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

FORM 10-Q

Commission file number 0-26829

Tully's Coffee Corporation
(Exact Name of Registrant as Specified in its Charter)

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 ý    No o

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 September 29, 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 possible or assumed future results and performance of the Company and its 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 thirteen and twenty-six- week periods ended September 29, 2002, and September 30, 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

        Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), was issued by the Financial Accounting Standards Board in June 2001. The statement changes the accounting for goodwill from an amortization method to an impairment only approach, and Tully's was required to adopt it for Fiscal 2003. Prior to the adoption of SFAS 142, the Company amortized goodwill using the straight-line method over the estimated life of fifteen years. Upon adoption of SFAS 142, the Company ceased amortization of goodwill thereby eliminating approximately $89,000 and $178,000 in amortization expense for the thirteen-week period ended September 29, 2002 ("Second Quarter 2003") and twenty-six-week period ended September 29, 2002 compared to the same periods in Fiscal 2002, respectively.

        SFAS 142 requires that companies perform periodic evaluations of potential impairment of goodwill, with the initial assessment to be completed during the first six months of the year in which SFAS 142 is first applied. During Second Quarter 2003, Tully's completed an impairment evaluation of its goodwill as of April 1, 2002, and determined that a non-cash impairment charge of $3,018,000 should be recorded. As provided in SFAS 142, this impairment charge has been retroactively recorded as the cumulative effect of a change in accounting principle as of April 1, 2002 (see Note 5).

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.

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2.    Liquidity

        For Second Quarter 2003 and the twenty-six-week period ended September 29, 2002, the Company had a loss (before the cumulative effect of change in accounting principle, discussed in Note 1) of $1,021,000 and $2,896,000, respectively, as compared with losses of $2,791,000 and $6,439,000 for the comparable periods in Fiscal 2002. The impairment charge recorded as the cumulative effect of change in accounting for goodwill did not affect the Company's cash flow or liquidity. The Company's cash operating activities provided $364,000 of cash during the thirteen-week period ended September 29, 2002, and used $1,908,000 of cash during the twenty-six week period ended September 29, 2002. The Company ended the Second Quarter 2003 with $686,000 in cash and cash equivalents and a working capital deficit of $2,679,000, an improvement of $3,236,000 in working capital deficit as compared to September 30, 2001. Although the Company's results for Fiscal 2003 reflect an improvement in net loss and working capital deficit as compared to the same periods in Fiscal 2002, the Company does expect to incur a net loss in Fiscal 2003. The Company has closed three stores during the twenty-six week period ended September 29, 2002 and another store in early November 2002, that did not meet the Company's performance criteria, and is continuing to evaluate store locations and operations to determine if closure, 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.

        On November 1, 2002, the Company entered into a new credit facility with a private investor, Kent Central LLC ("KCL"), secured by substantially all of the Company's assets and guaranteed by certain directors and stockholders of the Company (the "financial backers"), as described in Note 13. The new KCL credit facility allows the Company to borrow up to $2,000,000 through October 31, 2003. The KCL credit facility places conditions and restrictions on the Company's ability to raise capital through equity or debt, and to sell assets, but does permit the Company to enter into an additional borrowing facility of up to $1.0 million with another lender, subject to KCL's reasonable consent. The additional facility may be secured by the Company's accounts receivable and inventory, and KCL would have a subordinated interest in that collateral. The Company is evaluating possible lenders for this additional secured borrowing and expects to enter into such a facility as part of its Fiscal 2003 financing strategy.

        The Company believes that the combination of cash and cash equivalents at September 29, 2003, proceeds from the KCL credit facility, and the $1.0 million additional secured borrowing that the Company expects to obtain will be sufficient to fund ongoing operations of the Company through Fiscal 2003. In order to fund unanticipated operating requirements in excess of the Company's Fiscal 2003 operating plan and future capital expenditures, the Company would require additional capital. Additional sources of funding are expected to include debt or equity financings, and the Company is currently evaluating alternatives for raising additional capital. If the Company is unable to secure the additional secured borrowing or other sources of capital are unavailable, or are available only on a limited basis or under unsatisfactory terms, then the Company would be required to substantially reduce operating, marketing, general and administrative costs related to its continuing operations, and to reduce or discontinue its investments in store improvements, new customers and new products. In addition, the Company might be required to sell stores or other assets and would be unable to take advantage of business opportunities or respond to competitive pressures. The inability of the Company to secure additional capital on reasonable terms, if at all, during Fiscal 2003 could adversely affect our business, operating results and financial condition.

