<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
PURSUANT TO SECTION 12(b) OR (g) OF
THE SECURITIES EXCHANGE ACT OF 1934
TULLY'S COFFEE CORPORATION
(Exact name of issuer as specified in its charter)
WASHINGTON 91-1557436
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
2010 AIRPORT WAY SOUTH, SEATTLE, WASHINGTON 98134
(Address of registrant's principal executive's offices) (Zip Code)
Registrant's telephone number, including area code (206) 233-2070
Securities to be registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
to be so registered each class is to be registered
NONE NOT APPLICABLE
Securities to be registered pursuant to Section 12 (g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of Class)
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ITEM 1. BUSINESS
GENERAL
Tully's Coffee Corporation and its subsidiary (collectively "Tully's" or
the "Company") sells high quality, premium roasted whole bean coffees, rich
brewed coffees, Italian-style espresso and cold beverages, baked goods and
pastries along with coffee-related hardware and supplies. As of July 1, 1999,
Tully's had 59 Company-operated retail stores in the Seattle/Western Washington,
San Francisco/Northern California, and Sun Valley, Idaho markets. In addition to
its Company-operated stores, as of July 1, 1999, Tully's had 15 licensed stores
in Asia and 3 licensed stores in the San Francisco International airport.
Tully's continually seeks to expand by developing the Company through both its
international licenses, and new store locations. Tully's also sells its products
to wholesale accounts and provides office coffee service. The Company's
philosophy is straightforward - provide an upscale atmosphere, with quick,
friendly service where customers can relax and enjoy some of the finest coffee
and espresso drinks available. It is management's goal to make each location
warm and inviting with employees who go out of their way to make customers feel
special. The Company believes that developing customer loyalty and brand
recognition is of the utmost importance in its business and expansion strategy.
COMPANY BACKGROUND
Tully's was formed in July 1992, after its founder and Chairman of the
Board, Tom T. O'Keefe, determined that an opportunity existed to develop, own
and operate a chain of specialty coffee stores in the greater Puget Sound area.
Mr. O'Keefe is the owner of a company which owns and manages several commercial
and retail properties in the area. He was approached by numerous companies,
including Starbucks Corporation, 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 an
opportunity existed for development of an organization focused on the sale of
high-quality coffee beans, coffee drinks and coffee related products in an
upscale atmosphere which emphasized customer service. On September 16, 1992
Tully's opened its first store in Kent, Washington. Tully's opened 12 stores in
fiscal year 1999 (ending March 28, 1999), and acquired 11 Company-operated and
11 licensed stores through the acquisition of Spinelli Coffee Company.
Tully's Coffee Corporation is a Washington corporation. In January 1995
Tully's moved into the space located at 2010 Airport Way South, Seattle,
Washington 98134, where it maintains its executive offices, warehouse and coffee
roasting facilities. Its telephone number is (206) 233-2070 or 1-800-96Tully.
THE BUSINESS OF TULLY'S COFFEE
The Company wants each Tully's location to be a warm and inviting
atmosphere that will attract customers and encourage those customers to stay and
enjoy its coffee, espresso and other beverages and food products. Tully's seeks
to employ people who contribute to the "Coffee experience" of its customers.
Tully's strives to develop customer loyalty and brand recognition by
providing superior service and offering quality coffee products that are
competitively priced. Management believes that the Company's staff is well
trained and knowledgeable about the coffee products offered for sale. It is the
Company's belief that customer service, along with product freshness,
consistency and variety have become its trademark.
Another important element of the Company's strategy is to become an
integral part of the local communities it serves. This is accomplished in a
variety of ways, such as becoming involved in local fundraising and charitable
organizations, participating in primary and secondary school programs and by
providing jobs to area high school students. Community involvement not only
helps the Company by building goodwill, but also strengthens its market
position.
The Company's objective is to establish Tully's as the most respected brand
of coffee in the world. As part of this brand building strategy, the Company has
carried a management infrastructure larger than required for a comparable sized
company that is not growing and has spent significant amounts marketing and
building its brand. This decision was made consciously and in anticipation of
continuing growth. Tully's combination of strong comparable store sales growth,
new store openings and a growing wholesale business are a result of this brand
building effort.
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MARKETING, SALES AND CUSTOMER SERVICE
STORES
Tully's focus on consistency and quality in both its products and customer
service is the basis for its marketing program as the Company strives for
increased exposure in the community. Stores and kiosks are intended to be
billboards themselves as the Company opens new locations. Point of sale signage,
custom bags, boxes, cups, gift sets, products and literature with the Company's
distinctive name and logo are intended to increase name awareness and to portray
the Company's image in terms of color, layout, typeface, wording, graphics and
display.
WHOLESALE
Tully's uses its wholesale and office coffee service accounts to provide
additional opportunities for coffee consumers to experience the Company's coffee
and reinforce its branded logo and name. The Company's product is delivered to
its wholesale and coffee service accounts in branded packaging. Tully's also
provides logo-bearing coffee cups, banners and point of use signage to these
accounts. This type of secondary brand marketing reinforces the Company's brand
awareness and exposes the Company's coffee products to coffee consumers who may
not have previously sampled the products in one of its stores.
COMMUNITY
Tully's commitment to local community involvement is another key element of
its marketing strategy. The Company has provided and is planning on continuing
to provide monetary, service and/or product donations to a host of local
non-profit organizations, including schools, sports teams, churches, food banks,
charity and service organizations. The Company also provides product and
resource donations to national organizations including the Cystic Fibrosis
Foundation, the Juvenile Diabetes Foundation, Childhaven and Big Brothers and
Sisters. Such community involvement often results in the Company's name and logo
being displayed in promotional materials for organizations and events, at events
themselves and in media coverage of the organization or event.
SEATTLE MARINERS BASEBALL TEAM AND SAFECO FIELD
Tully's strives to establish brand name and product recognition by making
its products available in high volume consumer areas. An example of this
strategy is the Company's agreement with the Seattle Mariners Baseball
Organization.
In 1999, Tully's entered into a five-year agreement with the Seattle
Mariners Baseball Organization under which the Company operates a store in
Safeco Field, the team's home field. As the "Official Coffee of the Seattle
Mariners", Tully's sells its coffee and cups to the food concessionaire and all
coffee sold at Safeco Field is Tully's coffee in Tully's logo cups. Tully's
receives prominent exposure during each game through a variety of signage
arrangements in Safeco Field, including a large permanent sign with its name and
logo on the left field wall. The Company may associate its logo with the
Mariners logo in promotions. The partnership provides the Company exposure to
millions of people annually through local and national television broadcasts.
3
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MEDIA
In media, Tully's strives for a fun and lively, yet professional, feel to
its promotions. Newspaper ads and radio and television spots are designed to
portray the warm, friendly, sophisticated feel of the stores as grand openings,
hiring, product specials, community involvement and special events are
announced. Management believes that the various forms of planned and spontaneous
media coverage the Company has experienced have given it positive, repeat
exposure to potential as well as existing customers.
EXPANSION STRATEGY
The Company's principal strategy for expansion is new store development.
Depending upon the amount of capital resources available to it, during the next
12 months the Company anticipates opening a number of additional retail
locations in the Seattle and San Francisco Bay areas.
The Company's development plans also include expansion into other major
North American cities. In executing this strategy the Company believes it will
be most successful if it develops a nucleus of stores in each new location with
emphasis on high-density metropolitan locations. Management believes that once
it has established a strong identity in these metropolitan locations, the
surrounding suburban retail areas will provide adequate growth capability within
these market areas.
The Company may also expand operations through strategic acquisitions. As
an entry into the San Francisco market, in June 1998 the Company acquired all
the outstanding shares of Spinelli Coffee Company. Spinelli Coffee Company had
11 Company-operated stores, 3 licensed stores, and both a roasting and warehouse
facility in the San Francisco Bay area. Spinelli also had 8 licensed stores in
Asia.
This type of acquisition strategy allows the Company to move into a new
geographic area with a base of operating stores in locations which fit the
Company's store profile. This provides the Company with an established
infra-structure for operations in the new area from which the Company can
further expand. It also gives the Company an established customer base for its
store operations.
In addition to its U.S. based operations, the Company currently also has
operations in Japan, Singapore and Taiwan. Sales to customers in stores located
outside the United States accounted for approximately 1.7% of the Company's net
sales in fiscal year 1999 and less than 1.0% in fiscal 1998. Tully's
international operations began in fiscal year 1998. The balance of the Company's
net sales are generated by Company owned-stores in the United States and its
wholesale and office coffee service.
The Company's international operations are conducted through licensing
arrangements and one joint venture. Tully's expects that for the foreseeable
future its international operations will continue to be conducted through its
existing licensing arrangements, and possibly new agreements. The Company
believes that its licensees intend to aggressively pursue expansion in their
respective territories.
In Japan, the Company licensed its trade name and trade dress to
Tully's Coffee Japan, a Japan corporation, in August 1997. In 1999, the Company
entered into a joint venture with Tully's Coffee Japan to operate three
stores in Japan. The Company made a $82,500 capital investment in exchange
for a 12% interest in Tully's Coffee Japan. License Agreements with third
party licensees in Singapore and Taiwan were acquired in June 1998 as a part of
the Spinelli acquisition. These agreements, originally entered into by Spinelli
in November 1995, grant a license to the Company's trade name and trade dress.
COMPETITION
The specialty coffee market is highly competitive. A number of Tully's
competitors have greater financial and marketing resources and brand name
recognition combined with a larger customer base than Tully's. Tully's competes
with a number of specialty coffee retailers including Starbuck's Coffee, SBC and
Peet's Coffee & Tea as well as other lesser known companies. Nationally, coffee
manufacturers such as Kraft, General Foods, Proctor and Gamble, and Nestle
distribute coffee products in supermarkets and convenience stores. Many of these
products may be substitutes for Tully's coffees and coffee drinks. Tully's
coffee beverages compete directly against all restaurant and beverage outlets
that serve coffee and a growing number of espresso stands, carts, and stores.
Tully's whole bean coffees and its coffee beverages compete indirectly against
all other coffees available in the market. Tully's believes that its customers
choose among retailers primarily on the basis of product quality, service and
convenience and, to a lesser extent, on price.
4
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The development of the specialty coffee industry has shown that there
is room for a variety of retailers, all seeking their own niche. Tully's
management acknowledges that there is a high concentration of specialty
coffee outlets (stores, carts, kiosks, and drive throughs) in both Seattle
and San Francisco, but believes these markets are highly fragmented. There
are also many single-location operators. Tully's believes that it has
developed significant brand identity and customer loyalty, which give it a
competitive advantage over the numerous single-location operators.
Management believes there are certain areas within each city that are
important to Tully's development and marketing, due to demographics, visibility
and/or population density. These areas are primary Company targets for new
retail stores. Industry competitors often target these areas for similar
reasons. Tully's has and will continue to open new retail stores in these areas,
even if it means being across the street or in the same office building as a
competitor.
Tully's faces intense competition for suitable new store sites and for
qualified personnel to operate both new and existing stores. There can be no
assurance that Tully's will be able to continue to secure sites at acceptable
rent levels or that Tully's will be able to attract a sufficient number of
qualified workers. Tully's wholesale and office coffee service businesses also
face significant competition from established wholesale and mail order
suppliers, many of whom have greater financial and marketing resources than
Tully's.
5
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STORE OPERATIONS AND MANAGEMENT/EMPLOYEES
As of July 1, 1999, Tully's employed 545 people, approximately 500 of which
were employed in retail stores or regional operations. The remainder are
employed in the Company's administrative, wholesale, roasting and warehouse
operations. All employees are non-union and management anticipates this will
continue to be the case. Approximately 220 of the Company's employees are
full-time.
Tully's knows that its employees are an integral part of its business, and
has structured its benefit programs accordingly. Employees who consistently work
20 hours or more per week are considered full-time employees, and are eligible
for vacation, holidays, medical and dental insurance, childbirth and sick leave.
To promote product loyalty and enhance expertise, all employees receive
discounts on beverages and resale items. Each employee also becomes a
shareholder. Upon successfully completing barista skills testing, the employee
is granted 100 shares of stock. Tully's believes that its current relations with
employees are excellent.
To maintain Tully's high standards of quality products and customer
service, all employees complete a 3-day training course prior to working in a
Company store, plus 16 hours of on-site training while working in a store.
Training hours are devoted to orientation, which includes Company history and
philosophy, as well as 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
includes Coffee 101, an intensive course which examines coffee history,
roasting, decaffeination processes, and tastings, or cuppings, of Tully's
proprietary blends. Barista testing concludes the training program, with
extensive, hands on drink preparation.
Tully's is committed to attracting and retaining the best people in the
coffee business. It has developed a sense of partnership with its employees
through its corporate culture, employee ownership and quality employee benefits.
As continued evidence of this, Tully's has adopted a Stock Option Plan, a Stock
Purchase Plan and a 401k plan to help attract and retain employees.
SUPPLIERS AND EQUIPMENT VENDORS
COFFEE MARKETS. Coffee is the world's second largest agricultural product and
is grown commercially in over fifty countries in tropical regions of the
world. The price and supply of coffee are subject to significant volatility.
While most coffee trades in the commodity market, coffee of the quality
sought by the Company tends to trade on a negotiated basis at a substantial
premium above commodity coffee prices, depending upon the supply and demand
at the time of purchase. The Company purchases unroasted, or "green" coffee.
There are many varieties of green coffee and a range of quality grades within
each variety. Tully's purchases only premium grade arabica coffee beans and
believes these beans are the best available from each producing region.
Tully's seeks to purchase the finest qualities and varieties of coffee by
identifying the unique characteristics and flavor of the varieties available
from each region of the world. The background and experience of the Company's
personnel allows it to maintain its commitment to serve and sell only the
highest quality coffee.
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The supply and price of coffee can be affected by multiple factors in the
producing countries, including weather and economic and political conditions. In
addition, green coffee 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
through agreements establishing export quotas or restricting coffee supplies
worldwide.
During the buying season, Tully's may enter into forward commitments for
the purchase of green coffee that may only be available in small quantities.
Rotating our coffee selection enables the Company to provide its customers with
a wider variety of coffees, as well as certain coffees that are available only
on a seasonal basis. Tully's contracts for future delivery of green coffee to
help ensure adequacy of supply. As of July 20, 1999, the Company had
approximately $1,200,000 in fixed-price purchase commitments which, together
with existing inventory, is expected to provide an adequate supply of green
coffee well into fiscal year 2000. Tully's believes, based on relationships
established with its suppliers in the past, that the risk of non-delivery on
such purchase commitments is remote.
ROASTING. Tully's procures and roasts green coffee beans to its exacting
specifications at its roasting plants in Seattle and San Francisco. We employ 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 of each batch.
FRESHNESS. The Company is able to roast to order for its retail and
wholesale and office coffee service accounts. All of the Company's retail stores
and wholesale customers receive fresh roasted coffee shipped promptly after
roasting.
EQUIPMENT AND STORE SUPPLIES. Tully's purchases the equipment, fixtures and
supplies for its retail store locations from a number of different vendors. The
Company does not have agreements with any of these vendors. The materials are
purchased through purchase orders on an as needed basis. In the past Tully's has
used different vendors for the same type of equipment and supplies as it
searched for the best sources and best vendors to meet its requirements. As
Tully's has expanded, it has attempted to standardize its purchasing systems and
begun to use particular vendors and suppliers for particular products on a more
regular basis. The Company believes that this means its relationships with
vendors will develop into reliable, long-term relationships that will benefit
Tully's. However, if for some reason a particular supplier or vendor is unable
to meet the Company's needs, begins to deliver unsatisfactory materials or is
not price competitive, Tully's believes that there are a number of alternative
sources to meet all of its equipment, store supplies and other materials needs.
GOVERNMENTAL REGULATION
Tully's is subject to the general laws and regulations relating to the food
service industry. There are no specific laws or regulations that govern the
coffee industry as a whole, or coffee retailers specifically, that are
materially different than other retail or wholesale food businesses.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Tully's is subject to foreign currency exchange rate exposure, primarily
related to its retail operations in Asia. At the present time, Tully's does not
hedge foreign currency risk, but may hedge known transaction exposure in the
future.
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PATENTS AND TRADEMARKS
Tully's does not hold any patents. The Company owns several trademarks
that are registered with the United States Patent and Trademark Office,
including Swirkle-Registered Trademark- and Tullini-Registered Trademark. In
addition, it has applied for federal trademark registration in the United
States for, Tully's-TM-. Since Tully's filed its application for federal
trademark registration for Tully's it has received notice that two other
companies are claiming rights to the trademark. Tully's believes that the
claim of one of these companies is not likely to impact Tully's because that
company filed its application after Tully's and apparently cannot demonstrate
use of the trademark prior to Tully's. The second company also filed its
federal trademark registration application after the Company. This applicant
has filed an objection to the issuance of a trademark to the Company. It is
claiming use of a Tully's trademark prior to the Company. If it can
successfully support its claim, it may be able to exclude the Company's use
of the Tully's name in certain geographic areas. That applicant currently
operates a chain of 4 restaurants in up-state New York. At the present time
Tully's and the other trademark registration applicant are conducting
discovery related to the relative rights that each party has in the Tully's
tradename.
Tully's has also filed for various trademark registrations in several
countries outside the United States. These filings are in various stages of the
registration process.
SEASONALITY
Tully's business is subject to seasonal fluctuations. Significant portions
of Tully's net revenues and profits are realized during the third quarter of
Tully's fiscal year that includes the December holiday season. In addition,
quarterly results are affected by the timing of the opening of new stores, and
Tully's rapid growth may conceal the impact of other seasonal influences.
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.
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ITEM 2. FINANCIAL INFORMATION.
SELECTED TULLY'S COFFEE FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and the consolidated financial statements and notes
thereto and other financial information included elsewhere in this registration
statement. The selected consolidated statements of operations data for each of
the three fiscal years ended on the Sunday closest to March 31, and the selected
consolidated balance sheet data at fiscal year end are derived from our audited
consolidated financial statements, which are included elsewhere in this
registration statement. The selected consolidated statements of operations data
for the fiscal year ended March 31, 1996 and April 2, 1995 and the consolidated
balance sheet data at March 31, 1996 and April 2, 1995 have been derived from
audited consolidated financial statements that have not been included herein.
The consolidated statements of operations data for the thirteen weeks ended June
27, 1999 and June 28, 1998 and the balance sheet data as of June 27, 1999 are
derived from our unaudited financial statements.
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In the opinion of management all material adjustments (consisting of normal
recurring adjustments and accruals) necessary for a fair presentation for the
interim period have been reflected.
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED PRO FORMA YEAR ENDED
----------------------- YEAR ENDED --------------------------------------------------------------
JUNE 27, JUNE 28, MARCH 29, MARCH 28, MARCH 29, MARCH 30, MARCH 31, APRIL 2,
1999 1998 1999(1) 1999(2) 1998 1997 1996 1995
---------- ---------- ---------- ---------- ---------- ---------- --------- --------
UNAUDITED UNAUDITED (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Net Sales $ 6,115 $ 3,181 $ 22,174 $ 20,207 $ 9,020 $ 5,430 $ 2,710 $ 1,520
Operating Expenses
Costs of goods sold and
related occupancy costs 3,024 1,610 11,370 10,705 5,012 2,850 1,530 865
Selling, general and
administrative costs 3,557 2,192 13,290 12,088 6,096 3,618 2,330 1,395
Stock option expense 205 195 833 833 564 627 410 40
Depreciation and
amortization 555 216 1,784 1,670 614 455 230 115
---------- ---------- ---------- ---------- ---------- ---------- --------- -------
7,341 4,213 27,277 25,296 12,286 7,550 4,500 2,415
---------- ---------- ---------- ---------- ---------- ---------- --------- -------
Operating loss 1,226 1,032 5,103 5,089 3,267 2,120 1,790 895
Other expense (income):
Interest expense 891 834 258 175 30 10
Loan guarantee fee expense 729 729 295 179 - -
Miscellaneous, net 258 236 (46) (71) - 8 - -
---------- ---------- ---------- ---------- ---------- ---------- --------- -------
Net loss 1,484 1,268 6,677 6,581 3,820 2,482 1,820 905
Preferred stock
dividend/accretion 3,631 1,248 5,969 5,969 - - - -
---------- ---------- ---------- ---------- ---------- ---------- --------- -------
Net loss applicable to
common stockholders $ 5,115 $ 2,516 $ 12,549 $ 12,550 $ 3,820 $ 2,482 $ 1,820 $ 905
========== ========== ========== ========== ========== ========== ========= =======
Basic and diluted loss per
share $ 0.36 $ 0.18 $ 0.88 $ 0.88 $ 0.29 $ 0.20 $ 0.19 $ 0.92
========== ========== ========== ========== ========== ========== ========= =======
Shares used in calculating
net loss per share 14,366,747 14,290,942 14,298,754 14,298,754 13,366,176 12,687,569 9,409,162 982,854
CONSOLIDATED BALANCE SHEET
DATA:
Working capital (deficit) 496 (5,799) (1,617) (100) 50 (770)
Total assets 31,093 20,719 8,078 3,980 3,110 1,430
Long-term debt and bank 3,174 6,657 4,293 2,520 930 70
lines of credit, including
current portion
Stockholders' equity (3) 17,260 9,976 427 430 1,230 360
</TABLE>
(1) Gives effect to the acquisition of Spinelli Coffee Company ("Spinelli") as
if it had occurred on March 30, 1998. See "Unaudited Consolidated Pro Forma
Financial Information."
