As filed pursuant to Rule 424(b)(3)
Prospectus Supplement to Registration Statement No. 333-29465 and
Registration Statement No. 333-34425 (which incorporates
Registration Statement No. 333-29465 by reference)
BAB Holdings, Inc.
Supplement No. 1 to Prospectus Dated August 6, 1997
and Prospectus Dated August 27, 1997
The Date of this Supplement is October 17, 1997
This Supplement No. 1 (the "Supplement") to the Prospectus
of BAB Holdings, Inc. (the "Company") supplements the Prospectus
of the Company dated August 6, 1997, and the Prospectus of the
Company dated August 27, 1997 (which incorporates by reference
the information contained in the Prospectus of the Company dated
August 6, 1997) with financial information of the Company for the
nine months ended August 31, 1997. In addition, this Supplement
updates "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Legal Proceedings" and
"Unaudited Condensed Consolidated Financial Statements" contained
in the Prospectus dated August 6, 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The selected financial data contained herein have been
derived from the condensed consolidated financial statements of
BAB Holdings, Inc. included below. The data should be read in
conjunction with the condensed consolidated financial statements
and notes thereto contained elsewhere in this Supplement, and
with the audited financial statements and notes contained in the
Prospectus dated August 6, 1997.
Certain statements contained in Management's Discussion and
Analysis of Financial Condition and Results of Operations,
including statements regarding the development of the Company's
business, the markets for the Company's products, anticipated
capital expenditures, and the effects of completed and possible
future acquisitions, and other statements contained herein
regarding matters that are not historical facts, are forward-
looking statements (as such term is defined in the Private
Securities Litigation Reform Act of 1995). Because such
statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such
forward-looking statements. Certain risks and uncertainties are
outside the control of the Company and its management including
its ability to attract new franchisees, the continued success of
current franchisees, the effects of competition on franchisee and
Company-owned store results and consumer acceptance of the
Company's products in new and existing markets. Readers are
cautioned not to place undue reliance on these forward-looking
statements, which reflect management's analysis only as of the
date hereof. The Company undertakes no obligation to publicly
release the results of any revision to these forward-looking
statements which may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of
unanticipated events.
General
From its inception in November 1992, the Company has grown
to 36 Company-owned and 220 franchised and licensed units at
August 31, 1997. This rapid expansion in operations
significantly affects the comparability of results of operations
of the Company in several ways, particularly in the recognition
of initial franchise fee revenue and ongoing royalty fees, as
well as the significant increase in Company-owned store revenues.
The Company's revenues are derived primarily from the
operation of Company-owned stores, initial franchise fees and
ongoing royalties paid to the Company by its franchisees.
Additionally, in 1996 the Company significantly increased revenue
derived from the sale of licensed products as a result of
purchasing trademarks (Brewster's), licensing contracts
(Strathmore's licenses with Host Marriott) and by directly
entering licensing agreements (Mrs. Fields Cookies).
Additionally, the Company has generated other revenue through the
sale of store units to franchisees of the Company.
Cost of revenue includes expenses occurring at the Company-
owned stores, such as food, beverage and paper costs, payroll
related expenses, occupancy and other operating expenses, and
other store expenses, and selling, general and administrative
costs occurring Company-wide, such as payroll related expenses,
advertising and promotion expenses, professional service fees,
franchise-related expenses, depreciation and amortization, and
other expenses.
On May 13, 1997, the Company completed the acquisition of My
Favorite Muffin Too, Inc. ("MFM"). This acquisition added to the
Company's existing product offering a premium muffin product and
additional points of distribution for its branded bagel and
coffee products. It is expected that the introduction of MFM
muffin products will enhance the revenue potential of existing
bagel stores and result in operating leverage as corporate
overhead is spread over these additional units. The Company has
reduced the number of MFM employees and has closed MFM's
corporate facility and combined operations in the Company's
Chicago, Illinois headquarters. As the Company already has
significant infrastructure in place to oversee franchisee and
Company stores operations, it is expected that the continued
integration of MFM with the Company's operations will require
only minimal additional resources.
With the increase in both franchise, licensed and Company-
owned operations, the Company has experienced increases in
payroll, occupancy and overhead costs in the corporate offices.
