<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 18, 1998
REGISTRATION NO. 333-43111
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
KRAUSE'S FURNITURE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 5710 77-0310773
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYEE
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
200 NORTH BERRY STREET, BREA
CALIFORNIA 92821-3903
(714) 990-3100
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
PHILIP M. HAWLEY
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
KRAUSE'S FURNITURE, INC.
200 NORTH BERRY STREET
BREA, CALIFORNIA 92821-3903
(714) 990-3100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES OF ALL COMMUNICATIONS TO BE SENT TO:
<TABLE>
<S> <C>
JUDITH OLSON LASKER, ESQ. STEVEN D. PIDGEON, ESQ.
KRAUSE'S FURNITURE, INC. MICHAEL B. MALEDON, ESQ.
200 NORTH BERRY STREET, SNELL & WILMER LLP
BREA, CALIFORNIA 92821-3903 ONE ARIZONA CENTER
714-990-3100 PHOENIX, ARIZONA 85004-0000
AND 602-382-6000
MICHAEL J. CONNELL, ESQ.
MORRISON & FOERSTER LLP
555 WEST FIFTH STREET
LOS ANGELES, CALIFORNIA 90013-1024
213-892-5200
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this registration statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<S> <C> <C> <C> <C>
=========================================================================================================================
TITLE OF EACH CLASS OF AMOUNT OF
SECURITIES AMOUNT TO BE PROPOSED MAXIMUM OFFERING PROPOSED MAXIMUM AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED(1) PRICE PER UNIT(1) OFFERING PRICE(1) FEE(1)(2)
- -------------------------------------------------------------------------------------------------------------------------
Common Stock, par value
$.001..................... 4,500,000 shares $3.00 $13,500,000 $3,982.50
=========================================================================================================================
</TABLE>
(1) Estimated solely for purpose of calculating the amount of the registration
fee, based on the average of the high and low prices for the Common Stock as
reported on the Nasdaq SmallCap Market on December 18, 1997 in accordance
with Rule 457(c) under the Securities Act of 1933.
(2) Includes $3,540 already paid.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES
MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE
REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR
SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH
OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR
QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION DATED FEBRUARY 18, 1998
PROSPECTUS
4,500,000 SHARES
[KRAUSE'S LOGO]
COMMON STOCK
------------------------
Of the 4,500,000 shares of common stock, par value $.001 per share (the
"Common Stock"), offered hereby, 2,403,889 shares are being offered by Krause's
Furniture, Inc. (the "Company") and 2,096,111 shares are being offered by a
stockholder of the Company (the "Selling Stockholder"). The Company will not
receive any of the proceeds from the sale of shares by the Selling Stockholder.
See "Principal and Selling Stockholders." The Common Stock is quoted on the
Nasdaq SmallCap Market under the symbol "SOFA." On February , 1998, the last
reported sale price of the Common Stock, as quoted on the Nasdaq SmallCap Market
was $ . See "Price Range of Common Stock." The Company has applied to
list the Common Stock on the American Stock Exchange under the symbol "KFI."
This listing is expected to be effective prior to completion of the offering, at
which time the Common Stock will be withdrawn from the Nasdaq SmallCap Market.
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS," BEGINNING ON PAGE 9.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
================================================================================
<TABLE>
<CAPTION>
PROCEEDS TO
SELLING
PRICE TO PLACEMENT AGENT PROCEEDS TO STOCKHOLDER
PUBLIC FEES(1) COMPANY(2)(3) (2)
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------
Per Share.................... $ $ $ $
- ------------------------------------------------------------------------------------------------------
Total........................ $ $ $ $
======================================================================================================
</TABLE>
(1) The Common Stock is being offered on an all or none basis by the Company and
the Selling Stockholder primarily to selected institutional investors.
Cruttenden Roth Incorporated, Black & Company, Inc. and Morgan Fuller
Capital Group, LLC (the "Placement Agents") have been retained to act, on a
best efforts basis, as exclusive agents for the Company and the Selling
Stockholder in connection with the arrangement of this transaction. The
Company and the Selling Stockholder have agreed to pay the Placement Agents
a fee in connection with the arrangement of this transaction and the Company
has agreed to reimburse the Placement Agents for certain out-of-pocket
expenses. The Company and the Selling Stockholder have agreed to indemnify
the Placement Agents against certain liabilities, including liabilities
under the Securities Act of 1933, as amended (the "Securities Act"). See
"Plan of Distribution."
(2) The termination date of the offering is March 31, 1998, subject to extension
by mutual agreement of the Company, the Selling Stockholder and the
Placement Agents, but in no event later than , 1998. Prior to
the closing date of this best efforts, all or nothing offering, all investor
funds will promptly be placed in escrow with Imperial Trust Company, as
escrow agent for funds collected in connection with the offering (the
"Escrow Agent"), in an escrow account established for the benefit of the
investors. The Escrow Agent will invest such funds in accordance with Rule
15c2-4 promulgated under the Exchange Act. On the closing date, which will
occur after receipt of notice from the Escrow Agent that investors have
affirmed purchase of the Common Stock and deposited the requisite funds in
the full amount of this offering in the escrow account, the Company and the
Selling Stockholder will deliver the shares of Common Stock to be credited
to the accounts of the investors and will collect the investor funds from
the Escrow Agent. It is anticipated that the closing date will occur three
days after pricing, but it may occur at any time up to the termination date.
In the event that investor funds are not received in the full amount of the
Common Stock offered hereby, all funds deposited with the Escrow Agent will
be returned promptly to the investors and their proportionate share of
interest earned on the funds they deposited with the Escrow Agent will be
returned promptly after the fourth business day of the month immediately
following the month in which the offering is terminated. See "Plan of
Distribution."
(3) Before deducting expenses payable by the Company estimated at $ .
CRUTTENDEN ROTH
INCORPORATED
BLACK & COMPANY, INC.
MORGAN FULLER CAPITAL GROUP, LLC
THE DATE OF THIS PROSPECTUS IS FEBRUARY , 1998
<PAGE> 3
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus. Unless otherwise indicated, references to the
"Company" are to Krause's Furniture, Inc. and its wholly owned subsidiaries.
This Prospectus contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including statements
regarding (i) the anticipated performance of the Company's new management team,
(ii) the effect of the Company's remodeling and expansion program, (iii) the
Company's efforts to improve efficiency, (iv) the Company's intention to
capitalize on its brand names to increase sales and market share, and (v) the
Company's efforts to improve its financial performance. These statements involve
risks and uncertainties and actual results could differ materially from those
discussed in the forward-looking statements as a result of certain of the
factors set forth in "Risk Factors" and for the reasons described elsewhere in
this Prospectus. All forward-looking statements and reasons why results may
differ included in this Prospectus are made as of the date hereof, and the
Company assumes no obligation to update any such forward-looking statement or
reason why actual results might differ.
THE COMPANY
The Company is a leading vertically integrated manufacturer and retailer of
custom-crafted upholstered furniture and accessories. The Company operates 81
furniture showrooms under the Krause's (67 showrooms) and Castro Convertibles
(14 showrooms) brand names in 12 states, with 40 of those showrooms in
California and 13 in the New York City metropolitan area, including 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 it has
developed a reputation for delivering high quality, custom-crafted upholstered
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 approach with updated styles and
fabrics offering greater appeal to its customer base.
RECENT DEVELOPMENTS
In the spring of 1996, General Electric Capital Corporation ("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, a 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 debt and equity in the Company. The Company hired
new executives with retail experience and Mr. Hawley became its Chairman and
Chief Executive Officer.
Under the leadership of Mr. Hawley, the Company has embarked on a major
remodeling and expansion 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 18 existing showrooms, 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 Krause's showrooms. The Company
plans to remodel approximately 24 additional showrooms in fiscal 1998. 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 budgetary
controls, consolidating selling, general and administrative
2
<PAGE> 4
expenses and cutting costs, including revising its sales commission structure.
Although results are preliminary, these new strategies, combined with improved
economies in selected regions where the Company operates, are beginning to show
positive financial results. For the nine months ended November 2, 1997,
same-store sales (for showrooms opened a year or more) increased 4.3% compared
to the nine-month period ended October 27, 1996, with remodeled store sales
exceeding management's goal of 25%. In addition, gross profit increased from
48.8% to 51.1% of net sales in the first nine months of fiscal 1997 compared to
the same period in fiscal 1996. Since the management change, the Company has
also opened one new showroom featuring its new showroom design and has plans to
open approximately 20 showrooms in fiscal 1998.
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. According to the
American Furniture Manufacturers Association, the domestic residential furniture
industry was estimated to generate $21 billion in shipments in 1997 up from
approximately $20 billion in 1996 and is expected to increase 4.2% to $21.9
billion in 1998. Upholstered furniture accounted for approximately $8.4 billion
in shipments in 1996 according to the American Furniture Manufacturers
Association.
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 ratios are positioned to increase market share.
The Company believes it possesses a number of strengths that enable it to
compete effectively in its markets and that should help it gain market share,
including the following:
- Reputation for Value and Selection; Brand Names. The Company believes it
has attained a reputation for high quality, custom-crafted furniture at
prices comparable to those of mass-produced, sold-as-shown furniture.
Over 25 and 65 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.
- New, Experienced Management Team. The Company has recently 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.
- 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 control the introduction of new products and to capture
profits at both the manufacturing and retail level, with minimal
inventory risk because the manufacturing process does not begin until a
customer places an order. Further, the Company can use the available
capacity of its manufacturing facility to accommodate planned sales
growth.
- Well Located Retail Distribution Network. As of November 30, 1997, the
Company operated 81 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
3
<PAGE> 5
customers and from comparison shopping, typically by shoppers who compare
Company products to those of sold-as-shown retailers or premium-priced
custom manufacturers.
- 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 budgetary 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 improvement,
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 will seek to achieve these objectives
through the following strategies:
- Remodel Existing Showrooms. The Company has embarked upon 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. Plans call for remodeling
approximately 65 showrooms which will incorporate the new layout, design
and visual presentation themes. To date, the Company has remodeled 18
showrooms and expects to remodel approximately 24 more showrooms by the
end of the 1998 fiscal year.
- 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 between 40 to 50 opportunities to open showrooms in existing
markets. To date, the Company has opened one new showroom and expects to
open approximately 20 more showrooms by the end of the 1998 fiscal year.
- Relocate Under Performing Showrooms. The Company estimates that it has
between 10 and 15 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.
- 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 has changed the name it does business under from
Krause's Sofa Factory to Krause's Custom Crafted Furniture and has
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.
- Develop New Products; Increase Sales of Complementary Products. The
Company has put in place a new product development program, which will
accomplish a freshening of showroom inventories and introduce a number of
new styles designed to increase its appeal to customers; during the
fiscal year 1997, the Company introduced eight new sofa styles. 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 intends to increase 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. During fiscal 1996, accessories, custom-made chairs and
recliners accounted for 2%, 4%, and 8%, respectively, of the Company's
sales compared to the industry average (reported by
4
<PAGE> 6
the October 1997 issue of retail Ideas, a publication of Furniture/Today)
of 12%, 10%, and 17%, respectively. These additional merchandise
classifications will broaden the Company's offerings and should increase
sales per square foot.
- 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 plans to leverage this strong brand awareness by
adding a Castro Convertibles gallery in all of its Krause's remodeled and
new showrooms.
- Increase Showroom Productivity. For the year ended February 2, 1997, the
Company's sales per square foot of selling space averaged $112. To
further increase showroom productivity, the Company intends gradually to
reduce 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.
The Company's executive offices are located at 200 North Berry Street,
Brea, California 92821-3903; its telephone number is 714-990-3100, and its
facsimile number is 714-990-3561. The Company was incorporated in Delaware in
1992. The Company's Common Stock is currently traded in the Nasdaq SmallCap
Market under the symbol "SOFA". The Company has applied to list the Common Stock
on the American Stock Exchange under the symbol "KFI." It is expected that this
listing will be effective prior to completion of this offering.
5
<PAGE> 7
THE OFFERING
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Common Stock Offered by the Company......................... 2,403,889 shares
Common Stock Offered by the Selling Stockholder............. 2,096,111 shares
Common Stock to be Outstanding After the Offering........... 21,424,428 shares(1)
Use of Proceeds(1).......................................... To remodel showrooms, to open
new showrooms and for working
capital and other general
corporate purposes
American Stock Exchange Symbol.............................. KFI
</TABLE>
- ---------------
(1) Based upon the number of shares outstanding on January 30, 1998,
excluding 5,147,740 shares of Common Stock issuable upon exercise of
outstanding options, deferred stock units and warrants. See
"Description of Capital Stock."
RISK FACTORS
An investment in the Common Stock involves various risks, and investors
should consider carefully the matters discussed under "Risk Factors." Among the
significant risks are the following: the Company has reported losses from
operations in each of the last five years, expects to incur a loss in the
current fiscal year, and has a significant working capital deficiency; the
Company may violate covenants in its loan agreements and be unable to obtain a
waiver, which could restrict its ability to raise additional capital; the
Company depends on a small number of suppliers, and disruptions in delivery of
supplies have occasionally affected and could in the future adversely affect the
Company; and future performance of the Company is substantially dependant upon
the success of its remodeling and expansion program.
6
<PAGE> 8
SUMMARY CONSOLIDATED FINANCIAL DATA
The following data as of February 2, 1997 and January 28, 1996 and for each
of the three years in the period ended February 2, 1997 and for the month ended
January 29, 1995 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 December 31, 1994 and for the
year then ended has been derived from audited consolidated financial statements
not included herein. The following data as of and for the nine-month periods
ended November 2, 1997 and October 27, 1996, and for the month ended January 30,
1994, is unaudited. This summary data should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED FISCAL YEAR ENDED MONTH ENDED
------------------------- ---------------------------------------- -------------------------
NOVEMBER 2, OCTOBER 27, FEBRUARY 2, JANUARY 28, DECEMBER 31, JANUARY 29, JANUARY 30,
1997 1996 1997(4) 1996(4) 1994 1995(4)(5) 1994(5)
----------- ----------- ----------- ----------- ------------ ----------- -----------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Results of
Operations:
Net sales......... $85,569 $ 82,738 $ 112,737 $ 122,319 $116,471 $ 7,179 $ 7,326
Gross profit...... 43,729 40,374 56,247 62,467 62,949 3,532 3,807
Selling, general
and
administrative
expense......... 48,103 52,173 68,694 71,855 65,347 6,763 5,848
Loss from
operations...... (4,374) (11,799) (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........... (5,609) (12,374) (13,389) (8,715) 5,831 (3,221) (2,185)
Extraordinary
items(3)........ -- -- -- -- (436) -- --
Net income
(loss).......... (5,609) (12,374) (13,389) (8,715) 5,395 (3,221) (2,185)
Income (loss) per
share(1):
Income (loss)
before
extraordinary
items......... (.30) (1.62) (1.28) (2.21) 1.08 (.87) (.63)
Extraordinary
items......... -- -- -- -- (0.08) -- --
Net income
(loss)..... $ (.30) $ (1.62) $ (1.28) $ (2.21) $ 1.00 $ (0.87) $ (.63)
Number of shares
used in
computing income
(loss) per
share(1)........ 19,021 7,661 10,445 3,950 5,394 3,685 3,490
</TABLE>
<TABLE>
<CAPTION>
NOVEMBER 2, OCTOBER 27, FEBRUARY 2, JANUARY 28, DECEMBER 31,
1997 1996 1997 1996 1994
----------- ----------- ----------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total assets.......... $43,484 $47,402 $43,087 $46,866 $ 51,240
Current assets........ 18,081 20,339 17,553 18,602 21,784
Current liabilities... 19,262 24,135 19,735 25,480 23,732
Long-term debt(2)..... 11,073 5,260 6,306 5,584 89
Stockholders'
equity.............. 11,012 16,265 15,543 13,985 25,921
</TABLE>
7
<PAGE> 9
- ---------------
(1) Previously reported share and per share amounts have been restated to
reflect a one-for-three reverse stock split effected August 1, 1995.
(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 and the fiscal year
ended January 28, 1996 is a 52-week period.
(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.
8
<PAGE> 10
RISK FACTORS
In addition to the other information in this Prospectus, investors should
carefully consider the following risk factors in evaluating an investment in the
Common Stock offered hereby. This Prospectus contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including statements regarding (i) the anticipated performance of the Company's
new management team, (ii) the effect of the Company's remodeling and expansion
program, (iii) the Company's efforts to improve efficiency, (iv) the Company's
intention to capitalize on its brand name to increase sales and market share,
and (v) the Company's efforts to improve its financial performance. These
statements involve risks and uncertainties and actual results could differ
materially from those discussed in the forward-looking statements as a result of
certain of the risk factors set forth below and for the reasons described
elsewhere in this Prospectus. All forward-looking statements and reasons why
results may differ included in this Prospectus are made as of the date hereof,
and the Company assumes no obligation to update any such forward-looking
statement or reason why actual results might differ.
LACK OF PROFITABLE OPERATIONS; ACCUMULATED AND WORKING CAPITAL DEFICITS
The Company has reported losses from operations in each of the past five
years and for the thirty-nine week period ended November 2, 1997. The Company
had an accumulated deficit of $40.0 million at November 2, 1997. 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 and increase the risks of owning shares of Common Stock. At November
2, 1997, the Company had a working capital deficiency of approximately $1.2
million and current liabilities at November 2, 1997 were $19.3 million. In
future periods the Company will dedicate a substantial portion of the net cash
provided by operations to these working capital deficiencies and to repay
indebtedness. There can be no assurance that the Company will achieve
profitability or overcome its deficits.
CAPITAL REQUIREMENTS; RESTRICTIONS ON COMPANY'S ABILITY TO OBTAIN ADDITIONAL
CAPITAL
Although the Company has raised approximately $22 million in private
offerings of subordinated debt and equity since August 1996, it may need more
capital in the future to finance its strategic objectives if borrowings under
the Company's revolving and standby credit facilities and internally generated
cash are insufficient. The Company expects its existing capital resources,
borrowings under its revolving and standby credit facilities, internally
generated cash and proceeds from this offering will enable it to fund its plan
to remodel and upgrade approximately 24 showrooms and open approximately 20 new
showrooms during fiscal 1998 at a projected cost of approximately $7.1 million.
However, if this is not the case, the Company will need to obtain additional
capital. There can be no assurance that any additional equity or debt financing
will be available when needed or that, if available, such financing will be
obtained on terms favorable to the Company or the stockholders.
The Company's existing secured revolving credit facility provides for
borrowings of up to $10.0 million, is subject to maturity in January 2000,
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 working capital, 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
working capital deficiency and 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.
9
<PAGE> 11
LEVERAGE AND ABILITY TO SERVICE FIXED CHARGES
At November 2, 1997, the Company had $11.1 million of long-term debt and
had a negative tangible net worth (stockholders' equity less intangible assets)
of $4.9 million. For the thirty-nine weeks ended November 2, 1997, earnings
before interest, taxes, depreciation and amortization were negative $2.3
million. A high percentage of the Company's operating expenses are relatively
fixed, including approximately $1.6 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 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. From
time to time the Company has found it necessary to seek waivers and amendments
from its lenders because it could not meet financial covenants or other
restrictions in its credit agreements. The Company's future financial
performance may again fail to keep it in compliance with these covenants and
restrictions, and there can be no assurance that any waivers will be available
in the future. If the Company defaults on its obligations under any of its
indebtedness, the lenders could elect to declare all amounts borrowed, together
with accrued interest, due and payable. If the Company could not pay these
amounts, the lenders could proceed against any collateral securing those
obligations due to them. There can be no assurance that in that event, the
Company's assets securing those obligations would be sufficient to repay the
indebtedness or that there would be any assets in excess of the indebtedness to
benefit other creditors or holders of 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
10
<PAGE> 12
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. See
"Management -- Employment Agreements."
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 49% and 19%, respectively, of the Company's sales in
the nine-month period ended November 2, 1997 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 October 1997, the consumer confidence index, as reported
by the Conference Board, for the Middle Atlantic Region, which includes New
York, was 102.1, while the index for the Pacific Region, which includes
California, was 121.9, both of which are lower than the average index for the
United States as a whole, which was 123.4.
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 account for approximately 55.5% of its aggregate purchases in
the nine-month period ended November 2, 1997. During the nine-month period ended
November 2, 1997, approximately 13.1% of certain products and raw materials
purchases consisted of leather purchased from a supplier, constituting
approximately 87.2% of the leather purchases made by the Company during this
period, and approximately 8.9% 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. One of the Company's fabric
11
<PAGE> 13
suppliers has been unable to supply all of the Company's needs on a timely basis
due to unanticipated customer demand for some of its patterns. As a result,
customer orders representing approximately $1,000,000 in sales were not
completed as expected in the fourth quarter of fiscal year 1997. The Company is
likely to recoup most of these sales in the subsequent period but some sales may
be lost due to customer cancellations. Similarly, 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, 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."
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.
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. 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, because
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 markets, 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.
CONTROL BY PRINCIPAL STOCKHOLDERS
The current management, directors and other principal stockholders of the
Company own in the aggregate approximately 70.5% 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
12
<PAGE> 14
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. See "Certain Transactions"
and "Description of Capital Stock -- Stockholders Agreement." It is unlikely
that any principal stockholder or group of public stockholders acting in concert
would be in the position to 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 February 2, 1997, the Company had approximately $30 million of
federal net operating loss carryforwards, which were estimated to be
approximately $32 million prior to filing of the Company's tax return for fiscal
1996, 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 November 2, 1997 and contemplated by
this offering, the Company will have 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 RISK DURING ESCROW PERIOD
Investors in the Common Stock will deposit funds in an escrow account
shortly after the pricing of this offering. The market price of the Common Stock
may change between the time of pricing and the delivery of the Common Stock at
the close of the escrow account. During this period, which is anticipated to be
approximately three days but may be as long as days under the terms of
the Placement Agency Agreement and the Escrow Agreement, investors will bear the
risk of a decrease in the market price of the Common Stock, as if the purchase
had been consummated at the time of pricing. If this offering is not consummated
because the full purchase price of the offering is not tendered into the escrow
account, then the Escrow Agent will promptly return funds to the investors and
will return a proportionate share of their interest earned during the time the
funds were held in escrow after the fourth business day of the month immediately
following the month in which the offering is terminated. See "Plan of
Distribution."
MARKET FOR THE COMPANY'S COMMON STOCK; POTENTIAL VOLATILITY OF STOCK PRICE
The Company's Common Stock has been reported and traded on the Nasdaq
SmallCap Market, and the Company intends to list its shares on the American
Stock Exchange. Nevertheless, 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, the announcement
of new products or product enhancements by the Company or its competitors 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.
13
<PAGE> 15
MAINTAINING LISTING ON AMERICAN STOCK EXCHANGE
The Company intends to list its shares for trading on the American Stock
Exchange prior to the consummation of this offering. 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.
POTENTIAL ADVERSE MARKET IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock in the public
market following this offering could adversely affect the market price for the
Common Stock. Upon completion of this offering, the Company will have 21,424,428
shares of Common Stock outstanding. Of these shares, 8,536,154 shares are freely
tradeable without restriction or further registration under the Securities Act
of 1933, as amended (the "Securities Act"). The remaining 12,888,274 shares are
"restricted securities," as that term is defined under Rule 144 under the
Securities Act. In general, under Rule 144 as currently in effect, a person who
has beneficially owned restricted securities for at least one year, including
persons who may be deemed "affiliates" of the Company, would be entitled to sell
within any three-month period a number of securities that does not exceed the
greater of 1% of the number of shares of Common Stock then outstanding or the
average weekly trading volume of the Common Stock during the four calendar weeks
preceding the date of such sale. In addition, a person who has not been an
"affiliate" of the Company at any time during the 90 days preceding a sale and
who has beneficially owned the securities proposed to be sold for at least two
years would be entitled to sell such securities under Rule 144 without regard to
the foregoing limitation. Upon completion of the offering, executive officers,
directors and certain stockholders of the Company, who will beneficially own
9,625,329 shares of Common Stock in the aggregate, have agreed not to offer,
sell, contract to sell, or otherwise dispose of, any shares of Common Stock for
a period of 120 days, after the date of the Prospectus without prior written
consent of Cruttenden Roth Incorporated.
In addition to the shares of Common Stock currently outstanding, the
Company also has outstanding options, warrants, and deferred stock units to
purchase an aggregate of 5,147,740 shares of Common Stock. In connection with
prior financings and subject to future contingencies, warrants to purchase an
additional 1,000,000 shares of Common Stock may become issued by the Company.
See "Description of Capital Stock" and "Certain Transactions."
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
14
<PAGE> 16
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
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.
DILUTION
Purchasers of the shares of Common Stock offered hereby will experience
immediate and substantial dilution in the net tangible book value of their
investment from the offering price. Additional dilution will occur upon exercise
of outstanding options or warrants. See "Dilution."
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.
15
<PAGE> 17
USE OF PROCEEDS
The net proceeds from the sale of the 2,403,889 shares of Common Stock
offered by the Company hereby is estimated to be $ (after deducting the
Placement Agents' fees and the estimated offering expenses). The principal
purpose of this offering is to fund the remodeling of existing showrooms, to
fund the opening of new showrooms and for other general corporate purposes.
Projected capital expenditures in 1998 to remodel approximately 24 existing
showrooms and to open approximately 20 new showrooms, which will be leased, is
$7.1 million. Pending the application of the net proceeds, the Company intends
to pay down its secured revolving credit notes, which bear a current interest
rate of 9.5%.
The Company will not receive any of the net proceeds from the sale of
Common Stock being offered by the Selling Stockholder.
DIVIDEND POLICY
The Company has never declared or paid dividends on its Common Stock and
anticipates that all earnings will be retained for use in its business. The
payment of any future dividends will be at the discretion of the Board of
Directors and will continue to be subject to certain 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 such lenders.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock trades on the Nasdaq Small-Cap Market under the
ticker symbol SOFA. The following table sets forth the high and low prices for
the Company's Common Stock for the first three quarters during the 1997 fiscal
year and for the fourth quarter through January 30, 1998 (the last trading day
of the fourth fiscal quarter) and for each quarter during the 1996 (53 weeks
ended February 2, 1997) and 1995 (52 weeks ended January 28, 1996) fiscal years.
Quotations are as reported by Nasdaq, adjusted for periods prior to August 1,
1995 to reflect a one for three reverse stock split, effective on that date.
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
QUARTER HIGH LOW HIGH LOW HIGH LOW
--------------------------- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
First...................... $2.06 $1.25 $2.56 $ .88 $6.75 $4.87
Second..................... 1.81 1.48 1.63 .69 6.37 3.00
Third...................... 4.19 1.50 2.19 .50 4.37 2.00
Fourth..................... 3.25 2.13 2.13 1.00 3.00 1.63
</TABLE>
As of February 10, 1998, there were approximately 360 holders of record of
the Company's Common Stock.
The Company intends to list its shares on the American Stock Exchange prior
to the consummation of this offering and cease trading of its shares on the
Nasdaq Small-Cap Market.
16
<PAGE> 18
DILUTION
As of November 2, 1997, the net tangible book value per share of the
Company's Common Stock was negative $.26. Net tangible book value per share
represents the amount of the Company's tangible assets, less the amount of its
liabilities, divided by the number of shares of Common Stock outstanding.
After giving effect to the issuance of the 2,403,889 shares of Common Stock
offered hereby at an offering price of $ per share and after deduction
of the Placement Agents' fees and the estimated offering expenses payable by the
Company, and the receipt of the proceeds therefrom and assuming no exercise of
any outstanding stock options or warrants, the net tangible book value per share
of Common Stock as of November 2, 1997 would have been $ . This would
result in dilution to the new investors of $ per share, which is
greater than the public offering price. The following table illustrates the per
share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share(1)................................. $
Net tangible book deficit per share as of November 2, 1997......... $(.26)
Decrease in net tangible deficit per share attributable to the sale
by the Company of the shares offered hereby......................
Pro forma net tangible book deficit per share after the
offering(2)......................................................
----
Dilution of net tangible book value per share to new investors..... $
====
</TABLE>
- ---------------
(1) Before deducting the Placement Agents' fees and estimated offering expenses
to be paid by the Company.
(2) Assumes no exercise of the warrants or options to purchase Common Stock that
were outstanding at November 2, 1997. Outstanding options, all of which were
issued under option plans prior to November 2, 1997, cover the purchase of
an aggregate of 2,043,958 shares at a weighted average exercise price of
$1.29. If these options are exercised, they will be dilutive to the
Company's stockholders, including the new investors. Outstanding warrants
include warrants to purchase an aggregate of 3,065,502 shares at an average
exercise price of $1.10. If these warrants are exercised, they will be
dilutive to the Company's shareholders, including the new investors.
Giving effect to the exercise of all warrants and options referenced, with
the exception of anti-dilutive warrants and options, the adjusted net tangible
book value per share of the Common Stock as of November 2, 1997 after the
offering would have been $ . This would result in dilution to the new
investors of $ per share.
17
<PAGE> 19
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
November 2, 1997, and as adjusted to give effect to the sale of 2,403,889 shares
of Common Stock offered by the Company and the application of net proceeds
therefrom. See "Use of Proceeds." The table should be read in conjunction with
the consolidated financial statements and notes thereto included elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
NOVEMBER 2, 1997
------------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Current portion of notes payable.............................. $ 41 $ 41
Long-term notes payable:
Secured revolving credit notes.............................. 4,094 --
Subordinated notes payable to stockholders, net of $1,884 of
unamortized debt discount................................ 6,617 6,617
Other notes, excluding current portion...................... 362 362
-------- --------
Total long-term notes payable............................ 11,114 7,020
-------- --------
Stockholders' equity:
Preferred stock, $.001 par value; 666,667 shares authorized,
no shares outstanding.................................... -- --
Common stock, $.001 par value; 35,000,000 shares authorized,
19,020,539 shares outstanding (21,424,428 shares
outstanding as adjusted)(1).............................. 19 21
Capital in excess of par value.............................. 50,952
Accumulated deficit......................................... (39,959) (39,959)
-------- --------
Total stockholders' equity............................... 11,012
-------- --------
Total capitalization..................................... $ 22,167 $
======== ========
</TABLE>
- ---------------
(1) Excludes 2,043,958 shares issuable upon exercise of options, 3,065,502
shares issuable upon exercise of warrants and 38,280 shares issuable
pursuant to deferred stock rights. See "Description of Capital Stock."
BACKGROUND OF THE COMPANY
The Company is a combination of two pre-existing furniture manufacturing
and retailing businesses. Krause's Custom Crafted Furniture Corp., formerly
known as Krause's Sofa Factory ("Krause's"), was started in San Diego,
California in 1973. In April 1991, the Company acquired a controlling interest
in Krause's, and in October 1993, the Company acquired the remaining minority
interest in Krause's.
Castro Convertible Corporation, which was started in 1931, has developed a
reputation throughout the East Coast for its quality sofabed products and was an
early pioneer in developing the tri-fold sofabed mechanism. The Company acquired
certain assets related to the retail operations of Castro Convertible
Corporation including the "Castro Convertibles" tradename and trademark and
retail store locations in May 1993.
18
<PAGE> 20
SELECTED CONSOLIDATED FINANCIAL DATA
The following data as of February 2, 1997 and January 28, 1996 and for each
of the three years in the period ended February 2, 1997 and for the month ended
January 29, 1995 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 December 31, 1994, 1993 and 1992
and for each of the two years in the period ended December 31, 1993 have been
derived from audited consolidated financial statements not included herein. The
following data as of and for the nine-month periods ended November 2, 1997 and
October 27, 1996, and for the month ended January 30, 1994, is unaudited. This
summary data should be read in conjunction with the consolidated financial
statements and notes thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
THIRTY-NINE
WEEKS ENDED FISCAL YEAR ENDED
------------------------ ------------------------------------------------------------------
NOVEMBER 2, OCTOBER 27, FEBRUARY 2, JANUARY 28, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1997(4) 1996(4) 1994 1993 1992
----------- ----------- ----------- ----------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Results of Operations:
Net sales................... $ 85,569 $ 82,738 $ 112,737 $ 122,319 $116,471 $ 96,894 $ 87,045
Gross profit................ 43,729 40,374 56,247 62,467 62,949 50,792 45,688
Selling, general and
administrative expense.... 48,103 52,173 68,694 71,855 65,347 58,644 51,670
Loss from operations........ (4,374) (11,799) (12,447) (9,388) (2,398) (7,852) (5,982)
Gain from sale of Mr. Coffee
stock(2).................. -- -- -- -- 12,115 -- --
Income (loss) before
extraordinary items....... (5,609) (12,374) (13,389) (8,715) 5,831 (9,751) (3,641)
Extraordinary items(3)...... -- -- -- -- (436) (221) 3,330
Net income (loss)........... (5,609) (12,374) (13,389) (8,715) 5,395 (9,972) (311)
Income (loss) per share(1):
Income (loss) before
extraordinary items....... (.30) (1.62) (1.28) (2.21) 1.08 (3.88) (1.84)
Extraordinary items....... -- -- -- -- (0.08) (0.09) 1.68
Net income (loss)......... $ (.30) $ (1.62) $ (1.28) $ (2.21) $ 1.00 $ (3.97) $ (0.16)
Number of shares used in
computing income (loss)
per share(1).............. 19,021 7,661 10,445 3,950 5,394 2,510 1,982
<CAPTION>
MONTH ENDED
------------------------
JANUARY 29, JANUARY 30,
1995(4)(5) 1994(5)
----------- -----------
<S> <C> <C>
Results of Operations:
Net sales................... $ 7,179 $ 7,326
Gross profit................ 3,532 3,807
Selling, general and
administrative expense.... 6,763 5,848
Loss from operations........ (3,231) (2,041)
Gain from sale of Mr. Coffee
stock(2).................. -- --
Income (loss) before
extraordinary items....... (3,221) (2,185)
Extraordinary items(3)...... -- --
Net income (loss)........... (3,221) (2,185)
Income (loss) per share(1):
Income (loss) before
extraordinary items....... (.87) (.63)
Extraordinary items....... -- --
Net income (loss)......... $ (0.87) $ (.63)
Number of shares used in
computing income (loss)
per share(1).............. 3,685 3,490
</TABLE>
<TABLE>
<CAPTION>
NOVEMBER 2, OCTOBER 27, FEBRUARY 2, JANUARY 28, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1997 1996 1994 1993 1992
----------- ----------- ----------- ----------- ------------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet
Data:
Total assets... $43,484 $47,402 $43,087 $46,866 $ 51,240 $ 64,749 $ 47,730
Current
assets....... 18,081 20,339 17,553 18,602 21,784 24,081 16,405
Current
liabilities... 19,262 24,135 19,735 25,480 23,732 25,485 20,008
Long-term
debt(2)...... 11,073 5,260 6,306 5,584 89 17,700 15,500
Stockholders'
equity....... 11,012 16,265 15,543 13,985 25,921 20,626 11,170
</TABLE>
- ---------------
(1) Previously reported share and per share amounts have been restated to
reflect a one-for-three reverse stock split effected August 1, 1995.
