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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-K



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|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:
|- |  | -------------------------------------------------------------------------------------



For the fiscal year ended April 2, 2006



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:
|- |  | -----------------------------------------------------------------------------------------



For the transition period from
                 to



Commission File Number 0-26829



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TULLYS COFFEE CORPORATION

(Exact name of registrant as specified in its
charter)



|                                                              |  |                                     
|------------------------------------------------------------- |  | ------------------------------------
|Washington                                                    |  | 91-1557436                          
|(State or other jurisdictionof incorporation or organization) |  | (I.R.S. Employer Identification No.)



3100 Airport Way
South,

Seattle, Washington 98134

(Address of principal executive offices) (Zip Code)



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



Securities registered pursuant to Section 12(b) of the Act:

None



Securities registered pursuant to Section 12(g) of the
Act:

Common Stock, no par value

Series A Convertible Preferred Stock, no par value

(Title of each class)



Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.    Yes ̈No  x



Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ̈No  x



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



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



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Exchange Act Rule 12b-2).



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large Accelerated Filer ̈ |  | Accelerated Filer ̈ |  | Non-Accelerated Filer  x



Indicate by check
mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the act).    Yes ̈No  x



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



As of June 15, 2006 the number of shares of the registrants Common Stock outstanding was 17,769,191, and the
number of shares of the registrants Series A Convertible Preferred Stock outstanding was 15,559,152.



Documents incorporated by reference: None.



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TABLE OF CONTENTS



|                                           |  |                                                                                                              |  |        
|------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------ |  | -------
|Item No.                                   |  |                                                                                                              |  | PageNo.
|A WARNING ABOUT FORWARD-LOOKING STATEMENTS |  | 3                                                                                                           
|                                           |  |                                                                                                             
|                                           |  | PART I                                                                                                       |  |        
|ITEM 1.                                    |  | BUSINESS                                                                                                     |  | 4      
|ITEM 1A                                    |  | RISK FACTORS                                                                                                 |  | 13     
|ITEM 2.                                    |  | PROPERTIES                                                                                                   |  | 17     
|ITEM 3.                                    |  | LEGAL PROCEEDINGS                                                                                            |  | 17     
|ITEM 4.                                    |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                          |  | 18     
|                                           |  |                                                                                                             
|                                           |  | PART II                                                                                                      |  |        
|ITEM 5.                                    |  | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |  | 19     
|ITEM 6.                                    |  | SELECTED FINANCIAL DATA                                                                                      |  | 23     
|ITEM 7.                                    |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        |  | 25     
|ITEM 7A.                                   |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                   |  | 40     
|ITEM 8.                                    |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                  |  | 41     
|ITEM 9.                                    |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                         |  | 77     
|ITEM 9A.                                   |  | CONTROLS AND PROCEDURES                                                                                      |  | 77     
|                                           |  |                                                                                                             
|                                           |  | PART III                                                                                                     |  |        
|ITEM 10.                                   |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                           |  | 78     
|ITEM 11.                                   |  | EXECUTIVE COMPENSATION                                                                                       |  | 81     
|ITEM 12.                                   |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS               |  | 88     
|ITEM 13.                                   |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                               |  | 89     
|ITEM 14.                                   |  | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                       |  | 90     
|                                           |  |                                                                                                             
|                                           |  | PART IV                                                                                                      |  |        
|ITEM 15.                                   |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                      |  | 91     
|                                           |  | SIGNATURES                                                                                                   |  | 94     



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A Warning About Forward-Looking Statements



In this report, we refer to Tullys Coffee Corporation as we, us, or Tullys.We make forward-looking statements in this report that are subject to risks and uncertainties. These
forward-looking statements include information about possible or assumed future results of our operations and our financial condition, plans, objectives and performance. Additionally, when we use the words believe, expect,
may, could, will, anticipate, estimate or similar expressions, we are making forward-looking statements. Many possible events or factors could affect our future financial results and
performance. The forward-looking statements are not guarantees of future performance and results or performance may differ materially from those expressed in our forward-looking statements. In addition to the factors discussed under Risk
Factors in this report, the following possible events or factors could cause our actual results to differ materially:



| |  |  | future sources of financing may not be available when needed or may not be available on terms favorable to Tullys;
| | - |  | -------------------------------------------------------------------------------------------------------------------



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



| |  |  | our marketing and new product introduction strategies may not succeed as we expect;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | our strategies for reductions of cost and improvement of gross margins may not succeed as we expect;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | competition within the retail specialty coffee market is strong and may intensify;
| | - |  | ----------------------------------------------------------------------------------



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



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



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



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



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PART I



|ITEM 1. |  | BUSINESS
|------- |  | --------



General



Tullys
Coffee Corporation roasts and sells high quality, hand-roasted premium whole bean coffees. The Tullys specialty retail coffee stores operated by our Retail division and those operated by our franchisees offer our coffees and also serve a wide
selection of hot and cold beverages that feature coffee, espresso and teas. Other products offered by our stores depend upon the size of store and local market requirements. Our Bellaccino® cold blended beverages, tea and fruit-based blended beverages and smoothies,
hand-crafted ice cream shakes, and premium soft-serve vanilla and coffee ice cream are offered in most Tullys stores. Most stores also sell baked goods, pastries and other food products, and coffee-related supplies, accessories and equipment.
As of April 2, 2006, there were 111 Tullys retail stores, which are located in the western United States (88 stores operated by us and 23 stores operated by franchisees).



Our Wholesale division sells Tullys coffees and related products and supplies to domestic customers in the
supermarket, food service, restaurant, office coffee service, and institutional channels. The Wholesale division is also responsible for our mail order and Internet sales activities. Our Specialty division is responsible for the franchising of
Tullys stores in the U.S. The Specialty division also sells Tullys coffee and related products and supplies to foreign licensees and manages the relationships with these licensees, as applicable.



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



Fiscal Periods



We end our fiscal year on the Sunday closest to March 31. As a result, we record our revenue and expenses on a 52 or 53 week period, depending on the
year. The fiscal year ending April 1, 2007 (Fiscal 2007) will include 52 weeks. The fiscal year ending April 2, 2006 (Fiscal 2006) included 52 weeks. The fiscal year ending April 3, 2005 (Fiscal
2005) included 53 weeks, while the fiscal years ended March 28, 2004 (Fiscal 2004), March 30, 2003 (Fiscal 2003) and March 31, 2002 (Fiscal 2002) each included 52 weeks.



Company Background



Tullys was formed in 1992 after our founder and Chairman, Tom T. OKeefe, concluded there was an opportunity to
develop and operate a company focused on the sale of high-quality coffee beans, coffee drinks and coffee-related products in an upscale atmosphere that emphasized customer service. On September 16, 1992, we opened the first Tullys store,
in a suburb of Seattle, Washington. Tullys Coffee Corporation is a Washington corporation and is headquartered at 3100 Airport Way South, Seattle, Washington 98134. Our telephone number is (206) 233-2070 or 1-800-96 Tully. Information
contained on our website (www.tullys.com) does not constitute part of this report.



Strategy



General



From our founding, our objective was to establish
Tullys as one of the most respected coffee brands in the world. To achieve this goal, we made significant investments in marketing and building our brand and we



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concentrated on opening company-operated retail stores in the U.S. and on licensing third parties in international markets. In Fiscal 2002, we decided that
we had successfully developed our brand identity and that we could modify our strategy to place greater emphasis on improving overall corporate operating performance. We also decided that the Tullys brand, products and retail store model have
been developed to a point where they can be leveraged for improved operating results, and replicated in additional locations and markets. In Fiscal 2004, we commenced the franchising of Tullys stores in the U.S. (In this report, we refer to
Tullys retail stores operated by third parties as franchised stores for the U.S. and licensed stores outside the U.S.). Since Fiscal 2002 we have placed increased emphasis on growing our Wholesale division.



Tullys strives to develop customer loyalty and brand recognition by
providing superior service and offering quality coffee products that are competitively priced. Tullys seeks to employ people who contribute to the coffee experience of our customers. Management believes that our staff is well
trained and knowledgeable about the products offered for sale. It is our belief that customer service, along with product freshness and consistency, has become our hallmark, and we seek to sustain these attributes in all three of our operating
divisionsRetail, Wholesale, and Specialty.



We believe
that our customers enjoy the flavor profiles and qualities of our coffee beverages and other products, and often purchase them from more than one channel. For example, customers may patronize Tullys stores and also may enjoy Tullys
coffee beverages at a favorite restaurant or their work place, and may purchase Tullys premium coffee from a supermarket for home consumption. Tullys also believes that our customers are receptive to the introduction of other
complementary products into our stores and through our Wholesale division. Further, products that are successful in Tullys domestic stores may have opportunities for export or for licensing.



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



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



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



Prior to August 31, 2005, Tullys had license and supply agreements with Tullys Coffee Japan, a subsidiary of FOODX Globe Co. Ltd.
(Tullys Coffee Japan Co., Ltd. and FOODX Globe Co. Ltd. are collectively referred to in this report as Tullys Coffee Japan). Under those agreements, Tullys Coffee Japan operated and franchised others to operate
Tullys-branded stores in Japan. During discussions regarding the renewal of those agreements, the parties entered into an agreement (the Japan Rights Agreement) effective on August 31, 2005, whereby those agreements were
terminated, and we sold all of Tullys rights, title and interest for Japan with respect to the Tullys trademarks, store designs, processes and other intellectual property assets and rights for the Tullys business in Japan (the
Japan Rights) to Tullys Coffee Japan for $17,500,000 cash.



The cash proceeds from the Japan Rights sale improved our liquidity and provided capital resources for use in the development of our business outside of Japan. In Fiscal 2006, we repaid all borrowings under our Kent
Central promissory note and a convertible promissory note. As a result of the Japan Rights sale, the risks and rewards from the development of the Tullys brand in Japan accrue directly to Tullys Coffee Japan and Tullys



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is not directly affected by the Japanese business activities of Tullys Coffee Japan (and we will no longer receive license fees or roasting fees from
Tullys Coffee Japan). As the result of this transaction, we will be less dependent upon our relationship with Tullys Coffee Japan and have greater financial resources currently available for the development of our Retail division and
Wholesale division within the United States, and for the development of our Specialty division within the United States and internationally outside of Japan.



Historical Expansion and Future Growth Strategy



Tullys principal domestic expansion strategy has been to develop new retail stores in the western United States (including company-operated stores
and, since Fiscal 2004, franchised stores) and to introduce our Wholesale division to targeted wholesale segments (supermarket, food service and restaurants, office coffee services and institutional customers) in those same markets. Tullys
also has expanded by purchasing existing retail coffee locations, with the goal of converting these into Tullys stores. New store growth slowed during Fiscal 2002 to Fiscal 2004 as our focus shifted from brand development and revenue growth
toward improving overall corporate operating performance and in response to the local economies of our markets. The rate of store growth increased in Fiscal 2006 and is expected to continue to increase in Fiscal 2007. In Fiscal 2006, we added
twenty-one new stores (three company-operated stores and eighteen franchised stores). During Fiscal 2005 we added five new stores (one company-operated store and four franchised stores). Tullys opened one new store in Fiscal 2004 and added our
first franchised store. Tullys opened one new store in Fiscal 2003 and two new stores in Fiscal 2002. (These counts exclude stores opened by our foreign licensees.)



In Fiscal 2007 we expect to give more attention to growth of the business, with continued focus on improving overall
corporate operating performance and the conservative use of our capital. Subject to the availability of capital and suitable locations, we expect to open between six and ten new company-operated retail stores in Fiscal 2007, including stores located
within the premises of The Boeing Company, a major employer in our primary retail market areas. We also expect to add between fifteen and thirty additional franchised stores in the United States. Opening a new company-operated store typically
requires a capital investment of approximately $200,000 to $400,000, depending on the specific location. During Fiscal 2007 we will seek to improve the results of our retail stores through introduction of new products, targeted marketing,
merchandising, and advertising initiatives, and operating cost savings. In late Fiscal 2006 and the first quarter of Fiscal 2007, we have refreshed the décor and furnishings of most of our company-operated stores and have remodeled several
stores. The number and location of new franchised stores in Fiscal 2007 will depend in large part on the capital investment and business strategies of the third parties who will construct and operate these franchised stores.



Our Specialty division evaluates and develops licensing and franchising
opportunities meeting Tullys specific criteria, presently concentrating on the western United States and international markets. These criteria include geographic, marketplace, branding, venue, strategic and financial considerations. Certain
real estate and facilities may not typically be available for company-operated Tullys stores but may be available and appropriate for a franchised location. Currently, our franchised stores are located within the premises of supermarkets,
airports, hotels, a college and shopping centers. Further, certain geographic markets may not be targeted for new company-operated Tullys stores in the near future, but may be good markets for possible franchising. Franchisees must have
sufficient financial and operating capacity, and their Tullys stores must be consistent with our business standards and strategic objectives. Franchising stores in the domestic market offers the potential for growth in these particular venues
with minimal capital investment from Tullys. Franchising also offers challenges, including additional regulatory burdens, sharing of financial rewards with the franchisee and maintaining brand and operating standards in stores that are not
operated by Tullys employees. In the future, we expect to open additional franchised stores in targeted domestic markets and venues, as a complement to our continuing focus on company-operated Tullys stores.



In Fiscal 2006, we continued our strategy of expanding the supermarket
distribution of our packaged premium ground coffees in the western United States and we established initial supermarket distribution in the greater Chicago area. We have also increased our supermarket coffee sales with current supermarket customers
by adding additional products, such as packaged whole bean coffees, bulk bin sales of whole bean coffees, and



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additional coffee blends or varietals. As of April 2, 2006 approximately 3,200 supermarkets offered our coffee for sale, with coverage in most states
west of the Rocky Mountains. During Fiscal 2007, we expect further growth in the number of U.S. supermarkets offering Tullys premium coffee, and in their range of product offerings, primarily in the western U.S. and Chicago markets and with
possible introductions into other U.S. markets.



In the food
service channel, we have direct service relationships with restaurants and institutions, particularly in the Pacific Northwest, but our primary food service distribution strategy is to work with key food service distributors, like Food Services of
America, a leading regional distributor in the Pacific Northwest, and major beverage distribution companies, such as Dispenser Beverage, Inc. and Quick Dispense, Inc., who serve California and neighboring states. These distributors provide food
service channel customers with Tullys products, equipment and service as part of a broader service offering.



In February 2006, we commenced sales of Tullys coffee in single serving packages called K-Cups, which are used in special proprietary
coffee brewing equipment manufactured by Keurig, Incorporated (Keurig). We produce K-Cups under license from Keurig. Tullys K-Cups are currently sold through three primary channels: (1) our retail stores, (2) office
coffee and food service distributors, and (3) online sales through Keurigs website.



Fiscal 2007 Wholesale division growth is expected to include the addition of new customers and also programs to expand the volume of products sold to current customers.



In the United States, we seek to establish multi-dimensional relationships
with our customers and suppliers where possible. We believe that a broader and deeper relationship provides a mutual opportunity for Tullys and our trade partners to benefit from the resulting increase in sales and from Tullys brand
growth. For example, Tullys is the official coffee served in most locations on the campus of the University of Washington and we sell Husky Blend coffee in a distinctive package under license from the University of Washington.
Further, we seek to establish franchised Tullys store locations within the premises of our key supermarket customers. We work with our food service distribution partners to serve customers in locations that may introduce new customers to our
brand and products, such as at education, entertainment, sports, recreational and transportation centers.



Our primary international growth strategy is to license others to operate or franchise the right to operate Tullys-branded retail stores and sell
Tullys coffees in the foreign markets. During Fiscal 2007, we expect new licensed stores in at least one new international market outside of Japan.



Marketing



Retail Stores



Tullys retail marketing seeks to protect and develop our reputation for consistent hand-crafted quality and personal service to customers, combined
with periodic special offerings and events to reward current customers and attract new customers. Although we seek to maintain an overall brand identity in all stores, we also allow for variations that are appropriate to specific locations. Some
marketing elements and strategies are foundational to all locations, while other programs may apply only to certain markets at certain times, or may be unique to specific company-operated or franchised stores.



Tullys focus on consistency and quality in our products and customer
service has been a key element of our marketing program. Point-of-sale signage, custom bags, boxes, cups, gift sets, products and literature with our distinctive name and brand marks, and community activities in which Tullys name and brand
marks are featured, are intended to increase name awareness and to reinforce our image. We periodically use outdoor signage, direct mail and newspaper advertisements, television and radio advertisements, coupons and special offer books, special and
seasonal product offerings, promotional and community events, and joint promotions with our franchised store operators and other companies. Our flexible retail store menu boards and seasonal point-of sale signage are used to communicate our product
and service offerings, and other features of interest to customers.



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We believe that product quality and selection are very important factors to maintain the loyalty of our
current customers. We also believe these factors appeal to prospective customers. Therefore, our development efforts and marketing messages focus on the improvement of our current offerings and the addition of new products that complement our
existing offerings. New products may be available for only a limited season (such as a periodic offering of specially selected and roasted coffees available in our stores only for a limited time while supplies last), or they may become a recurring
offering. During the first quarter of Fiscal 2007, we introduced our new blended beverage line under the Bellaccino brand, featuring our espresso and other flavors. We also have expanded our cold blended beverage offering with more tea and
fruit-based products. Tullys premium softened ice cream is a flexible product platform for new beverages and treats. We offer both our own proprietary products and high-quality products from other respected brands, such as
Dean & Deluca (gourmet nuts, candies and snacks).



Convenience is another important factor for our retail store customers. Customers may use the Tullys Coffee CardTM(a stored-value payment card) like a gift certificate for gift giving and as a convenient personal purchase card at all company-operated Tullys stores and some franchised stores, instead of cash or credit card. The
Tullys Coffee Card encourages customer visits to Tullys stores, and is periodically incorporated into our promotional activities. In the first quarter of Fiscal 2007, we expanded the features of the Tullys Coffee Card to include a
loyalty program that provides customer rewards for use of the card, and we enabled online reloading of cards for customers.



Most of our company-operated Tullys stores and some franchised stores offer high-speed wireless Internet access (Wi-Fi) to customers.
Wi-Fi provides our customers an economical and convenient way to check email, surf the web and enjoy our great beverages, all in the comfort of a Tullys store.



Wholesale



Tullys Wholesale division provides additional opportunities for coffee consumers to experience our coffee and reinforces Tullys brand marks.
The Wholesale division makes many of our branded products available through supermarkets, restaurants, espresso bars, office coffee services, and institutional food service. Tullys offers logo-bearing coffee cups, banners and point-of-use
signage to Wholesale division customers (subject to Tullys usage requirements and standards). We believe marketing programs that support our brand and our retail stores also benefit our Wholesale division. In the supermarket channel,
Tullys provides marketing support through promotional allowances and discounts in support of special price offerings to the grocers customers and through cooperative advertising and other marketing funds. We also make use of other
marketing approaches such as direct mail to support wholesale customers, co-sponsoring of trade shows and consumer events with our customers, special displays and in-store demonstrations. Our Wholesale division also includes our mail order and
Internet sales channel (serviced through the gourmet foods site at Amazon.com), which make our coffee available to consumers who cannot yet buy it in their own neighborhood. These customers can order their coffee directly from our roasting plant and
have it ground to their specification.



Specialty



The Specialty division assists our franchised store
operators with the development of new franchised stores, and provides them with support to make Tullys retail experience and products available to more consumers.



We believe that the tourism, media, and trade ties between the principal domestic markets served by our Retail and Wholesale
divisions and our neighbors in Canada and Mexico and the Pacific Rim nations are beneficial to the international expansion of the Tullys brand. The Specialty division seeks to expand the geographic reach of the Tullys brand and products
to consumers outside the United States. As a result of the Japan Rights sale, the risks and rewards from the development of the Tullys brand in Japan accrue directly to Tullys Coffee Japan and Tullys will not be directly affected
by the business activities of Tullys Coffee Japan



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(we no longer receive license fees or roasting fees from Tullys Coffee Japan). The Japan Rights Agreement does not provide Tullys Coffee Japan
with the right to use Tullys proprietary intellectual properties outside of Japan and does not affect Tullys ownership or rights with respect to the Tullys intellectual properties outside of Japan. Tullys and Tullys
Coffee Japan have agreed to cooperate in the development of the Tullys brand for the mutual benefit of the two companies. As of April 2, 2006, Tullys Coffee Japan had 287 stores (company-operated and franchised) in Japan.



Under a license agreement dated April 1, 2001, other
Asian markets were licensed by Tullys to Ueshima Coffee Corporation, Ltd. (UCC). Since the license agreement was executed in April 2001, UCC has opened one store, which it closed in 2004. In June 2006, Tullys notified UCC
that it considers UCC to be in breach of this license agreement, and the parties have commenced discussions regarding the matter. Tullys continues to view all other international markets as opportunities for growth and intends to seek
opportunities in Canada, Mexico and other markets.



Community



Tullys commitment to the
local community is another key element of our marketing strategy. Tullys supports local and national organizations focusing on childrens educational and health-related issues. Each store supports events within its neighborhood and
community. Our employees volunteer their service and we donate product to local non-profit organizations, including schools, youth athletics, food banks, charities and service organizations. We also provide product and resource donations to national
organizations working to improve the health and development of children.



International Markets



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



Substantially all of our revenues from international markets in the three fiscal years ending April 2, 2006 were attributed to our licensee for Japan. As the result of the Japan Rights sale in Fiscal 2006 and the
growth in the number of Tullys Coffee Japan stores prior to the Japan Rights sale, revenues from customers outside the United States (excluding recognition of deferred revenue) accounted for approximately 1.6% of Tullys net sales
(excluding recognition of deferred revenue) for Fiscal 2006 as compared to 4.1% for Fiscal 2005 and 2.8% of Tullys net sales in Fiscal 2004.



Competition



The specialty coffee market is highly fragmented and very competitive. A number of Tullys competitors have much greater financial and marketing
resources, brand recognition and customer bases than Tullys. We compete with a number of specialty coffee roasters and retailers, including Starbucks Corporation (a multi-national operator of various coffee brands) and regional companies such
as Coffee Bean and Tea Leaf, Diedrich Coffee, Inc., and Peets Coffee & Tea, as well as smaller local chains and independent operators.



Coffee roasters and distributors, including Starbucks Corporation, Kraft Foods, Inc., The Proctor & Gamble Company, Green Mountain Coffee
Roasters, Inc., and Nestle, Inc., distribute premium coffee products nationally and internationally in supermarkets and other wholesale channels. Many of these products may be alternatives to Tullys coffees and coffee drinks. Consumers also
may choose non-coffee products and beverages offered by these and other competitors as alternatives to our products. Tullys coffee beverages, teas, and other beverages compete directly against all restaurant and beverage outlets that serve
coffee, tea and other beverages, and the many single location specialty coffee outlets (espresso stands, carts, kiosks, drive-thrus and stores). Restaurant



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and wholesale customers of our Wholesale division, and U.S. operations franchised through our Specialty division, serve products (including
Tullys-branded products) that may compete directly or indirectly with the offerings of our company-operated retail stores.



Premium specialty coffees have grown in popularity in the United States, and are being given additional selling space within supermarkets and increased
attention from distributors in the food services channel. Tullys must compete with other premium coffee roasters and distributors (including those providing branded and private label coffees) for space on the supermarket shelves and for
distribution by wholesale food service distributors.



The
companies with which we compete are strong competitors and may become even more formidable through continued growth and industry consolidation. These companies compete for retail and wholesale sales, for store locations, for employees and for
supplies of premium coffee beans. Tullys believes that there is opportunity for many companies to compete in the growing specialty coffee segment, and that the preferences and needs of consumers, owners of commercial store locations, coffee
growers, coffee store employees, wholesale distributors and other constituents of the specialty coffee industry will support continued competition in this segment. Tullys believes that its customers choose among specialty coffee brands
primarily on the basis of product quality, service, convenience, and, to a lesser extent, on price. Tullys also believes that the flavor profile of its coffee and coffee products, and the variety and quality of other food products provided by
Tullys stores, including Tullys premium ice cream shakes, cold blended beverages, and premium softened ice cream products, serve as a point of differentiation for many customers.



Store Operations and Management / Employees



As of April 2, 2006, Tullys employed approximately 1,000 people,
with approximately 900 employed in retail stores or regional operations. The remaining employees work in our administrative, wholesale, specialty, roasting and distribution operations. All employees are non-union and management anticipates this will
continue to be the case. Most of our employees work 20 or more hours per week. Full time employees are eligible for vacation, holidays, medical and dental insurance, and other benefits. Store managers, district managers, wholesale sales personnel
and other managers participate in incentive pay programs tied to financial criteria. Full time and part time employees receive discounts on beverages and merchandise items. Tullys believes that its current relations with employees are
satisfactory.



To maintain Tullys high standards of
quality products and customer service, new store employees complete a training course and receive on-site training while working in a store. Training hours are devoted to orientation, company philosophy, cash register and paperwork procedures, store
equipment use, cash handling, retail product knowledge, sales techniques, customer service and thorough familiarization with Tullys Employee Handbook. Training also covers coffee history, roasting, tasting of Tullys proprietary blends,
and hands-on beverage preparation. We require our U.S. franchisees to provide comparable training to their employees, supported by our staff. Employees who serve in the Wholesale and Specialty divisions, and those who serve in administrative support
roles, often receive much of the same training in order to build their specialty coffee industry expertise.



Tullys regularly evaluates store performance, and periodically closes stores that do not meet our financial expectations. We will continue to
evaluate the performance of our stores, and may close stores if they do not meet our financial criteria.



Suppliers and Equipment Vendors



Coffee Markets



Tullys purchases
unroasted, green coffee beans. There are many varieties of green coffee beans and a range of quality grades within each variety. Tullys purchases premium grade Arabica coffee beans and believes these beans are among the best
available from each producing region. Tullys seeks to purchase the finest qualities and varieties of coffee beans by identifying the unique characteristics and flavors of the varieties



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available from each region of the world. Many of our coffees contain green beans from Central America and South America, but we also purchase coffees from
Asia, Africa, Mexico and Hawaii.



Coffee is grown commercially
in the tropical and sub-tropical regions of the world. Coffee is harvested at different times each year, depending on the particular region. The price and supply of coffee are subject to significant volatility. While most coffee trades in the
commodity market, coffee beans of the quality sought by Tullys tend to trade on a negotiated basis at a substantial premium above commodity coffee bean prices, depending upon the supply and demand at the time of purchase. Supply and price can
be affected by multiple factors in the producing countries including weather and political and economic conditions. In addition, green coffee bean prices have been affected in the past, and may be affected in the future by the actions of certain
organizations and associations that have historically attempted to influence commodity prices of green coffee beans through agreements establishing export quotas or restricting coffee supplies worldwide. Our ability to raise sales prices in response
to rising coffee bean prices may be limited, and our future operating performance could be adversely affected if coffee bean prices were to rise substantially or if sufficient quantities of high quality beans were not available when needed.



Tullys enters into forward commitments for most of our
purchase of green coffee beans, in anticipation of the future seasonal harvests. We also make periodic buys on spot markets and from special offerings, when coffee requirements exceed the contracted supplies and when there are special
beans available that are suitable for special limited supply offerings. Green coffee pricing was relatively stable in the 2003-2004 seasons, but coffee prices have been more volatile and have generally increased for the 2005-2007 seasons. As of
April 2, 2006, we had contracts with fixed-price purchase commitments for Fiscal 2007 and we also had contracts to purchase coffee at prices to be determined by future market indices (permitting us to fix the price prior to delivery, based on
the then-current market). In June 2006, we exercised our option to fix the pricing for these remaining contracts. As of June 19, 2006, we had approximately $7,000,000 in fixed price purchase commitments for coffee. These purchase commitments,
together with existing inventory, are generally expected to provide an adequate supply of green coffee beans through Fiscal 2007. Tullys believes, based on relationships established with its suppliers, that the risk of non-delivery on such
purchase commitments is remote. However, if coffee spot market prices are attractive, or if our sales volumes increase beyond the levels anticipated for Fiscal 2007, or in connection with requirements for specific products, we may elect, or be
required to, purchase coffee on the spot market, which might be at prices greater or less than the fixed contract pricing.



Roasting and Packaging of Coffee



Tullys roasts green coffee beans to its exacting specifications at the Tullys roasting plant in Seattle, Washington. Tullys employs a
roasting process that varies based upon the variety, quality, origin and physical characteristics of the coffee beans being roasted. Each batch is craft roasted to maximize the flavor characteristics. Our roasting process produces coffee in small
batches. Coffee is roasted daily and is promptly packaged to preserve its freshness. Production and inventory levels are carefully monitored to minimize the time between roasting and delivery to the customer as coffee or a beverage, and coffee date
codes are monitored to maintain fresh coffee stocks.



Tullys packs its coffees in several different specialized package formats and in a range of package sizes. This enables us to develop distinctive and unique ground and whole bean coffees, to modify products to better fit the needs of
particular customer segments and serving equipment, and to control more elements of this aspect of our product mix. During Fiscal 2003, we leased new packaging equipment to package coffee for the supermarket channel. In Fiscal 2005 we leased new
equipment to more efficiently produce a wider range of package sizes and types for our institutional and food service packaging. During Fiscal 2006, we added new equipment (owned by Keurig and subject to a charge based on K-Cup volumes) for the
packaging of coffee in K-Cups. We believe that these changes have improved the quality of the packaged product while increasing our packaging capacity and reducing packaging costs.



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Equipment and Store Supplies



Tullys purchases non-coffee merchandise, and equipment, fixtures and supplies for retail store locations from a number
of vendors. The materials are purchased on an as-needed basis. Some materials and items are distributed through Tullys roasting plant and warehouse facility, while the suppliers deliver other items directly to our retail stores. Shipments of
products and supplies to Wholesale division and Specialty division customers are generally distributed from our Seattle roasting plant and warehouse facility. Tullys has standardized and consolidated most of its vendors and suppliers, for the
entire company or by geographic region, to improve the cost of purchases and simplify operations. Tullys believes that its relationships with its vendors are currently satisfactory. However, if a particular supplier or vendor is unable to meet
Tullys needs, begins to deliver unsatisfactory materials or is not price competitive, Tullys believes that there are a number of alternative sources to meet its merchandise, equipment, store supplies and other materials needs.
Tullys premium softened ice cream is produced especially for us. Our coffee flavored ice cream is flavored using Tullys coffee. Other materials such as teas, dairy products, juices, bakery goods and accessories are purchased from various
vendors and are generally less specialized, although some materials and products are made to our proprietary recipes, or packaged to our proprietary specifications. In Fiscal 2006, two suppliers combined provided more than thirty percent of our
product purchases, but we believe that there are alternative sources of supply if our relationship with any of these suppliers were to be interrupted. These suppliers are Food Services of America and List & Beisler (a coffee broker).



Trademarks



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



After we filed our first applications to register Tullys in
the U.S. for coffee and coffee store services, an operator of restaurants in upstate New York applied to register the mark and logo Tullys Good Times for restaurant and bar services, and claimed use of the marks prior to our first
use. In May 2003 the parties entered into a settlement agreement that sets forth the rights of each party to use and register marks containing Tullys. Our marks under the settlement agreement include Tullys and
Tullys Coffee and all of our logos (among other marks). We have since received federal trademark registration for the Tullys®trademark in various classes of goods and services, for the distinctive Tullys Coffee logo mark, and for other marks, and from
time to time we expect to seek additional registrations in other classes and for other marks.



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



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



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Tullys does not hold any patents.



Seasonality



Our business is subject to moderate seasonal fluctuations. Greater portions of Tullys net sales are generally realized during the third quarter of
Tullys fiscal year, which includes the December holiday season. Seasonal patterns are generally applicable to all three divisions, Retail, Wholesale and Specialty. In addition, quarterly results are affected by the timing of the opening of new
stores (by Tullys and its franchisees and licensees) or the closure of stores not meeting our expectations. Because of these factors, results for any quarter are not necessarily indicative of the results that may be achieved for the full
fiscal year.



|ITEM 1A. |  | RISK FACTORS
|-------- |  | ------------



This Annual Report on Form 10-K contains forward-looking statements, which are based on current expectations and assumptions that are subject to risks
and uncertainties. Actual results could differ materially because of risks and uncertainties such as those listed below and elsewhere in this report. You should consider these risks in evaluating our financial outlook.



Company Risks



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



Prior to Fiscal 2006, we have incurred losses in every year of operations. As a result of the Japan Rights sale, we reported net income for Fiscal 2006, but we cannot assure you that we will remain profitable.



Our credit facility restricts our operating flexibility and ability to raise additional
capital. If we were to default under the facility, the lender would have a right to seize certain of our assets.



Our Northrim secured credit facility provides the lender with a security interest in our accounts receivable and inventories. These provisions could limit
our ability to raise additional capital when needed, and a default by us under these agreements could result in the lenders taking actions that might be detrimental to the interests of our other creditors and shareholders.



We may require a significant amount of cash, which may not be available to us, to fund our
capital and liquidity needs.



For most of the fiscal years
since our founding, we have not generated sufficient cash to fully fund operations. We historically have financed this cash shortfall through the issuance of debt and equity securities, through borrowings, and through cash provided under our
international licensing relationships. As the result of the Japan Rights sale, described in Note 13 of the Notes to the Consolidated Financial Statements, we do not receive the operating cash flows from license fees and coffee roasting fees from
Tullys Coffee Japan after July 31, 2005. Our secured credit facility is subject to periodic renewal, and would need to be replaced if not renewed. We may need to raise additional capital in the future to fund growth of the business and
repayment of our obligations and commitments. Any equity or debt financing may not be available on favorable terms, if at all. Such a financing might provide lenders with a security interest in our assets or other liens that would be senior in
position to current creditors or that would require the repayment of the current lender. If financing is unavailable to us or is available only on a limited basis, we may be unable to take advantage of business opportunities or respond to
competitive pressures that could have an adverse effect on our business, operating results and financial condition. In such event, we would need to modify or discontinue our growth plans and our investments in store improvements, new customers and
new products, and reduce operating, marketing, general and administrative costs related to our continuing operations. We also could be required to sell stores or other assets



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(such as wholesale territories). Store sales would involve the assignment or sub-lease of the store location (which could require the lessors consent)
and the sale of the store equipment, leasehold improvements and related assets. We have previously disposed of only underperforming store locations, but might be required to dispose of our better-performing locations in order to obtain a significant
amount of sales proceeds. The proceeds received from the sale of stores or other assets might not be in amounts or timing satisfactory to us, and the sale of better performing locations or other income-producing assets could adversely affect our
future operating results and cash flows.



Lawsuits and other claims against
us may adversely affect our operating results and our financial condition.



We may from time to time become involved in legal proceedings or other claims. During Fiscal 2006, we entered into a tentative settlement (subject to court approval and acceptance by the class members) of claims
asserted against us in an employment practices lawsuit, which will require the payment of approximately $800,000 during the next three years, and the issuance of 300,000 shares of common stock to the plaintiffs. In investigating and resolving this
and any other future claims against us, or defending any such claims or allegations, we may incur legal fees, and may incur settlement fees, damages or remediation expenses that may harm our business, reduce our sales, increase our costs, and
adversely affect our operating results and financial condition.



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



Future growth of our business could strain our management, production, financial and other resources. We cannot assure you that we will be able to manage
any future growth effectively. Any failure to manage our growth effectively could have an adverse effect on our business, financial condition and results of operations. To manage our growth effectively, we must:



| |  |  | improve the productivity of our retail stores,
| | - |  | ----------------------------------------------



| |  |  | differentiate our retail concept from those of our competition in order to attract new customers, without losing the key elements of the Tullys store concept that appeal to
current customers,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide consumer-focused initiatives to improve the movement of our products through the food service and supermarket and other wholesale channels,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | continue to enhance our operational, financial and management systems, and
| | - |  | --------------------------------------------------------------------------



| |  |  | successfully attract, train, manage and retain our employees.
| | - |  | -------------------------------------------------------------



We have limited supplier choices for many of our products.



We use local bakeries to supply our stores with a multitude of bakery items. Most of these bakeries have limited capital resources to fund growth. Many of
our proprietary products, such as ice cream and blended drink mixes, are produced by one or two suppliers specifically for Tullys. In Fiscal 2006, two suppliers combined provided more than thirty percent of our product purchases, but we
believe that there are alternative sources of supply if our relationship with any of these suppliers were to be interrupted. If one or more of these suppliers is unable to provide high quality products to meet our requirements, or if our supplier
relationships are otherwise interrupted, we may experience temporary interruptions in the product availability while establishing replacement supplies, and our results of operations could temporarily suffer.



Our two largest shareholders have significant influence over matters subject to
shareholder vote and may support corporate actions that conflict with other shareholders interests.



As of April 2, 2006, Mr. Tom T. OKeefe, our founder and chairman, beneficially owned approximately 30.4% of the shares of our Common
Stock and the estate of Mr. Keith McCaw beneficially owned approximately



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19.4% of the shares of our Common Stock. This ownership position gives each of these parties individually, and on a combined basis if acting in unison, the
ability to significantly influence or control the election of our directors and other matters brought before the shareholders for a vote, including any potential sale or merger or a sale of our assets. This voting power could prevent or
significantly delay another company from acquiring or merging with us, even if the acquisition or merger was in the best interests of our shareholders.



