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

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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)

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

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 and (2) has been subject to such filing requirements for the past 90 days. Yes /x/    No / /

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

TULLY'S COFFEE CORPORATION
Form 10-Q
For the Quarterly Period Ended June 30, 2002

Index

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        Unless the context requires otherwise, as used in this report "Tully's", "Company", "we", "our" and "us" means Tully's Coffee Corporation and its affiliates.

Statement 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 the Company's future results and performance and possible or assumed future results of the Company's operations, plans and, objectives. 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 actual results or performance may differ materially from those expressed in our forward-looking statements. Information regarding factors that could cause our actual results to differ materially from our expectations are included this report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Our Future Results."

        You should not place undue reliance on 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. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TULLY'S COFFEE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)

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

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TULLY'S COFFEE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)

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

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TULLY'S COFFEE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)

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

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TULLY'S COFFEE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.    Basis of Presentation

        The condensed consolidated financial statements include the accounts of Tully's Coffee Corporation ("Tully's" or the "Company") and its wholly owned subsidiary, Spinelli Coffee Company, after elimination of all significant intercompany items and transactions.

        The Company's fiscal year ends on the Sunday closest to March 31. The fiscal year ending March 30, 2003 ("Fiscal 2003") will include 52 weeks. The fiscal years ending March 31, 2002 ("Fiscal 2002") and April 1, 2001 ("Fiscal 2001") both included 52 weeks. The fiscal year ending March 29, 2004 ("Fiscal 2004") will have 52 weeks.

        The accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments that, in the opinion of management, are necessary to present fairly the financial information set forth therein. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Results of operations for the 13-week periods ended June 30, 2002, and July 1, 2001, respectively, are not necessarily indicative of future financial results.

        Investors should read these interim statements in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and notes thereto for Fiscal 2002 included in our annual report on Form 10-K, SEC File No. 0-26829 for the fiscal year ended March 31, 2002.

Recently Issued Accounting Standards

        On April 1, 2002, we adopted Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets". Upon adoption, we ceased amortization of goodwill thereby eliminating approximately $89,000 in amortization expense for the 13 week period ended June 30, 2002 ("First Quarter 2003") compared to the same period last year. Prior to the adoption of SFAS 142, the Company amortized goodwill using the straight-line method over the estimated lives of fifteen years. We are in the process of completing our assessment for impairment of our goodwill required upon implementation of SFAS No. 142. When this assessment is completed later in Fiscal 2003, the adjustment, if any, will be recorded as an accounting change in accordance with SFAS 142. In the future, impairment must be assessed at least annually for goodwill, or when indication of impairment exists.

        In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This statement provides accounting and reporting standards for recognizing obligations related to asset retirement costs associated with the retirement of tangible long-lived assets. Under this statement, legal obligations associated with the retirement of long-lived assets are to be recognized at their fair value in the period in which they are incurred if a reasonable estimate of fair value can be made. The fair value of the asset retirement costs is capitalized as part of the carrying amount of the long-lived asset and expensed using a systematic and rational method over the asset's useful life. The provisions of SFAS 143 will be effective for fiscal years beginning after June 15, 2002. The Company intends to adopt this statement effective in Fiscal 2004. The Company is currently assessing the impact of this statement on its results of operations, financial position and cash flows.

        On April 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). This statement supersedes FASB Statement No. 121, "Accounting

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for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121") and replaces the provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of Segments of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of segments of a business. SFAS 144 retains the fundamental provisions of SFAS 121 for the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. The adoption of SFAS 144 did not have a material impact on the Company's financial position or the results of its operations.

        In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS 145 also rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. SFAS 145 amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS 145 will be effective for fiscal years beginning after May 15, 2002. The Company believes that the adoption of SFAS 145 will not have a material impact on the Company's financial position or the results of its operations.

        In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS 146, liabilities for certain costs associated with an exit or disposal activity shall be recognized and measured initially at fair value in the period in which the liability is incurred and can be estimated. The provisions of SFAS 146 will be effective for exit or disposal activities initiated after December 31, 2002. The Company is currently assessing the impact of this statement on its results of operations, financial position and cash flows.

Reclassifications

        Reclassifications of prior year balances have been made to conform to the current year classifications and have no impact on net loss or financial position.