(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 gain or 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 and the fiscal year
ended January 28, 1996 is a 52-week period.
(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.
19
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto included elsewhere in this
Prospectus. This Prospectus contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding (i) the anticipated performance of the Company's new
management team, (ii) the effect of the Company's remodeling and expansion
program, (iii) the Company's efforts to improve efficiency, (iv) the Company's
intention to capitalize on its brand names to increase sales and market share,
and (v) the Company's efforts to improve its financial performance. These
statements involve risks and uncertainties and actual results could differ
materially from those discussed in the forward-looking statements as a result of
certain factors, including but not limited to the reasons discussed in "Risk
Factors" and elsewhere in this Prospectus.
The Company has reported losses from operations in each of the past five
fiscal years and for the thirty-nine weeks ended November 2, 1997 due to
inefficiencies within its operations and due to an industry-wide softness in
retail sales. As a result of such losses, the Company had an accumulated deficit
of $39,959,000 and a working capital deficiency of $1,181,000 at November 2,
1997. The Company expects to incur a net loss in its fourth quarter of 1997.
The Company's management, which underwent a substantial restructuring after
the 1996 financings, discussed below under "Liquidity and Capital Resources,"
has developed a strategic plan for the business which provides, among other
things, for remodeling existing showrooms to provide a more appealing setting
for customers, adding new showrooms in existing markets, 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. Many
of these plans were implemented since the latter part of fiscal 1996 and are
expected to contribute significantly to reducing losses and ultimately returning
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 1998. 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.
20
<PAGE> 22
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.
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED FISCAL YEAR ENDED MONTH ENDED
------------------------- ---------------------------------------- -------------------------
NOVEMBER 2, OCTOBER 27, FEBRUARY 2, JANUARY 28, DECEMBER 31, JANUARY 29, JANUARY 30,
1997 1996 1997 1996 1994 1995 1994
----------- ----------- ----------- ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales....................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales................... 48.9 51.2 50.1 48.9 46.0 50.8 48.0
------ ------ ------ ------ ------ ------ ------
Gross profit.................... 51.1 48.8 49.9 51.1 54.0 49.2 52.0
Operating expenses:
Selling....................... 47.4 52.7 51.1 49.3 45.9 75.9 67.4
General and administrative.... 7.9 9.5 9.0 8.7 9.3 17.1 11.3
Amortization of goodwill...... 0.9 0.9 0.9 0.8 0.9 1.2 1.2
------ ------ ------ ------ ------ ------ ------
56.2 63.1 61.0 58.8 56.1 94.2 79.9
------ ------ ------ ------ ------ ------ ------
Loss from operations............ (5.1) (14.3) (11.1) (7.7) (2.1) (45.0) (27.9)
Interest expense................ (1.4) (0.9) (1.1) (0.6) (1.8) (0.2) (3.5)
Other income.................... (0.1) 0 .3 0.3 0.1 10.8 0.3 1.6
------ ------ ------ ------ ------ ------ ------
Income (loss) before income
taxes and extraordinary
items......................... (6.6) (14.9) (11.9) (8.2) 6.9 (44.9) (29.8)
Provision (benefit) for income
taxes......................... -- -- -- (1.1) 1.9 -- --
------ ------ ------ ------ ------ ------ ------
Income (loss) before
extraordinary items........... (6.6) (14.9) (11.9) (7.1) 5.0 (44.9) (29.8)
Extraordinary items............. -- -- -- -- (0.4) -- --
------ ------ ------ ------ ------ ------ ------
Net income (loss)............... (6.6)% (14.9)% (11.9)% (7.1)% 4.6% (44.9)% (29.8)%
====== ====== ====== ====== ====== ====== ======
STORE (SHOWROOM) DATA
Stores open at beginning of
period........................ 82 83 83 89 87 89 87
Stores opened during period..... 1 1 1 4 10 -- --
Stores closed during period..... 2 1 2 10 8 1 --
------ ------ ------ ------ ------ ------ ------
Stores open at end of period.... 81 83 82 83 89 88 87
Average sales per showroom(1)... $ 1,063 $ 997 $ 1,361 $ 1,432 $1,373 $ 82 $ 84
Same-store sales increase
(decrease)(2)................. 4.3% (9.9)% (6.0)% (2.9)% 11.7% (8.6)% (1.1)%
</TABLE>
- ---------------
(1) Based upon the weighted average number of stores open during the period
indicated.
(2) Same 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. A store opened at any time during the month is deemed to
have been open for the entire month.
THIRTY-NINE WEEKS ENDED NOVEMBER 2, 1997 COMPARED TO THIRTY-NINE WEEKS
ENDED OCTOBER 27, 1996
Net Sales. Net sales for the thirty-nine weeks ended November 2, 1997 were
$85,569,000 versus $82,738,000 for the comparable period of fiscal 1996, an
increase of $2,831,000 or 3.4%. The sales increase was primarily attributable to
an increase in same-store sales of 4.3% partially offset by a decrease
attributable to the operation of two fewer stores in the 1997 period. Sales for
the thirty-nine weeks ended October 27, 1996 were adversely impacted by a
shortage of raw materials, resulting from insufficient cash prior to the August
and September 1996 financings to purchase such raw materials which were required
for production and shipments.
Gross Profit. Gross profit was 51.1% of net sales for the thirty-nine weeks
ended November 2, 1997 and was 48.8% of net sales in the comparable period of
fiscal 1996. The increase in gross profit resulted primarily from increased
product prices and reduced promotional discounting.
Selling Expenses. Selling expenses were $40,558,000 or 47.4% of net sales
for the thirty-nine weeks ended November 2, 1997 and were $43,556,000 or 52.7%
of net sales in the comparable period of fiscal 1996. The decrease of $2,998,000
in selling expenses was primarily due to a decrease of $1,630,000 in variable
selling payroll, resulting from a new commission structure, and decreases of
$1,589,000 and $325,000 in store non-
21
<PAGE> 23
payroll expenses and delivery expenses, respectively, resulting primarily from
tighter cost controls offset by increased advertising costs of $824,000.
General and Administrative Expenses. General and administrative expenses
for the thirty-nine weeks ended November 2, 1997 were $6,780,000 compared to
$7,852,000, for the comparable period of fiscal 1996, a decrease of $1,072,000.
This decrease was primarily as a result of lower professional fees, contract
labor costs and computer rental and maintenance costs offset in part by higher
payroll related costs.
Interest Expense. Interest expense for the thirty-nine weeks ended November
2, 1997 increased by $395,000 over the comparable period of fiscal 1996 due to
higher average debt outstanding.
Income Taxes. The Company paid no taxes and no tax benefits were available
for either of the thirty-nine week periods of fiscal 1997 or 1996.
Net Loss. As a result of the above factors, the net loss was $5,609,000 for
the thirty-nine weeks ended November 2, 1997 as compared to a net loss of
$12,374,000 for the comparable period of fiscal 1996. Net loss per share in the
1997 period was $.30 based on 19,021,000 shares outstanding. In the comparable
1996 period the net loss per share was $1.62 based on 7,661,000 average shares
outstanding.
53 WEEKS ENDED FEBRUARY 2, 1997 (FISCAL 1996) AS COMPARED TO 52 WEEKS ENDED
JANUARY 28, 1996 (FISCAL 1995)
Net Sales. Sales were $112,737,000 in fiscal 1996, a decrease of 7.8% from
sales in fiscal 1995; same store sales decreased 6.0% between years. The sales
decrease was due to a combination of factors including (i) an industrywide
softness in retail sales, (ii) insufficient cash during the first eight months
of fiscal 1996 to timely purchase raw materials needed for the manufacture of
customer orders, and (iii) the Company's decision in the third quarter of fiscal
1996 to raise prices to competitive levels and reduce promotional discounting.
Gross Profit. Gross profit was 49.9% of net sales in fiscal 1996 as
compared to 51.1% in fiscal 1995. Lower gross profit in fiscal 1996 resulted
from extensive promotional discounting during the first half of 1996 and changes
in the mix of products sold. As noted above, the Company increased product
prices and reduced promotional discounting in the second half of fiscal 1996
which contributed to an overall improvement in gross profit from 47.1% for the
26 weeks ended July 28, 1996 to 52.7% for the 27 weeks ended February 2, 1997.
Selling Expenses. Selling expenses for fiscal 1996 were $57,573,000,
representing a decrease of $2,684,000 from fiscal 1995. Selling expenses were
51.1% of net sales in fiscal 1996 as compared to 49.3% in fiscal 1995. Selling
expenses increased as a percentage of sales primarily due to fixed showroom
expenses applied to lower sales volume. Also, commissions, delivery expenses and
advertising expenses were higher as a percentage of sales, offset in part by
certain expenses which were lower as a result of having fewer stores operating
in fiscal 1996. Showroom pre-opening expenses are a component of the Company's
selling expenses. The Company has historically capitalized these expenses and
amortized them over periods ranging from 12-24 months subsequent to the opening
of the showroom. In future periods the Company intends to amortize these
expenses for new showrooms over a period of not more than 12 months subsequent
to opening of the showroom. Management believes that had it reduced the
amortization period to a minimum of 12 months in any of the periods presented in
the consolidated financial statements, such reduction would not have had a
material effect on the Company's consolidated financial position or results of
operations.
General and Administrative Expenses. General and administrative expenses
increased as a percentage of sales from 8.7% to 9.0% due primarily to a lower
sales base in fiscal 1996; however, in total dollars, general and administrative
expenses decreased by $477,000 due principally to general cost reductions offset
somewhat by higher employee termination expenses and professional fees.
Interest Expense. Interest expense in fiscal 1996 increased by $509,000,
due principally to higher average debt outstanding compared to the prior year.
22
<PAGE> 24
Income Taxes. Income tax benefits of $1,327,000 in fiscal 1995 represent
refundable income taxes available from carryback of 1995 losses. There were no
carryback benefits recorded in fiscal 1996 and none are available in future
periods.
As of February 2, 1997, the Company has federal net operating loss
carryforwards of approximately $32 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 change of ownership as defined in the Internal
Revenue Code. As a result of these ownership changes 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 February 2, 1997, approximately $3 million of
the limited losses were available. In addition, the Company had state net
operating loss carryforwards of approximately $14 million which begin to expire
in the year 1997, if not utilized.
The valuation allowance for deferred tax assets totaled $8,310,000 at
January 28, 1996 and $13,643,000 at February 2, 1997. The valuation allowance
increased since the realization of net deferred tax assets is uncertain.
Net Loss. Although net loss in fiscal 1996 increased to $13,389,000 from
$8,715,000 in fiscal 1995, an increase of 54%, net loss per share decreased to
$1.28 in fiscal 1996 as compared to $2.21 in fiscal 1995, a decrease of 42%. The
change is due primarily to the increase in the weighted average number of
Company shares outstanding from 3,950,000 in fiscal 1995 to 10,445,000 in fiscal
1996 attributable to the issuance of 14,912,000 shares of the Company's Common
Stock in connection with the August and September 1996 financings discussed
below under Liquidity and Capital Resources.
52 WEEKS ENDED JANUARY 28, 1996 (FISCAL 1995) AS COMPARED TO YEAR ENDED
DECEMBER 31, 1994
Net Sales. Sales were $122,319,000 in fiscal 1995, an increase of 5.0% from
sales in 1994. The sales increase was primarily from sales of stores opened in
late 1994 and early 1995, which were offset somewhat by a decrease in sales of
stores open more than one year. Management believes that the sales increase was
not significantly attributable to increases in prices or increases in sales
volume for goods sold in existing stores or to the introduction of new products
being sold in comparable stores. During fiscal 1995, the Company opened four new
stores, relocated four stores and closed ten underperforming stores. A
comparable store sales decline of 2.9% was primarily the result of general
economic conditions in fiscal 1995 compared to 1994.
Gross Profit. Gross profits in fiscal 1995 were 51.1% compared to 54.0% in
1994. Lower gross profits in fiscal 1995 were due to price discounting and
clearance merchandise sales necessary to generate sales due to increased
competition and generally poor economic conditions in the Company's two major
markets, California and New York. In addition, the Company provided
approximately $760,000 to reduce certain showroom inventory to its estimated net
realizable value in fiscal 1995. During the fourth quarter of fiscal 1995, the
Company experienced a shortage of fabric for expected production. This fabric
out-of-stock position caused a disruption in operations, which had the effect of
increasing labor costs per unit and thereby reducing profits. Profit erosion
also occurred since additional discounts were given to customers due to delivery
delays. The out-of-stock position returned to normal levels in fiscal 1996.
Selling Expenses. Selling expenses were $60,257,000 in fiscal 1995, an
increase of approximately 12.7% from 1994. Selling expenses were 49.3% of sales
compared to 45.9% in 1994. The increase in total selling expenses was
principally attributable to higher sales incentives and operating costs
associated with new stores. Variable selling expenses and advertising expenses
as a percentage of sales are expected to decline in future periods.
General and Administrative Expenses. General and administrative expenses
declined by $289,000 and as a percentage of sales declined to 8.7% from 9.3%.
Exclusive of employee severance costs in fiscal 1995 of approximately $800,000,
general and administrative expenses were 8% of sales. General and administrative
expenses, exclusive of employee severance costs, declined by over $1,000,000
principally from reductions in payroll and related expenses.
23
<PAGE> 25
Interest Expense. Interest expense decreased by $1,419,000 in fiscal 1995
due to significantly less debt outstanding. In August and September 1994, the
Company paid off approximately $18,300,000 million of debt with proceeds from
the sale of its investment in Mr. Coffee.
Investment in Mr. Coffee. The Company's investment in Mr. Coffee was
accounted for by the equity method which resulted in equity in earnings of
$316,000 in 1994. The Company sold its investment in Mr. Coffee in August 1994.
Income Taxes. Income tax benefits of $1,327,000 represent refundable income
taxes available from the carryback of fiscal 1995 losses.
MONTH ENDED JANUARY 29, 1995 COMPARED TO MONTH ENDED JANUARY 30, 1994
Results of operations for the month of January are not indicative of
results for the full year since January has the lowest average weekly shipments
of any month due to seasonally low orders during the last three weeks of
December. The late December orders are normally shipped in January when the sale
is recorded. The low January sales and profits are not sufficient to cover
certain fixed selling expenses and general and administrative expenses, which
resulted in substantial operating losses during the respective periods.
Net Sales. Net sales for January 1995 were $7,179,000 which was a decrease
of approximately 2.0% from net sales in January 1994. The decrease was primarily
attributable to a lower backlog position in the 1995 period.
Gross Profit. Gross profit was 49.2% of net sales in January 1995 compared
to 52.0% in January 1994. The lower gross profits resulted from more product
discounting and higher freight costs associated with proportionately higher
sales in the East and a higher level of customer credits.
Selling Expenses. Selling expenses were $5,446,000 in January 1995 and
$4,935,000 in January 1994. The increase was principally due to higher
advertising expenses in 1995 offset by lower selling expenses attributable to
lower sales volume.
General and Administrative Expenses. General and administrative expenses
increased by $404,000 to $1,317,000 in January 1995 from the prior year period.
General administrative expenses were higher in the 1995 period principally
because of higher personnel costs and employee termination expenses.
Interest Expense. Interest expense decreased by $246,000 in January 1995
compared to January 1994 due principally to significantly less debt outstanding
in 1995.
The Company's investment in Mr. Coffee was accounted for by the equity
method and the Company recorded equity in earnings from Mr. Coffee of $93,000 in
January 1994. The Company sold its investment in Mr. Coffee in August 1994.
Net Loss. As a result of the above factors, the net loss was $3,221,000 in
January 1995 compared to a net loss of $2,185,000 in January 1994. Net loss per
share in January 1995 was $.87 based on 3,685,000 average shares outstanding. In
the comparable 1994 period, the net loss per share was $.63 on 3,490,000 average
shares outstanding.
Income Taxes. The Company paid no taxes and no tax benefits were available
for the January 1995 or 1994 operating losses.
LIQUIDITY AND CAPITAL RESOURCES
In recent periods, the Company has utilized its working capital to cover
operating deficits and to finance the remodeling and expansion of its showrooms.
In the balance of the fourth quarter of 1997 and in fiscal 1998, management
plans to remodel and upgrade approximately 28 existing showrooms, as well as add
approximately 20 additional showrooms, at an aggregate cost of approximately
$7.7 million. Management expects to fund such capital expenditures by internally
generated cash, by borrowings under the Company's revolving and standby credit
facilities, and by the proceeds to the Company of the sales of its shares in
this offering.
24
<PAGE> 26
The Company is not contractually committed to make 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. Hawley 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 $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. See "Certain Transactions."
In August 1997, the Company raised $3 million through the issuance of 9.5%
promissory notes to GECC and Japan Omnibus Ltd. ("JOL") in the principal amounts
of $2.5 million and $.5 million, respectively, together with warrants to
purchase 600,000 and 140,000 shares of Common Stock, respectively, at a purchase
price of $1.25 per share. In connection with this investment, GECC and JOL also
granted to the Company a standby credit facility under which the Company may, at
its option, subject to the attainment of certain financial covenants, borrow up
to an additional $3.5 million. In the event that the Company borrows funds under
the standby credit facility, the Company will issue to GECC and JOL additional
warrants to purchase 400,000 and 160,000 shares of Common Stock, respectively,
at $1.25 per share. The Company borrowed the full $3.5 million of this standby
credit facility in late December 1997. See "Certain Transactions."
Also in August 1997, the Company renegotiated the terms of its existing
revolving line of credit with Congress Financial Corporation (Western) by making
a change in the advance rate that will provide greater borrowing capacity. The
credit facility currently has a maximum commitment of $10 million, subject to
borrowing base limitations. The credit facility expires January 20, 2000,
accrues interest at a rate of prime plus 1%, and is secured by substantially all
of the Company's assets. Under the 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 million. In
addition, the credit facility requires the Company to maintain certain financial
covenants regarding working capital, net worth and earnings. As of February 1,
1998, the Company was out of compliance with one of these covenants but has
obtained a waiver. There can be no assurance that future financial performance
will result in compliance with these restrictions or that waivers will be
obtained if the Company fails to maintain compliance. See "Risk
Factors -- Leverage and Ability to Service Debt." As of November 2, 1997, the
Company had unused borrowing capacity under its credit facility of approximately
$3.6 million.
The Company believes that the net proceeds from this offering, combined
with borrowings under its credit facilities and internally generated funds, will
be sufficient to fund its requirements for working capital and capital
expenditures through the end of fiscal year 1998. 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 significant 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 February 2, 1997 are approximately as follows:
$41,000 in 1997, $74,000 in 1998, $4,111,000 in 1999, $2,098,000 in 2000, and
$1,286,000 in 2001. Management anticipates such payments will be made out of
operating cash flow.
Cash Flow -- Thirty-Nine Weeks Ended November 2, 1997. During the
thirty-nine weeks ended November 2, 1997, cash and cash equivalents decreased by
$977,000. Operating activities used net cash of $4,498,000, principally from a
cash loss from operations of $3,021,000, an increase in inventories of
$2,486,000 and a decrease in customer deposits of $408,000 partially offset by
decreases in prepaid expenses and other assets of $424,000 and accounts
receivable of $340,000 and an increase in Accounts Payable and Other Liabilities
of $653,000. Investing activities during the period included capital
expenditures of $1,498,000, nearly all of which was used to remodel certain
retail showrooms. Financing activities during the period
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<PAGE> 27
consisted principally of net borrowings of $2,095,000 under the Company's
revolving credit facility and $3,000,000 borrowed from GECC and JOL. Management
plans to continue its program of remodeling and upgrading showrooms as well as
to add new showrooms in existing markets; the Company expects to incur costs of
approximately $3,200,000 related to this program in fiscal 1997 and $6,750,000
in fiscal 1998.
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 (the cash loss from operations for the
first half of fiscal 1996 was $8,638,000 and $1,572,000 for the second half) 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.
1995 Cash Flow. During fiscal 1995 cash and cash equivalents decreased by
$616,000. Operating activities used net cash of $3,177,000, principally from a
cash loss from operations of $4,752,000 offset by a net change in operating
assets and liabilities of $1,575,000. Inventories and other operating assets
were reduced by $3,389,000 and $147,000, respectively, while accounts payable
and accrued liabilities were reduced by $1,961,000. Investing activities during
the year included capital expenditures of $1,883,000, primarily related to the
opening of four new showrooms and remodeling of four showrooms partially offset
by $1,039,000 of proceeds from the sale-leaseback of a showroom in Texas.
Financing activities in fiscal 1995 of $3,405,000 were principally net
borrowings under Krause's revolving credit agreement which was entered into in
January 1995.
YEAR 2000 ISSUES
During fiscal 1997, the Company initiated a plan to implement new business
information systems, which will address all year 2000 issues, as well as enhance
Company operations. This implementation may result in significant capital
expenditures during fiscal 1998 and 1999. In the event that this implementation
is not completed prior to the year 2000, the Company has a contingency plan,
pursuant to which, existing systems will be modified to eliminate remaining year
2000 issues. Expenditures related to this contingency plan will be expensed as
incurred and are not expected to have a significant impact on the Company's
results of operations.
CHANGE IN AUDITOR
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 most recent two years 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 two-year 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 has 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
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<PAGE> 28
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," which is
required to be adopted on December 31, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for calculating primary
earnings per share, the dilutive effect of stock options will be excluded.
Equity instruments, such as options and warrants are excluded if antidilutive in
the calculation of diluted earnings per share. Since the effect of stock options
is already excluded in the computation of net loss per share, the adoption of
Statement 128 will not result in any change in the loss per share amounts
reported for the thirty-nine weeks ended November 2, 1997 or October 27, 1996.
Effective for the year ending February 1, 1998, the Company will also be
required to adopt SFAS No. 129, "Disclosure of Information about Capital
Structure."
Effective in fiscal 1998, the Company will be required to adopt Statements
of Financial Accounting Standards (SFAS) No. 129 "Capital Structure," SFAS No.
130 "Reporting Comprehensive Income" and SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information." The impact of adoption of
these pronouncements is not expected to be material to the Company's financial
position or results of operations.
QUARTERLY OPERATING RESULTS
The following tables set forth certain unaudited consolidated financial
information for each of the four quarters in fiscal 1996 and the first three
quarters of fiscal 1997. In management's opinion, this unaudited quarterly
information has been prepared on the same basis as the audited consolidated
financial statements and includes all necessary adjustments, consisting only of
normal recurring adjustments, that management considered necessary for a fair
presentation of the unaudited quarterly results when read in conjunction with
the Consolidated Financial Statements and Notes thereto included elsewhere in
this Prospectus. The Company believes that quarter-to-quarter comparisons of its
financial results are not necessarily meaningful and should not be relied upon
as an indication of future performance.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------------
NOVEMBER 2, AUGUST 3, MAY 4, FEBRUARY 2, OCTOBER 27, JULY 28, APRIL 28,
1997 1997 1997 1997(1) 1996 1996 1996
------------ ---------- ------- ------------ ----------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales................. $ 30,159 $ 27,768 $27,642 $ 29,999 $26,865 $ 26,236 $ 29,637
Cost of sales............. 14,560 14,005 13,275 14,126 12,781 13,860 15,723
------- ------- ------- ------- ------- ------- -------
Gross profit.............. 15,599 13,763 14,367 15,873 14,084 12,376 13,914
Operating costs and
expenses:
Selling ................ 13,698 13,832 13,028 14,017 14,081 15,006 14,469
General and
administrative........ 2,191 2,293 2,296 2,249 2,084 3,072 2,696
Amortization of
goodwill.............. 255 255 255 255 255 255 255
------- ------- ------- ------- ------- ------- -------
16,144 16,380 15,579 16,521 16,420 18,333 17,420
------- ------- ------- ------- ------- ------- -------
Loss from operations...... (545) (2,617) (1,212) (648) (2,336) (5,957) (3,506)
Interest expense.......... (467) (370) (340) (448) (296) (304) (182)
Other income (expense).... (35) (8) (15) 81 111 45 51
------- ------- ------- ------- ------- ------- -------
Net loss.................. $ (1,047) $ (2,995) $(1,567) $ (1,015) $(2,521) $ (6,216) $ (3,637)
======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) All quarters are for a period of 13 weeks except the quarter ended February
2, 1997 which is for a period of 14 weeks.
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<PAGE> 29
The Company's operating results are subject to various risks and
uncertainties, including risks and uncertainties related to management's ability
to implement its business strategy, the Company's ability to service fixed
charges and to raise additional capital, economic conditions, competitive
pressures, availability and cost of supplies, the composition, timing and volume
of orders, overhead costs, manufacturing or production difficulties, certain
nonrecurring charges and other factors. Accordingly, the Company's operating
results may vary materially from quarter to quarter. Because a high percentage
of the Company's operating expenses are relatively fixed, if anticipated sales
and shipments in any quarter do not occur as expected, the Company's operating
results may be adversely affected and fall significantly short of expectations.
Any unanticipated decline in growth of the Company's net revenue, without a
corresponding and timely reduction in the growth of operating expenses, could
have an adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that, in the event of any
shortfall of sales or reduction in gross margin in a quarter, the Company will
be able to control expenses sufficiently or promptly to meet profitability
objectives for that quarter. See "Risk Factors" for a discussion of other
factors that may adversely affect the Company's operating results in any given
quarter.
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<PAGE> 30
BUSINESS
THE COMPANY
The Company is a leading vertically integrated manufacturer and retailer of
made-to-order upholstered furniture and accessories. The Company operates 81
furniture showrooms under the Krause's (67 showrooms) and Castro Convertibles
(14 showrooms) brand names in 12 states, with 40 of those showrooms in
California and 13 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.
RECENT DEVELOPMENTS
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.
Under the leadership of Mr. Hawley, the Company has adopted a major
expansion and remodeling program, and has developed a marketing and
merchandising strategy that is 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 18 existing showrooms, 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 remodel approximately 24 additional showrooms in
fiscal 1998. 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. Although
results are preliminary, these new strategies, combined with improved economies
in selected regions where the Company operates, have begun to show positive
financial results. For the nine months ended November 2, 1997, same-store sales
(for showrooms opened a year or more) increased 4.3% compared to the nine-month
period ended October 27, 1996, with remodeled store sales exceeding management's
goal of 25%. In addition, gross profit increased from 48.8% to 51.1% of net
sales in the first nine months of fiscal 1997 compared to the same period in
fiscal 1996. Since the management change, the Company has also opened one new
showroom featuring its new store design and has plans to open approximately 20
showrooms in fiscal 1998.
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. According to the
American Furniture Manufacturers Association, the domestic residential furniture
industry was estimated to generate $21 billion in shipments in 1997 up from
approximately $20 billion in 1996 and is expected to increase 4.2% to $21.9
billion in 1998. Upholstered
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<PAGE> 31
furniture accounted for approximately $8.4 billion in shipments in 1996,
according to the American Furniture Manufacturers Association.
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.
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. Over 25
and 65 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.
New, Experienced Management Team. The Company recently 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.
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.
Well Located Retail Distribution Network. As of November 30, 1997, the
Company operated 81 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.
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 will seek to achieve these objectives
by pursuing the following strategies:
- Remodel Existing Showrooms. The Company has embarked upon 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. Plans call for remodeling
approximately 65 showrooms which will incorporate the new layout, design
and visual presentation themes. To date,
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<PAGE> 32
the Company has remodeled 18 showrooms and expects to remodel
approximately 24 more showrooms by the end of the 1998 fiscal year.
- 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 between 40 to 50 opportunities to open showrooms in existing
markets. To date, the Company has opened one new showroom and expects to
open approximately 20 more showrooms by the end of the 1998 fiscal year.
- Relocate Under-Performing Showrooms. The Company estimates that it has
between 10 and 15 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.
- 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 has changed the name it does business under from
Krause's Sofa Factory to Krause's Custom Crafted Furniture and has
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.
- Develop New Products; Increase Sales of Complementary Products. The
Company has put in place a new product development program, which will
accomplish a freshening of showroom inventories and introduce a number of
new styles designed to increase its appeal to customers; during the
fiscal year 1997, the Company introduced eight new sofa styles. 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 intends to increase 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. During fiscal 1996, accessories, custom-made chairs and
recliners accounted for 2%, 4%, and 8%, respectively, of the Company's
sales compared to the industry average (reported by the October 1997
issue of retail Ideas, a publication of Furniture/Today) of 12%, 10%, and
17%, respectively. These additional merchandise classifications will
broaden the Company's offerings and should increase sales per square
foot.
- 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 plans to leverage this strong brand awareness by
adding a Castro Convertibles gallery in all of its Krause's remodeled and
new showrooms.
- Increase Showroom Productivity. For the year ended February 2, 1997, the
Company's sales per square foot of selling space averaged $112. To
further increase showroom productivity, the Company intends gradually to
reduce 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.
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<PAGE> 33
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 12,100 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.
Expansion and Remodeling. The Company recently adopted 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 Castro
Convertibles brand name and products into its Krause's Custom Crafted Furniture
showrooms. As part of this program, the Company has remodeled 18 showrooms to
date and has plans to remodel approximately 24 additional showrooms by the end
of fiscal 1998. 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 remodels in approximately one year through increased sales after the
remodel.
The Company will also seek 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 one new showroom
since it began its expansion program and intends to open approximately 20
additional showrooms during fiscal 1998. In addition, as leases expire on
showrooms that are not located in prime retail areas, but are in favorable
markets, the Company will seek to move those showrooms to more suitable
locations.
Merchandising and Advertising. The Company has begun 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 intends to further enhance and leverage 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 will seek to use its strong brand
awareness initially to 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 is adding 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
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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 intends to increase the promotion and sale of
these complimentary furniture products and accessories. Merchandise purchased
from other suppliers currently accounts for approximately 10% 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 eight new sofa 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 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-
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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 500 pieces of upholstered furniture per
day in a single shift. This output represents approximately 75% of single 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 November 2, 1997 was approximately $10.0 million compared to
$12.1 million at the end of October 1996.
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 55.5% of its purchased raw materials during the
nine-month period ended November 2, 1997, including one such supplier that
provided approximately 13.1% and another that provided 8.9% of such purchases.
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. For example, one of the Company's
fabric suppliers has been unable to supply all of the Company's needs on a
timely basis due to unanticipated customer demand for some of its patterns. As a
result, customer orders representing approximately $1,000,000 in sales were not
completed as expected in the fourth quarter of fiscal year 1997. The Company is
likely to recoup most of these sales in the subsequent period but some sales may
be lost due to customer cancellations.
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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<PAGE> 36
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 which expires in
May 1998 covers approximately 50 retail employees in the greater New York area.
At November 2, 1997, the total work force numbers approximately 977, with
approximately 365 working in manufacturing, 531 in retail and warehousing
operations, and 81 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.
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 11 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 81 showrooms occupy approximately
980,000 sq. ft. of selling space.
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 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.
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<PAGE> 37
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions of the Company's directors and officers are
as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------ --- -------------------------------------------------------
<S> <C> <C>
Philip M. Hawley.................... 72 Chairman of the Board and Chief Executive Officer
Thomas M. DeLitto................... 44 Vice Chairman of the Board
Robert A. Burton.................... 57 Senior Vice President and Chief Financial Officer
Herbert J. Friedman................. 47 Senior Vice President of Merchandising, Product
Development, Marketing and Stores
K. James McTaggart.................. 35 Senior Vice President of Manufacturing and Distribution
Klaus Tabar......................... 44 Senior Vice President of Real Estate and Construction
Kamal G. Abdelnour.................. 61 Director
Jeffrey H. Coats.................... 40 Director
Peter H. Dailey..................... 67 Director
John A. Gavin....................... 66 Director
</TABLE>
Philip M. Hawley has been Chairman of the Board and Chief Executive Officer
since August 1996. He served as Chairman and Chief Executive Officer of The
Broadway Stores, Inc. (formerly Carter Hawley Hale Stores, Inc.) from 1977 to
1993. Mr. Hawley is also a director of Johnson & Johnson, Weyerhauser Company
and Aeromovel, U.S.A.
Thomas M. DeLitto has been Vice Chairman of the Board since December 1994
and a director since June 1991. He was Chief Executive Officer from April 1995
to August 1996, President and Chief Executive Officer from July 1992 to December
1994, and Executive Vice President and Chief Operating Officer from June 1991 to
July 1992. Mr. DeLitto has been a Director and President of Permal Capital
Management, Inc., a wholly owned subsidiary of Worms & Co., Inc. (a wholly owned
subsidiary of Worms & Cie., a principal stockholder of the Company), since
October 1990; in this capacity he oversees operations of that company's direct
investment activities. Mr. DeLitto has served as Executive Vice President of
Worms & Co., Inc. since February 1996.