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3.    Inventories

        Inventories consist of the following:

        As of October 31, 2002, the Company had approximately $1,564,000 in fixed-price purchase commitments for green coffee.

4.    Short-term Investments

        Short-term investments at March 31, 2002 consisted of shares of FOODX GLOBE Co., Ltd. ("FOODX") (formerly known as Tully's Coffee Japan) common stock. During the thirteen-week period ended June 30, 2002 ("First Quarter 2003"), the Company sold 493 shares of FOODX stock for net proceeds of $1,813,000 and a realized gain of $27,000. During Second Quarter 2003, the Company sold its remaining 5 shares of FOODX common stock for net proceeds of $16,000 and a realized loss of $13,000 (See Notes 7 and 12).

5.    Goodwill

        During the twenty-six week period ended September 29, 2002, the Company adopted the full provisions of SFAS 142. SFAS 142 requires that companies perform periodic evaluations of potential impairment of goodwill, with the initial assessment to be completed during the first six months of the year in which SFAS 142 is first applied. During Second Quarter 2003, Tully's performed an evaluation of its goodwill, and determined that an impairment of $3,018,000 should be recorded as of April 1, 2002 related to the Company's 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. The change in carrying amount of goodwill as of April 1, 2002 is as follows (in thousands):

        Under SFAS 142, goodwill is no longer amortized. In accordance with SFAS 142, the effect of this accounting change is reflected prospectively, and Tully's ceased amortization of goodwill in Fiscal 2003.

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Supplemental comparative disclosure, as if this change had been retroactively applied to the prior year periods, is as follows:

**

Amounts are less than $0.01.

        Amortizable intangible assets at September 29, 2002 totaled $1,068,000 net of accumulated amortization of $384,000. Amortization expense for the thirteen and twenty-six week periods ended September 29, 2002, was approximately $26,000 and $53,000, respectively.

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 earliest 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 receives successfully a tax credit for such taxes.

        The Company has license and supply agreements with FOODX. During August 2002, Tully's Coffee Japan changed its name to FOODX as part of a strategy to enable FOODX to operate multiple restaurant strategies, including Tully's Coffee stores. Under the license agreement, as amended in Fiscal

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2002, FOODX 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. FOODX is required to pay licensing fees to the Company based upon the store revenues. The supply agreement, as amended during Fiscal 2002, allows FOODX 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. FOODX is required to pay a fee to the Company based upon the volume of coffee roasted in Japan. FOODX commenced coffee roasting in Japan during First Quarter 2003.

        In consideration, and in connection with the formation of FOODX, the Company received 824 shares of FOODX stock. On October 1, 2001, the Company received $4,200,000 in cash and 300 additional shares of FOODX common stock (valued at $1,771,000 on that date) in connection with the amendment of its supply agreement with FOODX (See Note 4). 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.

        In September 2002, the Company assigned its intellectual property rights outside of the United States relating to its Spinelli brand, including the trademarks and related goodwill, to Spinelli Pte. Ltd. ("SPL"), the licensee of the Company's Spinelli brand in Singapore and Taiwan. Under the agreement, SPL agreed to pay $500,000 to the Company. The Company received $250,000 from SPL during September 2002, and expects to receive the balance of the purchase price in March 2003. The Company retains certain rights with respect to the use of the Spinelli brand and related intellectual property in the United States and Japan. The $500,000 purchase price, less approximately $40,000 of costs, is reported as "other income" in Second Quarter 2003.

8.    Sponsorship Agreement

        The Company has a sponsorship agreement with the San Francisco Giants at 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, 2002 and provided for fees of $950,000 for Fiscal 2003. During August 2002, the parties amended the agreement to extend the term of the agreement through October 31, 2003 with an aggregate fee of $1,100,000 for the two years ($825,000 payable in Fiscal 2003 and $275,000 payable in Fiscal 2004), and with a reduced level of marketing benefits during Fiscal 2004. Based upon the provisions of the amended PacBell Stadium agreement, the charge to expense will be $675,000 for Fiscal 2003 and $425,000 for Fiscal 2004.

9.    Stockholders' Equity

Options

        During Second Quarter 2003, the Company granted options to purchase an aggregate of 100,000 shares of common stock to employees. The Company recorded deferred compensation for the difference between the exercise price for the options and the estimated market price for its common stock at the time of grant as established by the Company's board of directors, and is amortizing the

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deferred stock compensation over the three year vesting period of the options. Second Quarter 2003 option grants to employees and deferred stock compensation are summarized as follows: