fiscal 2005, but we will be required to make additional purchases for Fiscal 2006. 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 our sales volumes increase beyond the levels anticipated for Fiscal 2005, we may elect 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 the Tully’s roasting plant in Seattle, Washington. 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. Our 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, FOODX and UCC, to roast Tully’s coffee for sale in their territories. FOODX uses two contracted roasters in Japan, UCC and Unicafe. We require that our licensees have coffee roasted to Tully’s specifications, recipes and quality standards, and they are subject to periodic audit by Tully’s.

Equipment and Store Supplies

Tully’s purchases non-coffee merchandise, and equipment, fixtures and supplies for its retail store locations from a number of vendors. The materials are purchased 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 our retail stores. Shipments of products and supplies to Wholesale division and Specialty division international customers are generally distributed from our Seattle roasting plant and warehouse facility. Tully’s has standardized and consolidated most of its vendors and suppliers, for the entire Company or regionally, to

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improve the cost of purchases and simplify operations. Tully’s believes that its relationships with its 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 its merchandise, equipment, store supplies and other materials needs.

Trademarks

Tully’s has applied for trademark registration in the United States and in several foreign countries, for various marks including “Tully’s,” the “Tully’s Coffee” logo, many of our drink and coffee blend trademarks, and certain package design elements (among other marks). Many of the foreign trademark applications have issued into registrations, while others are still under examination. The duration of trademark registrations varies from country to country; however, trademark registrations are generally presumed valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained. Trademark registrations are generally granted for particular classes of goods or services, and may not restrict use of similar marks by other parties for other classes of goods or services. Tully’s typically applies to register its marks for more than one class of goods or services in a particular country.

After we filed our first applications to register “Tully’s” in the U.S. for coffee and coffee store services, an operator of a small chain of restaurants in upstate New York applied to register the mark and logo “Tully’s Good Times” for restaurant and bar services, and claimed use of the marks prior to our first use. In May 2003 the parties entered into a settlement agreement that sets forth the rights of each party to use and register marks containing “Tully’s.” Our marks under the settlement agreement include “Tully’s” and “Tully’s Coffee” and all of our logos (among other marks). We have since received federal trademark registration for the Tully’s^® trademark for coffee and for retail coffee store/café services and for our Tango^® mark, and we expect to complete U.S. trademark registration for other marks during Fiscal 2005.

In addition to registered and pending U.S. trademarks, Tully’s considers the overall design and visual language of its trade dress to be a valuable asset. The design of our stores, including but not limited to 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 our brand exposure and deliver “The Tully’s Experience” through all channels of our business. Although Tully’s considers store design, packaging and marketing collateral to be essential to brand identity, in most instances 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 our competitors depends, in part, on the strength and enforcement of its trademarks. If a competitor infringes Tully’s trademark rights, we may have to litigate to protect our rights, in which case Tully’s may incur significant expenses and management’s attention may be diverted from our business operations.

Tully’s does not hold any patents.

Seasonality

Our 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 Specialty. In addition, quarterly results are affected by the timing of the opening of new stores (by Tully’s and its international licensees) or the closure of stores not meeting our 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.

As of March 28, 2004, Tully’s operated 94 retail stores in the United States, all of which are located on property leased by us. Sixty-four of these stores are located in Washington, twenty-three are in California, six are in Oregon and one is in Idaho.

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We lease the building in Seattle, Washington, that houses our headquarters, roasting plant and distribution facilities (the “Airport Way Property”) pursuant to a ten-year lease (expiring May 2010) and with two five-year options to renew. In July 2003, the original lessor sold the Airport Way Property to Rainier Commons LLC (“Rainier”) and Rainier thereby became lessor to Tully’s. Effective as of July 17, 2004, Rainier and Tully’s amended the lease to (1) eliminate the lessor’s option to terminate the lease on 150 days notice, (2) reduce the portion of the property leased to Tully’s to approximately 80,000 square feet of building (the portion of the Airport Way Property that was used by Tully’s) and make available to the lessor the remainder of the Airport Way Property, and (3) reduce the rent and occupancy costs paid by us.