Robert A. Burton has been Senior Vice President and Chief Financial Officer
since December 1996. Mr. Burton was an independent financial consultant from
January 1995 to November 1996, and from November 1987 to December 1994 he was
Senior Vice President and Chief Financial Officer of John Breuner Company, a
home furnishings company. John Breuner Company filed for bankruptcy in October
1993 and emerged in July 1994.
Herbert J. Friedman has been Senior Vice President of Merchandising,
Product Development, Marketing and Stores since September 1996. Mr. Friedman was
Senior Vice President of Strategic Planning from April 1995 to September 1996
and Vice President of Merchandising from June 1989 to April 1995.
K. James McTaggart has been Senior Vice President of Manufacturing and
Distribution since April 1996. Mr. McTaggart was Vice President of Distribution
and Logistics from February 1996 to March 1996. Mr. McTaggart was formerly the
Vice President of Distribution/Logistics at Stanley-Works-Door Systems from
March 1995 to February 1996, and served in other positions in Stanley
Works-Door-Systems from November 1985 to March 1995.
Klaus Tabar is Senior Vice President of Real Estate and Construction. Mr.
Tabar was Senior Vice President of Real Estate and Store Construction from
September 1996 to April 1997 and Senior Vice President of Real Estate and
Administration from April 1996 to September 1996. He joined the Company as Vice
President of Real Estate in January 1989.
Kamal G. Abdelnour has been a director since September 1996. He had been a
director from February 1993 to August 1996 when he resigned in connection with
the Company's recapitalization.
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<PAGE> 38
Mr. Abdelnour has been President and Chief Executive Officer of ATCO
Development, Inc. ("ATCO") since 1980. ATCO is engaged in the business of
investments, real estate ownership and management, and export sales. Since 1989,
Mr. Abdelnour has served as a director of Permal Capital Management, Inc., a
wholly-owned subsidiary of Worms & Co., Inc., which is a wholly owned subsidiary
of Worms & Cie., a principal stockholder of the Company.
Jeffrey H. Coats has been a Director since August 1996. He has been a
Managing Director of GE Capital Equity Capital Group, Inc., a wholly owned
subsidiary of GECC, since April 1996. He was also a Managing Director of GE
Capital Corporate Finance Group, Inc., a wholly owned subsidiary of GECC, from
June 1987 to April 1993. From March 1994 to April 1996, Mr. Coats was President
of Maverick Capital Equity Partners, LLC and from April 1993 to January 1994, he
was Managing Director and a Partner of Veritas Capital, Inc., both of which are
investment firms. Mr. Coats is the Chairman of the Board of The Hastings Group,
Inc., a clothing retailer, which filed for bankruptcy in October 1995. The
Hastings Group, Inc. currently is in the process of formulating a plan of
liquidation under Chapter 11.
Hon. Peter H. Dailey has been a director since September 1996. He is also
the Chairman of the Board and Chief Executive Officer of Memorex Telex, NV, a
world-wide technology company headquartered in Amsterdam, the Netherlands and
has served in those roles since April 1996. He served as Ambassador to Ireland
from 1982 to 1984, and was special Presidential envoy to NATO countries. From
1985 to 1988, Mr. Daily served as counselor to the Director of the Central
Intelligence Agency. From 1985 to 1992 he was a member of President's Advisory
Committee on Arms Control and Disarmament. He also serves as founder and
Chairman of the Board of Enniskerry Financial, Inc., a private investment
company founded in 1968, and has been a principal of Gavin, Dailey and Partners,
an international capital and consulting firm, since 1991. Mr. Dailey is a member
of the Board of Directors of Chicago Title and Trust Company, Sizzler, Inc.,
Pinkerton's, Inc., and Jacobs Engineering Group, Inc. Prior to returning to
government service he served as a director of the Walt Disney Co. and the
Interpublic Group of Companies. Memorex Telex Corp., the U.S. Subsidiary of
Memorex Telex, NV, filed for bankruptcy in 1996 and is in the process of
liquidation.
Hon. John A. Gavin has been a director since September 1996. He founded and
has been the Chairman of Gamma Services Corporation and a principal of Gavin,
Dailey and Partners, both international capital and consulting firms, since 1968
and 1991, respectively. He has also been affiliated with Hicks, Muse, Tate and
Furst (Latin America) as Managing Director since 1995. Mr. Gavin is a member of
the Board of Directors of Atlantic Richfield Company, Dresser Industries,
Pinkerton's, Inc., International Wire Group and KAP Resources.
All Directors are elected annually and serve until the next annual meeting
of stockholders or until the election and qualification of their successors.
Nomination and election of the Board of Directors of the Company is subject to a
Stockholders Agreement. See "Capital Stock -- Stockholders Agreement." At
present, all directors have been elected pursuant to the Stockholders Agreement.
In this regard, Jeffrey H. Coats is the GECC designee, Thomas M. DeLitto is the
designee of the Permal group of stockholders and Kamal G. Abdelnour, Peter H.
Dailey and John A. Gavin are the Joint Designees. Mr. Abdelnour has also been
elected as a director of the Company in accordance with a contractual
undertaking by the Company to nominate him. This contract was entered into at
the time the Company issued and sold shares of capital stock to ATCO Holdings
Limited (See "Principal and Selling Stockholders").
In December 1997, a Succession Agreement was entered into by the Company
and the following stockholders: Philip M. Hawley, its Chairman, his sons John F.
Hawley and Dr. Philip M. Hawley, Jr., GECC and Permal Capital Management. The
parties to the Succession Agreement agreed that if Philip M. Hawley ceases to
serve on the Board of Directors, the stockholder parties would take all
necessary action to ensure that John F. Hawley, or his nominee if he is
unavailable, is elected to serve as a director. (See "Certain Transactions").
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has created an Executive Committee, an Audit
Committee, a Compensation Committee and a Nominating Committee. The Executive
Committee is composed of Philip M. Hawley, Thomas M. DeLitto and Jeffrey H.
Coats, and except to the extent prohibited by law has all power and
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<PAGE> 39
authority to manage the business and affairs of the Company on behalf of the
Board of Directors as may be necessary between regular meetings of the Board.
The Audit Committee is composed of John A. Gavin, Peter H. Dailey and Kamal G.
Abdelnour, and is charged with reviewing the Company's annual audit and meeting
with the Company's independent accountants to review the Company's internal
controls and financial management practices. The Compensation Committee, which
is composed of Kamal G. Abdelnour, John A. Gavin and Peter H. Dailey, recommends
to the Board of Directors compensation for the Company's key employees and
administers certain employee benefit plans. The Nominating Committee is composed
of Philip M. Hawley, Thomas M. DeLitto, Jeffrey H. Coats and Kamal G. Abdelnour,
and is charged with reviewing the qualifications of and recommending candidates
to the Board of Directors for election as directors of the Company. The
Nominating Committee also acts on other matters pertaining to membership on the
Board of Directors, including terms of tenure and compensation for Directors and
issues involving potential conflict of interests. It also reviews the
qualifications of, and recommends to the Board of Directors individuals for
senior management positions with the Company.
DIRECTOR COMPENSATION
All directors were reimbursed for travel and other expenses related to
their activities as directors during fiscal year 1996, and will continue to be
so reimbursed in fiscal year 1997 and beyond. The four non-employee directors
other than Jeffrey H. Coats were each paid a fee of $3,333 and were each granted
deferred stock units valued at $10,000 under the Company's 1997 Stock Incentive
Plan (see "Stock Plans" below) for services rendered as directors during fiscal
year 1996. Each non-employee director (other than Mr. Coats) will also be paid a
fee of $10,000, payable quarterly, for his services during fiscal year 1997.
Also, additional deferred stock units valued at $10,000 will be granted to each
non-employee director (other than Mr. Coats) in office on December 31, 1997 and
on December 31 of each year thereafter during the term of the 1997 Stock
Incentive Plan.
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<PAGE> 40
SUMMARY COMPENSATION TABLE
The following table sets forth all compensation paid by the Company during
fiscal 1996, 1995, and 1994 to (i) each of the individuals serving as the
Company's Chief Executive Officer during fiscal 1996, (ii) the four other most
highly compensated executive officers of the Company during fiscal 1996, and
(iii) up to two additional individuals who would have been among the Company's
four most highly compensated executive officers, but for the fact that they were
not serving as executive officers of the Company at the end of fiscal 1996
(collectively referred to as the "Named Executive Officers").
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL ---------------
COMPENSATION SECURITIES ALL OTHER
--------------------------- UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS/SARS(#) ($)(1)
- ------------------------------------- ---- ------- ------ --------------- ------------
<S> <C> <C> <C> <C> <C>
Philip M. Hawley(2).................. 1996 101,959 1,234,000
Chairman of the Board and Chief
Executive Officer
Thomas M. DeLitto(3)................. 1996 11,154 3,333
Vice Chairman; Former Chief 1995 1,666 9,375
Executive Officer 1994 1,666 15,000
Herbert J. Friedman.................. 1996 152,301 50,000
Senior Vice President of 1995 136,770 1,200 1,000
Merchandising,
Product Development, Marketing and 1994 130,192
Stores
Klaus Tabar.......................... 1996 141,645 34,030 50,000
Senior Vice President of 1995 117,899 13,505 1,000
Real Estate and Construction 1994 98,461 12,750
K. James McTaggart................... 1996 121,953 45,000
Senior Vice President of
Manufacturing and Distribution
Stephen P. Anderson(4)............... 1996 212,789 249,000
Former President 1995 203,846
1994 50,000
Robert G. Sharpe(5).................. 1996 166,878 366,068
Former Executive Vice President, 1995 157,278 30,000
Corporate Development and Treasurer 1994 149,187 30,000
</TABLE>
- ---------------
(1) Other annual compensation represents directors' fees for Mr. DeLitto and
severance benefits for Messrs. Anderson and Sharpe.
(2) Philip M. Hawley commenced employment with the Company, becoming Chairman of
the Board and Chief Executive Officer of the Company in August 1996. Mr.
Hawley's base salary is at the rate of $225,000 per year. See "Employment
Agreements."
(3) Mr. DeLitto resigned as Chief Executive Officer of the Company in August
1996. Permal Capital Management, Inc. received payments from the Company in
consideration for the performance of executive management services of Mr.
DeLitto who is President of Permal Capital Management, Inc. See "Certain
Transactions."
(4) Mr. Anderson resigned his employment with the Company effective January 26,
1997.
(5) Mr. Sharpe resigned his employment with the Company effective January 31,
1997.
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<PAGE> 41
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options and
deferred stock units granted during fiscal 1996 to the Named Executive Officers.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE
% OF TOTAL AT ASSUMED ANNUAL
NUMBER OF OPTIONS/SARS RATES
SECURITIES GRANTED TO OF STOCK PRICE
UNDERLYING EMPLOYEES IN EXERCISE OR APPRECIATION
OPTIONS/SARS FISCAL BASE PRICE EXPIRATION FOR OPTION TERM
NAME GRANTED(#) YEAR(1) ($/SH) DATE 5%($) 10%($)
- ----------------------- ------------ ------------ ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Philip M. Hawley(2).... 1,234,000 75.2% 1.00 08/26/06 2,010,056 3,200,678
Thomas M. DeLitto...... 5,000 .3% .78 07/31/06 6,353 10,116
6,154 .4% 1.62 01/19/07 16,239 25,858
Klaus Tabar............ 50,000 3.0% 1.62 01/19/07 131,940 210,093
Herbert J. Friedman.... 50,000 3.0% 1.62 01/19/07 131,940 210,093
K. James McTaggart..... 5,000 .3% 1.06 03/11/06 8,633 13,747
40,000 2.4% 1.62 01/19/07 105,552 168,074
Stephen P. Anderson.... -- -- -- -- -- --
Robert G. Sharpe....... -- -- -- -- -- --
</TABLE>
- ---------------
(1) The Company granted options for a total of 45,000 shares of Common Stock and
24,616 deferred stock units to directors and 1,572,000 shares of Common
Stock to employees of the Company during 1996. Options for 417,000 shares of
Common Stock were granted to employees in fiscal 1997. All of the options
and deferred stock units were granted under the 1997 Stock Incentive Plan.
(2) The grant date market price of the Company's Common Stock issued to Philip
M. Hawley was $1.66. The potential realizable value of these options at the
grant date was $2,048,440.
YEAR-END OPTION/SAR VALUES
The following table sets forth information concerning the value of
unexercised options and deferred stock units held by the Named Executive
Officers as of February 2, 1997, the end of the Company's 1996 fiscal year. No
Named Executive Officers exercised any options during fiscal 1996.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS
AT FISCAL YEAR-END AT FISCAL YEAR-END(1)
----------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Philip M. Hawley............................. 308,500 925,500 $ 308,500 $ 925,500
Thomas M. DeLitto............................ 11,152 5,000 2,308 6,100
Klaus Tabar.................................. 16,111 51,089 -- 19,000
Herbert J. Friedman.......................... 10,387 50,873 -- 19,000
K. James McTaggart........................... 1,667 43,333 1,567 18,333
Stephen P. Anderson(2)....................... 35,557 17,777 -- --
Robert G. Sharpe(2).......................... 17,332 4,333 -- --
</TABLE>
- ---------------
(1) Based on the closing price of Common Stock as quoted on the Nasdaq SmallCap
Market of $2.00 on January 31, 1997, the last trading day in fiscal 1996.
(2) Options for Messrs. Anderson and Sharpe expired in April 1997.
1997 MANAGEMENT COMMITTEE INCENTIVE AWARD PROGRAM
The 1997 Management Committee Incentive Award Program (the "Management
Plan") was adopted by the Board of Directors to provide bonuses to certain
management employees of the Company if the Company meets certain financial
objectives. The Management Plan currently provides that such employees will earn
eight percent of their respective base salaries if the Company's earnings before
interest, taxes, depreciation and amortization reach $1,100,000 during the last
six months of fiscal year 1997. In addition, such employees will
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<PAGE> 42
earn an additional one percent of their respective base salaries for each
$100,000 that such earnings before interest, taxes, depreciation and
amortization exceed $1,100,000. Also certain management employees may receive up
to seven percent of their base salaries based on their personal achievements.
The Management Plan is administered by the Compensation Committee.
STOCK PLANS
1997 Stock Incentive Plan
The 1997 Stock Incentive Plan (the "1997 Plan") was approved by the Board
of Directors in January 1997 and the stockholders in May 1997. The 1997 Plan
extends for 10 years, but may be terminated at an earlier date. The 1997 Plan
provides for the issuance of awards covering up to 1,000,000 shares of Common
Stock to employees, officers, directors and consultants.
Awards under the 1997 Plan can consist of options, stock appreciation
rights, dividend equivalent rights, restricted stock, performance shares,
deferred stock units or other stock based awards. The Compensation Committee of
the Board of Directors, which includes only non-employee directors as its
members, has been designated to administer the 1997 Plan. The administrator has
the power to select employees, officers, directors and consultants to receive
awards, to make awards, to determine the terms upon which awards are made, to
approve agreements with recipients of awards, to amend awards, to interpret the
1997 Plan and to take other actions not inconsistent with the express terms of
the 1997 Plan.
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 principal 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 an equivalent amount of the Company's
Common Stock, based upon the fair market value of the Company's 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
occurs in five annual installments, but a director may elect to receive a single
payment. If a change in control of the Company occurs, the director's deferred
stock unit account will be paid in cash.
The Compensation Committee in its capacity as administrator of the 1997
Plan has broad authority to determine the type and amount of all other awards.
All awards must be set forth in an agreement. If awards are intended to qualify
as ISO's, they must conform to the requirements of the Internal Revenue Code of
1986, as amended (the "Code"). The committee may establish award exchange
programs or permit early exercise of awards. In general, awards may not have a
term of more than 10 years, and in some cases must have shorter terms. ISO's may
not be transferable except upon death or disability and then only to a limited
extent. Other awards can be transferable to the extent provided in the award
agreement. All option and other awards intended to qualify as performance based
compensation under the Code must be issued at fair market value on the date of
grant or award. The Committee is permitted to issue other awards at prices it
finds appropriate. The Company is permitted to withhold shares or other awards
to compensate it for withholding or other taxes. The Committee also can issue
new options to replace options canceled for this purpose. The Committee
determines the vesting or other timing of the exercise of an award and the
extent to which a recipient of an award or his or her successor can exercise an
award following termination of employment.
The 1997 Plan provides for adjustments in the case of stock splits, reverse
stock splits, stock dividends and other similar events. In the event of a merger
or sale of substantially all of the Company's assets in connection with a
dissolution of the Company, awards under the 1997 Plan will become fully vested,
unless they are assumed by a successor or are otherwise replaced as is provided
in the 1997 Plan. The Committee has authority to authorize full vesting if a
change of control occurs.
1994 Directors Stock Option Plan
The 1994 Directors Stock Option Plan (the "Directors Plan") was adopted by
the Board of Directors and approved by the shareholders in 1994. The Directors
Plan was terminated by the Board of Directors in
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<PAGE> 43
January 1997, and no more options may be granted under the Directors Plan.
Options outstanding under the Directors Plan remain in full force and effect.
Prior to its termination, the Directors Plan provided for the automatic
grant of an option to each non-employee director upon his or her election to the
Board, entitling the optionee to purchase up to a total of 5,000 shares of
Common Stock, at an exercise price equal to the fair market value for such
shares as of the date of grant. On each anniversary of such first election,
provided that the individual continued to serve as a director, he or she
automatically received an additional grant of an option for the same number of
shares, exercisable again at the fair market value as of the date of the grant.
Each option granted under the Directors Plan may be exercised in whole or
in part at any time beginning upon conclusion of one year following the date of
grant until the expiration or earlier termination of the option. During his or
her lifetime, only the director who was the recipient of the option grant may
exercise the option. If a director is terminated with cause, as defined in the
Directors Plan, his or her option ceases to be exercisable and terminates upon
the effective date of termination. If a director ceases to serve on the Board
and his or her departure from the Board is not for cause, as defined, the option
is exercisable for a period of 90 days following the date when the director's
tenure on the Board ceases, but in no event later than the date of expiration of
the option in accordance with the terms of the Directors Plan. In the event a
director ceases to serve on the Board as a result of disability, as defined in
the Directors Plan, or if the director's death occurs while serving on the Board
or within 90 days following the date when he or she ceases to so serve, the
option must be exercised within 12 months following the date when the director
no longer is serving on the Board, subject to earlier expiration in accordance
with the terms of the Directors Plan. Options under the Directors Plan expire 10
years from their respective date of grant, unless subject to earlier
termination.
If any change, such as a stock split or dividend, is made in the Company's
capitalization which results in an exchange of Common Stock for a greater or
lesser number of shares without receipt of consideration, an appropriate
adjustment will be made in the exercise price of, and the number of shares
subject to, all outstanding options under the Directors Plan.
In the event of a proposed dissolution or liquidation of the Company, each
option outstanding under the Directors Plan will terminate immediately prior to
consummation of such proposed action. In the event of a sale of all or
substantially all of the assets of the Company or subsidiary of the Company or
the merger of the Company or one of its subsidiaries with or into another
corporation, unless each outstanding option will be assumed or an equivalent
option will be substituted by the successor corporation in the transaction or by
a parent or subsidiary of such successor corporation, the optionee shall have
the right to exercise the option as to all of the shares subject thereto,
including shares as to which the option would not otherwise be exercisable. In
this case, the option will be fully exercisable for a period of 30 days from the
date of such notice, and the option will terminate upon the expiration of such
period.
1990 Employees Stock Option Plan
The 1990 Employees Stock Option Plan (the "Employees Plan") was adopted by
the Board of Directors and approved by the stockholders in 1990. The Employees
Plan was terminated by the Board of Directors in January 1997, and no more
options may be granted under the Employees Plan. Options outstanding under the
Employees Plan remain in full force and effect.
Prior to its termination, under the Employees Plan, the Company was able to
grant incentive stock options ("ISOs") and nonstatutory stock options ("NSOs")
only to employees, including officers, of the Company and its subsidiaries. The
exercise price of all options granted under the Employees Plan is equal to 100%
of the fair market value of the Company's Common Stock on the date of grant,
provided that options granted to any person who owned more than 10% of the
voting power of all classes of capital stock of the Company at the date of grant
provided for an exercise price of not less than 110% of the fair market value of
the Company's Common Stock on the date of grant. Options are exercisable in
amounts and over specified periods of time as determined by the Compensation
Committee at the time of grant. The foregoing notwithstanding, all options shall
vest and be exercisable over a period not exceeding 10 years, provided that for
persons owning more than 10% of the total combined voting power of all classes
of capital stock of the
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<PAGE> 44
Company, the maximum term is not more than five years from the date of grant.
During his or her lifetime, only the employee or officer who is the recipient of
the option grant may exercise the option. If an employee or officer is
terminated with cause, as defined in the Employees Plan, his or her option
ceases to be exercisable and terminates upon the effective date of termination.
If an employee's or officer's employment terminates and such termination is not
for cause, as defined, the option is exercisable for a period of 90 days
following the date when the termination occurs, but in no event later than the
date of expiration of the option in accordance with the terms of the Employees
Plan. In the event an employee's or officer's employment terminates as a result
of disability, as defined in the Employees Plan, or if the employee's or
officer's death occurs while employed or within 90 following the date when he or
she ceases to be so employed, the option must be exercised within 12 months
following the date when the employee or officer becomes disabled or dies,
subject to earlier expiration in accordance with the terms of the Employees
Plan.
If any change, such as a stock split or dividend, is made in the Company's
capitalization which results in an exchange of Common Stock for a greater or
lesser number of shares without receipt of consideration, an appropriate
adjustment will be made in the exercise price of, and the number of shares
subject to, all outstanding options under the Employees Plan. In the event of a
merger or a consolidation of the Company with any other corporation in which the
Company is not the surviving corporation and in which the surviving corporation
does not assume the obligations of the Company under the Employees Plan, all
options outstanding under the Employees Plan will be automatically accelerated
and become exercisable. Any options not exercised prior to the merger or
consolidation will lapse.
In the event of a proposed dissolution or liquidation of the Company, each
option outstanding under the Employees Plan will terminate immediately prior to
consummation of such proposed action. In the event of a sale of all or
substantially all of the assets of the Company or subsidiary of the Company or
the merger of the Company or one of its subsidiaries with or into another
corporation, unless each outstanding option will be assumed or an equivalent
option will be substituted by the successor corporation in the transaction or by
a parent or subsidiary of such successor corporation, the optionee shall have
the right to exercise the option as to all of the shares subject thereto,
including shares as to which the option would not otherwise be exercisable. In
this case, the option will be fully exercisable for a period of 30 days from the
date of such notice, and the option will terminate upon the expiration of such
period.
Krause's Stock Option Plans
Krause's also has in effect several stock option plans which were
established prior to the time it was acquired by merger by the Company. Those
plans were terminated by the Board of Directors in January 1997, and no more
options may be granted under them. There are currently options to purchase an
aggregate of 11,880 shares of the Company's Common Stock outstanding to two
employees which will continue in full force and effect. The options were
originally granted for the purchase of Krause's stock, but were converted into
options to purchase the Company's Common Stock in connection with the merger.
EMPLOYMENT AGREEMENTS
In August 1996, the Company entered into an Employment Agreement with
Philip M. Hawley pursuant to which the Company agreed to employ Mr. Hawley for a
term ending on August 25, 1999, and to pay Mr. Hawley a base salary at the rate
of $225,000 per year and provide benefits. The Company has agreed to extend this
agreement to January 31, 2001. If Mr. Hawley's employment is terminated by the
Company without cause (as defined in the Employment Agreement) he is entitled to
receive his full base salary and benefits for the remaining term of the
Employment Agreement. If Mr. Hawley resigns from the Company upon a change in
control (as defined in the Employment Agreement) he is entitled to a lump sum
payment equal to the greater of (i) the remaining amounts that would be payable
to him under the Employment Agreement and (ii) $225,000. Furthermore, the
Company agreed to grant Mr. Hawley an option to purchase 1,234,000 shares of
Common Stock at an exercise of price of $1.00 per share with vesting over three
years. In the event of a change in control, the right to exercise the options
would accelerate. Mr. Hawley is also entitled to all other benefits of
employment available to executive officers of the Company generally, including
bonuses, retirement, vacation, deferred compensation, employee discount, and
various health related benefits.
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<PAGE> 45
The Company has entered into agreements with Messrs. Friedman and Tabar, as
well as several other officers and employees of the Company, providing for the
payment of severance benefits equal to such officers' or employees' monthly
salary plus benefits for up to 12 months if terminated without cause.
CERTAIN TRANSACTIONS
During 1997, 1996 and 1995 a number of transactions occurred between the
Company and its subsidiaries and certain directors and their affiliates. The
Company believes that each such arrangement was as fair as could have been
obtained from unaffiliated persons.
1996 Notes. From May 13, 1996 to June 19, 1996, various investors loaned an
aggregate of $2,950,000 to the Company. Among the investors were Permal Capital
Management, Inc., an indirect subsidiary of Worms & Cie ($50,000 principal
amount), ATCO Development, Inc. ($150,000), Mr. DeLitto, the Company's Vice
Chairman of the Board ($25,000), and Mr. Sharpe ($25,000) and Mr. Perrette
($250,000), each a former officer of the Company. In addition, on May 21, 1996
and July 2, 1996, JOL loaned to the Company $1,500,000 and $500,000,
respectively. All indebtedness pursuant to these loans (collectively, the "1996
Notes") was payable on demand and bore interest at the annual rate of 10% for
the first year only. All amounts outstanding under the 1996 Notes were retired
in connection with the 1996 Securities Purchase Agreement described below.
1996 Securities Purchase Agreement. On August 26, 1996, and September 4,
1996, the Company entered into a securities purchase agreement (the "Securities
Purchase Agreement") whereby the Company raised an aggregate of $18,735,000 in
debt and equity. Pursuant to the Securities Purchase Agreement:
- The Company sold 10,669,000 shares of Common Stock to certain investors,
at a price of $1.00 per share. Purchasers included GECC (5,000,000
shares), ATCO Holdings Ltd. (500,000 shares), certain affiliates of Worms
& Cie (500,000 shares), Mr. Hawley, the Company's Chairman of the Board
and Chief Executive Officer and various trusts established for the
benefit of relatives of Mr. Hawley (1,080,000 shares), and Mr. DeLitto,
the Company's Vice Chairman of the Board (25,000 shares).
- The Company issued 3,066,251 shares of Common Stock to the holders of the
1996 Notes in consideration for retirement of all amounts outstanding
under the 1996 Notes, including accrued interest. Shares were issued at a
rate of one share per $1.00 of debt retired.
- GECC made a loan to the Company in the original principal amount of
$5,000,000. This indebtedness was evidenced by a note (the "Original
Note") bearing interest at the rate of 10% per annum and payable in full
on or before August 31, 2001. Pursuant to the 1997 Supplemental
Securities Agreement (described below), this note was replaced with a
note bearing interest at 9.5% per annum and payable in full on August 31,
2002. In connection with the issuance of the Original Note, the Company
issued to GECC warrants to purchase a total of 1,400,000 shares of Common
Stock at an exercise price of $.001 per share, expiring August 31, 2006.
In the event that the Company fails to meet certain financial covenants,
including failure to repay this loan, the Securities Purchase Agreement
provides, in part, that GECC may take action to appoint additional
members of the Board of Directors such that GECC will control the
majority of the Board.
- The Company converted all outstanding shares of Series A Preferred Stock
into 1,176,950 shares of Common Stock. The holders of the Preferred Stock
who received shares of Common Stock included certain affiliates of Worms
& Cie and JOL.
- The Company entered into a Registration Rights Agreement with all
investors that received shares of Common Stock pursuant to the Securities
Purchase Agreement. See "Description of Capital Stock -- Registration
Rights Agreement."
- The Company entered into a Stockholders Agreement with investors. See
"Description of Capital Stock -- Stockholders Agreement." Pursuant to the
Stockholders Agreement, Mr. Hawley was appointed Chief Executive Officer
and named Chairman of the Board. Also pursuant to the Stockholders
Agreement, (i) Mr. Coats, a managing Director of GE Capital Equity
Capital Group, a wholly-owned subsidiary of GECC, was appointed to the
Board, and (ii) Mr. DeLitto, the President of Permal Capital Management,
Inc., was appointed to the Board.
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<PAGE> 46
The price of $1.00 per share for shares of Common Stock issued pursuant to
the Securities Purchase Agreement was negotiated at arm's length between the
Company and GECC, the lead investor, prior to August 19, 1996, the date of the
public announcement regarding the proposed GECC financing. The average of the
high and low sales prices on the Nasdaq SmallCap Market for the Company's Common
Stock during the two weeks prior to August 19, 1996, was $0.91 per share. The
average of the high and low sales prices on the Nasdaq SmallCap Market for the
Company's Common Stock on August 26, 1996, and on September 10, 1996, the
closing dates of the transactions, was $1.66 and $1.47, respectively.
1997 Supplemental Securities Purchase Agreement. On August 14, 1997, the
Company concluded a supplemental agreement to the Securities Purchase Agreement
(the "Supplemental Agreement"). Pursuant to the Supplemental Agreement:
- The Company sold subordinated notes to GECC and JOL in the principal
amounts of $2,500,000 and $500,000, respectively (together, the "1997
Notes"). The 1997 Notes bear interest at a rate of 9.5%, payable
quarterly. Principal is payable in six semi-annual installments,
commencing February, 2000. In addition, GECC and JOL were issued warrants
to purchase 600,000 shares of Common Stock and 140,000 shares of Common
Stock, respectively, at a purchase price of $1.25 per share. In the event
that the Company fails to meet certain financial covenants, including
failure to repay this loan, the Securities Purchase Agreement provides,
in part, that GECC may take action to appoint additional members of the
Board of Directors such that GECC will control the majority of the Board.
- The Company arranged for a standby credit facility under which the
Company may at its option, subject to attainment of certain financial
covenants, borrow up to an additional $3,500,000 (the "Standby Notes")
from GECC and JOL under the same terms and conditions of the 1997 Notes.
The Company borrowed funds pursuant to the Standby Notes on December 30,
1997 and issued to GECC and JOL additional warrants to purchase 400,000
and 160,000 shares of Common Stock, respectively, at $1.25 per share.
- The Company issued to GECC and JOL warrants to purchase in the aggregate
up to an additional 1,000,000 shares of Common Stock at a price of $0.01
per share (the "Performance Warrants"). The Performance Warrants first
become exercisable in April 2000 and will be canceled if the Company
meets certain economic performance targets for fiscal 1999.
- The Company issued a new 9.5% Subordinated Note due August 31, 2002 (the
"Replacement Note") in the principal amount of $5,501,091 to replace the
Original Note (which bore interest at 10% per annum and was payable in
full on or before August 31, 2001) in the principal amount of $5 million
and certain additional notes in aggregate principal amount of $501,091
reflecting accrued interest. The Replacement Note is payable semiannually
on a straight line basis over three years beginning February 2000.
- The Company amended the Registration Rights Agreement and the
Stockholders Agreement. See "Description of Capital Stock -- Registration
Rights Agreement" and "Description of Capital Stock -- Stockholders
Agreement."
Private Label Credit Card Program with Monogram Credit Card Bank of Georgia
(an Affiliate of GECC). In April 1997, the Company entered into an agreement
with Monogram Credit Card Bank of Georgia ("Monogram"), an affiliate of GECC,
pursuant to which Monogram provides a customized credit program to the Company.
Under this program, approved customers of the Company are able to purchase
products on credit through a credit card issued by Monogram. Monogram purchases
each credit from the Company and bears the risk of loss on such credit
purchases. The program is for an initial term of five years and will
automatically renew for consecutive five-year terms unless terminated by either
party at least six months prior to the end of any such five-year term.
Transactions with Permal Capital Management, Inc. (a wholly owned
subsidiary of Worms & Co., Inc., since October 1990). In 1996 and 1995, Permal
Capital Management, Inc. ("PCMI") provided various management services for the
Company and its subsidiaries, for which PCMI received $58,333 and $100,000,
respectively. PCMI's executive management services for the Company included
assistance with regard to executive management, financial consulting and
strategic planning during the year. Thomas M. DeLitto,
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<PAGE> 47
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 Board of
Directors.
Succession Agreement. In December 1997, a Succession Agreement was entered
into by the Company and the following stockholders: Philip M. Hawley, its
Chairman, his sons John F. Hawley and Dr. Philip M. Hawley, Jr., GECC and Permal
Capital Management. The parties to the Succession Agreement agreed that if
Philip M. Hawley ceases to serve on the Board of Directors, the stockholder
parties would take all necessary action to ensure that John F. Hawley, or his
nominee if he is unavailable, is elected to serve as a director. Furthermore,
GECC and each of the members of the Hawley Group agreed to cooperate in
connection with the acquisition by either of Common Stock held by the Permal
Group. The agreement will continue as long as the Hawley Group owns an aggregate
of at least 1,000,000 shares of Common Stock.