At August 31, 1997 the Company had 40 employees at the corporate
level who oversee operations of the franchise, licensed and
Company-owned store operations, up from 28 at August 31, 1996.
While these costs have increased, they have decreased as a
percentage of total revenues, and management expects that these
costs will further decline as a percentage of revenue as
additional franchise and Company-owned units are added. It is
expected that the MFM acquisition and existing Company growth
will require only modest increases in employees at the corporate
office. Additionally, as the Company approximately doubled the
space at the corporate headquarters in late 1996 through
subletting an office suite adjacent to the Company's existing
offices, it is anticipated that the Company will not require
additional office facilities in the foreseeable future. The
Company believes it is in a position to leverage selling, general
and administrative expenses across increasing revenue.
Results of Operations
Nine Months Ended August 31, 1997 versus
Nine Months Ended August 31, 1996
- ----------------------------------------
Total revenues increased 160% to $10.1 million for the nine
month period ended August 31, 1997, from $3.9 million in the
prior year period. This increase was driven primarily by the
increase in Company-owned store revenues which accounts for 68.2%
of total revenue this period, up from 50.3% of total revenue in
the prior year period. The Company added 23 Company-owned units
during the period, but sold two bringing the total to 36 in
operation at August 31, 1997, as compared to only 10 in operation
at August 31, 1996. Franchise and area development fees
decreased 4% to $773,000 or 7.6% of total revenue in this period
from $808,000 or 20.7% of total revenue in the year-ago period as
a result of fewer franchise store openings during the first three
quarters of 1997 as compared with last year's period. Included
in the comparative amounts were $250,000 related to the sale of
master franchise agreements in second quarter 1997, and $161,000
related to the sale of a master franchise in last year's third
quarter. Without the impact of these master franchise sales,
franchise and area development fees, would have declined by 19%
or $124,000 from last year's period as a result of opening only
30 franchise stores this period, versus 38 in the year-ago
period. This decrease in franchise openings during the period was
attributable to legal and geographic restrictions in selling
franchise territories during the last half of 1996 as the Company
attempted to acquire Chesapeake Bagel Bakery. During the last
six months of 1996, the Company was unable to complete franchise
sales in certain key markets while updating franchise offering
circulars and attempting to minimize territorial disputes with
existing Chesapeake area developers. Royalty fees from franchise
stores increased 65% to $1.7 million or 16.4% of revenue in this
period from $1.0 million or 25.8% of revenue in last year's
period, as a result of the higher number of franchise stores in
operation during the period compared to the prior year, including
the impact of adding MFM franchise units in May 1997. Licensing
fees and other income increased from approximately $125,000 in
last year's period to $791,000 in this year's first three
quarters or 7.8% of total revenues as a result of the Company's
entrance into various nontraditional channels of distribution,
including the sale of Brewster's Coffee to franchisees and
licensees of the Company, licensing fees paid by Host Marriott on
the sales of product in Big Apple Bagels licensed units, and
commissions received on the sale to Host Marriott and Mrs. Fields
by a third party commercial baker of par-baked Big Apple Bagels.
Additionally, the Company generated $188,000 from the resale to
franchisees of Company-operated units during the first three
quarters of 1997.
Food, beverage and paper costs increased by 239%, and store
payroll and other operating expenses increased by 312%, in the
nine month period ended August 31, 1997 from the year-ago period
as a result of increasing the Company-owned stores base from ten
units in operation last year to 36 at August 31, 1997. Total
food, beverage and paper costs was 33.6% of Company-store revenue
in this period versus 34.9% during last year's period, while
store payroll and other operating expenses increased to 57.4% of
Company-store revenue in this period versus 49.0% in last year's
period. The levels of these rates, and the increase from 1996 in
store payroll and other operating expenses, are a direct result
of the increase in Company-owned stores during this period and
related start-up inefficiencies. The Company is aggressively
working to decrease these rates as a percent of total sales in
operating units as evidenced by the decrease in food, beverage
and paper costs. Over half of the Company-owned stores have been
in operation for less than one year and have yet to fully reach
mature sales levels and operating efficiencies. It is expected
that as these stores are in operation for longer periods they
will better contribute to the Company's operating results.
