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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended January 31, 1999.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _____________ to ____________
Commission file number 0-17868
KRAUSE'S FURNITURE, INC.
(Exact name of Registrant as specified in its charter.)
DELAWARE 77-0310773
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 NORTH BERRY STREET, BREA, CALIFORNIA 92821-3903
(Address of principal executive offices) (Zip Code)
(714) 990-3100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE AMERICAN STOCK EXCHANGE
(Title of Class) (Name of each exchange where registered)
Securities registered pursuant to Section 12(g) of the Act: None
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 of this Form 10-K. [ ]
As of April 6, 1999 the aggregate market value of Registrant's $.001 par
value common stock held by non-affiliates was approximately $17,429,000 based on
the closing price for the stock. As of April 6, 1999 there were 19,020,539
shares of $.001 par value common stock outstanding.
Documents Incorporated by Reference: Proxy Statement for 1998 Annual
Meeting of Stockholders with respect to information required in Part III.
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This Report on Form 10-K contains certain forward-looking statements
that are based on current expectations. In light of the important factors that
can materially affect results, including those set forth in this Form 10-K, the
inclusion of forward-looking information herein should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved. The Company may encounter competitive,
financial and business challenges making it more difficult than expected to
continue to develop, market, manufacture and ship products on a timely basis;
competitive conditions may change adversely; demand for the Company's products
may weaken; the market may not accept the Company's merchandising strategies and
products; the Company may be unable to retain existing key management personnel;
the Company's forecasts may not accurately anticipate customer demand; and there
may be other material adverse changes in the Company's operations or business.
Certain important factors affecting the forward-looking statements made herein
include, but are not limited to (i) timely identifying, designing, and
delivering new products as well as enhancing existing products, (ii)
implementing current strategic plans, (iii) accurately forecasting capital
expenditures, and (iv) obtaining new sources of external financing. Assumptions
relating to budgeting, marketing, advertising, product development and other
management decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experiences and business
developments, the impact of which may cause the Company to alter its marketing,
advertising, capital expenditure or other budgets, which may in turn affect the
Company's financial position and results of operations.
PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
THE COMPANY. The Company is a leading vertically integrated manufacturer
and retailer of made-to-order upholstered furniture and accessories. The Company
operates 90 furniture showrooms under the Krause's (76 showrooms) and Castro
Convertibles (14 showrooms) brand names in 12 states, with 55 of those showrooms
in California and in the New York City metropolitan area, including New York,
New Jersey and Connecticut. Customers can choose from more than 60 styles and 40
sizes of sofas, incliners, recliners, sectionals, sofabeds and chairs, which
they can customize with 800 fabrics and 50 leathers. The Company believes that
it has developed a reputation for delivering high quality, custom-crafted
furniture at prices comparable to those of mass-produced sold-as-shown
furniture. In recent periods, the Company has undergone significant changes,
raising substantial new capital, hiring a new management team with extensive
expertise in retailing, and changing the Company's business strategy from a
factory-direct orientation to a retail-oriented, fashion conscious approach.
In the spring of 1996, GECC and Philip M. Hawley, the former Chairman
and Chief Executive Officer of The Broadway Stores, Inc. (formerly Carter Hawley
Hale Stores, Inc.), undertook an evaluation of the Company and determined that
it had strong brand name recognition, good retail locations in strong markets,
demonstrated manufacturing capability and a unique niche. They perceived that
the Company presented an opportunity for growth by remodeling existing
showrooms, opening new showrooms in existing markets and penetrating new
markets. Beginning in August 1996, GECC and certain other investors led by Mr.
Hawley invested approximately $22 million in equity and debt in the Company. The
Company hired new executives with retail experience and Mr. Hawley became its
Chairman and Chief Executive Officer.
RECENT DEVELOPMENTS. In April 1998 the Company raised approximately $7.3
million of equity as a result of a public offering of approximately 3.0 million
additional shares. At the same time as the public offering, the Company listed
its shares on the American Stock Exchange and terminated trading in the Nasdaq
SmallCap Market.
Under the leadership of Mr. Hawley, the Company has undergone a major
expansion and remodeling program, and has developed a marketing and
merchandising strategy designed to increase its appeal to its existing broad
customer base by promoting the Company's wide selection of products, styles and
fabrics, as well as quality and value. Under this program, the Company has
remodeled 38 existing showrooms, 22 of which were remodeled during fiscal 1998,
established design centers in prominent locations within showrooms to highlight
fabric selection, created decorated room settings, added new lighting and
carpeting, and integrated the Castro Convertibles brand name and products into
its remodeled Krause's showrooms. The Company plans to continue to remodel and
upgrade existing showrooms during fiscal 1999. The Company has also taken
significant steps to improve margins by increasing prices to competitive levels,
reducing promotional discounting and improving manufacturing efficiencies, and
to reduce expenses by implementing budgeting controls, consolidating selling,
general and administrative expenses and cutting costs, including revising its
sales commission structure. These new strategies, combined with improved
economies in regions where the Company operates, have begun to show positive
financial results. For the fiscal year ended January 31, 1999, same-store sales
(for showrooms opened a year or more) increased 9.8% compared to the prior
fiscal year. In addition, gross profit increased from 51.3% to 53.2% of net
sales in fiscal 1998 compared to fiscal 1997. Since the management change, the
Company has also opened thirteen new showrooms, eight of which were opened
during fiscal 1998, featuring its new store design and has plans to open
approximately 16 to 21 additional showrooms during the balance of fiscal 1999.
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INDUSTRY OPPORTUNITY AND COMPETITIVE STRENGTHS. The Company believes a
number of macroeconomic factors influence furniture sales, including existing
home sales, housing starts, consumer confidence, availability of credit,
interest rates and demographic trends. Management believes favorable fundamental
trends in home building and demography will continue to drive long-term growth
in the furniture industry.
The furniture market is large and diversified. Because the market for
custom crafted furniture is highly fragmented, the Company believes that
manufacturers with strong brand name recognition, broad distribution and good
value to price ratio are positioned to increase market share.
o Reputation for Value and Selection; Brand Names. The Company believes that
it has attained a reputation for high quality, custom-crafted furniture at
prices comparable to those of mass-produced, sold-as-shown furniture. For
over 26 and 68 years, respectively, Krause's and Castro Convertibles have
developed a reputation for selection, quality, price and service. The
Company believes that its reputation and strong brand recognition influence
customer purchasing decisions and will help the Company expand its
distribution in existing markets and penetrate new markets.
o New, Experienced Management Team. Since the 1996 investment, the Company has
hired a strong management team with extensive retailing experience, led by
Philip M. Hawley, the former Chairman and Chief Executive Officer of The
Broadway Stores, Inc. New management has adopted business and marketing
strategies designed to leverage the Company's existing brand name
recognition and distribution system and appeal to its existing broad
customer base. The management team has a substantial equity stake in the
Company.
o Vertically Integrated Manufacturer and Distributor of Custom Furniture. The
Company is a leading combined manufacturer and retailer of made-to-order
upholstered furniture. This vertical integration enables the Company to
manufacture high-quality, competitively priced custom upholstered furniture
and deliver it to the customer usually within two to four weeks from the
date ordered. Vertical integration also enables the Company to capture
profits at both the manufacturing and retail level, with minimal inventory
risk. Further, the Company can use the available capacity of its
manufacturing facility to accommodate planned sales growth.
o Well Located Retail Distribution Network. As of January 31, 1999, the
Company operated 88 showrooms, primarily in California and the New York City
metropolitan area, and in selected other markets in the Southwest, Northwest
and Midwest. The Company believes that its showrooms are in many markets
that have favorable demographics and upward economic trends, and that a
substantial majority of its showrooms are located in high traffic areas. In
addition, many showrooms are near other furniture retailers, where the
Company believes it can benefit from increased traffic of furniture
customers and from comparison shopping, typically by shoppers who compare
Company products to those of sold-as-shown retailers or premium-priced
custom manufacturers.
o Focus on Gross Margins and Cost Controls. In recent periods, the Company has
taken a number of steps to improve its gross margin and reduce expenses by
reducing discounts and other special pricing programs, improving its
manufacturing processes, introducing budgeting controls, revising its sales
commission structure, consolidating selling, general and administrative
expenses and cutting costs. As a result, the Company has developed an
organization focused on gross margin improvements, expense control and
operating efficiency.
BUSINESS STRATEGY. The Company intends to leverage its competitive
strengths in order to increase its sales volumes, improve its overall financial
performance and enhance its market position. The Company is attempting to
achieve these objectives by pursuing the following strategies:
o Remodel Existing Showrooms. The Company is well into a major remodeling
program to update its showrooms, imbue a sense of fashion and excitement and
move away from the Company's traditional factory-direct orientation. The
Company has developed new store layout, design and visual presentation
themes to center attention on fabric selection and customization options,
present merchandise by life style as complete room environments and enhance
lighting and color in order to add drama and create excitement throughout
its showrooms. The Company has remodeled 38 showrooms, 22 of which were
remodeled during fiscal 1998, and expects to complete the remodeling program
over the next eighteen months.
o Add New Showrooms in Existing Markets. The Company plans to expand its
presence in markets where it has an existing base of showrooms so that it
can leverage its brand name recognition and marketing efforts as well as its
existing distribution network and management. The Company estimates that it
has not less than 40 opportunities to open showrooms in existing markets. To
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date, the Company has opened thirteen new showrooms, eight of which were
opened during fiscal 1998, and expects to open approximately 16 to 21
additional showrooms during the balance of fiscal 1999.
o Relocate Under-Performing Showrooms. The Company estimates that it has
approximately two dozen showrooms that are in good market areas but in poor
locations within these market areas. As the leases on these showrooms
expire, the Company plans to seek more suitable locations and incorporate
into the new showrooms the same new layout, design and visual presentation
themes that it has developed in the remodeling program.
o Revamp Marketing and Sales Promotion. The Company has revamped its marketing
and sales promotion with the goal of better defining its market niche and
differentiating it from its competitors. A major focus of this effort is a
shift away from a factory-direct orientation to that of customization and
craftsmanship with emphasis on value rather than price. To this end, the
Company changed the name it does business under from Krause's Sofa Factory
to Krause's Custom Crafted Furniture and developed a new, modern logo.
Another focus of this effort has been to create an advertising format and
message and to use larger ads in an effort to better attract customers.
o Develop New Products; Increase Sales of Complementary Products. The Company
has put in place a new product development program, which is freshening
showroom inventories and introducing a number of new styles designed to
increase its appeal to customers. In addition, although the Company intends
to continue to focus on the manufacture and sale of upholstered products, as
a part of its new merchandising approach it has increased the promotion and
sale of other products, including accessories supplied by third parties such
as tables, lamps, area rugs and wall decor, custom-made chairs and
recliners. The Company believes these additional merchandise classifications
have broadened the Company's offerings and contributed to increased sales
per square foot.
o Leverage the Castro Franchise. In 1993, the Company acquired certain assets
principally related to the retail operations of Castro Convertible
Corporation, including the "Castro Convertibles" tradename and trademark and
retail store locations. Castro Convertibles, which started business in 1931,
has been known throughout the East Coast for its quality sofabed products
and was an early pioneer in developing the tri-fold sofabed mechanism. The
Company has leveraged this strong brand awareness by adding a Castro
Convertibles gallery in all of its Krause's remodeled and new showrooms.
o Increase Showroom Productivity. For the year ended January 31, 1999, the
Company's sales per square foot of selling space averaged $127. To further
increase showroom productivity, the Company is in the process of gradually
reducing the average size of its showrooms from approximately 12,100 square
feet of selling space to approximately 10,000 square feet, which it believes
is the optimal size to show and sell the Company's products. In addition,
the Company intends to increase same-store sales by continuing to (i) roll
out its remodeling and expansion program, which has produced higher
same-store sales at the initial group of remodeled showrooms, (ii) add new
products, including accessory products manufactured by third parties, and
(iii) increase the effective sales prices of its products through reduced
promotional discounting.
SHOWROOMS AND MERCHANDISING. Showrooms. The Company sells its products
exclusively through leased retail showrooms in 12 states. Retail showrooms in
California, Colorado, Arizona, Nevada, Texas, New Mexico, Washington and
Illinois operate under the name KRAUSE'S CUSTOM CRAFTED FURNITURE, KRAUSE'S SOFA
FACTORY(R) or KRAUSE'S SOFAS(R). The Company intends to convert all of these
showrooms to operate under the name KRAUSE'S CUSTOM CRAFTED FURNITURE. Retail
showrooms in New York, New Jersey, Connecticut and Florida are operated under
the name CASTRO CONVERTIBLES(R). Showroom locations are selected on the basis of
strictly defined criteria, including expected population growth, desirable
target consumer demographics and psychographics, high visibility with easy
access from major thoroughfares, adequate parking facilities and proximity to
other furniture retailers.
Selling space in retail showrooms varies in size from 1,400 square feet
to 23,400 square feet, with an average size of 11,700 square feet. The typical
showroom displays approximately 50 to 60 styles in coordinated furniture
groupings to illustrate the diversity and availability of contemporary and
traditional upholstered furniture.
When a customer makes a selection, a sales associate collects a down
payment and immediately enters the order in the Company's computer system
through a terminal at the showroom. The order, reflecting the customer's exact
specifications of style, color, size, configuration and fabric, is then sent to
the Company's facility in Brea, California for manufacturing.
REMODELING AND EXPANSION. The Company is well into a major expansion and
remodeling program. Key components of this program include establishing design
centers in prominent locations within showrooms to highlight fabric selection,
creating decorated room settings, adding new lighting and carpeting, developing
consistent and highly visible signage, and integrating the
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Castro Convertibles brand name and products into its Krause's Custom Crafted
Furniture showrooms. As part of this program, the Company has remodeled 38
showrooms, 22 of which were remodeled during fiscal 1998, and has plans to
remodel additional showrooms during fiscal 1999. The remodeled showrooms are
designed to present a more appealing environment to the consumer, emphasizing
the Company's wide array of styles and fabric selections, and highlight the
consumer's ability to customize furniture selections to suit individual taste.
Remodeled showrooms feature prominently displayed design centers to highlight
fabric selection, decorated room settings, and new lighting and carpeting. The
Company anticipates that it will recover the cost of each remodeled store in
approximately one year through increased sales after the remodeling.
The Company is also seeking to expand its presence in existing markets
to increase sales and market share. This will enable the Company to leverage its
brand name recognition and take advantage of the advertising umbrella and
infrastructure that currently exists. It will also focus on areas with strong
demographics and economic performance. The Company has opened thirteen new
showrooms, eight of which were opened during fiscal 1998, since it began its
expansion program and intends to open approximately 16 to 21 additional
showrooms during the balance of fiscal 1999. In addition, as leases expire on
showrooms that are not located in prime retail areas, but are in favorable
markets, the Company will attempt to move those showrooms to more suitable
locations.