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<PAGE> 48
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to
beneficial ownership of the Company's Common Stock as of January 30, 1998 and is
adjusted to reflect the sale of the shares offered hereby by (i) each person (or
group of affiliated persons) who is known by the Company to own beneficially
more than 5% of the Company's Common Stock, (ii) each of the Company's
directors, (iii) each of the Named Executive Officers, (iv) the Selling
Stockholder, and (v) all directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
SHARES BENEFICIALLY OWNED OWNED AFTER
PRIOR TO OFFERING(1) NUMBER OF OFFERING
------------------------- SHARES -------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT BEING OFFERED NUMBER PERCENT
- -------------------------------------- --------- ------- ------------- --------- -------
<S> <C> <C> <C> <C> <C>
GECC.................................. 7,400,000(2) 34.5% -- 7,400,000 31.1%
260 Long Ridge Road
Stamford, CT 06927
Worms & Cie........................... 5,278,818(3)(5) 27.1 -- 3,182,707(5) 14.6
55 rue la Boetie
75008 Paris, France
Japan Omnibus Ltd..................... 2,396,111(4) 12.4 2,096,111(5) 300,000 1.4
Tropic Isle Building
Road Town, Tortola
British Virgin Islands
John F. Hawley and Barbara H. Hawley,
as Trustees......................... 1,376,472(6) 7.2 -- 1,376,472 6.4
515 South Figueroa Street
Los Angeles, CA 900071
ATCO Holdings Limited................. 1,115,923 5.9 -- 1,115,923 5.2
c/o ATCO Development, Inc.
11777 Katy Freeway
Houston, TX 77079
Philip M. Hawley...................... 647,000(7) 3.3 -- 647,000 2.9
Thomas M. DeLitto..................... 109,327(8) * -- 109,327 *
Robert A. Burton...................... 12,500(9) * -- 12,500 *
Herbert J. Friedman................... 29,981(10) * -- 29,981 *
K. James McTaggart.................... 14,333(11) * -- 14,333 *
Klaus Tabar........................... 34,837(12) * -- 34,837 *
Stephen P. Anderson(14)............... -- -- -- -- --
Robert G. Sharpe(14).................. 55,378 * -- 55,378 *
Kamal G. Abdelnour.................... 47,520(13) * -- 47,520 *
Jeffrey H. Coats...................... -- -- -- -- --
Peter H. Dailey....................... 14,570(15) * -- 14,570 *
John A. Gavin......................... 14,570(15) * -- 14,570 *
All directors and executive officers
as a group (12 persons)............. 980,016 4.9 -- 980,016 4.4
</TABLE>
- ---------------
* Less than one percent
(1) Outstanding warrants and options held by each of the principal
stockholders, directors and executive officers which are exercisable
currently or within 60 days of the date of this table are deemed to be
outstanding shares of Common Stock for their respective calculations.
(2) Includes warrants to purchase 2,400,000 shares of Common Stock.
(3) Worms & Cie, through JOL, PCMI and certain other affiliates, may be deemed
to be the beneficial owner of 4,851,421 shares of Common Stock and warrants
to purchase 427,397 shares of Common Stock, which amounts include 1,288,040
shares and 29,442 warrants held by two former directors of the Company, and
exclude 109,327 shares, options and warrants held by Mr. DeLitto and shown
separately
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<PAGE> 49
below. The two former directors and Mr. DeLitto are directors and officers of
affiliates of Worms & Cie. Worms & Cie. disclaims ownership of the shares held
by these individuals.
(4) Includes warrants to purchase 300,000 shares of Common Stock.
(5) JOL is the sole Selling Stockholder. Worms & Cie's principal business is
investing. Worms & Cie does not directly own any shares of Common Stock. A
senior vice president of Worms & Co., Inc., an affiliate of Worms & Cie,
James Hodge, makes investment decisions for JOL in his capacity as its
Portfolio Manager, and accordingly, Worms & Cie may be deemed to share
voting and dispositive power with respect to, and therefore to beneficially
own, the shares of Common Stock beneficially owned by JOL. Therefore, the
number of shares beneficially owned after this offering by Worms & Cie
reflects a reduction by the number of shares sold by JOL, even though Worms
& Cie is not the seller thereof.
(6) As trustees for various Hawley Trusts, John F. Hawley and Barbara H. Hawley
are deemed to be beneficial owners of such shares.
(7) Includes option to purchase 617,000 shares of Common Stock.
(8) Includes options to purchase 9,998 shares of Common Stock, 9,570 deferred
stock units and a warrant to purchase 14,721 shares of Common Stock.
(9) Represents option to purchase 12,500 shares of Common Stock.
(10) Includes options to purchase 23,760 shares of Common Stock.
(11) Includes options to purchase 13,333 shares of Common Stock.
(12) Includes options to purchase 29,700 shares of Common Stock.
(13) Includes option to purchase 5,000 shares of Common Stock, 9,570 deferred
stock units and a warrant to purchase 32,950 shares of Common Stock.
(14) Resigned in January 1997.
(15) Consists of options to purchase 5,000 shares of Common Stock and 9,570
deferred stock units.
PLAN OF DISTRIBUTION
The Common Stock is being offered for sale by the Company and the Selling
Stockholder on a best efforts, all or nothing basis, primarily to selected
institutional investors. Cruttenden Roth Incorporated, Black & Company, Inc. and
Morgan Fuller Capital Group, LLC, the Placement Agents, have been retained
pursuant to a Placement Agency Agreement to act as the exclusive agents for the
Company and the Selling Stockholder in connection with the arrangement of offers
and sales of the Common Stock on a best efforts basis.
The Placement Agents are not obligated to take for themselves (or purchase)
any of the Shares offered hereby and do not intend to do so. It is anticipated
that the Placement Agents will obtain indications of interest from potential
investors for the amount of the offering and that effectiveness of the
Registration Statement will not be requested until indications of interest have
been received for the amount of the offering. No investor funds will be accepted
until indications of interest have been received for the amount of the offering,
and no investor funds will be accepted prior to effectiveness of the
Registration Statement. Confirmations and definitive prospectuses will be
distributed to all investors at the time of pricing, informing investors of the
closing date, which is expected to be scheduled for three business days after
pricing, but it may occur at any time up to the termination date. After the
Registration Statement is declared effective and prior to the closing date, all
investor funds will be placed promptly in escrow with Imperial Trust Company, as
Escrow Agent, in an escrow account established for the benefit of the investors.
Investors' checks will be made payable to or endorsed to the Escrow Agent and
any checks received by the Placement Agents will be transmitted directly to the
Escrow Agent by noon of the next business day after receipt. The Escrow Agent
will invest such funds in accordance with Rule 15c2-4 promulgated under the
Exchange Act. Prior to application of the investor funds to purchase the Shares,
all investor funds will be invested by the Escrow Agent. Prior to the closing
date, the Escrow Agent will advise the Company and the Selling Stockholder that
payment for the purchase of the Shares offered hereby has been affirmed by the
investors and that the
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<PAGE> 50
investors have deposited the requisite funds in the escrow account at the Escrow
Agent. Upon receipt of such notice, the Company and the Selling Stockholder will
deliver the shares of Common Stock to be credited to the accounts of the
investors and will collect the necessary funds from the Escrow Agent. Investor
funds, together with interest thereon will be collected by the Company and the
Selling Stockholder through the facilities of the Escrow Agent on the scheduled
closing date. The offering will not continue after the closing date. In the
event that investor funds are not received in the full amount of the Common
Stock offered hereby, all funds deposited in the escrow account will promptly be
returned to the investors and their proportionate share of interest earned on
the funds they deposited with the Escrow Agent will be returned promptly after
the fourth business day of the month immediately following the month in which
the offering is terminated.
The Company and the Selling Stockholder have agreed (i) to pay to the
Placement Agents 9.0% of the proceeds of the Shares being sold by each of them
in this offering as the selling commission, and (ii) to indemnify the Placement
Agents against certain liabilities, including liabilities under the Securities
Act. In addition, the Company has agreed to reimburse the Placement Agents up to
$100,000 for certain expenses incurred by them in connection with the offering.
The Company has agreed that for a period of 180 days from the date of this
Prospectus it will not, and certain officers, directors and affiliates of the
Company and the Selling Stockholder have agreed that for a period of 120 days
from the date of the Prospectus they will not, offer, sell or otherwise dispose
of any shares of capital stock or equity securities of the Company or any
securities convertible into, or exchangeable or exercisable for, Common Stock
(excluding those shares being sold pursuant to this offering), without the prior
written consent of the Placement Agents.
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 35,000,000 shares
of Common Stock, par value $.001 per share (the "Common Stock") and 666,667
shares of Preferred Stock par value $.001 per share (the "Preferred Stock"). As
of January 30, 1998, there were 19,020,539 shares of Common Stock issued and
outstanding. No shares of Preferred Stock are issued and outstanding.
COMMON STOCK
The holders of Common Stock (but not warrant holders or optionees) are
entitled to dividends and distributions, if any, with respect to the Common
Stock when, as and if declared by the Board of Directors from funds legally
available therefor. Holders of Common Stock are entitled to one vote per share
and are not entitled to cumulative voting in the election of directors. The
holders of Common Stock have no preemptive, subscription, redemption or
conversion rights. In the event of the liquidation, dissolution or winding up of
the Company, the holders of Common Stock are entitled to share ratably in all
assets remaining after payment of all debts and other liabilities, subject to
prior distribution rights of holders of Preferred Stock, if any, then
outstanding.
PREFERRED STOCK
The Company's Board of Directors is authorized to divide the Preferred
Stock into series and, with respect to each series, to determine the
preferences, rights, qualifications, limitations and restrictions thereof,
including the dividend rights, conversion rights, voting rights, redemption
rights and terms, liquidation preferences, sinking fund provisions, number of
shares constituting a series and the designation of such series. Although the
Company currently does not have any plans to issue shares of Preferred Stock or
to designate any new series of Preferred Stock, there can be no assurance that
the Company will not do so in the future. The Board of Directors could, without
stockholder approval, issue Preferred Stock with voting and other rights that
could adversely affect the voting power of the holders of Common Stock and could
have certain anti-takeover effects.
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<PAGE> 51
WARRANTS AND STOCK OPTIONS
As of January 30, 1998, the Company had warrants outstanding to purchase an
aggregate of 3,065,502 shares of its Common Stock. Of these warrants, 1,400,000
warrants were issued to GECC at a exercise price of $.001 per share. Also, in
connection with the August, 1997 financing, one million warrants were issued to
GECC and 300,000 were issued to JOL, all at an exercise price of $1.25 per
share. The remaining 365,502 warrants have exercise prices ranging from $1.32 to
$15.00 per share with expiration dates ranging from May 1998 to June 2005. The
warrants generally provide for certain anti-dilution adjustments. In addition,
in connection with the August 1997 financing, the Company agreed to issue
warrants to GECC and JOL to purchase up to 1,000,000 shares of Common Stock upon
the occurrence of certain events, and which expire August 31, 2006. See "Certain
Transactions." The Company also has 38,280 shares of Common Stock issuable upon
payment of deferred stock units and options outstanding to purchase an
additional 2,043,958 shares of Common Stock.
REGISTRATION RIGHTS
After this offering, holders of 7,244,612 shares of Common Stock will be
entitled to certain rights with respect to the registration of such shares under
the Securities Act, pursuant to a certain Registration Rights Agreement dated as
of August 26, 1996, as amended on August 14, 1997, among such holders and the
Company (the "Registration Rights Agreement"). Under the terms of the
Registration Rights Agreement, if the Company hereafter proposes to register any
of its securities under the Securities Act, either for its own account or for
the account of other security holders exercising registration rights, such
holders are entitled to notice of such registration and are entitled to include
shares of Common Stock therein. Stockholders benefiting from these rights may
also require the Company to file a registration statement under the Securities
Act with respect to their shares of Common Stock, and the Company is required to
use best efforts to effect up to two such registrations during any 12-month
period. This right is not exercisable prior to August 31, 1999, unless certain
conditions are satisfied. Further, these rights are subject to certain
conditions and limitations, among them the right of the underwriter of an
offering to limit the number of shares included in such registration and the
right of the Company not to effect a requested registration within 180 days
following the offering of the Company's securities in another public offering.
The Amendment to the Registration Rights Agreement provides for a one-time
registration right for the benefit of JOL and members of the Permal Group, as
JOL may designate, whereby JOL is permitted to offer for sale or sell a maximum
of 2,096,111 shares of Common Stock in the aggregate and a minimum of 1,000,000
shares of Common Stock.
STOCKHOLDERS AGREEMENT
As of August 26, 1996, in connection with the GECC financing described
under "Certain Transactions" above, the Company entered into a stockholders
agreement (the "Stockholders Agreement") with several investors, including GECC
as well as certain other existing stockholders. The Stockholders Agreement, as
amended on August 14, 1997, provides, among other things, for certain
restrictions on the transfer of shares by those stockholders who are parties to
the Stockholders Agreement and confers rights of first offer to GECC in the
event certain of the stockholders wish to sell their shares. Furthermore, the
Stockholders Agreement allows for GECC to name one director to the Board of
Directors of the Company, allows the Permal Group (as defined in the
Stockholders Agreement) to designate another director, provides that Philip M.
Hawley will be a third director, and provides that the three remaining directors
(the "Joint Designees") will be selected by Mr. Hawley and the directors who are
designated by GECC and the Permal Group. At each meeting of the stockholders of
the Company held for the purpose of electing directors, the stockholders who are
parties to the Stockholders Agreement (with the exception of certain trusts) are
required to vote to cause the GECC designee, the Permal Group designee, Mr.
Hawley and the Joint Designees to be elected as directors. In addition, the
Company is prohibited from taking certain actions unless the GECC designee on
the Board of Directors approves such action. Such restricted actions include
mergers; liquidations and dissolutions; acquisitions of all or a substantial
portion of the business or the assets of another person; the entering into of a
joint venture or partnership arrangement; expansion into new lines of business;
the sale, lease or transfer of any assets of the Company or any of its
subsidiaries except for sales of inventory in the ordinary course of business
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<PAGE> 52
and the subleasing of vacant retail space; the adoption or change of any
material accounting policy; the creation of any additional indebtedness (with
certain exceptions); the granting of liens against the Company's assets; the
payment of dividends or the redemption of capital stock; the making or
commitment to make any capital expenditure in any year in excess of $50,000; the
issuance or sale of any shares of capital stock or rights to purchase capital
stock; the entering into, adoption, amendment or termination of any employment
or consulting agreement or the hiring of any person who will report directly to
the Chief Executive Officer or to whom total compensation would be in the excess
of $110,000 per year; the adoption or amendment of any employment benefit plan;
the amendment of the Company's charter documents; a change in independent
certified accountants or actuaries; the registration of any security under the
Securities Act or the granting of any registration rights therefor; certain
related party transactions; changes to the Company's annual business plan; and
any action which is required by law to be approved by the Board of Directors.
The Stockholders Agreement further provides that each member of the Permal
Group will vote all of its shares in the same manner that GECC votes its shares
with respect to each matter subject to the vote or consent of stockholders of
the Company. In the event GECC or any member of the Permal Group, pursuant to a
common plan, were to enter into any agreement to sell to any person or group in
one transaction or series of related transactions in which such group would sell
in excess of 3,000,000 shares, then each of the other stockholders party to the
Stockholders Agreement would have the right to participate in such sale. The
Stockholders Agreement will terminate at such time as GECC is no longer the
beneficial owner of at least 2,000,000 of the outstanding shares of Common Stock
or at such earlier time as may be agreed by GECC and the Permal Group.
Furthermore, the Stockholders Agreement will terminate as to any member of the
Hawley Group on the later of (i) six months after Mr. Hawley ceases to be a
Director of the Company and (ii) August 31, 1999.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), an anti-takeover law that restricts certain transactions
and business combinations between a corporation and an "Interested Stockholder"
owning 15% or more of the corporation's outstanding voting stock, for a period
of three years from the date the stockholder becomes an Interested Stockholder.
Subject to certain exceptions, unless the transaction is approved by the board
of directors and the holders of at least two-thirds of the outstanding voting
stock of the corporation (excluding shares held by the Interested Stockholder),
Section 203 prohibits significant business transactions such as a merger with,
disposition of assets to, or receipt of disproportionate financial benefits by
the Interested Stockholder, or any other transaction that would increase the
Interested Stockholder's proportionate ownership of any class or series of the
corporation's stock. The statutory ban does not apply if, upon consummation of
the transaction in which any person becomes an Interested Stockholder, the
Interested Stockholder owns at least 85% of the outstanding voting stock of the
corporation (excluding shares held by persons who are both directors and
officers or by certain employee stock plans).
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is First National
Bank of Boston.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon by
Morrison & Foerster LLP, Los Angeles, California. Certain matters in connection
with this offering will be passed upon for the Placement Agent by Snell & Wilmer
L.L.P., Phoenix, Arizona.
51
<PAGE> 53
EXPERTS
The consolidated financial statements and financial statement schedule of
Krause's Furniture, Inc. as of February 2, 1997 and January 28, 1996, and for
the fiscal years ended February 2, 1997, January 28, 1996, and December 31,
1994, and for the month ended January 29, 1995, appearing in this Prospectus and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports thereon appearing elsewhere herein. The
consolidated financial statements and schedule referred to above are included in
reliance upon such reports, given upon the authority of such firm as experts in
accounting and auditing.
ADDITIONAL INFORMATION
The Company is subject to the reporting requirements of the Exchange Act,
and accordingly files annual and quarterly reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission"). The
Company has filed with the Commission a Registration Statement on Form S-1
(together with all amendments and exhibits thereto, the "Registration
Statement") under the Securities Act with respect to the shares of Common Stock
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. For further
information with respect to the Company and the shares of Common Stock offered
hereby, reference is made to the Registration Statement. Statements contained in
this Prospectus as to the contents of any contract or other document are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. Copies of
such materials may be examined without charge at, or obtained upon payment of
prescribed fees from, the Public Reference Section of the Commission at Room
1024 Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's regional offices located at 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and at 7 World Trade Center, 13th Floor, New York New
York 10048. The Commission maintains a World Wide Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission. The address of the
site is http://www.sec.gov. The Common Stock is currently traded on the Nasdaq
SmallCap Market. Reports, proxy statements and other information concerning the
Company may also be inspected at the National Association of Securities Dealers,
Inc. at 1735 K Street, N.W., Washington D.C. 20006.
52
<PAGE> 54
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.................................. F-1
Consolidated Balance Sheet at February 2, 1997 and January 28, 1996................ F-2
Consolidated Statement of Operations for the years ended February 2, 1997, January
28, 1996 and December 31, 1994................................................... F-3
Consolidated Statement of Stockholders' Equity for the period from January 1, 1994
to February 2, 1997.............................................................. F-4
Consolidated Statement of Cash Flows for the years ended February 2, 1997, January
28, 1996 and December 31, 1994................................................... F-5
Consolidated Statement of Operations for the months ended January 29, 1995 and
January 30, 1994 (unaudited)..................................................... F-6
Consolidated Statement of Cash Flows for the months ended January 29, 1995 and
January 30, 1994 (unaudited)..................................................... F-7
Notes to Consolidated Financial Statements......................................... F-8
Unaudited Consolidated Balance Sheet at November 2, 1997........................... F-18
Unaudited Consolidated Statement of Operations for the thirty-nine weeks ended
November 2, 1997 and October 27, 1996............................................ F-19
Unaudited Consolidated Statement of Stockholders' Equity for the thirty-nine weeks
ended November 2, 1997........................................................... F-20
Unaudited Consolidated Statement of Cash Flows for the thirty-nine weeks ended
November 2, 1997 and October 27, 1996............................................ F-21
Notes to Unaudited Consolidated Financial Statements............................... F-22
</TABLE>
53
<PAGE> 55
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the accompanying consolidated balance sheets of Krause's
Furniture, Inc. as of February 2, 1997 and January 28, 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the fiscal years ended February 2, 1997, January 28, 1996 and December 31, 1994,
and for the month ended January 29, 1995. 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.
The Company has reported losses from operations in each of the past five
years, projects that it will incur a net loss for the year ending February 1,
1998 and may be required to obtain a waiver as of February 1, 1998 with respect
to compliance with covenants contained in its revolving credit agreement.
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, the consolidated financial position of
Krause's Furniture, Inc. at February 2, 1997 and January 28, 1996, and the
consolidated results of its operations and its cash flows for the fiscal years
ended February 2, 1997, January 28, 1996 and December 31, 1994, and the month
ended January 29, 1995, in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
Orange County, California
March 28, 1997,
except for Note 2, as to which the date is
December 17, 1997
F-1
<PAGE> 56
KRAUSE'S FURNITURE, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 28,
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................... $ 1,227 $ 1,336
Accounts receivable, net of allowance for doubtful accounts of $327
($291 at January 28, 1996)....................................... 1,120 786
Inventories......................................................... 14,013 14,627
Prepaid expenses.................................................... 1,193 386
Income tax refund receivable........................................ -- 1,467
-------- --------
Total current assets............................................. 17,553 18,602
Property, equipment, and leasehold improvements, net.................. 6,389 6,738
Goodwill, net......................................................... 15,386 16,406
Leasehold interests, net.............................................. 1,504 1,830
Other assets.......................................................... 2,255 3,290
-------- --------
$ 43,087 $ 46,866
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................... $ 7,506 $ 12,036
Accrued payroll and related expenses................................ 1,468 1,696
Other accrued liabilities........................................... 5,099 4,715
Customer deposits................................................... 5,621 7,014
Notes payable....................................................... 41 19
-------- --------
Total current liabilities........................................ 19,735 25,480
Long-term liabilities:
Notes payable....................................................... 6,306 5,584
Other............................................................... 1,503 1,817
-------- --------
Total long-term liabilities...................................... 7,809 7,401
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.001 par value; 666,667 shares
authorized; no shares outstanding (117,694 at January 28, 1996)
at stated value.................................................. -- 7,523
Common stock, $.001 par value; 35,000,000 shares authorized,
19,020,539 shares outstanding (4,120,810 at January 28, 1996).... 19 4
Capital in excess of par value...................................... 49,874 27,419
Accumulated deficit................................................. (34,350) (20,961)
-------- --------
Total stockholders' equity....................................... 15,543 13,985
-------- --------
$ 43,087 $ 46,866
======== ========
</TABLE>
See accompanying notes.
F-2
<PAGE> 57
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
---------------------------------------------
FEBRUARY 2, JANUARY 28, DECEMBER 31,
1997 1996 1994
----------- ------------ ------------
<S> <C> <C> <C>
Net sales............................................. $ 112,737 $122,319 $116,471
Cost of sales......................................... 56,490 59,852 53,522
--------- --------- ---------
Gross profit.......................................... 56,247 62,467 62,949
Operating expenses:
Selling............................................. 57,573 60,257 53,460
General and administrative.......................... 10,101 10,578 10,867
Amortization of goodwill............................ 1,020 1,020 1,020
--------- --------- ---------
68,694 71,855 65,347
--------- --------- ---------
Loss from operations.................................. (12,447) (9,388) (2,398)
Interest expense...................................... (1,230) (721) (2,140)
Other income.......................................... 288 67 109
Gain from sale of Mr. Coffee stock.................... -- -- 12,115
Equity in earnings of Mr. Coffee...................... -- -- 316
--------- --------- ---------
Income (loss) before income taxes and extraordinary
item................................................ (13,389) (10,042) 8,002
Provision (benefit) for income taxes.................. -- (1,327) 2,171
--------- --------- ---------
Income (loss) before extraordinary item............... (13,389) (8,715) 5,831
Extraordinary loss from debt retirement, net of income
tax benefit of $291................................. -- -- (436)
--------- --------- ---------
Net income (loss)..................................... $ (13,389) $ (8,715) $ 5,395
========= ========= =========
Income (loss) per share:
Income (loss) before extraordinary item............. $ (1.28) $ (2.21) $ 1.08
Extraordinary loss.................................. -- -- (0.08)
--------- --------- ---------
Net income (loss)................................... $ (1.28) $ (2.21) $ 1.00
========= ========= =========
Number of shares used in computing income
(loss) per share.................................... 10,445 3,950 5,394
========= ========= =========
</TABLE>
See accompanying notes.
F-3
<PAGE> 58
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE CAPITAL
PREFERRED STOCK COMMON STOCK IN EXCESS TOTAL
----------------- ---------------- OF PAR ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT VALUE DEFICIT EQUITY
------ ------- ------ ------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993................... 547 $11,856 10,469 $ 10 $23,180 $ (14,420) $ 20,626
Conversion of Series A
preferred stock........ (63) (1,401) 636 1 1,400 -- --
Repurchase of common
stock.................. -- -- (55) -- (105) -- (105)
Issuance of common stock
related to exercise of
stock options.......... -- -- 5 -- 5 -- 5
Net income............... -- -- -- -- -- 5,395 5,395
---- ------ ------ --- ------- -------- -------
Balance at December 31,
1994................... 484 10,455 11,055 11 24,480 (9,025) 25,921
Net loss................. -- -- -- -- -- (3,221) (3,221)
---- ------ ------ --- ------- -------- -------
Balance at January 29,
1995................... 484 10,455 11,055 11 24,480 (12,246) 22,700
Conversion of Series B
preferred stock........ (119) (2,674) 1,190 1 2,673 -- --
Reverse stock split...... (235) -- (8,163) (8) 8 -- --
Conversion of Series A
preferred stock........ (12) (258) 39 -- 258 -- --
Net loss................. -- -- -- -- -- (8,715) (8,715)
---- ------ ------ --- ------- -------- -------
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
==== ====== ====== === ======= ======== =======
</TABLE>
See accompanying notes.
F-4
<PAGE> 59
KRAUSE'S FURNITURE, INC
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
---------------------------------------------
FEBRUARY 2, JANUARY 28, DECEMBER 31,
1997 1996 1994
----------- ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss).................................... $ (13,389) $ (8,715) $ 5,395
Adjustments to reconcile net income (loss) to net
cash used by operating activities:
Depreciation and amortization................... 2,561 2,760 3,501
Deferred income taxes........................... -- 920 (920)
Gain from sale of Mr. Coffee stock.............. -- -- (12,115)
Other non-cash charges.......................... 618 283 1,153
Change in assets and liabilities:
Accounts receivable............................. (334) 404 340
Inventories..................................... 614 3,389 (2,567)
Prepaid expenses and other assets............... 229 1,210 (1,153)
Income tax refund receivable.................... 1,467 (1,467) --
Accounts payable and accrued liabilities........ (4,688) (2,166) 6
Customer deposits............................... (1,393) 205 (517)
--------- --------- ---------
Net cash used by operating activities......... (14,315) (3,177) (6,877)
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures............................... (806) (1,883) (2,323)
Proceeds from sale-leaseback....................... -- 1,039 --
Proceeds from sale of Mr. Coffee stock............. -- -- 23,258
--------- --------- ---------
Net cash provided (used) by investing
activities................................. (806) (844) 20,935
--------- --------- ---------
Cash flows from financing activities:
Net borrowings (payments) on short-term notes...... 390 (18) (1,093)
Proceeds from long-term borrowings................. 142,612 141,371 100
Principal payments on long-term debt............... (138,178) (137,948) (17,700)
Proceeds from issuance of common stock............. 10,221 -- --
Other.............................................. (33) -- (50)
--------- --------- ---------
Net cash provided (used) by financing
activities................................. 15,012 3,405 (18,743)
--------- --------- ---------
Net decrease in cash................................. (109) (616) (4,685)
Cash and cash equivalents at beginning of year....... 1,336 1,952 6,302
--------- --------- ---------
Cash and cash equivalents at end of year............. $ 1,227 $ 1,336 $ 1,617
========= ========= =========
Supplemental disclosures of cash flow information --
Cash paid during the year for:
Interest........................................... $ 466 $ 543 $ 915
Income taxes....................................... 9 -- 2,100
Noncash investing and financing activities:
Preferred stock converted into common stock........ 7,523 2,932 1,401
Exchange of notes payable and related accrued
interest for common stock....................... 3,066 -- --
Issuance of common stock purchase warrant.......... 1,400 -- --
</TABLE>
See accompanying notes.
F-5
<PAGE> 60
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
MONTH ENDED MONTH ENDED
JANUARY 29, JANUARY 30,
1995 1994
----------- -----------
(UNAUDITED)
<S> <C> <C>
Net sales.......................................................... $ 7,179 $ 7,326
Cost of sales...................................................... 3,647 3,519
------- -------
Gross profit....................................................... 3,532 3,807
Operating expenses:
Selling.......................................................... 5,446 4,935
General and administrative....................................... 1,317 913
------- -------
6,763 5,848
------- -------
Loss from operations............................................... (3,231) (2,041)
Equity in earnings of Mr. Coffee................................... -- 93
Interest expense................................................... (12) (258)
Other income....................................................... 22 21
------- -------
Net loss........................................................... $(3,221) $(2,185)
======= =======
Net loss per share................................................. $ (.87) $ (.63)
======= =======
Number of shares used in computing loss per share.................. 3,685 3,490
</TABLE>
See accompanying notes.
F-6
<PAGE> 61
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MONTH ENDED MONTH ENDED
JANUARY 29, JANUARY 30,
1995 1994
----------- -----------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................................... $(3,221) $(2,185)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization................................. 217 321
Equity in earnings of Mr. Coffee.............................. -- (93)
Change in assets and liabilities:
Accounts receivable........................................... 81 (160)
Inventories................................................... (759) (1,396)
Prepaid expenses and other assets............................. (719) (196)
Accounts payable and accrued liabilities...................... 343 (1,899)
Customer deposits............................................. 3,113 2,349
Income taxes payable.......................................... -- 42
------- -------
Net cash used by operating activities....................... (945) (3,217)
------- -------
Cash flows from investing activities:
Capital expenditures............................................. (764) (60)
Cash flows from financing activities:
Proceeds from issuance of long-term debt......................... 2,092 --
Principal payments on long-term debt............................. (48) --
------- -------
Net cash provided by financing activities..................... 2,044 --
------- -------
Net increase (decrease) in cash.................................... 335 (3,277)
Cash and cash equivalents at beginning of month.................... 1,617 6,302
------- -------
Cash and cash equivalents at end of month.......................... $ 1,952 $ 3,025
======= =======
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest...................................................... $ -- $ 351
Noncash investing and financing activities:
Note receivable reduction in exchange for common stock and
warrants..................................................... -- 50
</TABLE>
See accompanying notes.
F-7
<PAGE> 62
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, Krauses Sofa Factory ("Krauses"). 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 Company's 1996 fiscal year (53 weeks) ended February 2, 1997.
All significant intercompany transactions and balances have been eliminated.
On August 1, 1995, the Company effected a one-for-three reverse split of
its common and preferred stock. Except for share amounts prior to August 1, 1995
appearing in the accompanying consolidated statement of stockholders' equity,
all share and per share data presented in this report have been restated to
reflect the reverse split.
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.
Certain reclassifications of previously reported financial information were
made to conform to the fiscal 1996 presentation.
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, and two licensed dealerships. As of February 2,
1997 there were 82 company-owned showrooms, all of which are leased, located in
12 states.
Cash and cash equivalents
Cash and cash equivalents include U.S. Treasury bills, government agency
securities and commercial paper 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 note, 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.
F-8
<PAGE> 63
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Inventories
Inventories are carried at the lower of cost or market using the first-in,
first-out method and are comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 28,
1997 1996
----------- ------------
(IN THOUSANDS)
<S> <C> <C>
Finished goods....................................... $10,693 $ 12,345
Work in progress..................................... 254 297
Raw materials........................................ 3,066 1,985
------- -------
$14,013 $ 14,627
======= =======
</TABLE>
Showroom pre-opening expenses
Showroom pre-opening expenses are capitalized and amortized over periods of
up to 12 (previously 12-24) months subsequent to opening of the showroom.
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 $1,073,000 in fiscal 1996,
$1,100,000 in fiscal 1995, and $928,000 in fiscal 1994. Property, equipment and
leasehold improvements are summarized as follows:
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 28,
1997 1996
----------- ------------
(IN THOUSANDS)
<S> <C> <C>
Leasehold improvements............................... $ 9,241 $ 8,985
Construction in progress............................. 463 214
Machinery and equipment.............................. 2,962 2,855
Office and store furniture........................... 872 923
------- -------
13,538 12,977
Less accumulated depreciation and amortization....... (7,149) (6,239)
------- -------
$ 6,389 $ 6,738
======= =======
</TABLE>
During late 1994 and early 1995, the Company constructed a showroom in
Dallas, Texas on leased land. The building was sold in May 1995 for $1,039,000
to an unrelated party and leased back for a period of 250 months. The sale
resulted in a gain of $364,000, which was deferred and is being amortized over
the term of the lease.
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 $4,940,000 as of February 2, 1997
and $3,920,000 as of January 28, 1996.
F-9
<PAGE> 64
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 February 2, 1997. The
Company's analysis at February 2, 1997 is based on an estimate of future
undiscounted cash flows using forecasts contained in the Company's operating
plan. 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 1996, 1995,
and 1994 indicate that it is at least reasonably possible that such
circumstances could arise in fiscal 1997.
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 $1,819,000
as of February 2, 1997 and $1,493,000 as of January 28, 1996.
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 February 2, 1997, January 28, 1996 and December 31, 1994,
were $11,184,000, $11,181,000 and $10,029,000, 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.
Income (loss) per share
Per share amounts for 1994 were computed based on the weighted average
number of common and common equivalent shares outstanding. Common equivalent
shares arise from dilutive stock options and warrants and convertibility of
preferred stock into common stock. Loss per share for 1996 and 1995 were
computed based on the weighted average number of common shares outstanding
during each period since common stock equivalents were antidilutive. If the
conversions of preferred stock during the years ended
F-10
<PAGE> 65
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 2, 1997 and January 28, 1996, had occurred at the beginning of the
years, the net loss per share for the fiscal years 1996 and 1995 would have been
$1.20 and $2.11, respectively.
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. As a result of such losses, the Company had an accumulated deficit of
$34,350,000 and a working capital deficiency of $2,182,000 at February 2, 1997.