In February 2004 a lawsuit was filed against Tully’s in California State Court by two former store managers alleging misclassification of employment position and seeking damages, restitution, reclassification and attorneys’ fees and costs. The plaintiffs also seek class action certification of their lawsuit. We are investigating and intend to vigorously defend this litigation, but cannot predict the financial impact to us of the litigation.

In April 2004, we were advised by FOODX that the Japanese tax authorities are conducting an examination regarding the withholding taxes collected by FOODX, and that the tax authorities had taken a position that certain amounts paid by FOODX under its supply agreement with us should be subject to Japanese withholding taxes. FOODX has informed us that the tax authorities have demanded taxes, interest and penalties in the aggregate amount of approximately $950,000, for which FOODX has requested indemnification from Tully’s. We have not been provided sufficient information to evaluate the position of the Japanese tax authorities, or to evaluate the validity of the FOODX claim for indemnification. We believe that the withholding tax treatment by FOODX under the supply agreement was appropriate. Further, if this assessment by the Japanese tax authority is determined to have been valid, we believe that FOODX may have compromised its ability to claim indemnification. We intend to investigate and vigorously defend our position, but cannot predict the financial impact to us of this matter.

We are a party to various other legal proceedings arising in the ordinary course of our business, but are not currently a party to any other legal proceeding that we believe could have a material adverse effect on our financial position or results of operations.

Tully’s Coffee Corporation held its 2003 annual shareholders meeting on Thursday, March 25, 2004 at the Museum of Flight in Seattle, Washington. Shareholders elected, by a plurality of the votes cast, seven members to the Board of Directors to serve until the next annual shareholder meeting or until their respective successors shall be elected and qualified. The elected directors (all of whom were already serving as directors of Tully’s) and the votes for and withheld were as follows:

Shareholders also ratified the selection of our independent registered public accounting firm, Moss Adams, LLP:

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PART II

Market Information, Holders and Dividends

Currently there is no public market for Tully’s common stock. As of May 31, 2004 there were 4,954 holders of record of Tully’s common stock.

We have not paid cash dividends in the past and we presently do not plan to pay dividends in the foreseeable future. We intend to retain and use earnings, if any, to finance the growth of our 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 our financial condition, results of operations, capital requirements, restrictions under our borrowing agreements, 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 28, 2004)

For a description of our equity compensation plans, see Note 17 of the Notes to the Consolidated Financial Statements.

The Rights Offering

On May 12, 2004, we filed a registration statement with the Securities and Exchange Commission (“SEC”) relating to a proposed offering of our common stock and investment units (each unit consisting of convertible preferred stock and warrants to purchase common stock), through the distribution of subscription rights to eligible shareholders and former shareholders (the “rights offering”). Upon the effectiveness of the registration statement, eligible shareholders and former shareholders of Tully’s will receive rights to purchase these securities at the prices at which the securities were issued by Tully’s between 1994 and 1999. Shareholders of record at the record date will receive subscription privileges to purchase any shares of common stock and investment units not purchased through the exercise of the rights. The registration statement has not yet become effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This report shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state.

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Recent Sales of Unregistered Securities

Tully’s issued and sold securities in the transactions described below during Fiscal 2004, Fiscal 2003, and 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.

Fiscal 2004

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Fiscal 2003

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Fiscal 2002

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The following selected financial data have been derived from the consolidated financial statements of Tully’s. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto appearing elsewhere in this report.

Notes for Selected Financial Data

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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 our results of operations and financial condition for the fiscal years ended March 28, 2004, March 30, 2003, and March 31, 2002. The following discussion should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this report. We believe that certain statements herein, including statements concerning anticipated store openings and closings, 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 our business plans, the impact of competition, the effect of legal proceedings, and the success of our foreign licensees. These and other factors that may cause our actual results and trends to differ materially from our expectations are described in the “Risk Factors” section of this report.

Overview

We end our fiscal year on the Sunday closest to March 31. As a result, we record our revenue and expenses on a 52 or 53 week period, depending on the year. Each of Fiscal 2004, Fiscal 2003, Fiscal 2002 and Fiscal 2001 included 52 weeks. Fiscal 2005 will include 53 weeks.