MERCHANDISING AND ADVERTISING. The Company has implemented new
merchandising programs designed to further leverage and enhance the strength of
the Krause's and Castro Convertibles brand names. In addition to implementing
its expansion and remodeling program designed to enhance the Company's appeal to
its existing broad customer base, the Company has further enhanced and leveraged
the strength of the Krause's and Castro Convertibles brand names through new
advertising and merchandising programs that emphasize the selection, features
and value of its products. The Company is seeking to use its strong brand
awareness to initially increase its share of existing markets and ultimately to
penetrate new markets. As an integral part of its new and remodeled Krause's
Custom Crafted Furniture showrooms, the Company has added a section dedicated to
its Castro Convertibles products to further leverage this product line and brand
name.
The Company primarily advertises through print media, both in newspapers
and by direct mail. It also employs targeted radio advertising in selected
markets. The Company has freshened the appearance of its advertising to give
more consistent placement of the Krause's and Castro Convertibles brand names,
to play down the Company's previous factory-direct image, and to appeal to a
more fashion-conscious buyer. While the Company plans to continue to display
prices in its advertising, it has reduced the prominence of promotional pricing
in favor of highlighting the selection, style and value of its products.
PRODUCTS. The Company focuses on manufacturing and retailing
high-quality, affordably priced made-to-order upholstered furniture. Its product
line consists primarily of upholstered (covered in woven fabric or leather)
sofas, sofabeds, chairs and sectionals. Customers of the Company may choose from
a selection of approximately 60 different styles, 40 sizes, 800 fabrics and 50
leather choices. Except for a few styles of occasional and reclining chairs
which the Company purchases from outside vendors, the Company manufactures
virtually all of the upholstered furniture offered in its showrooms.
In addition to its exclusive upholstered furniture line, the Company
retails an assortment of tables, area rugs, lamps and wall decor, custom-made
chairs and recliners. These furniture products and accessories, which are
supplied to the Company by outside vendors, complement the Company's upholstered
furniture products and help to create the room setting displays. Because the
Company typically views sales of these furniture products and accessories as
incremental to, rather than in lieu of, sales of the Company's own upholstered
furniture products, the Company has increased the promotion and sale of these
complimentary furniture products and accessories. Merchandise purchased from
other suppliers currently accounts for approximately 10.7% of net sales.
In order to be responsive to changing customer demands, the Company will
develop new products more aggressively. Since the 1996 financings, the Company
has introduced 24 new sofa styles and five new chair styles. In addition, the
Company is committed to periodically update its inventory of 800 fabrics by
replacing slow-moving, out-of-style fabrics with more contemporary designs.
Because of its made-to-order strategy, the Company does not require a
substantial inventory of finished goods, whether they are manufactured by it or
purchased from outside sources.
MANUFACTURING. The Company's manufacturing facilities in Brea, California
produce upholstered furniture for both Krause's and Castro Convertibles
showrooms. Manufacturing generally begins with the purchase of kits containing
wooden frame components. These components are chiefly hardwood, but also include
softwood and some engineered lumber. Outside mills make the components, first
kiln-drying the lumber for extra strength and straightness, then cutting the
component pieces to Company specifications for each different style, working to
precise standards. Company artisans, using pneumatic and power tools, assemble
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the wooden parts into frames for different furniture models. All corners are
blocked and glued for added strength and proper distribution of weight and
stress.
The Company primarily uses a one-piece frame method in which workers
build the entire frame before any upholstering occurs. This method makes the
frame stronger and leads to a more finely tailored appearance. Workers complete
the frames by installing metal springs, which contribute to the continued
comfort, durability and appearance of the upholstered furniture. Some Castro
Convertibles models have a frame that can be disassembled for delivery through
the narrow doorways and hallways of New York area apartments.
The first step in the upholstering process is cutting and sewing the
fabric chosen by the customer. The sewn fabric is sent to the assembly line
where workers construct the frame and upholster the seats, backs and arms. The
Company employs quilters as well as special seamstresses to sew zippers, bolster
covers, ruffles, skirts and pleats.
Upholstering takes place along an assembly line. Several individuals
work on each frame, each specializing in an area of responsibility -- springs,
outside body, seat, arm, inside body and so on. While the frame is upholstered,
seat cushions are filled with the customer's selection of either down, standard
foam or a Foreverflex(R) insert (the Company's proprietary seating material).
The Foreverflex(R) cushion insert is a high-density foam cushion which is
injection molded with springs suspended within the foam. An outside supplier
makes the Foreverflex(R) cushion insert to strict Company specifications and
provides a lifetime guarantee. Every piece of finished upholstered furniture
undergoes a quality control inspection during production and again prior to
shipment from the factory to the local distribution center.
The Company generally has adequate inventories of raw materials and
other supplies on hand to fill customer orders, and expects its suppliers to
satisfy its requirements shortly before materials are used in production.
The Company builds approximately 650 pieces of upholstered furniture per
day in two shifts. This output represents approximately 54% of double shift
manufacturing capacity. The level of production primarily reflects customer
orders, because the Company does not manufacture units for inventory.
When an order has completed the manufacturing or outside purchasing
process, it is shipped to a regional warehouse for the final preparation and
delivery to the customer. The Company uses outside delivery services, as well as
its own personnel in certain areas, for deliveries.
BACKLOG. The Company turns its manufacturing backlog approximately every
23 to 28 days. Backlog as of January 31, 1999 was approximately $11.3 million
compared to $10.7 million at February 1, 1998.
SUPPLIERS AND MATERIALS. Many suppliers currently provide the Company
with the materials used in manufacturing its upholstered furniture products. The
Company's ten largest suppliers provided it with 52.9% of its purchased raw
materials during the fiscal year ended January 31, 1999, including one such
supplier that provided approximately 10.2% The Company is dependent on the
continued supply of components and raw materials, including frame components,
fabrics, leather, foam and sofabed and motion mechanisms. Management constantly
seeks new suppliers and better prices through competitive bidding and the
qualification of alternative sources of supply. If the Company could not develop
alternative sources of supply when needed or failed to obtain sufficient
single-source products, components and raw materials, the resulting loss in
production capability would adversely affect the Company's sales and operating
results.
TRADEMARKS AND PATENTS. The Company holds trademarks and patents
registered in the United States for some of its products and processes. The
Company has a registered trademark in the United States for the Krause's Sofa
Factory(R) and Castro Convertibles(R) names and logos and the name
Foreverflex(R). The Company has applied for a trademark for the name Krause's
Custom Crafted Furniture. Trademarks, which the Company considers important to
its business, have expiration dates ranging from May 13, 2002 to November 30,
2004, but each is renewable in perpetuity. The Company also has other
trademarks, both registered and unregistered, that the Company believes are not
material to its business or to any ongoing product lines.
GOVERNMENT REGULATIONS. The Company's facilities are subject to numerous
federal, state and local laws and regulations designed to protect the
environment from waste emissions and from hazardous substances. The Company is
also subject to the federal Occupational Safety and Health Act and other laws
and regulations affecting the safety and health of employees in the production
areas of its facilities. Management believes that it is in compliance in all
material respects with all applicable environmental and occupational safety
regulations.
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EMPLOYEES. The majority of the Company's employees are not unionized and
many have worked for the Company for more than 10 years. A union contract covers
approximately 50 retail employees in the greater New York area. At January 31,
1999, the total work force numbers approximately 1,112, with approximately 433
working in manufacturing, 589 in retail and warehousing operations, and 90 in
administration.
COMPETITION. The home furnishings industry is highly competitive and
fragmented, and includes competition from traditional furniture retailers,
department stores and discount and warehouse outlets. Certain companies which
compete directly with the Company have greater financial and other resources
than the Company. The Company competes on a national level with Ethan Allen
Inc., Levitz Furniture, Leather Center, Inc., Expressions and traditional
department stores, among others. The Company also competes on a regional basis.
In New York, New Jersey and Chicago, the Company's primary competitor is
Jennifer Convertibles, Inc., and in the Western United States the Company's
primary regional competitors include Homestead House, Inc., The Leather Factory
and Norwalk Furniture Corporation (the latter of which also competes in the
Midwest market). In Houston, Texas, the Company's primary regional competitor is
Star Furniture Company. Expressions, Norwalk Furniture Corporation and Ethan
Allen Inc., like the Company, manufacture their own upholstered products and
offer "made-to-order" customization similar to that provided by the Company.
Levitz Furniture primarily addresses the low to middle end "as shown" market,
whereas traditional department stores typically focus on the middle to upper end
"as shown" market.
INSURANCE. The Company purchases occurrence-based product liability
insurance in the aggregate amount of $17 million. Management believes that based
upon its historical liability experience, the amount of insurance it carries is
adequate.
RISK FACTORS RELATING TO THE BUSINESS
LACK OF PROFITABLE OPERATIONS; ACCUMULATED DEFICITS. The Company has
reported losses from operations in each of the past five years and had an
accumulated deficit of $47.0 million at January 31, 1999. If losses from
operations continue, they could adversely affect the market price for the common
stock and the Company's ability to maintain existing financing and obtain new
financing. There can be no assurance that the Company will achieve profitability
in the future.
CAPITAL REQUIREMENTS; RESTRICTIONS ON COMPANY'S ABILITY TO OBTAIN
ADDITIONAL CAPITAL. The Company believes that borrowings under its Revolving
Credit Facility and internally generated funds will be sufficient to fund its
requirements for working capital and capital expenditures through the end of
fiscal year 1999. However, the Company may need to raise additional funds to
finance its remodeling and expansion program through either debt or equity
financing, and there can be no assurance that the Company's financial
performance will generate sufficient funds. The Company currently contemplates
that other sources of capital would be available, although this situation could
change.
The Company's existing secured revolving credit facility provides for
borrowings of up to $15.0 million, is subject to maturity in March 2002, imposes
borrowing base limitations, and restricts it from incurring future additional
indebtedness from third parties in an amount in excess of $5.0 million.
Consequently, if the Company needs any significant additional infusion of
capital, it may have to issue additional equity. Such additional capital, if
raised, is likely to dilute the interest of the Company's stockholders. The
revolving credit agreement further requires the Company to maintain financial
covenants regarding adjusted net worth and earnings before interest, taxes,
depreciation and amortization. Substantially all of the Company's assets are
pledged as collateral for repayment of existing indebtedness. The Company's
collateral pledge may make it more difficult for the Company to obtain
additional financing on advantageous terms, if at all.
Additionally, the restrictions described above could significantly impair
the Company's ability to raise additional capital by issuing either additional
equity or debt.
LEVERAGE AND ABILITY TO SERVICE FIXED CHARGES. At January 31, 1999, the
Company had $18.0 million of long-term debt and had a negative tangible net
worth (stockholders' equity less intangible assets) of $2.0 million. For the
fiscal year ended January 31, 1999, earnings before interest, taxes,
depreciation and amortization were $.9 million. A high percentage of the
Company's operating expenses are relatively fixed, including approximately $1.4
million per month in lease payments.
The Company's high level of debt and debt service requirements will have
several important effects on its future operations, including the following: (i)
the Company will need to devote significant cash to service debt, reducing funds
available for operations and future business opportunities and increasing the
Company's vulnerability to adverse economic and industry conditions and
competition; (ii) the Company's leveraged position will increase its
vulnerability to competitive pressures; (iii) the financial covenants and other
restrictions contained in certain agreements relating to the Company's
indebtedness will require the Company to meet
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certain financial performance tests which increase over time and will restrict
its ability to borrow additional funds, to dispose of assets, to issue preferred
stock or to pay cash dividends on or repurchase common stock; and (iv) funds
available for working capital, capital expenditures, acquisitions and general
corporate purposes will be limited.
Any default under the documents governing indebtedness of the Company
could have a significant adverse effect on the market value of the common stock.
NO ASSURANCE OF SUCCESSFUL IMPLEMENTATION OF BUSINESS STRATEGIES. The
Company's near-term business strategies include (i) revamping marketing and
sales promotion with the goal of better defining the Company's market niche and
differentiating the Company from its competitors; (ii) developing new products,
which will accomplish a freshening of inventories and see the introduction of a
number of new styles, designed to increase customer appeal; (iii) remodeling
showrooms and adding new showrooms in existing market areas; and (iv) enhancing
and leveraging the strength of its brand names. The Company's inability to
achieve any of these goals could have a material adverse effect on the Company's
business, financial condition, and results of operations. See"Business --
Business Strategy."
Certain internal and external factors directly affect the Company's
business, including the following: the availability of suitable showroom
locations in existing markets; the capacity of management to complete remodeling
at the planned pace; the availability of financing for expansion and remodeling;
and general economic conditions, including employment levels, business
conditions, interest rates and tax rates in the Company's market areas. While
the Company believes that current economic conditions favor growth in the
markets it serves, various factors, including those listed above, could reduce
sales or increase operating expenses. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations." There can be no assurance
that various factors will not adversely effect the Company's business in the
future or will not prevent the Company from successfully implementing its
business strategies.
DEPENDENCE UPON CHIEF EXECUTIVE OFFICER AND KEY PERSONNEL. The Company's
future performance will depend to a large extent upon the efforts of Philip M.
Hawley and other members of its executive management team. The loss of the
services of Mr. Hawley or other key members of the team could have an adverse
effect on the Company. In August 1996, the Company entered into an Employment
Agreement with Mr. Hawley, pursuant to which the Company agreed to employ Mr.
Hawley for a term ending on August 25, 1999. The Company has agreed to extend
this agreement to January 31, 2001.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. Because the Company sells
most of its products on a made-to-order basis with a two-to-four week delivery
cycle, it typically operates with about 30 days of backlog. As a result,
quarterly sales and operating results generally depend on the volume and timing
of orders and the Company's ability to fulfill orders within a quarter, which
are difficult to forecast. For example, because one of the Company's fabric
suppliers could not supply all of the Company's needs on a timely basis,
customer orders representing approximately $1,200,000 in sales were not
completed as expected in the fourth quarter of fiscal 1997. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall of demand for the
Company's products in relation to the Company's expectations would have an
immediate adverse impact on the Company's business, operating results and
financial condition. In addition, the Company plans to increase certain cash
expenditures in connection with the remodeling of existing showrooms and the
opening of new showrooms. To the extent that such expenditures precede or are
not subsequently followed by increased revenues, the Company's business,
operating results and financial condition will be materially adversely affected.
In addition, the Company's operating results are affected by a variety of
factors, including consumer tastes, housing activity, interest rates, credit
availability and general economic conditions in its selected market. It is
likely that in some future quarter the Company's operating results will be below
the expectations of public market analysts and investors. In that event, the
price of the common stock would likely be materially adversely affected.
DEPENDENCE ON SUPPLIERS. The Company obtains its raw materials and some
manufactured products from various outside sources and generally has had no
difficulty obtaining them. However, the Company is dependent on the continued
supply from relatively few suppliers of certain products, components and raw
materials, including fabrics, leather, foam, and sleeper and motion mechanisms.
Specifically, the Company's 10 largest suppliers accounted for approximately
52.9% of its aggregate purchases in the fiscal year ended January 31, 1999.
During the fiscal year ended January 31, 1999, approximately 11.3% of these
purchaes represented leather, with one supplier constituting approximately 28.0%
of the leather purchases made by the Company during this period, and
approximately 10.2% of these purchases consisted of pre-cut wood components
purchased from a supplier, constituting nearly all of the pre-cut wood component
purchases made by the Company. The Company has no supply contract with either of
these large suppliers, but instead makes each purchase under a separate purchase
order. Both leather and pre-cut wood components are commodities the Company
believes it can readily obtain from alternative sources, and from time to time
the Company has purchased such commodities from alternative sources. If the
Company could not develop alternative sources of supply of leather, pre-cut wood
components or certain other raw materials and products when needed, or could not
obtain sufficient single-source products,
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components and raw materials when needed, the resulting loss of production
capability, would adversely affect the Company's results of operations.
In addition, commodity raw materials are subject to fluctuations in
price. Because raw materials make up a substantial part of the cost of goods
sold by the Company, price fluctuations could have a material adverse effect on
the Company's results of operations. Although the Company has historically
absorbed gradual increases in raw material prices, there can be no assurance
that the Company will continue to be able to do so in the future. In addition,
sharp increases in material prices are more difficult to pass through to the
customer in a short period of time and may negatively impact the short-term
financial performance of the Company. See "Business -- Manufacturing."
COMPETITION. The home furnishings industry is highly competitive and
fragmented, and includes competition from traditional furniture retailers,
department stores and discount and warehouse outlets. Certain companies which
compete directly with the Company have greater financial and other resources
than the Company. The Company competes on a national level with Ethan Allen
Inc., Levitz Furniture, Leather Center, Inc., Expressions and traditional
department stores, among others. The Company also competes on a regional basis.
In New York, New Jersey and Chicago, the Company's primary competitor is
Jennifer Convertibles, Inc., and in the Western United States the Company's
primary regional competitors include Homestead House, Inc., The Leather Factory
and Norwalk Furniture Corporation (the latter of which also competes in the
Midwest market). In Houston, Texas, the Company's primary regional competitor is
Star Furniture Company. Expressions, Norwalk Furniture Corporation and Ethan
Allen Inc., like the Company, manufacture their own upholstered products and
offer custom-crafted furniture similar to that provided by the Company. Levitz
Furniture primarily addresses the low to middle end "as shown" market, whereas
traditional department stores typically focus on the middle to upper end "as
shown" market.
CYCLICAL NATURE OF THE FURNITURE INDUSTRY. The home furnishings industry
historically has been cyclical, fluctuating significantly with general economic
cycles. After economic downturns, the home furnishings industry tends to recover
more slowly than the general economy. The Company believes that the industry is
significantly influenced by economic conditions generally and particularly by
consumer behavior and confidence, the level of personal discretionary spending,
housing activity, interest rates and credit availability. A prolonged economic
downturn would have a material adverse effect on the Company.
DEPENDENCE ON REGIONAL ECONOMIES. The Company's markets are concentrated
in California and the New York City metropolitan area, where 50.7% and 12.6%,
respectively, of the Company's sales in the fiscal year ended January 31, 1999
originated. Consequently, an economic downturn in either of those states would
likely have a disproportionately negative impact on the financial condition of
the Company. Management believes the economic indicator most relevant to its
operations is consumer confidence. In January 1999, the consumer confidence
index, as reported by the Conference Board, for the Middle Atlantic Region,
which includes New York, was 113.2, the index for the Pacific Region, which
includes California, was 127.8, and the average index for the United States as a
whole, was 128.9.
RELIANCE ON MANUFACTURING FACILITY AND COMPUTER SYSTEM; VULNERABILITY TO
EARTHQUAKES. The Company's sole manufacturing plant, as well as the central
processing facility for the computer system that contains the Company's business
records and links the showrooms to Company headquarters is located in Southern
California, an area prone to earthquakes. An earthquake or other natural
disaster or work stoppage or other event affecting the normal operations of the
business could seriously impair the Company's capacity to continue its
manufacturing and retail operations. While the Company intends to implement a
disaster recovery system to lessen the impact of such a disaster or other work
stoppage, there can be no assurance that the Company will successfully put such
a system into operation.
In addition, the Company is pursuing replacing its computer system with a
new enterprise resource planning system to improve order configuration,
manufacturing scheduling and distribution processes. In the event that the
Company undertakes to replace its current computer system, failure to promptly
implement and integrate its system could have a material adverse affect on the
Company.
CONTROL BY PRINCIPAL STOCKHOLDERS. The current management, directors and
other principal stockholders of the Company own in the aggregate approximately
55.1% of the issued and outstanding capital stock of the Company on a
fully-diluted basis. Furthermore, the Company has entered into a Stockholders
Agreement with certain of its stockholders which provides, in part, that the
stockholders who are parties to the Stockholders Agreement will vote their
shares in any election of directors in a manner that assures the election of
directors designated by each of them. The Stockholders Agreement also prohibits
the Company from taking certain actions, such as mergers, liquidations or
dissolutions, without the approval of the member of the Board of Directors
designated by GECC. It is unlikely that any principal stockholder or group of
public stockholders acting in concert would be in the position to
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influence corporate policy, particularly where any such policy could have a
detrimental effect on GECC or others of the public stockholders. These factors
may have the effect of delaying, deferring or preventing a change in control of
the Company.
POSSIBLE LIMIT ON USE OF OPERATING LOSS CARRYFORWARDS RESULTING FROM
CHANGE IN CONTROL. As of January 31, 1999, the Company had approximately $40
million of federal net operating loss carryforwards including approximately $10
million which is currently limited by Section 382 of the Internal Revenue Code
of 1986, as amended. Also, Section 382 would further limit the Company's use of
its operating loss carryforwards if the cumulative ownership change during any
three-year period exceeds 50%. As a result of transactions occurring through
January 31, 1999, the Company experienced a cumulative ownership change of
approximately 42% as defined in Section 382. These factors may have the effect
of delaying, deferring or preventing a change in control of the Company.
MARKET FOR THE COMPANY'S COMMON STOCK; POTENTIAL VOLATILITY OF STOCK
PRICE. The Company's common stock began trading on the American Stock Exchange
on March 31, 1998. Prior to that date the Company's common stock traded on the
Nasdaq SmallCap Market. There can be no assurances as to the extent or nature of
the market for the Company's common stock (which is currently thinly traded) or
as to the price at which the Company's common stock will trade. The market price
of the Company's Common stock may be significantly affected by various factors
such as quarterly variations in the Company's operating results, changes in
revenue growth rates for the Company as a whole or for specific geographic areas
or products, earnings estimates or changes in estimates by market analysts,
speculation in the press or analyst community and general market conditions or
market conditions specific to particular industries. Further, there have been
periods of extreme volatility in the stock market that, in many cases, were
unrelated to the operating performance of, or announcements concerning, the
issuers of the affected securities. General market declines or volatility in the
future could adversely affect the price of the common stock. There can be no
assurance that the common stock will maintain its current market price.
Short-term trading strategies of certain investors can have a significant effect
on the price of specific securities. Due to sporadic trading, the Company does
not believe that an established trading market exists for its common stock.
MAINTAINING LISTING ON AMERICAN STOCK EXCHANGE. The Company began trading
on the American Stock Exchange on March 31, 1998. The American Stock Exchange
may at its discretion suspend or delist the securities of a company without
notice if, in the opinion of the exchange, certain circumstances apply,
including any one of the following: the financial condition and/or operating
results of the company appear to be unsatisfactory; it appears that the extent
of public distribution or the aggregate market value of the security has become
so reduced as to make further dealings on the exchange inadvisable; the Company
has sold or otherwise disposed of its principal operating assets, or has ceased
to be an operating company; the company has failed to comply with the listing
requirements of the exchange; or any other event has occurred or condition
exists that makes further trading on the exchange unwarranted. Because many of
these circumstances lie beyond the control of the Company, and because the
American Stock Exchange may determine at its discretion whether cause for
suspension or delisting exists, there is a risk that the Company may no longer
be able to list its shares for trading on the American Stock Exchange or any
other stock exchange or market system. In that event, the price of the common
stock would be materially, adversely affected and the ability of investors to
sell their shares of the common stock could be seriously impaired.
ANTITAKEOVER EFFECTS OF CERTAIN CHARTER PROVISIONS AND DELAWARE LAW.
Certain provisions of the Company's Certificate of Incorporation and of Delaware
law could discourage potential acquisition proposals and could delay or prevent
a change in control of the Company. Such provisions could diminish the
opportunities for stockholders to participate in tender offers, including tender
offers at a price above the then current market value of the Company's Common
Stock. See "Description of Capital Stock -- Section 203 of the Delaware General
Corporation Law." Such provisions may also inhibit fluctuations in the market
price of Company Common Stock that could result from takeover attempts. In
addition, while the Company currently has no plans to issue any preferred stock,
the Company's Certificate of Incorporation, as amended, authorizes the Board of
Directors to issue up to 666,667 shares of Preferred Stock without further
stockholder approval. Issuance of preferred stock could have the effect of
delaying, deterring or preventing a change in control of the Company. The
issuance of additional series of preferred stock could also adversely affect the
voting power of the holders of Common Stock, including the loss of voting
control to others. The Board of Directors also has the authority to fix and
determine the relative rights and preferences of preferred shares, as well as
the authority to issue such shares, without further stockholder approval. As a
result, the Board of Directors could authorize the issuance of a series of
Preferred Stock which would grant to holders preferred rights to the assets of
the Company upon liquidation, the right to receive dividends before dividends
would be declared to holders of Common Stock, and the right to the redemption of
such shares, together with a premium, prior to the redemption of the Common
Stock, or such other preferred provisions as the Board of Directors may in its
sole discretion deem appropriate. Holders of Common Stock have no redemption
rights or other preferences.
GOVERNMENTAL REGULATION. The Company's operations must meet federal,
state and local regulatory standards in the areas of safety, health and
environmental pollution and waste control. If the Company fails to comply with
these regulations, the Company
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could be subject to liability ranging from monetary fines and charges to
injunctive actions, any of which would adversely affect the Company. Future
changes in these regulations could also have a material adverse effect on the
Company.
ABSENCE OF DIVIDENDS. The Company has not paid cash dividends on its
Common Stock and does not anticipate that it will do so in the foreseeable
future. Furthermore, dividends are subject to limitations and restrictions under
the terms of the Company's indebtedness to various institutional lenders,
including a prohibition on the payment of dividends without the prior written
consent of the lenders.
ITEM 2. PROPERTIES
The Company maintains its administrative offices and manufacturing plant
in a leased 250,000 sq. ft. facility at 200 North Berry Street, Brea,
California. The lease has a remaining term of 10 years with four five-year
options and grants the Company certain options to purchase the facility. The
Company also leases approximately 275,000 sq. ft. for warehouse and distribution
facilities. The Company leases all its retail showrooms with rents either fixed
or with fixed minimums coupled with contingent rents based on the Consumer Price
Index or a percentage of sales. The Company's 90 showrooms occupy approximately
1,000,000 sq. ft. of selling space.
ITEM 3. LEGAL PROCEEDINGS
On May 27, 1994, the Company was served with a complaint in the case
captioned Miriam Brown v. Mr. Coffee, inc. et al. (Civil Action No. 13531), in
the Delaware Court of Chancery, New Castle County. The complaint names the
Company, Mr. Coffee and certain individuals including Jean R. Perrette and
Kenneth W. Keegan, both former directors and officers of the Company, as
defendants in a purported class action lawsuit. The complaint alleges that the
individuals named as co-defendants breached their fiduciary duties as directors
of Mr. Coffee by, among other things, their alleged efforts to entrench
themselves in office and prevent Mr. Coffee's public shareholders from
maximizing the value of their holdings, engaging in plans and schemes unlawfully
to thwart offers and proposals from third parties, and approving or causing the
Company and others to agree to vote in favor of a merger with Health o meter
Products, Inc. The Company is alleged to have participated in and advanced the
alleged breaches. The plaintiff originally sought to enjoin the merger; however,
plaintiff withdrew such action and the merger was completed in August 1994. The
Company and the Mr. Coffee directors filed motions to dismiss the complaint on
August 11, 1994. On October 9, 1996, the plaintiff filed a second amended
complaint. All defendants subsequently joined in filing a motion to dismiss the
complaint. The Court has taken the motion under advisement. The plaintiff seeks
compensatory damages and costs and disbursements in connection with the action,
including attorneys' and experts' fees, and such other further relief as the
court deems just and proper.
For a number of reasons, including the extensive solicitation and
negotiation process which preceded the acceptance by Mr. Coffee's Board of
Directors of the Health o meter offer, the Company believes that the plaintiff's
allegations are without merit. Management believes that any liability in the
event of final adverse determination of any of this matter would not be material
to the Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
On March 31, 1998, the Company's common stock began trading on the
American Stock Exchange under the ticker symbol KFI. Prior to that date the
Company's common stock traded on the Nasdaq SmallCap Market under the ticker
symbol SOFA. The following table sets forth the high and low per share prices
for the Company's Common Stock for each quarter during the 1998 and 1997 fiscal
years.
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1998 1997
------------- ------------
Quarter High Low High Low
----- ----- ----- -----
First ................ $4.44 $2.43 $2.06 $1.25
Second ............... 4.12 1.50 1.81 1.48
Third ................ 1.75 0.69 4.19 1.50
Fourth ............... 1.94 0.94 3.25 2.13
As of April 5, 1999, there were approximately 337 holders of record of
the Company's common stock. The Company has paid no dividends to date and does
not expect to do so in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
The following data as of and for the years ended January 31, 1999 and February
1, 1998 has been derived from consolidated financial statements appearing
elsewhere herein that have been audited by Arthur Andersen LLP, independent
public accountants. The following data for the year ended February 2, 1997 has
been derived from consolidated financial statements appearing elsewhere herein
that have been audited by Ernst & Young LLP, independent auditors. The following
data as of February 2, 1997, January 28, 1996 and January 29, 1995 and for the
years ended January 28, 1996 and December 31, 1994 and for the month ended
January 29, 1995 has been derived from audited consolidated financial statements
not included herein. The following data for the month ended January 30, 1994 is
unaudited. The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in this
Annual Report on Form 10-K.
Fiscal Year Ended Month Ended
-------------------------------------------------------------- ------------------------
January 31, February 1, February 2, January 28, December 31, January 29, January 30,
1999(4) 1998(4) 1997(4) 1996(4) 1994 1995(4)(5) 1994 (5)
---------- --------- --------- --------- --------- ---------- ----------
(in thousands except per share data)
RESULTS OF OPERATIONS:
Net sales $ 130,447 $ 115,201 $ 112,737 $ 122,319 $ 116,471 $ 7,179 $ 7,326
Gross profit 69,460 59,048 56,247 62,467 62,949 3,532 3,807
Loss from operations (2,112) (5,594) (12,447) (9,388) (2,398) (3,231) (2,041)
Gain from sale of Mr. Coffee
stock(2) -- -- -- -- 12,115 -- --
Income (loss) before
extraordinary items (5,134) (7,480) (13,389) (8,715) 5,831 (3,221) (2,185)
Extraordinary items(3) -- -- -- -- (436) -- --
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) $ (5,134) $ (7,480) $ (13,389) $ (8,715) $ 5,395 $ (3,221) $ (2,185)
========= ========= ========= ========= ========= ========= =========
Income (loss) per share(1):
Income (loss) before
extraordinary items $ (0.24) $ (0.39) $ (1.28) $ (2.21) $ 1.08 $ (0.87) $ (0.63)
Extraordinary items -- -- -- -- (0.08) -- --
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) $ (0.24) $ (0.39) $ (1.28) $ (2.21) $ 1.00 $ (0.87) $ (0.63)
========= ========= ========= ========= ========= ========= =========
Number of shares used in
computing income (loss)
per share(1) 21,490 19,021 10,445 3,950 5,394 3,685 3,490
========= ========= ========= ========= ========= ========= =========
January 31, February 1, February 2, January 28, January 29,
1999(4) 1998(4) 1997(4) 1996(4) 1995
---------- --------- --------- --------- ---------
(in thousands)
BALANCE SHEET DATA:
Total assets $ 52,506 $ 45,312 $ 43,087 $ 46,866 $ 53,750
Inventories 20,413 16,013 14,013 14,627 18,016
Working capital (deficiency) 2,858 (922) (2,182) (6,878) (3,751)
Intangible assets 14,261 15,557 16,890 18,236 19,910
Short-term debt 542 22 41 19 17
Long-term debt 17,990 13,731 6,306 5,584 2,181
Stockholders' equity 12,229 9,892 15,543 13,985 22,700
(1) Per share amounts are calculated in accordance with SFAS No. 128 and
represent diluted per share amounts. See Note 1 to the Consolidated
Financial Statements.
(2) In August 1994 the Company sold its ownership of 1,500,548 shares of Mr.
Coffee common stock for cash of $23.3 million. Proceeds from this sale were
used to retire debt of $18.3 million and pay income taxes of $2.1 million
with the remainder used for working capital.
(3) Represents loss from early debt retirement.
(4) In April 1995 the Company changed from a calendar year-end to a fiscal year
ending on the last Sunday in January, as determined by the 52/53 week
retail fiscal year. In connection with the change in fiscal periods, the
Company reported a net loss of $3,221,000 for the month ended January 29,
1995. The fiscal year ended February 2, 1997 is a 53-week period while the
fiscal years ended January 31, 1999, February 1, 1998 and January 28, 1996
are 52-week periods.
(5) Average weekly sales (shipments) in January are lower than other months due
to seasonally low order rates in the last three weeks of December.
Therefore, the operating loss reported in January is higher than other
months in the fiscal years presented.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere herein.
The Company has reported losses from operations in each of the past five
years due to inefficiencies within its operations. As a result of such losses,
the Company had an accumulated deficit of $46,964,000 at January 31, 1999.
The Company's management, which underwent a substantial restructuring
after the 1996 financings discussed under "Liquidity and Capital Resources," has
developed a strategic plan for the business which provides, among other things,
for remodeling showrooms to provide a more appealing setting for customers,
adding new showrooms, increasing product prices to competitive levels, reducing
promotional discounting, reconfiguring selling commissions, remerchandising,
refocusing advertising, improving the manufacturing processes and reducing
expenses through budgetary controls. These plans have been implemented since the
latter part of fiscal 1996, are believed to have contributed significantly to
reducing losses and are expected to ultimately return the Company to
profitability; however, there can be no assurance that the Company will achieve
profitability.
Management believes that the Company has sufficient sources of financing
to continue operations throughout fiscal 1999. However, the Company's long-term
success is dependent upon management's ability to successfully execute its
strategic plan and, ultimately, to achieve sustained profitable operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal cash needs are for funding capital expenditures
to open new showrooms and remodel existing showrooms; manufacturing samples of
upholstered furniture for display in its new and existing showrooms as well as
to purchase merchandise from other manufacturers that complement the upholstered
furniture manufactured and displayed by the Company; and for funding capital
expenditures related to the improvement and maintenance of its management
information systems. The cash required for funding production and fulfillment of
customer orders is typically provided by the Company's customers from a deposit
made at the time an order is placed. Beginning in fiscal 2000, the Company will
also require cash to make the scheduled principal payments on its subordinated
notes.
In recent periods, the Company has incurred additional debt and raised
equity capital to cover operating deficits and to finance the remodeling and
expansion of its showrooms. In fiscal 1999, management plans to remodel and
upgrade existing showrooms, as well as add 20 to 25 additional showrooms, at an
aggregate cost of approximately $6.7 million. Management expects to fund such
capital expenditures by internally generated cash and by borrowings under the
Company's revolving credit facility. As of March 15, 1999, the Company has
executed leases for 10 new stores, three of which will replace existing stores
upon expiration of leases. The Company is not contractually committed to make
the remainder of these capital expenditures and could slow its expansion and
remodeling program if the Company experiences any liquidity shortages.
In May 1996, the Company raised approximately $3 million through the
issuance of convertible notes to certain related party investors. In August and
September 1996, GECC and certain other investors led by Mr. Philip M. Hawley,
the Company's current Chairman and Chief Executive Officer, invested $15.7
million in the Company. In connection with this financing, the Company (i)
issued approximately $13.7 million of common stock, of which $5 million was
purchased by GECC and approximately $3 million was issued to the holders of
convertible notes in cancellation thereof; and (ii) issued to GECC a 10%
promissory note in the principal amount of $5 million, together with a warrant
to purchase 1.4 million shares at $.001 per share. Also in connection with this
financing, the holders of shares of the Company's pre-existing preferred stock
agreed to convert their shares into approximately 1.2 million shares of common
stock.
On August 14, 1997, the Company completed transactions with two
investors in which it issued $3 million of subordinated notes with (i) warrants
to purchase an aggregate of 740,000 shares of common stock at $1.25 per share
and (ii) warrants to purchase an aggregate amount of up to 1,000,000 shares of
common stock at $0.01 per share which warrants may be completely or partially
cancelled depending on the economic performance of the Company in fiscal 1999.
Also, the Company arranged a standby credit facility of $3.5 million which the
Company drew down on December 30, 1997. At the time the standby credit facility
was drawn down, the Company issued to the investors warrants to purchase 560,000
additional shares of common stock at $1.25 per share.
In April 1998, the Company issued approximately 2,963,000 additional
shares of common stock in a public secondary offering. Net proceeds to the
Company were approximately $7.3 million.
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In March 1999, the Company's existing revolving line of credit with
Congress Financial Corporation (Western) was amended (the "Revolving Credit
Facility") to increase the maximum commitment available from $10 million to $15
million, subject to borrowing base limitations, and to extend the maturity date
to March 31, 2002. The Revolving Credit Facility accrues interest at a rate of
prime plus a margin ranging from .5% to 1% based upon the Company's EBITDA
performance and is secured by substantially all of the Company's assets. As of
January 31, 1999, the Company had unused borrowing capacity of approximately $3
million under the original terms of its Revolving Credit Facility.
Under the terms of the agreements related to the Company's subordinated
notes, as well as under the terms of the Revolving Credit Facility, the Company
is required to maintain certain financial covenants and is prohibited from
incurring additional indebtedness from third parties in an amount in excess of
$5.0 million.
The Company believes that borrowings under its Revolving Credit Facility
and internally generated funds will be sufficient to fund its requirements for
working capital and capital expenditures through the end of fiscal year 1999.
However, the Company may need to raise additional funds to finance its
remodeling and expansion program through either debt or equity financing, and
there can be no assurance that the Company's financial performance will generate
sufficient funds. The Company currently contemplates that other sources of
capital would be available, although this situation could change.
The aggregate annual maturities of long-term debt during each of the
five fiscal years subsequent to January 31, 1999 are approximately as follows:
$542,000 in 1999, $3,268,000 in 2000, $4,330,000 in 2001, $12,005,000 in 2002,
and $13,000 in 2003. Management anticipates such payments will be made out of
operating cash flow, draws under the Revolving Credit Facility or through
refinancing.
As of January 31, 1999, the Company had cash and cash equivalents of
$80,000. Cash flow activity for the fiscal years ended January 31, 1999,
February 1, 1998 and February 2, 1997 is presented in the Consolidated
Statements of Cash Flows.
1998 Cash Flow During fiscal 1998, cash and cash equivalents decreased
by $836,000. Operating activities used net cash of $5,575,000, principally from
a cash loss from operations of $849,000 and increases in inventory and prepaid
expenses and other assets of $4,400,000 and $359,000, respectively. The increase
in inventory is principally due to the Company's expansion and remodeling
program. Investing activities during the period included capital expenditures of
$5,727,000, nearly all of which was used to remodel 22 retail showrooms and open
eight new showrooms. Financing activities during the period consisted
principally of net proceeds of $7,267,000 from the sale of 2,963,889 shares of
common stock and net borrowings of $3,180,000 under the Company's revolving
credit facility. Management plans to continue its program of remodeling and
upgrading showrooms as well as adding new showrooms; the Company expects to
incur costs of approximately $6.7 million related to this program in fiscal
1999.
1997 Cash Flow During fiscal 1997, cash and cash equivalents decreased
by $311,000. Operating activities used net cash of $4,998,000, principally from
a cash loss from operations of $3,806,000 and an increase in inventory of
$2,000,000 which was partially offset by an increase in accounts payable and
other liabilities of $753,000. The increase in inventory is principally due to
the Company's decision to expand its accessories business. Investing activities
during the period included capital expenditures of $3,521,000, nearly all of
which was used to remodel 16 retail showrooms and open one new showroom.
Financing activities during the period consisted principally of $6,500,000
borrowed from GECC and JOL and net borrowings of $1,813,000 under the Company's
revolving credit facility.
1996 Cash Flow. During fiscal 1996, cash and cash equivalents decreased
by $109,000. Operating activities used net cash of $14,315,000, principally from
a cash loss from operations of $10,210,000 and decreases in accounts payable and
other liabilities of $6,081,000, offset principally by a decrease in inventories
of $614,000 and collections of income tax refund receivables of $1,467,000.
Investing activities during the year included capital expenditures of $806,000,
principally for additions to leasehold improvements at certain retail showrooms.
Financing activities during fiscal 1996 were comprised principally of proceeds
from issuances of common stock of $10,669,000 less expenses of $448,000,
proceeds of $2,950,000 from issuances of convertible and demand notes
(subsequently converted into common stock, together with interest of $116,000)
and the issuance of a subordinated note of $5,000,000, offset by net payments of
$3,516,000 under the Company's revolving credit facility.
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16
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain items
from the Company's Consolidated Statement of Operations as a percentage of net
sales.
Fiscal Year Ended
----------------------------------------
January 31, February 1, February 2,
1999 1998 1997
----------- ----------- -----------
Net sales 100.0% 100.0% 100.0%
Cost of sales 46.8 48.7 50.1
----------- ----------- -----------
Gross profit 53.2 51.3 49.9
----------- ----------- -----------
Operating expenses:
Selling 46.9 47.3 51.1
General and administrative 7.2 7.9 9.0
Amortization of goodwill 0.8 0.9 0.9
----------- ----------- -----------
54.9 56.1 61.0
----------- ----------- -----------
Loss from operations (1.7) (4.8) (11.1)
Interest expense (2.0) (1.5) (1.1)
Other income (expense) (0.3) (0.1) 0.3
----------- ----------- -----------
Net loss (4.0)% (6.4)% (11.9)%
----------- ----------- -----------
Fiscal Year Ended(3)
----------------------------------------
January 31, February 1, February 2,
1999 1998 1997
----------- ----------- -----------
STORE (SHOWROOM) DATA
Stores open at beginning of period 81 82 83
Stores opened during period 8 1 1
Stores closed during period 1 2 2
----------- ----------- -----------
Stores open at end of period 88 81 82
Average sales per showroom(1) (in 000's) $ 1,548 $ 1,422 $ 1,361
Comparable store sales increase (decrease)(2) 9.8% 2.7% (6.0%)
(1) Based upon the weighted average number of stores open during the period
indicated.
(2) Comparable store sales are calculated by excluding the net sales of any
store for any month of the period if the store was not open during the same
month of the prior period. Also, a store opened at any time during the
month is deemed to have been open for the entire month.
(3) Fiscal 1998 and 1997 were 52 week years while fiscal 1996 was a 53 week
year.
52 WEEKS ENDED JANUARY 31, 1999 (FISCAL 1998) AS COMPARED TO 52 WEEKS
ENDED FEBRUARY 1, 1998 (FISCAL 1997)
Net Sales. Net sales for fiscal 1998 were $130,447,000 compared with
$115,201,000 for fiscal 1997. Sales increased $15,246,000 or 13.2% with same
store sales increasing 9.8%. The increase in sales was due to management's
strategy of continuing remodeling existing showrooms to provide a more appealing
setting for customers (22 showrooms were remodeled in fiscal 1998, compared to
16 in fiscal 1997); opening new showrooms in existing markets (eight new
showrooms were opened in fiscal 1998, compared to one in fiscal 1997); to
management's strategies of developing new products, increasing the promotion and
sale of accessories, and revamping the marketing and sales promotion program;
and to improved economies in regions where the Company operates.
Gross Profit. Gross profit was 53.2% of net sales in fiscal 1998
compared with 51.3% of net sales in fiscal 1997. The increase in gross profit as
a percentage of net sales resulted primarily from continuing improvements in the
manufacturing operations, less promotional discounting at the retail level and
negotiated reductions in raw material prices.
Selling Expenses. Selling expenses were $61,122,000 or 46.9% of net
sales in fiscal 1998 and were $54,481,000 or 47.3% of net sales in fiscal 1997.