2.    Liquidity

        For First Quarter 2003, the Company had a net loss of $1,875,000 and used $2,272,000 for cash operating activities. The Company ended the period at June 30, 2002 with $707,000 in cash and cash equivalents and a working capital deficit of $1,925,000, an improvement of $2,972,000 in working capital deficit as compared to the July 1, 2001. This reflects an improvement in net loss and working capital deficit as compared to July 1, 2001 and the 13 weeks then ended, however, the Company expects to incur a loss in Fiscal 2003. The Company closed one store during First Quarter 2003 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 flow from operations, including programs to improve sales through new product offerings and retail marketing programs, revisions to operational procedures and expansion of its Wholesale division.

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        The Company has historically funded its capital requirements principally through the issuance of equity and debt securities, through borrowings and lease financing, and through cash provided under its international licensing relationships. During Fiscal 2003, the Company expects to raise additional capital through bank borrowings, the issuance of 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. 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 short-term investments at June 30, 2002, plus the financial commitments made by the financial backers will be sufficient to fund on going operations of the Company through June 30, 2003. In order to fund any capital expenditures in Fiscal 2003 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, and the Company is currently evaluating possible courses of action for raising additional capital. In the event 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.

3.    Inventories

        Inventories consist of the following:

        As of June 30, 2002, the Company had approximately $2,300,000 in fixed-price purchase commitments for green coffee.

4.    Short-term Investments

        Investments consist of shares of Tully's Coffee Japan common stock, which are subject to significant risk of changes in value. During First Quarter 2003, the Company sold 493 shares of Tully's Coffee Japan common stock for net proceeds of $1,813,000 and a realized gain of $27,000 (See Note 11). On June 30, 2002, the Company owned five shares of Tully's Coffee Japan common stock with a market value of approximately $21,000. On July 31, 2002, the market value of these shares was $20,000.

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5.    Goodwill

        Goodwill consisted of $3,572,000 at June 30, 2002. The following represents what the net loss for First Quarter 2002 would have been exclusive of amortization expense recognized in that period related to goodwill that is no longer being amortized.

        The following represents what the net loss per share applicable to common stock for First Quarter 2002 would have been exclusive of amortization expense recognized in the period related to goodwill that is no longer being amortized:

6.    Related Party Notes Receivable

        In May 2002, the Company loaned an aggregate of $100,000 to its newly hired chief executive officer under non-interest bearing notes in accordance with the terms of his employment agreement. The notes are to be repaid on the earlier of (a) the third anniversary of the executive's commencement of employment, or (b) the date the executive's employment is terminated by the Company for cause.

7.    International Licenses and Deferred Licensing Revenue

        In April 2001, the Company granted Ueshima Coffee Company, LTD ("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, and received a $12,000,000 license fee. The Company has accounted for this payment as deferred licensing revenue and is amortizing this amount into income on a straight-line basis over seven years, the term of the prepaid royalties under the agreement. Commencing in April 2009, UCC is required to pay the Company a royalty and service fee based upon the aggregate net revenues of the stores that UCC is then operating 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 (other than Japan). Under this agreement, the Company has granted a security interest in certain of its intellectual property rights and certain proceeds related thereto solely as the same relate to stores located in the territories described in the License Agreement. The $12,000,000 license fee payment was the net payment after applicable Japanese tax withholdings paid by UCC which are subject to refund by Tully's to UCC in the event Tully's successfully receives a tax credit for such taxes.

        The Company has license and supply agreements with Tully's Coffee Japan. Under the license agreement, as amended in Fiscal 2002, the licensee has the right to use the Tully's trademark, brand name and products in Japan in operating and franchising retail stores and engaging in wholesale coffee sales. Tully's Coffee Japan is required to pay licensing fees to the Company based upon the store

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revenues. The supply agreement, as amended during Fiscal 2001, allows Tully's Coffee Japan to roast Tully's coffee in Japan and to purchase other supplies and materials from sources other than the Company, subject to quality and pricing requirements. Tully's Coffee Japan is required to pay a royalty to the Company based upon the volume of coffee roasted in Japan. Tully's Coffee Japan commenced coffee roasting in Japan during First Quarter 2003.