Tully’s derives its revenues from sales from its:

The relative percentage of net sales from each division for Fiscal 2002, Fiscal 2003 and Fiscal 2004 are depicted by these graphs:

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From our founding through Fiscal 2001, our primary objectives were to establish the Tully’s brand, increase our revenues and expand our retail store base. During this period and through Fiscal 2003, our cash flow from operations was insufficient to cover operating expenses. These losses have been exacerbated by the weak economy in our principal geographic markets since 2001. During Fiscal 2002 through Fiscal 2004, we shifted our emphasis toward improving our operating performance and placed less emphasis upon expanding our retail store base and revenues. This shift in emphasis reflects management’s view that Tully’s has sufficiently developed its brand identity and that greater emphasis should be placed on improving corporate productivity and operating performance, and upon the conservative use of capital. These continuing initiatives toward improved operating performance and cashflow include:

In Fiscal 2004, our operating cash flow was sufficient to cover our operating expenses ($1,287,000 of cash was provided by operations for the year). This reflects an improvement of $4,574,000 compared to $3,287,000 of cash used by operations in Fiscal 2003. Management expects that the continuing benefits from the improvement initiatives will result in improved operating results in Fiscal 2005 compared to Fiscal 2004. As described below under “Liquidity and Capital Resources,” management believes that the operating cash flows, financing cash flows, and investing cash flows projected in our Fiscal 2005 business plan, and the cash and cash equivalents of $1,247,000 at March 28, 2004, will be sufficient to fund ongoing operations of Tully’s through Fiscal 2005. We have not made a profit from operations in any year since inception.

The number of retail stores operated by Tully’s is summarized as follows (excludes stores operated or franchised by licensees):

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Comparable store sales are defined as sales from stores open for the full period in both the current and comparative prior year periods. Changes in Retail division comparable store sales for Fiscal 2002, and for each of the four quarters of Fiscal 2003 and Fiscal 2004, as compared to the corresponding periods in the previous fiscal year, are depicted in the graph presented below.

After experiencing negative comparable store sales in Fiscal 2002, we implemented programs to improve our comparable store sales, which have resulted in an improved comparable store sales trend. We believe that favorable customer response to our product, marketing and service improvement initiatives is primarily responsible for the comparable store sales increases during the recent past. We believe that the comparable store sales increases and decreases in the periods shown above reflect the effects of (i) the changes in economic conditions generally, (ii) competition (including the effects of new competitive stores opened during these periods), (iii) customers purchasing Tully’s coffee in supermarkets instead of Tully’s retail stores, and (iv) the relative levels of product innovation and marketing during each period.

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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 net sales:

Earnings (Loss) before Interest, Taxes, Depreciation and Amortization

Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a financial measurement we use to measure our operating performance, excluding the effects of financing costs, income taxes, and non-cash depreciation and amortization. We view EBITDA as a key indicator of our operating business performance, and EBITDA is the primary determinant in the computation of management incentive compensation.

Regulation G, “Conditions for Use of Non-GAAP Financial Measures,” and other provisions of the Exchange Act of 1934 define and prescribe the conditions for use of certain non-GAAP financial information. We believe that our “EBITDA” information, which meets the definition of a non-GAAP financial measure, is important supplemental information to investors.

We use EBITDA for internal managerial purposes and as a means to evaluate period-to-period comparisons. This non-GAAP financial measure is used in addition to and in conjunction with results presented in accordance with generally accepted accounting principles (“GAAP”) and should not be relied upon to the exclusion of

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GAAP financial measures. EBITDA information reflects an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business. We strongly encourage investors to review our financial statements and publicly filed reports in their entirety and to not rely on any single financial measure.

Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. For information about our financial results as reported in accordance with GAAP, see our financial statements. For a quantitative reconciliation of our EBITDA information to the most comparable GAAP financial measures, see the table below.

The following table sets forth, for the periods indicated, the computation of EBITDA and reconciliation to the reported amounts for net loss (dollars in thousands):

Earnings (loss) before interest, taxes, depreciation and amortization is computed as follows:

Fiscal Year Ended March 28, 2004 Compared To Fiscal Year Ended March 30, 2003

Net Sales

Our net sales for Fiscal 2004 decreased $32,000 to $50,768,000 as compared to net sales of $50,800,000 for Fiscal 2003. The decrease in net sales is comprised as follows:

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The Retail division sales increase represented a 0.8% increase compared to Retail division sales for Fiscal 2003. The factors comprising this sales increase are summarized as follows:

Comparable store sales for Fiscal 2004 increased by $1,137,000 or 3.0%, compared to Fiscal 2003. During Fiscal 2004 and Fiscal 2003, Tully’s closed twelve stores, resulting in a sales decrease of $1,288,000. One new store opened during the fourth quarter of Fiscal 2003 and one new store opened during the fourth quarter of Fiscal 2004. These new stores produced a net sales increase of $461,000 for Fiscal 2004.

Wholesale division net sales increased $744,000, or 12.9%, to $6,522,000 for Fiscal 2004, from $5,778,000 for Fiscal 2003. The increase reflects a $1,057,000 sales increase in the grocery channel, due primarily to growth in the number of supermarkets selling Tully’s coffees, partially offset by lower sales in food service channels.

Net sales for the Specialty division decreased by $1,086,000, or 23.0%, from $4,715,000 in Fiscal 2004 to $3,629,000 in Fiscal 2003. During Fiscal 2003, FOODX began to purchase coffee, supplies and equipment from Japanese suppliers rather than from Tully’s, and this trend continued during Fiscal 2004. The shift toward more local procurement by FOODX and the resulting increase in coffee roasting fees paid to Tully’s decreased our overall net sales to FOODX, but resulted in greater gross margins for Tully’s.

Operating Expenses

Cost of goods sold and related occupancy costs decreased $1,513,000, or 6.4%, to $22,153,000 for Fiscal 2004 as compared to Fiscal 2003, primarily as the result of the decrease in product sales to FOODX by the Specialty division (which resulted in a $1,322,000 decrease in cost of goods sold). During Fiscal 2003 and Fiscal 2004, we implemented programs to improve the efficiency of our manufacturing and distribution processes and we reduced our roasting and supply chain costs by approximately $342,000 in Fiscal 2004 (and increased the volume of coffee roasted by approximately 18%) compared to Fiscal 2003. These cost reductions were partially offset by an increase of $726,000 related to the cost of goods sold from the increased sales of the Wholesale division. Cost of sales and related occupancy costs decreased $417,000 in the Retail division. As a percentage of net sales, cost of goods sold and related occupancy costs decreased to 44.6% for the Fiscal 2004 as compared to 43.6% for Fiscal 2003, primarily as a result of these factors, the amounts of which are not separately determinable:

Store operating expenses decreased $290,000, or 1.7%, to $16,923,000 for Fiscal 2004 as compared to Fiscal 2003 as the result of the closure of stores not meeting our financial requirements, partially offset by costs of the two stores added in Fiscal 2003 and Fiscal 2004. As a percentage of net sales, store operating expenses improved to 33.4% for Fiscal 2004 from 33.9% for Fiscal 2003.

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Other operating expenses (expenses associated with all operations other than retail stores) increased $111,000 or 5.8% to $2,014,000 for Fiscal 2004 as compared to Fiscal 2003, as the result of expenses incurred in connection with the expansion of our Wholesale division business. As a percentage of net sales, other operating expenses increased to 4.0% for Fiscal 2004 as compared to 3.7% in Fiscal 2003.

Marketing, general and administrative costs decreased $2,109,000, or 22.7%, to $7,181,000 for Fiscal 2004 as compared to $9,290,000 for Fiscal 2003, reflecting our efforts to reduce such costs. This decrease reflects reductions of $1,094,000 in marketing and promotion costs, $296,000 in labor costs, and $244,000 in professional fees, as compared to Fiscal 2003.

Depreciation and amortization expense decreased $287,000, or 7.4%, to $3,607,000 for Fiscal 2004 as compared to Fiscal 2003. The reduction in depreciation and amortization expense reflects the lower depreciable asset base after asset retirements and asset impairment charges.

During Fiscal 2004 we entered into preliminary discussions with FOODX about the possibility of integrating our business with FOODX. On May 12, 2004, we reported that we have ceased discussions with FOODX. In connection with these discussions and the evaluation of this business integration opportunity, we incurred fees and other expenses of $541,000 in Fiscal 2004 (no such costs were incurred in Fiscal 2003).

During Fiscal 2004, we incurred store closure and lease termination costs of $170,000 in connection with the closure of seven stores that did not meet our financial criteria. Tully’s incurred $108,000 in store closure costs during Fiscal 2003.

Operating Loss

As a result of the factors described above, we had an operating loss of $1,920,000 for Fiscal 2004, which is an improvement of $4,744,000 (71.2%) as compared to the operating loss of $6,664,000 during Fiscal 2003.

Other Income (Expense)

Interest expense decreased $111,000, or 17.1%, to $537,000 for Fiscal 2004 as compared to $648,000 during Fiscal 2003 due to a lower value assigned to warrants issued as payment of interest under the convertible promissory note (see Note 12 of the Notes to the Consolidated Financial Statements), offset by increased cash interest from a full year of borrowings under the KCL credit facility in Fiscal 2004 as compared to a partial year of borrowing in Fiscal 2003.

During Fiscal 2004 we incurred loan guarantee fee expense of $227,000 from the non-cash compensation (paid with warrants) to the guarantors of the credit facility (see Note 11 of the Notes to the Consolidated Financial Statements). We incurred partial year expense of $94,000 of loan guarantee fee expense during Fiscal 2003 when this arrangement commenced.

As a result of the agreement with Spinelli Pte. Ltd. relating to the assignment of certain rights for our Spinelli brand, we recognized a net gain of $460,000 that is included in other income for Fiscal 2003 (see Note 13 of the Notes to the Consolidated Financial Statements). There was no such gain recognized during Fiscal 2004.

Earnings (Loss) before Interest, Taxes, Depreciation and Amortization

As a result of the factors described above, we had EBITDA of $1,741,000 for Fiscal 2004, which is an improvement of $3,987,000 as compared to the loss before interest, taxes, depreciation and amortization of $2,246,000 during Fiscal 2003.

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Cumulative Effect of Change in Accounting Principle

During Fiscal 2003, we adopted the full provisions of SFAS 142 (see Note 7 of the Notes to the Consolidated Financial Statements). We performed an evaluation of our goodwill as of April 1, 2002 and determined that an impairment charge of $3,018,000 should be recorded related to our Retail division operations in California and Oregon. As provided in SFAS 142, this impairment charge was retroactively recorded as the cumulative effect of a change in accounting principle as of the beginning of Fiscal 2003.

Loss before Cumulative Effect of Change in Accounting Principle and Net Loss

As a result of the factors described above, loss before cumulative effect of change in accounting principle decreased $4,217,000, or 61.2%, to $2,669,000 during Fiscal 2004, as compared to $6,886,000 during Fiscal 2003.

We had a net loss of $2,669,000 for Fiscal 2004, as compared to the net loss of $9,904,000 during Fiscal 2003 (including the Fiscal 2003 $3,018,000 non-cash charge for the write-off of goodwill from the cumulative effect of change in accounting principle).

Fiscal Year Ended March 30, 2003 Compared To Fiscal Year Ended March 31, 2002

Net Sales

Our net sales for Fiscal 2003 decreased $658,000, or 1.3%, to $50,800,000 as compared to net sales of $51,458,000 for Fiscal 2002. The decrease in net sales was comprised as follows:

Total Company

The Retail division sales decrease represented a 2.8% decrease compared to Fiscal 2002. The factors comprising this sales decrease are summarized as follows:

During Fiscal 2003 and Fiscal 2002, we closed a total of seventeen stores, which resulted in a sales decrease of $1,490,000 from Fiscal 2002 to Fiscal 2003, while a total of three new stores opened during Fiscal 2003 and Fiscal 2002 and produced a net sales increase of $598,000 in Fiscal 2003 compared to Fiscal 2002. Overall, comparable store sales for Fiscal 2003 decreased by (0.7%) compared to the previous year.