(2) Includes nine months of operations data as a result of Tully's acquisition
of Spinelli Coffee Company. See "Unaudited Consolidated Pro Forma Financial
Information."
(3) Reflects the issuance of additional preferred stock. See "Item 10--Recent
Sales of Unregistered Securities."
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The Company believes that certain statements herein, including anticipated
store openings, planned capital expenditures, projected goodwill amortization
and trends in or expectations regarding Tully's operations, specifically
including the effect of problems associated with the Year 2000, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements are based on currently available
operating, financial and competitive information, and are subject to risks and
uncertainties. Actual future results and trends may differ materially depending
on a variety of factors, including, but not limited to, coffee and other raw
materials prices and availability, successful execution of internal performance
and expansion plans, the impact of competition, the effect of legal proceedings,
and other risks detailed herein.
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The following is a discussion and analysis of the financial condition and
results of operations of Tully's Coffee and should be read in conjunction with
Tully's Coffee financial statements and notes thereto.
OVERVIEW
As of July 1, 1999, Tully's had 59 Company-operated stores and 18 licensed
stores operating in 3 states and 3 foreign countries. In June 1998, the Company
acquired all the outstanding shares of Spinelli Coffee Company for a cash
purchase price of $8.4 million. Spinelli Coffee Company had 11 Company-operated
stores, 3 licensed stores, both a roasting and warehouse facility in the San
Francisco Bay area as well as 8 licensed stores in Asia. The acquisition has
been accounted for under the purchase method of accounting. The purchase price
has been allocated to the assets acquired and liabilities assumed based on
management's estimates, arms-length negotiations with the sellers and in certain
cases, independent appraisals of asset fair values. The residual of
approximately $5.1 million was recorded as goodwill and is being amortized on a
straight-line basis over 15 years. The results of operations of the acquired
companies have been included in consolidated results of operations of the
Company from the date of the acquisition.
The Company's fiscal year ends on the Sunday closest to March 31. Fiscal
years 1999, 1998 and 1997 all included 52 weeks. The fiscal year ending April 2,
2000 will include 53 weeks.
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED: FISCAL YEAR ENDED:
JUNE 27, JUNE 28, MARCH 28, MARCH 29, MARCH 30,
1999 1998 1999 1998 1997
----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF EARNINGS DATA:
Net Sales 100.0% 100.0% 100.0% 100.0% 100.0%
-------------------------------------------------------------------------------------------
Cost of goods sold
and related occupancy costs 49.4% 50.6% 53.0% 55.5% 52.5%
Selling, general and
administrative 58.2% 68.9% 59.8% 67.6% 66.7%
Stock option expense 3.4% 6.1% 4.1% 6.2% 11.6%
Depreciation and amortization 9.1% 6.8% 8.3% 6.8% 8.3%
-------------------------------------------------------------------------------------------
Operating loss -20.1% -32.4% -25.2% -36.3% -39.0%
Interest income (expense) -4.1% -2.9% -3.1%
Loan guarantee fee expense -3.6% -3.2% -3.3%
Miscellaneous, net 4.2% 7.4% 0.3% 0.0% -0.2%
-------------------------------------------------------------------------------------------
Net loss -24.3% -39.8% -32.6% -42.4% -45.7%
-------------------------------------------------------------------------------------------
</TABLE>
THIRTEEN WEEKS ENDED JUNE 27, 1999 COMPARED TO THIRTEEN WEEKS ENDED JUNE 28,
1998
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REVENUES
Net sales for the 13 weeks ended June 27, 1999, increased 92% to $6,115,000
from $3,181,000 for the corresponding period in fiscal 1999. The Company
acquired Spinelli Coffee Company at the end of the first quarter of fiscal 1999.
Therefore, revenues of Spinelli are included in the 13 week period ended June
27, 1999 but not the 13 week period ended June 28, 1998. Retail sales increased
77% to $5,289,000 from $2,990,000 due primarily to the Spinelli acquisition,
which accounted for $1,323,000 of the increase, and, to a lesser extent, to
(i) the opening of 12 new retail stores within the last year and (ii) an
increase in comparable store sales (stores open 13 months or longer) of 13%.
During the 13 weeks ended June 27, 1999, the Company opened two new stores. The
Company ended the period with 57 Company-operated stores in the United States.
Specialty sales, including domestic and international wholesale revenues
increased 333% to $826,000 for the 13 weeks ended June 27, 1999, compared to
$191,000 for the corresponding period in fiscal year 1999. Specialty sales
growth was driven primarily by the Spinelli acquisition which accounted for
$539,000 of the increase with the remainder as a result of increased sales to
wholesale and coffee service accounts.
OPERATING EXPENSES
Costs of goods sold and related occupancy expenses for the 13 weeks ended
June 27 , 1999 increased to $3,024,000 from $ 1,609,000 for the same period last
year. This increase was the result of higher sales volumes offset partially
by improved green coffee costs and lower store occupancy costs. As a percentage
of sales, cost of goods sold and related occupancy expenses decreased to 49.4%
for the 13 weeks ended June 27, 1999 from 50.6% for the comparable period in
fiscal 1999. The decrease as a percentage of net sales was due to improved
coffee purchasing and lower store occupancy costs.
Selling, general and administrative costs for the 13 weeks ended June 27,
1999 increased to $3,557,000 from $2,192,000 for the same period last year. As a
percentage of net sales, selling, general and administrative costs decreased to
58.2% for the 13 weeks ended June 27, 1999 compared to 68.9% for the same period
last year. This decrease as a percentage of net sales is due primarily to lower
marketing costs for the 13 weeks ended June 27, 1999 and to a lesser extent to
lower general and administrative costs as a percentage of net sales. Stock
option expense increased to $205,000 for the 13 weeks ended June 27, 1999 from
$195,000 in the same period last year. Stock option expense is a non cash charge
representing the difference between the exercise price and fair market value of
stock at the date of grant.
Depreciation and amortization for the quarterly period ended June 27, 1999
was $555,000 compared to $216,000 for the quarterly period ended June 28, 1998.
This increase is due primarily to depreciation and amortization charges related
to the Spinelli acquisition and to a lesser extent the opening of additional
stores over the course of the year. As a percentage of net sales, depreciation
and amortization increased to 9.1% for the 13 week period ended June 27, 1999
compared to 6.8% in the same period last year.
INTEREST AND OTHER EXPENSES (INCOME)
Other expenses, comprised of interest expense and loan guarantee fees,
were essentially flat for the 13 weeks ended June 27, 1999 compared to the 13
weeks ended June 28, 1998 due to the average balance on the Company's
borrowings being approximately the same.
NET LOSS
12
<PAGE>
For the 13 weeks ended June 27, 1999, net operating loss was $1,484,000
compared to $1,268,000 for the 13 week period ended June 28, 1998. As a
percentage of sales, gross margins improved by 1.2%, selling general and
administrative expense improved by 10.7%, stock option expense improved by 2.7%
and other net expenses improved by 3.2%. These improvements were partially
offset by increased depreciation and amortization expenses. These changes
decreased the net loss as a percentage of sales by 15.5%. Net loss applicable to
common stockholders increased to $5,115,000 from $2,516,000 for the 13 week
period ended June 27, 1999 as described above and due to the preferred stock
dividend/accretion attributed to the issue of Series A Preferred Stock with
non-detachable warrants. Net loss applicable to common stockholders per share
increased to $0.36 per share compared to $0.18 in the prior year period due to
the reasons described above.
FISCAL YEAR ENDED MARCH 28, 1999, COMPARED TO FISCAL YEAR ENDED MARCH 29,
1998
REVENUES
Net sales for fiscal year 1999 (ended March 28, 1999), increased 124% to
$20,207,000 from $9,020,000 for fiscal 1998, primarily due to the Spinelli
acquisition, and, to a lesser extent, to the addition of new stores and same
store sales increases. Retail sales increased 108% to $17,537,000 from
$8,451,000, primarily due to the addition of new Company-operated stores and, to
a lesser extent, to a 14% increase in comparable store sales. Comparable store
sales increases resulted from an increase in the number of customer transactions
and an increase in the average dollar value per transaction. During fiscal 1999,
the Company opened 12 new stores and acquired 11 Company-operated stores and 11
licensed stores as a result of the Spinelli acquisition. At fiscal year end,
there were 59 Company-operated stores and 3 licensed stores in North America and
15 licensed stores in Singapore, Taiwan and Japan.
Domestic and international wholesale, office coffee service and mail order
sales increased 369% to $2,670,000 for fiscal 1999 compared with $569,000 for
fiscal 1998. The Spinelli acquisition accounted for $1,676,000 of this increase
with new accounts making up the remainder of the increase. While the Company
expects continued growth in wholesale, office coffee service and mail order
sales, it expects future sales increases to be lower than the fiscal 1998 to
fiscal 1999 increase.
OPERATING EXPENSES
Cost of goods sold and related occupancy costs increased from $5,012,000 to
$10,705,000 from fiscal 1999 to fiscal 2000. This increase was the result of
higher sales volumes offset partially by improved green coffee costs. As a
percent of net sales, cost of goods sold and related occupancy costs decreased
to 53.0% for fiscal 1999 from 55.5% for fiscal year 1998.
Selling, general and administrative costs increased from $6,096,000 to
$12,088,000. As a percentage of net sales, selling, general and administrative
costs decreased to 59.8% in fiscal 1999 from 67.6% in fiscal 1998 due to
declines in the following costs, as a percentage of net sales, for fiscal
year 1999 compared to fiscal year 1998: (i) store labor, which declined by
approximately 2%, (ii) general and administrative, which declined by
approximately 2% and (iii) marketing, which declined by approximately 3%.
Stock option expense increased from $564,000 to $833,000 as the number of
employees increased due to growth in the number of stores and as the Company
used stock options to attract new employees to the Company. As a percentage of
net sales, stock option expense decreased to 4.1% for fiscal 1999 from 6.2% for
fiscal year 1998. The expense is a noncash charge representing the difference
between the exercise price and fair market value of the stock at the date of
grant. Stock option expense is composed primarily of options to purchase common
stock granted to officers and key employees by Tully's majority stockholder. The
options were issued from the majority stockholder's shares rather than newly
issued shares of Tully's to avoid diluting the other stockholders.
Depreciation and amortization expense increased from $614,000 to
$1,670,000. As a percentage of net sales, depreciation and amortization expense
increased to 8.3% for fiscal 1999 from 6.8% for fiscal 1998 due primarily to the
Spinelli acquisition and the amortization of goodwill associated with that
transaction.
INTEREST AND OTHER EXPENSES (INCOME)
Interest expense for fiscal 1999 was $834,000 compared to $258,000 for
fiscal 1998. The increase was due primarily to higher average borrowings on the
Company's bank line of credit and, to a lesser extent, the issuance of
convertible debt and the assumption of debt as a result of the Spinelli
acquisition.
The Company's preferred stock offering is expected to fund expansion,
operating losses and working capital needs through fiscal year 2000. As a result
of this financing, it is anticipated that interest expense, net of interest
income will be significantly lower than in fiscal 1999 and that the Company will
incur additional preferred stock dividend/accretion as the sale of preferred
stock continues in fiscal 2000.
Miscellaneous income is primarily royalties and fee income from the
Company's Asian licensees acquired as a result of the Spinelli acquisition.
Loan guarantee fee expense for fiscal 1999 was $729,000 compared with
$295,000 for fiscal 1998. This non-cash expense is for options granted to the
Chief Executive Officer of the Company and to a Board member to purchase common
stock of the Company, issued in consideration of guarantees provided by these
individuals of the Company's bank line of credit.
Management believes the combination of strong comparable store sales
growth, new store openings and a growing wholesale business together with slower
growth in selling, general and administrative expenses and stock option expenses
will allow the Company to achieve profitable operations. While the Company has
experienced increased losses while it has been expanding, net losses as a
percentage of net sales have decreased by 9.8% comparing FY '99 with FY '98.
Management expects this trend to continue. Throughout fiscal 1999, 1998 and
1997, the Company has carried a management infrastructure larger than required
for a comparable sized company that is not growing and has spent significant
amounts marketing and building its brand. This decision was made consciously and
in anticipation of continuing growth. The Company believes that selling, general
and administrative expenses and stock offering expenses, both of which are a
function of this infrastructure, are expected to grow much slower than net
sales.
NET LOSS
For the fiscal year ended March 28, 1999, net operating loss was $6,581,000
compared to $3,820,000 for the fiscal year ended March 29, 1998. As a percentage
of sales, gross margins improved by 2.5%, selling general and administrative
expense improved by 7.8% and stock option expense improved by 2.1%. These
improvements were partially offset by higher depreciation and amortization and
other net expenses. These changes decreased the net loss as a percentage of
sales by 9.8%. Net loss applicable to common stockholders increased to
$12,549,000 from $3,820,000 for the fiscal year ended March 29, 1998 as
described above and due to the preferred stock dividend/accretion attributed to
the issue of Series A Preferred Stock with non-detachable warrants. Net loss
applicable to common stockholders per share increased to $0.88 per share
compared to $0.29 in the prior year period due to the reasons described above.
In connection with the issuance of preferred stock in 1999, the Company
issued 3,108,740 warrants to purchase common stock at an exercise price of $0.33
per share. The exercise price of the warrant at the date of issuance was below
Management's estimation of the fair market value of the common stock and is
therefor considered an "in the money" or beneficial conversion feature.
Accounting for the issuance of convertible preferred stock with a nondetachable
beneficial conversion feature at the date of issue requires that the conversion
feature be recognized and measured in the financial statements by allocating a
portion of the preferred stock offering proceeds to additional paid in capital.
The discount resulting from the allocation of the proceeds to the beneficial
conversion feature is conceptually similar to a dividend and is recognized as a
return to preferred shareholders from the date of issuance through the date the
warrants are exercisable. As a result of this accounting, the Company allocated
$5,968,781 of the preferred stock proceeds to additional paid in capital. As a
result, net loss applicable to common shareholders increased to 62.1% of sale in
fiscal 1999 from 42.3% in fiscal 1998.
FISCAL YEAR ENDED MARCH 29, 1998, COMPARED TO FISCAL YEAR ENDED MARCH 30, 1997
REVENUES
Net sales for fiscal year 1998 increased 66% to $9,020,000 from $5,430,000
for fiscal 1997. Retail sales increased 65% to $8,450,000 from $5,132,000, due
primarily to the addition of new Company-operated stores and, to a lesser
extent, to an increase in comparable store sales of 14%. Comparable store sales
increases resulted from an increase in the number of customer transactions and,
to a lesser extent, to an increase in the average dollar value per transaction.
During fiscal 1998, the Company opened 11 new stores. At fiscal year end, there
were 33 Company-operated stores and 3 licensed stores in Asia.
Domestic and international wholesale, office coffee service and mail order
sales increased 91% to $569,000 for fiscal 1998 compared with $298,000 for
fiscal 1997.
OPERATING EXPENSES
Cost of goods sold and related occupancy costs for fiscal year 1998
increased to $5,012,000 from $2,850,000 in fiscal 1997. This increase was the
result primarily of higher sales volumes and, to a lesser extent, higher green
coffee costs. As a percent of net sales, cost of goods sold increased to 55.5%
for fiscal 1998 from 52.5% for fiscal year 1997. This increase was due to higher
green coffee cost.
Selling, general and administrative costs increased from $3,618,000 in
fiscal 1997 to $6,096,000 in fiscal 1998. As a percentage of net sales selling,
general and administrative costs increased to 67.6% in fiscal 1998 from 66.7% in
fiscal 1997. This increase was due to increased marketing costs as a percentage
of net sales.
Stock option expense decreased from $627,000 in fiscal 1997 to $564,000 in
fiscal 1998. As a percentage of net sales, stock option expense decreased to
6.2% for fiscal 1998 from 11.6% for fiscal year 1997. The expense is a noncash
charge representing the difference between the exercise price and fair market
value of the stock at the date of grant. Stock option expense is comprised
primarily of options to purchase common stock granted to officers and key
employees by Tully's majority stockholder. The options were issued from the
majority stockholder's shares rather than newly issued shares of Tully's to
avoid diluting the other stockholders.
Depreciation and amortization increased from $455,000 to $614,000 comparing
fiscal 1997 to fiscal 1998, and, as a percentage of net sales , decreased to
6.8% for fiscal 1998 from 8.3% for fiscal 1997.
INTEREST AND OTHER EXPENSES (INCOME)
Interest expense for fiscal 1998 was $258,000 compared to $175,000 for
fiscal 1997. The increase was due to higher average borrowings on the Company's
bank line of credit.
Loan guarantee fee expense for fiscal 1998 was $295,000 compared with
$179,000 for fiscal 1997. This non-cash expense is for options granted to the
CEO and a Board member to purchase common stock of the Company, issued in
exchange for the guarantees of the bank line of credit.
NET LOSS
For the fiscal year ended March 29, 1998, net operating loss was $3,820,000
compared to $2,482,000 for the fiscal year ended March 30, 1997. As a percentage
of sales; cost of goods sold and related occupancy costs increased by 3.0%,
selling, general and administrative by 0.9%. These changes were offset by
improvements in stock option expense of 5.4%, depreciation and amortization of
1.5% and other net expenses of 0.5% which resulted in a 3.3% decrease in net
loss as a percentage of sales. Net loss applicable to common stockholders per
share increased to $0.29 per share compared to $0.20 in the prior year period
due to the reasons described above.
13
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company ended the period with $3,470,831 in cash and cash equivalents
and with working capital of $496,000. Cash and cash equivalents increased
$2,322,000 during the 13 week period ended June 27, 1999. The increase is the
result of the private placement funds received throughout the 13 week period
ended June 27, 1999, as described below, offset by operating activities during
the same period and repayments of the bank line of credit. Net cash used in
operating activities was $1,135,000 resulting primarily from a net loss before
non-cash charges of $536,000 and, to a lesser extent, an increase in non-cash
net operating assets.
As of March 28, 1999, the Company had $6,500,000 outstanding under a
$6,500,000 bank line of credit expiring March 31, 2000. Interest is charged
at the prime lending rate plus 1/2% (8.25% at March 28, 1999). This line is
secured by the assets of the Company, and has been guaranteed by the
Company's Chief Executive Officer and by a Director. These guarantees
assisted the Company in obtaining more favorable terms on its bank line than
would have otherwise been the case given that the Company's cash from
operations is not sufficient to fund its obligations currently.
Cash used by investing activities for the first 13 weeks of fiscal 2000
totaled $1,422,000. These investments included opening two new Company-operated
stores, new store construction work in progress, enhancing information systems
and capital improvements to certain existing stores.
During the first 13 weeks ended June 27, 1999, Tully's sold a total of
945,630 units of an "investment unit" at a price of $10.00 per unit. Each
investment unit consisted of 4 shares of the Company's Series A Convertible
Preferred Stock and a Warrant to purchase two shares of the Company's common
stock at an exercise price of $0.33 per share. In total during the 13 week
period, Tully's received $9,456,300 upon the issuance of 3,782,520 shares of
Series A Convertible Preferred Stock convertible into an equal number of
shares of common stock. The Preferred Stock included nondetachable warrants to
buy 1,891,260 shares of common stock at $0.33 per share. The investment units
were offered and sold to accredited investors pursuant to Rule 506 of
Regulation D of the Securities Act of 1933, as amended.
The proceeds from the sale of investment units were partially offset by
stock offering costs of $1,220,000 and $3,500,000 of the net proceeds was used
to pay down Tully's bank line of credit.
Tully's anticipates that cash requirements for the remainder of fiscal year
2000, other than normal operating expenses, will consist primarily of capital
expenditures related to the addition of new Company-operated retail stores. This
anticipated growth of the Company's store base could be both through new stores
and acquisition of existing competitors or operators in existing and new
markets. The Company also anticipates making additional expenditures to expand
its administrative offices and production capacity and to enhance information
systems and remodel certain existing stores. While there can be no assurance
that amounts and timing of the expenditures will occur as planned, management
believes that its cash on hand will be sufficient for its capital needs for the
next twelve months. To fund operations for the longer-term, Tully's expects
that additional capital raising efforts will be required.
Historically, the Company has funded its capital requirements
principally through private placements of common and preferred stock and long
term debt. To date, the Company continues to use cash and operate at a loss.
The Company's ability to achieve positive cash flow depends upon a variety of
factors, including the timely introduction and market success of its new
stores and products, the costs of producing and marketing such products and
various other factors, some of which may be beyond the Company's control. If
the Company requires additional capital, it would seek such funding through
additional public or private financing, although there can be no assurance
that the Company will be able to obtain such financing.
YEAR 2000 ISSUES
The Year 2000 issue results from computer programs being written using two
digits rather than four to define the applicable year. Computer programs, at the
Company and elsewhere, with time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculation causing disruptions of operations, including, among
other things, a temporary inability to produce and distribute products, process
transactions or engage in similar normal business activities.