In each of the three quarters subsequent to February 2, 1997, the Company has
reported unaudited net losses that aggregate $5,609,000 for the thirty-nine
weeks ended November 2, 1997. As a result of such losses, the Company reported
an unaudited accumulated deficit of $39,959,000 and an unaudited working capital
deficiency of $1,181,000 at November 2, 1997. The Company expects to incur a net
loss in its fourth quarter of fiscal 1997.
On August 26, 1996 and September 10, 1996, the Company completed
transactions with investors in which the Company received cash proceeds of
$15,669,000 from financings through issuances of $10,669,000 of common stock, at
$1 per share, and a $5,000,000 subordinated note with a warrant to purchase
1,400,000 shares of common stock at $.001 per share. 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. Also the
Company's revolving credit agreement was amended to extend the expiration date,
reduce the interest rate and provide for an increase in borrowing availability.
On August 14, 1997, the Company completed transactions with two investors
in which it issued $3,000,000 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 $3,500,000 which the
Company may draw on between January 2, 1998 and February 28, 2000 if it attains
certain financial covenants. If the Company draws on the standby credit
facility, it will issue to the investors warrants to purchase an aggregate of up
to 560,000 additional shares of common stock at $1.25 per share.
In conjunction with the 1997 financing described above, the Company issued
a new 9.5% Subordinated Note due August 31, 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 the principal
amount of $5,000,000 and certain additional notes in aggregate principal amount
of $501,091 reflecting related accrued interest. The Replacement Note is payable
semiannually, on a straight-line basis over three years beginning February 2000;
whereas, the Original Note was payable semiannually, on a straight-line basis
over three years beginning February 1999.
Also in August 1997, the Company renegotiated the term of its revolving
credit agreement by, among other things, making a change in the advance rate
which provided greater borrowing capacity. Under the credit agreement, the
Company is required to maintain certain financial covenants. As of November 2,
1997, the Company was out of compliance with one of these covenants but has
obtained a waiver. The Company may be in violation of one of these covenants as
of February 1, 1998 and anticipates being able to obtain a similar waiver, as
necessary, at the time. However, there can be no assurance that future financial
performance will
F-11
<PAGE> 66
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
result in compliance with these restrictions or restrictions contained in the
Company's other loan agreement, or that waivers will be obtained if the Company
fails to maintain compliance. Any default under the documents governing
indebtedness of the Company could have a significant adverse effect on the
financial position, results of operations or liquidity of the Company.
The Company's management, which underwent a substantial restructuring after
the 1996 financing described above, 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 in existing
markets, 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 expected to contribute significantly to reducing losses and,
ultimately, returning 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 and fund
its plan to remodel showrooms and open new showrooms throughout fiscal 1997 and
1998; however, if this is not the case, the Company will need to obtain
additional capital and there can be no assurance that any additional equity or
debt financing will be available. 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. INVESTMENT -- MR. COFFEE, INC.
On August 17, 1994, the Company sold all of its Mr. Coffee common stock
(1,500,548 shares) for $15.50 per share for a total cash consideration of
$23,258,000. The sale was completed pursuant to a merger of Mr. Coffee with
Health o meter Products, Inc. and resulted in a pretax gain to the Company of
$12,115,000. Since the Company and Mr. Coffee had certain members of the Board
of Directors in common, the investment in Mr. Coffee was accounted for using the
equity method. The Company's share of Mr. Coffee's earnings in 1994 up to the
time of the merger was $316,000.
4. NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 28,
1997 1996
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Secured revolving credit notes...................... $ 1,999 $ 5,515
Subordinated note payable to shareholder............ 5,133 --
Unamortized debt discount, net of accumulated
amortization of $137,000.......................... (1,263) --
Other notes......................................... 478 88
------- ------
6,347 5,603
Less current portion................................ 41 19
------- ------
$ 6,306 $ 5,584
======= ======
</TABLE>
The secured revolving credit notes were issued under a revolving credit
agreement between Krause's and a financial institution that expires in January
2000. The credit agreement provides for revolving loans of up to $10 million
based on the value of inventories. As of February 2, 1997, borrowing under the
revolving credit facility was limited to approximately $6.0 million as defined
in the agreement. Substantially all of Krause's assets are pledged as collateral
for the loans which are guaranteed by the Company. Interest on the loans as of
February 2, 1997 was payable monthly at the rate of 1.0% in excess of the prime
rate (8.25% at February 2, 1997).
F-12
<PAGE> 67
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The subordinated note payable to shareholder was issued August 26, 1996 and
bears interest at 10% per annum, payable in additional subordinated notes for
the first two years after which interest is payable quarterly. Interest
aggregating approximately $133,000 was added to the principal balance of the
subordinated note during fiscal 1996. Semiannual mandatory redemptions of
$1,015,336 are required beginning February 28, 1999 through final maturity on
August 31, 2001. The subordinated 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
subordinated note.
Pursuant to the terms of the Revolving Credit Agreement and the
Subordinated Note, the Company and Krause's are required to maintain certain
financial ratios and minimum levels of tangible net-worth and working capital.
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 February 2, 1997, the Company was in
compliance with all the terms and conditions of its Note Payable and Revolving
Credit Agreement.
The aggregate annual maturities of long-term debt during each of the five
fiscal years subsequent to February 2, 1997 are approximately as follows:
$41,000 in 1997, $74,000 in 1998, $4,111,000 in 1999, $2,098,000 in 2000, and
$1,286,000 in 2001.
5. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
----------------------------
JANUARY 28, DECEMBER 31,
1996 1994
----------- ------------
(IN THOUSANDS)
<S> <C> <C>
Current
Federal......................................... $(2,247) $2,413
State........................................... -- 678
------- ------
(2,247) 3,091
Deferred federal.................................. 920 (920)
------- ------
$(1,327) $2,171
======= ======
</TABLE>
The provision for income taxes differs from the amounts computed by
applying the federal statutory rate of 34% to income (loss) before income taxes,
as follows:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
--------------------------------------------
FEBRUARY 2, JANUARY 28, DECEMBER 31,
1997 1996 1994
----------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax at federal statutory rate.......... $(4,552) $(3,414) $2,721
Goodwill amortization.................. 347 346 350
Adjustment of valuation allowance...... 5,333 2,144 (920)
Benefit of net operating loss
carryforwards........................ -- -- (752)
State income tax, net of federal
benefit.............................. (742) (557) 630
Other.................................. (386) 154 142
------- ------- ------
$ -- $(1,327) $2,171
======= ======= ======
</TABLE>
F-13
<PAGE> 68
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
FEBRUARY 2, JANUARY 28,
1997 1996
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities............................ $ -- $ 200
Deferred tax assets:
Net operating loss carryforwards.................. 12,075 7,510
Reserves and accruals not currently deductible for
tax purposes................................... 1,443 900
Other............................................. 125 100
-------- -------
Total deferred tax assets......................... 13,643 8,510
Valuation allowance for deferred tax assets....... (13,643) (8,310)
-------- -------
Net deferred tax assets........................... -- 200
-------- -------
Net deferred taxes............................. $ -- $ --
======== =======
</TABLE>
The change in the valuation allowance was a net increase of $5,333,000 for
the fiscal year ended February 2, 1997, and a net increase of $2,144,000 for the
fiscal year ended January 28, 1996. The valuation allowance was increased since
the realization of net deferred tax assets is uncertain.
As of February 2, 1997 the Company has federal net operating loss
carryforwards of approximately $32 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, as defined in the Internal
Revenue Code. As a result of these ownership changes 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 February 2, 1997, approximately $3 million of
the limited loss carryforwards was available. In addition, the Company had state
net operating loss carryforwards of approximately $14 million, which begin to
expire in the year 1997, if not utilized.
6. STOCKHOLDERS' EQUITY
At February 2, 1997, there were outstanding warrants to purchase 1,754,956
shares of the Company's common stock. One million four hundred thousand of such
shares are subject to a warrant, issued as part of the 1996 financing (Note 2),
at a exercise price of $.001 per share exercisable in whole or in part at any
time or from time to time until August 31, 2006. Warrants to purchase an
additional 354,956 shares of the Company's common stock at exercise prices
ranging from $1.33 to $15.00 per share with expiration dates ranging from May
1998 to June 2005 are also outstanding. The warrants generally provide for
certain antidilution adjustments.
As of February 2, 1997, 4,688,956 shares of the company's common stock are
reserved for issuance upon exercise of warrants and stock options (Note 7).
7. 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 123, "Accounting for Stock-Based Compensation" requires
use of option valuation models that were not developed for use in valuing
employee stock options.
F-14
<PAGE> 69
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The 1997 Stock Incentive Plan was approved by the Board of Directors in
January 1997 and is scheduled to be presented to stockholders at the next annual
meeting of stockholders for their approval. Until stockholder approval is
obtained all awards under this plan are specifically conditioned upon obtaining
stockholder approval and, if the approval is not obtained, will be canceled. The
1997 plan provides for the issuance of awards covering up to 800,000 shares 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 to occur over three years. Compensation
expense was recorded in fiscal 1996 in the amount of $293,000 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 income (loss) and earnings (loss) per
share is required by SFAS 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 1996 and 1995; risk-free interest rates of 6.85% and 6.79%,
dividend yields of 0% for both periods, volatility factors of the expected
market price of the Company's common stock of .68% for both periods; and a
weighted-average life of the options of 6.5 and 6.0 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.
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. The Company's pro forma information follows (in
thousands, except for per share information):
<TABLE>
<CAPTION>
1996 1995
------- ------
<S> <C> <C>
Pro forma net loss........................................ $13,188 $8,715
Pro forma net loss per share.............................. $ 1.26 $ 2.21
</TABLE>
As of February 2, 1997, under all option plans, a total of 2,934,000 shares
of common stock are reserved for future issuance, options to purchase 1,722,457
shares of common stock were outstanding, options to
F-15
<PAGE> 70
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
purchase 409,222 were exercisable, at a weighted average exercise price of
$1.25, and options for 1,211,543 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 December 31, 1993
to February 2, 1997.
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF ACTUAL AVERAGE
OPTIONS EXERCISE PRICE EXERCISE PRICE
--------- -------------- --------------
<S> <C> <C> <C>
Outstanding December 31, 1993........ 329,020 $ 3.09 - $8.34 --
Granted.............................. 35,501 $ 6.00 - $7.13 --
Exercised............................ (4,678) $3.09 --
---------
Outstanding December 31, 1994........ 359,843 $ 3.09 - $8.34 --
Granted.............................. 140,828 $ 2.16 - $6.48 $ 2.73
Forfeited............................ (140,298) $ 3.09 - $6.38 $ 5.02
---------
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
=========
</TABLE>
The weighted-average grant-date fair value of options granted during 1996
and 1995, for options where the exercise price on the date of grant was equal to
the stock price on that date, was $2.14 and $1.09, respectively. The weighted
average grant date fair value of options granted during 1996 for options where
the exercise price on the date of grant was less than the stock price on that
date was $1.29.
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 February 2, 1997.
<TABLE>
<CAPTION>
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
- ---------- ------------- -------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
1,592,000 $ .78 - $1.95 $ 1.13 9.7 years 310,167 $ 1.00
69,832 $1.96 - $4.00 $ 2.52 .9 years 48,503 $ 2.55
60,625 $4.01 - $7.13 $ 5.71 2.1 years 50,552 $ 5.66
--------- --------
1,722,457 $ .78 - $7.13 $ 1.35 9.0 years 409,222 $ 1.25
========= ========
</TABLE>
8. 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 immaterial in fiscal 1996, 1995 and 1994.
9. COMMITMENTS AND CONTINGENCIES
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 12 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.
F-16
<PAGE> 71
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Commitments as of February 2, 1997 under operating leases require
approximate future minimum annual rental payments as follows:
<TABLE>
<CAPTION>
FISCAL YEAR TOTAL
------------------------------------------------------ -----------------
(IN THOUSANDS)
<S> <C>
1997.................................................. $14,777
1998.................................................. 13,811
1999.................................................. 12,061
2000.................................................. 10,283
2001.................................................. 7,729
Thereafter............................................ 23,739
----------
$82,400
==========
</TABLE>
Total rent expense under all operating leases was approximately
$15,389,000, $15,631,000, and $14,965,000 for the fiscal years ended February 2,
1997, January 28, 1996 and December 31, 1994, respectively.
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.
10. RELATED PARTY TRANSACTIONS
In fiscal 1996, 1995, and 1994, Permal Capital Management, Inc. (PCMI)
provided various management services for the Company and its subsidiaries, for
which PCMI received $58,333, $100,000, and $200,000, respectively. 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.
F-17
<PAGE> 72
KRAUSE'S FURNITURE INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
NOVEMBER 2,
1997
-----------
<S> <C>
Current assets:
Cash and cash equivalents...................................................... $ 250
Accounts receivable, net of allowance of $194 for doubtful accounts............ 780
Inventories.................................................................... 16,499
Prepaid expenses............................................................... 552
--------
Total current assets........................................................ 18,081
Property, equipment, and leasehold improvements, net............................. 7,085
Goodwill, net.................................................................... 14,621
Leasehold interests, net......................................................... 1,269
Other assets..................................................................... 2,428
--------
$ 43,484
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................... $ 8,820
Accrued payroll and related expenses........................................... 1,469
Other accrued liabilities...................................................... 3,719
Customer deposits.............................................................. 5,213
Current portion of notes payable............................................... 41
--------
Total current liabilities................................................... 19,262
Long-term liabilities:
Notes payable.................................................................. 11,073
Other liabilities.............................................................. 2,137
--------
Total long-term liabilities................................................. 13,210
Commitments and contingencies.................................................... --
Stockholders' equity:
Convertible preferred stock, $.001 par value; 666,667 authorized, no shares
outstanding................................................................. --
Common stock, $.001 par value; 35,000,000 shares authorized, 19,020,539 shares
outstanding................................................................. 19
Capital in excess of par value................................................. 50,952
Accumulated deficit............................................................ (39,959)
--------
Total stockholders' equity.................................................. 11,012
--------
$ 43,484
========
</TABLE>
See accompanying notes.
F-18
<PAGE> 73
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED
---------------------------
NOVEMBER 2, OCTOBER 27,
1997 1996
----------- -----------
<S> <C> <C>
Net sales............................................................ $85,569 $ 82,738
Cost of sales........................................................ 41,840 42,364
------- --------
Gross profit......................................................... 43,729 40,374
Operating expenses:
Selling............................................................ 40,558 43,556
General and administrative......................................... 6,780 7,852
Amortization of goodwill........................................... 765 765
------- --------
48,103 52,173
------- --------
Loss from operations................................................. (4,374) (11,799)
Interest expense..................................................... (1,177) (782)
Other income (expense)............................................... (58) 207
------- --------
Net loss............................................................. $(5,609) $ (12,374)
======= ========
Net loss per share................................................... $ (.30) $ (1.62)
======= ========
Average number of common shares outstanding.......................... 19,021 7,661
</TABLE>
See accompanying notes.
F-19
<PAGE> 74
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE CAPITAL IN
PREFERRED STOCK COMMON STOCK EXCESS OF TOTAL
--------------- --------------- PAR ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT VALUE DEFICIT EQUITY
------ ------ ------ ------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at February 2, 1997.... -- $-- 19,021 $ 19 $ 49,874 $ (34,350) $15,543
Issuance of common stock
purchase warrants............ -- -- -- -- 925 -- 925
Compensation expense on stock
option grant................. -- -- -- -- 153 -- 153
Net loss....................... -- -- -- -- -- (5,609) (5,609)
--- --- ------ --- ------- -------- -------
Balance at November 2, 1997.... -- $-- 19,021 $ 19 $ 50,952 $ (39,959) $11,012
=== === ====== === ======= ======== =======
</TABLE>
See accompanying notes.
F-20
<PAGE> 75
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED
---------------------------
NOVEMBER 2, OCTOBER 27,
1997 1996
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss............................................................. $ (5,609) $ (12,374)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization................................... 1,802 1,853
Other non-cash charges.......................................... 786 --
Change in assets and liabilities:
Accounts receivable............................................. 340 51
Income tax refund receivable.................................... -- 1,467
Inventories..................................................... (2,486) 2,006
Prepaid expenses and other assets............................... 424 (291)
Accounts payable and other liabilities.......................... 653 (643)
Customer deposits............................................... (408) (650)
------- ---------
Net cash used by operating activities......................... (4,498) (8,581)
------- ---------
Cash flows from investing activities:
Capital expenditures............................................... (1,498) (563)
------- ---------
Net cash used by investing activities........................... (1,498) (563)
------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings................................. 102,005 97,050
Principal payments on long-term borrowings......................... (99,986) (101,072)
Proceeds from issuance of subordinated note........................ 3,000 5,000
Proceeds from issuance of notes.................................... -- 2,950
Net proceeds from issuance of common stock......................... -- 10,221
------- ---------
Net cash provided by financing activities....................... 5,019 14,149
------- ---------
Net increase (decrease) in cash...................................... (977) 5,005
Cash and cash equivalents at beginning of period..................... 1,227 1,336
------- ---------
Cash and cash equivalents at end of period........................... $ 250 $ 6,341
======= =========
Supplemental disclosures of cash flow information -- Cash paid during
the period for interest............................................ $ 373 $ 431
Noncash investing and financing activities:
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......................... 925 1,400
</TABLE>
See accompanying notes.
F-21
<PAGE> 76
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying consolidated financial statements 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 Krause's Sofa Factory, ("Krause's"), have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission and reflect all
normal recurring adjustments which are, in the opinion of management, necessary
for a fair presentation for the periods reported. Certain information and note
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to those rules or regulations, although management believes
that the disclosures made are adequate to make the information presented not
misleading.
These financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the year ended February 2, 1997. The
results of operations for the thirty-nine weeks ended November 2, 1997 are not
necessarily indicative of results to be expected in future periods.
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 revenue and expenses during the reported
periods. Actual results could differ from those estimates.
2. The Company has reported losses from operations in each of the past five
years and for the thirty-nine weeks ended November 2, 1997 due to inefficiencies
within its operations and due to an industry-wide softness in retail sales. As a
result of such losses, the Company had an accumulated deficit of $39,959,000 and
a working capital deficiency of $1,181,000 at November 2, 1997. The Company
expects to incur operating losses in fiscal year 1997.
On August 26, 1996 and September 10, 1996, the Company completed
transactions with investors in which the Company received cash proceeds of
$15,669,000 from financings through issuances of $10,669,000 of common stock, at
$1 per share, and a $5,000,000 subordinated note with a warrant to purchase
1,400,000 shares of common stock at $.001 per share. 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 outstanding Series A
preferred stock was converted into 1,176,950 shares of common stock. Also the
Company's revolving credit agreement was amended to extend the expiration date,
reduce the interest rate and provide for an increase in borrowing availability.
The Company's management, which underwent a substantial restructuring after
the 1996 financing described above, 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 in existing
markets, 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. Many of these plans were implemented since the latter part
of fiscal 1996 and are expected to contribute significantly to reducing losses
and, ultimately, returning 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 1997. 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 (see Note 4 for
discussion of 1997 financing).
F-22
<PAGE> 77
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
3. Inventories are carried at the lower of cost or market using the
first-in, first-out method and are comprised of the following:
<TABLE>
<CAPTION>
NOVEMBER 2,
1997
--------------
(IN THOUSANDS)
<S> <C>
Finished goods................................................. $ 12,190
Work in progress............................................... 211
Raw materials.................................................. 4,098
-------
$ 16,499
=======
</TABLE>
4. Notes payable consists of the following:
<TABLE>
<CAPTION>
NOVEMBER 2,
1997
--------------
(IN THOUSANDS)
<S> <C>
Secured revolving credit notes................................. $ 4,094
Subordinated note payable to shareholder due 2002.............. 5,501
Unamortized debt discount, net of accumulated amortization of
$381......................................................... (1,019)
Subordinated notes payable to shareholders due 2003............ 3,000
Unamortized debt discount, net of accumulated amortization of
$60.......................................................... (865)
Other notes.................................................... 403
-------
11,114
Less current portion........................................... 41
-------
$ 11,073
=======
</TABLE>
The secured revolving credit notes were issued under a revolving credit
agreement between Krause's and a financial institution that expires in January
2000. The credit agreement, which was most recently amended December 11, 1997,
provides for revolving loans of up to $10 million based on the value of
inventories. As of November 2, 1997, borrowing under the revolving credit
facility was limited to approximately $7.7 million, as defined in the agreement.
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
the rate of 1.0% in excess of the prime rate (8.50% at November 2, 1997).
On August 14, 1997, the Company concluded a Supplemental Securities
Purchase Agreement (the "Agreement") among the Company, General Electric Capital
Corporation ("GECC") and Japan Omnibus Ltd. ("JOL"), a company formerly known as
Edison 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, which
notes are payable semi-annually on a straight-line basis over three years
beginning February 2000, and 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 warrant of $925,000 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
subordinated note. 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.
Also, under the Agreement, the Company, at its option and subject to the
attainment of certain financial covenants, may draw on a standby credit facility
with GECC and JOL by selling additional 9.5% subordinated notes in an aggregate
principal amount of up to $3,500,000; such standby credit facility is available
from January 2, 1998 to February 28, 2000. If the Company elects to draw down on
the credit available from GECC
F-23
<PAGE> 78
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
and JOL by issuing notes, the Agreement provides that the Company shall issue to
GECC and JOL warrants to purchase an aggregate of up to 560,000 additional
shares of the common stock of the Company.
In conjunction with the financing described above, the Company issued to
GECC a new 9.5% Subordinated Note due August 31, 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 subordinated note. The Replacement Note is payable
semiannually, on a straight-line basis over three years beginning February 2000
whereas the Pay-In-Kind Note was payable semiannually, on a straight-line basis
over three years beginning February 1999.
Pursuant to the terms of the revolving credit agreement and the
subordinated notes, the Company and Krause's are required to maintain certain
financial ratios and minimum levels of tangible net worth and working capital.
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 November 2, 1997, Krause's was not in
compliance with two of the covenants contained in the revolving credit agreement
and may not be in compliance with a financial covenant at the end of its current
fiscal year. On December 11, 1997, the financial institution waived the
non-compliance as it relates to the November 2, 1997 reporting period.
5. Net loss per share amounts were computed based on the weighted average
number of common shares outstanding during the periods reported. Common
equivalent shares are not included in the computation since such share
equivalents are antidilutive.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128 "Earnings per Share," which is
required to be adopted on December 31, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for calculating primary
earnings per share, the dilutive effect of stock options will be excluded.
Equity instruments, such as options and warrants are excluded if antidilutive in
the calculation of diluted earnings per share. Since the effect of stock options
is already excluded in the computation of net loss per share, the adoption of
Statement 128 will not result in any change in the loss per share amounts
reported for the thirty-nine weeks ended November 2, 1997 or October 27, 1996.
6. Effective for the year ending February 1, 1998, the Company will be
required to adopt SFAS No. 129 "Disclosure of Information about Capital
Structure," and effective for the year ending January 31, 1999, the Company will
be required to adopt SFAS No. 130 "Reporting Comprehensive Income" and SFAS No.
131 "Disclosures about Segments of an Enterprise and Related Information". The
impact of adoption of these pronouncements is not expected to be material to the
Company's financial position or results of operations.
F-24
<PAGE> 79
======================================================
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THIS OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, THE SELLING STOCKHOLDER OR THE PLACEMENT AGENT. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATIONS
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary.................... 2
Risk Factors.......................... 9
Use of Proceeds....................... 16
Dividend Policy....................... 16
Price Range of Common Stock........... 16
Dilution.............................. 17
Capitalization........................ 18
Selected Consolidated Financial
Data................................ 19
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 20
Business.............................. 29
Management............................ 36
Certain Transactions.................. 44
Principal and Selling Stockholders.... 47
Plan of Distribution.................. 48
Description of Capital Stock.......... 49
Legal Matters......................... 51
Experts............................... 52
Additional Information................ 52
Index to Consolidated Financial
Statements.......................... 53
</TABLE>
======================================================
======================================================
4,500,000 SHARES
[KRAUSE'S FURNITURE, INC. LOGO]
COMMON STOCK
-----------------
PROSPECTUS
-----------------
CRUTTENDEN ROTH
INCORPORATED
BLACK & COMPANY, INC.
MORGAN FULLER
CAPITAL GROUP, LLC
February , 1998
======================================================
<PAGE> 80
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following is an itemized list of the estimated expenses to be incurred
in connection with the offering of the securities being offered hereunder other
than underwriting discounts and commissions.
<TABLE>
<S> <C>
Registration Fee.......................................... $ *
--------
Printing and Engraving.................................... *
--------
Legal Fees and Expenses................................... *
--------
Blue Sky Fees and Expenses................................ *
--------
Accountants' Fees and Expenses............................ *
--------
Escrow Agent's Fees....................................... *
--------
Total**......................................... *
========
</TABLE>
- ---------------
* To be supplied by amendment.
** All costs to be borne by the Company.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the DGCL contains detailed provisions on indemnification of
directors and officers against expenses, judgments, fines and amounts paid in
settlement, actually and reasonably incurred in connection with legal
proceedings. Section 102(a)(7) of the DGCL permits a provision in the
certificate of incorporation of each corporation organized thereunder, such as
the Company, eliminating or limiting, with certain exceptions, the personal
liability of a director of the corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director. The Certificate of
Incorporation of the Company eliminates the liability of each of its directors
to its stockholders or the Company for monetary damages for breach of fiduciary
duty to the full extent provided by the Delaware General Corporation Law (the
"DGCL"), as such law exists or may hereafter be amended.
Indemnification applies to any threatened, pending or completed action,
suit or proceeding, whether, civil, criminal, administrative or investigative.
Indemnification may include all expenses (including attorneys' fees, judgments,
fines, ERISA excise taxes and amounts paid in settlement) reasonably incurred by
the indemnified person.
The Company maintains a directors and officers liability and reimbursement
insurance policy intended to reimburse the Company for any payments made by it
pursuant to its indemnification obligations.
The foregoing statements are subject to the detailed provisions of Section
102(a)(7) of the DGCL and the Certificate of Incorporation of the Company, as
applicable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
1. Within the past three years the Company sold an aggregate of 1,677
shares of Common Stock to one employee for consideration in the aggregate amount
of $5,150 pursuant to the Company's 1990 Employees Stock Option Plan.
2. From May 13, 1996, through June 19, 1996, the Company sold an aggregate
principal amount of $950,000 of its Series 1996-I and Series 1996-II Convertible
Promissory Notes (the "Notes") to certain directors, officers and 5%
stockholders of the Company and parties related to them. In connection with the
General Electric Capital Corporation ("GECC") financing, the holders of the
Notes converted the principle amount and accrued interest due under the Notes
into an aggregate of 970,140 shares of Common Stock at a conversion price of
$1.00 per share. The purchasers of the Notes were certain officers, directors
and affiliates of the Company.
II-1
<PAGE> 81
3. On May 21, 1996, the Company issued its Demand Promissory Note in the
principal amount of $1,500,000 to Edson Investments, Inc. ("Edson"). On July 2,
1996, the Company issued a second Demand Promissory Note in the principal amount
of $500,000 to Edson. In connection with the GECC financing, Edson acquired
2,096,111 shares of Common Stock at a price of $1.00 per share in consideration
for its cancellation of the Company's obligation to repay the principal and
accrued interest of the $96,111 owed under these Demand Promissory Notes. Edson
changed its name to Japan Omnibus Ltd. and is the Selling Stockholder in this
Registration Statement.
4. On August 26, 1996, and September 10, 1996, the Company completed a
private placement of 10,699,000 shares of Common Stock to 55 investors, some of
whom are related to each other, at a price of $1.00 per share. In addition, the
Company issued its subordinated note in the aggregate principal amount of
$5,000,000 and a warrant to purchase 1,400,000 additional shares of Common Stock
at a purchase price of $.001 per share to GECC. The purchasers of shares in this
private placement and the number of shares purchased are as follows:
<TABLE>
<CAPTION>
NO. OF SHARES NO. OF SHARES
NAME ON AUGUST 26, 1996 ON SEPTEMBER 10, 1996
------------------------------- -------------------- -----------------------
<S> <C> <C>
GECC........................... 5,000,000
Permal Noscal Ltd.............. 405,000
Zaxis Partners, L.P............ 40,000
Sidney Kimmel.................. 50,000
Quadra Appreciation Fund,
Inc.......................... 5,000
Branagh Revocable Trust........ 5,000
Sanford J. Colen............... 20,000
Jean R. Perrette............... 250,000
Isaac Robert Souede............ 250,000
Thomas M. DeLitto.............. 25,000
C. Redington Barrett, III...... 5,000
Hurley & Co.................... 35,000
United Gulf Bank............... 225,000
ATCO Holdings Ltd.............. 400,000
ATCO Development, Inc.......... 100,000
G(2) Investment Partners....... 60,000 30,000
Fairmont Services Ltd.......... 400,000
Carlton Securities N.V......... 100,000
Emmanual Bagdjian.............. 210,000
Heliopolis Inc................. 100,000
T. Michael Wallace............. 100,000 300,000
Gary S. Gladstein.............. 100,000 100,000
Peter L. Rhulen................ 100,000
Pollat, Evans & Co., Inc....... 15,000
Maureen Erin Hawley Trust I.... 112,500
Allison Booth Hawley Trust I... 112,500
Caitlin Hale Hawley Trust I.... 112,500
Shannon Follen Hawley Trust
I............................ 112,500
Hawley Family Trust............ 500,000
Philip M. Hawley............... 30,000
Dr. Philip M. Hawley, Jr....... 20,000
H.D. Investment Group, Inc..... 25,000
Morgan Adams, Inc.............. 50,000
Theodore D. Konopisos.......... 22,000
</TABLE>
II-2
<PAGE> 82
<TABLE>
<CAPTION>
NO. OF SHARES NO. OF SHARES
NAME ON AUGUST 26, 1996 ON SEPTEMBER 10, 1996
------------------------------- -------------------- -----------------------
<S> <C> <C>
William A. MacLaughlin IRA..... 25,000
Gregory M. Simon............... 20,000
Hugh H. Wilson, Jr............. 15,000
Codell Holdings Ltd............ 100,000
J. Stephen Emerson IRA......... 100,000
J. Stephen Emerson............. 100,000
Paul Marciano Trust............ 100,000
G. Tyler Runnels............... 50,000
Charles Perez.................. 100,000
JMG Capital Partners L.P....... 50,000
William C. Miller, IV.......... 25,000
Tendencia Investments
Overseas..................... 250,000
Lawrence S. Black.............. 50,000
Maureen Erin Hawley Trust II... 25,000
Allison Booth Hawley Trust
II........................... 25,000
Caitlan Hale Hawley Trust II... 25,000
Shannon Follen Hawley Trust
II........................... 25,000
Ian and Francine Jack.......... 10,000
Keith and Tanya Jacobs......... 10,000
J. Richard Cordsen............. 27,000
J.D. Yates..................... 10,000
</TABLE>
5. On August 14, 1997, the Company concluded a Supplemental Securities
Purchase Agreement (the "1997 Financing") among the Company, GECC and Japan
Omnibus Ltd. ("JOL"). Under the terms of the 1997 Financing, the Company sold
subordinated notes in an aggregate principal amount of $3,000,000 to GECC and
JOL. The Company issued warrants in conjunction with the notes, as follows: (i)
to GECC a warrant to purchase 600,000 shares of the Common Stock at a purchase
price of $1.25 per share and to JOL a warrant to purchase 140,000 shares of the
Common Stock at a purchase price of $1.25 per share; (ii) to GECC and JOL
warrants for the purchase of up to 1,000,000 shares of the Company's common
stock at a price of $0.01 per share (the "Performance Warrants"); the
Performance Warrants will be canceled if the Company meets certain economic
performance targets. The Company also agreed to issue additional warrants if it
draws on the standby credit facility.
Except for the issuance of the Series 1996-II Convertible Promissory Notes
and the shares of Common Stock acquired upon conversion thereof described in
item 2, the issuances of securities in the above transactions were deemed to be
exempt from registration under the Securities Act in reliance on Section 4(2)
thereof or Regulation D promulgated thereunder as transactions not involving a
public offering. The issuance of Series 1996-II convertible Promissory Notes and
the shares of Common Stock acquired upon conversion thereof described in item 2
above, were deemed exempt from registration under Securities Act in reliance on
Regulation S promulgated thereunder.
II-3
<PAGE> 83
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ---------------------------------------------------------------------------------
<S> <C>
1 Form of Placement Agency Agreement, including Form of Escrow Agreement and Form
of Custody Agreement.
* 3.1 Certificate of Incorporation.(1)
* 3.1a Certificate of Amendment of Certificate of Incorporation dated November 28,
1994.(5)
* 3.1b Certificate of Amendment of Certificate of Incorporation dated August 1, 1995.(6)
* 3.1c Certificate of Amendment of Certificate of Incorporation dated June 7, 1996.(7)
* 3.1d Certificate of Amendment of Certificate of Incorporation dated August 1, 1996.(7)
* 3.2 By-laws.(1)
* 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)
* 4.1a First Amendment to Loan and Security Agreement dated May 10, 1996 by and between
Congress Financial Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(6)
* 4.1b 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.(10)
* 4.1c 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.(10)
* 4.1d Amended and Restated Subordination Agreement dated as of August 26, 1996 by and
between Congress Financial Corporation (Western) and Krause's Furniture, Inc.(10)
* 4.1e 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)
* 4.1f Fifth Amendment to Loan and Security Agreement dated as of December 11, 1997 by
and between Congress Financial Corporation (Western) and Krause's Custom Crafted
Furniture Corp. and Castro Convertible Corporation.(13)
* 4.1g 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)
**5 Opinion of Morrison & Foerster LLP with respect to legality.
*10.1 1994 Directors Stock Option Plan.(5)
*10.2 1990 Employees Stock Option Plan.(2)
*10.3 Form of Securities Purchase Agreement between the Company and GECC dated as of
August 26, 1996.