We cannot be certain that our brand and products will be accepted in new markets. Failure to achieve market acceptance will adversely affect our revenues.



Our brand or products may not be accepted in new markets.
Consumer tastes and brand loyalties vary from one location or region of the country to another. Consumers in areas other than those currently familiar with our brand and products may not embrace the Tullys brand if we were to expand our
domestic or international operations into new geographic areas. Our retail store operations, and to a lesser extent, our Wholesale and Specialty divisions, sell ice cream products and various foodstuffs and products other than coffee and coffee
beverages. We believe that growth of these complementary product categories is important to the growth of our revenues from existing stores, and for growth in total net revenues and profits. Customers may not embrace these complementary product
offerings, or may substitute them for products currently purchased from us.



We may not be able to implement Section 404 of the Sarbanes-Oxley Act on a timely basis.



The Securities and Exchange Commission (the SEC), as directed by Section 404 of The Sarbanes-Oxley Act, adopted rules generally requiring
each public company to include a report of management on the companys internal controls over financial reporting in its annual report on Form 10-K that contains an assessment by management of the effectiveness of the companys internal
controls over financial reporting. In addition, the public companys independent registered public accounting firm must attest to and report on managements assessment of the effectiveness of the companys internal controls over
financial reporting. This requirement will first apply to our annual report on Form 10-K for the fiscal year ending March 31, 2008.



We are currently in the process of developing our Section 404 implementation plan. We may discover areas of our internal controls that need
improvement. How companies should be implementing these new requirements including internal control reforms to comply with Section 404s requirements, and how independent auditors will apply these requirements and test companies
internal controls, is still reasonably uncertain.



We expect
that we will need to hire and/or engage additional personnel and incur incremental costs in order to complete the work required by Section 404. There can be no assurance that we will be able to complete our Section 404 plan on a timely
basis. These costs may be substantial, and we may be required to expend cash on this effort instead of other business opportunities. Even if we timely complete our Section 404 plan, we may not be able to conclude that our internal controls over
financial reporting are effective, or in the event that we conclude that our internal controls are effective, our independent accountants may disagree with our assessment and may issue a report that is qualified. This could subject Tullys to
regulatory scrutiny and a loss of public confidence in our internal controls. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm Tullys operating results or
cause Tullys to fail to meet its reporting obligations.



Industry
Risks



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



We
operate in highly competitive markets in the United States. Our specialty coffees compete directly against all restaurant and beverage outlets that serve coffee and the large number of independent espresso stands, carts and stores. Companies that
compete directly with us in the retail and wholesale channels include, among others, Starbucks Corporation, Coffee Bean and Tea Leaf, Diedrich Coffee, Inc., Peets Coffee and Tea, Kraft



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Foods, Inc., Nestle, Inc., Caribou Coffee Company, Inc., Green Mountain Coffee Roasters, Inc., and The Proctor & Gamble Company, in addition to the
private-label brands of food service distributors, supermarkets, warehouse clubs and other channels. In foreign markets, we also may face competition from companies local to those international markets that may better understand those markets, or be
better established in those markets. We must spend significant resources to differentiate our product from the products offered by these companies, but our competitors still may be successful in attracting our Retail, Wholesale and Specialty
division customers. Our failure to compete successfully against current or future competitors would have an adverse effect on our business, including loss of customers, declining revenues and loss of market share.



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



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



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



Our future success depends to a large extent upon the availability of premium quality unroasted, or green, coffee beans at reasonable prices. Coffee prices have generally increased for the 2005-2007 seasons. There has
been increasing demand for such coffee beans and there are indications that supplies may not be keeping up with this growing demand. This could put additional upward pressure on prices or limit the quantities available to us. Natural or political
events, or disruption of shipping and port channels could interrupt the supply of these premium beans, or affect the cost. In addition, green coffee bean prices have been affected in the past, and could be affected in the future, by the actions of
organizations such as the International Coffee Organization and the Association of Coffee Producing Countries, which have attempted to influence commodity prices of green coffee beans through agreements establishing export quotas or restricting
coffee supplies worldwide. Price increases for whole bean coffee could result in increases in the costs of coffee beverages served in our stores and of other coffee products sold in our retail and wholesale channels. Such cost increases could
adversely affect our gross margins, or force us to increase the retail and wholesale prices for our coffee products, which could adversely affect our revenues.



Economic factors and consumer preferences related to coffee, dairy and bakery products could adversely affect our revenues or our costs.



Our business is not diversified. Our revenues are derived predominantly from
the sale of coffee, coffee beverages, baked goods and pastries, ice cream products, and coffee-related accessories and equipment. Many of these items contain coffee, milk and other dairy products, and typical bakery ingredients such as sugar and
flour. Changes in consumer product preferences away from products containing such ingredients could adversely impact our revenues. Increases in the costs of raw materials and ingredients for our products, such as the recent increases in dairy costs,
could adversely affect our gross margins, or force us to increase the retail and wholesale prices for some of our products, which could adversely affect our revenues.



Changes in the economy could adversely affect our revenues.



Our business is not diversified. Our revenues are derived predominantly from the sale of coffee, coffee beverages, tea, and
other beverages, baked goods and pastries, ice cream products, and coffee-related accessories and equipment. Given that many of these items are discretionary items in our customers budgets, our business depends upon a healthy economic climate
for the coffee industry as well as the economy generally. Adverse economic trends could be further adverse impact on our revenues.



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Risks Relating to our Capital Stock



Payment of liquidation preferences to holders of our Series A Convertible Preferred Stock could result in little or no proceeds remaining
available for other shareholders.



Our articles of
incorporation provide that our Series A Preferred stock is senior to the shares of Common Stock for a stated dollar amount of liquidation preferences, and the Series B Preferred stock is junior to a stated dollar amount of liquidation preference of
both the Series A Preferred stock and the shares of Common Stock. If we were acquired or sold all or a substantial portion of our assets, the amounts remaining for distribution to shareholders might be less than the aggregate liquidation preferences
of the more senior shareholders, and no amounts might be available for distribution to the more junior shareholders.



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



There is currently no public market for shares of our
Common Stock or our preferred stock, and consequently liquidity of an investment in our capital stock currently is limited and independent objective stock valuations are not readily determinable. Whether Tullys would ever go public
and, if so, the timing and particulars of such a transaction, would be determined by our evaluation of the market conditions, strategic opportunities and other important factors at the time, based on the judgment of our management, Board of
Directors and professional advisors. There can be no assurance that such a public market will ever become available for our Common Stock or preferred stock.



|ITEM 2. |  | PROPERTIES
|------- |  | ----------



As of April 2, 2006, Tullys operated 88 retail stores in the United States, all of which are located on property leased by us. Sixty-one of
these stores are located in Washington, twenty-three are in California, three are in Oregon and one is in Idaho.



We lease approximately 80,000 feet of office and warehouse space in Seattle, Washington, to house our headquarters, roasting plant and distribution
facilities (the Airport Way Property) pursuant to a ten-year lease expiring May 2010 and subject to two five-year options to renew.



|ITEM 3. |  | LEGAL PROCEEDINGS
|------- |  | -----------------



In February 2004 a lawsuit was filed against Tullys in Superior Court of California, Los Angeles County (the Court) by two former store
managers on behalf of themselves and on behalf of other former and current store managers in the state of California. The suit alleges that Tullys improperly classified such managers as exempt under Californias wage and hour laws and
seeks damages, restitution, reclassification and attorneys fees and costs. Since the lawsuit was filed, Tullys has investigated the matter and vigorously defended this litigation. Tullys has also pursued alternative dispute
resolution possibilities with the plaintiffs.



While
Tullys denies all liability in this case, in order to settle the lawsuit and fully resolve the claims brought by the plaintiffs without engaging in costly and protracted litigation, on April 21, 2005, the parties entered into a memorandum
of understanding regarding the settlement of this matter, which was subsequently reflected by the parties in a Joint Stipulation of Settlement and Release (the Settlement Agreement). On July 11, 2005 the Court conditionally
certified the class for purposes of the settlement and issued an order granting the motion for preliminary approval of the Settlement Agreement. The settlement is subject to court approval and Tullys may terminate the agreement if more than
ten members of the settlement class opt out of the settlement. In Fiscal 2005, Tullys incurred a one-time charge of approximately $1.6 million for the settlement and associated costs. Under the settlement, Tullys will make cash payments
totaling approximately $800,000 to the settlement class over a three year period starting upon final approval by the court. Subject to regulatory approval and compliance with applicable securities laws, Tullys will also issue 300,000 shares of
its common stock, with an agreed value of $450,000, to the settlement class during that three year period. The Court has set a final hearing date in September 2006.



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In April 2004, we were advised by Tullys Coffee Japan that the Japanese tax authorities were
conducting an examination regarding the withholding taxes collected by Tullys Coffee Japan, and that the tax authorities had taken a position that certain amounts paid by Tullys Coffee Japan under its supply agreement with us should be
subject to Japanese withholding taxes. Tullys Coffee Japan informed us that it paid taxes, interest and penalties, for which Tullys Coffee Japan requested indemnification from Tullys. Under the Japan Rights Agreement, the claim
from Tullys Coffee Japan was resolved without any payment from Tullys.



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



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



On March 8, 2006 we held our annual shareholders meeting (the 2005 Annual Meeting). Our shareholders elected seven incumbent members to
the Board of Directors to serve until the next annual shareholder meeting or until their respective successors shall be elected and qualified. The elected directors and the votes for and withheld were as follows:



|                      |  |            |  |          
|--------------------- |  | ---------- |  | ---------
|Director              |  | For        |  | Withheld 
|Kathi Ainsworth-Jones |  | 20,700,902 |  | 551,804  
|John K. Buller        |  | 20,802,206 |  | 450,500  
|Marc Evanger          |  | 20,834,266 |  | 418,440  
|John M. Fluke         |  | 20,766,487 |  | 486,219  
|Lawrence Hood         |  | 20,725,707 |  | 526,999  
|Gregory Hubert        |  | 20,804,506 |  | 448,200  
|Tom T. OKeefe        |  | 19,599,359 |  | 1,653,347



Our shareholders also
ratified the selection of our independent registered public accounting firm, Moss Adams, LLP, as follows:



|        |  |           
|------- |  | ----------
|        |  | VOTE      
|For     |  | 20,680,276
|Against |  | 124,571   
|Abstain |  | 447,859   



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PART II



|ITEM 5. |  | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OR EQUITY SECURITIES
|------- |  | ------------------------------------------------------------------------------------------------------------



Market Information, Holders and Dividends



Currently there is no public market for Tullys common stock. As of
June 15, 2006 there were 5,032 holders of record of Tullys common stock.



We have not paid cash dividends in the past and we presently do not plan to pay dividends in the foreseeable future. We intend to retain and use earnings, if any, to finance the growth of our business for an
indefinite period. Any determination to pay cash dividends will be at the discretion of the board of directors and will be dependent upon our financial condition, results of operations, capital requirements, restrictions under our borrowing
agreements, and such other factors as the board of directors deems relevant.



Securities Authorized for Issuance Under Equity Compensation Plans



Equity Compensation Plan Information

(As of April 2, 2006)



|                                                             |  |                                                                                          |  |                                                                           |      |                                                                                                                                        |          
|------------------------------------------------------------ |  | ---------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------- | ---- | -------------------------------------------------------------------------------------------------------------------------------------- | ---------
|Plan Category                                                |  | Number of securities to beissued upon exercise ofoutstanding options,warrants and rights |  | Weighted average exerciseprice of outstanding options,warrants and rights |      | Number of securitiesremaining available forfuture issuance under equitycompensation
plans(excluding securities reflectedin column (a))
|                                                             |  | (a)                                                                                      |  | (b)                                                                       |      | (c)                                                                                                                                   
|Equity compensation plans approved by security holders       |  |                                                                                          |  |                                                                           |      |                                                                                                                                        |          
|1994 Option Plan                                             |  | 3,340,760                                                                                |  | $                                                                         | 0.64 |                                                                                                                                        |         
|2004 Option Plan                                             |  | 484,008                                                                                  |  | $                                                                         | 1.29 |                                                                                                                                        | 2,017,992
|Equity compensation plans not approved by security holders * |  | 1,688,167                                                                                |  | $                                                                         | 0.01 |                                                                                                                                        |         
|                                                             |  |                                                                                          |  |                                                                           |      |                                                                                                                                        |          
|Total                                                        |  | 5,512,935                                                                                |  | $                                                                         | 0.51 |                                                                                                                                        | 2,017,992
|                                                             |  |                                                                                          |  |                                                                           |      |                                                                                                                                        |          

---

|* |  | These options were granted by our chairman to employees and third parties and may be exercised to purchase shares of Tullys Common Stock owned by our chairman. We refer to
these options as being granted under the Founders Stock Option Plan. We do not expect any additional options to be granted under the Founders Stock Option Plan.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In 1994, Tullys shareholders approved the 1994 Stock Option Plan,
pursuant to which we issued incentive or nonqualified stock options to our employees and directors. In August 1999 our shareholders approved an amended plan (the 1994 Option Plan), which established the maximum number of shares issuable
under the 1994 Option Plan and the Employee Stock Purchase Plan at 4,200,000 shares. The 1994 Option Plan expired on October 19, 2004 (this will not terminate outstanding options). As of April 2, 2006, options for 3,342,760 shares were
outstanding under the 1994 Option Plan and options for 366,331 shares had been exercised under the 1994 Option Plan, and no shares had been issued under the Employee Stock Purchase Plan.



On September 23, 2004, the board of directors approved the adoption of the 2004 Stock Option Plan, effective as of
November 1, 2004 and subject to shareholder approval. The 2004 Stock Option Plan authorizes the issuance of up to 2,500,000 shares of common stock under the 2004 Stock Option Plan and Tullys Employee Stock Purchase Plan. The Tullys
shareholders approved the 2004 Stock Option Plan in December 2004. As of April 2, 2006, 596,008 options had been granted and options for 66,000 shares were granted in June 2006 under the 2004 Stock Option Plan.



19



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##### Table of Contents

Stock options are granted solely at the discretion of our board of directors and are issued at a price
determined by our board of directors. The term of each option granted is for such period as determined by our board of directors, but not more than ten years from date of grant. Options are nontransferable and may generally be exercised based on a
vesting schedule determined by our board of directors. Options may be either incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, or nonqualified stock options. Our shareholders also previously approved the
Employee Stock Purchase Plan, under which employees would be permitted to purchase common stock from the company. No offerings have been made to employees under the Employee Stock Purchase Plan.



The Rights Offering



Before October 1999, our shareholders had a right to maintain their proportionate shareholdings in Tullys by
purchasing shares before we offered them to new investors. During Fiscal 2005, we conducted an offering of our common stock and investment units (each unit consisting of convertible preferred stock and warrants to purchase common stock) through the
distribution of subscription rights to eligible shareholders and former shareholders (the rights offering). The primary purpose of the rights offering was to provide an opportunity for our shareholders to satisfy any unsatisfied
preemptive rights that they may have had. We conducted the rights offering because we believed that our ability to engage in financing or strategic transactions could be limited by the potential risk of such possible future preemptive rights claims,
but that such risk could be mitigated by a number of possible defenses, including the completion of the rights offering. The registration statement for the rights offering was declared effective January 11, 2005 and eligible shareholders and
former shareholders of Tullys received rights to purchase these securities at the prices at which the securities were issued by Tullys between 1994 and 1999. Shareholders of record at January 6, 2005 received subscription privileges
to purchase any shares of common stock and investment units not purchased through the exercise of the rights. The rights offering closed on February 8, 2005. We received a total of $878,000 from the subscribers in this offering. Qualified
subscriptions were received with gross proceeds to Tullys of $701,000. In May 2005, we refunded $177,000 to subscribers for the ineligible subscriptions and issued certificates for 337,216 shares of common stock to the subscribers and we
issued certificates for 180,888 shares of Series A Convertible Preferred Stock and warrants to purchase 90,444 shares of common stock to the subscribers for the investment units. We incurred offering costs of $458,000.



Recent Sales of Unregistered Securities



Tullys issued and sold securities in the transactions described below
during Fiscal 2006, Fiscal 2005, and Fiscal 2004. The offer and sale of these securities were made in reliance on the exemptions from registration provided by Section 4(2) of the Securities Act of 1933, as amended, as offers and sales not
involving a public offering.



Fiscal 2006



| |  |  | As compensation for guaranties of debt under the our credit facilities, we issued to the guarantors (certain of our directors, former directors and shareholders) warrants to
purchase shares of Common Stock with an exercise price of $0.05 per share, as described in Note 11 of the Notes to the Consolidated Financial Statements. The warrants issued to these guarantors in Fiscal 2006 are summarized below:
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                               |  |                    |  |                 |  |       
|------------------------------ |  | ------------------ |  | --------------- |  | ------
|                               |  | Number of Shares  
|                               |  | DirectorGuarantors |  | OtherGuarantors |  | Total 
|Warrants issued in Fiscal 2006 |  | 13,430             |  | 31,337          |  | 44,767



Stock Issued upon Exercise of
Warrants



| |  |  | In May 2005, Tullys issued 5,000 shares of Common Stock to one warrant holder upon exercise of warrants for aggregate consideration to the company of $1,650.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



20



---

##### Table of Contents

| |  |  | In June 2005, Tullys issued 2,500 shares of Common Stock to one warrant holder upon exercise of warrants for aggregate consideration to the company of $825.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In October 2005, Tullys issued a total of 2,844 shares of Common Stock to four warrant holders upon exercise of warrants for aggregate consideration to Tullys of $939.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In January 2006, Tullys issued a total of 7,776 shares of Common Stock to two warrant holders upon exercise of warrants for aggregate consideration to Tullys of $2,566.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Fiscal 2005



| |  |  | As compensation for guaranties of debt under the our credit facilities, we issued to the guarantors (certain of our directors, former directors and shareholders) warrants to
purchase shares of Common Stock with an exercise price of $0.05 per share, as described in Note 11 of the Notes to the Consolidated Financial Statements. The warrants issued to these guarantors in Fiscal 2005 are summarized below:
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                               |  |                    |  |                 |  |        
|------------------------------ |  | ------------------ |  | --------------- |  | -------
|                               |  | Number of Shares  
|                               |  | DirectorGuarantors |  | OtherGuarantors |  | Total  
|Warrants issued in Fiscal 2005 |  | 222,192            |  | 518,448         |  | 740,640



Stock Issued upon Exercise of
Warrants



| |  |  | In May 2004, Tullys issued 6,000 shares of Common Stock to one warrant holder upon exercise of warrants for aggregate consideration to Tullys of $1,980.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2004, Tullys issued 75,000 shares of Common Stock to three warrant holders upon exercise of warrants for aggregate consideration to Tullys of $24,750.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In January and February 2005, Tullys issued 509,552 shares of Common Stock to eighteen warrant holders upon exercise of warrants for aggregate consideration to the company of
$33,624.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Fiscal 2004



| |  |  | Options Granted for Services. Tullys granted the following options to purchase its shares of Common Stock, which vest and become exercisable over a three-year period from the
grant date, to employees in consideration for services pursuant to our Amended and Restated 1994 Stock Option Plan (the 1994 Plan):
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2003, options for 100,000 shares, with an exercise price of $0.31, to our Chief Financial Officer.
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | In May 2003, options for 75,000 shares, with an exercise price of $0.31, to our Vice President, Retail.
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | On October 23, 2003 options for 266,400 shares, with an exercise price of $0.31, to thirty-four employees
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | On February 9, 2004 options for 25,000 shares, with an exercise price of $0.31 to one employee
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | In June 2003, we granted to five directors options to purchase an aggregate of 15,000 shares of Common Stock pursuant to the 1994 Plan at an exercise price of $0.01 per share in
consideration for participation in Board of Directors and Board committee meetings prior to June 30, 2002. These options were fully vested and exercisable from the time of grant. On June 2, 2004, Tullys also issued stock options for
a total of 54,000 shares to five directors for Board of Directors participation in Fiscal 2004 (with an exercise price of $0.30 per share and fully vested at April 2, 2006).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In June and August 2003, we issued a total of 60,000 shares of Common Stock to one warrant holder upon exercise of warrants for aggregate consideration to Tullys of $6,947.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2004, Tullys issued 22,000 shares of Common Stock to two warrant holders upon exercise of warrants for aggregate consideration to Tullys of $7,260.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



21



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##### Table of Contents

| |  |  | As of January 1, 2004, in lieu of cash interest, and as provided by the terms of the $3,000,000 convertible promissory note held by an affiliate of a former director (See Note
12 of the Notes to the Consolidated Financial Statements), we issued warrants with an estimated aggregate value of $72,000 at the time (exercise price of $0.01 per share) for 240,000 shares of Common Stock to the holder of the note.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As compensation for guaranties of debt under the our credit facilities, we issued to the guarantors (certain of our directors, former directors and shareholders) warrants to
purchase shares of Common Stock with an exercise price of $0.05 per share, as described in Note 11 of the Notes to the Consolidated Financial Statements. The warrants issued to these guarantors in Fiscal 2004 are summarized below:
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                               |  |                    |  |                 |  |        
|------------------------------ |  | ------------------ |  | --------------- |  | -------
|                               |  | Number of Shares  
|                               |  | DirectorGuarantors |  | OtherGuarantors |  | Total  
|Warrants issued in Fiscal 2004 |  | 444,384            |  | 292,950         |  | 737,334



22



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##### Table of Contents

|ITEM 6. |  | SELECTED FINANCIAL DATA
|------- |  | -----------------------



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



|                                                                           |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|-------------------------------------------------------------------------- |  | ---------------------- | ------ | - | ---------- | - | ------- | ----------- |  | - | ----------- | - |  | ----------- | ------- | - |  | - | ------- | -
|                                                                           |  | Fiscal Years Ended (1) |       
|(dollar amounts in thousands, except per share data)                       |  | Apr 2,2006             |        |   | Apr 3,2005 |   |         | Mar 28,2004 |  |   | Mar 30,2003 |   |  | Mar 31,2002 |        
|Results of Operations Data(2, 3, 4)                                        |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|Net sales                                                                  |  | $                      | 58,245 |   |            | $ | 53,980  |             |  | $ | 50,768      |   |  | $           | 50,800  |   |  | $ | 51,458  |  
|Operating income (loss)                                                    |  |                        | (1,313 | ) |            |   | (3,695  | )           |  |   | (1,846      | ) |  |             | (6,834  | ) |  |   | (13,381 | )
|Income (loss) before cumulative effect of change in accounting principle   |  |                        | 15,423 |   |            |   | (4,625  | )           |  |   | (2,595      | ) |  |             | (7,056  | ) |  |   | (11,422 | )
|Cumulative effect of change in accounting principle(2)                     |  |                        |       |   |            |   |        |             |  |   |            |   |  |             | (3,018  | ) |  |   |        |  
|Net income (loss)                                                          |  | $                      | 15,423 |   |            | $ | (4,625  | )           |  | $ | (2,595      | ) |  | $           | (10,074 | ) |  | $ | (11,422 | )
|Earnings (loss) per sharebasic and diluted:                               |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|Earnings (loss) before cumulative effect of change in accounting principle |  | $                      | 0.87   |   |            | $ | (0.28   | )           |  | $ | (0.16       | ) |  | $           | (0.43   | ) |  | $ | (0.70   | )
|Cumulative effect of change in accounting principle(2)                     |  |                        |       |   |            |   |        |             |  |   |            |   |  |             | (0.18   | ) |  |   |        |  
|Earnings (loss) per sharebasic                                            |  | $                      | 0.87   |   |            | $ | (0.28   | )           |  | $ | (0.16       | ) |  | $           | (0.62   | ) |  | $ | (0.70   | )
|Earnings (loss) per sharediluted                                          |  | $                      | 0.30   |   |            | $ | (0.28   | )           |  | $ | (0.16       | ) |  | $           | (0.62   | ) |  | $ | (0.70   | )
|Balance Sheet Data                                                         |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|Total assets                                                               |  | $                      | 21,527 |   |            | $ | 17,930  |             |  | $ | 20,017      |   |  | $           | 23,677  |   |  | $ | 32,469  |  
|Long-term obligations (including current portion)(5)                       |  |                        | 3,402  |   |            |   | 6,883   |             |  |   | 6,446       |   |  |             | 6,843   |   |  |   | 3,164   |  
|Stockholders equity (deficit)                                             |  | $                      | 5,127  |   |            | $ | (10,689 | )           |  | $ | (6,671      | ) |  | $           | (4,480  | ) |  | $ | 5,296   |  
|Other Data                                                                 |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|Earnings (loss) before interest, taxes, depreciation andamortization(3,
6) |  | $                      | 19,676 |   |            | $ | 2       |             |  | $ | 1,830       |   |  | $           | (2,093  | ) |  | $ | (5,558  | )
|Number of stores at fiscal year end                                        |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|Stores operated by Tullys                                                 |  |                        | 88     |   |            |   | 92      |             |  |   | 94          |   |  |             | 100     |   |  |   | 104     |  
|Stores operated or franchised by international licensees                   |  |                        |       | * |            |   | 245     |             |  |   | 174         |   |  |             | 113     |   |  |   | 50      |  
|Stores operated by U.S. franchisees                                        |  |                        | 23     |   |            |   | 5       |             |  |   | 1           |   |  |             |        |   |  |   |        |  
|                                                                           |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  
|Total retail stores at fiscal year end                                     |  |                        | 111    |   |            |   | 342     |             |  |   | 269         |   |  |             | 213     |   |  |   | 154     |  
|                                                                           |  |                        |        |   |            |   |         |             |  |   |             |   |  |             |         |   |  |   |         |  

---

|* |  | As the result of the Japan Rights sale, the Japanese Tullys stores operated and franchised by Tullys Coffee Japan (which totaled 287 stores as of April 2, 2006) are
excluded from our franchised and licensed store counts after August 31, 2005. Tullys and Tullys Coffee Japan have agreed to cooperate in the development of the Tullys brand for the mutual benefit of the two companies.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



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##### Table of Contents

Notes for Selected Financial Data



|(1) |  | Each fiscal year included 52 weeks, except for the fiscal year ended April 3, 2005 (Fiscal 2005) which had 53 weeks. The 53rd week accounted for $955,000 in net
sales in Fiscal 2005.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | The cumulative effect of a change in accounting for goodwill in the amount of $3,018,000 was recorded in Fiscal 2003.
|--- |  | ---------------------------------------------------------------------------------------------------------------------



|(3) |  | A $17,392,000 gain on the sale of the Japan Rights was recognized in Fiscal 2006. As the result of the termination of our license and supply agreements with Tullys Coffee
Japan, $4,405,000 of deferred license revenue was recognized in Fiscal 2006, and Tullys has not received the operating cash flows from license fees and coffee roasting fees from Tullys Coffee Japan since July 31, 2005. Additionally,
the following charges are included in the results of operations (dollars in thousands):
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                                                                                   |  |             |     |             |   |             |  |             |     |             |   |       |  |   |      
|------------------------------------------------------------------------------------------------------------------ |  | ----------- | --- | ----------- | - | ----------- |  | ----------- | --- | ----------- | - | ----- |  | - | -----
|                                                                                                                   |  | Fiscal 2006 |     | Fiscal 2005 |   | Fiscal 2004 |  | Fiscal 2003 |     | Fiscal 2002
|Impairment of long-lived assets                                                                                    |  | $           | 236 |             | $ | 200         |  | $           | 97  |             | $ | 1,310 |  | $ | 2,315
|Store closures and lease termination costs                                                                         |  |             | 219 |             |   | 43          |  |             | 170 |             |   | 108   |  |   | 1,583
|Liquidation and write-off of Tullys Europe B.V.                                                                   |  |             |    |             |   |            |  |             |    |             |   |      |  |   | 46   
|Severance costs related to resignation of then-president                                                           |  |             |    |             |   | 402         |  |             |    |             |   |      |  |   |     
|Settlement of litigation (see Note 16 of the Notes to the Consolidated Financial Statements)                       |  |             |    |             |   | 1,628       |  |             |    |             |   |      |  |   |     
|Evaluation of business integration opportunity (see Note 13 of the Notes to the Consolidated Financial Statements) |  |             |    |             |   | 129         |  |             | 541 |             |   |      |  |   |     
|                                                                                                                   |  |             |     |             |   |             |  |             |     |             |   |       |  |   |      
|Total                                                                                                              |  | $           | 455 |             | $ | 2,402       |  | $           | 808 |             | $ | 1,418 |  | $ | 3,944
|                                                                                                                   |  |             |     |             |   |             |  |             |     |             |   |       |  |   |      



|(4) |  | During Fiscal 2002, Tullys received a $12,000,000 license fee from UCC. In addition, we received $4,200,000 and 300 shares of Tullys Coffee Japan stock (with a market
value of approximately $1,771,000 at October 1, 2001) in connection with the amendment of our supply agreement with Tullys Coffee Japan. The Tullys Coffee Japan stock was sold by Tullys in Fiscal 2003.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) |  | Long term obligations are summarized as follows (dollars in thousands):
|--- |  | -----------------------------------------------------------------------



|                                                                |  |            |       |            |   |             |  |             |       |             |   |       |  |   |      
|--------------------------------------------------------------- |  | ---------- | ----- | ---------- | - | ----------- |  | ----------- | ----- | ----------- | - | ----- |  | - | -----
|                                                                |  | Apr 2,2006 |       | Apr 3,2005 |   | Mar 28,2004 |  | Mar 30,2003 |       | Mar 31,2002
|Current portion of long-term debt and capital lease obligations |  | $          | 2,209 |            | $ | 2,078       |  | $           | 1,145 |             | $ | 561   |  | $ | 308  
|Long-term debt, net of current portion                          |  |            | 28    |            |   | 600         |  |             | 2,167 |             |   | 3,106 |  |   | 26   
|Capital lease obligations, net of current portion               |  |            | 72    |            |   | 112         |  |             | 203   |             |   | 360   |  |   | 127  
|Other liabilities                                               |  |            | 1,093 |            |   | 1,093       |  |             |      |             |   |      |  |   |     
|Convertible promissory note, net of discount                    |  |            |      |            |   | 3,000       |  |             | 2,931 |             |   | 2,816 |  |   | 2,703
|                                                                |  |            |       |            |   |             |  |             |       |             |   |       |  |   |      
|Long term obligations (including current portion)               |  | $          | 3,402 |            | $ | 6,883       |  | $           | 6,446 |             | $ | 6,843 |  | $ | 3,164
|                                                                |  |            |       |            |   |             |  |             |       |             |   |       |  |   |      



|(6) |  | Earnings before interest, taxes, depreciation and amortization (EBITDA) is a financial measurement we use to measure our operating performance, excluding the effects of
financing costs, income taxes, and non-cash depreciation and amortization. See Managements Discussion and Analysis for additional information regarding the computation and usage of EBITDA information. The following table sets
forth, for the periods indicated, the computation of EBITDA and reconciliation to the reported amounts for net income (loss) (dollars in thousands):
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                                         |  |                    |        |            |   |        |             |  |   |             |   |  |             |         |   |  |   |         |  
|------------------------------------------------------------------------ |  | ------------------ | ------ | ---------- | - | ------ | ----------- |  | - | ----------- | - |  | ----------- | ------- | - |  | - | ------- | -
|                                                                         |  | Fiscal Years Ended |       
|                                                                         |  | Apr 2,2006         |        | Apr 3,2005 |   |        | Mar 28,2004 |  |   | Mar 30,2003 |   |  | Mar 31,2002 |        
|Net income (loss)                                                        |  | $                  | 15,423 |            | $ | (4,625 | )           |  | $ | (2,595      | ) |  | $           | (10,074 | ) |  | $ | (11,422 | )
|Add back cumulative effect of change in accounting principle             |  |                    |       |            |   |       |             |  |   |            |   |  |             | 3,018   |   |  |   |        |  
|                                                                         |  |                    |        |            |   |        |             |  |   |             |   |  |             |         |   |  |   |         |  
|Income (loss) before cumulative effect of change in accounting principle |  |                    | 15,423 |            |   | (4,625 | )           |  |   | (2,595      | ) |  |             | (7,056  | ) |  |   | (11,422 | )
|Add back amounts for computation of EBITDA                               |  |                    |        |            |   |        |             |  |   |             |   |  |             |         |   |  |   |         |  
|Interest income, interest expense, and loan guarantee fees               |  |                    | 385    |            |   | 924    |             |  |   | 760         |   |  |             | 721     |   |  |   | 904     |  
|Income taxes                                                             |  |                    | 339    |            |   | 52     |             |  |   | 43          |   |  |             | 25      |   |  |   | 6       |  
|Depreciation and amortization                                            |  |                    | 3,529  |            |   | 3,651  |             |  |   | 3,622       |   |  |             | 4,217   |   |  |   | 4,954   |  
|                                                                         |  |                    |        |            |   |        |             |  |   |             |   |  |             |         |   |  |   |         |  
|Earnings (loss) before interest, taxes, depreciation and amortization    |  | $                  | 19,676 |            | $ | 2      |             |  | $ | 1,830       |   |  | $           | (2,093  | ) |  | $ | (5,558  | )
|                                                                         |  |                    |        |            |   |        |             |  |   |             |   |  |             |         |   |  |   |         |  



24



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##### Table of Contents

|ITEM 7. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------



The following discussion and analysis provides information that Tullys believes is relevant to an assessment and
understanding of our results of operations and financial condition for the fiscal years ended April 2, 2006, April 3, 2005 and March 28, 2004. The following discussion should be read in conjunction with the consolidated financial
statements and related notes appearing elsewhere in this report. We believe that certain statements herein, including statements concerning anticipated store openings and closings, planned capital expenditures, and trends in or expectations
regarding Tullys operations, constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based on currently available operating, financial and
competitive information, and are subject to risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, coffee and other raw materials prices and availability,
successful execution of our business plans, the impact of competition, the effect of legal proceedings, and the success of our franchisees and licensees. These and other factors that may cause our actual results and trends to differ materially from
our expectations are described in the Risk Factors section of this report.



For financial reporting, we end our fiscal year on the Sunday closest to March 31. As a result, we record our revenue and expenses on a 52 or 53 week period, depending on the year. Fiscal 2006 included 52 weeks
while Fiscal 2005 included 53 weeks. Each of Fiscal 2004, Fiscal 2003, and Fiscal 2002 included 52 weeks.



Overview



As discussed
in Note 13 of the Notes to Consolidated Financial Statements, on August 31, 2005, we sold certain intellectual property assets and rights to Tullys Coffee Japan (the Japan Rights) for $17,500,000. As further discussed below,
the effects of this transaction on our financial condition and results of operations for Fiscal 2006, and our expected future financial condition and results of operations include:



| |  |  | A $17,392,000 gain on the sale of the Japan Rights was recognized in Fiscal 2006;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | As the result of the termination of our license and supply agreements with Tullys Coffee Japan, $4,405,000 of deferred license revenue was recognized in Fiscal 2006, and
Tullys has not received the operating cash flows from license fees and coffee roasting fees from Tullys Coffee Japan since July 31, 2005; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The cash proceeds from the transaction have improved our liquidity and have provided capital resources for use in the development of our business. We have repaid all borrowings
under our Kent Central promissory note and our convertible promissory note.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As a result of the Japan Rights sale, the risks and rewards from the development of the Tullys brand in Japan will accrue directly to Tullys Coffee Japan as the owner of the Tullys proprietary
intellectual properties in Japan, and Tullys will not be directly affected by the business activities of Tullys Coffee Japan. The Japan Rights Agreement does not provide Tullys Coffee Japan with the right to use Tullys
proprietary intellectual properties outside of Japan and does not affect Tullys ownership or rights with respect to the Tullys intellectual properties outside of Japan. Tullys and Tullys Coffee Japan have agreed to cooperate
in the development of the Tullys brand for the mutual benefit of the two companies. As the result of this transaction, we will be less dependent upon our relationship with Tullys Coffee Japan and have greater financial resources
currently available for the development of our Retail division and Wholesale division within the United States, and for the development of our Specialty division within the United States and internationally outside of Japan.



We derive our revenues from sales from the:



| |  |  | Retail division, which operates retail stores in the Western United States,
| | - |  | ---------------------------------------------------------------------------



| |  |  | Wholesale division, which sells Tullys-branded products to domestic supermarkets, food service distributors, restaurants, institutions, and office coffee services, and through
direct mail order and internet sales, and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



---

##### Table of Contents

| |  |  | Specialty division, which manages our U.S. franchising and which also sells Tullys-branded products to our foreign licensees and receives royalties and fees from those
licensees.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The relative percentage of net sales
from each division for Fiscal 2006, Fiscal 2005 and Fiscal 2004 are depicted by these graphs.