The Company has investigated the impact of the year 2000 problem on our
business, including our operational, information and financial systems. Tully's
has tested certain systems for compliance. Although the Company is not presently
aware of any material operational issues or costs associated with preparing its
internal systems for the year 2000, there can be no assurance that there will
not be a delay in, or increased costs associated with, the implementation of the
necessary systems and changes to address all year 2000 issues. The Company
estimates the cost of making systems compliant is approximately $40,000. As of
July 20, 1999, Tully's had expended approximately $5,000.
Tully's is in the process of identifying and working with its significant
suppliers, customers and financial institutions to ensure that those parties
have appropriate plans to remedy year 2000 issues when their systems may affect
our systems or otherwise impact operations. Although the Company has no reason
to conclude that any specific supplier represents a risk, the most reasonably
likely worst-case scenario would entail disruption to its business due to the
inability of a number of its suppliers to provide product. The Company is unable
to quantify such a scenario, but it could potentially materially harm its
results of operations, liquidity or financial position.
14
<PAGE>
Tully's expects that its review of non-information technology
systems(including voice communications and security) will be completed before
the end of the current fiscal year. The estimated cost to remedy non-information
technology systems is not expected to be material. Tully's expects that the
source of funds for evaluation and remediation of year 2000 compliance issues
will be cash flows from operations.
The third parties whose year 2000 problems could have the greatest effect
on Tully's are believed by Tully's to be banks that maintain Tully's depository
accounts and credit card processing systems, the company that processes Tully's
payroll and companies that supply or distribute coffee beans and other goods.
Tully's is in the process of confirming the state of year 2000 readiness of
these parties. It is anticipated Tully's will complete this process prior to the
end of the fiscal year. Tully's is in the process of developing a contingency
plan to address potential year 2000 problems. The contingency plan is
anticipated to be completed mid-third quarter.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." This
pronouncement will require Tully's to recognize certain derivatives on its
balance sheet at fair value. Changes in the fair values of derivatives that
qualify as cash flow hedges will be recognized in comprehensive income until the
hedged item is recognized in earnings. Tully's expects that this new standard
will not have a significant effect on its results of operations. SFAS 133 as
amended by SFAS 137 is effective for fiscal years beginning after June 15, 2000.
UNAUDITED COMBINED PRO FORMA FINANCIAL INFORMATION
The Pro Forma Consolidated Financial Information has been prepared from,
and should be read in conjunction with, the historical consolidated financial
statements and notes thereto of each of Tully's. Spinelli Coffee Company's
financial information has been prepared from internal financial statements for
period March 30, 1998 to June 25, 1998.
On June 26, 1998, the Company acquired all the outstanding shares of
Spinelli Coffee Company for a total purchase price of $8.4 million. Spinelli
Coffee Company had 11 Company-operated stores and 3 licensed stores in the San
Francisco Bay area as well as 8 licensed stores in Asia and a roasting and
warehouse facility. The acquisition has been accounted for under the purchase
method of accounting in fiscal 1999. The purchase price has been allocated to
the assets acquired and liabilities assumed based on management's estimates,
arms-length negotiations with the sellers and in certain cases, independent
appraisals of asset fair values. The residual of approximately $5.1 million was
recorded as goodwill and is being amortized on a straight-line basis over 15
years. The results of operations of the acquired companies have been included in
consolidated results of operations of the Company from the date of the
acquisition.
15
<PAGE>
UNAUDITED PROFORMA COSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
TULLY'S COFFEE SPINELLI COFFEE
MARCH 30, 1998- MARCH 30, 1998- PRO FORMA PRO FORMA
MARCH 28, 1999 JUNE 25, 1998 ADJUSTMENTS COMBINED
--------------- --------------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net sales $ 20,207 $1,967 $ - $ 22,174
Cost of goods sold and related occupancy costs 10,705 665 - 11,370
Selling, general and administrative costs 12,088 1,202 - 13,290
Stock option expense expense 833 - - 833
Depreciation and amortization 1,670 - (A) 114 1,784
---------- ------ ---- ----------
Operating loss (income) 5,089 (100) 114 5,103
Interest expense (income) 834 (12) (B) 69 891
Loan guarantee fee expense 729 - - 729
Miscellaneous, net (71) 24 - (46)
---------- ------ ---- ----------
1,490 12 69 1,574
---------- ------ ---- ----------
Net loss (income) 6,581 $ (87) $183 6,677
====== ====
Preferred stock dividend/accretion 5,969 5,969
---------- ----------
Net loss used in calculating net loss per share $ 12,550 $ 12,549
========== ==========
Basic and diluted net loss per common share $ 0.88 $ 0.88
========== ==========
Shares used in computing basic and
diluted net loss per share calculations 14,298,754 14,298,754
========== ==========
</TABLE>
See accompanying notes to the unaudited consolidated financial statements.
1. THE PERIODS, CONSOLIDATED
The Tully's Coffee Corporation consolidated statement of operations for the
year ended March 29, 1999 has been combined with the Spinelli Coffee Company
statements of operations for the period March 30, 1998 to June 25, 1998 as if
the merger had occurred as of the beginning of the period. The results of
Spinelli Coffee Company for the period June 26, 1998 to March 28, 1999 have
already been consolidated into the Tully's Coffee Corporation consolidated
statement of operations for the year ended March 28, 1999 as the merger was
effected June 26, 1998.
2. PRO FORMA BASIS OF PRESENTATION
These Unaudited Pro Forma Consolidated Statements of Operations have been
made for the purposes of presenting such pro forma information as necessary to
comply with the disclosure requirements of the Securities Exchange Commission.
The Unaudited Pro Forma Consolidated Statements of Operations does not purport
to be indicative of the consolidated Statements of Operations of future periods
or indicative of
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<PAGE>
the results of operations of future periods or indicative of the results that
actually would have been realized had the entities been a single entity during
these periods.
3. PRO FORMA EARNINGS PER SHARE
The unaudited Pro Forma Combined Statement of Operations for Tully's Coffee
Corporation have been prepared as if the merger was completed at the beginning
of the periods presented. The pro forma basic net loss per share is based upon
the combined weighted average number of shares of Tully's Coffee Corporation
Common Stock outstanding during the period.
The Pro Forma diluted net loss per share is computed using the weighted
average number of Tully's Coffee Corporation Common Stock and dilutive common
equivalent shares outstanding during the period. Common Stock equivalent shares
consist of incremental common shares issuable upon conversion of the exercise of
stock options and warrants using the treasury stock method. Common equivalent
shares are excluded from the computation if the effect is antidilutive. The
combined Company had a pro forma net loss for the year ended March 28, 1999;
therefore, none of the options and warrants outstanding during the period
presented were included in the computation of pro forma dilutive earnings per
share as they were antidilutive.
4. PRO FORMA STATEMENTS OF OPERATIONS ADJUSTMENTS
The objective of pro forma information is to show what the significant
effects on the historical financial information might have been had the
companies been combined for the period presented.
The purchase price of $8.4 for Spinelli Coffee Company million consists of
$6.7 million paid to the seller, $221,243 of acquisition costs and the
assumption of $1,446,356 in liabilities of the seller.
The categories of assets acquired and obligations assumed, at the date of
the acquisition is as follows:
<TABLE>
<CAPTION>
<S> <C>
Assets acquired
Cash $ 5,059
Accounts receivable 163,595
Inventories 965,415
Prepaid and other current assets 41,172
Goodwill and other intangible assets 5,522,928
Property and equipment 1,538,027
Other assets 131,403
-----------
Total assets $ 8,367,599
===========
Liabilities assumed
Current liabilities $ (520,478)
Other liabilities (925,878)
-----------
$(1,446,356)
===========
</TABLE>
The company incurred costs associated with the acquisition during 1999 of
$221,243. These costs were primarily for professional fees and expenditures to
facilitate integration of business systems of the acquired business with the
Company following the merger. Such costs were capitalized as part of the
purchase price.
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<PAGE>
Goodwill represents the excess of the purchase price over the fair value of
the net assets acquired. The goodwill will be capitalized and amortized over a
period of fifteen years. The property plant and equipment will be depreciated
over the remaining estimated lives of such assets. The Unaudited Pro Forma
Combined Statement of Operation reflects adjustments for such amortization and
depreciation.
Detail of the specific pro forma adjustments for all of the period March
30, 1998 to June 24, 1998, are as follows:
<TABLE>
<CAPTION>
(in thousands)
(A) AMORTIZATION AND DEPRECIATION
<S> <C>
Amortization of goodwill $ 84
Amortization of leasehold interests 5
Depreciation of property plant and
equipment and leasehold improvements 25
----
Total pro forma adjustment $114
====
</TABLE>
(B) INTEREST EXPENSE
In connection with this acquisition Tully's issued a $2,500,000 convertible
note to a director of the Company for cash. Had the Company issued the note on
March 30, 1998, the Company would have recorded an additional $69,000 in
interest expense. The note was converted into 1,000,000 shares of Series A
Convertible Preferred Stock on March 28, 1999.
18
<PAGE>
ITEM 3. PROPERTIES.
RETAIL LOCATIONS
Tully's currently leases space for all of its Company-operated store
locations. All of these locations are secured by long term leases with options
to extend beyond the initial lease term. Base lease terms are typically ten
years with two to four options to extend for five years each. Tully's firmly
believes that its current locations are situated in suburban and urban areas
that have high levels of pedestrian or vehicular traffic, or both.
Tully's has spent considerable time designing the look and feel of the
interior of its retail stores. Of utmost importance was creating a
sophisticated, yet warm and inviting environment. The materials used for the
interior improvements, including cherry wood cabinets, real slate tile flooring,
an eclectic furniture package and a distinctive paint pattern for the walls,
were all carefully and strategically selected to enhance the image projected for
Tully's by its stores. It is intended that all stores project and maintain a
consistent look and feel regardless of the square footage or dimensional
variations. The design and materials used were also selected to not be regional
specific so as to allow for consistent usage in other parts of the country.
STORE DESIGN AND CONSTRUCTION COSTS
Tully's has designed a store look and feel that it believes will best meet
its needs as they relate to the image, atmosphere and high level of customer
service that Tully's wants to present to its customers. The package is tailored
to be flexible enough to meet the different requirements presented by various
types of locations, e.g., Central Business District office buildings and
neighborhood center locations. The Company's expansion plans in the Puget Sound
and San Francisco Bay Areas, as well as in other U.S. markets, were a major
factor in the selection of materials, colors, fixtures and equipment. Management
feels it is critical to have a store design that is similar from one store to
another in order to strengthen its brand and instill a feeling of consistency
with its customers. While meeting these goals Tully's also believes the stores
are not only cost effective to build in all markets, but are enduring from a
design perspective.
EXECUTIVE OFFICE, WAREHOUSE AND ROASTING FACILITIES
Tully's currently occupies 8,400 square feet of space at 2010 Airport Way
South in Seattle, Washington where its executive offices, roasting plant and
warehouse facilities are located. While this space is currently serviceable for
Tully's needs, it has commenced a search to locate larger premises that will
meet its needs in the future. Tully's does not anticipate any problems in
securing the new premises. It also believes that the rent for its current
offices is substantially below market and therefore it will be able to sublet
the existing premises without difficulty for the remaining 5 year term of the
lease. Tully's also maintains a 14,000 square foot office and roasting facility
in San Francisco. Tully's currently anticipates maintaining this facility as a
regional office and additional roasting facility to meet its growth needs in
that area. The lease for 5,700 square feet of the San Francisco premises expires
in July, 2000. While Tully's has the right to extend the lease for additional
periods, it is possible that it will not renew the lease for this portion of the
property. Both facilities have adequate lease terms, with options to extend.
Tully's believes that the present facilities satisfy the immediate growth plans
of Tully's and that there are adequate additional spaces available to Tully's at
competitive lease rates into which it can relocate to meet
19
<PAGE>
its facilities needs as it continues to expand. The Company is currently in
negotiations to lease office space at the landmark Seattle building which was
formerly home of the Rainier Brewery.
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information concerning the
beneficial ownership of Common Stock and Series A Preferred Stock of (i) those
persons known by management of Tully's to own beneficially more than 5% of
Tully's outstanding Common Stock, (ii) the directors and director nominees of
Tully's, (iii) the executive officers named in the Summary Compensation Table
set forth in the "Executive Compensation" section of this registration statement
and (iv) all current directors and officers of Tully's as a group. Such
information is provided as of July 1, 1999. According to the rules adopted by
the Securities and Exchange Commission, a person is a "beneficial owner" of
securities if he or she has the right to acquire beneficial ownership of such
securities within 60 days through the exercise of an option, warrant, right of
conversion of a security or otherwise. Except as noted otherwise, the indicated
owners have sole voting and investment power with respect to shares beneficially
owned. An asterisk in the percent of class column indicates beneficial ownership
of less than 1%.
<TABLE>
<CAPTION>
SHARES OF COMMON SHARES OF SERIES A
NAME AND ADDRESS OF STOCK BENEFICIALLY PERCENT PREFERRED STOCK PERCENT
BENEFICIAL OWNER (2) OWNED (1) OF CLASS BENEFICIALLY OWNED (1) OF CLASS
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tom T. O'Keefe (3)........................ 5,145,431 23.6% 40,000 1.7%
George Hubman (4)......................... 1,271,510 5.8% 200,000 2.0%
Keith McCaw (5)........................... 1,046,835 4.8% 2,000,000 20.0%
Graham S. Anderson (6).................... 466,751 2.1% 40,000 *
Stephen R. Griffin (7).................... 377,703 1.7% - -
Marc Evanger (8).......................... 254,000 1.2% - -
Richard J. Padden (9)..................... 130,667 * 20,000 *
Lawrence L. Hood (10)..................... 120,251 * 10,000 *
Larry A. Culver (11)...................... 30,500 * 40,000 *
James Cameron Towne (12).................. 20,000 * 20,000 *
Robert J. Holmes (13)..................... 14,250 * 10,000 *
All Directors and Executive Officers
as a Group (11 Persons)................. 8,877,898 40.7% 2,380,000 23.8%
</TABLE>
20
<PAGE>
NOTES TO BENEFICIAL OWNERSHIP TABLE
(1) Computed in accordance with Rule 13d-3(d)(1) of the Exchange Act.
(2) The address for all persons listed unless otherwise noted 2010 Airport Way
South, Seattle, WA 98134
(3) Assumes certain officers and employees exercise options for the purchase of
1,479,999 shares from Mr. O'Keefe at an exercise price of $0.33 - $0.01 and
includes options to purchase 376,324 shares of common stock which are
immediately exercisable at a price of $0.01 - $2.25 per share under the
Company's stock option plan.
(4) Assumes the exercise of options for the purchase of 288,279 shares of
common stock at an exercise price of $0.01 and the exercise of Series A
Preferred Stock warrants for the purchase of 100,000 shares of common stock
at an exercise price of $0.33.
(5) Assumes the exercise of options for the purchase of 3,500 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 1,000,000 shares of common stock at an
exercise price of $0.33.
(6) Assumes the exercise of options for the purchase of 40,417 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 20,000 shares of common stock at an
exercise price of $0.33.
(7) Assumes the exercise of options for the purchase of 341,936 shares of
common stock at an exercise price of $0.01 - $2.25.
(8) Assumes the exercise of options for the purchase of 252,500 shares of
common stock at an exercise price of $0.01 - $1.78.
(9) Assumes the exercise of options for the purchase of 22,500 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 10,000 shares of common stock at an
exercise price of $0.33.
(10) Assumes the exercise of options for the purchase of 26,917 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 5,000 shares of common stock at an
exercise price of $0.33.
(11) Assumes the exercise of options for the purchase of 2,500 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 20,000 shares of common stock at an
exercise price of $0.33.
(12) Assumes the exercise of options for the purchase of 4,000 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 10,000 shares of common stock at an
exercise price of $0.33.
(13) Assumes the exercise of options for the purchase of 4,250 shares of common
stock at an exercise price of $0.01 and the exercise of Series A Preferred
Stock warrants for the purchase of 5,000 shares of common stock at an
exercise price of $0.33.
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions of the executive officers and directors of
Tully's Coffee are listed below along with their business experience during the
last five years. The business address of all officers of Tully's Coffee is 2010
Airport Way South, Seattle, Washington 98134. The Tully's Coffee Board of
Directors consists of ten directors. Directors are elected to serve one year
terms. Executive officers of Tully's Coffee are appointed by the Board of
Directors. No family relationships exist among any of the directors or executive
officers.
<TABLE>
<CAPTION>
NAME AGE POSITION
---------------------------------------
<S> <C> <C>
Tom T. O'Keefe 44 Chairman and Chief Executive Officer
Marc Evanger 44 Vice President - Corporate Planning and Development and Director
Stephen R. Griffin 42 Vice President - Finance, Chief Financial Officer & Secretary
21
<PAGE>
Graham Anderson 66 Director
Larry A. Culver 57 Director
Robert J. Holmes 54 Director
Lawrence L. Hood 40 Director
George Hubman 56 Director
Keith McCaw 44 Director
Richard J. Padden 46 Director
James Cameron Towne 56 Director
</TABLE>
TOM T. O'KEEFE - CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER. Tom T.
O'Keefe is the founder of Tully's Coffee. Mr. O'Keefe also serves as President
and CEO of O'Keefe Development Corporation (ODC), which he founded in 1986. ODC
is a real estate firm that has acquired or developed shopping centers, office
buildings and warehouses throughout the Puget Sound area. Prior to founding ODC,
Mr. O'Keefe was a commercial real estate broker with Coldwell Banker Commercial
Real Estate Services. Mr. O'Keefe works with and is a founder of several
non-profit organizations, including the Cystic Fibrosis Foundation and the
Juvenile Diabetes Guild of Seattle. He has served as president and event
chairperson for these organizations. Additionally, he is a Trustee for the Villa
Academy, a school his children attend in Seattle. Mr. O'Keefe has served as a
Director and Chairman of the Board since the Company's inception in 1992.
STEPHEN R. GRIFFIN - VICE PRESIDENT - FINANCE, CHIEF FINANCIAL OFFICER AND
SECRETARY. Mr. Griffin joined Tully's in 1994 as Vice President - Finance and
Chief Financial Officer. He was appointed secretary in 1995. From 1989 to 1994,
Mr. Griffin served in various capacities at Olympic Management Company,
including Chief Operating Officer, from 1992 to 1994 and Vice
President-Controller and Treasurer for Olympic and its affiliates, a diverse
group of real estate entities from 1989 to 1992. He was Director of Acquisitions
for Hillhaven Corporation from 1983 to 1989 and with Arthur Andersen & Co prior
to that. Mr. Griffin is a graduate of the University of Washington with a BA in
Business Administration.
GRAHAM S. ANDERSON - DIRECTOR. Mr. Anderson served as the Chairman and
President of the Pettit-Morry Company, a Regional Insurance Brokerage from 1987
to 1994. Mr. Anderson is a Director of a variety of companies including Marker
International (manufacturer and retailer of ski hardware and apparel), the
Commerce Bank, Janss Center and is former Chairman of the National Association
of Insurance Brokers and a member of Eldore LLC. Mr. Anderson has served as a
Director since February 7, 1994.
22
<PAGE>
LARRY A. CULVER - DIRECTOR. Mr. Culver has more than 35 years experience in
the hospitality industry. In 1982, Larry founded Inn Ventures, Inc. and has
served as the Chairman and CEO since that date. Mr. Culver and his staff have
developed and managed more than $300,000,000 in hotel product. Mr. Culver has
been recognized by numerous organizations for his accomplishments and innovative
leadership including being the recipient of the "Inn of the Year Award",
"Hotelier of the Year Award" and a finalist for several of Marriott
International's highest awards. He actively serves on various Boards of
Directors of civic and charity groups such as Big Brothers and Big Sisters of
King County (Past President, Board of Directors, and Executive Committee);
Northwest Harvest Food Drive; Fred Hutchinson Cancer Research; WSU Board of
Trustees; WSU Foundation; WSU Advisory Board for School of HRA. Mr. Culver has
served as a Director of the Company since February 5, 1998.
MARC EVANGER - VICE PRESIDENT CORPORATE PLANNING AND DEVELOPMENT AND
DIRECTOR. Mr. Evanger joined Tully's in December 1998 as Vice President -
Corporate Planning and Development. From 1984 to 1998 he was with Quality Food
Centers (QFC), most recently as Senior Vice President of Finance and
Administration and Chief Financial Officer, which position he held from 1987 to
1998. During his tenure, QFC grew from 20 to 145 stores, completed numerous
acquisitions, a leveraged buyout and an IPO. He retired in 1998 following the
merger of QFC and Fred Meyer, Inc. From 1978 to 1984, he was with Price
Waterhouse & Company. Mr. Evanger is a former member of the Board of Directors
of Associated Grocers, is currently a director of the Bellevue Boys & Girls Club
and is active in other charitable and community activities. Mr. Evanger is a
graduate of the University of Washington and Central Washington University. Mr.
Evanger has served as a Director of the Company since March 1999.
ROBERT J. HOLMES - DIRECTOR. Since 1996, Robert J. Holmes has served as
President and CEO of Harbor Properties, Inc., a real estate development and
recreation company located in Seattle. Harbor Properties is involved in the
development and management of residential, retail and office real estate as well
as resort and ski area operations. For the 10 years prior to joining Harbor, Mr.