The increase of $6,641,000 in selling expenses was primarily due to a
combination of higher sales volume and the opening of eight new showrooms in
fiscal 1998.
16
17
General and Administrative Expenses. General and administrative
expenses for fiscal 1998 were $9,430,000 or 7.2% of net sales compared to
$9,141,000 or 7.9% of net sales, for fiscal 1997. The increase of $289,000 was
primarily the result of higher management payroll costs. The decrease as a
percentage of net sales was the result of leveraging higher sales volume.
Interest Expense. Interest expense, including amortization of deferred
financing costs, for fiscal 1998 increased by $861,000 over fiscal 1997 due
primarily to higher average debt outstanding, partially offset by lower interest
rates on the Company's outstanding debt.
Income Taxes. The Company paid no income taxes and no income tax benefit
was recorded for either of fiscal 1998 or 1997 due to uncertainties regarding
the realization of deferred tax assets available.
As of January 31, 1999, the Company had federal net operating loss
carryforwards of approximately $40 million which begin to expire in 2003, if not
utilized. As a result of various equity transactions, one of the Company's
subsidiaries experienced a change of ownership in 1993, as defined in the
Internal Revenue Code. As a result of this ownership change and other provisions
of the Internal Revenue Code, utilization of approximately $10 million of these
net operating loss carryforwards is limited to the future income of one of the
Company's subsidiaries and is further limited to approximately $1 million per
year on a cumulative basis. As of January 31, 1999, approximately $5 million of
the limited losses were available. In addition, the Company had state net
operating loss carryforwards of approximately $30 million which begin to expire
in fiscal 1999, if not utilized.
Net Loss. As a result of the above factors, the net loss was $5,134,000
for fiscal 1998, compared to a net loss of $7,480,000 for fiscal 1997. Net loss
per share in the 1998 period was $0.24 based on 21,490,000 shares outstanding.
In fiscal 1997 the net loss per share was $0.39 based on 19,021,000 weighted
average shares outstanding.
52 WEEKS ENDED FEBRUARY 1, 1998 (FISCAL 1997) AS COMPARED TO 53 WEEKS
ENDED FEBRUARY 2, 1997 (FISCAL 1996)
Net Sales. Net sales for fiscal 1997, a 52-week fiscal period, were
$115,201,000 compared with $112,737,000 for fiscal 1996, a 53 week period. Sales
for the 53rd week of fiscal 1996 totaled $3,417,000; on a comparable 52-week
basis, sales increased $5,881,000 or 5.4% with same store sales increasing 5.9%.
The increase in sales was due principally to management's strategy of remodeling
existing showrooms to provide a more appealing setting for customers (16
showrooms were remodeled in fiscal 1997); to management's strategies of
developing new products, increasing the promotion and sale of accessories, and
revamping the marketing and sales promotion program; and to improved economies
in selected regions where the Company operates.
Gross Profit. Gross profit was 51.3% of net sales in fiscal 1997
compared with 49.9% of net sales in fiscal 1996. The increase in gross profit
resulted primarily from the Company's decision in the third quarter of fiscal
1996 to raise prices to competitive levels and reduce promotional discounting.
Selling Expenses. Selling expenses were $54,481,000 or 47.3% of net
sales in fiscal 1997 and were $57,573,000 or 51.1% of net sales in fiscal 1996.
The decrease of $3,092,000 in selling expenses was primarily due to a decrease
of $1,737,000 in variable selling payroll, resulting from a new commission
structure, and decreases of $1,044,000 and $554,000 in store non-payroll
expenses and delivery expenses, respectively, resulting primarily from tighter
cost controls, offset in part by increased advertising costs of $574,000.
General and Administrative Expenses. General and administrative expenses
for fiscal 1997 were $9,141,000 or 7.9% of net sales compared to $10,101,000 or
9.0% of net sales, for fiscal 1996, a decrease of $960,000. This decrease was
primarily the result of lower costs generally and specifically lower
professional fees, contract labor costs and computer rental and maintenance
costs which were offset in part by higher management payroll costs.
Interest Expense. Interest expense for fiscal 1997 increased by $493,000
over fiscal 1996 due to higher average debt outstanding.
Income Taxes. The Company paid no income taxes and no income tax benefit
was recorded for either of fiscal 1997 or 1996 due to uncertainties regarding
the realization of deferred tax assets available.
Net Loss. As a result of the above factors, the net loss was $7,480,000
for fiscal 1997 as compared to a net loss of $13,389,000 for fiscal 1996. Net
loss per share in the 1997 period was $0.39 based on 19,021,000 shares
outstanding. In fiscal 1996, the net loss per share was $1.28 based on
10,445,000 weighted average shares outstanding.
17
18
YEAR 2000 READINESS DISCLOSURE
In the past, computer engineers designed most computer programs and
embedded computer chips to use only two digits to specify a particular year. For
example, the digits "99" were used to specify the Year "1999." However,
computers that use only two digits cannot properly recognize the Year 2000 or
any following years. For example, after the Year 2000, the digits "01" could
mean either the Year "2001" or the Year "1901." This problem can cause computers
and other electronic devices to give erroneous results or to shut down.
Therefore, as dates employing the Year 2000 and following years come into use,
computer programs will need to use four digits to distinguish between the
different years of the 20th and the 21st century. Because of this Year 2000
problem, the Company and many other enterprises are vulnerable to unforeseen or
unanticipated problems with their computer systems and equipment containing
embedded computer chips, as well as from problems in the computer systems of
other parties on which their businesses rely.
The Company has a Year 2000 program in place to minimize any possible
effect on its business resulting from the Year 2000 problem. The Company has
evaluated its information technology ("IT") systems and believes it has
identified those that were not Year 2000 compliant. The Company upgraded its
payroll system to be Year 2000 compliant in the third quarter of fiscal 1998 and
its other mission critical business systems (manufacturing, procurement, order
processing and accounting) in the fourth quarter of fiscal 1998. The Company has
completed testing, implementation, and has conducted an end-to-end Year 2000
simulation test to validate compliance for its key business processes. The
Company has also assessed its desktops, communications systems and other
IT-related equipment. Remaining upgrades will be completed within the first
quarter of 1999.
The Company expects to bring its' IT systems into compliance without
incurring material costs. To date it has completed the remediation of business
systems by redirecting its existing internal programming resources, with costs
expensed as incurred. The Company expects total costs to be less than $10,000.
With regard to non-IT systems, the Company is continuing to assess its
facilities equipment, including but not limited to bank card terminals, alarm
systems and fax machines. These are being reviewed for Year 2000 compliance.
Disruption of these services would have a negligible impact on Company
operations and remediation costs are expected to be less than $5,000. The
Company plans to achieve readiness in this area by the second quarter of 1999.
Depending on whether suppliers and other entities with which the Company
does business are able to successfully address the Year 2000 issue, the
Company's results of operations could be materially adversely affected in any
given future reporting period during which such a Year 2000 event occurs. As a
result, the Company is communicating with such entities to determine their state
of readiness. The Company is also developing contingency plans to allow primary
operations of the Company to continue if the Company's significant systems or
such entities are disrupted by the Year 2000 problem. The Company expects that
its contingency plans will be developed by the end of the second quarter of
1999, and that it will be prepared in the event of systems failures to continue
to do business, although such operations may be at a higher cost.
At worst, if the Company's IT systems failed, the Company could use
manual systems to process furniture orders and manage its manufacturing
processes, but with a significant sacrifice in speed and efficiency. If the IT
systems of the Company's suppliers failed, the Company could experience
significant delays in delivery of materials that would, in turn, delay
production and customer deliveries.
These estimates and conclusions contain forward-looking statements that
are subject to risks and uncertainties that could cause actual results to differ
materially. New developments may occur that could affect the Company's
estimates, such as the amount of planning and modification needed to achieve
full resolution of the Year 2000 problem; the availability and cost of
resources; the Company's ability to discover and correct all Year 2000 sensitive
computer code and equipment; and the ability of suppliers and other entities to
bring their systems into compliance.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted the Financial Accounting Standards Board Statement
of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income" in fiscal 1998. This statement requires that all items that meet the
definition of components of comprehensive income be reported in a financial
statement for the period in which they are recognized. Components of
comprehensive income include revenues, expenses, gains and losses that under
generally accepted accounting principles are included in comprehensive income
but excluded from net income. There are no differences between the Company's net
loss, as reported, and comprehensive loss as defined, for the periods presented
as of January 31, 1999.
18
19
The Company has also adopted SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" in fiscal 1998. The Company believes
it operates in only one business segment.
During the first quarter of fiscal 1998, the American Institute of
Certified Public Accountants issued Statement of Position (SOP) No. 98-5
"Pre-Opening Costs." This Statement provides guidance on the financial reporting
of start-up costs and organization costs. The Company adopted this SOP in fiscal
1998 and it did not materially impact the Company's Consolidated Financial
Statements.
Emerging Issues Task Force (EITF) No. 98-9 "Accounting for Contingent
Rent in Interim Financial Periods" requires lessee's to recognize contingent
rental expense in interim periods if the achievement of future targets that
trigger such contingency is considered to be probable. The Company's method of
accounting for contingent rent is consistent with the requirements of EITF No.
98-9.
MARKET RISK EXPOSURE
The Company is exposed to market risks related to fluctuations in
interest rates on its variable rate debt which consists of revolving credit
notes issued to a financial institution. The Company does not use interest rate
swaps, futures contracts or options on futures, or other types of derivative
financial instruments.
Historically, the Company has used debt financing for funding its
capital investments in new and remodeled showrooms and for funding cash used in
operations. The Company's debt consists primarily of fixed rate subordinated
debt with attached warrants, variable rate revolving credit notes and other
fixed rate notes payable.
For fixed rate debt, changes in interest rates generally affect the fair
market value, but not earnings or cash flows. Conversely, for variable rate
debt, changes in interest rates generally do not influence fair market value,
but do affect future earnings and cash flows. The Company has managed its
exposure to changes in interest rates by issuing part of its debt with fixed
interest rates and part with variable interest rates. Holding the variable rate
debt balance constant, each one percentage point increase in interest rates
occurring on the first day of the year would result in an increase in interest
expense for the coming year of approximately $70,000.
The table below details the principal amount and the average nominal
interest rates for the debt in each category based on the final maturity dates
and applicable amortization schedules for the fixed rate debt. The fair market
value estimates for debt securities are based on discounting future cash flows
using current rates the Company believes would be available to it if it were to
enter the market for debt of the same type and remaining maturity. The
subordinated debt was issued with common stock warrants. The fair value of the
subordinated debt has been determined inclusive of the warrants and using an
interest rate that the Company believes would be available to it for a similar
debt instrument issued with warrants having similar terms.
1999 2000 2001 2002 2003 Thereafter Total Fair Value
------ ------ ------ ------ ------ ---------- ------ ----------
Fixed Rate Subordinated Notes -- $3,000 $4,000 $5,001 -- -- $12,001 $12,001
Average interest rate -- 9.50% 9.50% 9.50% -- -- -- --
Variable Rate Notes -- -- -- $6,992 -- -- $6,992 $ 6,992
Average interest rate -- -- -- 8.75% -- -- -- --
Fixed Rate Other Notes Payable $ 542 $ 268 $ 330 $ 12 $ 13 $ 79 $1,244 $ 1,244
Average interest rate 9.90% 9.90% 10.0% 9.0% 9.0% 9.0% -- --
The Company does not believe that the future market rate risks related
to the above securities will have a material impact on the Company or the
results of its future operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL
19
20
DISCLOSURE
As previously disclosed, the Board of Directors of the Company, upon the
recommendation of the Audit Committee of the Board on September 19, 1997,
terminated the Company's relationship with Ernst & Young LLP and engaged Arthur
Andersen LLP as its new independent accountants to audit the Company's
consolidated financial statements. The reports of Ernst & Young LLP on the
Company's consolidated financial statements for the year ended February 2, 1997
did not contain an adverse opinion or a disclaimer of opinion nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.
During this period and thereafter there were no disagreements between the
Company and Ernst & Young LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Ernst & Young LLP, would
have caused it to make reference to the subject matter of the disagreements in
connection with its report. The Company authorized Ernst & Young LLP to respond
fully to inquiries from Arthur Andersen LLP concerning all matters relating to
prior audits conducted by Ernst & Young LLP.
The Company interviewed Arthur Andersen LLP before making its decision.
During this interview Company representatives sought information concerning the
potential auditor's familiarity with accounting matters affecting the furniture
manufacturing and furniture retail industries and the Company. No specific
advice was sought. The Company did not perceive that there were any differences
with regard to substantive accounting issues between Arthur Andersen LLP and the
Company's prior auditors.
The Company has supplied a copy of this disclosure to both Ernst & Young
LLP and Arthur Andersen LLP and neither has indicated to the Company that it
objects or disagrees with this disclosure.
PART III
The information required by Items 10 through 13 of this Part is
incorporated by reference to the Company's Proxy Statement, under the captions
"Election of Directors", "Security Ownership of Certain Beneficial Owners and
Management", "Compensation of Executive Officers" and "Certain Relationships and
Related Transactions", which Proxy Statement will be mailed to stockholders in
connection with the Company's annual meeting of stockholders which is scheduled
to be held in May, 1999.
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21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page No.
--------
Report of Arthur Andersen LLP, Independent Public Accountants 25
Report of Ernst & Young LLP, Independent Auditors 26
Consolidated Balance Sheet at January 31, 1999 and February 1, 1998 27
Consolidated Statement of Operations for the years ended January 31, 1999,
February 1, 1998 and February 2, 1997 28
Consolidated Statement of Stockholders' Equity for the years ended
January 31, 1999 February 1, 1998, and February 2, 1997 29
Consolidated Statement of Cash Flows for the years ended
January 31, 1999, February 1, 1998 and February 2, 1997 30
Notes to Consolidated Financial Statements 31
Schedule II- Valuation and Qualifying Accounts 43
Schedules I, III, IV, and V have been omitted since they are not applicable.