*10.4 (8) 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)
</TABLE>
II-4
<PAGE> 84
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- ---------------------------------------------------------------------------------
<S> <C>
*10.9 Employment Agreement with Philip M. Hawley.(8)
*10.10 1997 Stock Incentive Plan.(11)
*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 Form of Amendment to Registration Rights Agreement and Stockholders Agreement
among the Company and GECC and certain other stockholders of the Company dated as
of August 14, 1997.
10.15 Form of Succession Agreement by and between the Company and Philip M. Hawley and
certain other stockholders of the Company.
*11 Statement regarding computation of per share earnings.
*21 Subsidiaries.
23.1 Consent of Morrison & Foerster LLP (included in its opinion filed as Exhibit 5).
*23.2 Consent of Ernst & Young LLP, Independent Auditors.
</TABLE>
- ---------------
(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 Exhibit A 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
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).
* Previously filed.
** To be filed by amendment.
- ---------------
(b)FINANCIAL STATEMENT SCHEDULES
Report of Ernst & Young LLP, Independent Auditors.
II-5
<PAGE> 85
Schedule II -- Valuation and Qualifying Accounts
ITEM 17. UNDERTAKINGS
In accordance with Rule 430A of Regulation C under the Securities Act of
1933, as amended (the "Securities Act"), each of the undersigned registrants
hereby undertakes:
(a) To file during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of Prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement.
(b) That insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the provisions described under Item
15 above, or otherwise, the registrants have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrants of expenses incurred
or paid by a director, officer or controlling person of either registrant
in the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrants will, unless in the opinion of
their counsel the matter has been settled by controlling precedent, submit
to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.
(c) That, for purposes of determining any liability under the
Securities Act, the information omitted from the form of prospectus filed
as part of this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrants pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this Registration Statement as of the time it was declared
effective.
(d) That, for the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-6
<PAGE> 86
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 1 to the Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Brea, County of Orange, State of California, on February 18, 1998.
KRAUSE'S FURNITURE, INC
By: /s/ ROBERT A. BURTON
------------------------------------
Robert A. Burton
Senior Vice President and Chief
Financial Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 1 to the Registration Statement on Form S-1 has been signed
on February 18, 1998 by the following persons or their respective
attorneys-in-fact in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------- ----------------------------------------------
<S> <C>
/s/ PHILIP M. HAWLEY * Chairman of the Board and Chief Executive
- --------------------------------------------- Officer
Philip M. Hawley
/s/ ROBERT A. BURTON Senior Vice President and Chief Financial
- --------------------------------------------- Officer (Principal Financial Officer,
Robert A. Burton Principal Accounting Officer)
/s/ THOMAS M. DELITTO * Vice Chairman of the Board
- ---------------------------------------------
Thomas M. DeLitto
/s/ KAMAL G. ABDELNOUR * Director
- ---------------------------------------------
Kamal G. Abdelnour
/s/ JEFFREY H. COATS * Director
- ---------------------------------------------
Jeffrey H. Coats
/s/ PETER H. DAILEY * Director
- ---------------------------------------------
Peter H. Dailey
/s/ JOHN A. GAVIN * Director
- ---------------------------------------------
John A. Gavin
</TABLE>
*By: /s/ ROBERT A. BURTON
-------------------------------
Robert A. Burton
Attorney-In-Fact
II-7
<PAGE> 87
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the consolidated financial statements of Krauses Furniture,
Inc. as of February 2, 1997 and January 28, 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for the fiscal
years ended February 2, 1997, January 28, 1996 and December 31, 1994, and for
the month ended January 29, 1995, and have issued our report thereon dated March
28, 1997, except for Note 2, as to which the date is December 17, 1997 (included
elsewhere in this Registration Statement). Our audits also included the
financial statement schedule listed in Item 16(b) of this Registration
Statement. This schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on this schedule based on our audits.
In our opinion, the financial statement schedule referred to above, 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
S-1
<PAGE> 88
KRAUSE'S FURNITURE, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FISCAL YEARS ENDED FEBRUARY 2, 1997 AND JANUARY 28, 1996, MONTH ENDED JANUARY
29, 1995 AND FISCAL
YEAR ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO CHARGED BALANCE
ALLOWANCE FOR BEGINNING COST AND TO OTHER END
DOUBTFUL ACCOUNTS OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS(A) OF PERIOD
- ------------------------------------- --------- ---------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C>
Fiscal 1996.......................... $ 291,487 $244,613 $ -- $ 209,293 $ 326,807
Fiscal 1995.......................... 616,148 218,414 -- 543,075 291,487
Month ended January 29, 1995......... 591,744 24,404 -- -- 616,148
Fiscal 1994.......................... 395,322 566,000 (320,000)(b) 49,578 591,744
</TABLE>
- ---------------
(a) Represents accounts written off.
(b) Represents allowance for sales returns reclassified to accrued liabilities
to conform to the presentation for the fiscal year ended January 28, 1996.
S-2
<PAGE> 89
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ------------------------------------------------------------------------------------
<C> <S>
1 Form of Placement Agency Agreement, including Form of Escrow Agreement and Form of
Custody Agreement.
* 3.1 Certificate of Incorporation.(1)
* 3.1a Certificate of Amendment of Certificate of Incorporation dated November 28, 1994.(5)
* 3.1b Certificate of Amendment of Certificate of Incorporation dated August 1, 1995.(6)
* 3.1c Certificate of Amendment of Certificate of Incorporation dated June 7, 1996.(7)
* 3.1d Certificate of Amendment of Certificate of Incorporation dated August 1, 1996.(7)
* 3.2 By-laws.(1)
* 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)
* 4.1a First Amendment to Loan and Security Agreement dated May 10, 1996 by and between
Congress Financial Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(6)
* 4.1b 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.(10)
* 4.1c 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.(10)
* 4.1d Amended and Restated Subordination Agreement dated as of August 26, 1996 by and
between Congress Financial Corporation (Western) and Krause's Furniture, Inc.(10)
* 4.1e 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)
* 4.1f Fifth Amendment to Loan and Security Agreement dated as of December 11, 1997 by and
between Congress Financial Corporation (Western) and Krause's Custom Crafted
Furniture Corp. and Castro Convertible Corporation.(13)
* 4.1g 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)
** 5 Opinion of Morrison & Foerster LLP with respect to legality.
*10.1 1994 Directors Stock Option Plan.(5)
*10.2 1990 Employees Stock Option Plan.(2)
*10.3 Form of Securities Purchase Agreement between the Company and GECC dated as of
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)
</TABLE>
<PAGE> 90
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ------------------------------------------------------------------------------------
<C> <S>
*10.10 1997 Stock Incentive Plan.(11)
*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 Form of Amendment to Registration Rights Agreement and Stockholders Agreement among
the Company and GECC and certain other stockholders of the Company dated as of
August 14, 1997.
10.15 Form of Succession Agreement between the Company and Philip M. Hawley and certain
other stockholders of the Company.
*11 Statement regarding computation of per share earnings.
*21 Subsidiaries.
23.1 Consent of Morrison & Foerster LLP (included in its opinion filed as Exhibit 5).
*23.2 Consent of Ernst & Young LLP, Independent Auditors.
</TABLE>
- ---------------
(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 Exhibit A 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
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).
* Previously filed.
** To be filed by amendment.
<PAGE> 1
KRAUSE'S FURNITURE, INC.
4,000,000 SHARES OF COMMON STOCK, PAR VALUE $0.001 PER SHARE
PLACEMENT AGENCY AGREEMENT
March ___, 1998
Cruttenden Roth Incorporated
Morgan Fuller Capital Group, LLC
Black & Company, Inc.
c/o Cruttenden Roth Incorporated
11150 Santa Monica Boulevard
Suite 750
Los Angeles, California 90025
Dear Sir or Madam:
Krause's Furniture, Inc., a Delaware corporation (the "Company"),
proposes to issue and sell up to 1,903,889 shares (the "Shares") of common
stock, par value $0.001 per share (the "Common Stock"), and Japan Omnibus Ltd.
(the "Selling Stockholder"), proposes to sell of up to 2,096,011 shares of
Common Stock (the "Selling Stockholder Shares") to certain investors
(collectively, the "Investors"). The Company and the Selling Stockholder desire
to engage you as placement agents (the "Placement Agents") in connection with
such issuance and sale. The Common Stock is more fully described in the
Registration Statement (as hereinafter defined).
The Company and the Selling Stockholder hereby confirm their respective
agreements with the Placement Agents as follows:
1. Agreement to Act as Placement Agents.
(a) On the basis of the respective representations, warranties
and agreements of the Company and the Selling Stockholder herein contained and
subject to all the terms and conditions of this Agreement, the Placement Agents
agree to act, on a best efforts basis, as the Company's exclusive Placement
Agents in connection with the issuance and sale, on an all or none basis, by the
Company and the Selling Stockholder of the Shares and the Selling Stockholder
Shares to the Investors. Each of the Company and the Selling Stockholder shall
pay to the Placement Agents 9.0% of the respective gross proceeds (the
"Placement Fee") received by the Company and the Selling Stockholder from the
sale of the Shares and the Selling Stockholder Shares, as applicable, as set
forth on the cover page of the Prospectus (as hereinafter defined). The
obligations of the Company and the Selling Stockholder to pay their
proportionate share of the Placement Fee shall be several and not joint.
<PAGE> 2
(b) Certificates in negotiable form (endorsed in blank or
accompanied by stock powers in blank, with signatures appropriately guaranteed,
and any funds necessary for the purchase of stock transfer stamps) representing
all of the Selling Stockholder Shares to be sold by the Selling Stockholder have
been placed in custody under a custody agreement (the "Custody Agreement") with
the custodian named therein, as Custodian (the "Custodian") and the Selling
Stockholder has duly executed and delivered a Power of Attorney (a "Power of
Attorney") appointing the attorneys-in-fact named therein, and each of them,
with full power of substitution, as Selling Stockholder's attorneys-in-fact (the
"Attorneys-in-Fact") with authority to execute this Agreement and the Escrow
Agreement (as herein defined) and to deliver this Agreement and the Escrow
Agreement on behalf of the Selling Stockholder, to authorize the delivery of the
Selling Stockholder Shares to be sold by the Selling Stockholder hereunder and
thereunder and otherwise to act on behalf of the Selling Stockholder in
connection with the transactions contemplated by this Agreement, the Escrow
Agreement and the Custody Agreement. The Selling Stockholder agrees that the
shares represented by the certificates held in custody for the Selling
Stockholder under the Custody Agreement are subject to the interests of the
Placement Agents hereunder and the arrangements made by the Selling Stockholder
for such custody, as well as the appointment by the Selling Stockholder of the
Attorneys-in-Fact, are, to that extent, irrevocable. The Selling Stockholder
specifically agrees that its obligations hereunder shall not be terminated,
except as otherwise provided herein, by any act of the Selling Stockholder,
operation of law or otherwise, or by the occurrence of any event.
2. Delivery and Payment. Concurrently with the execution and delivery
of this Agreement, the Company, the Selling Stockholder, the Placement Agents
and Imperial Trust Company, as escrow agent (the "Escrow Agent"), shall enter
into an Escrow Agreement substantially in the form of Exhibit A attached hereto
(the "Escrow Agreement"), pursuant to which an escrow account will be
established, at the Company's expense, for the benefit of the Investors (the
"Escrow Account"). Prior to the Closing Date (as defined below), (i) each of the
Investors will deposit an amount equal to the Price to Public per Share as shown
on the cover page of the Prospectus (as hereinafter defined) multiplied by the
number of Shares and the Selling Stockholder Shares purchased by said Investor
in the Escrow Account, and (ii) the Escrow Agent will notify the Company, the
Selling Stockholder and the Placement Agents in writing whether the Investors
have deposited funds in the amount equal to the proceeds of the sale of all of
the Shares and the Selling Stockholder Shares offered hereby (the "Requisite
Funds") into the Escrow Account. At 9:00 a.m., Los Angeles time, on
_____________, 1998 or at such other time on such other date as may be agreed
upon by the Company, the Selling Stockholder and the Placement Agents but in no
event prior to the date on which the Escrow Agent shall have received all of the
Requisite Funds (such date is hereinafter referred to as the "Closing Date"),
the Escrow Agent will release the Requisite Funds from the Escrow Account to the
Company, the Selling Stockholder and the Placement Agents as provided in the
Escrow Agreement and the Company and the Selling Stockholder shall deliver the
Company Shares and the Selling Stockholder Shares, respectively, to the
Investors, which delivery may be made through the facilities of The Depository
Trust Company. The closing (the "Closing") shall take place at the offices of
Morrison & Foerster LLP, 555 West Fifth Street, Los Angeles, California
90013-1024. All actions taken at the Closing shall be deemed to have occurred
simultaneously. If the Closing Date shall not have occurred on or before
_________, 1998, all
2
<PAGE> 3
funds, together with any interest earned thereon or provided in the Escrow
Agreement, shall be returned to the Investors who deposited such funds in the
Escrow and this Agreement shall terminate.
Certificates evidencing the Shares shall be in definitive form and
shall be registered in such names and in such denominations as Cruttenden Roth
Incorporated, as Representative (the "Representative") of the Placement Agents,
shall request by written notice to the Company. For the purpose of expediting
the checking and packaging of certificates for the Shares, the Company and the
Selling Stockholders agree to make such certificates available for inspection at
least 24 hours prior to delivery to the Investors.
3. Representations and Warranties of the Company. The Company
represents and warrants to and covenants with the Placement Agents that:
(a) The Company has prepared and filed with the Securities and
Exchange Commission (the "Commission") a registration statement on Form S-1
(Registration No. 333-43111) which has or will become effective, covering the
registration of the Shares and the Selling Stockholder Shares under the
Securities Act of 1933, as amended (the "1933 Act") and the rules and
regulations of the Commission thereunder (the "1933 Act Regulations"). The
Commission has not issued any order preventing or suspending the effectiveness
or use of the Prospectus or the Preliminary Prospectus (as defined below). The
term "Preliminary Prospectus" as used herein means a preliminary prospectus
relating to the Shares and the Selling Stockholder Shares as contemplated by
Rule 430 or Rule 430A ("Rule 430A") of the 1933 Act Regulations included at any
time as part of the Registration Statement. Copies of such Registration
Statement and amendments and of each related Preliminary Prospectus have been
delivered to the Placement Agents. If such Registration Statement has not become
effective, a further amendment to such Registration Statement, including a form
of final Prospectus, necessary to permit such Registration Statement to become
effective will be filed promptly by the Company with the Commission. If such
Registration Statement has become effective, a final Prospectus relating to the
Shares and the Selling Stockholder Shares containing information permitted to be
omitted at the time effectiveness by Rule 430A will be filed by the Company with
the Commission in accordance with Rule 424(b) of the 1933 Act Regulations
promptly after execution and delivery of this Agreement. The term "Registration
Statement" means the registration statement as amended at the time it becomes or
became effective (the "Effective Date"), including all material incorporated by
reference therein and any information deemed to be included by Rule 430A and any
additional registration statement filed pursuant to Rule 462(b) of the Rules and
Regulations ("Rule 462(b)") with respect to the Shares and the Selling
Stockholder Shares ("Rule 462(b) Registration Statement"). The term "Prospectus"
means the prospectus relating to the Shares and the Selling Stockholder Shares
as first filed with the Commission pursuant to Rule 424(b) of the Rules and
Regulations or, if no such filing is required, the form of final prospectus
relating to the Shares and the Selling Stockholder Shares included in the
Registration Statement at the Effective Date. Any reference herein to the
Registration Statement, the Prospectus or any Preliminary Prospectus shall be
deemed to refer to and include the documents incorporated by reference therein
pursuant to Form S-1 and Regulation S-K under the 1933 Act which were filed
3
<PAGE> 4
under the Securities Exchange Act of 1934, as amended (the "1934 Act") and the
rules and regulations of the Commission thereunder (the "1934 Act Regulations"),
on or before the date of this Agreement, or the issue date of the Prospectus or
any Preliminary Prospectus, as the case may be; and any reference herein to the
terms "amend," "amendment" or "supplement" with respect to the Registration
Statement, the Prospectus or any Preliminary Prospectus shall be deemed to refer
to and include the filing of any document under the 1934 Act after the date of
this Agreement, or the issue date of the Prospectus or any Preliminary
Prospectus, as the case may be, and deemed to be incorporated therein by
reference. For purposes of this Agreement, all references to the Registration
Statement, any Preliminary Prospectus, or any Prospectus, or any amendment or
supplement to any of the foregoing, shall be deemed to include the copy, if any,
filed with the Commission pursuant to its Electronic Data Gathering Analysis and
Retrieval system ("EDGAR").
(b) On the date that any Preliminary Prospectus was filed with
the Commission, the date the Prospectus is first filed with the Commission
pursuant to Rule 424(b) (if required), at all times subsequent to and including
the Closing Date and when any post-effective amendment to the Registration
Statement becomes effective or any amendment or supplement to the Prospectus is
filed with the Commission, the Registration Statement, each Preliminary
Prospectus and the Prospectus (as amended or as supplemented if the Company
shall have filed with the Commission any amendment or supplement thereto),
including the financial statements included in the Prospectus, did or will
comply with all applicable provisions of the 1933 Act and the 1933 Act
Regulations and did or will contain all statements required to be stated therein
in accordance with the 1933 Act and the 1933 Act Regulations. On the Effective
Date and when any post-effective amendment to the Registration Statement becomes
effective, no part of the Registration Statement or any such amendment did or
will contain any untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they were made, not
misleading. At the Effective Date, at the date the Prospectus or any amendment
or supplement to the Prospectus is filed with the Commission and at the Closing
Date the Prospectus did not or will not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
therein, in the light of the circumstances under which they were made, not
misleading. The Company has not distributed any offering material in connection
with the offering or sale of the Shares and the Selling Stockholder Shares,
other than the Registration Statement, the Preliminary Prospectus and the
Prospectus. Each Registration Statement, Preliminary Prospectus and Prospectus
filed with the Commission, including those filed by electronic transmission
pursuant to EDGAR (except as may be permitted by Regulation S-T under the 1933
Act), was identical to the copy thereof delivered to the Placement Agents for
use in connection with the offer and sale of the Shares and Selling Stockholder
Shares.
(c) Ernst & Young LLP, who have expressed their opinion with
respect to the financial statements and supporting schedules and related notes
included in the Registration Statement and the Prospectus, are independent
public accountants with respect to the Company as required by the 1933 Act and
the 1933 Act Regulations.
4
<PAGE> 5
(d) The financial statements of the Company and the related
notes thereto, included or incorporated by reference in the Registration
Statement and the Prospectus present fairly the consolidated financial position
of the Company and its subsidiaries, Krause's Custom Crafted Furniture Corp.
(formerly Krause's Sofa Factory) and KMC Enterprises, Inc. (collectively, the
"Subsidiaries" and each a "Subsidiary") as of the respective dates of such
financial statements, and their consolidated statement of operations and
statement of cash flows for the respective periods covered thereby; said
financial statements and related notes have been prepared in conformity with
generally accepted accounting principles applied on a consistent basis as
certified by the independent accountants named in subsection 3(c) above; and the
supporting schedules included in the Registration Statement present fairly the
information required to be stated therein. No other financial statements or
schedules are required to be included in the Registration Statement. The
selected financial and statistical data set forth in the Prospectus under the
captions "Capitalization" and "Selected Financial Data" fairly present the
information set forth therein on the basis stated in the Registration Statement
and have been prepared on an accounting basis consistent with the consolidated
financial statements of the Company.
(e) Since the respective dates as of which information is
given in the Registration Statement and the Prospectus, except as otherwise
stated therein, (i) there has been no material adverse change or any development
involving a prospective material adverse change in or affecting the condition,
financial or otherwise, or in the earnings, business affairs, or business
prospects of the Company and the Subsidiaries, whether or not arising in the
ordinary course of business, (ii) there have been no transactions entered into
by the Company or the Subsidiaries, other than those in the ordinary course of
business, which are material with respect to the Company and the Subsidiaries,
and (iii) there has been no dividend or distribution of any kind declared, paid
or made by the Company or the Subsidiaries on any class of their capital stock.
The Company and the Subsidiaries have no material contingent obligations which
are not disclosed in the Registration Statement.
(f) The Company and the Subsidiaries have been duly
incorporated and are validly existing as corporations in good standing under the
laws of their respective jurisdictions of incorporation, with corporate power
and authority to own, lease and operate their properties and to conduct their
businesses as described in the Prospectus and, in the case of the Company, to
enter into and perform its obligations under this Agreement; the Company and the
Subsidiaries are duly qualified as foreign corporations to transact business and
are in good standing in each jurisdiction in which such qualification is
required, whether by reason of the ownership or leasing of property or the
conduct of business, except where the failure to so qualify would not, singly or
in the aggregate, have a material adverse effect on the condition, financial or
otherwise, or the earnings, business affairs, results of operations or business
prospects of the Company and the Subsidiaries, taken as a whole (a "Material
Adverse Effect"). Other than in the Subsidiaries, or as disclosed in the
Registration Statement pursuant to Item 601 of Regulation S-K, the Company does
not own, directly or indirectly, any shares of capital stock or any other equity
securities of any corporation or have any equity interest in any firm,
partnership, joint venture, association or other entity.
5
<PAGE> 6
(g) The authorized, issued and outstanding capital stock of
the Company is as set forth in the Prospectus under "Capitalization" (except for
subsequent issuances, if any, pursuant to this Agreement or pursuant to
reservations, agreements, employee or director benefit plans or the exercise of
convertible securities referred to in the Prospectus); the shares of issued and
outstanding capital stock of the Company have been duly authorized and validly
issued and are fully paid and nonassessable and have not been issued in
violation of or are not otherwise subject to any preemptive or other similar
rights; the Company owns, beneficially and of record, all of the outstanding
capital stock of the Subsidiaries; the Shares have been duly authorized for
issuance and sale to the Investors pursuant to this Agreement and, when issued
and delivered by the Company pursuant to this Agreement against payment of the
consideration set forth herein, will be validly issued and fully paid and
nonassessable; the certificates evidencing the Shares and the Selling
Stockholder Shares are in due and proper form under Delaware law; the authorized
capital stock of the Company, including the Shares and the Selling Stockholder
Shares, conforms to all statements relating thereto contained in the Prospectus;
and the issuance of the Shares is not subject to preemptive or other similar
rights. There are no outstanding subscriptions, options, warrants, convertible
or exchangeable securities or other rights granted to or by the Company to
purchase shares of capital stock or other securities of the Company and there
are no commitments, plans or arrangements to issue any shares of capital stock
or any security convertible into or exchangeable for capital stock, in each case
other than as described in the Prospectus.
(h) The Company and the Subsidiaries: (i) are in material
compliance with any and all applicable foreign, United States, state and local
environmental laws, rules, regulations, treaties, statutes and codes promulgated
by any and all governmental authorities relating to the protection of human
health and safety, the environment or toxic substances or wastes, pollutants or
contaminates, and all amendments or modifications thereto ("Environmental
Laws"); (ii) have received all material permits, licenses or other approvals
required of them under applicable Environmental Laws to conduct their business
as currently conducted; and (iii) are in compliance in all material respects
with all terms and conditions of any such permit, license or approval. No
action, proceeding, revocation proceeding, writ, injunction or claim is pending
or, to the knowledge of the Company, threatened against the Company or the
Subsidiaries relating to the Environmental Laws or to the activities of the
Company or the Subsidiaries involving Hazardous Materials. The terms "Hazardous
Materials" as used in this Agreement means any material or substance that: (i)
is prohibited or regulated by any Environmental Laws; or (ii) has been
designated or regulated by any governmental authority as radioactive, toxic,
hazardous or otherwise a danger to health, reproduction or the environment.
(i) Where the Company or any Subsidiary is engaged in the
generation, use, manufacture, transportation or storage of any Hazardous
Materials on any of the properties or former properties of the Company or the
Subsidiaries, the Company and its Subsidiaries have complied in all material
respects with all Environmental Laws relevant to such activities. No Hazardous
Materials have been treated or disposed of on any properties of the Company or
the Subsidiaries or on properties formerly owned or leased by the Company or the
Subsidiaries during the time of such ownership or lease, except in compliance
with Environmental Laws. No spills, discharges, releases,
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<PAGE> 7
deposits, emplacements, leaks or disposal of any Hazardous Materials have
occurred on or under or have emanated from any of the Company's properties or
former properties of the Company or the Subsidiaries for which the cost of
remediation would materially and adversely affect the Company.
(j) Neither the Company nor any Subsidiary is in violation of
its respective charter or bylaws or similar governing instruments or is in
default in the performance or observance of any obligation, agreement, covenant
or condition contained in any contract, indenture, mortgage, loan agreement,
deed, trust, note, lease, sublease, voting agreement, voting trust, or other
instrument or agreement to which the Company or the Subsidiaries are a party or
by which the Company or the Subsidiaries may be bound, or to which any of the
property or assets of the Company or the Subsidiaries are subject, unless
irrevocable waiver shall have been obtained with respect to such default and
such default and the waiver thereof shall have been disclosed in writing to the
Placement Agents; and the execution, delivery and performance of this Agreement
and the consummation of the transactions contemplated herein and compliance by
the Company with its obligations hereunder have been duly authorized by all
necessary corporate action and will not conflict with or constitute a breach of,
or default under, or result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or the Subsidiaries
pursuant to, any contract, indenture, mortgage, loan agreement, deed, trust,
note, lease, sublease, voting agreement, voting trust or other instrument or
agreement to which the Company or the Subsidiaries is a party or by which they
may be bound, or to which any of the property or assets of the Company or the
Subsidiaries are subject, nor will such action result in any violation of the
provisions of the charter or bylaws of the Company or any applicable statute,
law, rule, regulation, ordinance, decision, directive or order.
(k) No labor dispute with the employees of the Company or the
Subsidiaries exists or, to the knowledge of the Company, is imminent; and the
Company is not aware of any existing or imminent labor disturbance by the
employees of any of its principal suppliers, manufacturers or contractors.
(l) There is no action, suit or proceeding before or by any
court or governmental agency or body, domestic or foreign, now pending, or, to
the knowledge of the Company, threatened, against or affecting the Company or
the Subsidiaries, which is required to be disclosed in the Registration
Statement (other than as disclosed therein), or which, singly or in the
aggregate, might result in any Material Adverse Effect or which might materially
and adversely affect the consummation of this Agreement; all pending legal or
governmental proceedings to which the Company or the Subsidiaries are a party or
of which any of their respective properties or assets is the subject which are
not described in the Registration Statement, including ordinary routine
litigation incidental to the business, are, considered in the aggregate, not
material; and there are no contracts or documents of the Company or the
Subsidiaries which are required to be filed as exhibits to the Registration
Statement by the 1933 Act or by the 1933 Act Regulations which have not been so
filed.
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<PAGE> 8
(m) No relationship, direct or indirect, exists between or
among the Company and any Subsidiary on the one hand, and the directors,
officers, shareholders, customers or suppliers of the Company and any Subsidiary
on the other hand, that is required by the 1933 Act or the 1933 Act Regulations
to be described in the Registration Statement and the Prospectus or documents
incorporated by reference therein that is not described as so required.
(n) The Company and the Subsidiaries own or are licensed to
use all patents, patent applications, inventions, trademarks, trade names,
applications for registration of trademarks, service marks, service mark
applications, copyrights, know-how, manufacturing processes, formulae, trade
secrets, licenses and rights in any thereof and any other similar intangible
property and assets (herein called the "Proprietary Rights") which are material
to the businesses of the Company or the Subsidiaries as now conducted and as
proposed to be conducted, in each case as described in the Prospectus. The
description of the Proprietary Rights is correct in all material respects and
fairly and correctly describes the Company's rights with respect thereto.
Neither the Company nor any Subsidiary has any knowledge of, and neither the
Company nor any Subsidiary has given or received any notice of, any pending
conflicts with or infringement of the rights of others with respect to any
Proprietary Rights or with respect to any license of Proprietary Rights. No
action, suit, arbitration, or legal, administrative or other proceeding, or
investigation is pending, or, to the knowledge of the Company, threatened, which
involves any Proprietary Rights. Neither the Company nor any Subsidiary is
subject to any judgment, order, writ, injunction or decree of any court or any
Federal, state, local, foreign or other governmental department, commission,
board, bureau, agency or instrumentality, domestic or foreign, or any
arbitrator, or has entered into or is a party to any contract which restricts or
impairs the use of any such Proprietary Rights in a manner which would
materially affect the use of any of the Proprietary Rights. To the knowledge of
the Company, no Proprietary Rights used by the Company or the Subsidiaries, and
no services or products sold by the Company or the Subsidiaries, conflict with
or infringe upon any proprietary rights available to any third party. The
Company has not received written notice of any pending conflict with or
infringement upon such third party proprietary rights. Neither the Company nor
any Subsidiary has entered into a consent, indemnification, forbearance to sue
or settlement agreement with respect to Proprietary Rights. No claims have been
asserted against the Company by written notice or formal proceedings or, to the
knowledge of the Company, by other means, by any person with respect to the
validity of the ownership or right to use the Proprietary Rights of the Company
or the Subsidiaries and, to the knowledge of the Company, there is no reasonable
basis for any such claim to be successful. The Proprietary Rights are valid and
enforceable and no registration relating thereto has lapsed, expired or been
abandoned or canceled or is the subject of cancellation or other adversarial
proceedings, and all applications therefore are pending and are in good
standing. The Company and the Subsidiaries have complied, in all material
respects, with their respective contractual obligations relating to the
protection of the Proprietary Rights used pursuant to licenses. To the knowledge
of the Company, no person is infringing on or violating the Proprietary Rights
owned or used by the Company or the Subsidiaries.
(o) No registration, authorization, approval, qualification or
consent of any court or governmental authority or agency is necessary in
connection with the offering, issuance or sale
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<PAGE> 9
of the Shares or the Selling Stockholder Shares hereunder, except such as may be
required under the 1933 Act or the 1933 Act Regulations or state securities or
Blue Sky laws (or such as may be required by the National Association of
Securities Dealers, Inc. ("NASD").
(p) Except as otherwise disclosed in the Prospectus, the
Company and the Subsidiaries now hold and at the Closing Date will hold, all
licenses, certificates, approvals and permits from all state, United States,
foreign and other regulatory authorities, and any foreign regulatory authorities
performing similar functions, that are material to the conduct of the businesses
of the Company and the Subsidiaries (as such businesses are currently
conducted), except for such licenses, certificates, approvals and permits the
failure of which to hold would not have a Material Adverse Effect, all of which
are in effect (and there is no proceeding pending or, to the knowledge of the
Company, threatened which may cause any such license, certificate, approval or
permit to be withdrawn, canceled, suspended or not renewed). Neither the Company
nor any Subsidiary is in violation of any law, order, rule, regulation, writ,
injunction or decree of any court or governmental agency or body, and neither
the Company nor any Subsidiary has received any notice of proceedings relating
to the revocation or modification of any such permit or any circumstance which
would lead them to believe that such proceedings are reasonably likely which,
singly or in the aggregate, if the subject of an unfavorable decision, ruling or
finding, would have a Material Adverse Effect.
(q) The Company has all corporate power and authority to enter
into this Agreement and the Escrow Agreement, and to perform its obligations
hereunder and thereunder, and all consents, authorizations, approvals and orders
required in connection herewith and therewith have been obtained, except such as
may be required under state securities or Blue Sky laws or the bylaws and rules
of the NASD and, if the Registration Statement is not effective under the 1933
Act as of the time of execution hereof, such as may be required (and shall be
obtained as provided in this Agreement) under the 1933 Act. Each of this
Agreement and the Escrow Agreement has been duly executed and delivered by the
Company and constitutes a valid and binding obligation of the Company,
enforceable against the Company in accordance with its terms, except as limited
by applicable bankruptcy, insolvency, reorganization, moratorium or other laws
nor or hereafter in effect relating to or affecting creditors, rights generally
or by general principles of equity relating to the availability of remedies and
except as rights to indemnity and contribution hereunder may be limited by
federal or state securities laws or the public policy underlying such laws.
(r) There are no persons with registration or other similar
rights to have any securities (i) registered pursuant to the Registration
Statement or (ii) otherwise registered by the Company under the 1933 Act, other
than, with respect to (i) and (ii) above, those rights whose holders have
received proper notice of the filing of the Registration Statement and have
declined to assert such registration rights (and who now no longer have a right
to do so), those rights which have been waived or are no longer entitled to be
asserted, or other than, with respect to (ii) above, those described in the
Prospectus.
(s) No order preventing or suspending the use of any
Preliminary Prospectus or the Prospectus has been issued and no proceedings for
that purpose are pending, or, to the knowledge
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<PAGE> 10
of the Company, threatened or contemplated by the Commission; and no order
suspending the offering of the Shares in any jurisdiction designated by the
Placement Agents pursuant to Section 5(f) of this Agreement has been issued and
no proceeding therefor has been instituted or, to the knowledge of the Company,
are any such proceedings threatened or contemplated. The Company has complied to
the Commission's and any state securities commission's satisfaction with all
requests of the Commission and such state securities commission with all
requests for additional or supplemental information.
(t) The Company and the Subsidiaries have good and marketable
title to their respective properties, free and clear of all material security
interests, mortgages, pledges, liens, charges, encumbrances, claims and equities
of record, except as disclosed in the Prospectus. The properties of the Company
and the Subsidiaries are, in the aggregate, in good repair (reasonable wear and
tear excepted), and suitable for their respective uses. Any real properties held
under lease by the Company and the Subsidiaries are held by it under valid,
subsisting and enforceable leases with such exceptions as are not material and
do not interfere with the conduct of the business of the Company or the
Subsidiaries.