Holmes was President, CEO and then Chairman of Intrawest USA, one the larger
real estate developers in the Puget Sound area. He also served in an executive
position with the parent company's Resort Development Group where he focused on
the acquisition of ski and resort companies throughout North America. Mr. Holmes
is a past Chairman and Director of the Seattle Housing Resources Group, Director
of the Bellevue Downtown Association and Director of Historic Seattle
Preservation and Development Authority. He currently serves on the Executive
Committee of the Downtown Seattle Association and sits on its Board of
Directors. Mr. Holmes has served as a Director since February 5, 1998.
LAWRENCE L. HOOD - DIRECTOR. Since 1993, Mr. Hood has served as the
Principal and Managing Partner of Pacific Portfolio Consulting, L.P., an
independent, fee only investment advisory firm, which he founded in 1993. Prior
to this, Mr. Hood was a principal in charge of the investment division of Kibble
& Prentice, Inc., a regional financial services firm. Mr. Hood has over
seventeen years of investment related experience, and has participated in a
number of operating companies in various stages of development. Mr. Hood served
as a director for A-Sport, Inc. and is a past member of the Charles Schwab
Advisory Board. Mr. Hood is a graduate of the University of Puget Sound, where
he majored in Economics and Finance. Mr. Hood has served as a Director since
February 7, 1994.
GEORGE HUBMAN - DIRECTOR. Mr. Hubman served as Vice President of Sales and
Marketing at WRQ, the sixteenth largest software company in the U.S., from 1981
to 1993. Mr. Hubman was co-founder of WRQ in 1981. Prior to WRQ, Mr. Hubman's
career included sales positions with Hewlett Packard and IBM. He currently sits
on the boards of Precision Digital Images, King County Big Brothers and Big
Sisters, Childhaven and served two years on the board of Interex, the
International Association of Hewlett-Packard Computer Users. He is a past
president of
23
<PAGE>
Washington State University's College of Business and Economics advisory
committee. Mr. Hubman has served as Director since February 7, 1994.
KEITH MCCAW - DIRECTOR. Mr. McCaw served as a Board Member and Vice
President of McCaw Communications Company and Vice President of the Radio Common
Carrier Division from 1994 to 1999 where his primary focus was on acquisitions
and corporate development. He coordinated McCaw Cellular's first five
applications to the F.C.C. McCaw Cellular was sold to AT&T in 1994. Together
with other family members, Mr. McCaw is a lead investor in NexTel Communications
and several other high tech ventures. He is involved with many cultural and
educational organizations and is currently self employed and managing personal
investments. Mr. McCaw has served as a Director of the Company since February 5,
1998.
RICHARD J. PADDEN - DIRECTOR. Mr. Padden is of counsel to the law firm of
Carney Badley Smith & Spellman, P.S. Mr. Padden joined with Carney Badley Smith
& Spellman, P.S. in 1978, and has specialized in commercial and corporate law.
In 1993, Mr. Padden founded Grays Harbor Paper, LP and has served as a
principal and board member since that date. He is a principal and board member
of Safeworks, L.L.C., S&P Foods, Inc. and Brown's Sugarless Bakery, Inc. Mr.
Padden is active in many charitable and volunteer organizations. He is past
president of the Washington Chapter of Cystic Fibrosis and is a founder and past
president of the Patrons of Cystic Fibrosis Guild. Mr. Padden has served as
director since February 7, 1994.
JAMES CAMERON TOWNE - DIRECTOR. Mr. Towne has been Chairman of Greenfield
Development Corporation, a remediation and development company since 1995. From
1993 through 1998, he was President of the Board of Overlake School. Mr. Towne
also serves on the board of directors of Cutter & Buck, a specialty upscale
sportswear and outerwear clothing retailer. He has a bachelor's degree in
economics and a master's degree in business administration from Stanford
University. Mr. Towne has served as a director of the Company since February 5,
1998.
KEY EMPLOYEES
R. J. SELFRIDGE - VICE PRESIDENT - OPERATIONS. Prior to joining Tully's in
1993 as Vice President Operations, R.J. Selfridge was employed by Nordstrom for
ten years. He served as a manager of Nordstrom's restaurant division
headquarters and commissary in Seattle. At Nordstrom, he coordinated the
expansion of espresso bars and cafes into all West Coast stores. Prior to this
he was in charge of cafe and espresso operations in the Northeast, while
headquartered in New Jersey. He also helped develop and bring to market the
company's signature Nordstrom Blend, a custom whole bean coffee. Mr. Selfridge
brings over 20 years of retail food service operations experience to Tully's.
SIOBHAN C. FOODY - VICE PRESIDENT - WHOLESALE. Ms. Foody has served as Vice
President - Wholesale since 1998. She joined Tully's in 1995 as Director of
Wholesale. From 1989 to 1995, Ms. Foody worked as a manufacturers'
representative in the housewares and gourmet coffee industries. Ms. Foody
represented major coffee accessory lines currently marketed by Tully's. A native
of Seattle, Ms. Foody graduated from the University of Washington with a
Bachelor of Arts degree in economics.
ITEM 6. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth compensation earned during the last three
fiscal years by the Company's Chief Executive Officer and its next four most
highly compensated executive officers (collectively referred to herein as the
"Named Executive Officers") whose total annual salary and bonus for that year
exceeded $100,000. No executive officer received compensation in excess of
$100,000 during the last fiscal year.
24
<PAGE>
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION AWARDS
---------------------------------- --------------------------------------
RESTRICTED
NAME AND STOCK ALL OTHER
PRINCIPAL POSITION FISCAL YEAR SALARY BONUS OPTIONS AWARDS COMPENSATION
--------------------------- ----------- ------ ----- ------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Tom T. O'Keefe 1999 - - 179,712 - -
President, Chairman and 1998 - - 123,567 - -
Chief Executive Officer (1) 1997 - - 54,833 - -
</TABLE>
(1) While Mr. O'Keefe has received no cash or other compensation for his
services, Tully's has recorded compensation expense for the estimated fair
market value of his past services and for fiscal year 1999. The value of
these services was recorded at $120,000 for fiscal year 1999. Mr. O'Keefe
has drawn no salary since Tully's inception.
GRANTS OF STOCK OPTIONS
STOCK OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options to
purchase Tully's Common Stock granted to executive officers of the Company
during the fiscal year ended March 28, 1999.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
% OF TOTAL OF ASSUMED ANNUAL RATES
OPTIONS OF STOCK APPRECIATION
GRANTED TO EXERCISE OR FOR OPTION TERM
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ---------------------------
NAME GRANTED(1) FISCAL YEAR (3) ($/SHARE) DATE 0%($) 5%($) 10%($)
-------------- ---------- --------------- ----------- ---------- ----- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Tom T. O'Keefe 8,500 0.9% $0.0100 2009 $ - $ 53 $ 75
9,250 1.0% $2.2500 2009 - 13,089 18,344
161,962(2) 17.2% $0.0100 2009 - 1,019 1,427
</TABLE>
(1) Options to purchase Tully's common stock and are subject to various vesting
terms.
(2) These options were granted as compensation for Mr. O'Keefe's agreement to
personally guarantee a $6,000,000 line-of-credit which Tully's maintains
with a commercial bank.
(3) A total of 1,132,632 stock options were granted to employees and
non-employees during fiscal 1999 of which 283,000 were options issued to
key employees of the Company to purchase common stock owned directly by Tom
T. O'Keefe while the remaining portion were options issued under the
Company's 1994 stock option plan.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth information concerning the number and value
of unexercisable options held by the following executive officers on March 28,
1999. None of these options to purchase common stock were exercised during
fiscal year 1999.
25
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS
FISCAL YEAR-END AT FISCAL YEAR-END (1)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
-------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Tom T. O'Keefe 376,324 9,250 $752,272 -
</TABLE>
(1) These amounts represent the difference between the exercise price of the
in-the money options and the fair market value of Tully's common stock on
March 28, 1999.
TULLY'S COFFEE STOCK OPTION PLAN
In 1994, Tully's adopted its 1994 Stock Option Plan under which the Board
of Directors will from time-to-time grant certain rights to eligible employees
and directors to purchase common stock. As of July 1, 1999, 1,493,058 options to
purchase stock at $0.33 - $2.25 per share have been granted. These options vest
pro-rata over five years beginning with the date of grant.
The purpose of the Option Plan is to promote Company success by aligning
employee financial interests with long-term shareholder value. At the present
time Tully's is authorized to issue options for 5% of common and preferred stock
outstanding shares under the Plan. The shareholders have been asked to approve
an amendment to the Plan which increases the number of shares that may be issued
under the Option Plan. Under the proposed amendment the maximum number of shares
issuable under the Option Plan would be increased to 4,200,000 shares of Tully's
Common Stock. However, the total number of shares which may be issued under
Tully's Option Plan and the Employee Stock Purchase Plan, if adopted by the
shareholders, cannot exceed 4,200,000 shares, in the aggregate.
The Board of Directors has the general authority to grant options under the
Option Plan to employees and officers of Tully's and to generally exercise all
administrative authority under the Option Plan. However, the Executive
Compensation Committee of the Board of Directors (comprised entirely of
non-employee directors) has been delegated the authority to grant options to
certain members of senior management.
The Option Plan may be modified, amended, or terminated by the Board except
with respect to incentive stock options granted prior to such action. The Board
has the authority to adopt such modifications, procedures, and subplans as may
be necessary or desirable to comply with provisions of the laws of foreign
countries in which Tully's or its subsidiaries may operate to assure the
viability of the benefits from options granted to employees employed in such
countries and to meet the objectives of the Option Plan. Notwithstanding the
foregoing, shareholder approval is required for any amendment which increases
the number of shares subject to the Option Plan (other than in connection with
automatic adjustments due to changes in capitalization or the assumption or
substitution of options in connection
26
<PAGE>
with mergers or acquisitions). Shareholder approval may also be required if
there are "material changes" to the Option Plan for purposes of Section 162(m)
of the Code or to comply with new legislation.
VESTED STOCK OPTIONS
During the fiscal year ended March 28, 1999, Tom T. O'Keefe granted options
to purchase 283,000 shares of Tully's common stock owned by him to key Tully's
employees. These options were fully vested as of the date of the grants and are
exercisable indefinitely at the exercise price of $0.01 per share. The options
were granted to the key employees as performance bonuses and to tie their
respective interests to those of Tully's. The options were issued for Mr.
O'Keefe's shares rather than newly issued shares of Tully's to avoid diluting
the other shareholders. Although the options were not granted by the Company,
under generally accepted accounting principles, Tully's was required to record
an increase in paid in capital and a noncash charge to compensation expense of
$701,256 in fiscal year 1999 which represented the difference between the
estimated fair market value of the underlying shares on the grant dates and the
exercise price.
TULLY'S COFFEE STOCK PURCHASE PLAN
The Company's shareholders have been asked to ratify the 1999 Employee
Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan, if approved by the
shareholders, will allow all employees who have been with Tully's for 3 months
and who are working more than 20 hours a week to authorize payroll deductions at
a rate of 2, 4, 6, 8, or 10% of base pay (including overtime or bonuses) to be
applied toward the purchase of Tully's common stock. The total number of shares
of common stock reserved for issuance under the Purchase Plan cannot exceed
4,200,000. Provided, that the total number of shares which may be issued under
Tully's Purchase Plan and its Option Plan cannot exceed 4,200,000 in the
aggregate.
As of July 1, 1999, there were approximately 320 employees eligible to
participate in the Purchase Plan. The Purchase Plan, which is to be administered
by the Board, will terminate on December 31, 2005, or earlier at the discretion
of the Board or in the event all shares reserved under the plan have been
purchased.
Separate six-month offerings of the Company's shares of Common Stock will
commence on January 1 and July 1 of each year. No employee may purchase more
than 2,250 shares of stock during any single offering. An employee must
authorize a payroll deduction before the start of an offering in order to
participate in that offering. On the last business day of the offering, the
employee will be deemed to have exercised the option to purchase as many shares
as the employee's payroll deduction will allow, at the option price. The option
price is 85% of the lesser of (i) the fair market value of the stock on the
first business day of the offering, or (ii) the fair market value of the stock
on the last business day of the offering. The fair market value of Tully's stock
shall initially be determined on a quarterly basis by Tully's Board of
Directors. When and if the stock is quoted or traded in an over the counter
market or exchange, then the fair market value shall mean the closing bid price
as reported on the National Association of Securities Dealers Automated
Quotation System or, if the stock is traded on a stock exchange, the closing
price for the stock on the principal such exchange.
No employee shall be permitted to purchase any shares under the Purchase
Plan if such employee, immediately after such purchase, owns shares possessing
five percent or more of the total combined voting power or value of all classes
of stock of Tully's or its parent or subsidiary corporations. The fair market
value of all shares purchased by an employee under the Purchase Plan during any
calendar year
27
<PAGE>
may not exceed $25,000.
The Board of Directors may at any time amend or terminate the Purchase
Plan, provided that no employee's existing rights under any offering already
commenced may be adversely affected thereby. No amendment may be made to the
Purchase Plan without prior approval of the shareholders of Tully's if such
amendment would increase the number of shares reserved thereunder, materially
modify the eligibility requirements, or materially increase the benefits that
may accrue to participants.
COMPENSATION OF DIRECTORS
The Directors of Tully's receive no cash compensation for serving on the
Board of Directors, but are reimbursed reasonable expenses incurred in attending
Board and Committee meetings. They are granted options to purchase 500 shares of
Tully's common stock per attended Board meeting and 250 shares of stock per
attended Committee meeting.
EMPLOYMENT AGREEMENTS AND COMPENSATORY ARRANGEMENTS
Tully's generally does not enter into employment agreements or written
compensatory arrangements with its employees, including management.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Until March 11, 1999 when the relationship was terminated, Tully's had
engaged the services of O'Keefe Development Corporation ("ODC"), a company
owned by Mr. O'Keefe, to oversee tenant improvements for Tully's new
locations at a price of $5,000 per store. The services rendered by ODC
primarily consist of providing a project manager to coordinate and oversee
the subcontractors who make the tenant improvements or remodeling work at the
locations. During fiscal year 1999 Tully's paid a total of $70,000 to ODC for
its services. The Company incurred costs of $48,500 and $50,000 related to
services provided by ODC during 1998 and 1997, respectively. The Company
believes that the terms of this relationship were commercially reasonable and
were on terms which were no less favorable to Tully's than could be
negotiated in an arms-length transaction with an unrelated third party.
Richard Padden, a director of Tully's, is a principal in the law firm of
Carney Badley Smith & Spellman, which provides legal services to Tully's. In
fiscal year 1999, the Company paid $137,683 to Carney Badley Smith & Spellman
for legal services.
Laurence Hood, a director of Tully's, is a principal of Pacific Portfolio
Consulting, LLC, a registered investment advisory firm. That firm will render
investment advisory services in connection with administration of the Company's
401k employee benefit plan. In fiscal year 1999, the Company did not incur any
advisory fees with Pacific Portfolio Consulting, LLC.
Tully's leases the premises for 3 of its stores from Harbor Properties,
Inc., whose President and CEO is Robert J. Holmes, a director of the Company.
During fiscal year 1999 and 1998 the Company paid rent in the total amount of
$221,016 and $136,285, respectively, to Harbor Properties.
Tully's has a $6,000,000 line of credit arrangement with a commercial
bank, which expires March 31, 2000. Interest is charged at the prime lending
rate plus 0.5%. The line is collateralized by all of the Company's assets and
is personally guaranteed by Tom T. O'Keefe and George Hubman, both Company
Directors. Mssrs. O'Keefe and Hubman receive a guarantee fee of 1.0% of the
operating line's monthly average balance. In payment of the guarantee fee,
the Company issued options to purchase the Company's Common Stock in total
amounts of 113,169, 130,964 and 323,924 for the fiscal years ended March 30,
1997, March 29, 1998 and March 28, 1999, respectively. The value of the
options were recorded as compensation expense. All of these options were
issued with an exercise price of $0.01 per share.
In June 1998, the Company issued a $2,500,000 convertible note to a
director of the Company for cash. The Company incurred interest expense of
$222,383 related to the note. The note was converted into 1,000,000 shares of
Series A Convertible Preferred Stock on March 28, 1999 (See Note 9 to
Consolidated Financial Statements).
Tully's believes that all of these relationships are commercially
reasonable and are on terms that are no less favorable to Tully's than could
have been negotiated in an arms-length transaction with an unrelated third
party. With respect to transactions with affiliated parties in the future, all
material
28
<PAGE>
transactions between Tully's and its officers, directors, principal shareholders
and affiliates will be approved by a majority of Tully's Board of Directors who
do not have an interest in the transaction, and will be on terms no less
favorable to Tully's than those that could be obtained from unaffiliated third
parties.
ITEM 8. LEGAL PROCEEDINGS.
The Company is or may from time to time be a party to routine litigation
incidental to our business. Management believes the ultimate resolution of these
routine matters will not materially harm our business, financial condition,
operating results, or cash flow.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS.
Currently there is no public market for Tully's Coffee Common Stock and
none is expected to develop in the immediate future. As of June 30, 1999, there
were approximately 4,300 holders of the Company's Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
2,880,600 of the Company's issued and outstanding common shares are freely
tradeable or "unrestricted securities." However, at the present time there is no
public market for any of the Company's securities. The remaining shares of
common stock and 24,999,125 shares of its Series A Preferred Stock outstanding
as of July 1, 1999 are "restricted securities" under the Securities Act of 1933,
as amended, and may only be sold in the public market upon the expiration of the
holding periods set forth in Rule 144 thereunder, described below, subject to
the volume, manner of sale and other limitations of Rule 144.
In general, under Rule 144 as currently in effect, a person who has
beneficially owned shares for at least one year, including an "affiliate," is
entitled to sell, within any three-month period, a number of shares that does
not exceed the greater of:
- 1% of the then outstanding shares of our common stock (approximately
143,140 shares as of July 1, 1999); or
- the average weekly trading volume during the four calendar weeks
preceding filing of notice of the sale of shares of common stock.
Sales under Rule 144 are also subject to certain manner of sale provisions,
notice requirements and the availability of current public information about the
Company. A stockholder who is deemed not to have been an "affiliate" of the
Company at anytime during the 90 days preceding a sale, and who has beneficially
owned restricted shares for at least two years, would be entitled to sell shares
under Rule 144(k) without regard to the volume limitations, manner of sale
provisions or public information requirements.
In addition, as of July 1, 1999, there were outstanding warrants to
purchase 4,999,825 shares of common stock and options to purchase 3,163,471
shares of common stock, of which 2,465,647 options
29
<PAGE>
were fully vested. The number of shares reserved for issue upon exercise of
options under our 1994 Employee Stock Option Plan cannot exceed 5% of the issued
and outstanding shares of the Company. Tully's intends to register the shares of
its common stock issuable or reserved for issuance under the Option Plan as soon
as practicable following the date of this registration statement.
Holders of warrants to purchase 4,999,825 shares of common stock issuable
upon exercise of such warrant are entitled to registration rights with respect
to these shares for resale under the Securities Act of 1933. If these holders,
by exercising their registration rights, cause a large number of shares to be
registered and sold in the public market, these sales could harm the market
price for Tully's common stock. See "Description of Capital Stock--Registration
Rights."
ESCROWED SHARES
As a condition to the Company's registration to sell its common stock under
the Washington State Securities Act, Tully's founders Tom T. and Cathy O`Keefe
have placed in escrow with Seafirst Bank 4,340,475 shares (the "Shares") of
Common Stock beneficially owned by them.
The Shares will be released from escrow when Tully's satisfies one or more
of the following requirements:
a. Tully's has demonstrated annual earnings per share for two consecutive
fiscal years of at least $0.075 per share per year.
b. Tully's has demonstrated average annual earnings over five years of at
least $0.075 per share.
c. Tully's establishes for its Common Stock a bona fide over-the-counter
trading market and such stock maintains an average bid price equal to or
greater than $2.625 per share for any period of twenty-six consecutive
weeks. In determining whether a bona fide market has been established, all
transactions in Tully's stock by any director or officer of Tully's, or any
affiliates of such persons, during the period in which the market is
claimed to have existed will be excluded. In addition, Tully's will have
disseminated to the public during said period, at least two quarterly
unaudited financial statements or one annual audited financial statement.
Unless released pursuant to subparagraphs (a), (b), or (c) above, all of
the Shares shall remain in escrow until the sixth anniversary of the effective
date of the offering. On each of the sixth, seventh, eighth, and ninth
anniversary dates, 25% of the Shares shall be released from escrow, such that no
shares will remain in escrow as of nine years from the effective date of the
offering.
While the Shares are escrowed they will remain in the ownership of Tom T.
and Cathy O'Keefe. They will have the right to vote the Shares and will also be
entitled to any dividends, share dividends, stock splits or any other benefit
which may inure to them as the result of owning the Shares.