21
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(a)(3) EXHIBITS
3.1 Certificate of Incorporation.(1)
3.1(a) Certificate of Amendment of Certificate of Incorporation dated
November 28, 1994. (5)
3.1(b) Certificate of Amendment of Certificate of Incorporation dated
August 1, 1995.(6)
3.1(c) Certificate of Amendment of Certificate of Incorporation dated June
7,1996.(7)
3.1(d) Certificate of Amendment of Certificate of Incorporation dated
August 1, 1996.(7)
3.2 By Laws.
4.1 Loan and Security Agreement dated January 20, 1995 by and between
Congress Financial Corporation (Western) and Krause's Sofa Factory
and Castro Convertible Corporation. (3)
4.1(a) First Amendment to Loan and Security Agreement dated as of May 10,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(6)
4.1(b) Second Amendment to Loan and Security Agreement dated as of August
26, 1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
4.1(c) Third Amendment to Loan and Security Agreement dated as of November
25, 1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
4.1(d) Amended and Restated Subordination Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Furniture, Inc.(14)
4.1(e) Fourth Amendment to Loan and Security Agreement dated as of August
14, 1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(12)
4.1(f) Fifth Amendment to Loan and Security Agreement dated as of December
11, 1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation. (15)
4.1(g) Sixth Amendment to Loan and Security Agreement dated as of March 15,
1999 by and between Congress Financial Corporation (Western) and
Krause's Custom Crafted Furniture Corp. and Castro Convertible
Corporation.
4.1(h) Letter agreement between Krause's Furniture, Inc. and Congress
Financial Corporation (Western).(12)
4.2 Guarantee dated January 20, 1995 by Krause's Furniture, Inc. to
Congress Financial Corporation (Western). (3)
4.5 Certificate of Designations of Preferred Stock. (4)
10.1 1994 Directors Stock Option Plan.
10.2 1990 Employees Stock Option Plan.
10.3 Form of Securities Purchase Agreement between the Company, GECC and
certain other stockholders of the Company dated as if August 26,
1996.(8)
10.4 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due August 31,
2001.(8)
10.5 Form of Warrant to Purchase 1,400,000 Shares of Common Stock.(8)
10.6 Form of Securities Purchase Agreement between the Company and
Certain Stockholders dated as of August 26, 1996.(8)
10.7 Form of Stockholders Agreement among the Company, GECC and certain
other stockholders of the Company dated as of August 26, 1996.(8)
10.8 Form of Registration Rights Agreement among the Company and GECC and
certain other stockholders of the Company dated as of August 26,
1996.(8)
10.9 Employment agreement with Philip M. Hawley.(8)
10.10 1997 Stock Incentive Plan. (9)
10.11 Supplemental Securities Purchase Agreement among Krause's Furniture,
Inc., General Electric Corporation and Japan Omnibus Ltd., dated as
of August 14, 1997. (12)
10.12 Letter agreement dated August 14, 1997 regarding Permal Group
shares.(12)
10.13 Letter agreement dated August 14, 1997 regarding warrant dilution
provisions.(12)
10.14 Amendment to the Supplemental Securities Purchase Agreement among
Krause's Furniture, Inc., General Electric Corporation and Japan
Omnibus Ltd., dated as of March 31, 1999.
11 Statement regarding computation of per share earnings.
22
23
21 Subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
23.2 Consent of Ernst & Young LLP, Independent Auditors
27 Financial Data Schedule
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4
dated June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form 10-K
for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K dated
as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form 10-K
dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1
dated March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibits to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
(14) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(15) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated April 30, 1998 (File No. 0-17868).
(b) REPORTS ON FORM 8-K
The Registrant did not file any reports on Form 8-K during the last quarter
of the period covered by this report.
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24
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.
KRAUSE'S FURNITURE, INC.
Date: April 23, 1999 By: /s/ PHILIP M. HAWLEY
--------------------------------------------------
Philip M. Hawley
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following person on behalf of the Registrant
and in the capacities and on the dates indicated.
Date: April 23 1999 /s/ PHILIP M. HAWLEY
-------------------------------------------------------------
Philip M. Hawley
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: April 23, 1999 /s/ THOMAS M. DELITTO
-------------------------------------------------------------
Thomas M. DeLitto
Director and Vice Chairman of the Board
Date: April 23, 1999 /s/ ROBERT A. BURTON
-------------------------------------------------------------
Robert A. Burton
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
Date: April 23, 1999 /s/ KAMAL G. ABDELNOUR
-------------------------------------------------------------
Kamal G. Abdelnour
Director
Date: April 23, 1999 /s/ JEFFREY H. COATS
-------------------------------------------------------------
Jeffrey H. Coats
Director
Date: April 23, 1999 /s/ PETER H. DAILEY
-------------------------------------------------------------
Peter H. Dailey
Director
Date: April 23, 1999 /s/ JOHN A. GAVIN
-------------------------------------------------------------
John A. Gavin
Director
24
25
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the accompanying consolidated balance sheets of Krause's
Furniture, Inc. and subsidiaries as of January 31, 1999 and February 1, 1998,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our 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 financial position of Krause's
Furniture, Inc. and subsidiaries as of January 31, 1999 and February 1, 1998 and
the results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 31, 1999
25
26
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the consolidated balance sheet of Krause's Furniture, Inc.
as of February 2, 1997 (not separately presented herein), and the related
consolidated statements of operations, stockholders' equity and cash flows. for
the fiscal year ended. Our audits also included the financial statement schedule
listed in the Index at Item 14(a) as it relates to the fiscal year ended
February 2, 1997. These financial statements and schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
The Company has reported losses from operations in each of the past five
years. Management's plan for meeting obligations as they become due is
summarized in Note 2 to the consolidated financial statements.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects and the consolidated results of its
operations of Krause's Furniture, Inc. at February 2, 1997, and the consolidated
results of its operations, and its cash flows for the fiscal year then ended, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, as it relates to the fiscal year ended
February 2, 1997, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material respects
the information set forth therein.
/s/ ERNST & YOUNG LLP
Orange County, California
March 28, 1997,
except for Note 2, as to which the date is
December 17, 1997
26
27
KRAUSE'S FURNITURE, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
January 31, February 1,
1999 1998
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 80 $ 916
Accounts receivable, net of allowance of $180 ($164 at February 1, 1998)
for doubtful accounts 1,193 1,148
Inventories 20,413 16,013
Prepaid expenses 1,465 515
-------- --------
Total current assets 23,151 18,592
Property, equipment, and leasehold improvements, net 13,066 8,577
Goodwill, net 13,346 14,366
Leasehold interests, net 915 1,191
Other assets 2,028 2,586
-------- --------
$ 52,506 $ 45,312
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,750 $ 8,111
Accrued payroll and related expenses 2,502 1,993
Other accrued liabilities 3,849 3,967
Customer deposits 5,650 5,421
Notes payable 542 22
-------- --------
Total current liabilities 20,293 19,514
-------- --------
Long-term liabilities:
Notes payable 17,990 13,731
Other 1,994 2,175
-------- --------
Total long-term liabilities 19,984 15,906
-------- --------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.001 par value; 666,667 shares authorized;
no shares outstanding -- --
Common stock, $.001 par value; 35,000,000 shares authorized;
21,984,428 shares outstanding (19,020,539 at February 1, 1998) 22 19
Capital in excess of par value 59,171 51,703
Accumulated deficit (46,964) (41,830)
-------- --------
Total stockholders' equity 12,229 9,892
-------- --------
$ 52,506 $ 45,312
======== ========
See accompanying notes.
27
28
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Fiscal Years Ended
----------------------------------------
January 31, February 1, February 2,
1999 1998 1997
---------- ---------- -----------
Net sales $ 130,447 $115, 201 $ 112,737
Cost of sales 60,987 56,153 56,490
--------- --------- ---------
Gross profit 69,460 59,048 56,247
--------- --------- ---------
Operating expenses:
Selling 61,122 54,481 57,573
General and administrative 9,430 9,141 10,101
Amortization of goodwill 1,020 1,020 1,020
--------- --------- ---------
71,572 64,642 68,694
--------- --------- ---------
Loss from operations (2,112) (5,594) (12,447)
Interest expense (2,584) (1,723) (1,230)
Other income (expense) (438) (163) 288
--------- --------- ---------
Net loss $ (5,134) $ (7,480) $ (13,389)
========= ========= =========
Basic and diluted loss per share $ (0.24) $ (0.39) $ (1.28)
========= ========= =========
Number of shares used in computing loss per share 21,490 19,021 10,445
========= ========= =========
See accompanying notes.
28
29
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
Convertible Capital in
Preferred Stock Common Stock Excess of Total
-------------------- -------------------- Par Accumulated Stockholders'
Shares Amount Shares Amount Value Deficit Equity
-------- -------- -------- -------- -------- -------- --------
Balance at January 28, 1996 118 $ 7,523 4,121 $ 4 $ 27,419 $(20,961) $ 13,985
Conversion of Series A preferred
stock (118) (7,523) 1,177 1 7,522 -- --
Exchange of notes payable and
related interest for common stock -- -- 3,066 3 3,063 -- 3,066
Issuance of common stock for cash,
net of expenses of $448 -- -- 10,669 11 10,210 -- 10,221
Issuance of common stock
purchase warrant -- -- -- -- 1,400 -- 1,400
Compensation expense on
stock option grant -- -- -- -- 293 -- 293
Repurchase of common stock -- -- (12) -- (33) -- (33)
Net loss -- -- -- -- -- (13,389) (13,389)
-------- -------- -------- -------- -------- -------- --------
Balance at February 2, 1997 -- -- 19,021 19 49,874 (34,350) 15,543
Issuance of common stock
purchase warrants -- -- -- -- 1,625 -- 1,625
Compensation expense on
stock option grant -- -- -- -- 204 -- 204
Net loss -- -- -- -- -- (7,480) (7,480)
-------- -------- -------- -------- -------- -------- --------
Balance at February 1, 1998 -- -- 19,021 19 9,892 51,703 (41,830)
Issuance of common stock for cash,
net of expenses of $1,625 -- -- 2,963 3 7,264 -- 7,267
Compensation expense on
stock option grant -- -- -- -- 204 -- 204
Net loss -- -- -- -- -- (5,134) (5,134)
-------- -------- -------- -------- -------- -------- --------
Balance at January 31, 1999 -- $ -- 21,984 $ 22 $ 59,171 $(46,964) $ 12,229
======== ======== ======== ======== ======== ======== ========
See accompanying notes.
29
30
KRAUSE'S FURNITURE, INC
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
Fiscal Years Ended
---------------------------------------
January 31, February 1, February 2,
1999 1998 1997
--------- --------- ---------
Cash flows from operating activities:
Net loss $ (5,134) $ (7,480) $ (13,389)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization 3,019 2,431 2,561
Other non-cash charges 1,266 1,243 618
Change in assets and liabilities:
Accounts receivable (45) (28) (334)
Inventories (4,400) (2,000) 614
Prepaid expenses and other assets (359) 283 229
Income tax refund receivable -- -- 1,467
Accounts payable and accrued liabilities (151) 753 (4,688)
Customer deposits 229 (200) (1,393)
--------- --------- ---------
Net cash used by operating activities (5,575) (4,998) (14,315)
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures (5,727) (3,521) (806)
--------- --------- ---------
Net cash used by investing activities (5,727) (3,521) (806)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 157,316 145,458 143,002
Principal payments on long-term debt (154,117) (137,250) (138,178)
Proceeds from issuance of common stock 7,267 -- 10,221
Other -- -- (33)
--------- --------- ---------
Net cash provided by financing activities 10,466 8,208 15,012
--------- --------- ---------
Net decrease in cash (836) (311) (109)
Cash and cash equivalents at beginning of year 916 1,227 1,336
--------- --------- ---------
Cash and cash equivalents at end of year $ 80 $ 916 $ 1,227
========= ========= =========
Supplemental disclosures of cash flow information -
Cash paid during the year for:
Interest $ 1,752 $ 754 $ 466
Income taxes -- -- 9
Noncash investing and financing activities:
Capital lease obligations incurred 850 -- --
Preferred stock converted into common stock -- -- 7,523
Exchange of notes payable and related accrued
interest for common stock -- -- 3,066
Issuance of common stock purchase warrants -- 1,625 1,400
See accompanying notes.
30
31
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements include the accounts of Krause's
Furniture, Inc., (the "Company") and its wholly owned subsidiaries, including
the Company's principal subsidiary, Krause's Custom Crafted Furniture Corp.,
formerly known as Krause's Sofa Factory ("Krause's"). In April 1995, the Company
changed its fiscal year from a calendar year-end to a fiscal year ending on the
last Sunday of January as determined by the 52/53 week retail fiscal year. The
fiscal years ended January 31, 1999 (fiscal 1998) and February 1, 1998 (fiscal
1997) are 52-week periods while the fiscal year ended February 2, 1997 (fiscal
1996) is a 53-week period. All significant intercompany transactions and
balances have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts 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 periods. Actual results could differ from those estimates.
Business
Krause's manufactures made-to-order sofas, sofabeds, loveseats and
chairs, and sells these products (as well as externally-sourced products)
through its own chain of retail showrooms. As of January 31, 1999 there were 88
Company-owned showrooms, all of which are leased, located in 12 states. The
Company's manufacturing facility and 42 showrooms are located in California.
Cash and cash equivalents
Cash and cash equivalents include cash on hand, cash in money market
accounts and certificates of deposit with original maturities of less than three
months, carried at cost, which approximates fair value.
Fair values of financial instruments
Fair values of cash and cash equivalents approximate cost due to the
short period of time to maturity. The fair values of the secured revolving
credit note, the subordinated notes, and other notes are based on borrowing
rates currently available to the Company for loans with similar terms or
maturity and approximate the carrying amounts reflected in the accompanying
consolidated financial statements.
32
Inventories
Inventories are carried at the lower of cost or market using the
first-in, first-out method and are comprised of the following:
January 31, February 1,
1999 1998
----------- -----------
(in thousands)
Finished goods $15,992 $12,368
Work in progress 47 66
Raw materials 4,374 3,579
------- -------
$20,413 $16,013
======= =======
Closed store expenses
Future expenses, such as rent and real estate taxes, net of estimated
sublease recovery, relating to closed showrooms are charged to operations upon a
formal decision to close the showroom.
Property, equipment and leasehold improvements
Property, equipment and leasehold improvements are stated at cost less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets which range
from three to five years. Leasehold improvements are amortized on a
straight-line basis over the shorter of the estimated useful life or the term of
the lease. Depreciation and amortization expense was $1,633,000 in fiscal 1998,
$1,099,000 in fiscal 1997, and $1,073,000 in fiscal 1996. Property, equipment
and leasehold improvements are summarized as follows:
January 31, February 1,
1999 1998
----------- -----------
(in thousands)
Leasehold improvements $ 14,038 $ 10,708
Construction in progress 2,490 1,922
Machinery and equipment 4,374 3,579
Office and store furniture 873 886
-------- --------
19,320 16,530
Less accumulated depreciation
and amortization (6,254) (7,953)
-------- --------
$ 13,066 $ 8,577
======== ========
Goodwill
Goodwill, which represents the excess of purchase price over the fair
value of net assets acquired, is being amortized on a straight-line basis over
20 years. Accumulated amortization amounted to $6,980,000 as of January 31, 1999
and $5,960,000 as of February 1, 1998.