LOGO



---

|* |  | Percentages for Fiscal 2006 include the effects from the accelerated recognition of $4,405,000 of deferred license revenues. Excluding this amount, the percentages for the Fiscal
2006 would be Retail (70.9%), Wholesale (24.6%) and Specialty (4.5%).
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



From our founding, our objective was to establish Tullys as one of the most respected coffee brands in the world. To achieve this goal, we made significant investments in marketing and building our brand and we
concentrated on opening company-operated retail stores in the U.S. and on licensing third parties in international markets. In Fiscal 2002, we decided that we had successfully developed our brand identity and that we could modify our strategy to
place greater emphasis on improving overall corporate operating performance. We also decided that the Tullys brand, products, and retail store model have been developed to a point where they can be leveraged for improved operating results, and
replicated in additional locations and markets. These continuing initiatives toward improved operating performance and cash flow include:



| |  |  | new and expanded product offerings,
| | - |  | -----------------------------------



| |  |  | enhancing our marketing efforts,
| | - |  | --------------------------------



| |  |  | initiating selective retail price changes,
| | - |  | ------------------------------------------



| |  |  | making cost of sales improvements through more efficient product purchasing,
| | - |  | ----------------------------------------------------------------------------



| |  |  | opening new company-operated stores that are expected to produce a return on investment that meets our requirements,
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | growing our Specialty division revenues through growth in the number of franchised stores in the U.S. and from new international licensing relationships,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | closing stores that do not meet our financial criteria,
| | - |  | -------------------------------------------------------



| |  |  | increasing sales from the Wholesale division through new products and new customers, and
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | controlling marketing, general and administrative costs.
| | - |  | --------------------------------------------------------



26



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##### Table of Contents

The retail stores operated by Tullys and our licensees and franchisees are summarized as follows:



|                                           |  |                    |   |  |              |   |  |               |  
|------------------------------------------ |  | ------------------ | - |  | ------------ | - |  | ------------- | -
|                                           |  | Fiscal Years Ended |  
|                                           |  | April 2,2006       |   |  | April 3,2005 |   |  | March 28,2004 |  
|STORES OPERATED BY TULLYS:                |  |                    |   |  |              |   |  |               |  
|Beginning of the year                      |  | 92                 |   |  | 94           |   |  | 100           |  
|New stores                                 |  | 3                  |   |  | 1            |   |  | 1             |  
|Closed stores                              |  | (7                 | ) |  | (3           | ) |  | (7            | )
|                                           |  |                    |   |  |              |   |  |               |  
|End of the year                            |  | 88                 |   |  | 92           |   |  | 94            |  
|                                           |  |                    |   |  |              |   |  |               |  
|LICENSEES AND FRANCHISEES (end of period): |  |                    |   |  |              |   |  |               |  
|International licensees                    |  |                   | * |  | 245          |   |  | 174           |  
|U.S. franchisees                           |  | 23                 |   |  | 5            |   |  | 1             |  
|                                           |  |                    |   |  |              |   |  |               |  
|Total licensees and franchisees            |  | 23                 |   |  | 250          |   |  | 175           |  
|                                           |  |                    |   |  |              |   |  |               |  
|Total retail stores at end of the year     |  | 111                |   |  | 342          |   |  | 269           |  
|                                           |  |                    |   |  |              |   |  |               |  

---

|* |  | As the result of the Japan Rights sale, the Japanese Tullys stores operated and franchised by Tullys Coffee Japan (which totaled 287 stores as of April 2, 2006) are
excluded from our franchised and licensed store counts after August 31, 2005. Tullys and Tullys Coffee Japan have agreed to cooperate in the development of the Tullys brand for the mutual benefit of the two companies.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Comparable store sales are defined as sales from
stores open for the full period in both the current and comparative prior year periods. Changes in Retail division comparable store sales for each of the four quarters of Fiscal 2004, Fiscal 2005, and Fiscal 2006, as compared to the corresponding
periods in the previous fiscal year, are depicted in the graph presented below.



LOGO



We believe that the comparable
store sales increases and decreases in the periods shown above reflect the effects of (i) the changes in economic conditions generally, (ii) competition (including the effects of new competitive stores opened during these periods),
(iii) the increased availability of Tullys coffee in supermarkets, and (iv) the relative levels and effectiveness of product innovation and marketing during each period. The 53rdweek of Fiscal 2005 is excluded from the computations of comparable store sales.



27



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##### Table of Contents

The increases and decreases in Retail division sales shown in the graph below reflect the factors
discussed below and normal seasonal patterns (generally, a slightly larger percentage of our Retail division sales occur in our third fiscal quarter).



LOGO

---

|* |  | The fourth quarter of Fiscal 2005 excludes sales from the 53rdweek of Fiscal 2005, which were $732,000.
|- |  | -------------------------------------------------------------------------------------------------------



Since Fiscal 2004, our Wholesale division has focused on growth through the addition of new customers and territories. The strategy has resulted in much greater distribution of our products in the supermarket and food
service channels and we believe is providing a basis for improved results in our Wholesale division. The increases and decreases in Wholesale division sales shown in the graph below reflect the general growth of our product distribution during the
last twelve fiscal quarters, and normal seasonal patterns (generally, a larger percentage of our annual Wholesale division sales occur in the second and third quarters of our fiscal year).



LOGO

---

|* |  | The fourth quarter of Fiscal 2005 excludes sales from the 53rdweek of Fiscal 2005, which were $223,000.
|- |  | -------------------------------------------------------------------------------------------------------



28



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##### Table of Contents

Franchised and licensed stores at the end of each respective quarter are set forth in the table below:



|                        |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |   |  |      |   |  |      |  
|----------------------- |  | ---- |  | ---- |  | ---- |  | ---- |  | ---- |  | ---- |  | ---- |  | ---- |  | ---- |  | ---- | - |  | ---- | - |  | ---- | -
|                        |  | FY04 |  | FY04 |  | FY04 |  | FY04 |  | FY05 |  | FY05 |  | FY05 |  | FY05 |  | FY06 |  | FY06 |   |  | FY06 |   |  | FY06 |  
|                        |  | Q1   |  | Q2   |  | Q3   |  | Q4   |  | Q1   |  | Q2   |  | Q3   |  | Q4   |  | Q1   |  | Q2   |   |  | Q3   |   |  | Q4   |  
|International licensees |  | 124  |  | 135  |  | 155  |  | 174  |  | 198  |  | 207  |  | 228  |  | 245  |  | 260  |  |     | * |  |     | * |  |     | *
|U.S. franchisees        |  |     |  |     |  |     |  | 1    |  | 2    |  | 3    |  | 4    |  | 5    |  | 6    |  | 12   |   |  | 20   |   |  | 23   |  
|                        |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |   |  |      |   |  |      |  
|Total                   |  | 124  |  | 135  |  | 155  |  | 175  |  | 200  |  | 210  |  | 232  |  | 250  |  | 266  |  | 12   |   |  | 20   |   |  | 23   |  
|                        |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |  |      |   |  |      |   |  |      |  

---

|* |  | As the result of the Japan Rights sale, the Japanese Tullys stores operated and franchised by Tullys Coffee Japan (which totaled 287 stores as of the end of Fiscal 2006)
are excluded from our franchised and licensed store counts after August 31, 2005. Tullys and Tullys Coffee Japan have agreed to cooperate in the development of the Tullys brand for the mutual benefit of the two companies.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



The following table sets forth actual and pro forma statement of operations
data expressed as a percentage of net sales, for the periods indicated. The actual and pro forma statement of operations data have been derived from our consolidated financial statements, which are included elsewhere in this report. The pro forma
statement of operations data excludes the $4,405,000 of deferred license revenues recognized in Fiscal 2006 as a result of the Japan Rights sale.



|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|------------------------------------------------- |  | -------------------- | -- |  | ---------- | -- |  | ---------- | -- |  | ----------- | --
|                                                  |  | Fiscal Years Ended   |   
|                                                  |  | Pro Forma Apr 2,2006 |    |  | Apr 2,2006 |    |  | Apr 3,2005 |    |  | Mar 28,2004 |   
|STATEMENTS OF OPERATIONS DATA:                    |  |                      |    |  |            |    |  |            |    |  |             |   
|Sales of products                                 |  | 95.5                 | %  |  | 88.3       | %  |  | 92.0       | %  |  | 93.5        | % 
|Licenses, royalties, and fees                     |  | 1.5                  | %  |  | 1.4        | %  |  | 4.1        | %  |  | 2.4         | % 
|Recognition of deferred revenue                   |  | 3.0                  | %  |  | 10.3       | %  |  | 3.9        | %  |  | 4.1         | % 
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|Net sales                                         |  | 100.0                | %  |  | 100.0      | %  |  | 100.0      | %  |  | 100.0       | % 
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|Cost of goods sold and related occupancy expenses |  | 50.3                 | %  |  | 46.5       | %  |  | 44.2       | %  |  | 43.6        | % 
|Store operating expenses                          |  | 31.8                 | %  |  | 29.4       | %  |  | 32.1       | %  |  | 33.3        | % 
|Other operating expenses                          |  | 6.6                  | %  |  | 6.1        | %  |  | 5.1        | %  |  | 4.0         | % 
|Marketing, general and administrative costs       |  | 14.6                 | %  |  | 13.5       | %  |  | 14.9       | %  |  | 14.0        | % 
|Depreciation and amortization                     |  | 6.5                  | %  |  | 6.1        | %  |  | 6.8        | %  |  | 7.1         | % 
|Settlement of litigation                          |  |                     |    |  |           |    |  | 3.0        | %  |  |            |   
|Evaluation of business integration opportunity    |  |                     |    |  |           |    |  | 0.2        | %  |  | 1.1         | % 
|Impairment of long-lived assets                   |  | 0.4                  | %  |  | 0.4        | %  |  | 0.4        | %  |  | 0.2         | % 
|Store closure and lease termination costs         |  | 0.4                  | %  |  | 0.4        | %  |  | 0.1        | %  |  | 0.3         | % 
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|Total cost of goods sold and operating expenses   |  | 110.6                | %  |  | 102.3      | %  |  | 106.8      | %  |  | 103.6       | % 
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|Operating loss                                    |  | (10.6                | )% |  | (2.3       | )% |  | (6.8       | )% |  | (3.6        | )%
|Other income (expense)                            |  |                      |    |  |            |    |  |            |    |  |             |   
|Interest expense                                  |  | (1.0                 | )% |  | (0.9       | )% |  | (1.1       | )% |  | (1.1        | )%
|Interest income                                   |  | 0.4                  | %  |  | 0.4        | %  |  | *          |    |  | *           |   
|Gain on sale of Japan Rights                      |  | 32.3                 | %  |  | 29.9       | %  |  | *          |    |  | *           |   
|Miscellaneous income (expense)                    |  | 0.1                  | %  |  | 0.1        | %  |  | 0.1        | %  |  | 0.1         | % 
|Loan guarantee fee expense                        |  | (0.1                 | )% |  | (0.1       | )% |  | (0.7       | )% |  | (0.4        | )%
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|Income (loss) before income taxes                 |  | 21.1                 | %  |  | 27.1       | %  |  | (8.5       | )% |  | (5.0        | )%
|Income taxes                                      |  | (0.6                 | )% |  | (0.6       | )% |  | (0.1       | )% |  | (0.1        | )%
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   
|Net income (loss)                                 |  | 20.5                 | %  |  | 26.5       | %  |  | (8.6       | )% |  | (5.1        | )%
|                                                  |  |                      |    |  |            |    |  |            |    |  |             |   

---

|* |  | Amount is less than 0.1%
|- |  | ------------------------



29



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##### Table of Contents

Earnings before Interest, Taxes, Depreciation and Amortization



Earnings before interest, taxes, depreciation and amortization
(EBITDA) is a financial measurement we use to measure our operating performance, excluding the effects of financing costs, income taxes, and non-cash depreciation and amortization. We view EBITDA as a key indicator of our operating
business performance. We expect to continue to incur these excluded items: interest income, interest expense based on our outstanding debt, income taxes, and depreciation and amortization as we will continue to have long-lived assets.



Regulation S-K (Item 10(e)) and other provisions of the Exchange Act of 1934
define and prescribe the conditions for use of certain non-GAAP financial information. We believe that our EBITDA information, which meets the definition of a non-GAAP financial measure, is important supplemental information to
investors.



We use EBITDA for internal managerial purposes and
as a means to evaluate period-to-period comparisons. This non-GAAP financial measure is used in addition to and in conjunction with results presented in accordance with generally accepted accounting principles (GAAP) and should not be
relied upon to the exclusion of GAAP financial measures. EBITDA information reflects an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial
measures, provide a more complete understanding of factors and trends affecting our business. We strongly encourage investors to review our financial statements and publicly filed reports in their entirety and to not rely on any single financial
measure.



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



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



Earnings before interest, taxes, depreciation and amortization is computed
as follows (dollars in thousands):



|                                                               |  |                    |        |              |   |        |               |  |   |        |  
|-------------------------------------------------------------- |  | ------------------ | ------ | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                               |  | Fiscal Years Ended |       
|                                                               |  | April 2,2006       |        | April 3,2005 |   |        | March 28,2004 | 
|Net income (loss)                                              |  | $                  | 15,423 |              | $ | (4,625 | )             |  | $ | (2,595 | )
|Add back amounts for computation of EBITDA                     |  |                    |        |              |   |        |               |  |   |        |  
|Interest income, interest expense, and loan guarantee fees     |  |                    | 385    |              |   | 924    |               |  |   | 760    |  
|Income taxes                                                   |  |                    | 339    |              |   | 52     |               |  |   | 43     |  
|Depreciation and amortization                                  |  |                    | 3,529  |              |   | 3,651  |               |  |   | 3,622  |  
|                                                               |  |                    |        |              |   |        |               |  |   |        |  
|Earnings before interest, taxes, depreciation and amortization |  | $                  | 19,676 |              | $ | 2      |               |  | $ | 1,830  |  
|                                                               |  |                    |        |              |   |        |               |  |   |        |  



Fiscal Year Ended April 2,
2006 Compared To Fiscal Year Ended April 3, 2005



During Fiscal 2006, we introduced new products to customers with promotions that included free trial and discount pricing offers, and implemented programs to improve retail store service levels, including increases in store
staffing and new training programs. These ongoing initiatives are having negative financial effects in the short term, but are intended to grow our retail customer traffic and sales in the future. Due to limited capital availability (before the
Japan Rights sale was completed), we limited our investment in merchandising and marketing programs, remodeling and renovation of existing stores, and opening of new stores.



30



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##### Table of Contents

Net Sales



Our net sales for Fiscal 2006 increased $4,265,000 (or 7.9%) to $58,245,000 as compared to net sales of $53,980,000 for
Fiscal 2005. The increase in net sales is comprised as follows:



|                                                                                                                     |  |                                |        |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | -
|Total company Fiscal year ended
April 2, 2006 compared to the fiscal year ended April 3, 2005 (dollars in thousands) |  | Increase(Decrease) inNet Sales |       
|Sales of products                                                                                                    |  | $                              | 1,733  |  
|Licenses, royalties and fees                                                                                         |  |                                | (1,392 | )
|Recognition of deferred license revenue                                                                              |  |                                | 3,924  |  
|                                                                                                                     |  |                                |        |  
|Net sales                                                                                                            |  | $                              | 4,265  |  
|                                                                                                                     |  |                                |        |  



Sales of products
increased by $1,733,000, or 3.5%, as the result of increased product sales in our Wholesale division, partially offset by decreased product sales in our Retail division as described below, and offset by the effects of having 52 weeks of product
sales in our Retail and Wholesale divisions in Fiscal 2006 as compared to 53 weeks in Fiscal 2005 (this extra week in Fiscal 2005 represented $955,000 of product sales). As the result of the Japan Rights sale and the related termination of our
license and supply agreements with Tullys Coffee Japan, there was a one-time accelerated recognition of $4,405,000 of deferred license revenue in Fiscal 2006, and licenses, royalties and fees decreased due to the cessation of such fees from
Tullys Coffee Japan after July 31, 2005. The divisional increase (decrease) in net sales was comprised as follows:



|                                                                                                                     |  |                                |        |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | -
|Total company Fiscal year ended
April 2, 2006 compared to the fiscal year ended April 3, 2005 (dollars in thousands) |  | Increase(Decrease) inNet Sales |       
|Retail division                                                                                                      |  | $                              | (1,908 | )
|Wholesale division                                                                                                   |  |                                | 3,671  |  
|Specialty division                                                                                                   |  |                                | 2,502  |  
|                                                                                                                     |  |                                |        |  
|Total Company                                                                                                        |  | $                              | 4,265  |  
|                                                                                                                     |  |                                |        |  



The Retail division
sales decrease represented a 4.8% decrease (comparable store sales decrease of 2.1%) compared to Retail division sales for Fiscal 2005. The factors comprising this sales decrease are summarized as follows:



|                                                                                                                                                        |  |                                |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | -
|Retail division Components of net
sales increase Fiscal year ended April 2, 2006 compared to the fiscal year ended April 3, 2005 (dollars in thousands) |  | Increase(Decrease) inNet Sales |       
|Comparable stores sales decrease                                                                                                                        |  | $                              | (774   | )
|Sales decrease from stores closed in Fiscal 2006 and Fiscal 2005                                                                                        |  |                                | (906   | )
|Sales increase from new stores                                                                                                                          |  |                                | 570    |  
|Other                                                                                                                                                   |  |                                | (66    | )
|Sales from 53rdweek in Fiscal 2005                                                                                                                      |  |                                | (732   | )
|                                                                                                                                                        |  |                                |        |  
|Total Retail division                                                                                                                                   |  | $                              | (1,908 | )
|                                                                                                                                                        |  |                                |        |  



Wholesale division net
sales increased $3,671,000, or 38.6%, to $13,187,000 for Fiscal 2006, from $9,516,000 for Fiscal 2005. The increase reflects a $2,782,000 sales increase in the grocery channel, due to growth in the number of supermarkets selling Tullys coffees
and expanded product selections in current supermarkets, combined with increased sales in food service channels. Fiscal 2005 included a 53rdweek, for which Wholesale division sales totaled $223,000.



Net sales for the Specialty division increased by $2,502,000, or 57.4%, to $6,864,000 in Fiscal 2006 from $4,362,000 in Fiscal 2005, reflecting the one-time accelerated recognition of $4,405,000 of deferred license
revenue in Fiscal 2006, offset by the other effects of the Japan Rights sale as described above.



31



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##### Table of Contents

Operating Expenses



The accelerated recognition of $4,405,000 of deferred license revenues in the Fiscal 2006, which had no associated cost of
good sold and only $55,000 of associated expenses, impacted the comparability of Fiscal 2006 amounts as a percentage of net sales as compared with Fiscal 2005. For purposes of comparability, the pro forma percentage of sales amounts shown in the
table above (which exclude the effects from the accelerated recognition of these deferred license revenues in Fiscal 2006) are presented in the discussion which follows.



Cost of goods sold and related occupancy costs increased $3,240,000, or 13.6%, to $27,097,000 for Fiscal 2006 as compared to
$23,857,000 in Fiscal 2005. The increase reflects approximately $2,400,000 of cost of goods sold for increased sales of our Wholesale division in Fiscal 2006 and approximately $800,000 of increased costs for green coffee with the new coffee crop. As
a percentage of net sales, cost of goods sold and related occupancy costs increased to 50.3% (pro forma) for Fiscal 2006 as compared to 44.2% for Fiscal 2005, with approximately one third of this resulting from the sales mix change (sales of the
Retail division and the Specialty division typically have higher gross margins than the Wholesale division) in Fiscal 2006 compared to Fiscal 2005 and the remaining two thirds resulting primarily from higher product costs (including coffee) and from
higher levels of sales discounts and allowances in the Wholesale division. Additionally, the Retail division gross margin was lower in Fiscal 2006 compared to Fiscal 2005, reflecting the product discount strategies described above and higher product
costs.



Store operating expenses decreased $246,000, or 1.4%,
to $17,095,000 for Fiscal 2006 as compared to $17,341,000 in Fiscal 2005 as the result of $129,000 of costs from the 53rdweek in Fiscal 2005 and cost reductions associated with the closure of stores not meeting our financial requirements, offset by costs of new stores and increased labor costs. As a percentage of net sales, store operating expenses
decreased to 31.8% (pro forma) for Fiscal 2006 as compared to 32.1% for Fiscal 2005.



Other operating expenses (expenses associated with all operations other than retail stores) increased $775,000 or 28.0% to $3,538,000 for Fiscal 2006 as compared to $2,763,000 in Fiscal 2005, reflecting $398,000 of
additional expenses incurred in connection with the expansion of our Wholesale division business, and $277,000 of increased costs incurred by the Specialty division for the acquisition and development of new customers and new markets. As a
percentage of net sales, other operating expenses increased to 6.6% (pro forma) for Fiscal 2006 as compared to 5.1% in Fiscal 2005.



Marketing, general and administrative costs decreased $219,000, or 2.7%, to $7,844,000 for Fiscal 2006 as compared to $8,063,000 for Fiscal 2005,
reflecting the inclusion in Fiscal 2005 of severance and related costs of $402,000 from the resignation of our then-president and $36,000 of costs from the 53rdweek in Fiscal 2005.



Depreciation and amortization expense decreased $122,000, or 3.3%, to $3,529,000 for Fiscal 2006 as compared to $3,651,000 in Fiscal 2005, reflecting a lower level of depreciable asset book value in Fiscal 2006 and $68,000 of expense from
the 53rdweek in Fiscal 2005.



During Fiscal 2004 we entered into preliminary discussions with Tullys Coffee Japan about the possibility of
integrating our business with Tullys Coffee Japan, which were terminated in Fiscal 2005. In Fiscal 2005, we incurred fees and other expenses of $129,000, but we did not incur such fees in Fiscal 2006.



During Fiscal 2006 and Fiscal 2005, we performed reviews of our long-lived
assets to determine whether such assets were impaired (see Note 8 of the Notes to the Consolidated Financial Statements). These reviews determined that impairments did exist, and a non-cash charge of $236,000 was recognized in Fiscal 2006 compared
to the non-cash impairment charge of $200,000 during Fiscal 2005.



During Fiscal 2006, we incurred store closure and lease termination costs of $219,000 in connection with the closure of stores that did not meet our financial criteria, as compared to $43,000 of such costs in Fiscal 2005.



Operating Loss



As a result of the factors described above, we had an operating loss of
$1,313,000 for Fiscal 2006, which is reduction in loss of $2,382,000 (64.5%) as compared to the operating loss of $3,695,000 during Fiscal 2005.



32



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##### Table of Contents

Other Income (Expense)



During Fiscal 2006, Tullys recognized a gain of $17,392,000 on the Japan Rights sale.



Interest income increased $205,000 to $208,000 for Fiscal 2006 as compared to
$3,000 during Fiscal 2005 due to the increase of the amount of cash invested in interest bearing accounts after the proceeds from the Japan Rights sale were received in Fiscal 2006.



Interest expense decreased $43,000, or 7.5%, to $527,000 for Fiscal 2006 as compared to $570,000 during Fiscal 2005 due to
lower outstanding debt during Fiscal 2006, partially offset by the effects of higher interest rates on outstanding debt during Fiscal 2006 as compared to Fiscal 2005, and $32,000 of interest expense from a multi-year state tax audit completed in
Fiscal Quarter 2006.



During Fiscal 2006 we incurred loan
guarantee fee expense of $66,000 from the non-cash compensation (paid with warrants) to the guarantors of the credit facility, as compared to $357,000 in Fiscal 2005. The decrease resulted primarily from the repayment of the related debt.



Income Taxes



Income tax expense increased $287,000 to $339,000 for Fiscal 2006 as
compared to $52,000 during Fiscal 2005 due to the income tax consequences from the Japan Rights sale in Fiscal 2006, offset by a reduction in foreign tax expense associated with the cessation of taxable revenues from Tullys Coffee Japan after
July 31, 2005. The gain recognized on the Japan Rights sale is generally sheltered from income tax due to our net operating loss carryforwards, but in Fiscal 2006 we recognized $335,000 of state income taxes and federal alternative minimum tax
(AMT) related to this sale.



Net Income (Loss)



As a result of Japan Rights sale and the other factors
described above, net income increased $20,048,000 to $15,423,000 during Fiscal 2006, as compared to a loss of $4,625,000 during Fiscal 2005.



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



As a result of the Japan Rights sale and other factors described above, we had EBITDA of $19,676,000 for Fiscal 2006, which
is an increase of $19,674,000 as compared to the EBITDA of $2,000 for Fiscal 2005.



Fiscal Year Ended April 3, 2005 Compared To Fiscal Year Ended March 28, 2004



Net Sales



Our net sales for Fiscal 2005 increased $3,212,000 (or 6.3%) to $53,980,000 as compared to net sales of $50,768,000 for Fiscal 2004. The increase in net
sales is comprised as follows:



|                                                                                                                      |  |                                |      
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | -----
|Total company Fiscal year ended
April 3, 2005 compared to the fiscal year ended March 28, 2004 (dollars in thousands) |  | Increase(Decrease) inNet Sales
|Sales of products                                                                                                     |  | $                              | 2,218
|Licenses, royalties and fees                                                                                          |  |                                | 994  
|                                                                                                                      |  |                                |      
|Net sales                                                                                                             |  | $                              | 3,212
|                                                                                                                      |  |                                |      



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Sales of products increased by $2,218,000, or 4.7%, as the result of increased product sales in our
Wholesale division, and due to having 53 weeks of product sales in Fiscal 2005 as compared to 52 weeks in Fiscal 2004 (this extra week in Fiscal 2005 represented $955,000 of product sales), which was partially offset by decreased product sales in
our Retail division as described below. The divisional increase or decrease in net sales was comprised as follows:



|                                                                                                                      |  |                                |       |  
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ----- | -
|Total company Fiscal year ended
April 3, 2005 compared to the fiscal year ended March 28, 2004 (dollars in thousands) |  | Increase(Decrease) inNet Sales |      
|Retail division                                                                                                       |  | $                              | (515  | )
|Wholesale division                                                                                                    |  |                                | 2,994 |  
|Specialty division                                                                                                    |  |                                | 733   |  
|                                                                                                                      |  |                                |       |  
|Total Company                                                                                                         |  | $                              | 3,212 |  
|                                                                                                                      |  |                                |       |  



Retail division sales
reflect a 1.3% decrease (comparable store sales decrease of 2.0%) compared to Retail division sales for Fiscal 2004. The factors comprising this sales decrease are summarized as follows:



|                                                                                                                                                         |  |                                |      |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ---- | -
|Retail division Components of net
sales increase Fiscal year ended April 3, 2005 compared to the fiscal year ended March 28, 2004 (dollars in thousands) |  | Increase(Decrease) inNet Sales |     
|Comparable stores sales decrease                                                                                                                         |  | $                              | (791 | )
|Sales decrease from stores closed in Fiscal 2005 and Fiscal 2004                                                                                         |  |                                | (973 | )
|Sales increase from new stores                                                                                                                           |  |                                | 297  |  
|Other                                                                                                                                                    |  |                                | 220  |  
|Sales from 53rdweek in Fiscal 2005                                                                                                                       |  |                                | 732  |  
|                                                                                                                                                         |  |                                |      |  
|Total Retail division                                                                                                                                    |  | $                              | (515 | )
|                                                                                                                                                         |  |                                |      |  



Wholesale division net
sales increased $2,994,000, or 45.9%, to $9,516,000 for Fiscal 2005, from $6,522,000 for Fiscal 2004. The increase reflects a $2,271,000 sales increase in the grocery channel, due primarily to growth in the number of supermarkets selling
Tullys coffees, combined with increased sales in food service channels. Fiscal 2005 included a 53rdweek, for
which Wholesale division sales totaled $223,000.



Net sales for
the Specialty division increased by $733,000, or 20.2%, to $4,362,000 in Fiscal 2005 from $3,629,000 in Fiscal 2004, reflecting the increase in royalties and coffee roasting fees that resulted from growth in the number of stores operated by
Tullys Coffee Japan.



Operating Expenses



Cost of goods sold and related occupancy costs increased
$1,704,000, or 7.7%, to $23,857,000 for Fiscal 2005 as compared to $22,153,000 in Fiscal 2004, primarily due to the cost of goods sold related to the increased sales of our Wholesale division. As a percentage of net sales, cost of goods sold and
related occupancy costs increased to 44.2% for the Fiscal 2005 as compared to 43.6% for Fiscal 2004, primarily as a result of growth in Wholesale division sales (which generally have a greater cost of sales percentage than Retail division and
Specialty division sales).



Store operating expenses increased
$418,000, or 2.5%, to $17,341,000 for Fiscal 2005 as compared to $16,923,000 in Fiscal 2004 as the result of $129,000 of costs from the 53rdweek in Fiscal 2005, costs of new stores and increased labor costs in Fiscal 2005, partially offset by cost reductions associated with closure of stores not meeting our financial requirements. As a percentage of net sales,
store operating expenses declined to 32.1% for Fiscal 2005 from 33.3% for Fiscal 2004.



Other operating expenses (expenses associated with all operations other than retail stores) increased $749,000 or 37.2% to $2,763,000 for Fiscal 2005 as compared to $2,014,000 in Fiscal 2004, reflecting the



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expenses incurred in connection with the expansion of our Wholesale division business, and including $6,000 of costs from the 53rdweek in Fiscal 2005. As a percentage of net sales, other operating expenses increased to 5.1% for Fiscal 2005 as compared to
4.0% in Fiscal 2004.



Marketing, general and administrative
costs increased $969,000, or 13.7%, to $8,063,000 for Fiscal 2005 as compared to $7,094,000 for Fiscal 2004, reflecting accrual of severance and related costs of $402,000 from the resignation of our then-president, $36,000 of costs from the
53rdweek in Fiscal 2005 and increased labor costs during Fiscal 2005.



Depreciation and amortization expense increased $29,000, or 0.8%, to
$3,651,000 for Fiscal 2005 as compared to $3,622,000 in Fiscal 2004 as the result of $47,000 of depreciation and amortization expense from the 53rdweek in Fiscal 2005.



In February 2004 a lawsuit was filed against Tullys in California state court by two former store managers on behalf of themselves and on behalf of other former and current store managers in the state of California. We have entered
into a preliminary agreement regarding the settlement of this matter. In Fiscal 2005, Tullys incurred a charge of approximately $1,628,000 for the settlement and associated costs of this lawsuit (see Note 16 of the notes to the Consolidated
Financial Statements).



During Fiscal 2004 we entered into
preliminary discussions with Tullys Coffee Japan about the possibility of integrating our business with Tullys Coffee Japan. On May 12, 2004, we reported that we have ceased discussions with Tullys Coffee Japan. In connection
with these discussions and the evaluation of this business integration opportunity, we incurred fees and other expenses of $129,000 in Fiscal 2005 and $541,000 in Fiscal 2004.



During Fiscal 2005 and Fiscal 2004, we performed reviews of our long-lived assets to determine whether such assets were
impaired (see Note 8 of the Notes to the Consolidated Financial Statements). These reviews determined that impairments did exist, and a non-cash charge of $200,000 was recognized in Fiscal 2005 compared to the non-cash impairment charge of $97,000
during Fiscal 2004.



During Fiscal 2005, we incurred store
closure and lease termination costs of $43,000 in connection with the closure of stores that did not meet our financial criteria. Tullys incurred $170,000 such costs in connection with the closure of stores during Fiscal 2004.



Operating Loss



As a result of the litigation settlement charge of $1,628,000 and the other
factors described above, we had an operating loss of $3,695,000 for Fiscal 2005, which is an increase of $1,849,000 (89.3%) as compared to the operating loss of $1,846,000 during Fiscal 2004.



Other Income (Expense)



Interest expense increased $33,000, or 6.1%, to $570,000 for Fiscal 2005 as
compared to $537,000 during Fiscal 2004 due to higher rates of cash interest on outstanding debt during Fiscal 2005 and the replacement of non-cash warrant interest with cash interest for the convertible promissory note commencing January 2005.



During Fiscal 2005 we incurred loan guarantee fee expense of
$357,000 from the non-cash compensation (paid with warrants) to the guarantors of the credit facility (see Note 11 of the Notes to the Consolidated Financial Statements). This increase was due to a higher share valuation associated with the
measurement of this expense in the fourth quarter of Fiscal 2005.



Net Income (Loss)



As a result of the
litigation settlement charge and the other factors described above, net loss increased $2,030,000 to $4,625,000 during Fiscal 2005, as compared to a net loss of $2,595,000 during Fiscal 2004.



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



As a result of the litigation settlement charge and the other factors
described above, we had EBITDA of $2,000 for Fiscal 2005, which is a decrease of $1,828,000 as compared to EBITDA of $1,830,000 during Fiscal 2004.



Liquidity and Capital Resources



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



|                                                                            |  |                        |         |   |              |   |        |               |  |   |        |  
|--------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                                            |  | Fiscal Years Ended     |        
|                                                                            |  | April 2,2006           |         |   | April 3,2005 |   |        | March 28,2004 | 
|                                                                            |  | (dollars in thousands) |        
|STATEMENTS OF CASH FLOWS DATA                                               |  |                        |         |   |              |   |        |               |  |   |        |  
|Cash provided by (used for):                                                |  |                        |         |   |              |   |        |               |  |   |        |  
|Net income (loss)                                                           |  | $                      | 15,423  |   |              | $ | (4,625 | )             |  | $ | (2,595 | )
|Gain on sale of Japan Rights                                                |  |                        | (17,392 | ) |              |   |       |               |  |   |       |  
|Adjustments for depreciation and other non-cash operating statement amounts |  |                        | (1,626  | ) |              |   | 2,474  |               |  |   | 2,376  |  
|                                                                            |  |                        |         |   |              |   |        |               |  |   |        |  
|Net income (loss) adjusted for non-cash operating statement amounts         |  |                        | (3,595  | ) |              |   | (2,151 | )             |  |   | (219   | )
|Deferred revenue cash received                                              |  |                        | 25      |   |              |   |       |               |  |   | 500    |  
|Cash provided (used) for other changes in assets and liabilities            |  |                        | (3,511  | ) |              |   | 3,495  |               |  |   | 1,006  |  
|                                                                            |  |                        |         |   |              |   |        |               |  |   |        |  
|Net cash provided by (used in) operating activities                         |  |                        | (7,081  | ) |              |   | 1,344  |               |  |   | 1,287  |  
|Net proceeds from Japan Rights sale                                         |  |                        | 17,392  |   |              |   |       |               |  |   |       |  
|Purchases of property and equipment and other                               |  |                        | (2,369  | ) |              |   | (564   | )             |  |   | (286   | )
|Net borrowings (repayments) of debt and capital leases                      |  |                        | (4,004  | ) |              |   | (909   | )             |  |   | (761   | )
|Proceeds from equity transactions                                           |  |                        | 6       |   |              |   | 319    |               |  |   | 14     |  
|                                                                            |  |                        |         |   |              |   |        |               |  |   |        |  
|Net increase in cash and cash equivalents                                   |  | $                      | 3,944   |   |              | $ | 190    |               |  | $ | 254    |  
|                                                                            |  |                        |         |   |              |   |        |               |  |   |        |  



Overall, our operating
activities, investing activities, and financing activities provided $3,944,000 of cash during Fiscal 2006 as compared to $190,000 of cash provided during Fiscal 2005 and $254,000 provided in Fiscal 2004.



As discussed in Note 13 of the Notes to the Consolidated Financial
Statements, on August 31, 2005 we sold the Japan Rights for $17,500,000. This transaction has resulted in improved liquidity and capital resources for Tullys. As a consequence of the Japan Rights sale, Tullys will not receive the
operating cash flows from license fees and coffee roasting fees from Tullys Coffee Japan after July 31, 2005. During Fiscal 2006, our operating cash flows included $811,000 from license fees and coffee roasting fees, as compared to
$2,234,000 in Fiscal 2005. We have used proceeds from the Japan Rights sale primarily to (1) repay our promissory note with Kent Central LLC (KCL) and our convertible note, which has reduced the level of borrowings by Tullys
and reduced our future obligations for payments of principal and interest, (2) reduce our levels of accounts payable and accrued liabilities, and (3) fund a higher level of capital expenditures compared to the previous year.



Cash used in operating activities for Fiscal 2006 was $7,081,000, a change of
$8,425,000 compared to Fiscal 2005 when operating activities provided cash of $1,344,000. This related primarily to a $7,117,000 difference in cash used for accounts payable and accrued liabilities: during Fiscal 2006, we used $2,534,000 of cash to
reduce the level of accounts payable and accrued liabilities, but in Fiscal 2005 cash of $4,583,000 was provided by an increase in accounts payable and accrued liabilities. Operating activities provided cash of $1,287,000 in Fiscal 2004.
Additionally, increased accounts receivable used cash of $813,000 during Fiscal 2006, primarily as the result of increased Wholesale division sales and the timing of customer payments, and increased inventories used cash of $600,000 as the result of
higher coffee costs and increased stocking levels for some products in support of sales increase objectives.



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Investing activities provided cash of $15,023,000 in Fiscal 2006. This reflected the net proceeds
received from the Japan Rights sale of $17,392,000, offset by cash used for capital expenditures of $2,307,000 in Fiscal 2006. Investing activities used cash of $564,000 in Fiscal 2005 and $286,000 in Fiscal 2004. In Fiscal 2005 and Fiscal 2004, we
minimized our investing activities as part of our strategy for conservative use of capital. Cash invested for capital expenditures increased in Fiscal 2006 compared to Fiscal 2005 and Fiscal 2004 due to increased investments for new stores and
improvements to existing retail stores. Cash used for capital expenditures was $2,307,000 in Fiscal 2006, $560,000 in Fiscal 2005 and $320,000 in Fiscal 2004.



Financing activities used cash of $3,998,000 in Fiscal 2006, $590,000 in Fiscal 2005, and $747,000 in Fiscal 2004. In each year, the primary financing
activity was repayment of debt and capital leases. In Fiscal 2005, the shareholder rights offering provided cash of $243,000 (after payment of offering costs).



As of April 2, 2006, we had cash and cash equivalents of $5,381,000, and working capital of $807,000. Because we principally operate as a
cash retail business, we generally do not require a significant net investment in working capital and historically have operated with current liabilities in excess of our current assets. Our inventory levels typically increase during the
spring due to coffee crop seasonality and, to a lesser degree, during the autumn due to holiday season merchandise. Inventories are also subject to short-term fluctuations based upon the timing of coffee receipts and Wholesale division shipments.
Tullys expects that its investment in accounts receivable and inventories will increase, primarily as the result of anticipated sales growth in the Wholesale division.



Cash requirements for Fiscal 2007, other than normal operating expenses and the commitments described below and in the
consolidated financial statements and notes, are expected to consist primarily of capital expenditures related to the opening of new company-operated stores and the remodeling of other company-operated stores, and equipment and accounts receivable
related to new Wholesale division business. We expect our investment in property and equipment during Fiscal 2007 to be comparable to the level of investment made in Fiscal 2006. During Fiscal 2007, we expect that the majority of the new
Tullys stores in the United States and in foreign markets (outside of Japan) will be franchised and licensed stores, rather than company-operated stores. Franchised and licensed stores do not require capital investment in property and
equipment by Tullys, but we do incur selling and support costs for such new stores related to store opening, training, and quality control. We expect to open between six and ten new company-operated stores in Fiscal 2007. Typically, a new
company-operated store will require capital investment of approximately $200,000 to $400,000, but this varies depending on the specific location. Some of these capital expenditures may be accomplished through operating or capital leases. We expect
to maintain a secured credit facility, such as our current Northrim facility, as a financing resource for our working capital requirements.



Liabilities at April 2, 2006 include deferred revenue in the aggregate amount of $4,367,000. We will liquidate the deferred revenue balance through
recognition of non-cash revenues in future periods, rather than through cash payments. The future cash expenses associated with this deferred revenue balance are expected to be less than $300,000.



We believe that the operating cash flows, financing cash flows, and investing
cash flows projected for Fiscal 2007, and the cash and cash equivalents of $5,381,000 at April 2, 2006, and our credit facility will be sufficient to fund ongoing operations of Tullys through Fiscal 2007. Accordingly, we do not anticipate
that additional equity or long-term debt capital will be required during Fiscal 2007 to sustain current operations and meet our current obligations. However, we may seek additional capital during Fiscal 2007 in order to fund a higher level of growth
than described above.



We do not have any off-balance sheet
arrangements as of April 2, 2006.



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The following table summarizes our principal financial commitments (other than ordinary trade obligations
such as accounts payable and accrued liabilities) as of April 2, 2006:



|                           |  |                             |        |            |   |            |  |            |       |            |   |            |  |            |       |  |   |       |  |   |    
|-------------------------- |  | --------------------------- | ------ | ---------- | - | ---------- |  | ---------- | ----- | ---------- | - | ---------- |  | ---------- | ----- |  | - | ----- |  | - | ---
|                           |  | Payments Due by Fiscal Year
|                           |  | Total                       |        | Fiscal2007 |   | Fiscal2008 |  | Fiscal2009 |       | Fiscal2010 |   | Fiscal2011 |  | Thereafter
|                           |  | (dollars in thousands)     
|Northrim facility          |  | $                           | 1,901  |            | $ | 1,901      |  | $          |      |            | $ |           |  | $          |      |  | $ |      |  | $ |   
|Other debt                 |  |                             | 253    |            |   | 225        |  |            | 10    |            |   | 10         |  |            | 8     |  |   |      |  |   |   
|Capital leases             |  |                             | 190    |            |   | 100        |  |            | 45    |            |   | 23         |  |            | 15    |  |   | 7     |  |   |   
|Operating leases           |  |                             | 18,266 |            |   | 5,100      |  |            | 4,443 |            |   | 3,744      |  |            | 3,076 |  |   | 1,301 |  |   | 602
|Green coffee purchases (1) |  |                             | 8,600  |            |   | 8,600      |  |            |      |            |   |           |  |            |      |  |   |      |  |   |   
|Executive severance (2)    |  |                             | 50     |            |   | 50         |  |            |      |            |   |           |  |            |      |  |   |      |  |   |   
|                           |  |                             |        |            |   |            |  |            |       |            |   |            |  |            |       |  |   |       |  |   |    
|                           |  | $                           | 29,260 |            | $ | 15,976     |  | $          | 4,498 |            | $ | 3,777      |  | $          | 3,099 |  | $ | 1,308 |  | $ | 602
|                           |  |                             |        |            |   |            |  |            |       |            |   |            |  |            |       |  |   |       |  |   |    

---

|(1) |  | As of April 2, 2006, we had contracts with fixed-price coffee purchase commitments and we also had commitments to purchase coffee at prices to be determined by future coffee
market indices (permitting us to fix the price prior to delivery, based on the then-current market). In June 2006, we exercised our option to fix the pricing for these remaining contracts. As of June 19, 2006, we had approximately $7,000,000 in
fixed price purchase commitments for Fiscal 2007.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Pursuant to the employment letters for members of Tullys senior management team, Tullys has agreed to pay severance compensation to these executives in the event their
employment by Tullys is terminated for reasons other than certain excluded circumstances. The amount of severance to be paid would depend upon the rate of salary at the time of termination and other factors. As of April 2, 2006, the
aggregate contingent obligation for severance to these individuals was approximately $370,000. Accrued liabilities at April 2, 2006 include accrued severance costs related to our former president in the amount of $50,000.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In Fiscal 2007 we expect to give more attention
to growth of the business, including a higher rate of new company-operated store openings compared to recent years, while continuing our focus on improving operating results. If we were to seek a higher growth rate than reflected in our current
business plans, we believe that additional sources of funding would be required to fund this increased capital investment. Further, if our actual results should differ unfavorably from the Fiscal 2007 business plan, it could become necessary for us
to seek additional capital during Fiscal 2007. Tullys expects that additional sources of funding will be required in subsequent periods to fund capital expenditures required for growth of the business and for other business needs. Such
additional sources of funding are expected to include debt or equity financings.



If the pricing or terms for any new financing do not meet our expectations, we may be required to choose between completion of the financing on such unfavorable terms or not completing the financing. If other sources
of capital are unavailable, or are available only on a limited basis or under unacceptable terms, then we could be required to reduce operating, marketing, general and administrative costs related to our continuing operations, or reduce or
discontinue our investments in store improvements, new customers and new products. In addition, we could be required to sell individual or groups of stores or other assets (such as wholesale distribution territories) and could be unable to take
advantage of business opportunities or respond to competitive pressures. Store sales would involve the assignment or sub-lease of the store location (which may require the lessors consent) and the sale of the store equipment, leasehold
improvements and related assets. The proceeds received from the sale of stores or other assets might not be sufficient to satisfy our capital needs, and the sale of better-performing stores or other income-producing assets could adversely affect our
future operating results and cash flows.



Application of Critical Accounting
Policies



We have identified the policies below as
critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Managements Discussion and Analysis of
Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 of the Notes to the Consolidated
Financial



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Statements. Note that our preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amount
of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not
differ from those estimates.



Our discussion and analysis of
our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. We believe the following critical
accounting policies affect our more significant judgments and estimates used in our consolidated financial statements, and should be read in conjunction with the Consolidated Financial Statements. Our critical accounting policies relate particularly
to (1) revenue recognition, (2) evaluation for impairment of long-lived assets, and (3) lease termination reserves.



Revenue recognition



Sales are generally recognized at the time of the sale at retail store locations. Sales for the Wholesale and Specialty divisions are recognized upon
shipment of the products. Allowances to Wholesale division customers for retail display and distribution positions (such as slotting allowances) are recognized as a reduction in sales, reducing gross profits until fully amortized
(typically a period of two to six months). Other wholesale sales discounts and allowances are recognized in the period earned by the customer. In some instances, the amounts of an allowance or discount will depend upon the actual performance of a
customer for a particular program (such as the number of packages of Tullys product sold in a particular period of time). The actual performance for the program will be determined by the customer and Tullys after the program is
completed. Tullys initially records Managements estimate of the expected results for such programs, and then an adjustment is made, as necessary, when the actual results are reported to Tullys.



Revenues from advance license fees and similar agreements are recognized on
the straight-line basis over the expected life of the agreements (ranging from eight to fifteen years). Managements judgment is involved in determining the applicable amortization periods for these advance license fees. Royalty revenues for
international licensees are recognized in accordance with the license agreements based upon sales at specific licensee store locations. Coffee roasting fees are recognized when the licensee that is subject to the fee purchases coffee. Initial
franchise fees for new stores franchised by Tullys are recognized when Tullys has completed the services required to earn the fee and make it non-refundable, which is generally upon opening of the store. Royalty revenues for stores
franchised by Tullys are recognized in accordance with the franchise agreements based upon sales at the franchised store locations.



Evaluation of long-lived assets for impairment



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



Recognition and measurement of lease
termination reserves



Periodically, we will determine that
certain leases will be terminated and the store or other operation will be closed. At the time when agreements are reached, we accrue for the net future minimum lease payments of the related lease agreements. Amounts accrued as net future minimum
losses include the discounted estimated future rental payments and lease termination fees, and estimated sub-lease recoveries.



New Accounting Standards



See Note 1 of the Notes to the Consolidated Financial Statements.



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##### Table of Contents

|ITEM 7A. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- |  | ----------------------------------------------------------



The supply and price of coffee beans are subject to significant volatility and can be affected by multiple factors in producing countries, including
weather, political and economic conditions. In addition, green coffee bean prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations that have historically attempted to
influence commodity prices of green coffee beans through agreements establishing export quotas or restricting coffee bean supplies worldwide. In order to limit the cost exposure of the main commodity used in our business, we enter into fixed-price
purchase commitments. Typically, Tullys has entered into contracts for the next seasons delivery of green coffee beans to help ensure adequacy of supply. As of April 2, 2006, we had contracts with fixed-price coffee purchase
commitments and we also had commitments to purchase coffee at prices to be determined by future coffee market indices (permitting us to fix the price prior to delivery, based on the then-current market). In June 2006, we exercised our option to fix
the pricing for these remaining contracts. As of June 19, 2006, we had approximately $7,000,000 in fixed price purchase commitments for Fiscal 2007. However, we estimate that a ten percent increase in coffee bean pricing could reduce operating
income by $600,000 to $900,000 annually if we were unable to adjust our retail prices. We currently have no foreign currency exchange rate exposure related to our purchasing of coffee beans because all transactions are denominated in U.S. dollars.



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##### Table of Contents

|ITEM 8. |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- |  | -------------------------------------------



The following consolidated financial statements, and related notes thereto, of Tullys Coffee Corporation, and the Report of Independent Registered
Public Accounting Firm, are filed as a part of this Annual Report on Form 10-K.



Index to Consolidated Financial Statements



|                                                                                                                                          |  |           
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ----------
|                                                                                                                                          |  | PageNumber
|Report of Independent Registered Public Accounting Firm                                                                                   |  | 42        
|Consolidated Balance SheetsApril 2, 2006 and April 3, 2005                                                                               |  | 43        
|Consolidated Statements of Operations for the years ended April 2, 2006, April 3, 2005, and March 28, 2004                                |  | 44        
|Consolidated Statements of Changes in Stockholders Equity (Deficit) for the years ended April 2, 2006, April 3, 2005, and March 28, 2004 |  | 45        
|Consolidated Cash Flow Statements for the years ended April 2, 2006, April 3, 2005, and March 28, 2004                                    |  | 48        
|Notes to Consolidated Financial Statements                                                                                                |  | 50        



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##### Table of Contents

Report of Independent Registered Public Accounting Firm



To the Board of Directors and Stockholders of

Tullys Coffee Corporation.



We have audited the accompanying consolidated balance sheets of Tullys Coffee Corporation as of April 2, 2006 and April 3, 2005 and the related
consolidated statements of operations, stockholders equity (deficit) and cash flows for each of the years in the three-year period ended April 2, 2006, April 3, 2005, and March 28, 2004. These consolidated 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 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial position of Tullys Coffee Corporation as of April 2, 2006 and April 3, 2005, and the consolidated results of its operations and its cash flows for each of the years
in the three-year period ended April 2, 2006, April 3, 2005, and March 28, 2004, in conformity with accounting principles generally accepted in the United States of America.



MOSS ADAMS LLP



Seattle, Washington

July 3, 2006



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##### Table of Contents

Tullys Coffee Corporation



Consolidated Balance Sheets



|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                                                                                                                                                                     |  | April 2,2006                             |         |   | April 3,2005 |  
|                                                                                                                                                                                                                                                                     |  | (dollars in thousands,except share data) |        
|Assets                                                                                                                                                                                                                                                               |  |                                          |         |   |              |   |         |  
|Current assets                                                                                                                                                                                                                                                       |  |                                          |         |   |              |   |         |  
|Cash and cash equivalents                                                                                                                                                                                                                                            |  | $                                        | 5,381   |   |              | $ | 1,437   |  
|Accounts receivable, net of allowance for doubtful accounts of $149 and $171 at 2006 and 2005, respectively                                                                                                                                                          |  |                                          | 2,305   |   |              |   | 1,687   |  
|Inventories                                                                                                                                                                                                                                                          |  |                                          | 3,140   |   |              |   | 2,330   |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                            |  |                                          | 853     |   |              |   | 836     |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Total current assets                                                                                                                                                                                                                                                 |  |                                          | 11,679  |   |              |   | 6,290   |  
|Property and equipment, net                                                                                                                                                                                                                                          |  |                                          | 8,611   |   |              |   | 10,106  |  
|Goodwill, net                                                                                                                                                                                                                                                        |  |                                          | 456     |   |              |   | 523     |  
|Other intangible assets, net                                                                                                                                                                                                                                         |  |                                          | 405     |   |              |   | 500     |  
|Other assets                                                                                                                                                                                                                                                         |  |                                          | 376     |   |              |   | 511     |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Total assets                                                                                                                                                                                                                                                         |  | $                                        | 21,527  |   |              | $ | 17,930  |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Liabilities and Stockholders Equity (Deficit)                                                                                                                                                                                                                       |  |                                          |         |   |              |   |         |  
|Current liabilities                                                                                                                                                                                                                                                  |  |                                          |         |   |              |   |         |  
|Accounts payable                                                                                                                                                                                                                                                     |  | $                                        | 3,398   |   |              | $ | 4,640   |  
|Accrued liabilities                                                                                                                                                                                                                                                  |  |                                          | 3,812   |   |              |   | 5,149   |  
|Current portion of long-term debt                                                                                                                                                                                                                                    |  |                                          | 2,126   |   |              |   | 1,950   |  
|Current portion of capital lease obligations                                                                                                                                                                                                                         |  |                                          | 83      |   |              |   | 128     |  
|Deferred revenue                                                                                                                                                                                                                                                     |  |                                          | 1,453   |   |              |   | 1,838   |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Total current liabilities                                                                                                                                                                                                                                            |  |                                          | 10,872  |   |              |   | 13,705  |  
|Long-term debt, net of current portion                                                                                                                                                                                                                               |  |                                          | 28      |   |              |   | 600     |  
|Capital lease obligation, net of current portion                                                                                                                                                                                                                     |  |                                          | 72      |   |              |   | 112     |  
|Other liabilities                                                                                                                                                                                                                                                    |  |                                          | 1,093   |   |              |   | 1,093   |  
|Deferred lease costs                                                                                                                                                                                                                                                 |  |                                          | 1,421   |   |              |   | 1,616   |  
|Convertible promissory note, net of discount                                                                                                                                                                                                                         |  |                                          |        |   |              |   | 3,000   |  
|Deferred revenue, net of current portion                                                                                                                                                                                                                             |  |                                          | 2,914   |   |              |   | 8,493   |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Total liabilities                                                                                                                                                                                                                                                    |  |                                          | 16,400  |   |              |   | 28,619  |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Commitments and contingencies (Note 16)                                                                                                                                                                                                                              |  |                                          |         |   |              |   |         |  
|Stockholders equity (deficit)                                                                                                                                                                                                                                       |  |                                          |         |   |              |   |         |  
|Series A Convertible Preferred stock, no par value; 31,000,000 shares authorized, 15,559,152 and 15,378,364 issued and outstanding at 2006 and
2005, respectively; stated value of $2.50 per share and a liquidation preference of $38,898 (2006) and $38,446 (2005) |  |                                          | 34,639  |   |              |   | 34,483  |  
|Series A Convertible Preferred stock, to be issued 180,888 Shares                                                                                                                                                                                                    |  |                                          |        |   |              |   | 157     |  
|Common stock, no par value; 120,000,000 shares authorized at 2006 and 2005; 17,769,191 and 17,353,822 shares issued and outstanding at 2006
and 2005, respectively, with a liquidation preference of $39,981 (2006) and $39,046 (2005)                               |  |                                          | 9,610   |   |              |   | 9,384   |  
|Common stock, to be issued 337,216 Shares                                                                                                                                                                                                                            |  |                                          |        |   |              |   | 86      |  
|Series B Convertible Preferred stock, no par value; 8,000,000 shares authorized, 4,920,709 and 4,980,709 issued and outstanding at 2006 and
2005, respectively, stated value of $2.50 per share and a liquidation preference of $12,302 (2006) and $12,452 (2005)    |  |                                          | 10,911  |   |              |   | 11,044  |  
|Deferred stock compensation                                                                                                                                                                                                                                          |  |                                          |        |   |              |   | (22     | )
|Additional paid-in capital                                                                                                                                                                                                                                           |  |                                          | 28,339  |   |              |   | 27,974  |  
|Accumulated deficit                                                                                                                                                                                                                                                  |  |                                          | (78,372 | ) |              |   | (93,795 | )
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Total stockholders equity (deficit)                                                                                                                                                                                                                                 |  |                                          | 5,127   |   |              |   | (10,689 | )
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  
|Total liabilities and stockholders equity (deficit)                                                                                                                                                                                                                 |  | $                                        | 21,527  |   |              | $ | 17,930  |  
|                                                                                                                                                                                                                                                                     |  |                                          |         |   |              |   |         |  



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



43



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##### Table of Contents

Tullys Coffee Corporation



Consolidated Statements of Operations



|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|------------------------------------------------------------------------------------- |  | -------------------------------------------- | ------ | - | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                                                      |  | Years ended                                  |       
|                                                                                      |  | April 2,2006                                 |        |   | April 3,2005 |   |        | March 28,2004 | 
|                                                                                      |  | (dollars in thousands, except pershare data) |       
|Net sales                                                                             |  |                                              |        |   |              |   |        |               |  |   |        |  
|Sales of products                                                                     |  | $                                            | 51,392 |   |              | $ | 49,659 |               |  | $ | 47,441 |  
|Licenses, royalties, and fees                                                         |  |                                              | 842    |   |              |   | 2,234  |               |  |   | 1,240  |  
|Recognition of deferred revenue                                                       |  |                                              | 6,011  |   |              |   | 2,087  |               |  |   | 2,087  |  
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Net sales                                                                             |  |                                              | 58,245 |   |              |   | 53,980 |               |  |   | 50,768 |  
|Cost of goods sold and operating expenses                                             |  |                                              |        |   |              |   |        |               |  |   |        |  
|Cost of goods sold and related occupancy expenses                                     |  |                                              | 27,097 |   |              |   | 23,857 |               |  |   | 22,153 |  
|Store operating expenses                                                              |  |                                              | 17,095 |   |              |   | 17,341 |               |  |   | 16,923 |  
|Other operating expenses                                                              |  |                                              | 3,538  |   |              |   | 2,763  |               |  |   | 2,014  |  
|Marketing, general and administrative costs                                           |  |                                              | 7,844  |   |              |   | 8,063  |               |  |   | 7,094  |  
|Depreciation and amortization                                                         |  |                                              | 3,529  |   |              |   | 3,651  |               |  |   | 3,622  |  
|Settlement of litigation                                                              |  |                                              |       |   |              |   | 1,628  |               |  |   |       |  
|Evaluation of business integration opportunity                                        |  |                                              |       |   |              |   | 129    |               |  |   | 541    |  
|Impairment of long-lived assets                                                       |  |                                              | 236    |   |              |   | 200    |               |  |   | 97     |  
|Store closure and lease termination costs                                             |  |                                              | 219    |   |              |   | 43     |               |  |   | 170    |  
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Total cost of goods sold and operating expenses                                       |  |                                              | 59,558 |   |              |   | 57,675 |               |  |   | 52,614 |  
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Operating loss                                                                        |  |                                              | (1,313 | ) |              |   | (3,695 | )             |  |   | (1,846 | )
|Other income (expense)                                                                |  |                                              |        |   |              |   |        |               |  |   |        |  
|Interest expense                                                                      |  |                                              | (527   | ) |              |   | (570   | )             |  |   | (537   | )
|Interest income                                                                       |  |                                              | 208    |   |              |   | 3      |               |  |   | 4      |  
|Gain on sale of Japan Rights                                                          |  |                                              | 17,392 |   |              |   |       |               |  |   |       |  
|Miscellaneous income                                                                  |  |                                              | 68     |   |              |   | 46     |               |  |   | 54     |  
|Loan guarantee fee expense                                                            |  |                                              | (66    | ) |              |   | (357   | )             |  |   | (227   | )
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Total other income (expense)                                                          |  |                                              | 17,075 |   |              |   | (878   | )             |  |   | (706   | )
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Income (loss) before income taxes                                                     |  |                                              | 15,762 |   |              |   | (4,573 | )             |  |   | (2,552 | )
|Income tax expense                                                                    |  |                                              | 339    |   |              |   | 52     |               |  |   | 43     |  
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Net income (loss)                                                                     |  | $                                            | 15,423 |   |              | $ | (4,625 | )             |  | $ | (2,595 | )
|                                                                                      |  |                                              |        |   |              |   |        |               |  |   |        |  
|Earnings (loss) per sharebasic and diluted                                           |  |                                              |        |   |              |   |        |               |  |   |        |  
|Earnings (loss) per sharebasic                                                       |  | $                                            | 0.87   |   |              | $ | (0.28  | )             |  | $ | (0.16  | )
|Earnings (loss) per sharediluted                                                     |  | $                                            | 0.30   |   |              | $ | (0.28  | )             |  | $ | (0.16  | )
|Weighted average shares used in computing basic and diluted earnings (loss) per share |  |                                              |        |   |              |   |        |               |  |   |        |  
|Earnings (loss) per sharebasic                                                       |  |                                              | 17,697 |   |              |   | 16,812 |               |  |   | 16,451 |  
|Earnings (loss) per sharediluted                                                     |  |                                              | 51,475 |   |              |   | 16,812 |               |  |   | 16,451 |  



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



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##### Table of Contents

Tullys Coffee Corporation



Consolidated Statements of Changes in Stockholders Equity (Deficit)

Years Ended April 2,
2006, April 3, 2005 and March 28, 2004



|                                                                             |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   |        |  |   |      |   |  |   |         |   |  |   |        |  
|---------------------------------------------------------------------------- | --------------- | --------------------------- | --------------- | ------------ | --------------- | ------------------------ | --------------- | ------------------------- | ------ | ------ | ------------------ | ---------- |  | ----- | ----- |  | - | ------ |  | - | ---- | - |  | - | ------- | - |  | - | ------ | -
|(dollars in thousands, except per share data)                                |                 | Convertible Preferred Stock |                 | Common Stock |                 | Additionalpaid-incapital |                 | DeferredStockCompensation |        |        | Accumulateddeficit |            |  | Total |      
|                                                                             | Series A Shares |                             | Series A Amount |              | Series B Shares |                          | Series B Amount |                           | Shares |        | Amount             |            |  |       |      
|Balance, March 30, 2003                                                      |                 | 15,378,264                  |                 | $            | 34,483          |                          | 4,990,709       |                           | $      | 11,066 |                    | 16,409,187 |  | $     | 9,272 |  | $ | 27,435 |  | $ | (161 | ) |  | $ | (86,575 | ) |  | $ | (4,480 | )
|Issuance of common stock warrants under terms of convertible promissory note |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   | 72     |  |   |      |   |  |   |         |   |  |   | 72     |  
|Issuance of common stock warrants as compensation for loan guarantees        |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   | 230    |  |   |      |   |  |   |         |   |  |   | 230    |  
|Amortization of deferred stock compensation                                  |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   |        |  |   | 87   |   |  |   |         |   |  |   | 87     |  
|Stock option expense                                                         |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   | 1      |  |   |      |   |  |   |         |   |  |   | 1      |  
|Exercise of common stock warrants                                            |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    | 82,000     |  |       | 14    |  |   |        |  |   |      |   |  |   |         |   |  |   | 14     |  
|Net loss                                                                     |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   |        |  |   |      |   |  |   | (2,595  | ) |  |   | (2,595 | )
|                                                                             |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   |        |  |   |      |   |  |   |         |   |  |   |        |  
|Balance, March 28, 2004                                                      |                 | 15,378,264                  |                 | $            | 34,483          |                          | 4,990,709       |                           | $      | 11,066 |                    | 16,491,187 |  | $     | 9,286 |  | $ | 27,738 |  | $ | (74  | ) |  | $ | (89,170 | ) |  | $ | (6,671 | )
|                                                                             |                 |                             |                 |              |                 |                          |                 |                           |        |        |                    |            |  |       |       |  |   |        |  |   |      |   |  |   |         |   |  |   |        |  





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



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Tullys Coffee Corporation



Consolidated Statements of Changes in Stockholders Equity (Deficit)

Years Ended April 2, 2006, April 3, 2005 and March 28, 2004

(continued)



|                                                                      |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------- | --------------- | --------------------------- | --------------- | - | ---------------------------------------- |  | --------- | --------------- |  | -------------------------- | ------ | - | ------------------------ | ------- |  | ------------------------- | ---- | ------ | ------------------ | ---------- |  | ------ | ----- |  | ------- |  | - | ---- | - |  | - | ------ | - |  | - | --- | - |  | - | ------- | - |  | - | ------- | -
|(dollars in thousands,except per share data)                          |                 | Convertible Preferred Stock |                 |   | Convertible PreferredStock, to be issued |  |           | Common Stock    |  | Common Stock, to be issued |        |   | Additionalpaid-incapital |         |  | DeferredStockCompensation |      |        | AccumulatedDeficit |            |  | Total  |      
|                                                                      | Series A Shares |                             | Series A Amount |   | Series B Shares                          |  |           | Series B Amount |  |                            | Shares |   | Series A                 |         |  | Shares                    |      | Amount |                    | Shares     |  | Amount |       |  |         |  |  
|Balance, March 28, 2004                                               |                 | 15,378,264                  |                 | $ | 34,483                                   |  | 4,990,709 |                 |  | $                          | 11,066 |   |                          |        |  | $                         |     |        |                    | 16,491,187 |  | $      | 9,286 |  |        |  | $ |     |   |  | $ | 27,738 |   |  | $ | (74 | ) |  | $ | (89,170 | ) |  | $ | (6,671  | )
|Issuance of common stock warrants as compensation for loan guarantees |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   | 226    |   |  |   |     |   |  |   |         |   |  |   | 226     |  
|Exercise of stock options                                             |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    | 262,083    |  |        | 16    |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   | 16      |  
|Issuance of stock options                                             |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   | 58     |   |  |   | (58 | ) |  |   |         |   |  |   |        |  
|Conversion of Series B to Common                                      |                 |                             |                 |   |                                          |  | (10,000   | )               |  |                            | (22    | ) |                          |         |  |                           |      |        |                    | 10,000     |  |        | 22    |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |        |  
|Amortization of deferred stock compensation                           |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   |        |   |  |   | 110 |   |  |   |         |   |  |   | 110     |  
|Cancellation of stock options                                         |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   | (48    | ) |  |   |     |   |  |   |         |   |  |   | (48     | )
|Exercise of common stock warrants                                     |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    | 590,552    |  |        | 60    |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   | 60      |  
|Proceeds from rights offering                                         |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          | 180,888 |  |                           | 452  |        |                    |            |  |        |       |  | 337,216 |  |   | 249  |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   | 701     |  
|Stock offering costs                                                  |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           | (295 | )      |                    |            |  |        |       |  |         |  |   | (163 | ) |  |   |        |   |  |   |     |   |  |   |         |   |  |   | (458    | )
|Net loss                                                              |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   | (4,625  | ) |  |   | (4,625  | )
|                                                                      |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |         |  
|Balance, April 3, 2005                                                |                 | 15,378,264                  |                 | $ | 34,483                                   |  | 4,980,709 |                 |  | $                          | 11,044 |   |                          | 180,888 |  | $                         | 157  |        |                    | 17,353,822 |  | $      | 9,384 |  | 337,216 |  | $ | 86   |   |  | $ | 27,974 |   |  | $ | (22 | ) |  | $ | (93,795 | ) |  | $ | (10,689 | )
|                                                                      |                 |                             |                 |   |                                          |  |           |                 |  |                            |        |   |                          |         |  |                           |      |        |                    |            |  |        |       |  |         |  |   |      |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |         |  



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



46



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##### Table of Contents

Tullys Coffee Corporation



Consolidated Statements of Changes in Stockholders Equity (Deficit)

Years Ended April 2, 2006, April 3, 2005 and March 28, 2004

(continued)



|                                                                      |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   |        |  |   |     |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------- |  | --------------------------- |  | -------- | --------------------------------------- | ------ | --------- | ------------ | -------- | -------------------------- | ------ | ------ | ------------------------- | -------- | ------------------------- |  | - | ------------------ | - | ------ | ---------- | ------ | - | ----- | ------ | -------- | - |  | - | --- | - |  | - | ------ |  | - | --- | - |  | - | ------- | - |  | - | ------- | -
|                                                                      |  | Convertible Preferred Stock |  |          | ConvertiblePreferred Stock, tobe issued |        |           | Common Stock |          | Common Stock, to be issued |        |        | Additional paid-incapital |          | DeferredStockCompensation |  |   | Accumulateddeficit |   |        | Total      |       
|(dollars in thousands, except per share data)                         |  | Shares                      |  | Series A |                                         | Shares |           |              | Series B |                            |        | Shares |                           |          | Series A                  |  |   | Shares             |   | Amount |            | Shares |   |       | Amount |          |   |  |   |    
|Balance, April 3, 2005                                                |  | 15,378,264                  |  | $        | 34,483                                  |        | 4,980,709 |              |          | $                          | 11,044 |        |                           | 180,888  |                           |  | $ | 157                |   |        | 17,353,822 |        | $ | 9,384 |        | 337,216  |   |  | $ | 86  |   |  | $ | 27,974 |  | $ | (22 | ) |  | $ | (93,795 | ) |  | $ | (10,689 | )
|Issuance of common stock warrants as compensation for loan guarantees |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   | 254-   |  |   |     |   |  |   |         |   |  |   | 254     |  
|Exercise of stock options                                             |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        | 33         |        |   |       |        |          |   |  |   |     |   |  |   |       |  |   |     |   |  |   |         |   |  |   |        |  
|Issuance of stock options                                             |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   | 42     |  |   |     |   |  |   |         |   |  |   | 42      |  
|Conversion of Series B to Common                                      |  |                             |  |          |                                         |        | (60,000   | )            |          |                            | (133   | )      |                           |          |                           |  |   |                    |   |        | 60,000     |        |   | 133   |        |          |   |  |   |     |   |  |   |        |  |   |     |   |  |   |         |   |  |   |        |  
|Amortization of deferred stock compensation                           |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   |        |  |   | 22  |   |  |   |         |   |  |   | 22      |  
|Stock option expense                                                  |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   | 69     |  |   |     |   |  |   |         |   |  |   | 69      |  
|Exercise of common stock warrants                                     |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        | 18,120     |        |   | 6     |        |          |   |  |   |     |   |  |   |        |  |   |     |   |  |   |         |   |  |   | 6       |  
|Issuance of shares from Rights Offering                               |  | 180,888                     |  |          | 156                                     |        |           |              |          |                            |        |        |                           | (180,888 | )                         |  |   | (157               | ) |        | 337,216    |        |   | 87    |        | (337,216 | ) |  |   | (86 | ) |  |   |        |  |   |     |   |  |   |         |   |  |   |        |  
|Net income                                                            |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   |        |  |   |     |   |  |   | 15,423  |   |  |   | 15,423  |  
|                                                                      |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   |        |  |   |     |   |  |   |         |   |  |   |         |  
|Balance, April 2, 2006                                                |  | 15,559,152                  |  | $        | 34,639                                  |        | 4,920,709 |              |          | $                          | 10,911 |        |                           |         |                           |  | $ |                   |   |        | 17,769,191 |        | $ | 9,610 |        |         |   |  | $ |    |   |  | $ | 28,339 |  | $ |    |   |  | $ | (78,372 | ) |  | $ | 5,127   |  
|                                                                      |  |                             |  |          |                                         |        |           |              |          |                            |        |        |                           |          |                           |  |   |                    |   |        |            |        |   |       |        |          |   |  |   |     |   |  |   |        |  |   |     |   |  |   |         |   |  |   |         |  



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



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Tullys Coffee Corporation



Consolidated Statements of Cash Flows



|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                                                                  |  | Years ended            |        
|                                                                                                  |  | April 2,2006           |         |   | April 3,2005 |   |        | March 28,2004 | 
|                                                                                                  |  | (dollars in thousands) |        
|Cash flows from operating activities                                                              |  |                        |         |   |              |   |        |               |  |   |        |  
|Net income (loss)                                                                                 |  | $                      | 15,423  |   |              | $ | (4,625 | )             |  | $ | (2,595 | )
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |  |                        |         |   |              |   |        |               |  |   |        |  
|Depreciation and amortization                                                                     |  |                        | 3,529   |   |              |   | 3,651  |               |  |   | 3,622  |  
|Impairment of long-lived assets                                                                   |  |                        | 236     |   |              |   | 200    |               |  |   | 97     |  
|Store closure costs charged to operations                                                         |  |                        | 219     |   |              |   | 43     |               |  |   | 170    |  
|Loss (gain) on sale of property and equipment                                                     |  |                        | 5       |   |              |   | 21     |               |  |   | (9     | )
|Gain on sale of Japan Rights                                                                      |  |                        | (17,392 | ) |              |   |       |               |  |   |       |  
|Stock option expense                                                                              |  |                        | 114     |   |              |   | 62     |               |  |   | 87     |  
|Provision for doubtful accounts                                                                   |  |                        | 220     |   |              |   | 103    |               |  |   | 83     |  
|Loan guarantee fee expense                                                                        |  |                        | 66      |   |              |   | 357    |               |  |   | 227    |  
|Non-cash interest expense                                                                         |  |                        |        |   |              |   | 124    |               |  |   | 186    |  
|Recognition of deferred revenue                                                                   |  |                        | (6,015  | ) |              |   | (2,087 | )             |  |   | (2,087 | )
|Changes in assets and liabilities                                                                 |  |                        |         |   |              |   |        |               |  |   |        |  
|Accounts receivable                                                                               |  |                        | (813    | ) |              |   | (902   | )             |  |   | 267    |  
|Inventories                                                                                       |  |                        | (600    | ) |              |   | (124   | )             |  |   | 278    |  
|Prepaid expenses and other assets                                                                 |  |                        | 631     |   |              |   | 19     |               |  |   | 108    |  
|Accounts payable                                                                                  |  |                        | (1,241  | ) |              |   | 2,463  |               |  |   | (212   | )
|Accrued liabilities                                                                               |  |                        | (1,293  | ) |              |   | 1,027  |               |  |   | 752    |  
|Other liabilities                                                                                 |  |                        |        |   |              |   | 1,093  |               |  |   |       |  
|Deferred lease costs                                                                              |  |                        | (195    | ) |              |   | (81    | )             |  |   | (187   | )
|Deferred revenue cash received                                                                    |  |                        | 25      |   |              |   |       |               |  |   | 500    |  
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|Net cash provided by (used in) operating activities                                               |  |                        | (7,081  | ) |              |   | 1,344  |               |  |   | 1,287  |  
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|Cash flows from investing activities                                                              |  |                        |         |   |              |   |        |               |  |   |        |  
|Net proceeds from Japan Rights sale                                                               |  |                        | 17,392  |   |              |   |       |               |  |   |       |  
|Purchases of property and equipment                                                               |  |                        | (2,307  | ) |              |   | (560   | )             |  |   | (320   | )
|Other                                                                                             |  |                        | (62     | ) |              |   | (4     | )             |  |   | 34     |  
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|Net cash (used in) provided by investing activities                                               |  |                        | 15,023  |   |              |   | (564   | )             |  |   | (286   | )
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|Cash flows from financing activities                                                              |  |                        |         |   |              |   |        |               |  |   |        |  
|Borrowings under credit lines                                                                     |  |                        | 1,901   |   |              |   | 350    |               |  |   |       |  
|Payment of credit lines                                                                           |  |                        | (2,366  | ) |              |   | (941   | )             |  |   | (382   | )
|Payments on long-term debt (including convertible note) and capital leases                        |  |                        | (3,539  | ) |              |   | (318   | )             |  |   | (379   | )
|Proceeds from exercise of stock options and warrants                                              |  |                        | 6       |   |              |   | 76     |               |  |   | 14     |  
|Proceeds from rights offering                                                                     |  |                        |        |   |              |   | 243    |               |  |   |       |  
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|Net cash used in financing activities                                                             |  |                        | (3,998  | ) |              |   | (590   | )             |  |   | (747   | )
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|Net increase in cash and cash equivalents                                                         |  |                        | 3,944   |   |              |   | 190    |               |  |   | 254    |  
|Cash and cash equivalents                                                                         |  |                        |         |   |              |   |        |               |  |   |        |  
|Beginning of period                                                                               |  |                        | 1,437   |   |              |   | 1,247  |               |  |   | 993    |  
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  
|End of period                                                                                     |  | $                      | 5,381   |   |              | $ | 1,437  |               |  | $ | 1,247  |  
|                                                                                                  |  |                        |         |   |              |   |        |               |  |   |        |  



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



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Tullys Coffee Corporation



Consolidated Statements of Cash Flows



Supplemental disclosure of cash flow information and non-cash investing and financing activities:



|                                          |  |                        |     |              |   |               |  |   |    
|----------------------------------------- |  | ---------------------- | --- | ------------ | - | ------------- |  | - | ---
|                                          |  | Years ended           
|                                          |  | April 2,2006           |     | April 3,2005 |   | March 28,2004
|                                          |  | (dollars in thousands)
|Cash paid during the period for interest  |  | $                      | 622 |              | $ | 296           |  | $ | 206
|Non-cash investing and financing activity |  |                        |     |              |   |               |  |   |    
|Capital leases for purchase of equipment  |  |                        | 83  |              |   | 40            |  |   | 250



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



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements



1.  The Company and significant accounting policies



The Company and nature of operations



Tullys Coffee Corporation was formed in 1992. In these consolidated financial statements, references to we, us, Tullys or the Company refer to Tullys Coffee Corporation.
Tullys hand roasts premium specialty coffees that are sold through retail specialty coffee stores operating under the Tullys brand and are also sold through our Wholesale division to domestic customers in the food service, supermarket,
restaurant, office coffee service and institutional channels. Tullys-branded retail stores are operated by our Retail division and are also operated by other parties under license or franchise. Tullys stores sell our high quality,
premium roasted whole bean coffees, and serve a wide selection of hot and cold beverages that feature our coffees and our premium softened ice cream. Tullys stores also sell baked goods and pastries and other complementary snack and food items
and coffee-related accessories, supplies, and equipment.