Mr. and Mrs. O'Keefe have also agreed under the terms of the escrow
agreement that upon a liquidation or dissolution of Tully's and following
payment to Tully's creditors, the Shares then held in escrow, if any, will be
subordinate to all other shares of Tully's Common Stock with respect to any
amounts paid to shareholders as a result of such liquidation or dissolution of
Tully's. Any such liquidation or payment to
30
<PAGE>
shareholders shall be paid as follows: (1) holders of shares, including shares
purchased in the Offering but excluding the Shares held in escrow, shall receive
$1.50 per share, (2) the founders shall receive $1.50 per share on the Shares in
escrow, (3) thereafter, all shares shall participate in any remaining
distributions on a pro rata basis
DIVIDENDS
Shareholders are entitled to receive such dividends, if any, that are
declared by Tully's Board of Directors out of funds legally available therefore
and, upon the liquidation, dissolution or winding up of Tully's, are entitled to
share ratably in all net assets available for distribution to such holders after
satisfaction of all obligations of Tully's, including stock preferences. The
Company has not paid dividends in the past and Tully's Board of Directors
presently does not intend to pay any dividends, but to retain and use any
earnings to finance the growth of its business for an indefinite period. The
line of credit arrangement restricts Tully's ability to pay dividends without
the bank's permission. Future dividend policies will depend upon Tully's
earnings, financial needs and other pertinent factors.
LIMITATIONS ON SHARES AND TRANSFER AGENT
2,880,600 share of Tully's Common Stock were qualified with the United
States Securities and Exchange Commission pursuant to the Securities Act of
1933, as amended and Regulation A and are not deemed "restricted securities."
The remaining 11,433,400 issued and outstanding shares of Common Stock are
deemed "restricted shares." None of its shares of Preferred Stock nor any of the
shares of Common Stock which may be issued upon conversion of the Preferred
Shares or exercise of the Warrants have been registered or otherwise qualified
with the United States Securities and Exchange Commission pursuant to the
Securities Act of 1933, as amended. They were offered and sold pursuant to the
exemption from registration under Rule 506 of Regulation D promulgated by the
United States Securities and Exchange Commission. As "restricted securities"
under the Federal securities laws none of these shares are freely transferable.
Therefore, neither investment units nor any of the other restricted securities
may be sold or otherwise transferred unless they are subsequently registered
under Federal and applicable state securities laws or there exists an exemption
from the applicable registration requirements with respect to such sale or
transfer.
TRANSFER AGENT AND REGISTAR
Tully's intends to act as its own transfer agent and registrar.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES.
As of July 1, 1999, the Company has sold a total of $24,999,125 of
"investment units" at a price of $10.00 per unit, payable in cash. Each of the
investment units consists of 4 shares of the Company's
31
<PAGE>
Class A Preferred Stock together with a Warrant to purchase two shares of the
Company's common stock at an exercise price of $0.33 per share of common stock.
The rights, preferences and other features of the preferred shares and the
warrants are described in Item 11. The investment units were offered and sold
only to accredited investors. The investment units were offered and issued
pursuant to Rule 506 of Regulation D. As of July 1, 1999 there were a total of
582 accredited investors that purchased the investment units.
In addition to the investment units that have been sold, as of July 1, 1999
the Company has received subscriptions for an additional 681,145 investment
units, with an aggregate purchase price of $6,811,450. The Company has not yet
accepted these subscriptions because as of the date hereof it does not have a
sufficient number of authorized shares of Series A Convertible Preferred Stock
to issue upon acceptance of the subscriptions. The Company's Board of Directors
has proposed certain amendments to the Company's Articles of Incorporation,
which amendments include an increase in the number of authorized Series A
Convertible Preferred Stock to 17,500,000 shares. When and if the Shareholders
ratify and approve the proposed Articles of Amendment, the Company will accept
the subscriptions and issue the Preferred Stock and Warrants.
In June 1998, the Company issued a $2,500,000 convertible note to a
director of the Company. The Company incurred interest expense of $222,383
related to the note. The note was converted into 1,000,000 shares of preferred
stock on March 28, 1999 (See Note 9 to Consolidated Financial Statements).
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED.
GENERAL
Tully's authorized capital stock consists of 120,000,000 shares of common
stock, no par value and 30,000,000 shares of preferred stock. As of July 1,
1999, 14,374,672 shares of common stock were issued and outstanding. As of that
same date there were 9,999,650 shares of preferred stock, designated as Series A
Convertible Preferred Stock, issued and outstanding which were convertible into
9,999,650 shares of Common Stock. There were also 2,499,913 Warrants outstanding
to purchase an additional 4,999,825 shares of Common Stock at a price of $0.33
per share.
The holders of common stock are entitled to one vote for each share held of
record on all maters submitted to a vote of shareholders. There are no
cumulative voting rights. Subject to preferences that may be applicable to any
outstanding shares of preferred stock, the holders of common stock are entitled
to receive ratably such dividends as may be declared by the board of directors
out of funds legally available therefor. In the event of a liquidation,
dissolution, or winding up of Tully's, subject to preferences that may be
applicable to outstanding shares of preferred stock, holders of common stock are
entitled to share ratably in all assets remaining after payment of liabilities.
Under Washington corporate law, shareholders owning two-thirds of the
outstanding shares must approve amendments to Tully's Articles of Incorporation
and other major corporate actions, such as adopting a plan of merger,
consolidation or exchange involving Tully's or its stock, or the sale of
substantially all of Tully's assets other than in the regular course of
business.
32
<PAGE>
PREFERRED STOCK
The Series A Preferred Stock has certain limited dividend rights, is
convertible into shares of Tully's common stock, has liquidation preferences
over Tully's common stock and has voting rights. In the event of any liquidation
or winding up of Tully's, the holders of the Series A Preferred Stock shall be
entitled to receive, prior and in preference to the holders of Common Stock and
any series of preferred stock ranked junior to the Series A Preferred Stock an
amount (the "Liquidation Amount") equal to the original purchase price of the
Series A Preferred Stock (aggregating $24,999,125 as of July 1, 1999 then held
by such holders, plus all declared but unpaid dividends, and shall thereafter be
entitled to participate on an as converted basis with the holders of Common
Stock.
Each share of the Series A Preferred Stock is automatically convertible
into one share of Tully's common stock when and if Tully's makes a "Qualified
Offering" of its common stock. Qualified Offering is defined as an offering of
Tully's common stock in excess of $15 million made pursuant to a registration
statement made effective under the Securities Act of 1933, as amended. Each
share of Preferred Stock is entitled to cast one vote on all matters submitted
to a vote of shareholders, except in connection with the election of Directors,
in which case shareholders may cumulate their votes and cast them all for one or
more of the director candidates.
REGISTRATION RIGHTS
The holders of Series A Convertible Preferred Stock have certain rights
granted to them to require registration of the common shares received upon
conversion of the Preferred Stock. These rights generally allow persons holding
the converted common shares to require Tully's to use its best efforts to
register the shares for resale under the Securities Act of 1933, as amended and
under such state securities laws as may be necessary. These rights include the
right to demand ("demand registration rights") that Tully's file a registration
statement for the converted shares at the shareholders' option no more than one
time following Tully's initial public offering, if any, and thereafter unlimited
rights once Tully's is eligible to use a certain form of Securities and Exchange
Commission registration statement that is available to issuers who have been
filing periodic reports with the Commission (i.e., quarterly, annual and other
reports as required of "reporting companies under the Securities Exchange Act of
1934, as amended).
WARRANTS
The warrants are non-detachable from the Series A Preferred Stock. Each
warrant entitles the holder to purchase two shares of Tully's common stock at a
price of $0.33 per share purchased. The warrants may be exercised by the holder,
in whole or in part, at any time after they are issued. Any warrants
outstanding, but unexercised, at the time Tully's commences a Qualified Offering
will be cancelled immediately prior to the commencement of such Qualified
Offering.
The Warrants include provisions for "weighted average anti-dilution
protection rights" for both the Preferred Stock and the shares of common stock
issuable upon any exercise of the warrants. Under these anti-dilution rights, if
Tully's were to issue additional stock at less than the conversion price for the
Preferred Stock (i.e. $2.50 per share), the conversion price for the Preferred
Stock and the exercise price under the warrants ($0.33 per share) would be
adjusted so that the new conversion price would be equal to take into account
the decreased value of the shares of common stock as represented by the new
selling price.
33
<PAGE>
GOVERNING LAW
Tully's was formed under the Washington Business Corporation Act and its
operations are subject to that law and to its Articles of Incorporation and
Bylaws. Under Washington law, management of corporate business and affairs is
entrusted to a board of directors.
34
<PAGE>
ITEM 12. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
INDEMNIFICATION AND LIMITATION OF DIRECTOR AND OFFICER LIABILITY
The Articles of Incorporation of Tully's limit the liability of its
directors to the maximum extent permitted by Washington law. Washington law
provides that the articles of incorporation may contain provisions that
eliminate or limit the personal liability of a director to the corporation or
its shareholders provided that such provisions do not eliminate or limit the
liability of a director for:
- Acts or omissions involving intentional misconduct or a knowing violation
of law;
- Unlawful payments or distributions; or
- Any transaction from which the director will personally receive an improper
benefit in money, property, or services.
The Articles of Incorporation also provide that the Company shall indemnify
and advance expenses to the employees and other agents to the fullest extent
permitted by law. The bylaws outline the procedures for seeking indemnification
and/or seeking advancement of expenses. The bylaws also permit the Company to
(i) secure insurance on behalf of any officer, director, employee or other agent
for any liability arising out of his or her actions in such capacity, regardless
of whether the bylaws would permit indemnification; (ii) enter into contracts
with any officer, director, employee or other agent to provide indemnification
consistent with Washington law; and (iii) create a trust fund, grant a security
interest, or use other means (including without limitation a letter of credit)
to ensure payment of any indemnification obligation of the Company.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of the Company where indemnification is
expected to be required or permitted. The Company is not aware of any threatened
litigation or proceeding that might result in a claim for such indemnification.
Under applicable Washington law, officers and directors of a corporation
have certain fiduciary duties to the corporation and its shareholders, violation
of which may be actionable and may entitle shareholders to sue for injunctive
remedies and damages. Under the Washington Business Corporations Act, certain
significant corporate acts, such as dissolution of a corporation or sale of
substantially all of its assets, require approval by holders of two-thirds of
the shares entitled to vote on such matters
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements required as a part of this Registration Statement
are included beginning on the index page F-1 of this Registration Statement.
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
During Tully's Coffee last two fiscal years there were no changes or
disagreements with accountants on accounting and financial disclosure of the
type required to be disclosed in this item.
35
<PAGE>
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS.
The financial statements required as a part of this Registration Statement
are included beginning on the index page F-1 of this Registration Statement.
EXHIBITS
The following exhibits required by item 601 of Regulation S-K are attached
hereto:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C>
2 Spinelli Coffee Company Acquisition Agreement
3.1 Articles of Incorporation, as amended(2)
3.2 Bylaws(1)
4.1 Tom T. O'Keefe Stock Escrow Agreement
4.2 Form of Registration Rights Agreement
4.3 Form of common stock warrant issued in Series A Preferred Stock financing
10.1 Tully's Coffee Corporation Amended and Restated 1994 Stock Option Plan(2)
10.2 Tully's Coffee Corporation 1999 Employee Stock Purchase Plan (2)
10.3 Lease Agreement dated between Tully's and Airport Way Rentals(1)
10.4 Borrowing Agreement between Tully's and SeaFirst Bank(1)
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Arthur Anderson LLP
27.1 Financial Data Schedule
</TABLE>
(1) Incorporated by reference to the Company's Registration Statement on
Form 10
(2) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 26, 1999
36
<PAGE>
TULLY'S COFFEE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of PricewaterhouseCoopers LLP, independent accountants .................. F-2
Consolidated Balance Sheets as of March 28, 1999 and March 29, 1998 ............ F-3
Consolidated Statements of Operations for the years ended March 28, 1999,
March 29, 1998 and March 30, 1997 .............................................. F-4
Consolidated Statements of Stockholders' Equity for the years ended
March 28, 1999, March 29, 1998 and March 30, 1997 ............................. F-5
Consolidated Statements of Cash Flows for the years ended March 28, 1999,
March 29, 1998 and March 30, 1997 .............................................. F-6
Notes to Consolidated Financial Statements ..................................... F-7
Consolidated Balance Sheets unaudited) as of June 27, 1999 ..................... F-21
Consolidated Statements of Operations (unaudited) for the thirteen weeks ended
June 27, 1999 and June 28, 1998 ................................................ F-22
Consolidated Statements of Cash Flows (unaudited) for the thirteen weeks ended
June 27, 1999 and June 28, 1998 ................................................ F-23
Notes to Consolidated Financial Statements ..................................... F-24
Spinelli Coffee Company
Report of Arthur Anderson LLP, independent accountants ......................... F-25
Balance Sheet as of February 1, 1998 ........................................... F-26
Statement of Operations for the year ended February 1, 1998 .................... F-27
Statement of Changes in Stockholders' Equity for the year ended
February 1, 1998 ............................................................. F-28
Statement of Cash Flows for the year ended February 1, 1998 .................... F-29
Notes to Financial Statements .................................................. F-30
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Tully's Coffee Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows present fairly, in all material respects, the financial position of
Tully's Coffee Corporation and its subsidiary as of March 28, 1999 and March 29,
1998, and the results of their operations and their cash flows for the years
ended March 28, 1999, March 29, 1998 and March 30, 1997 in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
July 20, 1999
Seattle, Washington
F-2
<PAGE>
TULLY'S COFFEE CORPORATION
CONSOLIDATED BALANCE SHEETS
MARCH 28, 1999 AND MARCH 29, 1998
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 1,149,160 $ 21,566
Accounts receivable, net of allowance for doubtful
accounts of $166,236 and $54,218, respectively 695,037 353,030
Inventories, net 1,808,556 617,301
Prepaid expenses 84,197 6,249
------------ ------------
Total current assets 3,736,950 998,146
Property and equipment, net 10,991,722 6,507,135
Goodwill, net 4,973,370 146,706
Other intangible assets, net 760,320 343,079
Other assets 256,657 83,363
------------ ------------
Total assets $20,719,019 $ 8,078,429
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 27,744 $ 33,343
Bank line of credit 6,500,000
Accounts payable 1,808,619 2,092,503
Accrued liabilities 1,199,413 375,385
Checks drawn in excess of bank balances - 113,893
------------ ------------
Total current liabilities 9,535,776 2,615,124
Bank line of credit - 4,157,000
Long-term debt, net of current portion 128,978 103,072
Capital lease obligation 192,754 133,873
Deferred lease costs 885,232 642,168
------------ ------------
Total liabilities 10,742,740 7,651,237
------------ ------------
Commitments and contingencies (Note 11)
Stockholders' equity
Series A Convertible Preferred stock, no par;
10,000,000 shares authorized 6,217,480 issued
and outstanding at March 28, 1999, stated value of
$2.50 and a liquidation preference of $15,543,700 14,351,934 -
Common stock, no par value; 40,000,000 shares
authorized; 14,314,000 and 14,265,200 shares issued
and outstanding 7,444,922 7,348,840
Additional paid-in capital 10,489,829 2,839,319
Accumulated deficit (22,310,406) (9,760,967)
------------ ------------
Total stockholders' equity 9,976,279 427,192
------------ ------------
Total liabilities and stockholders' equity $20,719,019 $ 8,078,429
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
TULLY'S COFFEE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net sales $20,207,183 $ 9,020,314 $ 5,430,003
Cost of goods sold and related occupancy expenses 10,705,398 5,012,058 2,850,176
Selling, general and administrative costs 12,087,455 6,096,606 3,617,814
Stock option compensation expense 832,898 564,412 627,017
Depreciation and amortization 1,669,389 613,970 454,784
------------- ------------- -------------
Operating loss 5,087,957 3,266,732 2,119,788
------------- ------------- -------------
Other expense (income)
Interest expense 833,838 258,170 174,827
Miscellaneous expense (income) (69,968) 7,561
Loan guarantee fee expense 728,831 294,669 179,452
------------- ------------- -------------
1,492,701 552,839 361,840
------------- ------------- -------------
Net loss $ 6,580,658 $ 3,819,571 $ 2,481,628
------------- ------------- -------------
------------- ------------- -------------
Preferred stock dividend/accretion 5,968,781 - -
------------- ------------- -------------
Net loss applicable to
common stockholders $12,549,439 $ 3,819,571 $ 2,481,628
------------- ------------- -------------
------------- ------------- -------------
Weighted average number of
common and common equivalent
shares outstanding 14,298,754 13,366,176 12,687,569
------------- ------------- -------------
------------- ------------- -------------
Basic and diluted net loss per common share $ 0.88 $ 0.29 $ 0.20
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
TULLY'S COFFEE CORPORATION
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
MARCH 28, 1999, MARCH 29, 1998 AND MARCH 31, 1997
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED
STOCK AMOUNT COMMON STOCK
----------------------------- -----------------------------
SHARES SERIES A SHARES AMOUNT
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
BALANCE, APRIL 1, 1996 12,416,174 $ 3,786,296
Issuance of 113,169 options in exchange
for loan guarantees
Sale of common stock at $1.75 426,006 745,511
Issuance of common stock in connection with 21,152
purchases of goods and services 34,845
Leasehold interests satisfied by majority shareholders
Stock issuance costs (55,922)
Issuance of stock options
Imputed officer compensation
Net loss
-------------- -------------- -------------- --------------
BALANCE, MARCH 30, 1997 12,863,332 4,510,730
-------------- -------------- -------------- --------------
Issuance of 130,964 options in exchange
for loan guarantees
Sale of common stock at $2.25 per share 1,305,533 2,937,449
Issuance of common stock in connection with 75,000
purchase agreements 168,750
Issuance of common stock in connection with 21,335
purchases of goods and services 48,004
Stock issuance costs (316,093)
Issuance of stock options
Imputed officer compensation
Net loss
-------------- -------------- -------------- --------------
BALANCE, MARCH 29, 1998 14,265,200 7,348,840
-------------- -------------- -------------- --------------
Issuance of 323,924 options in exchange
for loan guarantees
Sale of preferred stock at $2.50 per share 5,217,480 $13,043,700
Conversion of note into preferred stock 1,000,000 2,500,000
Issuance of common stock warrants (5,968,781)
Issuance of common stock in connection with
purchase agreements 10,000 22,500
Preferred stock dividend/accretion 5,968,781
Issuance of common shares in connection with
purchases of goods and services 38,800 73,582
Stock issuance costs (1,191,766)
Issuance of stock options
Imputed officer compensation
Net loss
-------------- -------------- -------------- --------------
BALANCE, MARCH 28, 1999 6,217,480 $14,351,934 14,314,000 $ 7,444,922
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
<CAPTION>
NOTES
RECEIVABLE ADDITIONAL
FROM PAID-IN ACCUMULATED
STOCKHOLDERS CAPITAL DEFICIT TOTAL
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
BALANCE, APRIL 1, 1996 $ (54,462) $ 960,587 $ (3,459,768) $ 1,232,653
Issuance of 113,169 options in exchange
for loan guarantees 179,452 179,452
Sale of common stock at $1.75 745,511
Issuance of common stock in connection with
purchases of goods and services 34,845
Leasehold interests satisfied by majority shareholders 27,644 27,644
Stock issuance costs (55,922)
Issuance of stock options 26,818 600,199 627,017
Imputed officer compensation 120,000 120,000
Net loss (2,481,628) (2,481,628)
-------------- -------------- -------------- --------------
BALANCE, MARCH 30, 1997 1,860,238 (5,941,396) 429,572
-------------- -------------- -------------- --------------
Issuance of 130,964 options in exchange
for loan guarantees 294,669 294,669
Sale of common stock at $2.25 per share 2,937,449
Issuance of common stock in connection with
purchase agreements 168,750
Issuance of common stock in connection with
purchases of goods and services 48,004
Stock issuance costs (316,093)
Issuance of stock options 564,412 564,412
Imputed officer compensation 120,000 120,000
Net loss (3,819,571) (3,819,571)
-------------- -------------- -------------- --------------
BALANCE, MARCH 29, 1998 2,839,319 (9,760,967) 427,192
-------------- -------------- -------------- --------------
Issuance of 323,924 options in exchange
for loan guarantees 728,831 728,831
Sale of preferred stock at $2.50 per share 13,043,700
Conversion of note into preferred stock 2,500,000
Issuance of common stock warrants 5,968,781 -
Issuance of common stock in connection with
purchase agreements 22,500
Preferred stock dividend/accretion (5,968,781) -
Issuance common shares in in connection with
purchases of goods and services 73,582
Stock issuance costs (1,191,766)
Issuance of stock options 832,898 832,898
Imputed officer compensation 120,000 120,000
Net loss (6,580,658) (6,580,658)
-------------- -------------- -------------- --------------
BALANCE, MARCH 28, 1999 $ - $ 10,489,829 $(22,310,406) $ 9,976,279
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
TULLY'S COFFEE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (6,580,658) $ (3,819,571) $ (2,481,628)
Adjustments to reconcile net loss to net cash used by
operating activities
Depreciation and amortization 1,669,389 613,970 454,784
Stock option expense 832,898 564,412 627,017
Provision for doubtful accounts 112,018 54,218
Stock issued in exchange for services 96,082 48,004 34,845
Loan guarantee fee expense 728,831 294,669 179,452
Deferred lease costs 243,065 336,486 80,831
Imputed officer compensation 120,000 120,000 120,000
Loss on sale of property 24,215 7,561
Changes in assets and liabilities
Accounts receivable (290,430) (307,709) (41,436)
Inventories (225,840) (301,822) (122,368)
Prepaid expenses and other assets (78,669) 5,272 17,445
Accounts payable (888,542) 983,052 (82,225)
Accrued liabilities 487,014 184,219 15,027
---------------- ---------------- ----------------
Net cash used in operating activities (3,750,627) (1,224,800) (1,190,695)
---------------- ---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (4,097,609) (3,142,153) (1,338,044)
Proceeds from sale of property and equipment - 323,040
Purchase of Spinelli Coffee Company, net of
cash acquired (6,916,184)
Additions to intangible assets (40,745) (170,600) (37,579)
---------------- ---------------- ----------------
Net cash used in investing activities (11,054,538) (3,312,753) (1,052,583)
---------------- ---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under bank line of credit 2,343,000 3,642,000 2,313,277
Repayment of bank line of credit - (1,985,000) (710,000)
Payments on notes payable (648,282) 77,453 (34,669)
Advance to stockholder (42,356)
Proceeds from the issuance of convertible note 2,500,000
Proceeds from issuance of common stock 2,937,449 745,511
Proceeds from issuance of preferred stock 13,043,700
Stock issuance costs (1,191,766) (316,093) (55,922)
Checks drawn in excess of bank balances (113,893) 113,893
---------------- ---------------- ----------------
Net cash provided by financing activities 15,932,759 4,469,702 2,215,841
---------------- ---------------- ----------------
Net increase (decrease) in cash and cash equivalents 1,127,594 (67,851) (27,437)
Cash and cash equivalents
Beginning of period 21,566 89,417 116,854
---------------- ---------------- ----------------
End of period $ 1,149,160 21,566 $ 89,417
---------------- ---------------- ----------------
---------------- ---------------- ----------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for interest $ 258,171 $ 220,929 $ 139,436
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Noncash investing and financing activity
Accounts Payable to purchase equipment $ 132,000 $ 703,227 $
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Notes issued to purchase equipment $ 91,325 $ 50,402 $ 20,097
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Note payable converted into preferred stock $ 2,500,000 - -
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Common stock issued to purchase equipment, leasehold
improvements $ - $ 168,750 $ -
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Leasehold interests satisfied by majority shareholder in
settlement of amounts due Company from shareholder $ - $ $ 70,000
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Deemed preferred stock dividend on preferred stock
issuance as a result of beneficial conversion feature of
attached common stock warrants $ 5,968,781 - -
---------------- ---------------- ----------------
---------------- ---------------- ----------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY AND NATURE OF OPERATIONS
Tully's Coffee Corporation, (the "Company") was formed in 1992 for the
purpose of developing and operating retail specialty coffee shops. The
Company sells high quality, premium roasted whole bean coffees, rich brewed
coffees, Italian-style espresso and cold beverages, baked goods and
pastries along with coffee-related hardware and supplies. In addition to
its retail operations, the Company sells roasted coffee to wholesale
accounts. Wholesale operations represent approximately 8% of revenue. The
Company's fiscal years end on the Sunday closest to March 31.