        In consideration, and in connection with the formation of Tully's Coffee Japan, the Company received 824 shares of Tully's Coffee Japan stock. On October 1, 2001, the Company received $4,200,000 in cash and 300 additional shares of Tully's Coffee Japan common stock (valued at $1,771,000 on that date) in connection with the amendment of its supply agreement with Tully's Coffee Japan. The Company has accounted for the October 1, 2001 payment as deferred licensing revenue and is amortizing this amount into income on a straight-line basis over fifteen years, the estimated life of the agreement.

        During August 2002, Tully's Coffee Japan changed its name to FOODX GLOBE Co., Ltd. as part of a strategy to enable FOODX GLOBE Co., Ltd. to operate multiple restaurant strategies, including Tully's Coffee stores.

8.    Stockholders' Equity

Options

        During First Quarter 2003, the Company granted options to purchase an aggregate of 1,305,000 shares of common stock to employees (including options for 1,000,000 shares to its new chief executive officer and 225,000 shares to its new chief financial officer). The Company recorded deferred compensation for the difference between the exercise price for the options and the estimated market price for common stock at the time of grant as established by the Company's board of directors, and is amortizing the deferred stock compensation over the three year vesting period of the options. First Quarter 2003 option grants to employees are summarized as follows:

        Additionally, during First Quarter 2003, the Company granted stock options for 15,000 shares to its directors for participation in board and board committee meetings. These options are fully vested and exercisable and have an exercise price of $0.01. The Company recorded stock option expense of $4,650 for the difference between the exercise price for the options and the estimated market price for common stock at the time of grant as established by the Company's board of directors.

Warrants

        The Company had warrants outstanding to purchase 8,038,176 and 7,586,047 shares of common stock as of June 30, 2002 and July 1, 2001, respectively, at exercise prices ranging from $0.01 to $0.33 per share. The weighted average exercise price of these warrants is $0.28 per share.

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9.    Segment Reporting

        The Company presents segment information in accordance with Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," ("SFAS 131"), which established reporting and disclosure standards for an enterprise's operating segments. Operating segments are defined as components of an enterprise for which separate financial information is available and regularly reviewed by the Company's senior management.

        During the fourth quarter of Fiscal 2002, the Company realigned into three business units: (1) its Retail division, which includes its domestic store operations, (2) its Wholesale division, which sells to domestic customers in the supermarket, food service, office coffee service, restaurant and institutional channels, and which also handles the Company's mail order sales, and (3) its International division, which sells products and materials to the Company's international licensees and manages the international licensing of the Tully's brand and the related royalty programs. The previously reported First Quarter 2002 amounts have been reclassified to reflect this realignment.

        The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company's annual consolidated financial statements in the Fiscal 2002 Form 10-K. Operating income/(loss) represents earnings before interest income and expense.

        The tables below present information by operating segment:

**

Amounts are less than $1,000.

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(1)

For First Quarter 2003 and First Quarter 2002, the International division includes the amortization of fees received under the agreements with UCC and (for only the First Quarter 2003) with Tully's Coffee Japan.

(2)

For First Quarter 2002, the Retail division includes $837,000 for amounts required to close stores and terminate store leases.

10.  Net Loss Per Common Share

        Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing net loss by the sum of the weighted average number of common shares and the effect of dilutive common share equivalents.

        The Company has granted options and warrants to purchase common stock, and issued preferred stock and debt convertible into common stock. These instruments may have a dilutive effect on the calculation of earnings or loss per share. As of June 30, 2002 and July 1, 2001, there were outstanding options and warrants convertible into 11,590,025 and 10,007,164 shares of common stock, respectively. All such instruments were excluded from the computation of diluted loss per share for First Quarter 2003 and First Quarter 2002 because the effect of these instruments on the calculation would have been antidilutive.

11.  Comprehensive Loss

        Other comprehensive loss consists of the unrealized gains and losses, net of applicable taxes, on available-for-sale securities. The balances are as follows:

        Because of the Company's net operating losses, no tax expense (benefit) has been allocated to other comprehensive loss.

12.  Subsequent Event

        The Company has a sponsorship agreement with the San Francisco Giants for PacBell Stadium in San Francisco that provides for certain advertising and marketing rights in exchange for annual fees. The PacBell Stadium agreement was to expire on October 31, 200