As of
April 2, 2006, there were 111 Tullys retail stores operating in the United States, summarized as follows:



|               |  |                       |  |                  |  |      
|-------------- |  | --------------------- |  | ---------------- |  | -----
|State location |  | CompanyOperatedStores |  | FranchisedStores |  | Total
|Washington     |  | 61                    |  | 11               |  | 72   
|California     |  | 23                    |  | 3                |  | 26   
|Oregon         |  | 3                     |  | 1                |  | 4    
|Idaho          |  | 1                     |  | 2                |  | 3    
|Arizona        |  |                      |  | 6                |  | 6    
|               |  |                       |  |                  |  |      
|Total          |  | 88                    |  | 23               |  | 111  
|               |  |                       |  |                  |  |      



Our Specialty division
is responsible for our U.S. franchising activities (exclusive of any product sales to these customers, which are included in the Wholesale division) and also our international business activities (see Note 13). For purposes of these consolidated
financial statements, the terms franchise and license are used interchangeably.



Fiscal periods



We end
our fiscal year on the Sunday closest to March 31. As a result, we record our revenue and expenses on a 52 or 53 week period, depending on the year. The fiscal year ended April 2, 2006 (Fiscal 2006) included 52 weeks, while our
fiscal year ending April 3, 2005 (Fiscal 2005) included 53 weeks. Each of the fiscal years ending March 28, 2004 (Fiscal 2004) and March 30, 2003 (Fiscal 2003) included 52 weeks. The fiscal year
ending April 1, 2007 (Fiscal 2007) will have 52 weeks.



Consolidation



The consolidated financial
statements include the accounts of the Company and its wholly owned subsidiary, Spinelli Coffee Company. All significant intercompany balances and transactions have been eliminated in consolidation.



Use of estimates



The preparation of financial statements in conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the reported



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



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



Cash equivalents
in excess of current operating requirements are invested in short-term, interest-bearing instruments with maturities of three months or less at the date of purchase and are stated at cost, which approximates market value.



Trade Accounts Receivable



Tullys provides products to approved customers on an open account
basis. We generally do not require collateral on trade receivables. Tullys reviews a customers credit history before extending credit and establishes an allowance for doubtful accounts based on the risk of specific customers.
Historically, credit related losses on trade receivables have not been significant.



Inventories



Inventories are stated at the
lower of cost (on the first-in, first-out basis) or market. Our sourcing and merchandising process is centralized, but each store generally orders its individual requirements from our distribution facility and our authorized vendors. We purchase our
green coffee beans primarily from three vendors and are not significantly dependent on any single source of supply.



Property and equipment



Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation of property and equipment includes amortization of
assets under capital leases and is provided on the straight-line method over the estimated economic lives. Machinery and equipment are depreciated over 5 to 7 years. Leasehold improvements are depreciated over the shorter of their estimated economic
lives (generally ten years) or the applicable lease term as defined under generally accepted accounting principles. Software is depreciated over 3 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 improvements 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. Certain properties and equipment have been reduced below cost due to impairment
charges.



Goodwill and other intangible assets



Other intangible assets include leasehold interests, trademark and logo
design costs, covenants not to compete, goodwill and other assets. Amortization of leasehold interests is provided over the applicable lease term as defined under generally accepted accounting principles. Other intangible assets are amortized on the
straight-line method over 5 to 15 years.



Impairment of long-lived assets



Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), requires that long-lived assets and certain intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable. If impairment has occurred, an impairment loss must be recognized.



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



As part of our review, assets are grouped and evaluated at the lowest level for which there are
identifiable cash flows that are largely independent of the cash flows of other groups of assets. Tullys has identified this lowest level to be principally individual stores. We consider historical performance and future estimated results in
our evaluation of potential impairment and then compare the carrying amount of the asset to the estimated future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted
future cash flows, we measure the amount of the impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is measured by discounting expected future cash flows.



Lease termination costs



Periodically, Tullys will determine that certain leases will be terminated and the location will be closed. At such
determination, we accrue for the net future minimum lease payments of the related lease agreements. Amounts accrued as net future minimum losses include the discounted estimated future rental payments, lease termination fees, and sub-lease
recoveries.



Segment reporting



Tullys is organized into three principal business units. We complement
our Retail divisions operations with additional channels for distribution of our branded products, which we manage as separate business segments: (1) our Specialty division, which sells Tullys coffee and related products and
supplies to our foreign licensees and manages the relationships with these licensees, and is responsible for the franchising of Tullys stores in the U.S. and for developing business opportunities for complementary Tullys-branded products
and (2) our Wholesale division, which sells Tullys coffee and related products and supplies to domestic resellers in the supermarket, food service, restaurant, office coffee service, and institutional channels. The Wholesale division is
also responsible for our mail order and Internet sales activities.



Revenue
recognition



Sales are generally recognized at the time of
the sale at retail store locations. Sales for the Wholesale and Specialty divisions are generally recognized upon shipment of the products. Allowances to Wholesale division customers for retail display or distribution positions (such as
slotting allowances) are recognized as a reduction in sales, reducing gross profits until fully amortized (typically a period of two to six months). Other discounts and allowances are recognized in the period earned by the customer.



Revenues from advance territorial license fees and from
international roasting agreements are recognized on the straight-line basis over the expected life of the agreements (ranging from eight to fifteen years). Royalty revenues for international licensees are recognized in accordance with the license
agreements based upon sales at specific licensee store locations. Coffee roasting fees are recognized when the licensee that is subject to the fee purchases coffee. Initial franchise fees for new stores franchised by Tullys are recognized when
Tullys has completed the services required to earn the fee and make it non-refundable, which is generally upon opening of the store. Royalty revenues for stores franchised by Tullys are recognized in accordance with the franchise
agreements based upon sales at the franchised store locations.



Concentrations of credit risk



We sell to
various individuals and organizations while extending credit to customers and are therefore subject to credit risk. Accounts receivable at April 3, 2005 include amounts due from our then-licensee, Tullys Coffee Japan Co., Ltd.
(Tullys Coffee Japan), which represented 13% of the April 3, 2005 total (there was no receivable from Tullys Coffee Japan at April 2, 2006).



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



Tullys maintains its cash and investment balances with what we believe to be high credit
quality financial institutions.



Store pre-opening costs



Costs incurred in connection with start-up and promotion of new store
openings are expensed when incurred.



Advertising costs



Costs incurred for advertising and marketing are expensed in the periods to
which the promotions are applicable and totaled $1,238,000, $1,259,000, and $1,322,000 during Fiscal 2006, Fiscal 2005, and Fiscal 2004, respectively. Included in advertising and marketing are baseball park and other sponsorship fees totaling
approximately $56,000, $56,000, and $477,000, during Fiscal 2006, Fiscal 2005, and Fiscal 2004, respectively. Local store advertising and marketing costs are reported in store operating expenses, while the advertising and marketing costs of our
Wholesale and Specialty divisions are reported in other operating expenses. General advertising and marketing costs for the Company and our Retail division are reported in marketing, general and administrative costs.



Freight costs



Freight and shipping costs related to merchandise are generally included in cost of goods sold, except for outbound freight
costs related to sales of our Wholesale division which are included in marketing, general and administrative costs and which totaled $489,000, $309,000, and $191,000 during Fiscal 2006, Fiscal 2005, and Fiscal 2004, respectively.



Rent expense



Tullys operates in leased buildings. 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. Such stepped rent expense is recorded on a straight-line basis over the respective terms of the leases. Certain leases require contingent rent
based on gross sales and such rent expense is recognized as incurred. Certain leases have rent holiday (free rent) periods, and Tullys recognizes these rental credits on a straight-line basis over the respective lease terms.



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 for 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.



Tullys has recorded a valuation allowance against net deferred tax assets as we could not conclude that it was more likely than not that the tax
benefits from temporary differences and net operating loss carryforwards would be realized. In subsequent periods, we may reduce the valuation allowance, provided that the possibility of utilization of the deferred tax assets is more likely than
not.



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



Fair value of financial instruments



The carrying amount of cash and cash equivalents and other current assets and liabilities, such as accounts receivable and
accounts payable as presented in the consolidated financial statements, approximates fair value based on the short-term nature of these instruments. We believe the carrying amounts of our 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



In December 2002, the Financial Accounting Standards Board issued Financial Accounting Standards No. 148, Accounting for Stock-Based CompensationTransition and Disclosure (SFAS No. 148), an amendment
to Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). SFAS No. 148 provides alternative methods of transition for voluntary change to the fair value
method of accounting for stock-based compensation. In addition, SFAS No. 148 requires more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect
of the method used on reported results. We adopted the disclosure-only provisions of SFAS No. 148. We have 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 Tullys stock at the date of grant
over the amount an employee must pay to acquire the stock. Compensation cost is amortized on a straight-line basis, over the vesting period of the individual options.



In December 2004, the FASB reissued SFAS No. 123 as SFAS No. 123R, Share Based Compensation. Under
SFAS No. 123R, public entities will be required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognize the cost over the period during which
an employee is required to render services in exchange for the award. Additionally, SFAS No. 123R will require entities to record compensation expense for employee stock purchase plans that may not have previously been considered compensatory
under the existing rules. On April 14, 2005, the effective date of SFAS No. 123R was extended and will now be effective for the Company at the beginning of Fiscal 2007. Adoption of this standard is not expected to have a material impact on
our consolidated financial statements.



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



Had compensation cost for our stock option plans been determined based on the fair value at the grant
date of the awards, consistent with the provisions of SFAS No. 123, as amended by SFAS No. 148, our net income (loss) and earnings (loss) per share would have been reported as pro forma amounts indicated below (in thousands, except per
share data):



|                                                   |  |                                               |        |              |   |        |               |  |   |        |  
|-------------------------------------------------- |  | --------------------------------------------- | ------ | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                   |  | Years ended                                   |       
|                                                   |  | April 2,2006                                  |        | April 3,2005 |   |        | March 28,2004 | 
|                                                   |  | (dollars in thousands, except per share data) |       
|Stock-based employee compensation cost             |  |                                               |        |              |   |        |               |  |   |        |  
|As reported                                        |  | $                                             | 113    |              | $ | 82     |               |  | $ | 87     |  
|Pro forma                                          |  | $                                             | 280    |              | $ | 99     |               |  | $ | 137    |  
|Net income (loss) as reported                      |  | $                                             | 15,423 |              | $ | (4,625 | )             |  | $ | (2,595 | )
|Net income (loss) pro forma                        |  | $                                             | 15,256 |              | $ | (4,642 | )             |  | $ | (2,645 | )
|Basic and diluted earnings (loss) per common share |  |                                               |        |              |   |        |               |  |   |        |  
|As reportedBasic                                  |  | $                                             | 0.87   |              | $ | (0.28  | )             |  | $ | (0.16  | )
|Pro formaBasic                                    |  | $                                             | 0.86   |              | $ | (0.28  | )             |  | $ | (0.17  | )
|As reportedDiluted                                |  | $                                             | 0.30   |              | $ | (0.28  | )             |  | $ | (0.16  | )
|Pro formaDiluted                                  |  | $                                             | 0.30   |              | $ | (0.28  | )             |  | $ | (0.17  | )



The fair values of the
options granted were estimated on the date of grant using the Black-Scholes option valuation model based on the following assumptions used for grants in Fiscal 2006, Fiscal 2005, and Fiscal 2004:



|                        |  |               |  |               |  |               
|----------------------- |  | ------------- |  | ------------- |  | --------------
|                        |  | Years ended  
|                        |  | April 2, 2006 |  | April 3, 2005 |  | March 28, 2004
|Risk free interest rate |  | 2.78%         |  | 2.13%         |  | 2.13% to 4.22%
|Expected lives          |  | 3 years       |  | 3 years       |  | 3-7 years     
|Expected volatility     |  | 86%           |  | 75%           |  | 75%           



Earnings (loss) per share



Basic earnings (loss) per share is calculated as net
income (loss) applicable to the common shareholders divided by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings (loss) per share is based on the weighted-average number of shares of common stock
and common stock equivalents outstanding during the period, including options, warrants, convertible preferred stock and convertible debt computed using the treasury stock method. The computation of net income (loss) per share is summarized in Note
22.



Reclassifications



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



New accounting standards



In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS 123R). This pronouncement requires that the compensation cost relating to share-based payment transactions be recognized
in financial statements based on the fair value of the equity or liability instruments issued. We will be required to apply SFAS 123R as of the beginning of Fiscal 2007. Adoption of this standard is not expected to have a material impact on our
consolidated financial statements.



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Notes to Consolidated Financial Statements(Continued)



In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary AssetsAn
Amendment of APB Opinion No. 29 (SFAS 153). The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the
amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. The provisions in SFAS
153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Adoption of this standard is not expected to have a material impact on our consolidated financial statements.



In May 2005, the FASB issued SFAS No. 154, Accounting Changes
and Error Corrections (SFAS 154), which replaced APB Opinion No. 20, Accounting Changes,and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statement
(SFAS 3). Among other changes, SFAS 154 requires retrospective application of a voluntary change in accounting principle to prior period financial statements presented on the new accounting principle, unless it is impracticable
to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also requires accounting for a change in method of depreciating or amortizing a long-lived non-financial asset as a change in accounting estimate
(prospectively) affected by a change in accounting principle. Further, the SFAS 154 requires that corrections of errors in previously issued financial statements to be termed as a restatement. The new standard is effective for accounting
changes and error corrections made in fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS 154 to have a material impact on our consolidated financial statements.



2. Liquidity



As discussed in Note 13, on August 31, 2005 we sold the Japan Rights for $17,500,000. This transaction has resulted in
improved liquidity and capital resources for Tullys. As a consequence of the Japan Rights sale, Tullys will not receive the operating cash flows from license fees and coffee roasting fees from Tullys Coffee Japan after
July 31, 2005. We have used proceeds from the Japan Rights sale to repay our promissory note with Kent Central LLC (KCL) as described in Note 11 and our convertible note (see Note 12), which has reduced the level of borrowings by
Tullys and reduced our future obligations for payments of principal and interest. We also used proceeds from the Japan Rights sale to reduce our levels of accounts payable and accrued liabilities, and to fund capital expenditures.



As of April 2, 2006, we had cash and cash equivalents of $5,381,000,
and working capital of $807,000. Because we principally operate as a cash retail business, we generally do not require a significant net investment in working capital and historically have operated with current liabilities in excess of
our current assets. Our inventory levels typically increase during the spring due to coffee crop seasonality and, to a lesser degree, during the autumn due to holiday season merchandise. Inventories are also subject to short-term fluctuations based
upon the timing of coffee receipts and product shipments. Tullys expects that its investment in accounts receivable and inventories will increase, primarily as the result of anticipated sales growth in the Wholesale division.



Cash requirements for Fiscal 2007, other than normal operating expenses and
the commitments described in the consolidated financial statements and notes, are expected to consist primarily of capital expenditures related to the opening of new stores and the remodeling of retail stores, and equipment and accounts receivable
related to new Wholesale division business. We expect our investment in property and equipment during Fiscal 2007 to be comparable to the level of Fiscal 2006. During Fiscal 2007, we expect that the majority of the new Tullys stores in the
United States and in foreign markets (outside of Japan) will be franchised stores, rather than company-operated stores. Franchised stores do not require capital investment in property and equipment by Tullys, but we do incur selling and
support costs for such new stores related to store opening, training and quality control. We expect to open between six and ten new company-operated stores in Fiscal 2007.



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Notes to Consolidated Financial Statements(Continued)



Typically, a new company-operated store will require capital investment of approximately $200,000 to $400,000, but this varies depending on the specific
location. Some of these capital expenditures may be accomplished through operating or capital leases. We expect to maintain a secured credit facility, such as our current credit facility with Northrim Funding Services, a division of Northrim Bank
(Northrim, see Note 11), as a financing resource for our working capital requirements.



Liabilities at April 2, 2006 include deferred revenue in the aggregate amount of $4,367,000. We will liquidate the deferred revenue balance through
recognition of non-cash revenues in future periods, rather than through cash payments. The future cash expenses associated with this deferred revenue balance are expected to be less than $300,000.



We believe that the operating cash flows, financing cash flows, and investing
cash flows projected for Fiscal 2007, and the cash and cash equivalents of $5,381,000 at April 2, 2006, and our credit facility will be sufficient to fund ongoing operations of Tullys through Fiscal 2007. Accordingly, we do not anticipate
that additional equity or long-term debt capital will be required during Fiscal 2007 to sustain current operations and meet our current obligations. However, we may seek additional capital during Fiscal 2007 in order to fund a higher level of growth
than described above.



3. Accounts Receivable and allowance for
doubtful accounts



Accounts receivable represent amounts
billed to customers, net of any off-invoice discounts included in those billings and are stated at the amount that management expects to collect from outstanding balances. Certain promotional allowances to Wholesale division customers
(bill-back allowances) are separately computed, such as retail display and distribution (slotting) allowances and allowances which are determined based on criteria such as retail sale performance. These bill-back allowances
are recorded by Tullys in accrued liabilities when they are recognized as a reduction in sales, and are later remitted to the customer by a payment from Tullys or through an allowed deduction from the customer remittance for amounts
billed by Tullys to the customer. In some instances, the amounts of a bill-back allowance will depend upon the actual performance of a customer for a particular program (such as the number of packages of Tullys product sold in a
particular period of time). The actual performance for the program will be determined by the customer and Tullys after the program is completed. Tullys initially records Managements estimate of the expected results for such
programs, and then an adjustment is made, as necessary, when the actual results are determined. Accrued liabilities include accrued Wholesale division allowances and discounts of $253,000 (April 2, 2006) and $420,000 (April 3, 2005).



The allowance for doubtful accounts reflects our best estimate of probable
losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence accounts receivable determined to be uncollectible are charged against the
allowance for doubtful accounts and recoveries are credited to the allowance for doubtful accounts.



The allowance for doubtful accounts is summarized as follows:



|                                        |  |                        |      |   |              |   |     |  
|--------------------------------------- |  | ---------------------- | ---- | - | ------------ | - | --- | -
|                                        |  | Years ended            |     
|                                        |  | April 2,2006           |      |   | April 3,2005 |  
|                                        |  | (dollars in thousands) |     
|Balance, beginning of the year          |  | $                      | 171  |   |              | $ | 134 |  
|Additions charged to costs and expenses |  |                        | 220  |   |              |   | 104 |  
|Write-offs and other deductions         |  |                        | (242 | ) |              |   | (67 | )
|                                        |  |                        |      |   |              |   |     |  
|Balance, end of the year                |  | $                      | 149  |   |              | $ | 171 |  
|                                        |  |                        |      |   |              |   |     |  



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Notes to Consolidated Financial Statements(Continued)



4. Inventories



Inventories consist of the following:



|                             |  |                        |       |              |   |      
|---------------------------- |  | ---------------------- | ----- | ------------ | - | -----
|                             |  | April 2,2006           |       | April 3,2005
|                             |  | (dollars in thousands)
|Coffee                       |  |                        |       |              |   |      
|Unroasted                    |  | $                      | 939   |              | $ | 822  
|Roasted                      |  |                        | 1,361 |              |   | 671  
|Other goods held for sale    |  |                        | 416   |              |   | 503  
|Packaging and other supplies |  |                        | 424   |              |   | 334  
|                             |  |                        |       |              |   |      
|Total                        |  | $                      | 3,140 |              | $ | 2,330
|                             |  |                        |       |              |   |      



5. Other assets



Other assets consist of the following:



|                  |  |                        |     |              |   |    
|----------------- |  | ---------------------- | --- | ------------ | - | ---
|                  |  | April 2,2006           |     | April 3,2005
|                  |  | (dollars in thousands)
|Security deposits |  | $                      | 255 |              | $ | 279
|Prepaid expenses  |  |                        | 121 |              |   | 232
|                  |  |                        |     |              |   |    
|Total             |  | $                      | 376 |              | $ | 511
|                  |  |                        |     |              |   |    



6. Property and equipment



Property and equipment consist of the following:



|                                                |  |                        |         |   |              |   |         |  
|----------------------------------------------- |  | ---------------------- | ------- | - | ------------ | - | ------- | -
|                                                |  | April 2,2006           |         |   | April 3,2005 |  
|                                                |  | (dollars in thousands) |        
|Machinery and equipment                         |  | $                      | 10,997  |   |              | $ | 10,486  |  
|Leasehold improvements                          |  |                        | 16,115  |   |              |   | 15,825  |  
|Furniture and fixtures                          |  |                        | 4,031   |   |              |   | 3,640   |  
|Software                                        |  |                        | 343     |   |              |   | 317     |  
|                                                |  |                        |         |   |              |   |         |  
|                                                |  |                        | 31,486  |   |              |   | 30,268  |  
|Less: Accumulated depreciation and amortization |  |                        | (22,875 | ) |              |   | (20,162 | )
|                                                |  |                        |         |   |              |   |         |  
|Total                                           |  | $                      | 8,611   |   |              | $ | 10,106  |  
|                                                |  |                        |         |   |              |   |         |  



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Notes to Consolidated Financial Statements(Continued)



7. Goodwill and intangible assets



Goodwill and other intangible assets consist of the following:



|                                |  |                        |       |   |              |   |       |  
|------------------------------- |  | ---------------------- | ----- | - | ------------ | - | ----- | -
|                                |  | April 2,2006           |       |   | April 3,2005 |  
|                                |  | (dollars in thousands) |      
|Goodwill                        |  | $                      | 456   |   |              | $ | 523   |  
|                                |  |                        |       |   |              |   |       |  
|Other intangible assets:        |  |                        |       |   |              |   |       |  
|Leasehold interests             |  |                        | 491   |   |              |   | 521   |  
|Lease commissions               |  |                        | 199   |   |              |   | 200   |  
|Trademark and logo design costs |  |                        | 411   |   |              |   | 405   |  
|Covenants not to compete        |  |                        | 261   |   |              |   | 261   |  
|Other                           |  |                        | 10    |   |              |   |      |  
|                                |  |                        |       |   |              |   |       |  
|                                |  |                        | 1,372 |   |              |   | 1,387 |  
|Less accumulated amortization   |  |                        | (967  | ) |              |   | (887  | )
|                                |  |                        |       |   |              |   |       |  
|Total other intangible assets   |  | $                      | 405   |   |              | $ | 500   |  
|                                |  |                        |       |   |              |   |       |  



Under SFAS 142,
goodwill is to be periodically reevaluated and the carrying amount for goodwill is required to be reduced if an impairment is identified. Tullys has determined that this analysis will be performed annually during the fourth quarter of each
fiscal year. The analysis was performed and no impairment was identified for Fiscal 2004, Fiscal 2005, or Fiscal 2006.



The total amortization expense of other intangible assets was $105,000, $88,000 and $102,000 in Fiscal 2006, Fiscal 2005 and Fiscal 2004, respectively.
Amortization expense for these other intangible assets during the next five years is estimated to be between $70,000 and $100,000 per year.



8. Impairment of long-lived assets



Tullys recognized non-cash impairment losses of $236,000, $200,000, and $97,000 in the fourth quarters of Fiscal 2006, Fiscal 2005 and Fiscal 2004,
respectively, in accordance with the provisions of SFAS 144 and SFAS 142. This relates to impairment of leasehold improvements and equipment. These reviews were performed in connection with the development and implementation of our annual business
plans. In order to determine the impairment, considerable management judgment is necessary to estimate discounted future cash flows. Accordingly, actual results could vary significantly from such estimates.



9. Income taxes



The gain recognized on the Japan Rights sale is taxable for federal and state income tax purposes. Our net operating loss
carryforwards have offset this gain for federal income tax purposes, but a portion of the gain is taxable for state income taxes and for federal alternative minimum tax (AMT) purposes. We recognized estimated state income tax and AMT
expense of $335,000 in Fiscal 2006.



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Notes to Consolidated Financial Statements(Continued)



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:



|                                                             |  |                        |         |   |               |   |         |  
|------------------------------------------------------------ |  | ---------------------- | ------- | - | ------------- | - | ------- | -
|                                                             |  | April 2, 2006          |         |   | April 3, 2005 |  
|                                                             |  | (dollars in thousands) |        
|Deferred tax assets                                          |  |                        |         |   |               |   |         |  
|Net operating loss carryforwards                             |  | $                      | 9,283   |   |               | $ | 16,515  |  
|Stock options                                                |  |                        | 1,671   |   |               |   | 2,004   |  
|Deferred revenue                                             |  |                        | 1,604   |   |               |   | 3,586   |  
|Property and equipment                                       |  |                        | 2,118   |   |               |   | 3,066   |  
|Asset impairment, store closures and lease termination costs |  |                        | 1,450   |   |               |   | 1,894   |  
|Deferred lease costs                                         |  |                        | 522     |   |               |   | 1,093   |  
|Tax credit                                                   |  |                        | 207     |   |               |   |        |  
|Allowance for doubtful accounts                              |  |                        | 55      |   |               |   | 87      |  
|Accrued vacation and other liabilities                       |  |                        | 893     |   |               |   | 913     |  
|Other                                                        |  |                        | 95      |   |               |   | 77      |  
|                                                             |  |                        |         |   |               |   |         |  
|Total deferred tax assets                                    |  |                        | 17,898  |   |               |   | 29,235  |  
|                                                             |  |                        |         |   |               |   |         |  
|Deferred tax liabilitiesNone                                |  |                        |         |   |               |   |         |  
|Less: Valuation allowance                                    |  |                        | (17,898 | ) |               |   | (29,335 | )
|                                                             |  |                        |         |   |               |   |         |  
|Net deferred tax asset                                       |  | $                      |        |   |               | $ |        |  
|                                                             |  |                        |         |   |               |   |         |  



At April 2, 2006,
we had tax net operating loss carryforwards of approximately $25,000,000 that expire between 2013 and 2024.



Our ability to use our 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 losses and credit carryforwards if certain stock ownership changes occur.



The provision for income taxes is summarized as follows (dollars in thousands):



|                   |  |              |     |              |   |               |  |   |   
|------------------ |  | ------------ | --- | ------------ | - | ------------- |  | - | --
|                   |  | Years ended 
|                   |  | April 2,2006 |     | April 3,2005 |   | March 28,2004
|Current taxes      |  |              |     |              |   |               |  |   |   
|Federal            |  | $            | 281 |              | $ |              |  | $ |  
|State              |  |              | 58  |              |   | 17            |  |   | 2 
|Foreign            |  |              |    |              |   | 35            |  |   | 41
|                   |  |              |     |              |   |               |  |   |   
|Total current      |  |              | 339 |              |   | 52            |  |   | 43
|                   |  |              |     |              |   |               |  |   |   
|Deferred taxes     |  |              |    |              |   |              |  |   |  
|                   |  |              |     |              |   |               |  |   |   
|Income tax expense |  | $            | 339 |              | $ | 52            |  | $ | 43
|                   |  |              |     |              |   |               |  |   |   



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Notes to Consolidated Financial Statements(Continued)



A reconciliation of the statutory federal income tax rate to Tullys effective income tax rate
is as follows:



|                                           |  |              |    |  |              |    |  |               |   
|------------------------------------------ |  | ------------ | -- |  | ------------ | -- |  | ------------- | --
|                                           |  | Years ended  |   
|                                           |  | April 2,2006 |    |  | April 3,2005 |    |  | March 28,2004 |   
|Tax expense (benefit)                      |  |              |    |  |              |    |  |               |   
|Federal statutory rate                     |  | 35.0         | %  |  | (34.0        | )% |  | (34.0         | )%
|State income taxes, net of federal benefit |  | 1.7          | %  |  | (1.6         | )% |  | (1.6          | )%
|Other                                      |  | 0.2          | %  |  | 0.8          | %  |  | 0.7           | % 
|Valuation allowance                        |  | (35.4        | )% |  | 34.8         | %  |  | 34.9          | % 
|                                           |  |              |    |  |              |    |  |               |   
|Effective income tax rate                  |  | 1.5          | %  |  |             | %  |  |              | % 
|                                           |  |              |    |  |              |    |  |               |   



10. Accrued liabilities



Accrued liabilities consist of the following:



|                                                  |  |                        |       |              |   |      
|------------------------------------------------- |  | ---------------------- | ----- | ------------ | - | -----
|                                                  |  | April 2,2006           |       | April 3,2005
|                                                  |  | (dollars in thousands)
|Employee wages and taxes                          |  | $                      | 1,149 |              | $ | 1,372
|Professional fees and services                    |  |                        | 322   |              |   | 697  
|Accrued lease termination and store closure costs |  |                        | 190   |              |   | 292  
|Accrued real estate and property taxes            |  |                        | 340   |              |   | 355  
|Accrued discounts and allowances (Note 3)         |  |                        | 253   |              |   | 420  
|Other                                             |  |                        | 1,558 |              |   | 2,013
|                                                  |  |                        |       |              |   |      
|Total                                             |  | $                      | 3,812 |              | $ | 5,149
|                                                  |  |                        |       |              |   |      



11. Credit lines and long term
debt



On June 22, 2005, Tullys entered into a
secured credit facility with Northrim (the Northrim Facility). The Northrim Facility provides a credit facility of up to $3,000,000, subject to the amount of eligible accounts receivable. In June 2006, the credit facility was renewed
until May 31, 2007, unless terminated earlier by either party and the interest rate was reduced to prime plus 3.5%. Borrowings under this facility at April 2, 2006 bear interest at the prime rate plus five percent and are secured by our
inventories and through the assignment (with recourse) of our accounts receivable.



On November 1, 2002, Tullys entered into a borrowing arrangement with KCL that was secured by substantially all of our assets (the KCL promissory note). The KCL promissory note was in the
initial amount of $2,890,037, but was amended in March 2003 to allow up to $1,000,000 of additional borrowings depending on the level of eligible collateral. On June 24, 2004 Tullys and KCL amended the terms of the KCL promissory note to
require monthly payments of principal for the KCL promissory note with the remaining principal due on August 1, 2005. Prior to this amendment, interest was paid at a floating rate based upon the bank prime rate and annual loan fees were
assessed. Under the June 24, 2004 amendment, the loan fees were eliminated and the interest rate for the KCL promissory note was set at 12% per year. On June 21, 2005, Tullys and KCL agreed to further amend the KCL promissory
note to extend the note maturity until July 1, 2006 and to permit Tullys to enter into the Northrim facility. Certain of our directors and shareholders (the Guarantors) guaranteed $2,000,000 of the borrowings under the KCL
promissory note.



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Notes to Consolidated Financial Statements(Continued)



On August 31, 2005, the KCL promissory note was repaid in full. Concurrently with the repayment
of the KCL promissory note, the guaranty agreements between Tullys and the Guarantors were terminated and the Guarantors released their conditional security interest in Tullys assets.



In consideration for providing the guaranties of the KCL promissory note,
Tullys issued warrants (with an exercise price of $0.05 per share) to the Guarantors while the debt was outstanding. Until March 31, 2005, we issued warrants to purchase 30.86 shares of common stock for each $1,000 of debt guaranteed
during a month, but this formula was amended effective April 1, 2005 to be subject to periodic adjustment based upon the valuation of our common stock (which reduced the number of warrants that were issued as compensation). Tullys
recognized these non-cash loan guaranty costs as a financing expense based upon the fair value at the date of grant of the warrants. We granted warrants to the Guarantors as summarized below:



|                               |  |                    |  |                 |  |        
|------------------------------ |  | ------------------ |  | --------------- |  | -------
|                               |  | Number of Shares  
|                               |  | DirectorGuarantors |  | OtherGuarantors |  | Total  
|Warrants issued in Fiscal 2004 |  | 444,384            |  | 292,950         |  | 737,334
|Warrants issued in Fiscal 2005 |  | 222,192            |  | 518,448         |  | 740,640
|Warrants issued in Fiscal 2006 |  | 13,430             |  | 31,337          |  | 44,767 



Obligations under
long-term debt consist of the following:



|                                                                                                                                                                                                                                                    |  |                        |        |   |              |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | - | ------------ | - | ------ | -
|                                                                                                                                                                                                                                                    |  | April 2,2006           |        |   | April 3,2005 |  
|                                                                                                                                                                                                                                                    |  | (dollars in thousands) |       
|Borrowings under the Northrim facility                                                                                                                                                                                                              |  | $                      | 1,901  |   |              | $ |       |  
|Borrowings under KCL promissory note                                                                                                                                                                                                                |  |                        |       |   |              | $ | 2,366  |  
|Note payable for purchase of insurance, payable in monthly installments of approximately $55,000 including interest at 4.95%, through
September 2006), collateralized by unearned or return insurance premiums, accrued dividends and loss payments |  |                        | 216    |   |              |   | 184    |  
|Vehicle purchase note payable in monthly installments of approximately $833 including interest at 3.98%, through March 2010, secured by the
related vehicles                                                                                        |  |                        | 37     |   |              |   |       |  
|                                                                                                                                                                                                                                                    |  |                        |        |   |              |   |        |  
|                                                                                                                                                                                                                                                    |  |                        | 2,154  |   |              |   | 2,550  |  
|Less: Current portion                                                                                                                                                                                                                               |  |                        | (2,126 | ) |              |   | (1,950 | )
|                                                                                                                                                                                                                                                    |  |                        |        |   |              |   |        |  
|Long-term debt, net of current portion                                                                                                                                                                                                              |  | $                      | 28     |   |              | $ | 600    |  
|                                                                                                                                                                                                                                                    |  |                        |        |   |              |   |        |  



12. Convertible promissory
note



In December 2000, Tullys issued a promissory
note in the principal amount of $3,000,000 to an affiliate of a shareholder and then-director of Tullys, convertible into Series A Preferred stock at the option of the note holder. The note was subsequently amended to mature on August 1,
2006 and to bear interest at 8% per year. On November 14, 2005, Tullys repaid the convertible promissory note and accrued interest.



13. International Licenses and Deferred Revenue



Prior to August 31, 2005, Tullys had license and supply agreements with its licensee for Japan, Tullys Coffee Japan. These license and
supply agreements were subject to renewal at the end of Fiscal 2006 and the parties had been in discussion regarding possible modifications in these license and supply agreements. As the result of these discussions, on August 19, 2005,
Tullys and Tullys Coffee Japan entered into the Japan Rights



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Notes to Consolidated Financial Statements(Continued)



Agreement under which Tullys agreed to sell to Tullys Coffee Japan all of Tullys rights, title and interest for Japan with respect to the
Tullys trademarks, store designs, processes and other intellectual property assets and rights for the Tullys business in Japan for $17,500,000. The Japan Rights Agreement does not provide Tullys Coffee Japan with the right to use
Tullys proprietary intellectual properties outside of Japan and does not affect Tullys ownership or rights with respect to the Tullys intellectual properties outside of Japan. Tullys and Tullys Coffee Japan have agreed
to cooperate in the development of the Tullys brand for the mutual benefit of the two companies.



The Japan Rights sale closed on August 31, 2005 and Tullys received $13,819,000 on August 31, 2005. The remaining $3,681,000 of the
purchase price was paid by Tullys Coffee Japan to Tullys on October 5, 2005. Under the Japan Rights Agreement, the parties also resolved a tax indemnification claim previously made by Tullys Coffee Japan without any further
payments by either party. Tullys recognized a gain of $17,392,000 on the Japan Rights sale, as follows (dollars in thousands):



|                                  |  |   |        |  
|--------------------------------- |  | - | ------ | -
|Cash sales price for Japan Rights |  | $ | 17,500 |  
|Lesstransaction costs            |  |   | (108   | )
|                                  |  |   |        |  
|Gain on sale of Japan Rights      |  | $ | 17,392 |  
|                                  |  |   |        |  



Under the Japan Rights
Agreement, the license and supply agreements with Tullys Coffee Japan were terminated on August 31, 2005 and Tullys right to receive license fees and coffee roasting fees from Tullys Coffee Japan terminated for periods after
July 31, 2005. License fees and coffee roasting fee revenues from Tullys Coffee Japan are summarized as follows (dollars in thousands):



|                                                                        |  |              |     |              |   |               |  |   |      
|----------------------------------------------------------------------- |  | ------------ | --- | ------------ | - | ------------- |  | - | -----
|                                                                        |  | Years ended 
|                                                                        |  | April 2,2006 |     | April 3,2005 |   | March 28,2004
|License fees and coffee roasting fee revenues from Tullys Coffee Japan |  | $            | 811 |              | $ | 2,234         |  | $ | 1,240
|                                                                        |  |              |     |              |   |               |  |   |      



As the result of the
termination of the license and supply agreements with Tullys Coffee Japan, we recognized the unamortized balance of the deferred license revenue related to these agreements, which aggregated $4,405,000 as of August 31, 2005, in Fiscal
2006. Deferred licensing revenue recognized under the agreements with Tullys Coffee Japan and the license agreement with Ueshima Coffee Company (UCC) is summarized as follows (dollars in thousands):



|                                                                                                                |  |              |       |              |   |               |  |   |      
|--------------------------------------------------------------------------------------------------------------- |  | ------------ | ----- | ------------ | - | ------------- |  | - | -----
|                                                                                                                |  | Years ended 
|                                                                                                                |  | April 2,2006 |       | April 3,2005 |   | March 28,2004
|Recognition of deferred license revenue                                                                         |  |              |       |              |   |               |  |   |      
|Periodic recognition of deferred license revenue under agreements with Tullys Coffee Japan                     |  | $            | 166   |              | $ | 647           |  | $ | 647  
|Revenue recognized upon termination of license and supply agreements under agreements with Tullys Coffee Japan |  |              | 4,405 |              |   |              |  |   |     
|                                                                                                                |  |              |       |              |   |               |  |   |      
|Total deferred license revenue recognized under agreements with Tullys Coffee Japan                            |  |              | 4,571 |              |   | 647           |  |   | 647  
|Periodic recognition of deferred license revenue under UCC license agreement                                    |  |              | 1,440 |              |   | 1,440         |  |   | 1,440
|                                                                                                                |  |              |       |              |   |               |  |   |      
|Total deferred license revenue recognized under agreements with Tullys Coffee Japan and UCC                    |  | $            | 6,011 |              | $ | 2,087         |  | $ | 2,087
|                                                                                                                |  |              |       |              |   |               |  |   |      



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Notes to Consolidated Financial Statements(Continued)



In April 2001, Tullys granted UCC a license to use Tullys business names, trademarks and
other intellectual property rights to develop and operate specialty coffee stores throughout Asia, except for Japan. Commencing in April 2009, UCC is required to pay us a royalty and service fee based upon the aggregate net revenues of the stores
that UCC is then operating under the Tullys business name, and all other sales of products or services made under the Tullys business names and trademarks in Asia (other than Japan). We received a $12,000,000 initial license fee. We have
accounted for this payment as deferred revenue and are amortizing this amount into income through April 2009. Under this agreement, Tullys has granted UCC a security interest in certain of our intellectual property rights and certain proceeds
related thereto solely as the same relate to stores located in the licensed territories. Since the license agreement was executed in April 2001, UCC has opened one store, which it closed in 2004. In June 2006, Tullys notified UCC that it
considers UCC to be in breach of this license agreement, and the parties have commenced discussions regarding the matter.



Deferred revenue is summarized as follows:



|                                               |  |                        |        |   |              |   |        |  
|---------------------------------------------- |  | ---------------------- | ------ | - | ------------ | - | ------ | -
|                                               |  | Years Ended            |       
|                                               |  | April 2,2006           |        |   | April 3,2005 |  
|                                               |  | (dollars in thousands) |       
|Additions to deferred revenue in the year      |  | $                      | 50     |   |              | $ |       |  
|Less: Deferred revenue recognized in net sales |  |                        | (6,011 | ) |              |   | (2,087 | )
|Other, net                                     |  |                        | (3     | ) |              |   | (2     | )
|                                               |  |                        |        |   |              |   |        |  
|Net decrease in deferred revenue for the year  |  |                        | (5,964 | ) |              |   | (2,089 | )
|Deferred revenue                               |  |                        |        |   |              |   |        |  
|Beginning of year                              |  |                        | 10,331 |   |              |   | 12,420 |  
|                                               |  |                        |        |   |              |   |        |  
|End of year                                    |  |                        | 4,367  |   |              |   | 10,331 |  
|Less: Current portion                          |  |                        | (1,453 | ) |              |   | (1,838 | )
|                                               |  |                        |        |   |              |   |        |  
|Non-current portion of deferred revenue        |  | $                      | 2,914  |   |              | $ | 8,493  |  
|                                               |  |                        |        |   |              |   |        |  



During Fiscal 2004 we
entered into preliminary discussions with Tullys Coffee Japan about the possibility of integrating our business with Tullys Coffee Japan. On May 12, 2004, we reported that we had ceased discussions with Tullys Coffee Japan. In
connection with these discussions and the evaluation of this business integration opportunity, we incurred fees and other expenses of approximately $129,000 in Fiscal 2005 and $541,000 in Fiscal 2004.



14. Related-party transactions



In connection with the KCL promissory note, warrants to purchase shares of
common stock were issued to the Guarantors of the KCL promissory note in Fiscal 2004, Fiscal 2005 and Fiscal 2006 (see Note 11).



In February 2006, an affiliate of Northrim acquired a 24% ownership interest in Pacific Wealth Advisors, LLC (PWA), a newly formed company
which is the successor by merger to Pacific Portfolio Consulting (Pacific Portfolio). PWA is a wealth management and investment advisory services holding company. A member of the Tullys Board of Directors is the president of PWA
and Pacific Portfolio and has an ownership interest of more than 10% in PWA. During Fiscal 2006, Tullys paid approximately $168,000 to Northrim for interest on the amounts borrowed, and the outstanding debt to Northrim at April 2, 2006
was $1,901,000. Pacific Portfolio provides investment advisory consulting services for the Tullys employee 401(k) savings plan (see Note 20) and received fees of approximately $6,000 for this service in Fiscal 2006.



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Notes to Consolidated Financial Statements(Continued)



15. Store closure and lease termination costs



Store closure and lease termination costs are summarized as follows (dollars
in thousands):



|                                                                              |  |             |     |             |   |             |  |   |    
|----------------------------------------------------------------------------- |  | ----------- | --- | ----------- | - | ----------- |  | - | ---
|                                                                              |  | Fiscal 2006 |     | Fiscal 2005 |   | Fiscal 2004
|Store closure costs, including losses from disposal of property and equipment |  | $           | 43  |             | $ | 43          |  | $ | 170
|Lease termination costs                                                       |  |             | 176 |             |   |            |  |   |   
|                                                                              |  |             |     |             |   |             |  |   |    
|Total                                                                         |  | $           | 219 |             | $ | 43          |  | $ | 170
|                                                                              |  |             |     |             |   |             |  |   |    



During Fiscal 2006, we
closed six stores that did not meet our financial criteria. These six stores represented approximately 3.2% of our Fiscal 2006 sales. During Fiscal 2005, we closed three stores that did not meet our financial criteria. These three stores represented
approximately 0.07% of our Fiscal 2005 sales. During Fiscal 2004, we closed seven stores that did not meet our financial criteria. These seven stores represented approximately 1.5% of our Fiscal 2004 sales.



16. Commitments and contingencies



Lease commitments



We lease all of our retail, roasting plant and office space under operating
leases, which expire through 2016. The leases provide for minimum annual payments, and (in certain cases) contingent rentals based upon gross sales, escalation clauses and/or options to renew. Rental expense is recorded on a straight-line basis over
the respective terms of the leases. Rental expense under these operating leases was approximately $5,300,000, $5,800,000, and $5,800,000 for Fiscal 2006, Fiscal 2005 and Fiscal 2004, respectively. Contingent rental expense was approximately
$218,000, $197,000, and $147,000 for Fiscal 2006, Fiscal 2005 and Fiscal 2004, respectively and is recognized as incurred.



In connection with certain leases, lessors have granted tenant improvement allowances to Tullys. These amounts, included in liabilities 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 stepped rent excess of rental expense computed on a
straight-line basis over the actual rent payments required by the terms of our leases.



Minimum future rental payments under noncancellable operating leases as of April 2, 2006 are summarized as follows:



|                       |  |   |       
|---------------------- |  | - | ------
|Fiscal year            |  |  
|(dollars in thousands) |  |  
|2007                   |  | $ | 5,100 
|2008                   |  |   | 4,443 
|2009                   |  |   | 3,744 
|2010                   |  |   | 3,076 
|2011                   |  |   | 1,301 
|Thereafter             |  |   | 602   
|                       |  |   |       
|Total                  |  | $ | 18,266
|                       |  |   |       



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



We have subleased some of our leased premises to third parties under subleases with varying terms
through 2008. Expected future sublease receipts under such sub-lease agreements are summarized as follows:



|                       |  |   |      
|---------------------- |  | - | -----
|Fiscal year            |  |  
|(dollars in thousands) |  |  
|2007                   |  | $ | 385  
|2008                   |  |   | 334  
|2009                   |  |   | 283  
|2010                   |  |   | 191  
|2011                   |  |   | 50   
|                       |  |   |      
|Total                  |  | $ | 1,243
|                       |  |   |      



Tullys has
funded the acquisition of equipment through capital leases. These leases typically have terms ranging from three to five years and generally have bargain purchase options. Minimum future rental payments under capital leases as of April 2, 2006
are summarized as follows:



|                                                                 |  |   |     |  
|---------------------------------------------------------------- |  | - | --- | -
|Fiscal year                                                      |  |   |    
|(dollars in thousands)                                           |  |   |    
|2007                                                             |  | $ | 100 |  
|2008                                                             |  |   | 45  |  
|2009                                                             |  |   | 23  |  
|2010                                                             |  |   | 15  |  
|2011                                                             |  |   | 7   |  
|                                                                 |  |   |     |  
|Total minimum lease payment                                      |  |   | 190 |  
|Less: Amount representing future interest                        |  |   | (35 | )
|                                                                 |  |   |     |  
|Present value of net minimum lease payments under capital leases |  | $ | 155 |  
|                                                                 |  |   |     |  



Purchase
commitments



It is our general practice to enter into
forward commitments for the purchase of green coffee in order to secure future supplies of premium quality coffee beans that meet our specifications, in quantities that we estimate will be required to meet our future roasting needs. Typically,
Tullys has entered into contracts for the next seasons delivery of green coffee beans to help ensure adequacy of supply. As of April 2, 2006, we had contracts with fixed-price coffee purchase commitments and we also had commitments
to purchase coffee at prices to be determined by future coffee market indices (permitting us to fix the price prior to delivery, based on the then-current market). In June 2006, we exercised our option to fix the pricing for these remaining
contracts. As of June 19, 2006, we had approximately $7,000,000 in fixed price purchase commitments for Fiscal 2007. We believe, based on relationships established with our suppliers, that the risk of non-delivery on such purchase commitments
is remote.



Employment Agreements and Compensatory
Arrangements



Under the employment letters for members
of Tullys senior management group, Tullys has agreed to pay severance compensation to these several executives in the event their employment by Tullys is terminated for reasons other than certain excluded circumstances. The amount
of severance to be paid would depend upon the rate of salary at the time of termination and other factors. As of April 2, 2006, the aggregate contingent obligation for severance to these individuals was approximately $370,000.



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



In April 2004 Tullys accepted the resignation of our then-president, and, pursuant to his
employment agreement is required to pay him severance compensation in varying installments over a twenty-four month period ending July 2006. We recorded expense of $402,000 in Fiscal 2005 as a result of this matter, and the unpaid balance of $50,000
was included in accrued liabilities at April 2, 2006.



Contingencies



In February 2004 a
lawsuit was filed against Tullys in Superior Court of California, Los Angeles County (the Court) by two former store managers on behalf of themselves and on behalf of other former and current store managers in the state of
California. The suit alleges that Tullys improperly classified such managers as exempt under Californias wage and hour laws and seeks damages, restitution, reclassification and attorneys fees and costs. Since the lawsuit was filed,
Tullys has investigated the matter and vigorously defended this litigation. Tullys has also pursued alternative dispute resolution possibilities with the plaintiffs.



While Tullys denies all liability in this case, in order to settle the lawsuit and fully resolve the claims brought by
the plaintiffs without engaging in costly and protracted litigation, on April 21, 2005, the parties entered into a memorandum of understanding regarding the settlement of this matter, which was subsequently reflected by the parties in a Joint
Stipulation of Settlement and Release (the Settlement Agreement). On July 11, 2005 the Court conditionally certified the class for purposes of the settlement and issued an order granting the motion for preliminary approval of the
Settlement Agreement. The settlement is subject to court approval and Tullys may terminate the agreement if more than ten members of the settlement class opt out of the settlement. In Fiscal 2005, Tullys incurred a one-time charge of
approximately $1.6 million for the settlement and associated costs. Under the settlement, Tullys will make cash payments totaling approximately $800,000 to the settlement class over a three year period starting upon final approval by the
court. Subject to regulatory approval and compliance with applicable securities laws, Tullys will also issue 300,000 shares of its common stock, with an agreed value of $450,000, to the settlement class during that three year period. The Court
has set a final hearing date in September 2006. Tullys incurred approximately $32,000 in legal fees and expenses during Fiscal 2006 in connection with this settlement. The settlement and associated costs expensed in Fiscal 2005, and the
anticipated timing for payment of the settlement costs, are summarized as follows (in addition, cash settlement payments after the initial payment will include interest at 6.75% per year):



|                                                                   |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  
|------------------------------------------------------------------ |  | --------------------------------- |  | ------------------------------------------- | ------- | --------------------------------------- | - | ---------------------------------- |  | - | --------- | -
|                                                                   |  | Shares ofcommon stockto be issued |  | Valuation ofcommon stock(at $1.50 pershare) |         | Cashsettlementpayments andrelated costs |   | Combinedcash costs andcommon stock | 
|Settlement costs payable in                                        |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  
|Fiscal 2007                                                        |  | 56,250                            |  | $                                           | 84,375  |                                         | $ | 150,000                            |  | $ | 234,375   |  
|Fiscal 2008                                                        |  | 93,750                            |  |                                             | 140,625 |                                         |   | 250,000                            |  |   | 390,625   |  
|Fiscal 2009                                                        |  | 93,750                            |  |                                             | 140,625 |                                         |   | 250,000                            |  |   | 390,625   |  
|Fiscal 2010                                                        |  | 56,250                            |  |                                             | 84,375  |                                         |   | 150,000                            |  |   | 234,375   |  
|                                                                   |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  
|Total settlement costs                                             |  | 300,000                           |  |                                             | 450,000 |                                         |   | 800,000                            |  |   | 1,250,000 |  
|Legal and other costs                                              |  |                                  |  |                                             |        |                                         |   | 378,000                            |  |   | 378,000   |  
|                                                                   |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  
|Total settlement and associated costs                              |  | 300,000                           |  | $                                           | 450,000 |                                         | $ | 1,178,000                          |  |   | 1,628,000 |  
|                                                                   |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  
|Lessamounts paid or included in accrued expenses at April 2, 2006 |  |                                   |  |                                             |         |                                         |   |                                    |  |   | (535,000  | )
|                                                                   |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  
|Amount reported as other long-term liability at April 2, 2006      |  |                                   |  |                                             |         |                                         |   |                                    |  | $ | 1,093,000 |  
|                                                                   |  |                                   |  |                                             |         |                                         |   |                                    |  |   |           |  



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



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



17. Stock options



Company Stock Incentive Plan



In 1994, Tullys shareholders approved a Stock Incentive Plan (the 1994 Plan) In August 1999 our stockholders approved an amended plan,
which established the maximum number of shares issuable under the 1994 Plan and the Employee Stock Purchase Plan (See Note 19) at 4,200,000, and in June 2003, our Board of Directors further amended the 1994 Plan. By its terms, the 1994 Plan expired
in October 2004 (this did not terminate outstanding options).



On September 23, 2004, the Tullys Board of Directors approved the adoption of the 2004 Stock Option Plan, effective as of November 1, 2004 and subject to shareholder approval. The 2004 Stock Option Plan authorizes the
issuance of up to 2,500,000 shares of common stock under the 2004 Stock Option Plan and Tullys Employee Stock Purchase Plan. The Tullys shareholders approved the 2004 Stock Option Plan in December 2004.



The provisions of the 2004 Stock Option Plan (and the 1994 Plan prior to its
expiration) are summarized as follows. We may issue incentive or nonqualified stock options to our employees and directors. Stock options are granted solely at the discretion of our Board of Directors and are issued at a price determined by our
Board of Directors. The term of each option granted is for such period as determined by our Board of Directors, but not more than ten years from date of grant. Options are nontransferable and may generally be exercised based on a vesting schedule
determined by our Board of Directors. The plan provides for acceleration of outstanding options under certain conditions, including certain changes in control of Tullys.



Founders Stock Option Plan



In addition to options granted under the 1994 Plan, our chairman and founder has granted options to purchase shares of his
stock to employees and third parties (the Founders Plan). No options have been granted by the Chairman under the Founders Plan since Fiscal 2002. These options have vesting periods ranging from immediate vesting to five year
vesting and have a twenty-five year life. In October 2005, the chairman and founder contributed his holdings of Tullys common stock to TTOK, LLC, a limited liability company owned by the chairman, and the Founders Plan stock option
obligations were assigned to TTOK, LLC.



All Plans



Under the intrinsic value method of accounting,
compensation cost is measured as the excess, if any, of the fair value of our stock at the date of grant over the amount the employee must pay to acquire the stock. Compensation cost is amortized on a straight-line basis over the vesting period of
the individual options. For purposes of these computations, the estimated market price per common share at the time of grant has been established by our board of directors and was $0.30 per share for options granted in Fiscal 2004 and Fiscal 2005
and $1.50 per share for options granted in Fiscal 2006. We have adopted the disclosure-only provisions SFAS No. 123 for options granted to employees (see Note 1 for the disclosure of compensation expense as if determined under the provisions of
SFAS No. 123). Non-cash stock option compensation expense, determined under the intrinsic value method of accounting, totaled $114,000, $62,000, and $87,000 for Fiscal 2006, Fiscal 2005 and Fiscal 2004, respectively.



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Notes to Consolidated Financial Statements(Continued)



Stock option activity under the 1994 Plan, the 2004 Stock Option Plan, and the Founders Plan for
Fiscal 2006, Fiscal 2005 and Fiscal 2004 is summarized as follows:



|                        |  |                  |   |  |                                |     
|----------------------- |  | ---------------- | - |  | ------------------------------ | ----
|                        |  | Number ofoptions |   |  | Weighted-averageexercise price
|Balance, March 30, 2003 |  | 5,254,350        |   |  |                                | 0.49
|Granted                 |  | 553,900          |   |  |                                | 0.37
|Forfeited               |  | (145,664         | ) |  |                                | 0.64
|Exercised               |  |                 |   |  |                                |    
|                        |  |                  |   |  |                                |     
|Balance, March 28, 2004 |  | 5,662,586        |   |  | $                              | 0.47
|Granted                 |  | 596,000          |   |  |                                | 1.06
|Forfeited               |  | (629,849         | ) |  |                                | 1.25
|Exercised               |  | (263,783         | ) |  |                                | 0.06
|                        |  |                  |   |  |                                |     
|Balance, April 3, 2005  |  | 5,364,954        |   |  | $                              | 0.47
|Granted                 |  | 596,008          |   |  |                                | 1.50
|Forfeited               |  | (447,394         | ) |  |                                | 0.01
|Exercised               |  | (633             | ) |  |                                | 0.03
|                        |  |                  |   |  |                                |     
|Balance, April 2, 2006  |  | 5,512,935        |   |  | $                              | 0.51
|                        |  |                  |   |  |                                |     



At April 2, 2006,
options for 3,342,760 shares were outstanding under the 1994 Plan and options for 366,331 shares had been exercised under the 1994 Plan. At April 2, 2006, options for 484,008 shares were outstanding under the 2004 Stock Option Plan and no
options had been exercised under the 2004 Stock Option Plan, leaving 2,015,992 shares available for grant under the 2004 Stock Option Plan and the Employee Stock Purchase Plan. During June 2006, options for 66,000 shares were granted to the members
of the board of directors for service in Fiscal 2006. Outstanding stock options are summarized as follows:



|                                             |  |               |  |               |  |               
|-------------------------------------------- |  | ------------- |  | ------------- |  | --------------
|                                             |  | April 2, 2006 |  | April 3, 2005 |  | March 28, 2004
|Issued under the 1994 Plan                   |  |               |  |               |  |               
|Employees and Directors                      |  | 2,188,525     |  | 2,521,952     |  | 2,817,884     
|Directors, for Loan Guarantees               |  | 1,152,235     |  | 1,152,235     |  | 1,152,235     
|                                             |  |               |  |               |  |               
|Total Outstanding under the 1994 Plan        |  | 3,340,760     |  | 3,674,187     |  | 3,970,119     
|Outstanding under the 2004 Stock Option Plan |  | 484,008       |  |              |  |              
|Outstanding under the Founders Plan         |  | 1,688,167     |  | 1,690,767     |  | 1,692,467     
|                                             |  |               |  |               |  |               
|Total Outstanding Stock Options              |  | 5,512,935     |  | 5,364,954     |  | 5,662,586     
|                                             |  |               |  |               |  |               



The following table
summarizes information about options granted under the 1994 Plan and the 2004 Stock Option Plan:



|                                                                                                                                                                  |  |             |  |                            |      |             |         |                            |   |        |  |                            |  |   |     
|----------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- |  | -------------------------- | ---- | ----------- | ------- | -------------------------- | - | ------ |  | -------------------------- |  | - | ----
|                                                                                                                                                                  |  | Fiscal 2006 |  | Fiscal 2005                |      | Fiscal 2004
|                                                                                                                                                                  |  | Shares      |  | Weighted-averagefair value |      | Shares      |         | Weighted-averagefair value |   | Shares |  | Weighted-averagefair value
|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                |  | 96,008      |  | $                          | 0.30 |             | 200,000 |                            | $ | 0.01   |  |                           |  |   |    
|Weighted-average fair value of options granted during the year whose exercise price was greater than or equal to the fair value of the stock
on the date of grant |  | 500,000     |  | $                          | 1.53 |             | 396,000 |                            | $ | 1.59   |  | 553,900                    |  | $ | 0.37
|                                                                                                                                                                  |  |             |  |                            |      |             |         |                            |   |        |  |                            |  |   |     
|Total                                                                                                                                                             |  | 596,008     |  |                            |      |             | 596,000 |                            |   |        |  | 553,900                    |  |   |     
|                                                                                                                                                                  |  |             |  |                            |      |             |         |                            |   |        |  |                            |  |   |     



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Notes to Consolidated Financial Statements(Continued)



The following table summarizes information about fixed-price options outstanding at April 2,
2006 under the 1994 Plan and the 2004 Stock Option Plan (it excludes options exercisable under the Founders Plan, which will not affect the outstanding shares, or provide cash proceeds to Tullys, if exercised):



|               |  |                   |  |                                           |  |                  
|-------------- |  | ----------------- |  | ----------------------------------------- |  | -----------------
|Exercise price |  | Numberoutstanding |  | Weighted-averageremainingcontractual life |  | Numberexercisable
|               |  |                   |  | (years)                                   |  |                  
|$0.01          |  | 1,893,460         |  | 4.47                                      |  | 1,893,460        
|0.30           |  | 105,008           |  | 8.96                                      |  | 105,008          
|0.31           |  | 415,161           |  | 7.62                                      |  | 322,152          
|0.33           |  | 10,874            |  | 5.02                                      |  | 10,874           
|1.50           |  | 494,092           |  | 8.71                                      |  | 58,092           
|1.75           |  | 50,858            |  | 2.92                                      |  | 50,858           
|1.78           |  | 411,666           |  | 4.47                                      |  | 411,666          
|2.00           |  | 130,000           |  | 8.65                                      |  |                 
|2.25           |  | 73,250            |  | 3.46                                      |  | 73,250           
|2.50           |  | 240,399           |  | 7.06                                      |  | 140,399          
|               |  |                   |  |                                           |  |                  
|Total          |  | 3,824,768         |  |                                           |  | 3,065,759        
|               |  |                   |  |                                           |  |                  



18. Stockholders equity



Rights Offering



Before October 1999, our shareholders had a right to maintain their
proportionate shareholdings in Tullys by purchasing shares before we offered them to new investors. During Fiscal 2005, we conducted an offering of our common stock and investment units (each unit consisting of convertible preferred stock and
warrants to purchase common stock) through the distribution of subscription rights to eligible shareholders and former shareholders (the rights offering). The primary purpose of the rights offering was to provide an opportunity for our
shareholders to satisfy any unsatisfied preemptive rights that they may have had. We conducted the rights offering because we believed that our ability to engage in financing or strategic transactions could be limited by the potential risk of such
possible future preemptive rights claims, but that such risk could be mitigated by a number of possible defenses, including the completion of the rights offering. The registration statement for the rights offering was declared effective
January 11, 2005 and eligible shareholders and former shareholders of Tullys received rights to purchase these securities at the prices at which the securities were issued by Tullys between 1994 and 1999. Shareholders of record at
January 6, 2005 received subscription privileges to purchase any shares of common stock and investment units not purchased through the exercise of the rights. The rights offering closed on February 8, 2005. We received a total of $878,000
from the subscribers in this offering. Qualified subscriptions were received with gross proceeds to Tullys of $701,000. In May 2005, we refunded $177,000 to subscribers for the ineligible subscriptions and issued certificates for 337,216
shares of common stock to the subscribers and we issued certificates for 180,888 shares of Series A Convertible Preferred Stock and warrants to purchase 90,444 shares of common stock to the subscribers for the investment units. We incurred offering
costs of $458,000.



Preferred stock



Each outstanding share of our Series A Preferred Stock is convertible at
any time by the holder thereof into shares of common stock at the then-effective conversion price. In addition, each outstanding share of Series A Preferred Stock is automatically convertible into shares of common stock when and if Tullys
completes an underwritten public offering of Tullys shares of common stock with gross proceeds to Tullys in excess of $15 million, at a per share price of $5.00 or more (Qualified Offering). The Series A Preferred Stock
contains an



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Notes to Consolidated Financial Statements(Continued)



anti-dilution protection right that provides for a weighted average adjustment of the conversion price in the event we issue shares of capital stock at an
effective price less than the Series A Preferred conversion price then in effect, subject to certain limitations and exclusions. As a result, at April 2, 2006, each outstanding Series A Convertible Preferred share could be converted at the
option of the shareholder into 1.13 of our shares of common stock.



Holders of Series A Preferred Stock are entitled to receive dividends when and if any dividends are declared to be paid by our Board of Directors. Voting rights of the Series A Preferred Stock are subject to adjustment for the anti-dilution
adjustment and as a result, at April 2, 2006, each share of Series A Preferred Stock was entitled to cast 1.13 votes on all matters submitted to a vote of our shareholders. Series A Preferred shareholders may exercise cumulative voting rights
with respect to the election of Directors.



In the event of any
liquidation or winding up of Tullys, each share of Series A Preferred Stock is entitled to receive, prior and in preference to all other payments to the holders of Series B Preferred Stock and the shares of common stock, an amount equal to
$2.50, plus any and all declared but unpaid dividends with respect to such share of Series A Preferred Stock (the Series A Liquidation Preference). Assuming distribution of the full Series A Liquidation Preference, common stock
liquidation preference (described below), and the Series B Liquidation Preference (described below), and subject to the rights of any additional preferred stock that may in the future be designated and issued by Tullys, our remaining assets
available for distribution to shareholders would be distributed pro rata among the holders of the Series A Preferred Stock, Series B Preferred Stock and shares of common stock, treating the shares of Series A Preferred Stock and Series B Preferred
Stock on an as-converted basis.



Holders of Series A Preferred
Stock have certain rights to require us to register the shares of common stock issued upon conversion of the Series A Preferred Stock. These rights generally allow persons holding the underlying shares of common stock 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 that we file a registration statement for the
underlying shares of common stock at the shareholders option no more than one time following our initial public offering, if any, and thereafter, unlimited rights once Tullys is eligible to use Form S-3.



Each outstanding share of Series B Preferred Stock is convertible at any time
by the holder thereof into shares of common stock at the then-effective conversion price. In addition, each outstanding share of Series B Preferred Stock is automatically convertible into shares of common stock at the then-effective conversion price
when and if we make a Qualified Offering. The conversion price for the Series B Convertible Preferred shares is subject to an anti-dilution adjustment, but no adjustment has been required and each Series B Convertible Preferred share could be
converted at the option of the shareholder into one share of common stock as of April 2, 2006.



Holders of Series B Preferred Stock are entitled to receive dividends when and if any dividends are declared to be paid by our Board of Directors. Each
share of Series B Preferred Stock also is entitled to cast one vote for each share of common stock into which such share is then convertible on all matters submitted to a vote of the shareholders of Tullys.



In the event of any liquidation or winding up of Tullys, each share of
Series B Preferred Stock is entitled to receive, after full satisfaction of the Series A Liquidation Preference and the common stock liquidation preference (described below), and prior and in preference to all other payments to the holders of shares
of common stock, an amount equal to $2.50, plus any and all declared but unpaid dividends with respect to such share of Series B Preferred Stock (the Series B Liquidation Preference). Assuming distribution of the full



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Tullys Coffee Corporation



Notes to Consolidated Financial Statements(Continued)



Series A Liquidation Preference, common stock liquidation preference and the Series B Liquidation Preference, and subject to the rights of any additional
series or classes of preferred stock that may in the future be designated and issued by Tullys, the remaining assets of Tullys available for distribution to shareholders would be distributed pro rata among the holders of the Series A
Preferred Stock, Series B Preferred Stock and shares of common stock, treating the shares of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock on an as-converted basis.



Common stock and Warrants



In the event of any liquidation or winding up of Tullys, after
distribution of the full Series A Liquidation Preference, each common share is entitled to receive an amount per share equal to $2.25, plus any and all declared but unpaid dividends with respect to such share of shares of common stock (the
common stock liquidation preference). Assuming distribution of the full Series A Liquidation Preference, common stock liquidation preference and the Series B Liquidation Preference (described above), and subject to the rights of any
additional preferred stock that may in the future be designated and issued by us, our remaining assets available for distribution to shareholders would be distributed pro rata among the holders of the Series A Convertible Preferred Stock, Series B
Convertible Preferred Stock and shares of common stock, treating the shares of Series A Preferred Stock and Series B Preferred Stock on an as-converted basis.



Warrants to purchase an aggregate of 44,767 shares of common stock were issued to the Guarantors of the KCL promissory note in Fiscal 2006. In May 2005
we issued warrants to purchase 90,444 shares to subscribers in the rights offering as described above.



In Fiscal 2006, warrants to purchase 18,120 shares of common stock were exercised at $0.33 per share. During Fiscal 2005, warrants to purchase 590,552
shares of common stock were exercised at prices between $0.01 and $0.33 per share and during Fiscal 2004, warrants to purchase 82,000 shares of common stock were exercised at prices between $0.01 and $0.33 per share.



At April 2, 2006, we had warrants outstanding to purchase shares of our
common stock as follows:



|                                                                  |  |                     |  |                   |  |                |           
|----------------------------------------------------------------- |  | ------------------- |  | ----------------- |  | -------------- | ----------
|                                                                  |  | Outstandingwarrants |  | Numberexercisable |  | ExercisePrices
|Issued with Series A Preferred Stock investment units             |  | 6,470,772           |  | 6,470,772         |  | $              | 0.33      
|Issued to guarantors of KCL promissory note (see Note 11)         |  | 1,812,825           |  | 1,768,058         |  | $              | 0.05      
|Issued to holder of the convertible note in lieu of cash interest |  | 960,000             |  | 960,000           |  | $              | 0.01      
|Other                                                             |  | 431,052             |  | 431,052           |  | $              | 0.01-$0.33
|                                                                  |  |                     |  |                   |  |                |           
|Totals                                                            |  | 9,674,649           |  | 9,629,882         |  |                |           
|                                                                  |  |                     |  |                   |  |                |           



19. Stock purchase plan



In Fiscal 2000, our stockholders approved the Employee
Stock Purchase Plan (the Purchase Plan). The Purchase Plan qualifies under Section 423 of the Internal Revenue Code. Tullys has authorized up to 2,500,000 shares of common stock to be offered under the Purchase Plan and 2004
Stock Option Plan combined. No offerings have yet occurred under the Purchase Plan.



20. Employee 401(k) savings plan



During
Fiscal 2000, we adopted a 401(k) savings plan for employees. Eligible employees may contribute up to 20% of their salaries to the plan. Eligible employees are employees over the age of 18 who have been employed by Tullys for six months. There
is no mandatory match from Tullys. Most plan administrative costs are paid by the 401(k) savings plan.



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Notes to Consolidated Financial Statements(Continued)



21. Segment Reporting



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



We are organized into three business units: (1) the Retail division, which includes our U.S. company-operated retail store operations, (2) the
Wholesale division, which sells to domestic customers in the supermarket, food service, office coffee service, restaurant and institutional channels, and which also handles our mail order and internet sales, and (3) the Specialty division which
sells products and materials to our international licensees and manages the international licensing of the Tullys brand and is responsible for the franchising of Tullys stores in the U.S.



The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in Note 1. We do not allocate our assets among our business units for purposes of making business decisions, and therefore do not present asset information by operating segment. Earnings
before interest, taxes, depreciation and amortization (EBITDA) is a financial measurement we use to measure the operating performance of our operating segments. EBITDA excludes the effects of financing costs, income taxes, and non-cash
depreciation and amortization. During the fourth quarter of Fiscal 2006, we modified the financial information presented to our senior management to include within the operating segment financial information (1) the cost of shipping products
from our roasting plant and (2) allocated costs of our roasting and distribution facility based upon the respective operating segment product usage. For purposes of comparability, we have restated the operating segment information for Fiscal
2006, Fiscal 2005 and Fiscal 2004 to reflect this presentation.



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Notes to Consolidated Financial Statements(Continued)



The tables below present information by operating segment:



|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|-------------------------------------------------------------- |  | ---------------------- | ------ | - | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                               |  | Years Ended            |       
|                                                               |  | April 2,2006           |        |   | April 3,2005 |   |        | March 28,2004 | 
|                                                               |  | (dollars in thousands) |       
|Net sales                                                      |  |                        |        |   |              |   |        |               |  |   |        |  
|Retail division                                                |  | $                      | 38,194 |   |              | $ | 40,102 |               |  | $ | 40,617 |  
|Wholesale division                                             |  |                        | 13,187 |   |              |   | 9,516  |               |  |   | 6,522  |  
|Specialty division(1)                                          |  |                        | 6,864  |   |              |   | 4,362  |               |  |   | 3,629  |  
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|Net sales                                                      |  | $                      | 58,245 |   |              | $ | 53,980 |               |  | $ | 50,768 |  
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|Earnings before interest, taxes, depreciation and amortization |  |                        |        |   |              |   |        |               |  |   |        |  
|Retail division(2)                                             |  | $                      | 1,953  |   |              | $ | 3,762  |               |  | $ | 4,759  |  
|Wholesale division                                             |  |                        | 1,750  |   |              |   | 1,549  |               |  |   | 1,191  |  
|Specialty division(1)                                          |  |                        | 6,356  |   |              |   | 4,105  |               |  |   | 3,318  |  
|Corporate and other expenses(3)                                |  |                        | (7,775 | ) |              |   | (9,414 | )             |  |   | (7,438 | )
|Gain on Japan Rights sale                                      |  |                        | 17,392 |   |              |   |       |               |  |   |       |  
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|Earnings before interest, taxes, depreciation and amortization |  |                        | 19,676 |   |              |   | 2      |               |  |   | 1,830  |  
|Depreciation and amortization                                  |  |                        | (3,529 | ) |              |   | (3,651 | )             |  |   | (3,622 | )
|Income taxes                                                   |  |                        | (339   | ) |              |   | (52    | )             |  |   | (43    | )
|Interest income, interest expense, and loan guarantee fees     |  |                        | (385   | ) |              |   | (924   | )             |  |   | (760   | )
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|Net income (loss)                                              |  | $                      | 15,423 |   |              | $ | (4,625 | )             |  | $ | (2,595 | )
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|Depreciation and amortization                                  |  |                        |        |   |              |   |        |               |  |   |        |  
|Retail division                                                |  | $                      | 2,444  |   |              | $ | 2,561  |               |  | $ | 2,519  |  
|Wholesale division                                             |  |                        | 330    |   |              |   | 346    |               |  |   | 318    |  
|Specialty division                                             |  |                        | **     |   |              |   | **     |               |  |   | **     |  
|Corporate and other expenses                                   |  |                        | 755    |   |              |   | 744    |               |  |   | 785    |  
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  
|Total depreciation and amortization                            |  | $                      | 3,529  |   |              | $ | 3,651  |               |  | $ | 3,622  |  
|                                                               |  |                        |        |   |              |   |        |               |  |   |        |  

---

|** |  | not materialless than $1,000
|-- |  | -----------------------------

|(1) |  | Specialty division net sales and operating income for Fiscal 2006 include $4,405,000 of deferred license revenue recognized as the result of the termination of the license and
supply agreements with Tullys Coffee Japan (see Note 13).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The Retail division operating results include adjustments for impairment of long-lived assets of $236,000 (Fiscal 2006), $200,000 (Fiscal 2005), $97,000 (Fiscal 2004) and for
amounts required to close stores and terminate store leases totaling $219,000 (Fiscal 2006), $43,000 (Fiscal 2005), $170,000 (Fiscal 2004) (See Notes 8 and 15).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Corporate and other expenses for Fiscal 2005 include a charge of approximately $1,628,000 for the settlement and associated costs related to a lawsuit (See Note 16).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



22. Earnings (loss) per share



Basic earnings (loss) per share is computed by dividing net income (loss) by
the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) adjusted to eliminate the interest on convertible debt (if assumed to be converted), by the sum
of the weighted average number of common shares and the effect of dilutive common share equivalents.



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Notes to Consolidated Financial Statements(Continued)



Tullys has granted options and warrants to purchase common stock, and issued preferred stock
and debt convertible into common stock (collectively, the common share equivalent instruments). Under some circumstances, the common share equivalent instruments may have a dilutive effect on the calculation of earnings or loss per
share. All of the common share equivalent instruments were excluded from the computation of diluted loss per share for Fiscal 2005 and Fiscal 2004 because the effect of these instruments on the calculation would have been antidilutive.



The computations of earnings (loss) per share, and of the weighted average
shares used for basic earnings (loss) per share and diluted earnings (loss) per share are summarized as follows:



|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|--------------------------------------------------------------------------------------------- |  | ------------------------------------------------------- | ------ | ------------ | - | ------ | ------------- |  | - | ------ | -
|                                                                                              |  | Years Ended                                             |       
|                                                                                              |  | April 2,2006                                            |        | April 3,2005 |   |        | March 28,2004 | 
|                                                                                              |  | (dollars and shares in thousands,except per share data) |       
|Computation of basic earnings (loss) per share                                                |  |                                                         |        |              |   |        |               |  |   |        |  
|Net income (loss)                                                                             |  | $                                                       | 15,423 |              | $ | (4,625 | )             |  | $ | (2,595 | )
|Adjustments for basic earnings (loss) per share                                               |  |                                                         |       |              |   |       |               |  |   |       |  
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Net income (loss) for basic earnings (loss) per share                                         |  | $                                                       | 15,423 |              | $ | (4,625 | )             |  | $ | (2,595 | )
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Weighted average shares used in computing basic earnings (loss) per share                     |  |                                                         | 17,697 |              |   | 16,812 |               |  |   | 16,451 |  
|Basic earnings (loss) per share                                                               |  | $                                                       | 0.87   |              | $ | (0.28  | )             |  | $ | (0.16  | )
|                                                                                              |  |                                                         |       
|Computation of diluted earnings (loss) per share                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Net income (loss)                                                                             |  | $                                                       | 15,423 |              | $ | (4,625 | )             |  | $ | (2,595 | )
|Add interest on convertible note, if assumed to be converted                                  |  |                                                         | 167    |              |   |       |               |  |   |       |  
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Net income (loss) for diluted earnings (loss) per share                                       |  | $                                                       | 15,590 |              | $ | (4,625 | )             |  | $ | (2,595 | )
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Weighted average shares used in computing diluted earnings (loss) per share                   |  |                                                         | 51,475 |              |   | 16,812 |               |  |   | 16,451 |  
|Diluted earnings (loss) per share                                                             |  | $                                                       | 0.30   |              | $ | (0.28  | )             |  | $ | (0.16  | )
|                                                                                              |  |                                                         |       
|Weighted average shares used in computing earnings (loss) per share                           |  |                                                         |        |              |   |        |               |  |   |        |  
|Weighted average common shares outstanding, used in computing basic earnings (loss) per share |  |                                                         | 17,697 |              |   | 16,812 |               |  |   | 16,451 |  
|Common share equivalent instruments for computing diluted earnings (loss) per share           |  |                                                         |        |              |   |        |               |  |   |        |  
|Dilutive effect of Series A Convertible Preferred stock                                       |  |                                                         | 17,534 |              |   |       |               |  |   |       |  
|Dilutive effect of Series B Convertible Preferred stock                                       |  |                                                         | 4,938  |              |   |       |               |  |   |       |  
|Dilutive effect of convertible promissory note                                                |  |                                                         | 837    |              |   |       |               |  |   |       |  
|Dilutive effect of stock options (treasury stock method)                                      |  |                                                         | 2,407  |              |   |       |               |  |   |       |  
|Dilutive effect of warrants (treasury stock method)                                           |  |                                                         | 8,062  |              |   |       |               |  |   |       |  
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Total common share equivalent instruments for computing diluted earnings (loss) per share     |  |                                                         | 33,778 |              |   |       |               |  |   |       |  
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  
|Weighted average shares used in computing diluted earnings (loss) per share                   |  |                                                         | 51,475 |              |   | 16,812 |               |  |   | 16,451 |  
|                                                                                              |  |                                                         |        |              |   |        |               |  |   |        |  



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Notes to Consolidated Financial Statements(Continued)



23. Subsequent Events



In June 2006, we renewed our credit facility with Northrim until May 31, 2007 (see Note 11). Also in June 2006,
Tullys notified UCC that it considers UCC to be in breach of Tullys license to UCC, and the parties have commenced discussions regarding the matter (see Note 13).



24. Selected Quarterly Financial Data (Unaudited)



Summarized quarterly financial information for Fiscal 2006 and Fiscal 2005 is as follows. Our sales are moderately seasonal.



|                                    |  |                                               |        |   |         |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|----------------------------------- |  | --------------------------------------------- | ------ | - | ------- | - | ------ | ------- |  | - | ------- | - |  | ----- | ------ | - |  | - | ------ | -
|                                    |  | 1st Qtr                                       |        |   | 2nd Qtr |   |        | 3rd Qtr |  |   | 4th Qtr |   |  | Total |       
|                                    |  | (dollars in thousands, except per share data) |       
|Fiscal 2006                         |  |                                               |        |   |         |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|Net Sales                           |  | $                                             | 13,746 |   |         | $ | 17,774 | *       |  | $ | 14,228  |   |  | $     | 12,497 |   |  | $ | 58,245 |  
|Gross Profit                        |  |                                               | 7,385  |   |         |   | 11,268 | *       |  |   | 6,346   |   |  |       | 6,149  |   |  |   | 31,148 |  
|Net income (loss)                   |  |                                               | (885   | ) |         |   | 19,996 | *       |  |   | (1,311  | ) |  |       | (2,377 | ) |  |   | 15,423 |  
|Basic and Diluted Loss per Share    |  |                                               |        |   |         |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|Net income (loss) per basic share   |  | $                                             | (0.05  | ) |         | $ | 1.13   |         |  | $ | (0.07   | ) |  | $     | (0.13  | ) |  | $ | 0.87   |  
|Net income (loss) per diluted share |  | $                                             | (0.05  | ) |         | $ | 0.39   |         |  | $ | (0.07   | ) |  | $     | (0.13  | ) |  | $ | 0.30   |  
|Fiscal 2005                         |  |                                               |        |   |         |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|Net Sales                           |  | $                                             | 13,038 |   |         | $ | 13,356 |         |  | $ | 13,869  |   |  | $     | 13,717 |   |  | $ | 53,980 |  
|Gross Profit                        |  |                                               | 7,310  |   |         |   | 7,262  |         |  |   | 7,422   |   |  |       | 8,129  |   |  |   | 30,123 |  
|Net Loss                            |  |                                               | (997   | ) |         |   | (285   | )       |  |   | (590    | ) |  |       | (2,753 | ) |  |   | (4,625 | )
|Basic and Diluted Loss per Share    |  |                                               |        |   |         |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|Net Loss per Share                  |  | $                                             | (0.06  | ) |         | $ | (0.02  | )       |  | $ | (0.04   | ) |  | $     | (0.16  | ) |  | $ | (0.28  | )

---

|* |  | Net sales, gross profits and net income for the second quarter of Fiscal 2006 include $4,405,000 of deferred license revenue recognized as the result of the termination of the
license and supply agreements with Tullys Coffee Japan (see Note 13). Net income for the second quarter of Fiscal 2006 also includes $17,392,000 gain from the Japan Rights sale.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



During the fourth quarter of Fiscal 2006 and Fiscal 2005, the following
adjustments were recorded (dollars in thousands):



|                                                                                                                      |  |             |     |             |   |      
|--------------------------------------------------------------------------------------------------------------------- |  | ----------- | --- | ----------- | - | -----
|                                                                                                                      |  | Fiscal 2006 |     | Fiscal 2005
|Impairment of long-lived assets                                                                                       |  | $           | 236 |             | $ | 200  
|Wholesale discounts and allowances, adjustment for actual earned allowances in excess of amounts previously estimated |  | $           | 300 |             | $ |     
|Increase allowance for doubtful accounts receivable                                                                   |  | $           | 100 |             | $ |     
|Settlement of litigation (see Note 16)                                                                                |  | $           |    |             | $ | 1,628



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|ITEM 9. |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- |  | ------------------------------------------------------------------------------------



None.



ITEM 9A. CONTROLS AND PROCEDURES



The Companys Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Companys disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and
15d-14(c)) as of April 2, 2006 (the Evaluation Date), concluded that as of the Evaluation Date, the Companys disclosure controls and procedures were effective and designed to reasonably ensure that material information
relating to the Company and its consolidated subsidiary would be made known to them by others within those entities. There has been no change in the Companys internal control over financial reporting that occurred during its last fiscal
quarter that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.



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PART III



|ITEM 10. |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- |  | --------------------------------------------------



|                             |  |     |  |                                                                                                              |  |              
|---------------------------- |  | --- |  | ------------------------------------------------------------------------------------------------------------ |  | -------------
|Name                         |  | Age |  | Position with Tullys                                                                                        |  | DirectorSince
|Tom T. OKeefe(1*) (4)       |  | 52  |  | Chairman of the Board                                                                                        |  | 1992         
|Kathi Ainsworth-Jones(3)     |  | 46  |  | Director                                                                                                     |  | 2004         
|John K. Buller(3*) (4)       |  | 59  |  | Director                                                                                                     |  | 2005         
|Marc Evanger(2) (3)          |  | 51  |  | Director                                                                                                     |  | 1999         
|John M. Fluke(1) (2*)        |  | 63  |  | Director                                                                                                     |  | 2005         
|Lawrence L. Hood(1) (2) (4*) |  | 47  |  | Director                                                                                                     |  | 1994         
|Gregory A. Hubert(1)         |  | 55  |  | Director                                                                                                     |  | 2004         
|John D. Dresel               |  | 46  |  | President and Chief Operating Officer (principal executive officer)                                          |  |              
|Kristopher S. Galvin         |  | 53  |  | Executive Vice President, Chief Financial Officer and Secretary (principal accounting and financial officer) |  |              

---

Committee
Appointments as of June 21, 2006

|(1) |  | Member of the executive committee
|--- |  | ---------------------------------

|(2) |  | Member of the audit committee
|--- |  | -----------------------------

|(3) |  | Member of the compensation committee
|--- |  | ------------------------------------

|(4) |  | Member of the governance and nominating committee
|--- |  | -------------------------------------------------

|* |  | Designates Committee Chair
|- |  | --------------------------



Tom T. OKeefeChairman of the Board, Founder. Tom T. OKeefe founded Tullys in 1992 and has served as a director and chairman
of the Board of Directors since that date. Mr. OKeefe served as chief executive officer of Tullys from 1992 until March 2001. Mr. OKeefe is also president and chief executive officer of OKeefe Development
Corporation, a real estate development and investment firm he founded. Tom and his wife Cathy have been actively involved in local and national community organizations for over 20 years. In 1983, the OKeefes co-founded the Patrons of
Cystic Fibrosis, a local guild of volunteers working to support cystic fibrosis research in Washington. Mr. OKeefe is a previous national board member, a former president and event chairman of the Cystic Fibrosis Foundation. Tom and Cathy
are the recipients of the 1996 Breath of Life Award from the Patrons of Cystic Fibrosis and 2000 Living and Giving Award from the Juvenile Diabetes Foundation of Seattle. Mr. OKeefes charitable efforts focus largely on children in
the community. Mr. OKeefe is presently serving as a board member to the Boys and Girls Club of Bellevue, Childrens Hospital Foundation, and Virginia Mason Hospital. He is on the Board of Governors of the Columbia Tower Club and is
the Chairman of the capital campaign and a board member for the Museum of Flight.



Kathi Ainsworth-JonesDirector. Ms. Ainsworth-Jones has served as the executive director and secretary for the Microsoft Alumni Network since 2003. From 1998 to 2003, Ms. Ainsworth-Jones served
in human resources and operational roles including director of Human Resources with Aventail Corporation, a provider of SSL VPN technology and services. Prior to 1998, Ms. Ainsworth-Jones founded and served as president of KAJ Consulting (a
provider of human resource and operations consulting services) and served, for over ten years, in management positions with two retailers, The Gap and Banana Republic. Ms. Ainsworth-Jones serves on the board of directors of the Microsoft Alumni
Network, The Microsoft Alumni Network Giving Foundation, the Female Editorial Board for the Puget Sound Business Journal, The Washington Society of Association Executives, chairs The World-Wide Alumni Round Table, and is also active in many local
charitable organizations such as Childrens Hospital and FareStart. Ms. Ainsworth-Jones was elected as a director at the 2004 Annual Meeting.



John K. BullerDirector. Mr. Buller serves as the executive director of the University of Washington (UW) Alumni Association (UWAA) and
Advancement Communications and as the associate vice president of



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alumni relations at the UW. Prior to his positions at the UW, Mr. Buller served for 10 years as senior vice president of sales promotion, marketing and
public relations at Bon Macys, and for seven years was the head of the National Federated Marketing team. Mr. Buller was appointed as a director on March 7, 2005.



Marc EvangerDirector.Mr. Evanger served as interim president and chief executive officer of Tullys
from July 2001 through May 2002. Mr. Evanger has been a director of Tullys since March 1999. Mr. Evanger joined Tullys in December 1998 as vice president of corporate planning and development, a part-time position. From 1984 to
1998, Mr. Evanger was with Quality Food Centers (QFC), a regional supermarket company, and served as senior vice president of finance and administration and chief financial officer from 1987 to 1998. From 1978 to 1984, Mr. Evanger was with
Price Waterhouse. Mr. Evanger is currently a director of Car Toys, Inc., a retailer of specialty automotive sound systems and cellular, Families Northwest, and the Boys & Girls Club of Bellevue and is active in other charitable and
community activities.



John M FlukeDirector.Mr. Fluke is chairman of Fluke Capital Management, L.P., (which he founded in 1976), and was Chairman and CEO of the John Fluke Manufacturing Co. until 1990. Mr. Fluke serves on the board and the audit committee of PACCAR Inc.
(financial expert), and previously served on the boards of Cell Therapeutics, Primus International, and American Seafoods Group. Mr. Fluke is a past chairman of the Seattle Council of Boy Scouts of America, Greater Seattle Chamber of Commerce
and the Washington State China Relations Council. Mr. Fluke has served as a director since March 2005.



Lawrence L. HoodDirector.Mr. Hood is CEO and president of Pacific Wealth Advisors (founded in January 2006) and founder (1993), CEO and
president of Pacific Portfolio Consulting, L.P., (which is now a wholly owned subsidiary of Pacific Wealth Advisors). Prior to 1993, Mr. Hood was a principal in charge of the investment division of Kibble & Prentice, Inc. Mr. Hood
serves as a director for Elliot Cove Capital Management and Pacific Wealth Advisors. Mr. Hood has served as a director of Tullys since February 1994.



Gregory A. HubertDirector. Mr. Hubert is president of Restaurant Development Company of America. Mr. Hubert has been
owner-operator of Red Robin franchised restaurants since 1989 (currently seven locations) and has also bought the rights to franchise Johnny Carinos Italian Restaurants in Washington and Oregon. From 1978 to 1988, Mr. Hubert was employed
by Red Robin International, an operator and franchisor of upscale hamburger restaurants, and ultimately served as its president. From 1973 to 1978, Mr. Hubert was a CPA with Price Waterhouse. Mr. Hubert serves as president of Gonzaga
University Board of Regents and as trustee of Seattle Preparatory High School. Mr. Hubert was elected as a director at the 2004 Annual Meeting.



Non-Director Executive Officer:



John D. DreselPresident, Chief Operating Officer.Mr. Dresel began full-time service to Tullys on November 1, 2004 after a
transition period in October 2004. Prior to joining Tullys, Mr. Dresel provided business development and management advisory services to Ackerley Partners LLC, a private investment firm (2002 to October 2004) and Ariel Development, Inc.,
a real estate development and management firm (March 2004 to October 2004). From 1986 to 2002, Mr. Dresel served in various managerial and executive roles with The Ackerley Group, a media and entertainment company with diversified groups of
professional sports teams, outdoor advertising, broadcast and interactive media. Mr. Dresel served as president of the Ackerley Television Group from 2001 to 2002 and as president of Full House Sports and Entertainment and executive vice
president of the Seattle SuperSonics from 1992 to 2001. Mr. Dresel served as vice president/general manager of KJR Sports Radio 950 and KLTX Radio 95.7 from 1989 to 1994.



Kristopher S. GalvinExecutive Vice President, Chief Financial Officer and Secretary.Mr. Galvin joined
Tullys in February 2002 as vice president, chief financial officer and secretary and was named executive vice president in May 2004. From July 11, 2004 to October 2004, he served as principal executive officer for Tullys. From 1995
to December 2001, Mr. Galvin served first as CFO for Deposit Payment Protection Systems, Inc. (a subsidiary of Deluxe Corporation) for five years and in 2001 became Vice President for Retail Product Management for a company spun-off from Deluxe
Corporation, eFunds Corporation, which provides electronic



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payment and risk management services to major retailers and financial institutions. Previously, he was CFO of three Pacific Northwest retail
chainsPayn Save Drug Stores (1984-1992), Seattle Lighting Fixture Co. (1992-1994) and Ballard Computer (1994-1995). During 1975 to 1984 he was a CPA with the audit practice of Price Waterhouse.



Section 16(a) Beneficial Ownership Reporting Compliance



Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires that Tullys directors, executive officers and greater-than-10% stockholders file reports with the Securities and Exchange Commission reporting their initial beneficial ownership of Tullys equity securities and any subsequent
changes to their respective security holdings. They also must provide Tullys with copies of these reports. To the Companys knowledge, based solely on the review of the copies of such reports furnished to the Company and written
representations that no other reports were required, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with for the fiscal year ended April 2, 2006, except for
Mr. OKeefe and Mr. Fluke, who each had one transaction and were each late in filing one statement of changes.



Code of Ethics



Since 2001, Tullys has had a code of business conduct. In June 2004 our Board of Directors adopted a new Code of Business Conduct (replacing the
previous code), applicable to all employees including our chief executive officer, chief financial officer, controller and other finance leaders, which is a code of ethics as defined by applicable rules of the Securities and Exchange
Commission.



If Tullys makes any amendments to this code
other than technical, administrative, or other non-substantive amendments, or grants any waivers, including implicit waivers, from a provision of this code to our chief executive officer, chief financial officer, controller or other finance leaders,
we will disclose the nature of the amendment or waiver, its effective date and to whom it applies in a report on Form 8-K filed with the Securities and Exchange Commission.



Financial Expert



In May 2005, the Board of Directors appointed Mr. Evanger to serve on the Audit Committee, and determined that he met the qualifications (determined
by the Securities and Exchange Commission) to serve as financial expert on the committee.



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|ITEM 11. |  | EXECUTIVE COMPENSATION
|-------- |  | ----------------------



Executive Compensation



The following table discloses compensation awarded or paid to, or earned by our executive officers during Fiscal 2006. No other executive officer received
salary and bonus that exceeded $100,000 during Fiscal 2006.



SUMMARY COMPENSATION TABLE



|                                                                                        |  |              |  |                     |                       |                                                            |     |                       |          |  |     |                     
|--------------------------------------------------------------------------------------- |  | ------------ |  | ------------------- | --------------------- | ---------------------------------------------------------- | --- | --------------------- | -------- |  | --- | --------------------
|Name and Principal Positions                                                            |  | FiscalYear   |  | Annual Compensation |                       | Long-TermCompensationAwardsSecuritiesUnderlyingOptions (#) |     | All OtherCompensation
|                                                                                        |  | Salary (1)   |  | Bonus               |                       |                                                           
|John D. Dresel Chief Operating Officer and President(2)                                 |  | 20062005     |  | $$                  | 197,38580,279         |                                                            |   |                       | 500,000  |  |     |                   
|                                                                                        |  |              |  |                     |                      
|Kristopher S. Galvin Chief Financial Officer, Executive Vice President and Secretary(3) |  | 200620052004 |  | $$$                 | 182,200185,235157,200 |                                                            |  |                       | 150,000 |  |     |                  
|                                                                                        |  |              |  |                     |                      
|Tom T. OKeefe Founder and Chairman of the Board(4)                                     |  | 200620052004 |  | $$$                 | 114,911117,135114,911 |                                                            |  |                       |       |  |     |                  
|                                                                                        |  |              |  |                     |                      
|Anthony J. Gioia Former Chief Executive Officer and President(5)                        |  | 200620052004 |  | $$                  | 94,159259,000        |                                                            |  |                       |       |  | $$$ | 171,875208,60110,000

---

|(1) |  | Salary amounts include deferred compensation and cash car allowances.
|--- |  | ---------------------------------------------------------------------

|(2) |  | Mr. Dresel began his employment with Tullys in October 2004 at an annual rate of $180,000, plus a cash car allowance. In March 2006, the Board of Directors approved an
adjustment, in Mr. Dresels base salary, effective as of November 1, 2005, to an annual rate of $200,000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Mr. Galvin began his employment with Tullys on February 25, 2002. In March 2004, the Board of Directors increased Mr. Galvins salary to the annual rate of
$175,000, plus cash car allowance, effective April 5, 2004.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Mr. OKeefe has served as Founder and Chairman of the Board since 1992. During Fiscal 2006, we paid a salary of $115,000 to Mr. OKeefe for his services as
Chairman of Tullys. His salary is subject to review and adjustment by the Board of Directors. Mr. OKeefe also is entitled to all benefits offered generally to our employees.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Mr. Gioia began his employment with Tullys on May 13, 2002. Other compensation includes moving allowances of $10,000 in Fiscal 2004. Mr. Gioia resigned from our
employment, and from our Board of Directors, effective as of July 11, 2004 (see Employment Agreements and Compensatory Arrangements). Fiscal 2005 and Fiscal 2006 include severance payments pursuant to his employment
agreement.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In January 2003, Mr. Gioia,
Mr. Galvin, three other members of Tullys management, and our Chairman, Mr. OKeefe, offered to defer receipt of a portion of their cash compensation until Tullys achieved certain financial objectives. The Board of
Directors approved the Executive Compensation Deferral Plan in February 2003. Under the Executive Compensation Deferral Plan, the deferred compensation was withheld from the pay of the participant and would be paid only upon the occurrence of a
Payment Event as defined in the plan. In March 2004, the Board of Directors approved the cessation of deferrals for all participants other than Mr. Gioia and Mr. OKeefe. In September 2004, the Board of Directors and
Mr. OKeefe agreed to a modification whereby deferrals ceased for Mr. OKeefe and amounts deferred for him were forfeited. In October 2005, the deferred amounts were paid, with the approval of the Board of Directors, to all of
the remaining participants under the plan, including Mr. Galvin ($17,308) and Mr. Gioia ($23,269).



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Option Grants in Fiscal 2006



The following table provides information relating to stock options awarded to our executive officers during Fiscal 2006:



|                     |  |                                                          |  |                                                   |   |  |                     |      |                 |              |                          |   |       
|-------------------- |  | -------------------------------------------------------- |  | ------------------------------------------------- | - |  | ------------------- | ---- | --------------- | ------------ | ------------------------ | - | ------
|Name                 |  | Number ofSecuritiesUnderlyingOptionsGranted(# of Shares) |  | % of TotalOptionsGranted toEmployeesin Fiscal2004 |   |  | ExercisePrice($/Sh) |      | Expiration Date |              | GrantDatePresentValue(1)
|John D. Dresel       |  | 30,000                                                   |  | 5.3                                               | % |  | $                   | 1.50 |                 | May 15, 2015 |                          | $ | 25,302
|Kristopher S. Galvin |  | 20,000                                                   |  | 3.5                                               | % |  | $                   | 1.50 |                 | May 15, 2015 |                          | $ | 16,868

---

|(1) |  | The present value of the stock options was estimated on their date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
(a) risk-free interest rate of 2.78%, (b) expected life of 3 years, volatility of 86%, and (d) no dividend yield.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Aggregated Option Values as of Fiscal Year-End 2006



The following table provides information regarding the aggregate number of options exercised during Fiscal 2006 by the Named Executive Officers and the
number of shares subject to both exercisable and unexercisable stock options as of April 2, 2006.



Aggregated Option Exercises in Fiscal Year 2006

and 2006 Year-End Option
Values



|                     |  |                          |             |                  |               |                                                                             |             |                                                                       |               |   |         |  |   |       
|-------------------- |  | ------------------------ | ----------- | ---------------- | ------------- | --------------------------------------------------------------------------- | ----------- | --------------------------------------------------------------------- | ------------- | - | ------- |  | - | ------
|Name                 |  | SharesAcquiredonExercise |             | ValueRealized($) |               | Number of SecuritiesUnderlying UnexercisedOptions at End ofFiscal Year 2006 |             | Value of UnexercisedIn-The-Money Options atEnd of Fiscal Year 2006(1)
|                     |  |                          | Exercisable |                  | Unexercisable |                                                                             | Exercisable |                                                                       | Unexercisable
|John D. Dresel       |  |                         |             |                 |               | 100,000                                                                     |             | 330,000                                                               |               | $ | 149,000 |  | $ |      
|Kristopher S. Galvin |  |                         |             |                 |               | 225,000                                                                     |             | 70,001                                                                |               | $ | 129,000 |  | $ | 59,501
|Tom T. OKeefe       |  |                         |             |                 |               | 624,368                                                                     |             |                                                                      |               | $ | 886,725 |  | $ |      
|Anthony J. Gioia     |  |                         |             |                 |               | 483,332                                                                     |             |                                                                      |               | $ | 447,000 |  | $ |      

---

|(1) |  | The stock options were granted with exercise prices ranging from $0.01 to $2.50 per share. The value was determined using a fair market value of $1.50 per share as compared to the
exercise price at grant.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Compensation Committee Interlocks
and Insider Participation



During Fiscal 2006, management
compensation issues generally were reviewed and approved by the compensation committee, which was composed of Ms. Ainsworth-Jones, Mr. Evanger, and Mr. Hubert, all of whom are non employee directors. During Fiscal 2006, no executive
officer of Tullys served on the board of directors or compensation committee of another entity that had an executive officer serve on Tullys Board or its compensation committee.



On November 1, 2002, we entered into a borrowing arrangement with KCL
that was secured by substantially all of our assets. In connection with the KCL promissory note, warrants to purchase shares of Common Stock were issued to the guarantors of the KCL promissory note, including Mr. Evanger. In Fiscal 2006, we
issued warrants to purchase 2,238 shares of Common Stock to Mr. Evanger. In August 2005, we repaid the KCL promissory note and terminated the guarantor agreements with the guarantors, including Mr. Evanger.



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Director Compensation



The director compensation policy from Fiscal 2004 was continued in Fiscal 2005. Under that policy, non-employee directors received an annual cash payment
of $5,000 plus a per-meeting cash fee of $400 per Board of Directors meeting and $250 per committee meeting, with total cash compensation not to exceed $10,000 per year for any director. For Fiscal 2005, non-employee directors also received an
annual grant of nonqualified options to purchase 10,000 shares of Common Stock (plus 2,000 additional shares for the chairs of the Audit, Compensation and Governance and Nominating committees), with an exercise price equal to the value of the stock
at the beginning of the fiscal year and a term of ten years. The directors annual stock option grant would be cancelled if the director does not attend at least 75% of the Board of Directors and committee meetings of record for the year, but
otherwise was fully vested upon completion of the fiscal year. Compensation amounts were generally subject to prorating for directors whose terms commenced or expired during the fiscal year. Based upon these criteria, in October 2005, Tullys
paid compensation and issued stock options for director service in Fiscal 2005 as follows:



|                       |  |                   |        |                                     |       
|---------------------- |  | ----------------- | ------ | ----------------------------------- | ------
|Director Name          |  | Cash Compensation |        | Stock Options (Exercise price$0.30)
|Kathi Ainsworth-Jones* |  | $                 | 3,150  |                                     | 3,100 
|John K. Buller*        |  |                   | 764    |                                     | 728   
|Marc Evanger           |  |                   | 10,000 |                                     | 12,000
|John M. Fluke*         |  |                   | 40     |                                     | 80    
|Lawrence L. Hood       |  |                   | 10,000 |                                     | 12,000
|Gregory A. Hubert*     |  |                   | 3,150  |                                     | 3,100 

---

|* |  | Prorated compensation for partial year of service.
|- |  | --------------------------------------------------



Under the director compensation policy for Fiscal 2006, non-employee directors received an annual cash payment of $5,000 plus a per-meeting cash fee of
$400 per Board of Directors meeting and $250 per committee meeting, with total cash compensation not to exceed $10,000 per year for any director. For Fiscal 2005, non-employee directors also received an annual grant of nonqualified options to
purchase 10,000 shares of Common Stock (plus 2,000 additional shares for the chairs of the Audit, Compensation and Governance and Nominating committees), with an exercise price equal to the value of the stock at the beginning of the fiscal year and
a term of ten years. The directors annual stock option grant would be cancelled if the director does not attend at least 75% of the Board of Directors and committee meetings of record for the year, but otherwise was fully vested upon
completion of the fiscal year. Compensation amounts were generally subject to prorating for directors whose terms commenced or expired during the fiscal year. The policy provided that after the completion of the fiscal year, the Governance and
Nominating Committee would consult with the members of the Board of Directors, and with management of the Company, to assess whether any members of the Board of Directors may have provided services to the Company which may not adequately be
considered in the compensation determined by the formulae set forth above, and if so additional cash compensation or stock options may be awarded, if approved by the Board of Directors (but the total cash compensation may not exceed $10,000 per year
for any director, and the total stock option grant may not exceed 10,000 shares of common stock, plus 2,000 additional shares for the chairs of the Audit, Compensation and Governance and Nominating committees). Based upon these criteria, in June
2006, Tullys Board of Directors approved payment of cash compensation and granted stock options for director service in Fiscal 2006 as follows:



|                      |  |                   |        |                                     |       
|--------------------- |  | ----------------- | ------ | ----------------------------------- | ------
|Director Name         |  | Cash Compensation |        | Stock Options (Exercise price$1.50)
|Kathi Ainsworth-Jones |  | $                 | 10,000 |                                     | 12,000
|John K. Buller        |  |                   | 10,000 |                                     | 10,000
|Marc Evanger          |  |                   | 10,000 |                                     | 10,000
|John M. Fluke         |  |                   | 10,000 |                                     | 12,000
|Lawrence L. Hood      |  |                   | 10,000 |                                     | 12,000
|Gregory A. Hubert     |  |                   | 10,000 |                                     | 10,000



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In June 2006, the Board of Directors approved a new director compensation policy applicable for Fiscal
2007. This provides that non-employee directors shall receive an annual cash payment of $10,000 plus a per-meeting cash fee of $1,000 per Board of Directors meeting and $500 per committee meeting (for meetings of the Audit, Compensation, Executive,
and Governance and Nominating committees), paid after completion of the fiscal year. For Fiscal 2007, non-employee directors also receive an annual grant of nonqualified options to purchase 10,000 shares of Common Stock (plus 4,000 additional shares
for the chairs of the Audit, Compensation, Executive, and Governance and Nominating committees), with an exercise price equal to the value of the stock at the beginning of the fiscal year and a term of ten years. The directors annual stock
option grant would be cancelled if the director does not attend at least 75% of the Board of Directors and committee meetings of record for the year, but otherwise are fully vested upon completion of the fiscal year. Compensation amounts are
generally subject to prorating for directors whose terms commence or expire during the fiscal year. Further, after the completion of the fiscal year, the Governance and Nominating Committee shall consult with the members of the Board of Directors,
and with management of the Company, to assess whether any members of the Board of Directors may have provided services to the Company which may not adequately be considered in the compensation determined by the formulae set forth above, and if so
additional cash compensation or stock options may be awarded, if approved by the Board of Directors.



Directors are reimbursed for reasonable expenses incurred in attending Board of Directors and committee meetings.



Employment Agreements and Compensatory Arrangements



On October 1, 2004, Tullys engaged Mr. John Dresel, as
president and chief operating officer at an initial base salary at the annual rate of $180,000. Mr. Dresels compensation is subject to periodic review. In March 2006, the Board of Directors approved an adjustment in Mr. Dresels
base salary, effective as of November 1, 2005, to an annual rate of $200,000. No bonus was paid to Mr. Dresel for Fiscal 2005 or Fiscal 2006. For Fiscal 2007, the amount of Mr. Dresels bonus, if any, will be based on his
then-current annual base salary and Tullys operating results. Mr. Dresel receives an automobile allowance of $750 per month and is entitled to all benefits offered generally to Tullys employees.



At the time his employment commenced, Mr. Dresel was granted options to
purchase 500,000 shares of common stock with exercise prices and vesting as follows:



|                       |  |         |  |                |     
|---------------------- |  | ------- |  | -------------- | ----
|Vesting on November 1, |  | Shares  |  | Exercise Price
|2004                   |  | 100,000 |  | $              | 0.01
|2005                   |  | 100,000 |  | $              | 0.01
|2006                   |  | 100,000 |  | $              | 1.50
|2007                   |  | 100,000 |  | $              | 2.00
|2008                   |  | 100,000 |  | $              | 2.50
|                       |  |         |  |                |     
|Total                  |  | 500,000 |  |                |     
|                       |  |         |  |                |     



Mr. Dresels
employment is generally terminable by either party on 30 days written notice. If Mr. Dresels employment is terminated without cause by Tullys, he will be entitled to one year of severance following the termination date (paid ratably
over the year) and accelerated vesting with respect to any stock options that would have vested at the next annual vesting date. In the event of Mr. Dresels termination as a result of a change in control, all of Mr. Dresels
unvested stock options will immediately become fully vested and he will be entitled to receive cash compensation for one year paid ratably during the year following in an amount equal to the total cash compensation paid or payable in the most recent
calendar year ended (following his third year of service, the cash compensation shall be for a two-year period, paid ratably over two years).



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Effective June 21, 2002, Tullys entered into an employment arrangement with Mr. Galvin.
Under the employment arrangement, Mr. Galvin received an annual base salary of $150,000, subject to annual review and adjustment by the Board of Directors. Effective April 5, 2004, the Board adjusted his annual base salary to $175,000.
Mr. Galvin also is entitled to an annual cash performance bonus, subject to the discretion of the Board of Directors. No bonus was paid for Fiscal 2004, Fiscal 2005, or Fiscal 2006. For Fiscal 2007, the amount of Mr. Galvins bonus,
if any, will be based on his then-current annual base salary and our operating results. Mr. Galvin receives an automobile allowance of $600 per month. Mr. Galvin also is entitled to all benefits offered generally to our employees.
Mr. Galvins employment agreement is generally terminable by either party on 30 days written notice. If Mr. Galvins employment is terminated by Tullys without cause, then Mr. Galvin will be entitled to receive his
base salary for an additional six months following the date of his termination.