Selling, general and administrative expenses increased 90%
to $4.2 million in this period from $2.2 million in the prior
year period as a result of supporting an increasing base of
franchise stores, as well as the significant increase in Company-
owned stores from last year's period. Payroll-related costs
increased 58% from the year-ago period due to the increase in
corporate-level headcount from 28 at August 31, 1996, to 40 at
August 31, 1997. Depreciation and amortization expense increased
376% due to the significant increase in Company-owned store
depreciation and amortization of intangible assets including
goodwill, contract rights, noncompetition agreements, franchise
contract rights and trademarks resulting from the Company's
various acquisitions. Other selling, general and administrative
expenses increased 63% as a result of the increase in Company-
owned and franchise units, as well as the increase in office
space of the corporate headquarters supporting the increased
corporate headcount. Selling, general and administrative expenses
excluding depreciation and amortization, as a percent of total
revenue, declined to 31.9% in this period versus 51.6% in last
year's period as the Company continues to realize operating
leverage from its increasing revenue base.
Loss from operations was $371,000 in the nine month period
ended August 31, 1997 versus income from operations of $35,000 in
last year's period. Interest income decreased to $49,000 in this
year's period from $262,000 in last year's period. This decrease
resulted from lower cash and equivalent balances than last year
as the Company had just completed its initial public offering in
November 1995, and invested proceeds in interest-bearing
securities during the first three quarters of fiscal 1997.
Interest expenses was $32,000 this period versus $4,000 in the
last year period as a result of borrowings on the Company's
credit facility this year.
Net loss for the period was approximately $354,000 as
compared to net income in the prior year period of $292,000.
Preferred stock dividends accumulated, related to the issuance of
87,710 shares of Preferred Stock during the period, resulted in a
net loss attributable to common shareholders of $952,000.
Preferred dividends in the amount of $598,000 were accumulated
during the period, which included $387,000 attributable to the
15% discount available to holders of the Company's Series A
Convertible Preferred Stock ("Preferred Stock") in acquiring
common stock upon ultimate conversion. Such discounts are
recognized as dividends under generally accepted accounting
principles. The total discount treated as a dividend was
recognized over the minimum period from issuance, to the first
date of convertibility, August 1, 1997. The Company was
additionally obligated to issue warrants to purchase two shares
of Common Stock for each share of Preferred Stock on August 1,
1997. The value of these two-year warrants was additionally
recorded as a preferred stock dividend accumulated of $138,000.
As fully recognized by August 1, 1997, no additional preferred
dividends will accumulate related to this conversion discount or
the warrants.
The preferred dividend accumulated attributable to the
conversion discount was a non-cash entry having no impact on
operating income or total equity of the Company. Upon issuance
of the Preferred Stock, the total of $387,000 representing the
conversion discount, was recorded as additional paid-in capital.
As the dividend was accumulated during the period prior to
convertibility, the dividend was recorded as a reduction in
retained earnings, and an increase in the preferred stock
carrying value. Similarly, the preferred dividend related to the
issuance of the warrants noted above represents a non-cash
adjustment reducing retained earnings and increasing additional
paid-in capital.
Net loss per share for this period was $0.13, as compared to
net income per share in last year's period of $0.04.
Liquidity and Capital Resources
During the nine months ended August 31, 1997, cash used in
operating activities was $501,000 as compared with $88,000
provided by operating activities during the comparable last year
period. Cash used for investing activities during the nine
months ended May 31, 1997 totaled $3.8 million of which $2.9
million was used to purchase of property, plant and equipment
primarily for new Company-owned store construction. Business
acquisitions during the period required $651,000, net of $455,000
in notes receivable related to the Just Bagels, Inc. and
affiliate acquisition in January 1997 converted to purchase
consideration. Collections on notes receivable provided
approximately $140,000 during the period.
Financing activities provided a total of $3 million during
the nine months ended August 31, 1997. In April 1997 the Company
completed the sale of 87,710 shares of $25.00 Preferred Stock in
a private placement to qualified investors, netting approximately
$2 million after placement agent commissions and fees.