Through licenses and one joint venture, the Company operates 16 stores
internationally. The Company entered into a joint venture to operate
three stores in Japan during 1999. The Company made a $82,500 capital
contribution in exchange for a 12% interest in this venture and its
share of losses for 1999 is approximately $12,000.
As of March 28, 1999, the Company operated 59 retail stores in the Seattle
and San Francisco metropolitan areas.
CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary. All significant inter-company balances
and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash equivalents represent short-term investments consisting of money
market funds. The Company considers all short-term investments with a
maturity of three months or less when purchased to be cash equivalents.
The Company places its cash and cash equivalents with one financial
institution.
INVENTORIES
Inventories are stated at the lower of cost (on the first-in, first-out
basis) or market.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less accumulated depreciation
and amortization. Depreciation of property and equipment, which includes
amortization of assets under capital leases, is provided on the
straight-line method over estimated useful lives, generally ranging from
three to seven years. Leasehold improvements are amortized over the
shorter of their estimated useful lives or the related lease life,
generally three to fifteen years. The cost of property held under capital
lease is equal to the lower of the net present value of the minimum lease
payments or the fair value of the leased property at the inception of the
lease. Expenditures for additions and betterments are capitalized and
expenditures for repairs and maintenance are charged to expense as
incurred. The cost and accumulated depreciation of assets sold or retired
are removed from the accounts, and the related gains and losses are
included in the results of operations.
F-7
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
When facts and circumstances indicate that the cost of long-lived assets
may be impaired, an evaluation of recoverability is performed by comparing
the carrying value of the asset to projected undiscounted future cash
flows. Upon indication that the carrying value of such assets may not be
recoverable, the Company recognizes an impairment loss based on
discounted cash flow by a charge against current operations.
INTANGIBLE ASSETS
Intangible assets include leasehold interests (see Note 10), trademark and
logo design costs, covenants not to compete, goodwill and other assets.
Amortization of leasehold interests is provided over the life of the lease,
including options to renew. Goodwill is amortized on the straight-line
method over 15 years. Other intangible assets are amortized on the
straight-line method over 5 to 15 years.
Costs in excess of net assets acquired "Goodwill" is amortized on a
straight-line basis over the expected periods to be benefited. The Company
assesses the recoverability of this intangible asset by determining whether
the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the
acquired operations. The amount of goodwill impairment, if any, is
measured based on projected discounted future operating cash flows using
a discount rate reflecting the Company's average cost of funds. The
assessment of the recoverability of goodwill will be impacted if
estimated future operating cash flows are not achieved.
CASH MANAGEMENT
Checks issued but not presented for payment to the bank are reflected as
"Checks drawn in excess of bank balances" in the accompanying financial
statements.
REVENUE RECOGNITION
Revenue is recognized at the time of the sale or upon delivery of the
products.
STORE PRE-OPENING COSTS
Costs incurred in connection with start-up and promotion of new store
openings are expensed as incurred.
ADVERTISING COSTS
Costs incurred for advertising and promotions are expensed when incurred
and totaled $433,990, $234,640 and $56,499 during 1999, 1998 and 1997
respectively.
RENT EXPENSE
Certain lease agreements provide for scheduled rent increases during the
lease terms or for rental payments commencing on a date other than the
date of initial occupancy. Rent expense is recorded on a straight-line
basis over the respective terms of the leases.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
F-8
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
OFFICER COMPENSATION
In accordance with Staff Accounting Bulletin (SAB) 5T added by SAB
79 "Accounting for Expenses on liabilities paid by principal
stockholder", the Company records an amount in the financial
statements for compensation expense for its President who draws no
salary. The Company recognized as compensation expense $120,000 in
1999, 1998 and 1997 and corresponding increases to additional
paid-in capital have been recorded.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents and other current
assets and liabilities, such as accounts payable, accrued
liabilities and accounts receivable as presented in the consolidated
financial statements approximates fair value based on the short-term
nature of these instruments. The Company believes the carrying
amounts of the Company's notes payable, line of credit and long-term
debt approximate fair value because the interest rates are subject
to change with, or approximate, market interest rates.
STOCK-BASED COMPENSATION
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting
for Stock-Based Compensation". The Company has chosen to continue to
account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related
interpretations. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the fair value of the Company's
stock at the date of grant over the amount an employee must pay to
acquire the stock.
NET LOSS PER SHARE
Statement of Financial Accounting Standards No.128 "Earnings per
Share" (SFAS 128) was issued in February 1997. This pronouncement
modified the calculation and disclosure of loss per share. All
periods presented have been prepared under the provisions of SFAS
128. Under these provisions, basic loss per share is calculated as
loss available to the common stockholder divided by the
weighted-average number of common shares outstanding during the
period. Diluted loss per share is based on the weighted-average
number of shares of common stock and common stock equivalents
outstanding during the periods, including options and warrants
computed using the treasury stock method. Common stock equivalent
shares are excluded from the calculation of diluted loss per share
if their effect is antidilutive. The Company had a net loss for all
periods presented herein; therefore none of the options, warrants and
convertible preferred stock outstanding during each of the periods
presented were included in the computation of diluted loss per share
as they were antidilutive. Such instruments convertible into a total
of 10,929,862, 2,000,894 and 1,418,629 shares of common stock were
excluded from the calculations of diluted loss per share for the
years ended March 28, 1999, March 29, 1998 and March 30, 1997,
respectively.
RECLASSIFICATIONS
Reclassifications of prior year balances have been made to conform
to the current year classifications.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS
133, "Accounting for Derivative Instruments and Hedging Activities."
This pronouncement will require Tully's to recognize certain
derivatives on its balance sheet at fair value. Changes in the fair
values of derivatives that qualify as cash flow hedges will be
recognized in comprehensive income until the hedged item is
recognized in earnings. Tully's expects that this new standard will
not have a significant effect on its results of operations. SFAS 133
was amended by SFAS 137, deferring the effective date to fiscal
years beginning after June 15, 2000.
2. ACQUISITIONS
On June 26, 1998, the Company acquired all the outstanding shares of
Spinelli Coffee Company for a total purchase price of $8.4 million.
Spinelli Coffee Company had 11 Company-operated stores, 3 licensed
stores, both a roasting and warehouse facility in the San Francisco
Bay area as well as 8 licensed stores in Asia. The acquisition has
been accounted for under the purchase method of accounting in fiscal
1999. The purchase price has been allocated to the assets acquired
and liabilities assumed based on management's estimates, arms-length
negotiations with the sellers and in certain cases,
F-9
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
independent appraisals of asset fair values. The residual of
approximately $5.1 million was recorded as "Goodwill" and is being
amortized on a straight-line basis over 15 years. The results of
operations of the acquired companies have been included in
consolidated results of operations of the Company from the date of the
acquisition.
The purchase price of $8.4 million consists of $6.7 million paid to
the seller, $221,243 of acquisition expense and the assumption of
$1,446,356 in liabilities of the seller.
The categories of assets acquired and obligations assumed, at the
date of the acquisition is as follows:
<TABLE>
<S> <C>
Assets acquired
Cash $ 5,059
Accounts receivable 163,595
Inventories 965,415
Prepaid and other current assets 41,172
Goodwill and other intangible assets 5,522,928
Property and equipment 1,538,027
Other assets 131,403
------------
Total assets $ 8,367,599
------------
------------
Liabilities assumed
Current liabilities $ (520,478)
Other liabilities (925,878)
------------
$(1,446,356)
------------
------------
</TABLE>
The company incurred costs associated with the acquisition during
1999 of $221,243, primarily for professional fees and direct
costs. Such costs were capitalized as part of the purchase price.
The following unaudited pro forma summary presents the consolidated
results of operations of the Company as if the acquired entity had been
acquired as of the beginning of the period presented, including the
impact of certain adjustments:
<TABLE>
<CAPTION>
UNAUDITED
----------------------------
YEAR ENDED YEAR ENDED
MARCH 29, MARCH 28,
1998 1999
---------- -----------
(IN THOUSANDS, EXCEPT
FOR PER SHARE DATA)
<S> <C> <C>
Net sales $ 15,789 $ 22,180
---------- -----------
---------- -----------
Net loss $ 4,695 $ 6,663
---------- -----------
---------- -----------
Preferred stock dividend/accretion $ - $ 5,970
---------- -----------
Net loss used in calculating loss
per common share $ 4,695 $ 12,633
---------- -----------
---------- -----------
Basic and diluted net loss per
common share $ 0.35 $ 0.88
---------- -----------
---------- -----------
</TABLE>
The pro forma results are not necessarily indicative of what actually
would have occurred if the acquisition had been in effect for the years
presented. In addition, they are not intended to be a projection of
future results and do not reflect any synergies that might be achieved
from combined operations.
F-10
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
3. ALLOWANCE FOR DOUBTFUL ACCOUNTS
<TABLE>
<S> <C>
BALANCE AT MARCH 31, 1996 $ -
Additions charged to costs and expenses 8,718
Deductions (8,718)
---------
BALANCE AT MARCH 30, 1997 $ -
Additions charged to costs and expenses 54,218
Deductions -
---------
BALANCE AT MARCH 29, 1998 $ 54,218
Additions charged to costs and expenses 144,689
Deductions (32,671)
---------
BALANCE AT MARCH 28, 1999 $ 166,236
---------
---------
</TABLE>
4. INVENTORY
Inventories consist of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Coffee
Unroasted $ 696,281 $ 72,030
Roasted 114,847 55,098
Other goods held for sale 547,064 402,214
Packaging and other supplies 450,364 102,050
---------- ----------
1,808,556 631,392
Reserve for obsolete inventory - (14,091)
---------- ----------
$1,808,556 $ 617,301
---------- ----------
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Facility under capital lease $ 87,634 $ 87,634
Machinery and equipment 4,180,325 2,238,758
Leasehold improvements 8,055,382 4,583,789
Office equipment, furniture and fixtures 1,214,774 839,516
Software 127,823 80,322
----------- -----------
13,665,938 7,830,019
Less: Accumulated depreciation and
amortization (2,674,216) (1,322,884)
----------- -----------
$10,991,722 $ 6,507,135
----------- -----------
</TABLE>
Accumulated depreciation related to assets held under capital leases
included in the above balance as of March 28, 1999 and March 29, 1998
was $26,267 and $23,046, respectively.
F-11
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
6. INTANGIBLE ASSETS
Other intangible assets consist of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Goodwill $5,297,422 $ 202,458
Leasehold interests 397,848 -
Lease Commissions 134,849 118,090
Trademark and logo design costs 241,199 212,098
Covenants not to complete 85,000 60,000
Other 23,560 23,560
----------- -----------
6,179,878 616,206
Less: Accumulated amortization (446,188) (126,421)
----------- -----------
$5,733,690 $ 489,785
----------- -----------
----------- -----------
</TABLE>
7. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting and income tax purposes. The significant
components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 4,481,000 $ 2,421,000
Stock options 944,000 671,000
Goodwill 229,000 -
Allowance for doubtful accounts 60,000 18,000
Accrued vacation 41,000 20,000
Other 41,000 -
----------- -----------
Total deferred tax assets 5,796,000 3,130,000
----------- -----------
Deferred tax liabilities:
Depreciation and amortization (249,000) (33,000)
----------- -----------
Total deferred tax liabilities (249,000) (33,000)
----------- -----------
Total deferred tax assets 5,547,000 3,097,000
Less: Valuation allowance (5,547,000) (3,097,000)
----------- -----------
Net deferred tax assets $ - $ -
----------- -----------
----------- -----------
</TABLE>
At March 28, 1999, the Company had accumulated tax net operating loss
carryforwards of approximately $12,600,000 which expire through 2019.
The Company's ability to use its net operating losses to offset future
income could be subject to restrictions enacted in the United States
Internal Revenue Code of 1986 as amended. These restrictions limit
future use of net operating loss and credit carryfowards if certain
stock ownership changes occur.
A reconciliation of the statutory Federal income tax rate with the
Company's effective income tax rate is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Federal statutory rate (34.0%) (34.0%) (34.0%)
State income taxes, net of Federal benefit (1.6) -- --
Change in tax rate (2.0) -- --
Other 1.3 1.75 1.9
Valuation allowance 36.3 32.25 32.1
------ ------ ------
--% --% --%
------ ------ ------
</TABLE>
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Commissions payable $ 410,085 -
Employee wages and taxes 589,420 $ 285,474
Other 199,908 89,911
----------- -----------
$ 1,199,413 $ 375,385
</TABLE>
9. BANK LINE OF CREDIT AND LONG-TERM DEBT:
At March 28, 1999, the Company had $6,500,000 outstanding under a
$6,500,000 bank line of credit expiring March 31, 2000. Interest is
charged at the prime lending rate plus 1/2% (8.25% at March 28, 1999).
The line is collateralized by all of the Company's assets, and is
guaranteed by the CEO and a board member in return for a guarantee fee
of 1.0% of the line's monthly average balance. In 1999, 1998 and 1997,
in exchange for the guarantee, the Company issued stock options for
323,924, 130,964 and 113,169 shares of common stock with an estimated
fair market value of $728,828, $294,669 and $179,452 to the guarantors,
respectively.
The line of credit agreement contains certain covenants and
restrictions requiring, among other things, a minimum level of tangible
net worth, limitations on capital expenditures and certain other
restrictions. The Company is in compliance with these provisions at
March 28, 1999.
In June 1998, the Company amended its bank line of credit agreement,
which reduced the amount available under the line to $6,500,000 through
March 1999 and $6,000,000 through the term of the agreement.
On April 1, 1999, the Company paid $500,000 on the line of credit.
In June 1998, the company issued a convertible note to a shareholder in
the amount of $2,500,000. The note accrues interest at a rate of 12%
per annum and matures on June 30, 2003. The note and any accrued
interest is convertible at any time into Series A Preferred Stock at a
conversion rate of $10.00 for four shares of the stock plus warrants to
purchase two shares of common stock at a price of $0.33 per share. The
note was converted on March 28, 1999 into 1,000,000 shares of Series
A Preferred Stock.
F-12
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
Long-term debt consists of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Note payable in monthly installments of $2,420, $ 133,612 -
including interest at 10.25%, through June 2004,
collateralized by equipment
Note payable in monthly installments of $542,
including interest at 10.9%, through January 2001,
collateralized by equipment 10,313 $ 15,366
Note payable in monthly payments of $442,
including interest at 10.9%, through January 1999,
collateralized by equipment - 3,797
Note payable in monthly installments of $501,
including interest at 4.8%, through June 2000,
collateralized by equipment 12,797 18,090
Note payable in monthly installments of $2,000,
including interest at 9.5%, through January 2000,
repaid in fiscal 1999 - 99,162
----------- ----------
156,722 136,415
Less: Current portion (27,744) (33,343)
----------- ----------
$ 128,978 $ 103,072
----------- ----------
</TABLE>
Future principal payments on long-term debt are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
<S> <C>
2000 $ 27,744
2001 27,759
2002 21,216
2003 21,844
Thereafter 58,159
----------
$ 156,722
----------
</TABLE>
10. RELATED PARTY TRANSACTIONS
A company controlled by the majority stockholder of the Company
provides development services to the Company. The Company incurred
costs of $70,000, $48,500 and $50,000 related to services provided by
this company during 1999, 1998 and 1997.
F-13
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
A director of the Company provides legal services to the Company.
During 1999, 1998 and 1997, the Company incurred costs of $137,683
$64,950 and $13,760, respectively, related to services performed by
the director, (of which $0, $10,614 and $1,527 was payable at March
28, 1999, March 29, 1998 and March 30, 1997, respectively).
During 1997, the Company entered into certain purchase agreements with
third parties to assume leases for certain locations and purchase
certain assets such as equipment and leaseholds. In settlement of
amounts owed to the Company by the majority shareholder, 40,000 shares
of common stock valued at $1.75 per share were issued by the majority
shareholder, rather than the Company, to the lessees. The estimated
fair value of the stock at the transaction dates ($70,000) has been
recorded as leasehold interests.
In June 1998, the Company issued a $2,500,000 convertible note to a
director of the Company. The Company incurred interest expense of
$223,383 related to the note. The note was converted into 1,000,000
shares of preferred stock on March 28, 1999. (See Note 9).
A company owned by a director of the Company leases space for three
retail stores to the Company. Rental expense for 1999, 1998 and 1997
was $221,016, $136,285 and $0, respectively.
Certain stockholders provide a guarantee on the Company's line of
credit (See Note 9).
11. COMMITMENTS
LEASE COMMITMENTS
The Company leases retail and office space under operating leases
which expire through 2016. The leases provide for minimum annual
payments, contingent rentals based upon gross sales and, in certain
cases, escalation clauses and options to renew leases. Rental
expense is recorded on a straight-line basis over the respective
terms of the leases. Rental expense under these leases was
$1,830,332, $960,455 and $542,674 for 1999, 1998 and 1997,
respectively. Contingent rental expense was $140,612, $88,197 and
$23,414 for 1999, 1998 and 1997, respectively. The majority
shareholder has guaranteed performance under one of the Company
operating leases.
In connection with certain leases, lessors granted tenant improvement
allowances. These amounts, included in the financial statements under
the caption deferred lease costs, are amortized into income on a
straight-line basis over the life of the related lease. Also recorded
in deferred lease costs is the excess of rental expense computed on a
straight-line basis over the actual rent payments required by the terms
of the Company's leases.
The Company has subleased certain space through 2003. Sublease
income is $40,596 in 2000 and 2001 and $21,548 and $3,000 in 2002 and
2003, respectively.
F-14
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
Minimum future rental payments under noncancelable operating leases
as of March 28, 1999 are summarized as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
<S> <C>
2000 $ 2,393,994
2001 2,235,341
2002 2,005,665
2003 1,721,888
2004 1,346,593
Thereafter 3,640,424
-----------
Total $13,343,905
-----------
-----------
</TABLE>
Minimum future rental payments under capital leases as of March 28,
1999 are summarized as follows:
<TABLE>
<S> <C>
2000 $ 60,760
2001 57,474
2002 45,500
2003 42,165
2004 33,334
Thereafter 221,712
----------
Total minimum lease payment 460,945
Less: Amount representing interest (268,191)
----------
Present value of net minimum lease payments
under capital lease $ 192,754
----------
----------
</TABLE>
PURCHASE COMMITMENTS
During 1998, the Company entered into certain purchase agreements with
third parties to assume leases for certain locations and purchase
certain assets such as equipment and leasehold improvements and obtain
non-compete agreements from the sellers. In the aggregate, the Company
paid $86,200 in cash, issued a $108,456 note payable due in equal
payments over 45 months, and issued 75,000 shares of common stock,
valued at $2.25 per share, to the sellers in connection with the
purchase agreements.