Long-lived assets and certain identifiable intangibles held and used by
the Company are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Based upon its analysis, management believes that no impairment of
the carrying value of its long-lived assets inclusive of goodwill exists at
January 31, 1999. The Company's analysis at January 31, 1999 is based on an
estimate of future undiscounted cash flows using forecasts contained in the
Company's operating plan.
33
Should the results of the operating plan not be achieved, future analyses may
indicate insufficient future undiscounted net cash flows to recover the carrying
value of the Company's long-lived assets, in which case the carrying value of
such assets should be written down to fair value. The Company's historical
results of operations and its cash flows in fiscal years 1998, 1997, and 1996
indicate that it is at least reasonably possible that such circumstances could
arise in fiscal 1999.
Leasehold interests
Leasehold interests represent the present value of the excess of fair
market value lease rates on certain retail facility leases as compared to the
stated lease rates contained in the leases as determined at the date the leases
were acquired. Amortization of leasehold interests is on a straight-line basis
over the remaining lease terms. Accumulated amortization amounted to $2,407,000
as of January 31, 1999 and $2,132,000 as of February 1, 1998.
Revenue recognition
Sales are recorded when goods are delivered to the customer. The Company
provides for estimated customer returns and allowances by reducing sales or by a
charge to operations, as appropriate, in the period of the sale.
Advertising expenses
Advertising costs, which are principally newspaper ads, mail inserts and
radio spots, are charged to expense as incurred. Advertising expenses in the
fiscal years ended January 31, 1999, February 1, 1998, and February 2, 1997 were
$12,272,000, $11,758,000 and $11,184,000, respectively.
Warranty costs
Estimated amounts for future warranty obligations for furniture sold are
charged to operations in the period the products are sold.
Income taxes
The Company provides for income taxes under the liability method.
Accordingly, deferred income tax assets and liabilities are computed for
differences between financial reporting and tax bases of assets and liabilities
that will result in taxable or deductible amounts in the future based on enacted
tax laws and rates applicable to the periods in which the differences are
expected to affect taxable income; valuation allowances are established when
necessary to reduce deferred tax assets to amounts which are more likely than
not to be realized.
Recent Accounting Pronouncements
The Company adopted the Financial Accounting Standards Board
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income" in fiscal 1998. This statement requires that all items
that meet the definition of components of comprehensive income be reported in a
financial statement for the period in which they are recognized. Components of
comprehensive income include revenues, expenses, gains and losses that under
generally accepted accounting principles are included in comprehensive income
but are excluded from net income. There are no differences between the Company's
net loss, as reported, and comprehensive loss as defined, for the periods
presented as of January 31, 1999.
34
The Company has also adopted SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" in fiscal 1998. The Company believes
it operates in only one business segment.
During the first quarter of fiscal 1998, the American Institute of
Certified Public Accountants issued Statement of Position (SOP) No. 98-5
"Pre-Opening Costs." This Statement provides guidance on the financial reporting
of start-up costs and organization costs. The Company adopted this SOP in fiscal
1998 and it did not materially impact the Company's Consolidated Financial
Statements.
Emerging Issues Task Force (EITF) No. 98-9 "Accounting for Contingent
Rent in Interim Financial Periods" requires lessees to recognize contingent
rental expense in interim periods if the achievement of future targets that
trigger such contingency is considered to be probable. The Company's method of
accounting for contingent rent is consistent with the requirements of EITF No.
98-9.
Loss per share
Loss per share for fiscal 1998, 1997 and 1996 was computed based on the
weighted average number of common shares outstanding during each period since
common stock equivalents were antidilutive. If the conversion of preferred stock
during the year ended February 2, 1997 had occurred at the beginning of the
year, the net loss per share would have been $1.20.
The Company calculates loss per share in accordance with SFAS No. 128,
"Earnings Per Share". This statement requires the presentation of both basic and
diluted net income (loss) per share. Basic net income (loss) per share is
computed by dividing income (loss) available to common stockholders by the
weighted average number of common shares outstanding. Diluted net income (loss)
per share includes the effect of the potential shares outstanding, including
dilutive stock options and warrants using the treasury stock method. Because the
impact of options and warrants are antidilutive, there is no difference between
the loss per share amounts computed for basic and diluted purposes.
Credit risk
Finance options are offered to customers through non-affiliated third
parties, at no material risk to the Company. Non-financed retail consumer
receivables are collected during the normal course of operations. There is no
significant concentration of credit risk and credit losses have been minimal.
2. OPERATIONS
The Company has reported losses from operations in each of the past five
years due to inefficiencies within its operations. As a result of such losses,
the Company had an accumulated deficit of $46,964,000 at January 31, 1999.
The Company's management, which underwent substantial restructuring in
the second half of fiscal 1996, has developed a strategic plan for the business
which provides, among other things, for remodeling showrooms to provide a more
appealing setting for customers, opening new showrooms, increasing product
prices to competitive levels, reducing promotional discounting, reconfiguring
selling commissions, remerchandising, refocusing advertising, improving the
manufacturing process and reducing expenses through budgetary controls. In the
opinion of management, all of these plans have been implemented and are believed
to have contributed significantly to reducing losses and are expected to
ultimately return the Company to profitability; however, there can be no
assurance that the Company will achieve profitability. During this period, the
Company has also raised additional equity capital and negotiated new credit
facilities as discussed more fully in Notes 5 and 3, respectively. Management
believes that the Company has sufficient sources of financing to continue
operations and fund its plan to remodel showrooms and open new showrooms
throughout fiscal 1999; however, if this is not the case, the
35
Company will need to obtain additional capital and there can be no assurance
that any additional equity or debt financing will be available or available on
terms acceptable to the Company. The Company's long-term success is dependent
upon management's ability to successfully execute its strategic plan and,
ultimately, to achieve sustained profitable operations.
3. NOTES PAYABLE
Notes payable consist of the following:
January 31, February 1,
1999 1998
---------- -----------
(in thousands)
Secured revolving credit notes $ 6,992 $ 3,812
Subordinated notes payable to shareholders 12,001 12,001
Unamortized debt discount, net of accumulated amortization of
$1,320,000 at January 31, 1999 and $590,000 at February 1, 1998 (1,705) (2,435)
Other notes 1,244 375
-------- --------
18,532 13,753
Less current portion 542 22
-------- --------
$ 17,990 $ 13,731
======== ========
The secured revolving credit notes were issued under a revolving credit
agreement, which was most recently amended March 15, 1999, (the "Revolving
Credit Facility") between Krause's and a financial institution that expires in
March 2002. The Revolving Credit Facility provides for revolving loans of up to
$15 million based on the value of inventories. Available borrowing capacity
under the original terms of the Revolving Credit Facility, at January 31, 1999,
was $2,986,000. Substantially all of Krause's assets are pledged as collateral
for the loans which are guaranteed by the Company. Interest on the loans is
payable monthly at a margin ranging from .5% to 1.0% in excess of the prime rate
(7.75% at January 31, 1999) which margin varies depending on the Company's
performance.
On August 14, 1997, the Company concluded a Supplemental Securities
Purchase Agreement, which was amended as of March 31, 1999 (the "Agreement")
among the Company, General Electric Capital Corporation ("GECC") and Japan
Omnibus Ltd. ("JOL"), a company formerly known as Edson Investments, Inc. Under
the Agreement, the Company sold 9.5%, subordinated notes in an aggregate
principal amount of $3,000,000 to GECC and JOL (the "Supplemental Notes"), which
notes have a final maturity of July 30, 2002, and concurrently issued to GECC
and JOL warrants to purchase an aggregate of 740,000 shares of common stock of
the Company at a purchase price of $1.25 per share. The fair value of the
warrants of $925,000 was reflected in the consolidated financial statements as a
discount on the subordinated notes and an increase in capital in excess of par
value. This discount is being amortized to interest expense using the effective
interest method over the term of the Supplemental Notes. The Company also issued
to GECC and JOL a warrant to purchase an aggregate amount of up to 1,000,000
shares of the Company's common stock at a price of $0.01 per share which warrant
may be completely or partially cancelled depending on the economic performance
of the Company in fiscal 1999. The Company periodically assesses the likelihood
of vesting of the warrants, and, when and if probable, will further discount the
debt to assign value to the warrants.
Also, under the Agreement, on December 30, 1997, the Company drew on a
standby credit facility with GECC and JOL by selling additional 9.5%
subordinated notes in an aggregate principal amount of $3,500,000 (the "Standby
Notes") which notes have a final maturity of July 30, 2002. As part of the
Agreement, the Company issued to GECC and JOL warrants to purchase an aggregate
of 560,000 shares of common stock of the Company at a purchase price of $1.25
per share. The fair value of the warrants of $700,000 was reflected in the
consolidated financial statements as a discount on the subordinated notes and an
increase in capital in excess of par value. This
36
discount is being amortized to interest expense using the effective interest
method over the term of the Standby Notes.
In conjunction with the August 14, 1997 financing described above, the
Company issued to GECC a new 9.5% subordinated note which note has a final
maturity of July 30, 2002 (the "Replacement Note") in the principal amount of
$5,501,091, to replace the Company's 10% Subordinated Pay-In-Kind Note (the
"Original Note") due August 31, 2001, in principal amount of $5,000,000, and
certain additional notes in aggregate principal amount of $501,091 reflecting
accrued interest. The Original Note was issued with a warrant to purchase
1,400,000 shares of common stock at $.001 per share at any time through August
31, 2006. The fair value of the warrant of $1,400,000 was reflected in the
consolidated financial statements as a discount on the subordinated note and an
increase in capital in excess of par value. This discount is being amortized to
interest expense using the effective interest method over the term of the
Replacement Note.
Each of the Replacement Note, Supplemental Notes and Standby Notes are
payable in ten quarterly installments beginning April 2000.
Pursuant to the terms of the Agreement and the Revolving Credit
Facility, the Company and Krause's are required to maintain certain financial
ratios and minimum levels of tangible net worth and working capital as well as
to achieve certain levels of earnings before interest, taxes, depreciation and
amortization. In addition, the Company and Krause's are restricted from entering
into certain transactions or making certain payments and dividend distributions
without the prior consent of the lenders. As of January 31, 1999, the Company
and Krause's were in compliance with the terms and conditions of these
agreements.
The aggregate annual maturities of long-term debt during each of the
five fiscal years subsequent to January 31, 1999 are approximately as follows:
$542,000 in 1999, $3,268,000 in 2000, $4,330,000 in 2001, $12,005,000 in 2002,
and $13,000 in 2003.
4. INCOME TAXES
Income tax benefits differ from the amounts computed by applying the
federal statutory rate of 34% to the loss before income taxes, as follows:
Fiscal Years Ended
--------------------------------------
January 31, February 1, February 2,
1999 1998 1997
----------- ----------- -----------
(in thousands)
Tax at federal statutory rate $(1,745) $(2,543) $(4,552)
Goodwill amortization 347 347 347
State income tax, net of federal benefit (280) (390) (742)
Other 245 (75) (386)
Adjustment of valuation allowance 1,433 2,661 5,333
------- ------- -------
$ -- $ -- $ --
======= ======= =======
37
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities are as follows:
Fiscal Year Ended
---------------------------
January 31, February 1,
1999 1998
----------- -----------
(in thousands)
Deferred tax liabilities $ -- $ --
Deferred tax assets:
Net operating loss carryforwards 15,043 14,200
Reserves and accruals not currently deductible for tax purposes 2,694 2,104
-------- --------
Total deferred tax assets 17,737 16,304
Valuation allowance for deferred tax assets (17,737) (16,304)
-------- --------
Net deferred tax assets -- --
-------- --------
Net deferred taxes $ -- $ --
======== ========
The change in the valuation allowance was a net increase of $1,433,000
for the fiscal year ended January 31, 1999, and a net increase of $2,661,000 for
the fiscal year ended February 1, 1998. The valuation allowance was increased
since the realization of net deferred tax assets is uncertain.
As of January 31, 1999 the Company has federal net operating loss
carryforwards of approximately $40 million which begin to expire in 2003, if not
utilized. As a result of various equity transactions, one of the Company's
subsidiaries has experienced a change of ownership in 1993, as defined in the
Internal Revenue Code. As a result of this ownership change and other provisions
of the Internal Revenue Code, utilization of approximately $10 million of these
net operating loss carryforwards is limited to the future income of one of the
Company's subsidiaries and is further limited to approximately $1 million per
year on a cumulative basis. As of January 31, 1999, approximately $5 million of
the limited loss carryforwards was available. In addition, the Company had state
net operating loss carryforwards of approximately $30 million, which begin to
expire in the year beginning February 1, 1999, if not utilized.
5. STOCKHOLDERS' EQUITY
On August 26, 1996 and September 10, 1996, the Company completed
transactions with investors in which the Company received net cash proceeds of
$10,221,000 from issuances of 10,669,000 shares of common stock. In addition,
$950,000 of convertible notes and $2,000,000 of demand notes (issued between May
13, 1996 and July 2, 1996 to related parties) together with accrued interest of
$116,251 were exchanged for 3,066,251 shares of common stock, and shares of
Series A preferred stock were converted into 1,176,950 shares of common stock.
In April 1998, the Company completed a public offering of 2,963,889
shares of its common stock at a price of $3.00 per share. Proceeds of the
offering totaled $7,267,000 after deducting underwriters' fees and offering
expenses. The purpose of the offering was to fund the remodeling of the
Company's existing showrooms, to fund the opening of new showrooms and for
general corporate purposes.
At January 31, 1999, the Company had warrants outstanding to purchase an
aggregate of 2,949,765 shares of its common stock. Of these warrants, 1,400,000
warrants were issued to GECC in fiscal 1996 at a exercise price of $.001 per
share and 1,300,000 were issued to GECC and JOL in fiscal 1997 at an exercise
price of $1.25 (see further discussion in Note 3). The remaining 249,765
warrants have exercise prices ranging from $1.32 to $2.91 per share and
expiration dates ranging from May 1999 to June 2005. The warrants generally
provide for certain anti-dilution adjustments. In addition, in connection with
the August 1997 financing, the Company issued warrants to GECC and JOL to
purchase up to 1,000,000 shares of common stock upon the occurrence of certain
events; such warrants expire August 31, 2006 (see Note 3). The Company also has
61,948 shares of common stock issuable
38
upon payment of deferred stock units and options outstanding to purchase an
additional 2,208,458 shares of common stock.
As of January 31, 1999, 6,305,171 shares of the Company's common stock
are reserved for issuance upon exercise of warrants and stock options (see Note
6) and upon the payment of deferred stock units.