Additionally, in April 1997, the Company entered a $2 million
line of credit agreement (the "Credit Facility") with a bank
expiring in October 1998. Maximum borrowing under the Credit
Facility is limited to a borrowing base of 80% of accounts
receivable under 90 days and 40% of equipment costs. Interest is
payable monthly at prime plus one percent (currently 9.5%), with
principal due upon maturity of the note in October 1998. At
August 31, 1997, the Company had approximately $1.4 million
outstanding under the Credit Facility. In the MFM acquisition,
the Company assumed approximately $350,000 in long-term debt, of
which $330,000 payable to MFM's existing bank was converted to
borrowings under the Credit Facility in July 1997. The Company
believes that its current cash position, combined with
availability on its Credit Facility, will provide the Company
with sufficient working capital in future periods.
LEGAL PROCEEDINGS
On April 16, 1996, the Company filed an arbitration action
against a franchisee alleging breach of its franchise agreement
for refusal to submit required sales reports and pay royalty fees
and contributions to the national marketing fund. The franchisee
filed suit in the Circuit Court of Cook County, Illinois against
the Company and its officers and directors on April 19, 1996. The
franchisee alleges that the Company misrepresented the initial
investment required to establish a store and made untrue and
unauthorized earnings claims in violation of the Illinois
Franchise Disclosure Act. Plaintiffs seek rescission of the
franchise agreement, damages of $600,000 and punitive damages in
the amount of $6,000,000. Management believes the case is without
merit and obtained an order staying litigation in order to compel
the plaintiffs to have their claims heard in arbitration as
required by the provisions of the franchise agreement. Hearings
have been held on this matter and the Company anticipates a
ruling on this matter in February 1998.
On August 18, 1995, MFM filed a claim in federal court
against a franchisee alleging trademark violations as a result of
the franchisee's alleged misuse of the MFM trademark.
Subsequently the franchisee filed a counter claim to be heard in
arbitration, as required under the franchise agreement, against
MFM alleging unauthorized earnings claims in violation of the
Trade Regulation Rule of the Federal Trade Commission. The
federal court claim was dismissed as a result of the issue being
moved to arbitration. The franchisee originally sought $250,000
in damages against MFM and subsequently amended the claim in
April 1997 to $500,000. To date, seven arbitration hearings have
been held on this matter. One additional hearing date has been
set for October 1997. In connection with the MFM acquisition,
the Company has placed in escrow 200,000 shares of Common Stock
issued as consideration in the acquisition, to secure
indemnification by the former owners of MFM against the outcome
of this litigation.
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BAB Holdings, Inc.
Condensed Consolidated Balance Sheet
August 31, 1997
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents, including
restricted cash of $272,624 $ 860,206
Other current assets 2,501,933
------------
Total current assets 3,362,139
Property, plant, and equipment, net of
accumulated depreciation of $823,378 6,806,613
Goodwill, net of accumulated amortization of $83,751 2,773,191
Franchise contract rights, net of accumulated
amortization of $24,811 1,801,572
Other assets and intangible assets, net of
accumulated amortization of $585,692 1,804,559
------------
$ 16,548,074
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 2,123,017
Deferred franchise fee revenue 646,900
Current portion of long-term debt 28,502
Other current liabilities 595,124
------------
Total current liabilities 3,393,543
Long-term debt, less current portion 1,452,117
Shareholders' equity:
Common stock 10,642,376
Additional paid-in capital 1,409,652
Preferred stock 2,018,568
Accumulated deficit ( 2,368,182)
------------
Total shareholders' equity 11,702,414
------------
$ 16,548,074
============
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
BAB Holdings, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
1997 1996
-----------------------
REVENUES
Net sales by Company-owned stores $ 6,918,171 $1,965,939
Royalty fees from franchised stores 1,664,301 1,008,398
Franchise and area development fees 772,545 808,331
Licensing fees and other income 791,424 124,765
-----------------------
10,146,441 3,907,433
OPERATING COSTS AND EXPENSES
Food, beverage, and paper costs 2,323,786 686,274
Store payroll and other operating expenses 3,970,983 963,312
Selling, general, and administrative expenses:
Payroll-related expenses 1,470,326 932,975
Depreciation and amortization 988,820 207,631
Other 1,763,806 1,082,386
-----------------------
4,222,952 2,222,992
-----------------------
10,517,721 3,872,578
-----------------------
Income (loss) before interest (371,280) 34,855
Interest expense (32,291) (4,346)
Interest income 49,145 261,578
-----------------------
Net income(loss) (354,426) 292,087
Preferred stock divided accumulated (597,577) -
-----------------------
Net income (loss) attributable to
common shareholders $ (952,003) $ 292,087
=======================
Net income (loss) attributable to common and
common equivalent share:
Primary $ (0.13) $ 0.04
=======================
Fully diluted $ (0.13) $ 0.04
=======================
Average number of common and common
equivalent shares used in calculation:
Primary 7,330,246 7,250,672
=======================
Fully diluted 7,330,246 7,337,226
=======================
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
BAB Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
1997 1996
-----------------------
OPERATING ACTIVITIES
Net cash provided(used)by operating activities $ (500,684) $ 88,137
INVESTING ACTIVITIES
Business acquisitions (650,531) (2,103,008)
Purchases of property, plant and equipment (2,897,038) (955,181)
Loans to franchisees - (578,902)
Other (279,133) (247,439)
-----------------------
Net cash used for investing activities (3,826,702) (3,884,530)
FINANCING ACTIVITIES
Proceeds from issuance of common stock - 1,020,000
Proceeds from issuance of preferred stock 2,192,750 -
Borrowings under line of credit 1,420,975 -
Repayment of long-term debt (362,152) -
Payment of preferred stock issuance costs (227,274) -
Other - (171,787)
----------------------
Net cash provided by financing activities 3,024,299 848,213
----------------------
Net decrease in cash and cash equivalents (1,303,087) (2,948,180)
Cash and cash equivalents at beginning of period 2,163,293 7,679,009
----------------------
Cash and cash equivalents at end of period $ 860,206 $4,730,829
======================
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
BAB Holdings, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial
statements represent the financial activity of BAB Holdings, Inc.
(the "Company" or "Holdings"), an Illinois corporation
incorporated on November 25, 1992, and its four wholly-owned
subsidiaries, BAB Operations, Inc. ("Operations"), BAB Systems,
Inc. ("Systems"), Brewster's Franchise Corporation ("BFC") and My
Favorite Muffin Too, Inc. ("MFM"). Systems was incorporated on
December 2, 1992, and was primarily established to franchise "Big
Apple Bagels" specialty bagel retail stores. Operations was
formed on August 30, 1995, primarily to operate Company-owned
stores, including one which currently serves as the franchise
training facility. BFC was established on February 15,1996, to
franchise "Brewster's Coffee" concept retail coffee stores. MFM
operates and franchises "My Favorite Muffin" specialty muffin
retail stores and was acquired on May 13, 1997.
The accompanying condensed consolidated financial statements are
unaudited. These financial statements have been prepared in
accordance with the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote
disclosures normally included in financial statement prepared in
accordance with generally accepted accounting principles have
been condensed or omitted pursuant to such rules and regulations.
In the opinion of the Company's management, the condensed
consolidated financial statements for the unaudited interim
periods presented include all adjustments necessary to fairly
present the results of such interim periods and the financial
position as of the end of said period. These adjustments were of
a normal recurring nature and did not have a material impact on
the financial statements presented.
2. Stores Open and Under Development
Stores which have been opened and unopened stores for which an
agreement has been executed and franchise or area development
fees collected at August 31, 1997 are as follows:
Stores opened:
Company-owned 36
Franchisee-owned 180
Licensed 40
____
256
Unopened franchised stores for which an agreement
has been sold:
Franchise agreement 29
Area development agreement 34
____
63
____
Total 319
====
3. Acquisitions and Dispositions
In January 1997, the Company completed the acquisitions of Just
Bagels, Inc. ("JBI"), and affiliate, franchisees of the Company,
operating a total of four stores in southern California. The
total purchase price paid was $770,000 including $120,000 related
to a noncompetition agreement with the former owners of JBI and
was paid in part through the forgiveness of notes receivable from
JBI of approximately $455,000.