As of July 20, 1999, the Company had fixed price inventory purchase
commitments for green coffee totaling approximately $1.2 million. The
Company believes, based on relationships
F-15
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
established with its suppliers in the past, that the risk of loss on
non-delivery on such purchase commitments is remote. Such contracts are
generally short-term in nature and the Company believes that their cost
approximates fair market value.
The Company entered into a sponsorship agreement, effective February 5,
1999 through 2003, which provides for certain advertising and marketing
rights in exchange for an annual fee. The annual fee is $241,500 for
1999, $476,000 for 2000 and increases by the rate of 3% per year
thereafter.
CONTINGENCIES
In the ordinary course of its business, the Company may become involved
in legal proceedings from time to time. As of July 20, 1999, the Company
was not aware of any pending legal proceedings which in the opinion of
management would adversely affect operations, or cash flow.
12. STORE OPERATIONS
Between March 28, 1999 and July 20, 1999, the Company opened 3 new
stores and entered into lease agreements for these additional stores.
The lease terms are commensurate with the Company's existing lease
agreements.
13. STOCK OPTIONS
The Company has a stock option plan (the "Plan") which allows for the
granting of incentive stock options and non-qualified stock options. The
number of shares of common stock of the Company reserved for issue upon
the exercise of options granted under the Plan cannot exceed 5% of the
issued and outstanding shares of the Company. Grants, terms and vesting
provisions are determined by the Board of Directors. The options vest
pro rata over five years beginning with the employee's hire date and
remain exercisable for a period not to exceed seven years from the date
of grant. During 1999, 1998 and 1997, 359,000, 200,451 and 201,948
options, respectively, were granted at exercise prices of $1.78 and $2.25,
$1.75 and $1.50, respectively, per share (the estimated fair value at the
grant date) pursuant to the plan.
During 1999, 1998, and 1997, options to purchase 283,000, 240,350 and
352,786 shares, respectively, of common stock owned by the majority
stockholder at an exercise price of $.01 per share were granted to
certain key employees by the stockholder. The options were issued from
the majority stockholder's shares rather than newly issued shares of the
Company to avoid diluting the other stockholders. These options, all of
which were outstanding and fully vested as of March 28, 1999, are
exercisable indefinitely. Although the options were not granted by the
Company, generally accepted accounting principle requires that the
Company record an expense related to these grants. In 1999 and 1998, the
Company recorded an increase to additional paid-in capital and a
non-cash charge to compensation expense of $701,256 and $540,787,
respectively. In 1997, the Company recorded an increase to additional
paid-in capital of $572,074, a decrease to stockholder receivable of
$26,818 and a non-cash charge to compensation expense of $598,892. The
amount of expense recorded represents the difference between the
estimated fair value of the underlying shares on the grant dates and
the exercise price.
F-16
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
The Company granted fully vested options to its directors as compensation
for attending Board of Director meetings, and to certain outside
contractors. Non-cash charges of $70,416, $23,625 and $28,125 were recorded
in 1999, 1998 and 1997 related to these options for 33,500, 10,500 and
17,500 shares, respectively.
In addition, in exchange for a guarantee on its line of credit, the Company
issued stock options for 323,924, 130,964 and 113,169 shares of common
stock in 1999, 1998 and 1997 respectively (see Note 9).
Subsequent to March 28, 1999, options to purchase 6,500 shares of common
stock at an exercise price of $0.01 per share were granted to certain
employees and non-employees in connection with the Plan.
F-17
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
Stock option activity including amounts granted by the majority
shareholder, under all plans for 1999 and 1998 is summarized as follows:
<TABLE>
<CAPTION>
OUTSTANDING STOCK OPTIONS
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
------------- --------------
<S> <C> <C>
Balance, April 1, 1996 733,226 $.025
Granted 685,403 .449
------------- ---------
Balance, March 30, 1997 1,418,629 0.230
Granted 582,265 0.610
------------- ---------
Balance, March 29, 1998 2,000,894 0.340
Granted 1,132,632 0.720
Forfeited (49,885) 0.010
------------- ---------
Balance, March 28, 1999 3,083,641 0.485
------------- ---------
------------- ---------
<CAPTION>
1999 1998 1997
---------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE
---------- ---------- -------- ------------ -------- -----------
FAIR VALUE FAIR VALUE FAIR VALUE
<S> <C> <C> <C> <C> <C> <C>
Weighted average fair value of options
granted during the year whose exercise
price was less than the fair value of the
stock on the date of grant 929,188 $2.01 381,814 $2.24 483,455 $1.67
Weighted average fair value of options
granted during the year whose exercise
price was equal to the fair value of the
stock on the date of grant 203,444 $0.89 200,451 $0.41 201,948 $0.51
--------- ------- -------
1,132,632 --- 582,265 685,403
--------- ------- -------
--------- ------- -------
</TABLE>
In 1999, 1998 and 1997, the majority shareholder granted options to
purchase 283,000, 240,350, and 243,863 shares of his common stock,
respectively. These shares are presented as outstanding in the tables
above.
F-18
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
The following table summarizes information about fixed-price options
outstanding at March 28, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISEABLE
---------------------------------------------- --------------------------
WEIGHTED- WEIGHTED-AVERAGE WEIGHTED-
RANGE OF AVERAGE REMAINING AVERAGE
EXERCISE NUMBER EXERCISE CONTRACTUAL NUMBER EXERCISE
PRICES OUTSTANDING PRICE LIFE EXERCISABLE PRICE
---------- ------------ ------------ ------------------ ------------- -----------
(YEARS)
<S> <C> <C> <C> <C> <C>
$0.0033 300,000 $0.0033 4 300,000 $0.0033
0.01 1,986,605 0.01 7.7 1,778,804 0.01
0.33 41,078 0.33 5 42,432 0.33
1.50 201,948 1.50 7 121,169 1.50
$1.75 -2.25 554,010 1.90 9.1 236,742 $1.80
---------- ---------
3,083,641 2,479,147
---------- ---------
---------- ---------
</TABLE>
The following table presents net loss for 1999, 1998 and 1997, as
if the Company accounted for compensation expense related to stock options
under the fair value method prescribed by SFAS 123:
<TABLE>
<CAPTION>
YEARS ENDED
------------------------------------------------
MARCH 28,1999 MARCH 29,1998 MARCH 31, 1997
-------------- ------------- --------------
<S> <C> <C> <C>
Net loss-as reported $ (6,580,658) $ (3,819,571) $ (2,481,628)
Net loss-pro forma (6,696,739) $ (3,860,160) $ (2,503,129)
Basic and diluted loss per
common share
As reported (0.88) (0.29) (0.20)
Pro forma $(0.89) $(0.29) $(0.20)
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the minimum value method with the following weighted average
assumptions used for grants in 1999, 1998 and 1997:
<TABLE>
<CAPTION>
YEARS ENDED
-----------------------------------------------
MARCH 28,1999 MARCH 29,1998 MARCH 30, 1997
-------------- ------------- --------------
<S> <C> <C> <C>
Risk free interest rate 4.17% to 5.72% 4.55% to 6.05% 4.84% to 6.07%
Expected lives 5-10 years 5-7 years 5-7 years
</TABLE>
As of March 28, 1999, March 29, 1998 and March 31, 1997 options for
2,479,147, 1,659,112 and 1,237,208 shares respectively, were exercisable.
14. STOCKHOLDERS' EQUITY
F-19
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 28, 1999, MARCH 29, 1998 AND MARCH 30, 1997
--------------------------------------------------------------------------------
PREFERRED STOCK
In June 1998, the Company offered 2,000,000 Investment Units in a
Regulation D offering. Each unit consists of 4 shares of the Company's
Series A Preferred Stock and a Warrant to purchase two shares of the
Company's Common Stock at an exercise price of $0.33 per share. The
warrants have a ten year life. The per share offering price was $2.50.
The Series A Preferred Stock is convertible into one share each of
common stock, has preference over common stock upon liquidation of the
Company, and the right to participate in any dividend payable on the
common stock. The Preferred Stock also has voting rights. Each share of
Preferred Stock is automatically convertible into one share of the
Company's common stock if the Company makes a 'Qualified Offering' of its
common stock. A Qualified Offering is defined as an offering of the
Company's common stock in excess of $15 million made pursuant to a
registration statement filed under the Securities Act of 1933. As of
March 28, 1999, the Company had, as a result of selling 1,304,370 units
and converting a note to 250,000 units, issued 6,217,480 shares of
Series A Preferred Stock.
As of July 20, 1999, the offering is oversubscribed by 748,495 units,
with an aggregate purchase price of $7,484,950. The Company has not yet
accepted these subscriptions because as of this date does not have a
sufficient number of authorized shares of Class A Preferred Stock to
issue upon acceptance of the subscriptions. The Company's Board of
Directors has proposed certain amendments to the Company's Articles of
Incorporation which include an increase in the number of authorized
Class A Preferred Shares to 17,500,000. When and if the shareholders
ratify and approve the proposed amended Articles, the Company will
accept the subscriptions and issue the Preferred Shares and Warrants.
COMMON STOCK
During 1997, the Company issued 426,006 shares of common stock in a
Regulation D securities offering. Proceeds of the offering were $745,511.
In 1998, in a Regulation A offering, the Company issued 1,305,533 shares
of common stock for a total of $2,937,449. The proposed amendment
discussed above, if approved, would increase the authorized number of
common shares to 120,000,000.
The line of credit arrangement restricts the Company's ability to pay
dividends without the bank's permission.
WARRANTS
In connection with the preferred stock offering and the conversion of a
note to preferred stock, the Company issued warrants in 1999 to purchase
2,608,740 and 500,000 shares of common stock, respectively, at an
exercise price of $0.33 per share. The per share exercise price of the
warrant at the date of issuance was below the fair market value of the
common stock and is therefor considered an "in the money" or beneficial
conversion feature. Accounting for the issuance of a convertible
preferred stock with a non detachable beneficial conversion feature at
the date of issue requires that the conversion feature be recognized and
measured in the financial statements by allocating a portion of the
preferred stock offering proceeds to additional paid in capital. The
discount resulting from the allocation of the proceeds to the beneficial
conversion feature is analogous to a dividend and is recognized as a
return to preferred shareholders from the date of issuance through the
date the warrants are exercisable. As a result of the aforementioned
accounting, the Company allocated $5,968,781 of the preferred stock
proceeds to additional paid in capital. As the warrants are exercisable
the entire allocation was recognized as a preferred dividend through a
charge to retained earnings and a credit to preferred stock. The weighted
average fair value of the warrants on the date of grant was $2.08. In
relation to preferred stock oversubscription at July 20, 1999, additional
warrants to purchase 1,496,990 shares of common stock are pending issue
upon approval of proposed amended Articles.
F-20
<PAGE>
TULLY'S COFFEE CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 27, 1999
(unaudited) March 28, 1999
------------- --------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 3,470,831 $ 1,149,160
Restricted cash 6,111,575
Accounts receivable, net 737,164 695,037
Inventories, net 2,384,390 1,808,556
Prepaid expenses 426,120 84,197
----------- -----------
Total current assets 13,130,080 3,736,950
Property and equipment, net 11,682,413 10,991,722
Goodwill, net 4,884,217 4,973,370
Other intangible assets, net 1,026,188 760,320
Other assets 369,708 256,657
----------- -----------
Total assets $31,092,606 $20,719,019
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 41,504 $ 27,744
Bank line of credit 3,000,000 6,500,000
Accounts payable 1,163,880 1,808,619
Accrued liabilities and other current liabilities 8,428,354 1,199,413
----------- -----------
Total current liabilities 12,633,738 9,535,776
Long-term debt, net of current portion 132,450 128,978
Capital lease obligation 182,830 192,754
Deferred lease costs 883,634 885,232
----------- -----------
Total liabilities 13,832,652 10,742,740
Commitments and Contingencies
Stockholders' equity:
Series A convertible preferred stock, no par;
10,000,000 shares authorized, 10,000,000 and
6,217,480 issued and outstanding, stated
value of $2.50 and a liquidation preference
of $25,000,000 and $15,543,700 at June 27,
1999 and March 28, 1999, respectively 22,588,819 14,351,934
Common stock, no par value; 40,000,000
shares authorized; 14,374,672 and 14,314,000
shares issued and outstanding 7,581,433 7,444,922
Additional paid-in capital 14,515,541 10,489,829
Accumulated deficit (27,425,839) (22,310,406)
----------- -----------
Total stockholders' equity 17,259,954 9,976,279
----------- -----------
Total liabilities and stockholders' equity $ 31,092,606 $ 20,719,019
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-21
<PAGE>
TULLY'S COFFEE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Thirteen Weeks Ended
June 27, June 28,
1999 1998
(unaudited)
------------------------------
<S> <C> <C>
Net sales $ 6,115,062 $ 3,180,915
Cost of sales and related occupancy
expense 3,024,179 1,609,402
Selling, general and administrative
costs 3,556,569 2,192,144
Stock option compensation expenses 205,088 195,427
Depreciation and amortization 555,055 215,677
--------------- -------------
Operating loss (1,225,829) (1,031,735)
--------------- -------------
Other expense 258,385 236,320
--------------- -------------
Net loss $(1,484,214) $(1,268,055)
Preferred stock dividend/accretion 3,631,219 1,248,000
--------------- -------------
Net loss applicable to common
stockholders $(5,115,433) $(2,516,055)
=============== =============
Weighted average number of common
and common equivalent shares
outstanding 14,366,747 14,290,942
=============== =============
Basic and diluted net loss per common
share $ (0.36) $ (0.18)
=============== =============
</TABLE>
The accompanying notes are an integral part of these financial statements
F-22
<PAGE>
TULLY'S COFFEE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Twenty-six Weeks Ended
June 27, June 28,
1999 1998
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,484,214) $(1,268,055)
Adjustments to reconcile net loss
to net cash used in operating activities
Depreciation and amortization 555,055 215,677
Stock option expense 205,088 195,427
Interest on convertible note 74,795
Provisions for doubtful accounts - -
Stock issued in exchange for services 1,510 -
Loan guarantee fee expense 159,406 130,941
Deferred lease costs (1,598) 83,414
Imputed officer compensation 30,000 30,000
Changes in assets and liabilities
Accounts receivable (42,127) 85,579
Inventories (575,834) (22,113)
Prepaid expense and other assets (454,974) (89,748)
Accounts payable (644,739) (195,147)
Accrued liabilities 1,117,366 9,252
----------- -----------
Net cash used in operating activities (1,135,061) (749,978)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (1,245,746) (683,608)
Purchase of Spinelli Coffee Company, net - (6,916,184)
Additions to intangible assets (176,715) 45,323
----------- -----------
Net cash used in investing activities (1,422,461) (7,554,469)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under bank line of credit - 2,733,733
Repayment of bank line of credit (3,500,000) -
(Payments)/borrowings on notes payable (12,884)
Proceeds from the issuance of note payable 7,308 2,500,000
Proceeds from the issuance of convertible
preferred stock 9,456,300 3,200,000
Proceeds from issuance common stock 135,000 134,375
Stock issuance costs (1,219,415)
Checks drawn in excess of bank balances - 5,215,115
----------- -----------
Net cash provided by financing activities 4,879,193 13,770,339
----------- -----------
Net increase in cash and cash equivalents 2,321,671 5,465,892
Cash and cash equivalents at beginning of period 1,149,160 21,566
----------- -----------
Cash and cash equivalents at end of period $ 3,470,831 $ 5,487,458
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Deemed preferred stock dividend on convertible
preferred stock issuance as a result of
beneficial conversion feature of attached
common stock warrants 3,631,219 1,248,000
Noncash investing and financing activities:
Accrued liability for preferred stock to be issued 1,436,045 -
for commissions
Restricted Cash from oversubscription of
preferred stock 6,111,575 -
</TABLE>
The accompanying notes are an integral part of the financial statements
F-23
<PAGE>
TULLY'S COFFEE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The 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. Certain amounts previously reported have been
reclassified to conform with current year presentations with no effect on
total equity or net income. The accompanying unaudited consolidated financial
statements as of June 27, 1999 and June 28, 1998, and for the 13-week periods
ended June 27, 1999 and June 28, 1998 have been prepared by Tully's pursuant
to the rules and regulations of the Securities and Exchange Commission (the
"SEC"). The consolidated financial statements contained in this Amendment No.
1 to Form 10 are unaudited. In the opinion of management all adjustments
(consisting only of normal recurring adjustments and accruals) necessary for
a fair presentation for the interim periods have been reflected. These
consolidated financial statements should be read in conjunction with the
financial statements and notes thereto for the year ended March 28, 1999
included in the Company's Form 10, as amended. The results of operations for
the 13-weeks ended June 27, 1999 are not necessarily indicative of the
results for the entire year ending April 2, 2000.
2. INVENTORIES CONSIST OF THE FOLLOWING:
<TABLE>
<CAPTION>
June 27, 1999 March 28, 1999
<S> <C> <C>
Coffee
Unroasted coffee $ 1,250,861 $ 696,281
Roasted coffee 130,085 114,847
Other goods held for sale 526,945 547,064
Packaging and other 476,499 450,364
----------- ----------
$ 2,384,390 $1,808,556
=========== ==========
</TABLE>
As of June 27, 1999, the Company has fixed-price purchase commitments for
coffee totaling approximately $500,000.
3. LOSS PER COMMON SHARE
Basic loss per common share have been calculated based on the
weighted-average common shares of 14,366,747, 14,290,942, for the 13 weeks
ended June 27, 1999 and the 13 weeks ended June 28, 1998, respectively. The
Company had a net loss for all periods presented herein; therefore none of
the options, warrants and convertible preferred stock outstanding during the
each of the periods presented were included in the computation of diluted
loss per share as they were antidilutive.
4. STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK
For the 13 week period ending June 27, 1999, the Company issued 945,630 units
or 3,782,520 shares of Series A Preferred Stock, with an aggregate purchase
price of $9,456,300 bringing the total number of units issued to 2,500,000
and aggregate proceeds of the offering to $25,000,000. Each unit consists of
4 shares of the Company's Series A Preferred Stock and a Warrant to purchase
two shares of the Company's Common Stock at an exercise price of $0.33 per
share. The unit offering price was $10.00.
As of June 27, 1999, the offering is oversubscribed by 611,158 units, with an
aggregate purchase price of $6,111,575. The Company has not yet accepted
these subscriptions because as of this date it does not have a sufficient
number of authorized shares of Series A Preferred Stock to issue upon
acceptance of the subscriptions. The Company's Board of Directors has
proposed certain amendments to the Company's Articles of Incorporation which
include an increase in the number of authorized Series A Preferred Shares to
17,500,000. When and if the shareholders ratify and approve the proposed
amended Articles, the Company will accept the subscriptions and issue the
Preferred Shares and Warrants.
WARRANTS
In connection with the Series A Preferred Stock issued during the 13 week period
ending June 27, 1999, the Company issued warrants to purchase 1,891,000 shares
of common stock at an exercise price of $0.33 per share bringing the total
number of shares of common stock subject to purchase under the warrants to
5,000,000 shares. The exercise price of the warrant at the date of issuance was
below the fair market value of the common stock and is therefore considered an
"in the money" or beneficial conversion feature. Accounting for the issuance of
convertible preferred stock with a nondetachable beneficial conversion feature
at the date of issue requires that the conversion feature be recognized and
measured in the financial statements by allocating a portion of the preferred
stock offering proceeds to additional paid in capital. The discount resulting
from the allocation of the proceeds to the beneficial conversion feature is
analogous to a dividend and is recognized as a return to preferred shareholders
from the date of issuance through the date the warrants are exercisable.
As a result of the aforementioned accounting, the Company allocated $3,631,219
of the preferred stock proceeds to additional paid in capital. As the warrants
were exercisable upon issuance, the entire allocation was recognized as a
preferred dividend through a charge to retained earnings and a credit to
preferred stock during the period. The weighted-average fair value of the
warrants on the date of grant was $1.92 per share of common stock.
F-24
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Spinelli Coffee Company:
We have audited the accompanying balance sheet of Spinelli Coffee Company (a
California corporation) as of February 1, 1998, and the related statements of
operations, changes in stockholders' equity and cash flows for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Spinelli Coffee Company as of
February 1, 1998, and the results of its operations and its cash flows for the
year then ended, in conformity with accounting principles in the United States.