6. STOCK OPTION PLANS
The Company has elected to follow APB 25, "Accounting for Stock Issued
to Employees" and related interpretations in accounting for its employee stock
options because, as discussed below, the alternative fair value accounting
provided for under SFAS No. 123, "Accounting for Stock-Based Compensation"
requires use of option valuation models that were not developed for use in
valuing employee stock options.
The 1997 Stock Incentive Plan provides for the issuance of awards
covering up to 2,000,000 shares of Common Stock to employees, officers,
directors, and consultants. Awards under this plan can consist of options, stock
appreciation rights, dividend equivalent rights, restricted stock, performance
shares, deferred stock units or other stock based awards.
Directors who are not employees of the Company, other than one
non-employee director who has indicated that he cannot accept an award because
of his current employment by a stockholder, receive automatic grants of deferred
stock units covering shares having a fair market value of $10,000 for each year
of service as a director. These awards provide deferred compensation to
directors equivalent to an investment in shares on the date the award is
effective. Payout of the award is made in stock following a director's
retirement from the Board of Directors or death. Normally the payment is made in
five annual installments, but a director may elect to receive a single payment.
In August 1996, the Company awarded the Chief Executive Officer of the
Company an option to purchase 1,234,000 shares of common stock at an exercise
price of $1.00 per share with vesting over three years. Compensation expense was
recorded in the amount of $204,000, $204,000 and $293,000 in fiscal 1998, 1997
and 1996, respectively, based upon the vesting provisions and the market value
of the stock on the date of grant.
Options to purchase the Company's common stock are outstanding under the
Company's 1990 Employees Stock Option Plan, 1994 Directors Stock Option Plan,
and various plans established by Krause's prior to the time it was acquired by
the Company. All of these plans have been cancelled and no further grants may be
made under them.
Pro forma information regarding net loss and loss per share is required
by SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for fiscal
1998, 1997 and 1996; risk-free interest rates of 5.67%, 6.28% and 6.85%,
dividend yields of 0% for all periods, volatility factors of the expected market
price of the Company's common stock of 80%, 82% and 68%; and a weighted-average
life of the options of 7.0, 7.0 and 6.5 years, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
39
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The pro forma
disclosures are not likely to be representative of the effects on reported net
income (loss) for future years since only options granted since fiscal 1995 are
considered. The Company's pro forma information follows (in thousands, except
for per share information):
1998 1997 1996
------- ------- --------
Pro forma net loss $ 5,564 $ 7,700 $ 13,188
Pro forma net loss per share $ 0.26 $ 0.40 $ 1.26
As of January 31, 1999, under all option plans, a total of 3,293,458
shares of common stock are reserved for future issuance, options to purchase
2,208,458 shares of common stock were outstanding, options to purchase 1,390,708
were exercisable, at a weighted average exercise price of $1.44, and options for
1,085,000 shares were available for future grants.
The following table reflects option activity and related exercise
prices, actual and weighted average, under all stock option plans from January
28, 1996 to January 31, 1999.
Weighted
Number of Actual Average
Options Exercise Price Exercise Price
--------- ------------- --------------
Outstanding January 28, 1996 360,373 $2.16 - $8.34 $4.48
Granted 1,617,000 $ .78 - $1.62 $1.12
Forfeited (254,916) $ .78 - $8.34 $4.32
---------
Outstanding February 2, 1997 1,722,457 $ .78 - $7.13 $1.35
Granted 417,000 $1.56 $1.56
Forfeited (95,499) $2.16 - $7.13 $3.54
---------
Outstanding February 1, 1998 2,043,958 $ .78 - $6.38 $1.29
Granted 165,000 $3.25 $3.25
Forfeited (500) $3.18 $3.18
Outstanding January 31, 1999 2,208,458 $ .78 - $6.38 $1.44
=========
The weighted average grant-date fair value of options granted during
1998 and 1997, for options where the exercise price on the date of grant was
equal to the stock price on that date, was $2.62 and $1.22, respectively.
The following table reflects the weighted average exercise price of
options outstanding, weighted average remaining contractual life of options
outstanding, number of shares exercisable and the weighted average exercise
price of exercisable options as of January 31, 1999.
Weighted
Weighted Average Exercise
Number of Actual Weighted Average Number of Price of
Options Exercise Average Remaining Options Exercisable
Outstanding Price Range Exercise Price Contractual Life Exercisable Options
------------- ------------- -------------- ---------------- ----------- ----------------
2,009,000 $ .78 - $1.62 $1.22 7.9 years 1,221,250 $1.14
199,458 $3.09 - $6.38 $3.60 8.3 years 169,458 $3.66
--------- ---------
2,208,458 $ .78 - $6.38 $1.44 8.0 years 1,390,708 $1.44
========= =========
7. RETIREMENT PLAN
The Company has a 401(k) retirement plan (effective January 1, 1994) to
which eligible employees may contribute up to 18% of their annual earnings. At
its discretion the Company matches employees' contributions. The Company's
contributions were not significant in fiscal 1998, 1997 and 1996.
40
8. COMMITMENTS AND CONTINGENCIES
Leases
The Company and its subsidiaries lease production, office and retail
facilities and equipment under operating leases. Lease terms range from three to
25 years and most leases contain renewal options and certain leases contain
purchase options. The Company's administrative offices and manufacturing
facilities lease has a remaining term of 10 years with four five-year renewal
options. Retail showrooms are all leased with rents either fixed or with fixed
minimums coupled with contingent rents based on the Consumer Price Index or a
percentage of sales.
Commitments as of January 31, 1999 under operating leases require
approximate future minimum annual rental payments as follows:
Total
Fiscal Year (in thousands)
--------------
1999 $17,087
2000 15,204
2001 12,224
2002 10,741
2003 7,579
Thereafter 18,048
--------------
$80,883
==============
Total rent expense under all operating leases was approximately
$17,278,000, $15,456,000, and $15,389,000 for the fiscal years ended January 31,
1999, February 1, 1998 and February 2, 1997, respectively.
Litigation
The Company and its subsidiaries are also parties to various legal
actions and proceedings incident to normal business activity. Management
believes that any liability in the event of final adverse determination of any
of these matters would not be material to the Company's consolidated financial
position, liquidity or results of operations.
Year 2000 Readiness Disclosure
In the past, computer engineers designed most computer programs and
embedded computer chips to use only two digits to specify a particular year. For
example, the digits "99" were used to specify the Year "1999." However,
computers that use only two digits cannot properly recognize the Year 2000 or
any following years. For example, after the Year 2000, the digits "01" could
mean either the Year "2001" or the Year "1901." This problem can cause computers
and other electronic devices to give erroneous results or to shut down.
Therefore, as dates employing the Year 2000 and following years come into use,
computer programs will need to use four digits to distinguish between the
different years of the 20th and the 21st century. Because of this Year 2000
problem, the Company and many other enterprises are vulnerable to unforeseen or
unanticipated problems with their computer systems and equipment containing
embedded computer chips, as well as from problems in the computer systems of
other parties on which their businesses rely.
The Company has a Year 2000 program in place to minimize any possible
effect on its business resulting from the Year 2000 problem. The Company has
evaluated its information technology ("IT") systems and believes it has
identified those that were not Year 2000 compliant. The Company upgraded its
payroll system to be Year 2000 compliant in the third quarter of fiscal 1998 and
its other mission critical business systems (manufacturing, procurement, order
processing and accounting) in the fourth quarter of fiscal 1998. The Company has
completed testing, implementation, and has conducted an end-to-end Year 2000
simulation test to validate compliance for its
41
key business processes. The Company has also assessed its desktops,
communications systems and other IT-related equipment. Remaining upgrades will
be completed within the first quarter 1999. The Company expects to bring its' IT
systems into compliance without incurring material costs. To date it has
completed the remediation of business systems by redirecting its existing
internal programming resources, with costs expensed as incurred. The Company
expects total costs to be less than $10,000.
With regard to non-IT systems, the Company is continuing to assess its
facilities equipment, including but not limited to bank card terminals, alarm
systems and fax machines. These are being reviewed for Year 2000 compliance.
Disruption of these services would have a negligible impact on Company
operations and remediation costs are expected to be less than $5,000. The
Company plans to achieve readiness in this area by the second quarter of 1999.
Depending on whether suppliers and other entities with which the Company
does business are able to successfully address the Year 2000 issue, the
Company's results of operations could be materially adversely affected in any
given future reporting period during which such a Year 2000 event occurs. As a
result, the Company is communicating with such entities to determine their state
of readiness. The Company is also developing contingency plans to allow primary
operations of the Company to continue if the Company's significant systems or
such entities are disrupted by the Year 2000 problem. The Company expects that
its contingency plans will be developed by the end of the third quarter of 1999,
and that it will be prepared in the event of systems failures to continue to do
business, although such operations may be at a higher cost.
These estimates and conclusions contain forward-looking statements that
are subject to risks and uncertainties that could cause actual results to differ
materially. New developments may occur that could affect the Company's
estimates, such as the amount of planning and modification needed to achieve
full resolution of the Year 2000 problem; the availability and cost of
resources; the Company's ability to discover and correct all Year 2000 sensitive
computer code and equipment; and the ability of suppliers and other entities to
bring their systems into compliance.
9. RELATED PARTY TRANSACTIONS
In fiscal 1996, Permal Capital Management, Inc. (PCMI) provided various
management services for the Company and its subsidiaries, for which PCMI
received $58,333. PCMI's services for the Company included assistance with
regard to executive management, financial consulting and strategic planning.
Thomas M. DeLitto, President of PCMI, served as President and Chief Executive
Officer of the Company from January to December 1994, served as Chief Executive
Officer from April 1995 to August 1996 and is currently Vice Chairman of the
Company's Board of Directors.
10. MAJOR SUPPLIERS
During the year ended January 31, 1999, the Company's 10 largest
suppliers accounted for 52.9% of its aggregate purchases. One supplier
represented approximately 10.2% of aggregate purchases for fiscal 1998.
42
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited in accordance with generally accepted auditing
standards, the financial statements of Krause's Furniture, Inc. as of and for
the years ended January 31, 1999 and February 1, 1998, included in this Form
10-K and have issued our report thereon dated March 31, 1999. Our audit was made
for the purpose of forming an opinion on the basic financial statements taken as
a whole. The schedule listed in the index above is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule, for the years ended January 31, 1999 and
February 1, 1998, has been subjected to the auditing procedures applied in the
audit of the basic financial statements and, in our opinion, fairly states in
all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 31, 1999
43
KRAUSE'S FURNITURE, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FISCAL YEARS ENDED JANUARY 31, 1999, FEBRUARY 1, 1998, AND
FEBRUARY 2, 1997
Additions
Balance Charged to Charged Balance
Allowance for Beginning Cost and to Other End
Doubtful Accounts of Period Expenses Accounts Deductions(a) of Period
- --------------------------- ------------- ------------- ---------- --------------- ------------
Fiscal 1998 $ 163,924 $ 286,000 $ - $ 269,557 $ 180,367
Fiscal 1997 326,807 180,736 - 343,619 163,924
Fiscal 1996 291,487 244,613 - 209,293 326,807
(a) Represents accounts written off.
44
EXHIBIT INDEX
Exhibit
No. Description
- --------- -----------
3.1 Certificate of Incorporation.(1)
3.1(a) Certificate of Amendment of Certificate of Incorporation dated
November 28, 1994. (5)
3.1(b) Certificate of Amendment of Certificate of Incorporation dated
August 1, 1995.(6)
3.1(c) Certificate of Amendment of Certificate of Incorporation dated June
7,1996.(7)
3.1(d) Certificate of Amendment of Certificate of Incorporation dated
August 1, 1996.(7)
3.2 By Laws.
4.1 Loan and Security Agreement dated January 20, 1995 by and between
Congress Financial Corporation (Western) and Krause's Sofa Factory
and Castro Convertible Corporation. (3)
4.1(a) First Amendment to Loan and Security Agreement dated as of May 10,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(6)
4.1(b) Second Amendment to Loan and Security Agreement dated as of August
26, 1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
4.1(c) Third Amendment to Loan and Security Agreement dated as of November
25, 1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
4.1(d) Amended and Restated Subordination Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Furniture, Inc.(14)
4.1(e) Fourth Amendment to Loan and Security Agreement dated as of August
14, 1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(12)
4.1(f) Fifth Amendment to Loan and Security Agreement dated as of December
11, 1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation. (15)
4.1(g) Sixth Amendment to Loan and Security Agreement dated as of March 15,
1999 by and between Congress Financial Corporation (Western) and
Krause's Custom Crafted Furniture Corp. and Castro Convertible
Corporation.
4.1(h) Letter agreement between Krause's Furniture, Inc. and Congress
Financial Corporation (Western).(12)
4.2 Guarantee dated January 20, 1995 by Krause's Furniture, Inc. to
Congress Financial Corporation (Western). (3)
4.5 Certificate of Designations of Preferred Stock. (4)
10.1 1994 Directors Stock Option Plan.
10.2 1990 Employees Stock Option Plan.
10.3 Form of Securities Purchase Agreement between the Company, GECC and
certain other stockholders of the Company dated as if August 26,
1996.(8)
10.4 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due August 31,
2001.(8)
10.5 Form of Warrant to Purchase 1,400,000 Shares of Common Stock.(8)
10.6 Form of Securities Purchase Agreement between the Company and
Certain Stockholders dated as of August 26, 1996.(8)
10.7 Form of Stockholders Agreement among the Company, GECC and certain
other stockholders of the Company dated as of August 26, 1996.(8)
10.8 Form of Registration Rights Agreement among the Company and GECC and
certain other stockholders of the Company dated as of August 26,
1996.(8)
10.9 Employment agreement with Philip M. Hawley.(8)
10.10 1997 Stock Incentive Plan. (9)
10.11 Supplemental Securities Purchase Agreement among Krause's Furniture,
Inc., General Electric Corporation and Japan Omnibus Ltd., dated as
of August 14, 1997. (12)
10.12 Letter agreement dated August 14, 1997 regarding Permal Group
shares.(12)
10.13 Letter agreement dated August 14, 1997 regarding warrant dilution
provisions.(12)
10.14 Amendment to the Supplemental Securities Purchase Agreement among
Krause's Furniture, Inc., General Electric Corporation and Japan
Omnibus Ltd., dated as of March 31, 1999.
11 Statement regarding computation of per share earnings.
45
Exhibit
No. Description
- ------- -----------
21 Subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
23.2 Consent of Ernst & Young LLP, Independent Auditors
27 Financial Data Schedule
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4
dated June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form 10-K
for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K dated
as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form 10-K
dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1
dated March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibits to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
(14) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(15) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated April 30, 1998 (File No. 0-17868).