Wholesale division net sales increased $662,000, or 12.9%, to $5,778,000 for Fiscal 2003 from $5,116,000 for Fiscal 2002. The increase reflects a $945,000 sales increase due primarily to growth in the number of supermarkets selling Tully’s coffees, partially offset by a $283,000 decline in office coffee service sales. Wholesale division sales accounted for 11.4% of net sales in Fiscal 2003 and 10.0% in Fiscal 2002.

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Net sales for the Specialty division decreased by $142,000, or 2.9%, for Fiscal 2003 from $4,857,000 to $4,715,000 for Fiscal 2003. Although FOODX increased the number of its owned and franchised stores from 50 to 112 during Fiscal 2003, FOODX began to purchase coffee, supplies and equipment from Japanese suppliers rather than from us during this period. The shift toward more local procurement by FOODX will generally decrease our sales to FOODX, but will result in greater gross margins for Tully’s. The growth in FOODX’s retail store base and business and the shift in its procurement resulted in a $728,000 increase in license royalties (related to the stores franchised by FOODX) and coffee roasting fees compared to Fiscal 2002, but also resulted in a decrease in sales of coffee and supplies of $870,000. Recognition of deferred revenue related to the UCC and FOODX agreements increased by $130,000 because Fiscal 2002 included only a partial year of such revenues. Specialty division sales accounted for 9.3% and 9.4% of net sales in Fiscal 2003 and Fiscal 2002, respectively.

Operating Expenses

Cost of goods sold and related occupancy costs decreased $2,239,000, or 8.6%, to $23,666,000 in Fiscal 2003 from $25,905,000 in Fiscal 2002. As a percentage of net sales, cost of goods sold and related occupancy costs decreased to 46.6% for Fiscal 2003 compared with 50.3% for Fiscal 2002. These changes resulted primarily from:

Store operating expenses remained flat, decreasing $177,000, or 1.0%, to $17,213,000 in Fiscal 2003 from $17,390,000 in Fiscal 2002, reflecting the net decrease in the number of stores in operation. As a percentage of net sales, store operating expenses remained unchanged at 33.9% for Fiscal 2003 compared to 33.8% for Fiscal 2002.

Other operating expenses (expenses associated with all operations other than retail stores) increased $322,000 or 20.4% to $1,903,000 in Fiscal 2003 from $1,581,000 in Fiscal 2002. As a percentage of net sales, other operating expenses increased to 3.7% for Fiscal 2003 compared to 3.1% for Fiscal 2002. This increase was primarily due to growth in selling costs related to the growth in the Wholesale division.

Marketing, general and administrative costs decreased $1,870,000, or 16.8%, to $9,290,000 in Fiscal 2003 from $11,160,000 in Fiscal 2002 reflecting our efforts to reduce costs to levels appropriate for our revenue base. This decrease includes $175,000 in reduced costs under baseball park sponsorship agreements, a $762,000 decrease in professional fees, and a $178,000 decrease in stock option compensation expense.

Depreciation and amortization expense decreased $706,000, or 15.3%, to $3,894,000 in Fiscal 2003 from $4,600,000 in Fiscal 2002. During Fiscal 2003, we adopted the full provisions of SFAS 142 and therefore no amortization of goodwill was recorded in Fiscal 2003, compared to $252,000 recorded in Fiscal 2002. The reduction in depreciation and amortization expense also reflects the lower depreciable asset base caused by asset retirements and asset impairment charges (described below) during Fiscal 2001-2003.

Impairment of Long-Lived Assets

During Fiscal 2003 and Fiscal 2002, we performed reviews of our long-lived assets to determine whether such assets were impaired (see Note 7 of the Notes to the Consolidated Financial Statements). These reviews determined that impairments did exist, and a non-cash charge of $1,390,000 was recognized in Fiscal 2003 compared to the non-cash impairment charge of $2,350,000 during Fiscal 2002. These non-cash charges represent the write-off of the goodwill, leasehold improvements and other long-lived assets determined to be impaired.