ARTHUR ANDERSON LLP
San Francisco, California,
May 6, 1998
F-25
<PAGE>
SPINELLI COFFEE COMPANY
BALANCE SHEET
FEBRUARY 1, 1998
<TABLE>
<CAPTION>
ASSETS
<S> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 435,870
Accounts receivable, trade, net of allowance for doubtful accounts of $4,841 136,127
Accounts receivable, other 17,963
Inventories 334,789
Prepaid expenses 37,010
Deferred income tax asset 32,427
-----------
Total Current assets 994,186
PROPERTY AND EQUIPMENT, net 890,050
DEFERRED INCOME TAX ASSET 65,982
OTHER ASSETS 126,346
-----------
Total assets $ 2,076,564
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of notes payable and long-term debt $ 239,117
Current maturities of notes payable--stockholders 50,000
Current maturities of capital leases 12,637
Accounts payable 171,851
Accrued wages 82,093
Other accrued expenses 173,052
-----------
Total current liabilities 728,750
LONG-TERM LIABILITIES:
Notes payable and long-term debt, net of current maturities 404,723
Notes payable--stockholders 150,000
Capital leases, net of current maturities 16,398
Accrued compensation 54,736
Deferred rent 74,300
-----------
Total liabilities 1,428,907
-----------
STOCKHOLDERS' EQUITY:
Common stock, no par value, 1,500,000 shares authorized, 875,700 issued and outstanding 655,046
Deferred compensation (90,739)
Retained earnings 83,350
-----------
Total stockholders' equity 647,657
-----------
Total liabilities and stockholders' equity $ 2,076,564
===========
</TABLE>
The accompanying notes are an integral part of this statement.
F-26
<PAGE>
SPINELLI COFFEE COMPANY
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED FEBRUARY 1, 1998
<TABLE>
<S> <C>
NET SALES $ 8,315,822
COST OF SALES 2,984,101
-----------
Gross margin 5,331,721
-----------
OPERATING EXPENSES 3,871,526
CORPORATE GENERAL AND ADMINISTRATIVE EXPENSES 912,493
RETAIL GENERAL AND ADMINISTRATIVE EXPENSES 241,744
-----------
5,025,763
-----------
Operating income 305,958
-----------
OTHER INCOME (EXPENSE):
Other income 85,199
Interest expense (99,962)
-----------
Total other expense (14,763)
-----------
Income before provision for income taxes 291,195
PROVISION FOR INCOME TAXES 65,147
-----------
Net income $ 226,048
===========
</TABLE>
The accompanying notes are an integral part of this statement.
F-27
<PAGE>
SPINELLI COFFEE COMPANY
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED FEBRUARY 1, 1998
<TABLE>
<CAPTION>
COMMON STOCK RETAINED TOTAL
---------------------- DEFERRED EARNINGS STOCKHOLDERS'
SHARES AMOUNT COMPENSATION (DEFICIT) EQUITY
-------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, February 2, 1997 875,700 $ 655,046 $ (142,590) $ (142,698) $ 369,758
Amortization of deferred compensation 0 0 51,851 0 51,851
Net income 0 0 0 226,048 226,048
-------- ------------ ------------ ----------- -----------
BALANCE, February 1, 1998 875,700 $ 655,046 $ (90,739) $ 83,350 $ 647,657
======== ============ ============ =========== ===========
</TABLE>
The accompanying notes are an integral part of this statement.
F-28
<PAGE>
SPINELLI COFFEE COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED FEBRUARY 1, 1998
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 226,048
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 296,661
Loss on disposal of property and equipment 15,940
Deferred income tax benefit (87,383)
Changes in operating assets and liabilities:
Accounts receivable, net (42,871)
Inventories 190,875
Prepaid expenses (421)
Accounts payable (117,613)
Accrued expenses 38,906
Other assets (5,246)
Accrued compensation 34,573
Deferred rent 24,429
----------
Net cash provided by operating activities 573,898
----------
CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (105,970)
----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital lease obligations (11,203)
Repayment of notes from stockholder and related parties (70,070)
Repayment of notes and other debt (257,219)
Net borrowings under line of credit 240,942
----------
Net cash used in financing activities (97,550)
----------
Net increase in cash and cash equivalents 370,378
CASH AND CASH EQUIVALENTS:
Beginning of year 65,492
----------
End of year $ 435,870
==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 100,534
==========
Income taxes $ 141,112
==========
</TABLE>
The accompanying notes are an integral part of this statement.
F-29
<PAGE>
SPINELLI COFFEE COMPANY
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 1, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF OPERATIONS
Spinelli Coffee Company (the Company) was incorporated in January 1986 in the
state of California. The Company is a coffee roaster/retailer currently
operating 11 coffee stores located in San Francisco and Marin County,
California. The Company sells a variety of coffee beverages, as well as
whole-bean coffee, pastries, and coffee-related accessories and equipment
through these Company-owned locations. In addition to the retail operation, the
Company operates a wholesale division, which sells whole-bean coffee nationally
to over 200 accounts, and operates a mail order business, with several hundred
domestic and international customers. The Company is also an international
licensor, having entered into an exclusive agreement in 1995 for selected Asian
countries and Australia with an Asian licensee who is currently operating six
retail stores in Singapore, and has entered into a sublicense agreement for the
country of Taiwan. Licensing income for the fiscal year ended February 1, 1998,
was $71,468. During the fiscal year ended February 1, 1998, the Company's retail
stores accounted for approximately 76 percent of net sales. The Company has
various product lines; coffee beverage and whole-bean sales represented
approximately 79 percent of net sales for the fiscal year ended February 1,
1998. The Company competes in a highly competitive market in which competition
is expected to increase. Competitors consist of national companies, as well as a
number of regional companies. In addition, the Company's future profitability
may be affected by green coffee commodity prices that are subject to substantial
price fluctuations, primarily caused by weather and political or economic
decisions. The Company attempts to mitigate these fluctuations by entering into
fixed-price purchase commitments (see Note 8).
FISCAL YEAR
The Company operates on a 52-week fiscal year.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
the average cost method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method based on the estimated useful lives of the assets.
Additions and improvements are capitalized, while repairs and maintenance are
charged to expenses as incurred.
LONG-LIVED ASSETS
The carrying value of long-lived assets is periodically reviewed for impairment
by the Company based on expected future undiscounted operating cash flows of the
related asset.
REVENUE RECOGNITION
Revenue is recognized at the time of sale to retail customers, while nonretail
sales are recognized at the time the product is shipped to the customer.
Historically, returns have represented an insignificant amount.
F-30
<PAGE>
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," which was effective at the beginning of the Company's 1996 fiscal
year, encourages, but does not require companies to record compensation cost for
stock-based employee compensation plans at fair value. The Company has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
estimated market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under the liability
method specified by SFAS No. 109, deferred taxes are determined based on the
difference between the financial statement and tax bases of assets and
liabilities as measured by the effective tax rates in effect in the years in
which the differences are expected to reverse. Deferred tax expense (benefit)
represents the change in the deferred tax asset/liability balance.
2. INVENTORIES:
Inventories consist of the following:
<TABLE>
<S> <C>
Green coffee $ 192,192
Brown coffee 17,388
Accessories, packaged goods and supplies 125,209
----------
$ 334,789
==========
</TABLE>
3. PROPERTY AND EQUIPMENT:
Property and equipment and their estimated useful lives as of February 1, 1998,
were as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
ESTIMATED USEFUL LIVES
-------------------------------------------------
Furniture and fixtures $ 229,510 5-10 years
Equipment 772,493 3-12 years
Leasehold improvements 895,950 Life of asset or lease term, whichever is shorter
------------
1,897,953
Less: Accumulated depreciation
and amortization (1,007,903)
------------
$ 890,050
============
</TABLE>
Depreciation expense for the fiscal year ended February 1, 1998, was $223,379.
4. OTHER ASSETS:
Other assets as of February 1, 1998, consist of the following:
<TABLE>
<S> <C>
Notes receivable from stockholders $ 52,379
Capitalized lease commissions 27,091
Deposits 38,557
Other 8,319
---------
$ 126,346
=========
</TABLE>
Notes receivable from stockholders bear interest at 6 percent and require annual
interest payments, with the principal balance due on December 31, 1999. Interest
income on the notes was $3,353 for the fiscal year ended February 1, 1998.
Capitalized lease commissions are being amortized over the related lease terms.
Amortization expense for other assets was $21,431 for the fiscal year ended
February 1, 1998.
F-31
<PAGE>
5. CREDIT AGREEMENTS AND LONG-TERM DEBT:
The Company entered into an agreement for a nonrevolving line of credit with a
bank on February 10, 1997. The agreement provided for borrowings up to $595,058
and was due on February 10, 1998. Interest was at 10.5 percent. As of February
1, 1998, $490,942 was outstanding under this agreement. On March 10, 1998, the
nonrevolving line of credit was converted into a 36-month promissory note at
10.5 percent interest and maturing on March 10, 2001.
In addition, on February 10, 1997, the Company entered into a revolving line of
credit agreement with the same bank for up to $450,000 at an interest rate
determined based on the bank's base rate, which was 9.25 percent as of February
1, 1998, plus 2 percent, due February 10, 1998. As of February 1, 1998, there
are no amounts outstanding under this agreement. On February 10, 1998, the
Company entered into a new line of credit agreement for up to $350,000 at an
interest rate determined based on the bank's base rate, which was 8.5 percent as
of February 10, 1998, plus 2 percent, due February 2, 1999.
The above agreements are secured by the assets of the Company and are guaranteed
by a Company officer and a director. These agreements include restrictive
covenants, including tangible net worth and profitability requirements.
Notes payable outstanding at February 1, 1998, are described below:
<TABLE>
<CAPTION> CURRENT NONCURRENT
TOTAL MATURITIES MATURITIES
------------- ------------- --------------
<S> <C> <C> <C>
Note payable to a bank secured by all assets of the Company,
principal and interest of 10.5 percent due in monthly installments
of $15,963 through March 10, 2001 $ 490,942 $ 121,375 $ 369,567
Note payable to a bank secured by all assets of the Company,
principal and interest of prime plus 2.5 percent (11 percent as of
February 1, 1998) due in monthly installments through June 2, 2004 152,898 17,742 135,156
Notes payable to stockholders, principal payable at end of note
terms, which range from May 6, 1998, to December 10, 1999; notes
bear interest at 10 percent, interest payable in monthly
installments; $50,000 note was prepaid on March 5, 1998 200,000 150,000 50,000
--------- --------- ---------
$ 843,840 $ 289,117 $ 554,723
========= ========= =========
</TABLE>
As of February 1, 1998, notes payable to stockholders of $200,000 were
convertible into 32,000 shares of common stock upon written notice as required
prior to the maturity dates of the notes. On March 5, 1998, a $50,000 note
payable to a stockholder was prepaid, canceling the option for 8,000 shares of
common stock. On March 6, 1998, the notice period expired for a $100,000 note
payable to a stockholder that was convertible into 16,000 shares of common
stock.
Maturities of notes payable obligations as of February 1, 1998, are as follows:
<TABLE>
<CAPTION>
FOR THE FISCAL
YEAR ENDING
--------------
<S> <C>
1999 $ 289,117
2000 230,116
2001 200,075
2002 55,899
2003 27,493
Thereafter 41,140
---------
Total $ 843,840
=========
</TABLE>
6. LEASE COMMITMENTS:
The Company leases certain equipment under capital leases. In addition, the
Company leases certain equipment and office space for its administrative offices
and retail locations pursuant to noncancelable operating leases for periods from
2 to 9 years. Certain Company lease agreements include scheduled rent increases
during the lease terms or provide for free rent periods. Lease payments for
these operating leases are amortized to expense on a straight-line basis over
the term of the lease. Amounts expensed in excess of rent paid are recorded as
deferred rent in the accompanying balance sheet.
F-32
<PAGE>
Future minimum payments under capital leases and noncancelable operating leases
are due as follows:
<TABLE>
<CAPTION>
FOR THE FISCAL CAPITAL OPERATING
YEAR ENDING LEASES LEASES
-------------- ------- ---------
<S> <C> <C>
1999 $ 15,743 $ 566,819
2000 9,753 525,017
2001 8,941 429,110
2002 0 285,348
2003 0 241,352
Thereafter 0 446,745
--------- -----------
Total minimum lease payments 34,437 $ 2,494,391
===========
Less: Amounts representing interest (5,402)
---------
Present value of minimum lease payments 29,035
Less: Principal portion due within one year (12,637)
---------
Principal portion due after one year $ 16,398
=========
</TABLE>
Rent expense under operating leases for the fiscal year ended February 1, 1998,
was approximately $655,019.
7. ACCRUED COMPENSATION:
The Company has entered into an employment contract with a principal employee.
Under the contract, the employee is guaranteed a future payout of $106,460 upon
completion of three years of employment. If the employee or Company initiates
employment termination prior to such date, other than by the Company for cause,
the individual shall be paid an alternative bonus equal to $2.50 multiplied by
the number of shares vested under this employee's stock option agreement (see
Note 10) at the time of employment termination. The agreement also provides that
the employee will receive 12 months' salary in the event that the employee
voluntarily terminates employment within six months of a change in control of
the Company. For the fiscal year ended February 1, 1998, the Company recorded
$34,573 in compensation expense related to this contract. As of February 1,
1998, the Company has recorded $54,736 in accrued compensation related to this
contract.
8. COMMITMENTS:
As of February 1, 1998, the Company has agreements to purchase green coffee
inventory from various suppliers through June 1998. All agreements are
noncancelable to both parties. Total commitments remaining at February 1, 1998,
under these agreements were approximately $1,074,338. This amount includes
contract prices which were fixed as well as unfixed. Due to the recent decline
in coffee prices, some of the contracts may have been fixed at prices above the
prevailing market price as of delivery date, assuming product availability and
similar contractual terms.
9. INCOME TAXES:
The provision (benefit) for income taxes consists of:
<TABLE>
<S> <C>
Current tax provision:
Federal $ 102,568
State 39,235
Foreign 10,727
---------
Total current 152,530
---------
Deferred tax benefit:
Federal (67,114)
State (20,269)
---------
Total deferred (87,383)
---------
Total provision $ 65,147
=========
</TABLE>
F-33
<PAGE>
Deferred income taxes result from differences in the recognition of revenue and
expense for tax and financial statement purposes. Deferred tax assets comprised
the following at February 1, 1998:
<TABLE>
<S> <C>
Deferred and accrued compensation $ 54,925
Accrued vacation 16,616
Deferred rent 29,824
Depreciation 47,288
State income taxes 13,340
Other 2,465
---------
Gross deferred tax assets 164,458
Deferred tax asset valuation allowance (66,049)
---------
Net deferred tax assets $ 98,409
=========
</TABLE>
The provision (benefit) for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory federal income tax rate to
income before income taxes as a result of the following differences:
<TABLE>
<CAPTION>
AMOUNT PERCENTAGE
--------- ----------
<S> <C> <C>
Statutory U.S. tax rates $ 99,006 34.0%
State income tax, net of federal benefit 17,879 6.1
Benefit of operating loss carryforwards
and foreign tax credit carryforwards (52,882) (18.1)
Other 1,144 0.4
-------- -----
$ 65,147 22.4%
======== =====
</TABLE>
In the prior fiscal year, the Company provided a valuation allowance against a
substantial portion of its net deferred tax asset due to the uncertainty
relating to the Company's ability to ultimately benefit from these items. During
the fiscal year ended February 1, 1998, the valuation allowance decreased
$93,900 due primarily to the use of net operating loss carryforwards in the
current period.
10. STOCK OPTION PLAN:
The Company has various stock option plans as follows:
- Options to purchase 80,000 shares of common stock at $6.25 per share
were granted to a Company officer and a director in October 1994. As of
February 1, 1998, the options are fully vested and exercisable. The
options expire January 31, 2002. The options are subject to antidilution
provisions described below under which 6,650 additional fully vested
options were granted prior to February 2, 1997.
- Options to purchase 42,584 shares of common stock at $2.50 per share
were granted to a Company officer during the fiscal year ended
February 2, 1997. The options are exercisable as follows: 30 percent
after July 1, 1997, 30 percent after July 1, 1998, and 40 percent
after July 1, 1999. However, the options will become fully vested upon
the effective date of an initial public offering of the Company's
stock or a change in control of the Company as defined in the agreement.
The estimated market price of the Company's common stock on the grant
date was $6.25. Accordingly, the Company recorded deferred compensation
of $172,836 at the date of grant that is being amortized over the
shorter of the initial vesting period or the actual period of
employment. Compensation expense of $51,851 was recorded for the fiscal
year ended February 1, 1998, related to these options. Nonvested
options expire upon termination of the officer's employment. Options
expire seven years after vesting. The options are subject to an
antidilution provision described below under which 3,505 additional
options were granted prior to February 2, 1997.
- Options to purchase 17,034 shares of common stock at $6.25 per share
were granted to a Company director during the fiscal year ended February
2, 1997. The options were cancelled during the fiscal year ended
February 1, 1998.
As of February 2, 1997, and February 1, 1998, there were 149,773 and 132,739
options outstanding, respectively, with an average option price of $5.10 and
$4.96 per share, respectively. As of February 2, 1997, and February 1, 1998,
options exercisable were 86,650 and 117,511, respectively, with weighted average
exercise prices of $6.25 and $5.81, respectively. The options outstanding at
February 1, 1998, have a weighted average remaining contractual life of 5.2
years.
F-34
<PAGE>
Three of the option agreements covering 122,584 shares contain antidilutive
provisions whereby the option holder will receive adjustments to the number of
options granted in the event that the outstanding shares of the Company's common
stock are increased or decreased as a result of stock dividends, stock splits,
stock sales, option grants, or other stock-related transactions as described in
the agreements. In connection with these antidilutive provisions, these option
holders received 10,155 in additional options prior to February 2, 1997.
Certain of the Company's stockholders have expressed concern that their
preemptive rights may have been violated with respect to certain issuances of
convertible debt, stock and stock options that took place subsequent to the
issuance of the Company's stock to such stockholders. To date, none of these
stockholders has indicated any intent to pursue the matter; however, the
Company's Board of Directors is prepared to allow any affected stockholder to
increase his/her equity investment in the Company in order to reestablish
his/her prior relative equity interest.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock Based Compensation." Accordingly, no stock option expense
has been recognized for the plan except as described above. Net income for the
fiscal year ended February 1, 1998, would decrease by $41,667 had compensation
cost for the plan been determined consistently with SFAS 123. The fair value of
each option was estimated on the date of grant using the Black-Scholes option
pricing model, with the following assumptions used for grants in the prior
fiscal year ended February 2, 1997: expected dividend yield of 0 percent;
expected volatility of 0 percent; risk-free interest rate of 6.6 percent;
expected lives of five years.
11. WARRANTS TO PURCHASE COMMON STOCK:
In 1995, the Company issued warrants (the Warrants) to purchase 9,411 shares of
the Company's common stock at $6.25 per share. Unexercised Warrants expire on
August 4, 2005. The Warrant agreement provides for, among other things, the
issuance of new Warrants in the event of a consolidation or merger of the
Company into another corporation, an adjustment in the number of Warrants in the
event of a stock split or a reverse stock split, and an adjustment in the
exercise price of the Warrants in the event of a stock dividend.
12. RETIREMENT PLAN:
On January 1, 1996, the Company adopted a 401(k) retirement plan (the Plan) for
all employees who have completed at least one year of service. The Plan year is
from January 1 to December 31, and the Company will contribute 25 percent of the
first 6 percent of the employee's elective deferral. The elective deferrals
range from 1 percent to 15 percent of the employee's compensation. Participants
become fully vested after six years of service, although they vest incrementally
on an annual basis after two years of service and until the six-year period is
completed. All years of service are credited to determine the vested service.
The Company recorded expense of $5,447 for the fiscal year ended February 1,
1998, for the Company's matching contributions.
13. SUBSEQUENT EVENTS:
On March 5, 1998, the Company entered into an agreement with an
employee/stockholder/ director whereby the employee resigned his employment with
the Company and the Company agreed to repurchase 20,000 shares of common stock
at $6.25 per share, as well as to prepay a $50,000 note payable to a
stockholder. In addition, both the employee and Company agreed to mutual
releases, with the exception of certain indebtedness to the Company that the
employee acknowledged.
On April 10, 1998, the Company entered into a nonbinding letter of intent for
the sale of 100 percent of the Company's common stock. It is the intent of the
parties to complete the transaction by June 15, 1998.
F-35
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the registrant has duly caused this amendment to registrant statement to
be signed on its behalf by the undersigned, unto duly authorized.
TULLY'S COFFEE CORPORATION
Date June 30, 2000 By /s/ Tom T. O'Keefe
Tom T. O'Keefe, Chief Executive
Officer and Chairman of the Board
This Amendment No. 1 to Form 10 was signed by the following persons in the
capacities and on the dates stated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- -----
<S> <C> <C>
/s/ Tom T. O'Keefe
-------------------------------- President, Chief Executive Officer June 30, 2000
Tom T. O'Keefe and Chairman of the Board
/s/ Stephen R. Griffin Vice President - Finance and Chief June 30, 2000
-------------------------------- Financial Officer
Stephen R. Griffin
</TABLE>
37
<PAGE>
<TABLE>
<S> <C> <C>
/s/ Graham Anderson
-------------------------------- Director June 30, 2000
Graham Anderson
/s/ Larry A. Culver
-------------------------------- Director June 30, 2000
Larry A. Culver
/s/ Marc Evanger
-------------------------------- Director June 30, 2000
Marc Evanger
/s/ Robert J. Holmes
-------------------------------- Director June 30, 2000
Robert J. Holmes
/s/ Lawrence L. Hood
-------------------------------- Director June 30, 2000
Lawrence L. Hood
/s/ George Hubman
-------------------------------- Director June 30, 2000
George Hubman
-------------------------------- Director June 30, 2000
Keith McCaw
/s/ Richard J. Padden
-------------------------------- Director June 30, 2000
Richard J. Padden
</TABLE>
38