(u) The Company maintains a system of internal accounting
controls sufficient to provide reasonable assurances that (i) transactions are
executed in accordance with management's general or specific authorization, (ii)
transactions are recorded as necessary to permit preparation of financial
statements in conformity with generally accepted accounting principles and to
maintain accountability for assets, (iii) access to assets is permitted only in
accordance with management's general or specific authorization, and (iv) the
recorded accountability for assets is compared with the existing assets at
reasonable intervals and appropriate action is taken with respect to any
differences.
(v) The Company and the Subsidiaries have conducted and are
conducting their businesses in material compliance with all applicable Federal,
state, local and foreign statutes, laws, rules, regulations, ordinances, codes,
decisions, decrees, directives and orders.
(w) Neither the Company nor any Subsidiary nor, to the
Company's or any Subsidiary's knowledge, any employee or agent of the Company or
any Subsidiary, has, directly or indirectly, made any payment of funds of the
Company or the Subsidiaries or received or retained any funds in violation of
any law, rule or regulation, which payment, receipt or retention of funds is of
a character required to be disclosed in the Prospectus, including, without
limitation, any unlawful contribution to any candidate for public office, or
failed to disclose fully contributions in violation of law, or other payments to
any federal, state or foreign governmental officer or official, or other person
charged with similar public or quasi-public duties, other than payments required
or permitted by the laws of the United States, any foreign jurisdiction, or any
jurisdiction thereof.
(x) The Company is not now, and after sale of the Shares to be
sold by it hereunder and application of the net proceeds from such sale as
described in the Prospectus under the caption "Use of Proceeds" will not be, an
"investment company" within the meaning of the Investment Company Act of 1940,
as amended.
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(y) All offers and sales of capital stock and other securities
of the Company made within the three years prior to the date hereof were at all
relevant times duly registered or exempt from the registration requirements of
the 1933 Act and were duly registered or qualified or subject to an available
exemption from the registration or qualification requirements of the applicable
state securities or Blue Sky laws. No Person who purchased a security from the
Company prior to the date hereof has any right to rescind his or her purchase or
otherwise seek recovery of the purchase price from the Company.
(z) The Common Stock is registered pursuant to Section 12(g)
of the 1934 Act. The Shares and the Selling Stockholder Shares have been
accepted for listing on the AMEX. The Company has taken no action designed to,
or likely to have the effect of, terminating the registration of the Common
Stock under the 1934 Act or delisting the Common Stock from the AMEX, nor has
the Company received any notification that the Commission or the AMEX is
contemplating terminating such registration or listing.
(aa) Neither the Company, nor, to its knowledge, any of its
officers, directors or affiliates has taken, and at the Closing Date, neither
the Company nor, to its knowledge, any of its officers, directors or affiliates
will have taken, directly or indirectly, any action which has constituted, or
might reasonably be expected to constitute, the stabilization or manipulation of
the price of sale or resale of the Common Stock.
(ab) The Company maintains insurance of the types and in
amounts that are adequate for its and its Subsidiaries' businesses and
consistent with insurance coverage maintained by similar companies in similar
businesses, including but not limited to, insurance covering product liability
and real and personal property owned or leased against theft, damage,
destruction, acts of vandalism and all other risks customarily insured against,
all of which insurance is in full force and effect.
(ac) The Company and the Subsidiaries have filed all necessary
federal, state and foreign tax returns required to be filed by them and have
paid or accrued all taxes shown as due thereon, which returns are true and
correct in all material respects, and neither the Company nor any Subsidiary is
in default in the payment of any taxes, including penalties and interest,
assessments, fees and other charges, shown thereon due or otherwise assessed,
other than those being contested in good faith and for which adequate reserves
have been provided or those currently payable without interest which were
payable pursuant to said returns or any assessments with respect thereto.
(ad) To the knowledge of the Company, if any full-time
employee identified in the Prospectus has entered into any non-competition,
non-disclosure, confidentiality or other similar agreement with any party other
than the Company or any Subsidiaries, such employee is neither in violation
thereof nor is expected to be in violation thereof as a result of the business
conducted or expected to be conducted by the Company or the Subsidiaries as
described in the Prospectus or such person's performance of his obligations to
the Company or any Subsidiaries; neither the Company nor any Subsidiary has
received written notice that any consultant or employee of the Company or
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<PAGE> 12
the Subsidiaries is in violation of any noncompetition, non-disclosure,
confidentiality or similar agreement.
(ae) The Company has delivered or caused to be delivered to
the Placement Agents an agreement in the form of Attachment A hereto (with
respect to the Company) and in the form of Attachment B hereto (with respect to
the officers, directors and certain affiliates of the Company listed on Exhibit
B hereto) to the effect that neither the Company nor any of the officers,
directors or affiliates listed on Exhibit B hereto will, without the prior
written consent of the Placement Agents, offer, sell, or otherwise dispose of
any shares of capital stock or equity securities of the Company or securities
convertible into, or exchangeable or exercisable for, shares of capital stock of
the Company (other than the Shares and the Selling Stockholder Shares) for a
period of 180 days (with respect to the Company) and 120 days (with respect to
the officers, directors and affiliates of the Company) after the Closing Date,
subject to the exceptions set forth in Attachment A with respect to the Company.
4. Representations, Warranties and Covenants of the Selling
Stockholder. The Selling Stockholder represents, warrants and covenants to the
Company and to the Placement Agents that:
(a) The Selling Stockholder is, and at the Closing Date will
be, duly organized, validly existing and in good standing under the laws of the
jurisdiction of its organization with corporate power and authority to own,
lease and operate its properties and to conduct its business.
(b) The Selling Stockholder has all corporate power and
authority to enter into this Agreement and the Escrow Agreement and to carry out
all the terms and provisions hereof and thereof to be carried out by it. All
authorizations and consents necessary for the execution and delivery by the
Selling Stockholder of this Agreement and the Escrow Agreement have been given.
This Agreement and the Escrow Agreement have been duly authorized, executed and
delivered by or on behalf of the Selling Stockholder and constitute valid and
binding agreements of the Selling Stockholder and are enforceable against the
Selling Stockholder in accordance with their terms, except as limited by
applicable bankruptcy, insolvency, reorganization, moratorium or other laws now
or hereafter in effect relating to or affecting creditors' rights generally or
by general principles of equity relating to the availability of remedies and
except as rights to indemnity or contribution may be limited by federal or state
securities laws and the public policy underlying such laws.
(c) The Selling Stockholder has full power and authority to
enter into the Power of Attorney in the form heretofore furnished to the Selling
Stockholder and the Custody Agreement in the form heretofore furnished to the
Selling Stockholder and to carry out all the terms and provisions thereof to be
carried out by it. All authorizations and consents necessary for the execution
and delivery by the Selling Stockholder of the Power of Attorney and the Custody
Agreement have been given. Each of the Power of Attorney and the Custody
Agreement has been duly authorized, executed and delivered by the Selling
Stockholder and is enforceable against the Selling Stockholder in accordance
with the terms thereof, except as limited by applicable bankruptcy, insolvency,
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<PAGE> 13
reorganization, moratorium or other laws now or hereafter in effect relating to
or affecting creditors' rights generally or by general principles of equity
relating to the availability of remedies.
(d) The Selling Stockholder now has, and at the time of
delivery thereof hereunder will have, (i) good and marketable title to the
Selling Stockholder Shares to be sold by the Selling Stockholder hereunder, free
and clear of all encumbrances and adverse claims, and (ii) full legal right and
power, and all authorizations and approvals required by law, to sell, transfer
and deliver the Selling Stockholder Shares to the Investors and to make the
representations, warranties and agreements made by the Selling Stockholder
herein.
(e) None of the execution, delivery or performance of this
Agreement, the Escrow Agreement, the Power of Attorney or the Custody Agreement
or the consummation of the transactions contemplated herein or therein by the
Selling Stockholder conflicts or will conflict with or results or will result in
any breach or violation of any of the terms or provisions of, or constitute a
default under, or result in the creation or imposition of any encumbrance upon,
any property or assets of the Selling Stockholder pursuant to (i) the terms of
its organizational documents; (ii) the terms of any contract or other agreement
to which the Selling Stockholder is a party or by which it is bound or to which
any of its properties is subject, which conflict, breach, violation or default
would adversely affect the Selling Stockholder's ability to perform its
obligations hereunder; (iii) any statute, rule or regulation of any governmental
body having jurisdiction over the Selling Stockholder or any of its activities
or properties; or (iv) the terms of any judgment, decree or order of any
arbitration or governmental body having such jurisdiction.
(f) No consent, approval, authorization or order of, or any
filing or declaration with any governmental body is required for the
consummation by the Selling Stockholder of the transactions on its part
contemplated herein, except such as have been obtained under the state
securities or Blue Sky laws and under the NASD rules.
(g) The sale of the Selling Stockholder Shares proposed to be
sold by the Selling Stockholder is not prompted by the Selling Stockholder's
knowledge of any material adverse information concerning the Company or its
Subsidiaries which is not set forth or described in the Prospectus.
(h) On the Effective Date, the date of the Preliminary
Prospectus and the date of the Prospectus, and on the Closing Date, the
information with respect to the Selling Stockholder included therein did not
contain any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary in order to make the statements
therein not misleading.
(i) On the date that any Preliminary Prospectus was filed with
the Commission, the date the Prospectus is first filed with the Commission
pursuant to Rule 424(b) (if required), at all times subsequent to and including
the Closing Date, all information with respect to the Selling Stockholder
included in the Registration Statement, each Preliminary Prospectus and the
Prospectus (as amended or as supplemented if the Company shall have filed with
the Commission any
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<PAGE> 14
amendment or supplement thereto), did or will comply with all applicable
provisions of the 1933 Act and the 1933 Act Regulations and did or will contain
all statements required to be stated therein in accordance with the 1933 Act and
the 1933 Act Regulations.
(j) The Selling Stockholder has delivered to the Placement
Agents an agreement in the form of Attachment B hereto to the effect that it
will not, without the prior written consent of the Representative, offer, sell,
or otherwise dispose of any shares of capital stock or equity securities of the
Company or securities convertible into, or exchangeable or exercisable for,
shares of capital stock of the Company (excluding the Selling Stockholder
Shares) for a period of 120 days after the Closing Date.
5. Agreements of the Company and the Selling Stockholder. The Company
(as to Sections 5(a)-(l)) and the Selling Stockholder (as to Sections 5(i), 5(k)
and 5(m)) covenant and agree with the Placement Agents as follows:
(a) The Company will not, either prior to the Effective Date
or thereafter during such period as, in the opinion of counsel for the Placement
Agents, the Prospectus would be required by law to be delivered in connection
with sales of the Shares or the Selling Stockholder Shares by an underwriter or
dealer, file any amendment or supplement to the Registration Statement or the
Prospectus, unless a copy thereof shall first have been submitted to the
Placement Agents within a reasonable period of time prior to the filing thereof
and the Placement Agents shall not have objected thereto in good faith.
(b) If the Registration Statement has not been declared
effective prior to the execution of this Agreement, the Company will use its
best efforts to cause the Registration Statement to become effective, and will
notify the Placement Agents promptly, and will confirm such advice in writing,
(1) when the Registration Statement has become effective and when any
post-effective amendment thereto becomes effective, (2) of any request by the
securities or other governmental authority (including, without limitation, the
Commission) of any jurisdiction for amendments or supplements to the
Registration Statement or the Prospectus or for additional or supplemental
information, (3) of the issuance by any securities or other governmental
authority (including, without limitation, the Commission) of any jurisdiction of
any stop order suspending the effectiveness of the Registration Statement or the
initiation of any proceedings for that purpose or the threat thereof, (4) of the
happening of any event during the period mentioned in Section 5(a) that in the
judgment of the Company makes any statement made in the Registration Statement
or the Prospectus untrue or that requires the making of any changes in the
Registration Statement or the Prospectus in order to make the statements
therein, in light of the circumstances in which they are made, not misleading
and (5) of receipt by the Company or any representative or attorney of the
Company of any other communication from the securities or other governmental
authority (including, without limitation, the Commission) of any jurisdiction
relating to any of the Registration Statement, any Preliminary Prospectus or the
Prospectus. If at any time any securities or other governmental authority
(including, without limitation, the Commission) of any jurisdiction shall issue
any order suspending the effectiveness of the Registration Statement, the
Company will make
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<PAGE> 15
every reasonable effort to obtain the withdrawal of such order at the earliest
possible moment. If the Company has omitted any information from the
Registration Statement, pursuant to Rule 430A, it will use its best efforts to
comply with the provisions of and make all requisite filings with the Commission
pursuant to said Rule 430A and to notify the Placement Agents promptly of all
such filings. If the Company elects to rely on Rule 462(b), the Company shall
both file a Rule 462(b) Registration Statement with the Commission in compliance
with Rule 462(b) and pay the applicable filing fees in accordance with Rule 111
of the Rules and Regulations by the earlier of (A) 10:00 p.m., New York time, on
the date of this Agreement and (B) the time confirmations are sent or given, as
specified by Rule 462(b)(2).
(c) If, at any time when a Prospectus relating to the Shares
and the Selling Stockholder Shares is required to be delivered under the 1933
Act, any event occurs as a result of which the Prospectus, as then amended or
supplemented, would, in the judgment of counsel to the Company or counsel to the
Placement Agents, include any untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements therein, in the
light of the circumstances under which they were made, not misleading, or the
Registration Statement, as then amended or supplemented, would, in the judgment
of counsel to the Company or counsel to the Placement Agents, include any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements therein not misleading, or if for any other reason it is
necessary, in the judgment of counsel to the Company or counsel to the Placement
Agents, at any time to amend or supplement the Prospectus or the Registration
Statement to comply with the 1933 Act or the 1933 Act Regulations, the Company
will promptly notify the Placement Agents and, subject to Section 5(a) hereof,
will promptly prepare and file with the Commission, at the Company's expense, an
amendment to the Registration Statement or an amendment or supplement to the
Prospectus that corrects such statement or omission or effects such compliance
and will deliver to the Placement Agents, without charge, such number of copies
thereof as the Placement Agents may reasonably request. The Company consents to
the use of the Prospectus or any amendment or supplement thereto by the
Placement Agents.
(d) The Company will furnish to the Placement Agents and their
counsel, without charge, (i) an aggregate of three manually signed copies of the
registration statement described in Section 3(a) hereof and each pre-effective
amendment thereto, including financial statements and schedules, and all
exhibits thereto, and any registration statement filed pursuant to Rule 462(b)
and (ii) so long as a prospectus relating to the Shares and the Selling
Stockholder Shares is required to be delivered under the 1933 Act, as many
copies of each Preliminary Prospectus or the Prospectus or any amendment or
supplement thereto as the Placement Agents may reasonably request.
(e) The Company will comply with all the undertakings
contained in the Registration Statement and shall file, on a timely basis, with
the Commission, the NASD, the AMEX and any other securities exchange on which
the securities of the Company are then listed, all periodic and other reports
and documents required to be filed under the Exchange Act.
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(f) Prior to the sale of the Shares and the Selling
Stockholder Shares to the Investors, the Company and the Selling Stockholder
will cooperate with the Placement Agents and their counsel in connection with
the registration or qualification of the Shares and the Selling Stockholder
Shares for offer and sale under the state securities or Blue Sky laws of such
jurisdictions as the Placement Agents may request; provided, that in no event
shall the Company be obligated to qualify to do business in any jurisdiction
where it is not now so qualified or to take any action which would subject it to
general service of process in any jurisdiction where it is not now so subject.
The Company will advise the Placement Agents promptly of the suspension of the
qualification or registration of (or any exemption relating to) the Shares or
the Selling Stockholder Shares for offering, sale or trading in any jurisdiction
or any initiation or threat of any proceedings for such purpose, and in the
event of the issuance of any order suspending such qualification or registration
or exemption, the Company shall use its best efforts to obtain the withdrawal
thereof at the earliest possible time.
(g) During the period of three years commencing on the
Effective Date, the Company will furnish to the Placement Agents: (i) as soon as
practicable after the end of each fiscal year of the Company, copies of the
Annual Report of the Company containing the balance sheet of the Company as of
the close of such fiscal year and statements of income, stockholders' equity and
cash flows for the fiscal year then ended and the opinion thereon of the
Company's independent public or certified public accountants; (ii) as soon as
practicable after the filing thereof, copies of each proxy statement, Annual
Report on Form 10-K (or Form 10-KSB, if applicable), Quarterly Report on Form
10-Q (or Form 10-QSB, if applicable), Current Report on Form 8-K, or other
report filed by the Company with the Commission, the NASD, the AMEX, or any
other securities exchange; and (iii) as soon as available, copies of any reports
or communications of the Company mailed generally to holders of its capital
stock.
(h) As soon as practicable, but in any event not later than 45
days after the end of the 12-month period beginning on the day after the end of
the fiscal quarter of the Company during which the Effective Date of the
Registration Statement occurs (90 days in the event that the end of such fiscal
quarter is the end of the Company's fiscal year), the Company will make
generally available to its security holders, in the manner specified in Rule
158(b) of the 1933 Act Regulations, and to the Placement Agents, an earnings
statement which will be in the detail required by, and will otherwise comply
with, the provisions of Section 11(a) of the 1933 Act and Rule 158(a) of the
19933 Act Regulations, which statement need not be audited unless required by
the 1933 Act or the 1933 Act Regulations, covering a period of at lest 12
consecutive months after the effective date of the Registration Statement.
(i) Neither the Company nor the Selling Stockholder will, at
any time, directly or indirectly, take any action intended, or which might
reasonably be expected, to cause or result in, or which will constitute,
stabilization or manipulation of the price of the Common Stock to facilitate the
sale or resale of any of the Shares or the Selling Stockholder Shares.
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(j) Prior to the Closing Date, the Company shall furnish to
the Placement Agents, as soon as they have been prepared, copies of any
unaudited interim consolidated financial statements of the Company, for any
periods subsequent to the periods covered by the financial statements appearing
in the Registration Statement and the Prospectus.
(k) Prior to the Closing Date, the Company and the Selling
Stockholder will issue no press release or other communications directly or
indirectly and hold no press conferences with respect to the Company, the
condition, financial or otherwise, or the earnings, business affairs or business
prospects of the Company, or the offering of the Shares or the Selling
Stockholder Shares, without the prior written consent of the Placement Agents
unless in the opinion of legal counsel to the Company, and after reasonable
advance notification to the Placement Agents, such press release or
communication is required by law.
(l) The Company will apply the net proceeds from the offering
and sale of the Shares in the manner set forth in the Prospectus under the
caption "Use of Proceeds."
(m) The Selling Stockholder will deliver to the Placement
Agents and the Escrow Agent prior to or on the effective date a properly
completed and executed United States Treasury Department Form W-9 (or other
applicable form or statement specified by Treasury Department regulations in
lieu thereof).
You may waive in writing the performance by the Company of any one or
more of the foregoing covenants or extend the time for their performance.
6. Expenses. Whether or not the transactions contemplated by this
Agreement are consummated or this Agreement is terminated, the Company will pay
all costs and Expenses incident to the performance of the obligations of the
Company and the Placement Agents under this Agreement, including but not limited
to costs and Expenses of or relating to (1) the preparation, printing and filing
of the Registration Statement (including each pre- and post-effective amendment
thereto) and exhibits thereto, any registration statement filed pursuant to Rule
462(b), each Preliminary Prospectus, the Prospectus and any amendment or
supplement to the Prospectus, including all fees, disbursements and other
charges of counsel to the Company, (2) the preparation and delivery of
certificates representing the Shares, (3) furnishing (including costs of
shipping and mailing) such copies of the Registration Statement (including all
pre- and post-effective amendments thereto), the Prospectus and any Preliminary
Prospectus, and all amendments and supplements to the Prospectus, as may
reasonably be requested for use in connection with the direct placement of the
Shares and the Selling Stockholder Shares, (4) the listing of the Common Stock
on the AMEX and withdrawal of the Common Stock from the Nasdaq SmallCap Market,
(5) any filings required to be made by the Placement Agents with the NASD and
the registration or qualification of the Shares and the Selling Stockholder
Shares for offer and sale under the state securities or Blue Sky laws of such
jurisdictions designated pursuant to Section 5(f), including the reasonable
fees, disbursements and other charges of counsel to the Placement Agents in
connection therewith and with the preparation and printing of preliminary,
supplemental and final Blue Sky memoranda, (6)
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fees, disbursements and other charges of counsel to the Company and the
Company's independent public or certified public accountants and other advisors,
(7) the fees of the Escrow Agent, (8) all expenses incident to the issuance and
delivery of the Shares (including all printing and engraving costs), (9) all
fees and expenses of the registrar and transfer agent of the Common Stock, (10)
all necessary issue, transfer and other stamp taxes in connection with the
delivery of the Shares or Selling Stockholder Shares, and (11) all other fees,
costs and expenses referred to in Item 13 of Part II of the Registration
Statement. The Company shall reimburse the Placement Agents for all their travel
expenses, reasonable legal fees, disbursements and other charges and other
out-of-pocket Expenses incurred in connection with the engagement hereunder, up
to a maximum of $100,000, regardless of whether or not the placement of the
Shares or the Selling Stockholder Shares is consummated as contemplated hereby.
If, within three months after the termination of this Agreement, the
Company or the Selling Stockholders shall sell any shares of Common Stock to
investors previously identified and/or contacted by the Placement Agents in
their capacity as such, as set forth on a list furnished to the Company and the
Selling Stockholder within a reasonable period of time after such termination,
then the Company and/or the Selling Stockholder, as appropriate, shall pay the
Placement Agents, at the time of each such sale, an amount equal to the
Placement Fee with respect to the gross proceeds to the Company or the Selling
Stockholder from each such sale.
7. Conditions of the Obligations of the Placement Agents. The
obligations of the Placement Agents hereunder are subject to the following
conditions:
(a) Notification that the Registration Statement has become
effective shall be received by the Placement Agents not later than 5:30 p.m.,
Los Angeles time, on the date of this Agreement or at such later date and time
as shall be consented to by the Placement Agents and all filings required by
Rule 424 of the Rules and Regulations and Rule 430A shall have been made.
(b) (i) No stop order suspending the effectiveness of the
Registration Statement shall have been issued, and no proceedings for that
purpose shall be pending or threatened by any securities or other governmental
authority (including, without limitation, the Commission), (ii) no order
suspending the effectiveness of the Registration Statement or the qualification
or registration of the Shares and the Selling Stockholder Shares under the
securities or Blue Sky laws of any jurisdiction shall be in effect and no
proceeding for such purpose shall be pending before or threatened or
contemplated by any securities or other governmental authority (including,
without limitation, the Commission), (iii) any request for additional
information on the part of the staff of any securities or other governmental
authority (including, without limitation, the Commission) shall have been
complied with to the satisfaction of the staff of the Commission or such
authorities and (iv) after the date hereof no amendment or supplement to the
Registration Statement or the Prospectus shall have been filed unless a copy
thereof was first submitted to the Placement Agents and the Placement Agents did
not object thereto in good faith, and the Placement Agents shall have received
certificates, dated the Closing Date and signed by the President and Chief
Executive Officer or the Chairman of the Board of Directors of the Company, and
the Chief Financial Officer of the
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<PAGE> 19
Company (who may, as to proceedings threatened, rely upon the best of their
information and belief), to the effect of clauses (i), (ii) and (iii) above.
(c) Since the respective dates as of which information is
given in the Registration Statement and the Prospectus, (i) there shall not have
been a material adverse change in the general affairs, business, prospects,
properties, management, condition (financial or otherwise) or results of
operations of the Company and the Subsidiaries, taken as a whole, whether or not
arising from transactions in the ordinary course of business, in each case other
than as set forth in or contemplated by the Registration Statement and the
Prospectus and (ii) neither the Company nor any Subsidiary shall have sustained
any material loss or interference with its business or properties from fire,
explosion, flood or other casualty, whether or not covered by insurance, or from
any labor dispute or any court or legislative or other governmental action,
order or decree, which is not set forth in the Registration Statement and the
Prospectus, if in the judgment of the Placement Agents any such development
makes it impracticable or inadvisable to consummate the sale and delivery of the
Shares to Investors at the public offering price.
(d) Since the respective dates as of which information is
given in the Registration Statement and the Prospectus, there shall have been no
litigation or other proceeding instituted against the Company or the
Subsidiaries or any of its officers or directors in their capacities as such,
before or by any Federal, state or local court, commission, regulatory body,
administrative agency or other governmental body, domestic or foreign, in which
litigation or proceeding an unfavorable ruling decision or finding would have a
Material Adverse Effect.
(e) Each of the representations and warranties of the Company
contained herein shall be true and correct at the Closing Date, as if made on
such date, and all covenants and agreements herein contained to be performed on
the part of the Company and all conditions herein contained to be fulfilled or
complied with by the Company at or prior to the Closing Date shall have been
duly performed, fulfilled or complied with.
(f) The Placement Agents shall have received:
(i) The favorable opinion, dated as of the Closing
Date, of Morrison & Foerster LLP, counsel for the Company, in form and substance
satisfactory to counsel for the Placement Agents, to the effect that:
(A) The Company and the Subsidiaries have
been duly incorporated and are validly existing as corporations in good
standing under the laws of their respective jurisdictions of
incorporation.
(B) The Company and the Subsidiaries have
corporate power and authority to own their properties and carry on
their businesses as described in the Registration Statement and the
Prospectus and the Company has corporate power and
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<PAGE> 20
authority to enter into and perform its obligations under this
Agreement and the Escrow Agreement.
(C) The Company is duly qualified to
transact business and is in good standing in each state of the United
States in which the conduct of its business or the ownership or leasing
of property requires such qualification, except to the extent that the
failure to be so qualified or be in good standing would not materially
and adversely affect the Company or its business, properties, financial
condition or results of operations.
(D) The authorized, issued and outstanding
number of shares of capital stock of the Company is as set forth under
the caption "Capitalization" in the Prospectus and in the Preliminary
Prospectus as of the dates therein. The issued and outstanding capital
stock of the Company has been duly authorized, validly issued, fully
paid and is non-assessable and has not been issued in violation of or
is not otherwise subject to any preemptive rights set forth in the
Certificate of Incorporation, Bylaws or any agreement or other
arrangement known to counsel. To their knowledge, all offers and sales
of the Company's capital stock or securities since January 1, 1992,
including all offers and sales of securities described in Item 15 of
Part II of the Registration Statement, were exempt from the
registration and qualification requirements of the 1933 Act and state
securities or Blue Sky laws or were duly registered or qualified under
the 1933 Act or state securities laws, assuming that all
representations made to the Company by any purchaser of such capital
stock were true and correct when made.
(E) Issuance and sale of the Shares to the
Investors under the terms of this Agreement have been duly authorized
by the Company and, when the Shares are issued and delivered by the
Company, pursuant to the terms of this Agreement and the Company
receives the consideration recited herein, such Shares will be validly
issued, and fully paid and non-assessable and the issuance of the
Shares is not subject to preemptive or, to their knowledge, other
similar rights granted by the Company.
(F) To their knowledge, except as described
in the Prospectus, (i) there are no outstanding options, warrants or
other rights granted to or by the Company to purchase shares of Common
Stock or other securities of the Company or the Subsidiaries, and (ii)
there are no commitments, plans or arrangements to issue any shares of
Common Stock or other securities of the Company or the Subsidiaries.
(G) This Agreement and the Escrow Agreement
have been duly authorized, executed and delivered by the Company.
(H) The form of certificate evidencing the
Shares and the Selling Stockholder Shares is in due and proper form
under Delaware law.
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(I) To their knowledge, except as described
in the Registration Statement or in the Prospectus, there are no
actions, suits or proceedings pending or threatened to which the
Company or the Subsidiaries are a party that are required to be
described in the Registration Statement or the Prospectus and are not
so described.
(J) The information set forth in the
Prospectus under the captions "Risk Factors - Control by Principal
Stockholders," "Risk Factors - Potential Adverse Market Impact of
Shares Eligible for Future Sale," "Risk Factors - Antitakeover Effects
of Certain Charter Provisions, and Delaware Law," "Risk Factors -
Governmental Regulation," "Business - Trademarks and Patents,"
"Business - Governmental Regulations," "Business - Legal Proceedings,"
"Management - Director Compensation," "Management - Summary
Compensation Table," "Management - Option/SAR Grants in Last Fiscal
Year," "Management - Year-End Option/SAR Values," "Management - 1997
Management Committee Incentive Award Program," "Management - Stock
Plans," "Management Employment Agreements," "Certain Transactions," and
"Description of Capital Stock," and in Part II of the Registration
Statement under the captions "Indemnification of Directors and
Officers," and "Recent Sales of Unregistered Securities," to the extent
that they constitute a summary of legal matters, documents or
proceedings referred to therein, have been reviewed by us and fairly
present and summarize, in all material respects, the information with
respect to such legal matters, documents under the Act and the Rules
and Regulations.
(K) To their knowledge, there are no
agreements, contracts, leases or other documents to which the Company
is a party of a character required to be described or referred to in
the Registration Statement or Prospectus or to be filed as an exhibit
to the Registration Statement which are not described or referred to
therein or filed as required and, to their knowledge, the Company is
not in default in the due performance or observance of any material
obligation, agreement, covenant or condition contained in any material
instrument or agreement filed as an exhibit to the Registration
Statement.
(L) No consent, approval, authorization or
order of or qualification with any court, government or governmental
agency or body having jurisdiction over the Company or over any of its
properties or operations is necessary in connection with the
consummation by the Company of the transactions contemplated in this
Agreement and the compliance by the Company with its obligations
thereunder on the Closing Date, other than the filing of the
Registration Statement and the Prospectus with the Commission and the
issuance of an effectiveness order by the Commission with respect to
the Registration Statement, all of which have been, or will prior to
the Closing Date be, completed.
(M) Neither the execution and delivery nor
the performance of this Agreement by the Company (i) conflicts with any
provision of the Certificate Incorporation or Bylaws of the Company,
(ii) violates any law applicable to the Company, or (iii) results in a
breach or violation of, or constitutes a default under, any term of any
agreement or
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<PAGE> 22
instrument filed as an exhibit to the Registration Statement or of any
order, writ or decree, of which we have knowledge, of any court,
governmental agency or body.
(N) To their knowledge, there are no
proceedings, pending or threatened before any regulatory body or
agency, which if the subject of an unfavorable decision, ruling or
finding, would have a Material Adverse Effect.
(O) To their knowledge, all holders of
securities of the Company who have rights to the registration of Common
Stock or other securities because of the filing of the Registration
Statement by the Company have waived such rights or have received
proper notice of the filing of the Registration Statement and have not
asserted, and no longer have the right to assert, such rights.
(P) The Company is not an "investment
company" or a company "controlled" by an "investment company" within
the meaning of the Investment Company Act of 1940, as amended.
(Q) To their knowledge, the Company is in
compliance with and has conducted its businesses (and the businesses of
its Subsidiaries) in conformity with, all applicable laws and
regulations known to them relating to the operation of its business as
described in the Registration Statement, except to the extent that any
failure so to comply or conform would not have a Material Adverse
Effect.
(R) The Registration Statement has become
effective under the 1933 Act; any required filing of the Prospectus,
and any supplements thereto pursuant to Rule 424(b) has been made in
the manner and within the time period required; and to their knowledge
and information, no stop order suspending the effectiveness of the
Registration Statement or any part thereof has been issued and no
proceedings therefor have been instituted or are pending or
contemplated under the 1933 Act.
Following their opinions required by subsection (f)(i) of this
Section 7, Morrison & Foerster LLP shall additionally state that nothing has
come to their attention that leads them to believe that the Registration
Statement (except for financial statements and schedules and other financial and
statistical information included therein, as to which counsel need make no
statement), at the time it became effective, contained an untrue statement of a
material fact or omitted to state a material fact required to be stated therein
or necessary to make the statements therein, in light of the circumstances under
which they were made, not misleading or that the Prospectus (except for
financial statements and schedules and other financial and statistical
information included therein, as to which counsel need make no statement), as of
its date (unless the term "Prospectus" refers to a prospectus which has been
provided to the Placement Agents by the Company for use in connection with the
offering of the Securities which differs from the Prospectus on file at the
Commission at the time the Registration Statement becomes effective, in which
case at the time it is first provided to the Placement Agents for such use) or
at the Closing Date, included or includes
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<PAGE> 23
an untrue statement of a material fact or omitted or omits to state a material
fact necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading.