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Store Closure and Lease Termination Costs

Store closure and lease termination costs were $108,000 for Fiscal 2003 as compared to $1,583,000 in Fiscal 2002. This decrease in the amount of costs associated with closure and disposal of stores not meeting our financial criteria and disposal of undeveloped property under leases is the result of the lower number of store closures and surplus properties to be disposed of in Fiscal 2003. See Note 15 of the Notes to the Consolidated Financial Statements.

Operating Loss

As a result of the factors described above, we had an operating loss of $6,664,000 in Fiscal 2003 as compared to the operating loss of $13,111,000 in Fiscal 2002, which is an improvement of $6,447,000, or 49.2%, as compared to Fiscal 2002. The improvement includes a $2,435,000 reduction in the amount of charges for impairment of long-lived assets and for store closure and lease termination costs for Fiscal 2003 as compared to Fiscal 2002.

Other Income (Expense)

Interest expense decreased $164,000, or 20.2%, to $648,000 for Fiscal 2003 compared to $812,000 for Fiscal 2002. The decrease relates to the lower level of average outstanding debt during Fiscal 2003 as compared to during Fiscal 2002 as the result of the repayment of our bank borrowings in Fiscal 2002 and the repayment of other notes and contracts, and the lower cost recorded for warrants issued in lieu of cash interest for the convertible promissory note during Fiscal 2003. See Notes 11 and 12 of the Notes to the Consolidated Financial Statements.

Gains on sale of investments of $14,000 in Fiscal 2003 and $2,887,000 in Fiscal 2002 are the realized gains from the sale of our holdings of FOODX stock. The greater gain in Fiscal 2002 is the result of (i) lower cost per share on the shares sold in Fiscal 2002, (ii) higher selling price per share in Fiscal 2002, and (iii) more shares sold in Fiscal 2002.

Miscellaneous income (expense) increased $528,000 to income of $510,000 for Fiscal 2003 from expense of $18,000 for Fiscal 2002. The increase reflects primarily the Fiscal 2003 sale of certain intellectual property to Spinelli Pte. Ltd., in the amount of $500,000 less approximately $40,000 of costs (See Note 13 of the Notes to the Consolidated Financial Statements).

Loan guarantee fee expense decreased $122,000 to $94,000 in Fiscal 2003 from $216,000 for Fiscal 2002 primarily as the result of the lower level of average outstanding debt during Fiscal 2003 that was subject to such fees, as compared to Fiscal 2002. These are non-cash fees paid with options or warrants (see Note 11 of the Notes to the Consolidated Financial Statements).

Loss before Interest, Taxes, Depreciation and Amortization

As a result of the factors described above, we had a loss before interest, taxes, depreciation and amortization of $2,246,000 for Fiscal 2003, which is an improvement of $3,396,000 as compared to the loss before interest, taxes, depreciation and amortization of $5,642,000 during Fiscal 2002.

Cumulative Effect of Change in Accounting Principle

During Fiscal 2003, we adopted the full provisions of SFAS 142. We performed an evaluation of our goodwill as of April 1, 2002 and determined that an impairment charge of $3,018,000 should be recorded related to our Retail division operations in California and Oregon. As provided in SFAS 142, this impairment charge has been retroactively recorded as the cumulative effect of a change in accounting principle as of the beginning of Fiscal 2003. See Note 7 of the Notes to the Consolidated Financial Statements.

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Loss before Cumulative Effect of Change in Accounting Principle and Net Loss

Loss before Cumulative Effect of Change in Accounting Principle decreased $4,266,000, or 38.3%, to $6,886,000 in Fiscal 2003 from $11,152,000 for Fiscal 2002. The smaller loss in Fiscal 2003 reflects the $6,447,000 improvement in operating loss during Fiscal 2003, partially offset by the smaller gain on sale of investments during Fiscal 2003 as compared to Fiscal 2002.

After the $3,018,000 non-cash charge for the write-off of goodwill from the cumulative effect of change in accounting principle, we had a net loss of $9,904,000 for Fiscal 2003 as compared to $11,152,000 for Fiscal 2002.

Liquidity and Capital Resources

The following table sets forth, for the periods indicated, selected statement of cash flows data (dollars in thousands):