In February 1997, the Company purchased the 50% interest held by
its joint venture partner in Downtown Bagels, a franchise Big
Apple Bagels satellite unit, for $20,000. The unit, and certain
other assets, were sold by the Company to a franchisee for
$60,000 consisting of a note receivable from the purchasers of
$55,000 and cash of $5,000. The note receivable bears interest at
prime plus one percent, and is payable monthly over a seven-year
period. Also in February 1997, the Company sold its Park Ridge,
Illinois Company-operated unit to a franchisee for $233,000. In
payment, the Company received a note receivable for $183,000 from
the purchasers, bearing interest at 9%, payable monthly over a
seven-year period, and cash of $50,000. The Company recognized
$156,400 in gains from the sale of these units to franchisees.
In April and May 1997, the Company completed the acquisitions of
two stores from Heartland Bagels, Inc. ("Heartland"), franchisees
of the Company. In April the Buffalo Grove, Illinois store was
purchased for $170,000, through the issuance of 25,611 shares of
restricted Company common stock, and the payment of approximately
$78,000 in outstanding liabilities of Heartland. In May the
Berwyn, Illinois store was purchased for approximately $140,000,
consisting of $111,000 paid to a bank in satisfaction of an
outstanding bank loan of Heartland, and $29,000 paid to creditors
of Heartland for outstanding liabilities.
On May 13, 1997 the Company acquired MFM. MFM franchises and
operates muffin and bagel specialty retail stores concentrated
primarily in the Eastern United States and Florida, and had 60
franchise and 5 company-operated units in operation at to point
of the acquisition. The acquisition was completed by exchanging
150 shares of MFM stock, for 432,608 shares of the Company's
common stock, restricted as to transfer until January 1, 1999,
and $260,000 in cash. In addition to current liabilities, the
Company has assumed approximately $350,000 of MFM's existing bank
debt and converted it to borrowings under the Company's credit
facility. Total revenue of MFM was $2.7 million for the year
ended December 31, 1996.
In August 1997 the Company sold the Buffalo Grove, Illinois unit
acquired from Heartland to a franchisee for $231,000 consisting
of two notes receivable from the purchasers, $43,000 due October
1997, and $188,000 due in monthly payments through August 2004,
with interest at 8.5%.
During 1996 the Company completed several acquisitions. On May
1, 1996, the Company acquired certain assets of Bagels Unlimited,
Inc., a franchisee of the Company which operated five Big Apple
Bagels stores in southeastern Wisconsin, for a purchase price,
including acquisition costs, of approximately $1,428,000. On May
21, 1996, the Company acquired certain assets and contract rights
of Strathmore Bagels Franchise Corporation ("Strathmore") for a
purchase price including acquisition costs of approximately
$1,740,000, plus additional consideration based on future
openings of units operated by Host Marriott Services Corporation
("Host Marriott"). On October 7, 1996, the Company acquired
certain assets of Danville Bagels, Inc. ("Danville"), a
franchisee of the Company operating two Big Apple Bagels stores
in northern California, for a purchase price of approximately
$603,000. The acquired stores are currently operated as Company-
owned Big Apple Bagels units.
4. Preferred Stock - Series A Convertible Preferred Stock
In April 1997 the Company completed the sale of 87,710 shares of
$25.00 Series A Convertible Preferred Stock (the "Preferred
Stock") in a private placement to qualified investors. The
Preferred Stock carries an 8% annual dividend payable in cash or,
at the option of the Company, in shares of Holdings common stock
("Common Stock") at the conversion rate inherent in the
convertibility feature of the security described below.
The principal terms of the Preferred Shares are as follows:
DIVIDENDS. From and after the date of issuance until the
Expiration Date (defined below), the holders of the
Preferred Shares are entitled to an annual dividend prior to
the payment of any cash dividends on the Common Stock, equal
to eight percent (8%) of $25.00 (the "Original Purchase
Price"), or $2.00 per share; provided that during a
Conversion Suspension Period (defined below), dividends will
accrue at the rate of 15% per annum, or $3.75 per share.