Effective May 13, 2002, we entered into an employment agreement with Mr. Gioia. Under the employment agreement, Mr. Gioia received an annual base salary of $250,000 during the first twelve months of the
agreement. The employment agreement provided that Mr. Gioias annual base salary was to be subject to annual review by the Board of Directors, and would be increased by a minimum of ten percent for the second and third years the agreement
is in effect. Although the first anniversary adjustment was to be effective as of May 13, 2003, Mr. Gioia was paid at the first year salary level while he and the Compensation Committee discussed his compensation. For Fiscal 2003 and
Fiscal 2004, Mr. Gioia did not receive a performance bonus. For Fiscal 2004 and subsequent fiscal years, the amount of Mr. Gioias bonus was to be based on his then-current annual base salary and our earnings before interest, taxes,
depreciation and amortization, as defined in the agreement. Prior to the termination of his employment, Mr. Gioia received an automobile allowance of $750 per month, and was entitled to all benefits offered generally to our employees.
Mr. Gioias employment agreement contained provisions related to the termination of his employment, however these provisions were modified on April 12, 2004 as described in the next paragraph.



On April 12, 2004, Mr. Gioia submitted his resignation from our
employment, and from our Board of Directors, effective as of July 11, 2004 (the termination date), subject to the execution of the Second Amendment to Employment Agreement (the Second Amendment) and Employment
Termination Agreement (ETA) between Mr. Gioia and Tullys. We accepted his resignation and the parties executed both the Second Amendment and the ETA. Under the provisions of the Second Amendment and the ETA, and subject to
certain conditions, (1) Mr. Gioia received his base salary through the termination date, (2) no payment will be made of amounts deferred under the Executive Compensation Deferral Plan prior to September 28, 2003, but amounts
deferred after September 28, 2003 are subject to payment upon the occurrence of a Payment Event, (3) Mr. Gioia was paid $80,000 within 15 days after the termination date, (4) Mr. Gioia will be paid a severance amount of $14,323
per month for twenty-four months from the termination date (the severance payments), and (5) certain stock options with a May 13, 2004 vesting date have been cancelled (116,667 shares at $1.78 and 66,667 shares at $2.50).



Under the provisions of our stock option plan, vesting and
exercise of employee stock options, including those of the executive officers, accelerate in the event of certain change of control events.



Report of Compensation Committee on Executive Compensation



Executive Compensation Philosophy



The compensation committee of the Board of Directors was composed of outside directors during Fiscal 2006, consisting of Ms. Ainsworth-Jones,
Mr. Evanger and Mr. Hubert. The compensation committee is responsible for evaluating compensation levels and compensation programs for Tullys executives and for making recommendations to the board regarding appropriate compensation
awards for executive management.



The executive compensation
program of Tullys is designed to attract, retain and motivate executive officers capable of leading Tullys to meet its business objectives, to enhance long-term shareholder value and to reward



85



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executive management based on contributions to both the short and long term success of Tullys. The compensation committees philosophy is for
Tullys to use compensation policies and programs that align the interests of executive management with those of the shareholders and to provide compensation programs that create incentives for and reward both the short and long term
performance of the executive officers based on the success of Tullys in meeting its business objectives. While the components of compensation described below are discussed separately, the board and the compensation committee take into account
the full compensation package provided by Tullys to its executive officers.



Executive Compensation Components



Base Salary. Recommendations for base salaries for executive officers are made at levels believed by the compensation committee to be sufficient to attract and retain qualified executive officers based
upon the requirements and resources of Tullys and the market practices of other companies. A change in base salary of an executive officer is based on an evaluation of the performance of the executive, prevailing market practices, and the
performance and financial condition of Tullys as a whole.



Incentive Bonus. The compensation committee believes that a portion of the total cash compensation for executive officers should be based on our success in meeting its short-term performance objectives and contributions by the
executive officers that enable Tullys to meet its long-term objectives, and has structured the executive compensation program to reflect this philosophy. This approach creates a direct incentive for executive officers to achieve desired
short-term corporate goals that also further the long-term objectives of Tullys, and places a portion of each executive officers annual compensation at risk. In Fiscal 2006, the incentive compensation for the President and for the Chief
Financial Officer was dependent upon Tullys achieving a targeted level of operating results. The incentive bonus for Fiscal 2006 did not provide for any payment of the incentive bonus unless 100% of this target was achieved. This target was
not achieved and therefore no incentive bonus was payable to the President or the Chief Financial Officer for Fiscal 2006.



Stock Options. The compensation committee believes that periodic grants of stock options are a key component of our executive compensation
program. Stock options are awarded by the Board of Directors to executive officers based on the executives responsibilities, and his or her actual historical contributions and anticipated future contributions to the attainment of our strategic
goals. These awards are designed to retain executive officers and to motivate them to enhance stockholder value by aligning the financial interests of executive officers with those of stockholders.



Recruitment and Retention. It is the philosophy of the
compensation committee to recruit qualified senior executives and then to retain them for continuing service from year to year, so that Tullys will receive the benefits from management stability and from more consistent year-to-year planning
and execution of strategies for the benefit of Tullys and its shareholders. The compensation committee believes that these goals are facilitated through written terms of employment with senior executives, setting forth the key elements of
compensation, and including severance pay provisions in those terms of employment.



President and Chief Operating Officer Compensation. During Fiscal 2006, Mr. Dresels compensation as President and COO (principal executive officer) was based upon the compensation package
established in the September 30, 2004 employment letter with Mr. Dresel. In March 2006, the members of the Compensation Committee, in consultation with the Chairman, approved an adjustment, in Mr. Dresels base salary, effective
as of November 1, 2005, to an annual rate of $200,000, and this was ratified by the Board of Directors in June 2006. In establishing and modifying the Presidents compensation package, the Committee pursued the objectives discussed above.
The Committee believes that Mr. Dresels compensation during Fiscal 2006 was in line with our compensation strategy, considering the individual performance of the President and the cash resources and needs of Tullys.



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Code Section 162(m)



The compensation committee also considers the potential impact of Section 162(m) of the Code. Section 162(m)
disallows a tax deduction for any publicly held corporation for individual compensation exceeding $1 million in any taxable year for the Chief Executive Officer and certain other senior executive officers, other than compensation that is
performance-based under a plan that is approved by the shareholders of the corporation and that meets certain other technical requirements. Based on these requirements, the compensation committee has determined that Section 162(m) will not
prevent Tullys from receiving a tax deduction for any of the compensation paid to executive officers. At the present time, our executive officer compensation levels do not exceed $1 million. If the individual cash compensation of any executive
officer should ever approach the $1 million level, the compensation committee will consider what actions might be required.



Compensation Committee

Kathi Ainsworth-Jones, Chair

Marc Evanger

Greg Hubert



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##### Table of Contents

|ITEM 12. |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- |  | ----------------------------------------------------------------------------------------------



The following table sets forth certain information regarding the ownership of Tullys Common Stock, Series A
Convertible Preferred Stock and Series B Convertible Preferred Stock as of April 2, 2006 by: (i) each director; (ii) the president and chief financial officer of Tullys (the Named Executive Officers); (iii) all
executive officers and directors of Tullys as a group; and (iv) all shareholders known by us to be beneficial owners of more than five percent of our voting securities:



|                                                           |  |                        |      |  |                          |   |  |                          |     |  |                  |   |  |                        |  |                  |  
|---------------------------------------------------------- |  | ---------------------- | ---- |  | ------------------------ | - |  | ------------------------ | --- |  | ---------------- | - |  | ---------------------- |  | ---------------- | -
|                                                           |  | Common Stock           |      |  | Series A Preferred Stock |   |  | Series B Preferred Stock |    
|                                                           |  | BeneficialOwnership(1) |      |  | Percent Of Total         |   |  | BeneficialOwnership(1)   |     |  | Percent Of Total |   |  | BeneficialOwnership(1) |  | Percent Of Total |  
|Tom T. OKeefe                                             |  | 5,703,233              | (2)  |  | 30.4                     | % |  |                         |     |  |                 |   |  |                       |  |                 |  
|Estate of Keith McCaw2365 Carillon PointKirkland, WA 98033 |  | 4,263,885              | (3)  |  | 19.4                     | % |  | 2,000,000                | (4) |  | 12.9             | % |  |                       |  |                 |  
|George Hubman                                              |  | 2,356,601              | (4)  |  | 12.2                     | % |  | 200,000                  |     |  | 1.3              | % |  |                       |  |                 |  
|Marc Evanger                                               |  | 550,144                | (5)  |  | 3.0                      | % |  | 10,000                   |     |  | *                |   |  |                       |  |                 |  
|Anthony Gioia                                              |  | 483,333                | (6)  |  | 2.6                      | % |  |                         |     |  |                 |   |  |                       |  |                 |  
|Kristopher S. Galvin                                       |  | 364,999                | (7)  |  | 2.0                      | % |  |                         |     |  |                 |   |  |                       |  |                 |  
|Lawrence L. Hood                                           |  | 298,739                | (8)  |  | 1.7                      | % |  | 10,000                   |     |  | *                |   |  | 40,000                 |  | *                |  
|John D. Dresel                                             |  | 210,000                | (9)  |  | 1.2                      | % |  |                         |     |  |                 |   |  |                       |  |                 |  
|John M. Fluke                                              |  | 20,080                 | (10) |  | *                        |   |  |                         |     |  |                 |   |  |                       |  |                 |  
|Kathi Ainsworth-Jones                                      |  | 11,250                 | (11) |  | *                        |   |  | 5,000                    |     |  | *                |   |  |                       |  |                 |  
|Gregory A. Hubert                                          |  | 3,100                  | (12) |  |                         |   |  |                         |     |  |                 |   |  |                       |  |                 |  
|John K. Buller                                             |  | 728                    | (13) |  |                         |   |  |                         |     |  |                 |   |  |                       |  |                 |  
|Executive officers and directors as a group (9 persons)    |  | 7,162,273              |      |  | 36.0                     | % |  | 25,000                   |     |  | *                | % |  | 40,000                 |  | *                | %

---

|* |  | Less than 1%.
|- |  | -------------

|(1) |  | Beneficial ownership is determined in accordance with the rules and regulations of the Securities and Exchange Commission and generally requires that the shareholder have voting or
investment power with respect to the securities in question. Shares of Common Stock issuable upon exercise or conversion of options, warrants or Series A and Series B Stock that are exercisable or convertible within 60 days of April 2, 2006,
are deemed to be beneficially owned by the holder of such securities but are not outstanding for the purpose of computing the percentage ownership of any other shareholder. Unless otherwise indicated in the footnotes to this table and subject to
community property laws where applicable, we believe that each shareholder named in this table has sole voting and investment power with respect to the shares indicated as beneficially owned thereby, and such shareholders address is 3100
Airport Way S., Seattle, WA 98134. As of April 2, 2006, we had 17,769,191 shares of Common Stock, 15,559,152 shares of Series A Convertible Preferred Stock, and 4,920,709 shares of Series B Convertible Preferred Stock issued and outstanding.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes 4,489,639 shares of Common Stock owned by TTOK, LLC, a limited liability company owned by Mr. OKeefe and his wife (Mr. OKeefe contributed his personal
shareholdings to TTOK, LLC, in October 2005). There are outstanding stock options for 1,688,167 shares of the Common Stock owned by TTOK, LLC under currently exercisable purchase options granted by Mr. OKeefe to employees and third
parties. Also includes 142,500 shares of Common Stock held by the OKeefe Childrens Trust, and an aggregate of 982,344 shares of Common Stock that Mr. OKeefe has the right to acquire pursuant to options and warrants exercisable
within 60 days of April 2, 2006.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Includes an aggregate of 1,960,550 shares of Common Stock that the estate of Mr. McCaw has the right to acquire pursuant to options and warrants exercisable within 60 days of
April 2, 2006 and 2,260,000 shares of Common Stock issuable upon conversion of 2,000,000 shares of Series A Convertible Preferred Stock owned of issuable to the estate or its affiliates.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(4) |  | Includes an aggregate of 1,257,581 shares of Common Stock that Mr. Hubman has the right to acquire pursuant to options and warrants exercisable within 60 days of April 2,
2006 and Common Stock issuable upon conversion of 200,000 shares of Series A Convertible Preferred Stock. Mr. Hubman retired from the Board of Directors in March 2005.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Includes an aggregate of 536,944 shares of Common Stock that Mr. Evanger has the right to acquire pursuant to options and warrants exercisable within 60 days of April 2,
2006 and Common Stock issuable upon conversion of 10,000 shares of Series A Convertible Preferred Stock.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Includes 483,333 shares of Common Stock that Mr. Gioia has the right to acquire pursuant to options exercisable within 60 days of April 2, 2006. Mr. Gioia resigned
from his position as director and chief executive officer on July 11, 2004.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) |  | Includes 265,000 shares of Common Stock that Mr. Galvin has the right to acquire pursuant to options exercisable within 60 days of April 2, 2006.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Includes an aggregate of 147,944 shares of Common Stock that Mr. Hood has the right to acquire pursuant to options and warrants exercisable within 60 days of April 2,
2006. Also includes 10,000 Series A Convertible Preferred Stock. Additionally, includes Common Stock issuable upon conversion of 40,000 shares of Series B Convertible Preferred Stock owned by PPC Partners LLC, a company in which Mr. Hood has a
0.96% interest.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) |  | Includes 110,000 shares of Common Stock that Mr. Dresel has the right to acquire pursuant to options exercisable within 60 days of April 2, 2006.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | Includes 80 shares of Common Stock that Mr. Fluke has the right to acquire pursuant to options exercisable within 60 days of April 2, 2006.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(11) |  | Includes an aggregate of 5,600 shares of common stock that Ms. Ainsworth-Jones has the right to acquire pursuant to options and warrants exercisable within 60 days of
April 2, 2006 and 5,650 shares of Common Stock issuable upon conversion of 5,000 shares of Series A Preferred Stock.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) |  | Includes 3,100 shares of Common Stock that Mr. Hubert has the right to acquire pursuant to options exercisable within 60 days of April 2, 2006.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------

|(13) |  | Includes 728 shares of Common Stock that Mr. Buller has the right to acquire pursuant to options exercisable within 60 days of April 2, 2006.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------



For information regarding our Equity Compensation Plans, see Item 5.



|ITEM 13. |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- |  | ----------------------------------------------



On November 1, 2002, Tullys entered into a borrowing arrangement with KCL that was secured by substantially all of our assets (the KCL
promissory note). On August 31, 2005, the KCL promissory note plus accrued interest was repaid in full. Concurrently with the repayment of the KCL promissory note, the guaranty agreements between Tullys and the several guarantors of
the KCL promissory note were terminated and the guarantors released their conditional security interest in Tullys assets. For Fiscal 2006, we issued warrants to these guarantors as follows: Mr. OKeefe, director (8,954),
Mr. Hood, director (2,238), and Mr. Evanger, director (2,238) and Mr. Hubman, beneficial owner of more than 5% of our outstanding Common Stock (13,430).



A company affiliated with the estate of Mr. Keith McCaw (a beneficial owner of more than 5% of our outstanding Common
Stock) was the holder of our Convertible Promissory Note in the principal amount of $3,000,000, issued by Tullys in December 2000. The note was repaid on November 14, 2005. During Fiscal 2006, we paid interest in the amount of $168,667,
computed on the outstanding principal at the annual rate of 12% through May 31, 2005 and at the annual rate of 8% after May 31, 2005.



In February 2006, an affiliate of Northrim acquired a 24% ownership interest in Pacific Wealth Advisors, LLC (PWA), a newly formed company
which is the successor by merger to Pacific Portfolio Consulting. Tullys entered into a secured credit facility with Northrim in June 2005, which was renewed in June 2006 (see Note 11 of the Notes to the Consolidated Financial Statements). PWA
is a wealth management and investment advisory services holding company. Mr. Hood, a director of Tullys, is the president of PWA and has an



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ownership interest of more than 10% in PWA. During Fiscal 2006, Tullys paid $167,964 to Northrim for interest on the amounts borrowed, and the
outstanding debt to Northrim at April 2, 2006 was $1,901,000, bearing interest at 12.75%.



Our certificate of incorporation and bylaws contain provisions limiting the liability of our directors and requiring that we indemnify our directors and officers in specified circumstances.



We have employment and severance arrangements with our executive officers,
Mr. Dresel and Mr. Galvin. See Employment Agreements and Compensatory Arrangements on page 71.



|ITEM 14. |  | PRINCIPAL ACCOUNTING FEES AND SERVICES
|-------- |  | --------------------------------------



Fees Paid to PricewaterhouseCoopers LLP



The following table shows the fees billed to Tullys by PricewaterhouseCoopers LLP for Fiscal 2005:



|              |  |            |        
|------------- |  | ---------- | -------
|              |  | Fiscal2005
|Other Fees(1) |  | $          | 146,000
|              |  |            |        
|Total Fees    |  | $          | 146,000
|              |  |            |        

---

|(1) |  | Other fees for Fiscal 2005 of PricewaterhouseCoopers LLP consisted of fees related to their consents for the restatement of the Fiscal 2002 and prior financial statements and
consents for inclusion in our registration statements for the rights offering.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Fees Paid to Moss Adams LLP



The following table shows the fees billed to us by Moss Adams LLP in Fiscal 2006 and Fiscal 2005:



|                      |  |            |         |            |   |        
|--------------------- |  | ---------- | ------- | ---------- | - | -------
|                      |  | Fiscal2006 |         | Fiscal2005
|Audit Fees(1)         |  | $          | 122,000 |            | $ | 101,000
|Audit-Related Fees(2) |  |            | 26,000  |            |   | 98,000 
|Tax Fees(3)           |  |            | 93,000  |            |   | 18,000 
|                      |  |            |         |            |   |        
|Total Fees            |  | $          | 241,000 |            | $ | 217,000
|                      |  |            |         |            |   |        

---

|(1) |  | Audit services consisted of the examination of our Fiscal 2005 and Fiscal 2006 consolidated financial statements and quarterly reviews of Fiscal 2005 and Fiscal 2006 financial
statements.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Audit-related fees relate to consultation in connection with the evaluation of the possible business integration opportunity with FOODX and the shareholder rights offering.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Tax services of Moss Adams billed for Fiscal 2006 and Fiscal 2005 were for tax compliance and tax advice services.
|--- |  | ------------------------------------------------------------------------------------------------------------------



Audit Committee Preapproval Policy



The audit committee does not have a written preapproval policy. However, as
a matter of practice, prior to engaging Moss Adams LLP for any services, we obtain the prior approval of the audit committee.



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PART IV



|ITEM 15. |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|-------- |  | ---------------------------------------



(a) The following documents are filed as part of this Annual Report on Form 10-K



| | 1. |  | Financial StatementsThe following financial statements are included in Part II, Item 8 of this Annual Report on Form 10-K:
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------



Consolidated Balance Sheets as of April 2, 2006 and April 3, 2005;



Consolidated Statements of Operations for the years ended
April 2, 2006, April 30, 2005 and March 28, 2004;



Consolidated Statements of Changes in Stockholders Equity for the years ended April 2, 2006, April 3, 2005 and March 28, 2004,



Consolidated Cash Flow Statements for the years ended April 2, 2006, April 3, 2005 and March 28, 2004,



Notes to Consolidated Financial Statements; and



Report of Independent Registered Public Accounting Firm



| | 2. |  | Financial Statement SchedulesAll schedules have been omitted, as they are either not required or not applicable or because the information required to be presented is
included in the Consolidated Financial Statements and related notes
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. |  | Exhibits
| | -- |  | --------



(a) The exhibits listed below are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K.



|              |  |                                                                                                                                                                                                                                                                                                          
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                              
|3.1           |  | Amended and Restated Articles of Incorporation of Tullys Coffee Corporation (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended April 1, 2001,
as filed with the Commission on October 19, 2001)                                                                  
|              | 
|3.1.1         |  | Articles of Amendment of the Restated Articles of Incorporation containing the Statement of Rights and Preferences of Series B Preferred Stock (incorporated by reference to the Companys
Annual Report on Form 10-K for the year ended April 1, 2001, as filed with the Commission on October 19, 2001)
|              | 
|3.2           |  | Amended Bylaws of Tullys Coffee Corporation (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended March 31, 2002, as filed with the Commission
on July 1, 2002)                                                                                                     
|              | 
|4.1           |  | Description of capital stock contained in the Amended and Restated Articles of Incorporation (see Exhibit 3.1) (incorporated by reference to the Companys Registration Statement on Form
10, as filed with the Commission on July 27, 1999)                                                             
|              | 
|4.2           |  | Description of rights of security holders contained in the Bylaws (see Exhibit 3.2) (incorporated by reference to the Companys Registration Statement on Form 10, as filed with the
Commission on July 27,1999)                                                                                         
|              | 
|4.3           |  | Form of common stock warrants issued in Series A Convertible Preferred Stock financing (incorporated by reference to the Companys Registration Statement on Form 10, as amended and filed
with the Commission on July 3, 2000)                                                                          



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|              |  |                                                                                                                                                                                                                                                                                                   
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                       
|4.4           |  | Form of Registration Rights Agreement with Series A Preferred Shareholders (incorporated by reference to the Companys Registration Statement on Form 10, as amended and filed with the
Commission on July 3, 2000.)                                                                              
|              | 
|4.7           |  | Form of Common Stock Purchase Warrant issued with the Convertible Promissory Note (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended December
31, 2000, as filed with Commission on February 20, 2001)                                               
|              | 
|4.8           |  | Registration Rights Agreement, dated December 14, 2000 between Tullys and KWM Investments LLC (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarter ended December 31, 2000, as filed with Commission on February 20, 2001)                                  
|              | 
|4.9           |  | Form of Common Stock Purchase Warrant issued to Guarantors of Kent Central, LLC Promissory Note, dated November 1, 2002 (incorporated by reference to the Companys Quarterly Report
on Form 10-Q for the quarter ended December 28, 2003, as filed with Commission on February 11, 2004)         
|              | 
|10.1          |  | Tullys Coffee Corporation Amended and Restated 1994 Stock Option Plan (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended September 26,
1999, as filed with the Commission on November 15, 1999)                                                     
|              | 
|10.2          |  | Tullys Coffee Corporation 1999 Employee Stock Purchase Plan (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended September 26, 1999, as
filed with the Commission on November 15, 1999)                                                               
|              | 
|10.3          |  | Lease Agreement between Tullys and Kent Central, LLC, as amended (Incorporated by reference to the Companys Annual Report on Form 10-K for the year ended April 2, 2000, as filed
with the Commission on July 3, 2000)                                                                          
|              | 
|10.4          |  | Third Lease Amendment between Tullys and Kent Central, LLC, dated November 7, 2000 (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
April 1, 2001, as filed with the Commission on October 19, 2001)                                                    
|              | 
|10.5          |  | Fourth Lease Amendment between Tullys and Kent Central, LLC, dated February 21, 2001 (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
April 1, 2001, as filed with the Commission on October 19, 2001)                                                  
|              | 
|10.6          |  | Fifth Lease Amendment between Kent Central, LLC and Tullys Coffee Corporation (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 29, 2002, as filed with the Commission on November 13, 2002))                                            
|              | 
|10.7          |  | Tullys Coffee Exclusive License Agreement, dated April 11, 2001 between Tullys and UCC Ueshima Coffee Company, LTD. (incorporated by reference to the Companys Current Report
on Form 8-K, dated March 12, 2001, as filed with the Commission on May 2, 2001)                                  
|              | 
|10.8          |  | Employment Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated May 13, 2002 (incorporated by reference to the Companys Annual Report on Form 10-K for the year
ended March 31, 2002, as filed with the Commission on July 1, 2002)                                          
|              | 
|10.9          |  | Tullys Coffee Corporation Employment Summary dated June 21, 2002 for Kristopher S. Galvin (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
March 31, 2002, as filed with the Commission on July 1, 2002)                                                
|              | 
|10.10         |  | First Amendment to Employment Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated December 3, 2002 (incorporated by reference to the Companys Quarterly Report
on Form 10-Q for the quarter ended December 29, 2002, as filed with the Commission on February 12, 2003)     
|              | 
|10.11         |  | Amended Stock Option Agreement Tullys Coffee Corporation Second Amended and Restated 1994 Stock Option Plan, as amended on June 19, 2003 (incorporated by reference to the Companys
Annual Report on Form 10-K for the year ended March 30, 2003, as filed with the Commission on June 30, 2003)



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|              |   |  |                                                                                                                                                                                                                                                                                                     
|------------- | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |   |  | Description                                                                                                                                                                                                                                                                                         
|10.12         |   |  | Sixth Amendment to Lease Agreement between Tullys and Rainier Commons, LLC, dated June 26, 2003 (incorporated by reference to the Companys Annual Report on Form 10-K for the year
ended March 30, 2003, as filed with the Commission on June 30, 2003)                                           
|              |  
|10.13         |   |  | Second Amendment to Employment Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated April 12, 2004 (incorporated by reference to the Companys Registration
Statement Report on Form S-1, as filed with Commission on May 12, 2004)                                             
|              |  
|10.14         |   |  | Employment Termination Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated April 12, 2004 (incorporated by reference to the Companys Registration Statement
Report on Form S-1, as filed with Commission on May 12, 2004)                                                     
|              |  
|10.15         |   |  | Letter of Employment for John D. Dresel (incorporated by reference to the Companys Current Report on Form 8-K, dated September 30, 2004, as filed with the Commission on October 5,
2004)                                                                                                          
|              |  
|10.16         |   |  | Termination Of Agreement Between Tullys Coffee and Guarantors Re Kent Central Financing dated August 15, 2005 (incorporated by reference to the Companys Current Report on Form
8-K, dated August 31, 2005, as filed with the Commission on September 2, 2005)                                    
|              |  
|10.17         |   |  | Asset Purchase Agreement by and between Tullys Coffee Japan Co., Ltd. and Tullys Coffee Corporation, dated August 19, 2005 (incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended July 3, 2005, as filed with the Commission on August 22, 2005)
|              |  
|10.18         |   |  | First Amendment of Asset Purchase Agreement between Tullys Coffee Japan Co., Ltd. and Tullys Coffee Corporation dated August 31, 2005 (incorporated by reference to the
Companys Current Report on Form 8-K, dated August 31, 2005, as filed with the Commission on September 2, 2005)           
|              |  
|10.19         | * |  | Contract of Sale & Security Agreement between Tullys Coffee Corporation and Northrim Funding Services dated June 29, 2006                                                                                                                                                                          
|              |  
|10.20         | * |  | Inventory Security Agreement between Tullys Coffee Corporation and Northrim Funding Services dated June 29, 2006                                                                                                                                                                                   
|              |  
|14.1          |   |  | Tullys Coffee Corporation Code of Business Conduct (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended April 2, 2006, as filed with the
Commission on June 28, 2004)                                                                                         
|              |  
|23.1          | * |  | Consent of Moss Adams LLP                                                                                                                                                                                                                                                                           
|              |  
|31.1          | * |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                       
|              |  
|31.2          | * |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                       
|              |  
|32.1          | * |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                   
|              |  
|32.2          | * |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                   

---

|* |  | Filed herewith
|- |  | --------------



(b) Current Reports on Form 8-K during the fourth fiscal quarter (the thirteen week period ended April 2, 2006).



None.



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SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in Seattle, Washington on July 3, 2006.



TULLYS COFFEE CORPORATIONBy:

/S/    KRISTOPHER S.
GALVINExecutive Vice President, Chief Financial Officer andSecretary Signing on behalf of the Registrant and asprincipal financial and accounting
officer




Pursuant to
the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on July 3, 2006 on behalf of the Registrant and in the capacities indicated:



|                                                  |  |                                                                                                             
|------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------
|Signature                                         |  | Title                                                                                                       
|                                                  | 
|/S/    JOHN D.
DRESELJohn D. Dresel               |  | President and Chief Operating Officer (principal executive officer)                                         
|                                                  | 
|/S/    TOM T.
OKEEFETom T.
OKeefe               |  | Chairman of the Board                                                                                       
|                                                  | 
|/S/    JOHN K.
BULLERJohn K.
Buller               |  | Director                                                                                                    
|                                                  | 
|/S/    MARC
EVANGERMarc
Evanger                   |  | Director                                                                                                    
|                                                  | 
|/S/    JOHN M.
FLUKEJohn M.
Fluke                 |  | Director                                                                                                    
|                                                  | 
|/S/    LARRY
HOODLarry Hood                       |  | Director                                                                                                    
|                                                  | 
|/S/    GREGORY A.
HUBERTGregory A.
Hubert         |  | Director                                                                                                    
|                                                  | 
|/S/    KATHI
AINSWORTH-JONESKathi
Ainsworth-Jones |  | Director                                                                                                    
|                                                  | 
|/S/    KRISTOPHER S.
GALVINKristopher S.
Galvin   |  | Executive Vice President, Chief Financial Officer and Secretary (principal accounting and financial officer)



94



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##### Table of Contents

EXHIBIT INDEX



|              |  |                                                                                                                                                                                                                                                                                                          
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                              
|3.1           |  | Amended and Restated Articles of Incorporation of Tullys Coffee Corporation (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended April 1, 2001,
as filed with the Commission on October 19, 2001)                                                                  
|              | 
|3.1.1         |  | Articles of Amendment of the Restated Articles of Incorporation containing the Statement of Rights and Preferences of Series B Preferred Stock (incorporated by reference to the Companys
Annual Report on Form 10-K for the year ended April 1, 2001, as filed with the Commission on October 19, 2001)
|              | 
|3.2           |  | Amended Bylaws of Tullys Coffee Corporation (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended March 31, 2002, as filed with the Commission
on July 1, 2002)                                                                                                     
|              | 
|4.1           |  | Description of capital stock contained in the Amended and Restated Articles of Incorporation (see Exhibit 3.1) (incorporated by reference to the Companys Registration Statement on Form
10, as filed with the Commission on July 27, 1999)                                                             
|              | 
|4.2           |  | Description of rights of security holders contained in the Bylaws (see Exhibit 3.2) (incorporated by reference to the Companys Registration Statement on Form 10, as filed with the
Commission on July 27,1999)                                                                                         
|              | 
|4.3           |  | Form of common stock warrants issued in Series A Convertible Preferred Stock financing (incorporated by reference to the Companys Registration Statement on Form 10, as amended and filed
with the Commission on July 3, 2000)                                                                          
|              | 
|4.4           |  | Form of Registration Rights Agreement with Series A Preferred Shareholders (incorporated by reference to the Companys Registration Statement on Form 10, as amended and filed with the
Commission on July 3, 2000.)                                                                                     
|              | 
|4.7           |  | Form of Common Stock Purchase Warrant issued with the Convertible Promissory Note (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended December
31, 2000, as filed with Commission on February 20, 2001)                                                      
|              | 
|4.8           |  | Registration Rights Agreement, dated December 14, 2000 between Tullys and KWM Investments LLC (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarter ended December 31, 2000, as filed with Commission on February 20, 2001)                                         
|              | 
|4.9           |  | Form of Common Stock Purchase Warrant issued to Guarantors of Kent Central, LLC Promissory Note, dated November 1, 2002 (incorporated by reference to the Companys Quarterly Report on
Form 10-Q for the quarter ended December 28, 2003, as filed with Commission on February 11, 2004)                
|              | 
|10.1          |  | Tullys Coffee Corporation Amended and Restated 1994 Stock Option Plan (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended September 26,
1999, as filed with the Commission on November 15, 1999)                                                            
|              | 
|10.2          |  | Tullys Coffee Corporation 1999 Employee Stock Purchase Plan (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended September 26, 1999, as
filed with the Commission on November 15, 1999)                                                                      
|              | 
|10.3          |  | Lease Agreement between Tullys and Kent Central, LLC, as amended (Incorporated by reference to the Companys Annual Report on Form 10-K for the year ended April 2, 2000, as filed
with the Commission on July 3, 2000)                                                                                 
|              | 
|10.4          |  | Third Lease Amendment between Tullys and Kent Central, LLC, dated November 7, 2000 (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
April 1, 2001, as filed with the Commission on October 19, 2001)                                                           



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##### Table of Contents

|              |   |  |                                                                                                                                                                                                                                                                                                     
|------------- | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |   |  | Description                                                                                                                                                                                                                                                                                         
|10.5          |   |  | Fourth Lease Amendment between Tullys and Kent Central, LLC, dated February 21, 2001 (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
April 1, 2001, as filed with the Commission on October 19, 2001)                                                    
|              |  
|10.6          |   |  | Fifth Lease Amendment between Kent Central, LLC and Tullys Coffee Corporation (incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 29, 2002, as filed with the Commission on November 13, 2002))                                              
|              |  
|10.7          |   |  | Tullys Coffee Exclusive License Agreement, dated April 11, 2001 between Tullys and UCC Ueshima Coffee Company, LTD. (incorporated by reference to the Companys Current Report
on Form 8-K, dated March 12, 2001, as filed with the Commission on May 2, 2001)                                    
|              |  
|10.8          |   |  | Employment Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated May 13, 2002 (incorporated by reference to the Companys Annual Report on Form 10-K for the year
ended March 31, 2002, as filed with the Commission on July 1, 2002)                                            
|              |  
|10.9          |   |  | Tullys Coffee Corporation Employment Summary dated June 21, 2002 for Kristopher S. Galvin (incorporated by reference to the Companys Annual Report on Form 10-K for the year
ended March 31, 2002, as filed with the Commission on July 1, 2002)                                                  
|              |  
|10.10         |   |  | First Amendment to Employment Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated December 3, 2002 (incorporated by reference to the Companys Quarterly Report
on Form 10-Q for the quarter ended December 29, 2002, as filed with the Commission on February 12, 2003)       
|              |  
|10.11         |   |  | Amended Stock Option Agreement Tullys Coffee Corporation Second Amended and Restated 1994 Stock Option Plan, as amended on June 19, 2003 (incorporated by reference to the Companys
Annual Report on Form 10-K for the year ended March 30, 2003, as filed with the Commission on June 30, 2003)  
|              |  
|10.12         |   |  | Sixth Amendment to Lease Agreement between Tullys and Rainier Commons, LLC, dated June 26, 2003 (incorporated by reference to the Companys Annual Report on Form 10-K for the year
ended March 30, 2003, as filed with the Commission on June 30, 2003)                                           
|              |  
|10.13         |   |  | Second Amendment to Employment Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated April 12, 2004 (incorporated by reference to the Companys Registration
Statement Report on Form S-1, as filed with Commission on May 12, 2004)                                             
|              |  
|10.14         |   |  | Employment Termination Agreement between Anthony J. Gioia and Tullys Coffee Corporation, dated April 12, 2004 (incorporated by reference to the Companys Registration Statement
Report on Form S-1, as filed with Commission on May 12, 2004)                                                     
|              |  
|10.15         |   |  | Letter of Employment for John D. Dresel (incorporated by reference to the Companys Current Report on Form 8-K, dated September 30, 2004, as filed with the Commission on October 5,
2004)                                                                                                          
|              |  
|10.16         |   |  | Termination Of Agreement Between Tullys Coffee and Guarantors Re Kent Central Financing dated August 15, 2005 (incorporated by reference to the Companys Current Report on Form
8-K, dated August 31, 2005, as filed with the Commission on September 2, 2005)                                    
|              |  
|10.17         |   |  | Asset Purchase Agreement by and between Tullys Coffee Japan Co., Ltd. and Tullys Coffee Corporation, dated August 19, 2005 (incorporated by reference to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended July 3, 2005, as filed with the Commission on August 22, 2005)
|              |  
|10.19         | * |  | Contract of Sale & Security Agreement between Tullys Coffee Corporation and Northrim Funding Services dated June 29, 2006                                                                                                                                                                          
|              |  
|10.20         | * |  | Inventory Security Agreement between Tullys Coffee Corporation and Northrim Funding Services dated June 29, 2006                                                                                                                                                                                   



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##### Table of Contents

|              |  |                                                                                                                                                                                                                                                                                          
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                              
|10.18         |  | First Amendment of Asset Purchase Agreement between Tullys Coffee Japan Co., Ltd. and Tullys Coffee Corporation dated August 31, 2005 (incorporated by reference to the
Companys Current Report on Form 8-K, dated August 31, 2005, as filed with the Commission on September 2, 2005)
|              | 
|14.1          |  | Tullys Coffee Corporation Code of Business Conduct (incorporated by reference to the Companys Annual Report on Form 10-K for the year ended April 2, 2006, as filed with the
Commission on June 28, 2004)                                                                              
|              | 
|23.1*         |  | Consent of Moss Adams LLP                                                                                                                                                                                                                                                                
|              | 
|31.1*         |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                            
|              | 
|31.2*         |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                            
|              | 
|32.1*         |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                        
|              | 
|32.2*         |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                        

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|* |  | Filed herewith
|- |  | --------------