Such dividends are payable only when the Preferred Shares
are converted to shares of Common Stock. Payment may be in
cash or, at the option of the Company, in shares of Common
Stock at the Conversion Rate (as defined below).
LIQUIDATION, DISSOLUTION OR WINDING UP. The holders of the
Preferred Shares are entitled to be paid an amount per share
equal to the Original Purchase Price of $25.00, plus accrued
dividends, out of the assets of the Company available for
distribution to its shareholders before any payment is made
to the holders of Common Stock. After the payment of all
preferential amounts, the holders of the Preferred Shares
are not entitled to share in or receive any remaining assets
or funds available for distribution to shareholders.
VOTING. The holders of the Preferred Shares have no rights
to vote, except as may be required by law.
OPTIONAL CONVERSION. The holders of the Preferred Shares
may convert such Preferred Shares to shares of Common Stock
on or after August 1, 1997 (the "Initial Conversion Date")
until the close of business on July 31, 1999 (the
"Expiration Date"), subject to extension by a number of days
equal to the number of trading days in any Conversion
Suspension Period (defined below) during the period prior to
the Expiration Date. Each Preferred Share is convertible
into such number of fully paid and nonassessable shares of
Common Stock as is determined by dividing the Original
Purchase Price by the lesser of $5.64 or 85% of the average
closing bid price of the Common Stock for the 30 trading
days immediately preceding the Conversion Date (as so
determined, the "Conversion Rate").
CONVERSION SUSPENSION. A Conversion Suspension Period takes
effect if, at any time on or after the later of
(i) September 15, 1997, or (ii) the date which is 30 trading
days following the date a registration statement for the
conversion Common Stock is declared effective by the
Securities and Exchange Commission, the closing bid price of
the Common Stock is less than $2.325 for 30 consecutive
trading days. The Conversion Suspension Period continues
until the first trading day thereafter that the closing bid
price for the Common Stock has exceeded $2.325 for 30
consecutive trading days; provided, however, that a
Conversion Suspension Period shall not continue for more
than sixty (60) days in any period of 365 days. The Company
is not required to recognize or accept any conversion of
Preferred Shares during a Conversion Suspension Period.
During any Conversion Suspension Period, the Company, at its
option, may redeem any or all of the Preferred Shares by
payment to the holders of $28.75 per share, plus all accrued
and unpaid dividends.
5. Preferred Stock Dividend Accumulated
Preferred dividends in the amount of $375,000 accumulated during
the period, which included $194,000 attributable to the 15%
discount available to holders of the Preferred Stock in acquiring
Common Stock upon ultimate conversion. Such discounts are
recognized as dividends under generally accepted accounting
principles. The total discount which was treated as a dividend
was recognized over the minimum period from issuance to the first
date of convertibility which was August 1, 1997. During second
quarter 1997 the Company previously recorded preferred dividends
of $193,000 related to this discount. As fully recognized at
August 31, 1997, no additional preferred dividends will
accumulate related to this conversion discount. The Company was
additionally obligated to issue warrants to purchase two shares
of Common Stock for each share of Preferred Stock on August 1,
1997. The value of these two-year warrants was additionally
recorded as a preferred stock dividend accumulated of $138,000.
The preferred dividend accumulated which is attributable to the
conversion discount is a non-cash entry which had no impact on
operating income or total equity of the Company. Upon issuance
of the Preferred Stock, the total of $387,000 representing the
conversion discount was recorded as additional paid-in capital.
As the dividend was accumulated during the period prior to
convertibility, the dividend was recorded as a reduction in
retained earnings and an increase in the preferred stock carrying
value.
6. Line of Credit Agreement
In April 1997, the Company entered a $2 million line of credit
agreement with a bank expiring in October 1998. Maximum
borrowing under the line is limited to a borrowing base of 80% of
accounts receivable under 90 days and 40% of equipment costs.
Interest is payable monthly at prime plus one percent (currently
9.5%), with principal due upon the maturity of the note in
October 1998. At August 31, 1997, the Company had approximately
$1,421,000 outstanding under this agreement, including $330,000
representing the conversion of remaining bank debt assumed in the
MFM acquisition noted above, to this credit facility.