(ii) The favorable opinion, dated the Closing Date,
of Stroock & Stroock & Lavan LLP, counsel for the Selling Stockholder, in form
and substance satisfactory to the Placement Agents, to the effect that:
(A) To such counsel's knowledge, the Selling
Stockholder has full right, power and authority to enter into this
Agreement, the Escrow Agreement, the Power of Attorney and the Custody
Agreement; the execution, delivery and performance of this Agreement,
the Escrow Agreement, the Power of Attorney and the Custody Agreement
by the Selling Stockholder and the consummation by the Selling
Stockholder of the transactions contemplated hereby and thereby will
not conflict with or result in a breach or violation of any of the
terms or provisions of, or constitute a default under, any statute, any
indenture, mortgage, deed of trust, loan agreement or other agreement
or instrument known to such counsel to which the Selling Stockholder is
a party or by which the Selling Stockholder is bound or to which any of
the property or assets of the Selling Stockholder is subject, which
breach, violation or default is reasonably likely to have a material
adverse effect on the performance of such Selling Stockholder's
obligations hereunder, nor will such actions result in any violation of
any statute or any order, rule or regulation known to such counsel of
any court or governmental agency or body having jurisdiction over the
Selling Stockholder or the property or assets of the Selling
Stockholder, and, except for the registration of the Selling
Stockholder Shares under the Securities Act and such consents,
approvals, authorizations, registrations or qualifications as may be
required under the Exchange Act and applicable state securities laws in
connection with the purchase of the Selling Stockholder Shares by the
Investors and the placement of such shares by the Placement Agents, no
consent, approval, authorization or order of, or filing or registration
with, any such court or governmental agency or body (except for those
consents, approvals, authorizations, orders, filings or registrations,
which, if not secured, filed or registered, as applicable, would not
have a material adverse effect on the performance of such Selling
Stockholder's obligations hereunder) is required for the execution,
delivery and performance of this Agreement, the Power of Attorney or
the Custody Agreement by the Selling Stockholder and the consummation
by the Selling Stockholder of the transactions contemplated hereby and
thereby;
(B) This Agreement and the Escrow Agreement
have been duly executed and delivered by or on behalf of the Selling
Stockholder;
(C) A Power-of-Attorney and a Custody
Agreement have been duly executed and delivered by the Selling
Stockholder and, to such counsel's knowledge, constitute valid and
binding agreements of such Selling Stockholder, enforceable in
accordance with their respective terms subject to the effect of
bankruptcy, insolvency,
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<PAGE> 24
fraudulent conveyance, reorganization, moratorium and similar laws
relating to or affecting creditor's rights generally (and court
decisions with respect thereto), equitable principles (whether
considered in a proceeding in equity or at law) or an implied covenant
of good faith and fair dealing;
(D) Immediately prior to the date of this Agreement,
the Selling Stockholder had, to such counsel's knowledge, full right,
power and authority to sell, assign, transfer and deliver such shares
to be sold by such Selling Stockholder hereunder; and
(E) All rights of the Selling Stockholder in the
Selling Stockholder Shares have been transferred to the Investors and,
in addition, each Investor (whom such counsel may assume to be
"protected purchasers") has acquired its interest in the Selling
Stockholder Shares to be acquired by it free of any "adverse claim" (as
such terms are defined in the Uniform Commercial Code as in effect in
the State of New York).
Following their opinions required by subsection (f)(ii) of
this Section 7, Stroock & Stroock & Lavan LLP shall additionally state that no
facts have come to the attention of such counsel which lead it to believe that
the Registration Statement, as of the Effective Date, contained any untrue
statement of a material fact relating to the Selling Stockholder or omitted to
state such a material fact required to be stated therein or necessary in order
to make the statements therein not misleading (other than financial statements
and related schedules and other financial and statistical information contained
therein as to which such counsel need express no opinion), or that the
Prospectus contains any untrue statement of a material fact relating to the
Selling Stockholder or omits to state such a material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(g) At the time of the execution of this Agreement, the
Placement Agents shall have received from Ernst & Young LLP, former independent
public accountants for the Company, and from Arthur Andersen LLP, independent
accountants for the Company, as appropriate, a letter dated such date and
addressed to the Placement Agents, in form and substance satisfactory to the
Placement Agents, containing statements and information of the type ordinarily
included in accountants' "comfort letters" to underwriters, delivered according
to Statement of Auditing Standards No. 72 (or any successor bulletin), with
respect to the audited and unaudited financial statements and certain financial
and capital stock information contained in the Registration Statement and the
Prospectus.
(h) The Placement Agents shall have received from Ernst &
Young LLP, former independent accountants for the Company, and from Arthur
Andersen LLP, independent accountants for the Company, as appropriate, a letter
addressed to the Placement Agents, and in form and substance satisfactory to the
Placement Agents, dated as of the Closing Date, to the effect that they reaffirm
the statements made in the letters furnished pursuant to subsection (g) of this
Section 7.
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(i) At the Closing Date, there shall be furnished to the
Placement Agents a certificate, dated the date of its delivery, signed by each
of the Chief Executive Officer and the Chief Financial Officer of the company,
in form and substance satisfactory to the Placement Agents, to the effect that:
(A) Each signer of such certificate has carefully
examined the Registration Statement and the Prospectus and (i) as of
the date of such certificate, (x) the Registration Statement does not
contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary in order to
make the statements therein, in light of the circumstances under which
they were made, not misleading and (y) the Prospectus does not contain
any untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary in order to make the
statements therein, in the light of the circumstances under which they
were made, not misleading and (ii) since the Effective Date, no event
has occurred as a result of which it is necessary to amend or
supplement the Prospectus in order to make the statements therein not
untrue or misleading in any material respect.
(B) Each of the representations and warranties of the
Company contained in this Agreement were, when originally made, and
are, at the time such certificate is delivered, true and correct in all
material respects.
(C) Each of the covenants required herein to be
performed by the Company on or prior to the date of such certificate
has been duly, timely and fully performed and each condition herein
required to be complied with by the Company on or prior to the delivery
of such certificate has been duly, timely and fully complied with.
(D) No stop order suspending the effectiveness of the
Registration Statement or of any part thereof has been issued and no
proceedings for that purpose have been instituted or, to their
knowledge, are contemplated by the Commission.
(E) Subsequent to the date of the most recent
financial statements in the Prospectus, there has been no material
adverse change in the financial position or results of operations of
the Company or the Subsidiaries, except as set forth in or contemplated
by the Prospectus.
(j) The Shares and the Selling Stockholder Shares shall be
qualified for sale in such states as the Placement Agents may reasonably
request, each such qualification shall be in effect and not subject to any stop
order or other proceeding on the Closing Date.
(k) The Common Stock (including Shares and the Selling
Stockholder Shares) shall have been approved for listing on the American Stock
Exchange ("AMEX"), and, contingent upon such approval, withdrawn from the Nasdaq
SmallCap Market.
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(l) The Placement Agents and counsel for the Placement Agents
shall have been furnished with such documents and opinions as they may require
in order to evidence the accuracy of any of the representations or warranties or
the fulfillment of any of the conditions herein contained; and all proceedings
taken by the Company in connection with the issuance and sale of the Shares as
herein contemplated shall be satisfactory in form and substance to the Placement
Agents and counsel for the Placement Agents. Any certificate or document signed
by any officer of the Company and delivered to you or to your counsel shall be
deemed a representation and warranty by the Company to each of you as to the
statements made therein and such statements are true and correct except where
the inaccuracy of such statements alone or in the aggregate would not have a
Material Adverse Effect.
(m) The Selling Stockholder shall have furnished to the
Placement Agents such certificates, in addition to those specifically mentioned
herein, as the Placement Agents may have reasonably requested as to the accuracy
and completeness at the Closing Date of any statement in the Registration
Statement or the Prospectus regarding the Selling Stockholder, as to the
accuracy at the Closing Date of the representations and warranties of the
Selling Stockholder, as to the performance by the Selling Stockholder of its
obligations hereunder, or as to the fulfillment of the conditions concurrent and
precedent to the obligations hereunder of the Placement Agents.
(n) The NASD shall have raised no objection to the fairness
and reasonableness of the underwriting or placement agency terms and agreements.
(o) As of the date hereof the Company, its directors and
officers, and certain affiliates of the Company (as designated on Exhibit B
hereto by the Company), and the Selling Stockholder, shall have furnished to the
Placement Agents "lock-up" agreements substantially in the forms of Attachment A
and Attachment B hereto, and such agreements shall be in full force and effect
on the Closing Date.
8. Indemnification.
(a) The Company shall indemnify and hold harmless the
Placement Agents and the Selling Stockholder, the directors, officers, employees
and agents of the Placement Agents and the Selling Stockholder and each person,
if any, who controls the Placement Agents or the Selling Stockholder within the
meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act from and
against any and all losses, claims, liabilities, expenses and damages, joint or
several (including any and all investigative, reasonable legal and other
expenses reasonably incurred in connection with, and any amount paid in
settlement of, any action, suit or proceeding or any claim asserted), to which
any of them may become subject under the 1933 Act or other Federal or state
statutory law or regulation, at common law or otherwise. Such indemnity shall
not, however, cover any such loss, claim, damage, liability, cost or expense
which is held in a final judgment of a court to have arisen primarily out of the
gross negligence or willful misconduct of the Placement Agents, or the failure
of the Placement Agents to deliver a Prospectus if it fails to correct such
deficiency under the 1933 Act. This indemnity agreement will be in addition to
any liability which the Company may
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<PAGE> 27
otherwise have. The Company will not, without the prior written consent of the
Placement Agents or the Selling Stockholder (which consent shall not be
unreasonably withheld), settle or compromise or consent to the entry of any
judgment in any pending or threatened claim, action, suit or proceeding in
respect of which indemnification has been sought hereunder (whether or not such
Placement Agents or the Selling Stockholder or any person who controls such
Placement Agents or the Selling Stockholder within the meaning of Section 15 of
the 1933 Act or Section 20 of the 1934 Act is a party to each claim, action,
suit or proceeding), unless such settlement, compromise or consent includes an
unconditional release of the Placement Agents and the Selling Stockholder and
each such controlling person from all liability arising out of such claim,
action, suit or proceeding and does not impair or alter the business or affairs
of the Placement Agents or the Selling Stockholder.
(b) The Selling Stockholder shall indemnify and hold harmless
the Placement Agents and the Company, the directors, officers, employees and
agents of the Placement Agents and the Company and each person, if any, who
controls the Placement Agents or the Company within the meaning of Section 15 of
the 1933 Act or Section 20 of the 1934 Act from and against any and all losses,
claims, liabilities, expenses and damages, joint or several (including any and
all investigative, reasonable legal and other expenses reasonably incurred in
connection with, and any amount paid in settlement of, any action, suit or
proceeding or any claim asserted), to which any of them may become subject under
the 1933 Act or other Federal or state statutory law or regulation, at common
law or otherwise, insofar as such losses, claims, damages, liabilities or
expenses (or actions in respect thereof as contemplated below) arise out of or
are based on a breach of the terms and conditions of this Agreement, or arise
out of or are based upon the inaccuracy of any representation made by the
Selling Stockholder herein or any untrue or alleged untrue statement of any
material fact contained in the Registration Statement, the Prospectus, or any
amendment or supplement thereto, or arise out of or are based upon the omission
or alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading, in each case
to the extent, but only to the extent, that such untrue statement or alleged
untrue statement or omission or alleged omission was made in the Registration
Statement, the Prospectus, or any amendment or supplement thereto, in reliance
upon and in conformity with written information furnished to the Company by or
on behalf of the Selling Stockholder expressly for use therein. This indemnity
agreement will be in addition to any liability which the Selling Stockholder may
otherwise have. The Selling Stockholder will not, without the prior written
consent of the Placement Agents or the Company (which consent will not be
unreasonably withheld), settle or compromise or consent to the entry of any
judgment in any pending or threatened claim, action, suit or proceeding in
respect of which indemnification has been sought hereunder (whether or not such
Placement Agents or the Company or any person who controls such Placement Agents
or the Company within the meaning of Section 15 of the 1933 Act or Section 20 of
the 1934 Act is a party to such claim, action, suit or proceeding), unless such
settlement, compromise or consent includes an unconditional release of the
Placement Agents and the Company and each such controlling person from all
liability arising out of such claim, action, suit or proceeding. Such indemnity
shall not, however, cover any such loss, claim, damage, liability, cost or
expense which is held in a final judgment of a court to have arisen primarily
out of the gross negligence or willful misconduct of the Placement Agents or the
failure of the Placement Agents to deliver a Prospectus if it fails to correct
27
<PAGE> 28
such deficiency under the 1933 Act. This indemnity agreement will be in addition
to any liability which the Selling Stockholder may otherwise have. The liability
of the Selling Stockholder under this section shall be limited to an amount
equal to the aggregate offering price of the shares sold by the Selling
Stockholder to the Investors.
(c) Any party that proposes to assert the right to be
indemnified under this Section 8 will, promptly after receipt of notice of
commencement of any action against such party in respect of which a claim is to
be made against an indemnifying party or parties under this Section 8, notify
each such indemnifying party of the commencement of such action, enclosing a
copy of all papers served, but the omission so to notify such indemnifying party
will not relieve it from any liability that it may have to any indemnified party
under the foregoing provisions of this Section 8 unless, and only to the extent
that, such omission results in the forfeiture of substantive rights or defenses
by, or otherwise prejudices, the indemnifying party. If any such action is
brought against any indemnified party and it notifies the indemnifying party of
its commencement, the indemnifying party will be entitled to participate in and,
to the extent that it elects by delivering written notice to the indemnified
party promptly after receiving notice of the commencement of the action from the
indemnified party, jointly with any other indemnifying party similarly notified,
to assume the defense of the action, with counsel satisfactory to the
indemnified party, and after notice from the indemnifying party to the
indemnified party of its election to assume the defense, the indemnifying party
will not be liable to the indemnified party for any legal or other expenses
except as provided below and except for the reasonable costs of investigation
incurred by the indemnified party in connection with the defense. The
indemnified party will have the right to employ its own counsel in any such
action, but the fees, expenses and other charges of such counsel will be at the
expense of such indemnified party unless (1) the employment of counsel by the
indemnified party has been authorized in writing by the indemnifying party, (2)
the indemnified party has reasonably concluded that a conflict exists (based on
advice of counsel to the indemnified party) between the indemnified party and
the indemnifying party that would prevent the counsel selected by the
indemnifying party from representing the indemnified party (in which case the
indemnifying party will not have the right to direct the defense of such action
on behalf of the indemnified party) or (3) the indemnifying party has not in
fact employed counsel to assume the defense of such action within a reasonable
time after receiving notice of the commencement of the action, in each of which
cases the reasonable fees, disbursements and other charges of counsel will be
paid by the indemnifying party or parties. It is understood that the
indemnifying party or parties shall not, in connection with any proceeding or
related proceedings in the same jurisdiction, be liable for the reasonable fees,
disbursements and other charges of more than one separate firm admitted to
practice in such jurisdiction at any one time for all such indemnified party or
parties. All such fees, disbursements and other charges will be reimbursed by
the indemnifying party promptly as they are incurred and demand delivered
therefor. No indemnifying party will, without the prior written consent of the
indemnified parties (which consent will not be unreasonably withheld), settle or
compromise or consent to the entry of any judgment in any pending or threatened
claim, action, suit or proceeding in respect of which indemnification has been
sought hereunder (whether or not the indemnified parties are parties to such
claim, action, suit or proceeding), unless such settlement, compromise or
consent includes an unconditional release of each indemnified party from all
liability arising out of such claim, action,
28
<PAGE> 29
suit or proceeding. An indemnifying party will not be liable for any settlement
of any action or claim effected without its written consent (which consent will
not be unreasonably withheld).
(d) In order to provide for just and equitable contribution in
circumstances in which the indemnification provided for in the foregoing
paragraphs of this Section 8 is applicable in accordance with its terms but for
any reason is held to be unavailable from the Company, the Selling Stockholder
or the Placement Agents, each indemnifying party will contribute to the total
losses, claims, liabilities, expenses and damages (including any investigative,
legal and other expenses reasonably incurred in connection with, and any amount
paid in settlement of, any action, suit or proceeding or any claim asserted, but
after deducting any contribution received by the Company from persons other than
the Placement Agents such as persons who control the Company within the meaning
of the 1933 Act or the 1934 Act, officers of the Company who signed the
Registration Statement and directors of the Company, who also may be liable for
contribution) to which the Company, the Selling Stockholder and the Placement
Agents may be subject in proportion to the relative benefits received by the
Company, the Selling Stockholder and the Placement Agents and the relative fault
of the Company, the Selling Stockholder and the Placement Agents, with respect
to the statements or omissions which resulted in such loss, claim, liability,
expense or damage, or action in respect thereof, as well as any other relevant
equitable considerations with respect to such offering. The relative benefits
received by the Company, the Selling Stockholder and the Placement Agents shall
be deemed to be in the same proportion as the total net proceeds from the
offering (before deducting Company expenses) received by the Company and the
Selling Stockholders as set forth in the table on the cover page of the
Prospectus bear to the fee received by the Placement Agents hereunder. The
relative fault shall be determined by reference to whether the untrue or alleged
untrue statement of a material fact or omission or alleged omission to state a
material fact relates to information supplied by the Company, the Selling
Stockholder or the Placement Agents, the intent of the parties and their
relative knowledge, access to information and opportunity to correct or prevent
such statement or omission. The Company, the Selling Stockholder and the
Placement Agents agree that it would not be just and equitable if contribution
pursuant to this Section 8(d) were to be determined by pro rata allocation or by
any other method of allocation which does not take into account the equitable
considerations referred to herein. Notwithstanding the provisions of this
Section 8(d), the Placement Agents shall not be required to contribute any
amount in excess of the fee received by it under this Agreement, the Selling
Stockholder shall not be required to contribute any amount in respect of which
it would not have had an indemnification obligation under Section 8(b) above,
and no person found guilty of fraudulent misrepresentation (within the meaning
of Section ll(f) of the 1933 Act) will be entitled to contribution from any
person who was not guilty of such fraudulent misrepresentation. For purposes of
this Section 8(d), any person who controls a party to this Agreement within the
meaning of the 1933 Act or the 1934 Act will have the same rights to
contribution as that party, and each director of the Company and each officer of
the Company who signed the Registration Statement will have the same rights to
contribution as the Company, subject in each case to the provisions hereof. Any
party entitled to contribution, promptly after receipt of notice of commencement
of any action against such party in respect of which a claim for contribution
may be made under this Section 8(d), will notify any such party or parties from
whom contribution may be sought, but the omission so to notify will not relieve
29
<PAGE> 30
the party or parties from whom contribution may be sought from any other
obligation it or they may have under this Section 8(d). No party will be liable
for contribution with respect to any action or claim settled without its written
consent (which consent will not be unreasonably withheld).
9. Termination.
(a) The obligations of the Placement Agents under this
Agreement may be terminated at any time prior to the Closing Date, by notice to
the Company from the Placement Agents, without liability on the part of the
Placement Agents to the Company if, prior to delivery and payment for the Shares
or the Selling Stockholder Shares, in the sole judgment of the Placement Agents
(i) trading in the Common Stock of the Company shall have been suspended by the
Commission, by Nasdaq, or by the AMEX, (ii) trading in securities generally on
the New York Stock Exchange, the AMEX, or the Nasdaq National Market shall have
been suspended or limited or minimum or maximum prices shall have been generally
established on any of such exchanges, or additional material governmental
restrictions, not in force on the date of this Agreement, shall have been
imposed upon trading in securities generally by any of such exchanges or by
order of the Commission or any court or other governmental authority, (iii) a
general banking moratorium shall have been declared by Federal or New York State
authorities or (iv) any material adverse change in the financial or securities
markets in the United States or any outbreak or material escalation of
hostilities or declaration by the United States of a national emergency or war
or other calamity or crisis shall have occurred, the effect of any of which is
such as to make it, in the sole judgment of the Placement Agents, impracticable
or inadvisable to market the Shares on the terms and in the manner contemplated
by the Prospectus.
(b) The obligations of the parties under this Agreement shall
be automatically terminated in the event that the Requisite Funds have not been
deposited by the Investors into the Escrow Account by the close of business on
__________, 1998.
10. Notices. Notice given pursuant to any of the provisions of this
Agreement shall be in writing and, unless otherwise specified, shall be mailed
or delivered (a) if to the Company, at the office of the Company, 200 North
Berry Street, Brea, California 92821-3963, Attention: Judith O. Lasker, Esquire
or (b) if to the Placement Agents, at the office of Cruttenden Roth
Incorporated, 11150 Santa Monica Boulevard, Suite 750, Los Angeles, California
90025, Attention: Christopher Jennings or (c) if to the Selling Stockholder, at
the office of Worms & Co., Inc., 900 Third Avenue, New York, New York 10022,
Attention: Ms. Georgette Miller. Any such notice shall be effective only upon
receipt. Any notice under Section 8 may be made by facsimile or telephone, but
if so made shall be subsequently confirmed in writing.
11. Survival. The respective representations, warranties, agreements,
covenants, indemnities and other statements of the Company, its officers, the
Selling Stockholder and the Placement Agents set forth in this Agreement or made
by or on behalf of them, respectively, pursuant to this Agreement shall remain
in full force and effect, regardless of (i) any investigation made by or on
behalf of the Company, any of its officers or directors, the Selling
Stockholder, the
30
<PAGE> 31
Placement Agents or any controlling person referred to in Section 8 hereof and
(ii) delivery of and payment for the Shares or the Selling Stockholder Shares.
The respective agreements, covenants, indemnities and other statements set forth
in Sections 6 and 8 hereof shall remain in full force and effect, regardless of
any termination or cancellation of this Agreement.
12. Successors. This Agreement shall inure to the benefit of and shall
be binding upon the Placement Agents, the Selling Stockholder, the Company and
their respective successors and legal representatives, and nothing expressed or
mentioned in this Agreement is intended or shall be construed to give any other
person any legal or equitable right, remedy or claim under or in respect of this
Agreement, or any provisions herein contained, this Agreement and all conditions
and provisions hereof being intended to be and being for the sole and exclusive
benefit of such persons and for the benefit of no other person except that (i)
the indemnification and contribution contained in Sections 8(a) and (d) of this
Agreement shall also be for the benefit of the directors, officers, employees
and agents of the Placement Agents and any person or persons who control the
Placement Agents within the meaning of Section 15 of the 1933 Act or Section 20
of the 1934 Act and (ii) the indemnification and contribution contained in
Sections 8(b) and (d) of this Agreement shall also be for the benefit of the
directors of the Company, the officers of the Company who have signed the
Registration Statement and any person or persons who control the Company within
the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act. No
Investor shall be deemed a successor because of such purchase.
13. Headings. Section headings in this Agreement are for convenience of
reference only, do not constitute a part of this Agreement, and shall not affect
its interpretation.
14. Changes. This Agreement may not be modified or amended except
pursuant to an instrument in writing signed by the Company, the Selling
Stockholder and the Placement Agents.
15. Applicable Law. The validity and interpretations of this Agreement,
and the terms and conditions set forth herein, shall be governed by and
construed in accordance with the laws of the State of California, without giving
effect to any provisions relating to conflicts of laws.
16. Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
[SIGNATURES APPEAR ON FOLLOWING PAGE; REMAINDER OF THIS
PAGE LEFT INTENTIONALLY BLANK]
31
<PAGE> 32
If the foregoing is in accordance with your understanding of our
agreement, kindly sign and return to us the enclosed duplicate hereof, whereupon
it will become a binding agreement between the Company, the Selling Stockholder
and the Placement Agents in accordance with its terms.
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:
--------------------------------------
Name:
Title:
JAPAN OMNIBUS LTD.
By:
--------------------------------------
As Attorney-in Fact for the Selling
Stockholder
The foregoing Placement Agency
Agreement is hereby confirmed
and accepted as of the date first
above written.
CRUTTENDEN ROTH INCORPORATED
MORGAN FULLER CAPITAL GROUP, LLC
BLACK & COMPANY, INC.
By: Cruttenden Roth Incorporated
By:
----------------------------------
Name:
Title:
32
<PAGE> 33
ATTACHMENT A
Cruttenden Roth Incorporated
11150 Santa Monica Blvd., Suite 750
Los Angeles, CA 90025
Morgan Fuller Capital Group, LLC
[ADDRESS]
Black & Company, Inc.
[ADDRESS]
Ladies and Gentlemen:
Reference is made to a Placement Agency Agreement (the "Placement
Agency Agreement"), which will be executed between Krause's Furniture, Inc., a
Delaware corporation (the "Company"), Japan Omnibus Ltd., and Cruttenden Roth
Incorporated (the "Placement Agents"). All capitalized terms not otherwise
defined herein shall have the meanings given to such terms in the Placement
Agency Agreement.
In consideration of the Placement Agency Agreement, the undersigned
hereby agrees not to, without the prior written consent of the Placement Agents,
offer, sell or otherwise dispose of any shares of the Company's Common Stock,
par value $0.001 per share (the "Common Stock") (other than the Shares) or any
other equity securities of the Company, including securities convertible into or
exercisable or exchangeable for Common Stock, for a period of 180 days after the
Closing Date, except with respect to (i) the issuance of securities pursuant to
contractual obligations of the Company in effect on November 10, 1997 to the
extent disclosed in writing to the Placement Agents prior to the effective date
of the Registration Statement, (ii) the issuance of shares of Common Stock or
stock options to purchase shares of Common Stock under any employee benefit or
purchase plan of the Company in effect on November 10, 1997, or (iii) securities
of the Company issued on a pro rata basis to all holders of a class of
outstanding equity securities of the Company.
It is understood that, if the Placement Agency Agreement does not
become effective, the undersigned will be released from his obligations under
this letter agreement.
Dated: _____________, 1998
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:
---------------------------------
Name:
Title:
<PAGE> 34
ATTACHMENT B
Cruttenden Roth Incorporated
11150 Santa Monica Blvd., Suite 750
Los Angeles, CA 90025
Morgan Fuller Capital Group, LLC
[ADDRESS]
Black & Company, Inc.
[ADDRESS]
Ladies and Gentlemen:
Reference is made to a Placement Agency Agreement (the "Placement
Agency Agreement"), which will be executed between Krause's Furniture, Inc., a
Delaware corporation (the "Company"), Japan Omnibus Ltd., and Cruttenden Roth
Incorporated (the "Placement Agents"). All capitalized terms not otherwise
defined herein shall have the meanings given to such terms in the Placement
Agency Agreement.
In consideration of the Placement Agency Agreement, the undersigned
hereby agrees not to, without the prior written consent of the Placement Agents,
offer, sell or otherwise dispose of any shares of the Company's Common Stock,
par value $0.001 per share (the "Common Stock") (other than the Selling
Stockholder Shares), or any other equity securities of the Company, including
securities convertible into or exercisable or exchangeable for Common Stock, for
a period of 120 days after the Closing Date.
It is understood that, if the Placement Agency Agreement does not
become effective, the undersigned will be released from his or its obligations
under this letter agreement.
Dated: _____________, 1998
Very truly yours,
By:
---------------------------------
Name:
Title:
<PAGE> 35
EXHIBIT A
ESCROW AGREEMENT
WITH
IMPERIAL TRUST COMPANY
ESCROW AGREEMENT, dated as of March ___, 1998, by and among KRAUSE'S
FURNITURE, INC., a Delaware corporation (the "Company"), JAPAN OMNIBUS LTD. (the
"Selling Stockholder"), CRUTTENDEN ROTH INCORPORATED, MORGAN FULLER CAPITAL
GROUP, LLC and BLACK & COMPANY, INC. (the "Placement Agents"), and Imperial
Trust Company, a California corporation (the "Escrow Agent").
WHEREAS, the Company proposes to sell 1,903,889 shares of its Common
Stock and the Selling Stockholder proposes to sell 2,096,011 shares of Common
Stock of the Company (together, the "Securities") all as described in the
Company's Prospectus dated March ___, 1998, (the "Prospectus"), under a
Registration Statement on Form S-1 (File No. 333-43111) [and a subsequent
Registration Statement on Form S-1 filed pursuant to SEC Rule 462(b)], at $____
per share;
WHEREAS, the Securities are being offered to investors by the Placement
Agents, pursuant to registration under the Securities Act of 1933, as amended,
and pursuant to registration or exemptions from registration under state
securities laws;
WHEREAS, the offering of the Securities will terminate on [March 13],
1998 (the "Final Closing Date") and, if acceptable subscriptions for the
Securities have not been received by the Company on or before the Final Closing
Date, no Securities will be sold and all payments made by subscribers will be
refunded by the Escrow Agent with interest earned thereon, if any; and
WHEREAS, with respect to all subscription payments received from
subscribers, the Company proposes to establish an escrow account with the Escrow
Agent at its offices located at 201 North Figueroa, Suite 610, Los Angeles,
California 90012.
NOW THEREFORE, it is agreed as follows:
1. Establishment of Escrow. The Escrow Agent hereby agrees to receive
and disburse the proceeds from the offering of the Securities and any interest
earned thereon in accordance herewith.
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<PAGE> 36
2. Deposit of Escrowed Property. The Placement Agents, on behalf of the
subscribers for Securities, shall from time to time, but in no event later than
12:00 noon on the date following the date of receipt by the Placement Agents,
cause to be wired to or deposited with, or cause the subscribers for the
Securities to wire to or deposit with, the Escrow Agent funds or checks of the
subscribers delivered in payment for Securities (the "Escrowed Property"). Any
checks delivered to the Escrow Agent pursuant to the terms hereof shall be made
payable to or endorsed to the order of the Escrow Agent for the account of the
Company. The Escrow Agent upon receipt of such checks shall present such checks
for payment to the drawee-bank under such checks. Any checks not honored by the
drawee-bank thereunder after the first presentment for payment shall be returned
to the Placement Agents, on behalf of the subscriber, in the same manner notices
are delivered pursuant to Section 6. Upon receipt of funds or checks from the
Placement Agents, the Escrow Agent shall invest such funds and the amount of
such checks in the Monarch Government Money Market Fund (the "Escrow Account")
in the name of the Escrow Agent. If following the credit of the amount of any
check to the Escrow Account such check is dishonored, the Escrow Agent shall
liquidate to the extent of such dishonored check amount such investments.
3. Investment of Escrowed Property. Pursuant to Section 2 and until
release of subscription proceeds in accordance with the terms hereof, the Escrow
Agent shall invest such proceeds in the Monarch Government Money Market Fund,
pursuant to Rule l5c2-4 promulgated by the Securities and Exchange Commission
under the Securities Exchange Act of 1934, as amended, in accordance with the
terms set forth on Exhibit A hereto (which Exhibit is made a part of this Escrow
Agreement as if herein set forth). The Escrow Agent shall in no event be liable
for any loss resulting from any change in interest rates applicable to proceeds
invested pursuant to this Section. Interest on proceeds invested pursuant to
this Section shall accrue from the date of investment of such proceeds until the
termination of such investment pursuant to the terms hereof and shall be paid as
set forth in Section 5. The parties recognize that in authorizing the Escrow
Agent to invest principal and income cash balances held as Escrowed Property
into money market instruments or deposits that are obligations of Imperial Bank
or related entities, in addition to the fees provided for herein, the Escrow
Agent or a related entity may also benefit or profit from the use of such
obligations. The parties hereby authorize the receipt of such benefit or profit
and expressly waive any special computation or accounting. The Escrow Agent
hereby agrees to provide the parties with periodic statements describing such
obligations and and reporting the interest earned thereon so that the parties
may review and evaluate to the transactions effected by the Escrow Agent
pursuant to this authorization.
4. List of Subscribers. The Placement Agents shall furnish or cause to
be furnished to the Escrow Agent, at the time of each deposit of funds or checks
pursuant to Section 2, a list, substantially in the form of Exhibit B hereto,
containing the name of, the address of, number of Securities subscribed for by,
the subscription amount delivered to the Escrow Agent on behalf of, and the
social security or taxpayer identification number, if applicable, of each
subscriber whose funds are being deposited, and to which is attached a completed
W-9 form (or, in the case of any subscriber who is not a United States citizen
or resident, a W-8 form) for each listed subscriber. The Escrow Agent shall
notify the Placement Agents, the Company and the Selling Stockholder of any
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<PAGE> 37
discrepancy between the subscription amounts set forth on any list delivered
pursuant to this Section 4 and the subscription amounts received by the Escrow
Agent, and shall notify the Company, the Selling Stockholders and the Placement
Agents whether the funds set forth on such list have been deposited. The Escrow
Agent is authorized to revise such list to reflect the actual subscription
amounts received and the release of any subscription amounts pursuant to Section
5.
5. Withdrawal of Subscription Amounts. (a) If the Escrow Agent shall
receive a notice, substantially in the form of Exhibit C hereto (an "Offering
Termination Notice"), from the Company, the Escrow Agent shall (i) promptly
after receipt of such Offering Termination Notice and the clearance (or dishonor
by the drawee-bank) of all checks received by the Escrow Agent as Escrowed
Property, liquidate any investments that shall have been made pursuant to
Section 3 and send to each subscriber listed on the list held by the Escrow
Agent pursuant to Section 4 whose total subscription amount shall not have been
released pursuant to paragraph (b) or (c) of this Section 5, in the manner set
forth in paragraph (d) of this Section 5, a check to the order of such
subscriber in the amount of the remaining subscription amount held by the Escrow
Agent (which shall not include the amount of any check not honored by the
drawee-bank) as set forth on such list held by the Escrow Agent, and (ii)
promptly after the fourth business day of the month immediately following the
month in which the investments made pursuant to Section 3 were terminated
pursuant to this paragraph, send, in the manner set forth in paragraph (d) of
this Section 5, a check to the order of each such subscriber in the amount of
interest and other income earned and not yet paid with respect to any investment
of such subscriber's funds, with the amount of interest calculated by the
Company and the Escrow Agent based on the subscription amount and the date of
deposit. The Escrow Agent shall notify the Company, the Selling Stockholder and
the Placement Agents of the distribution of such funds to the subscribers.
(b) In the event that (i) the Securities have been subscribed for and
funds in respect thereof shall have been deposited with the Escrow Agent on or
before the Final Closing Date and (ii) no Offering Termination Notice shall have
been delivered to the Escrow Agent, the Company, the Selling Stockholder and the
Placement Agents from time to time may deliver to the Escrow Agent a joint
notice, substantially in the form of Exhibit D hereto (a "Closing Notice"),
designating the date on which Securities are to be sold and delivered to the
subscribers thereof (the "Closing Date"), which date shall not be earlier than
the clearance of any checks received by the Escrow Agent as Escrowed Property,
the proceeds of which are to be distributed on such Closing Date, and
identifying the subscribers and the number of Securities to be sold to each
thereof on such Closing Date. Such Closing Notice, unless the parties otherwise
agree, shall be delivered not less than two (2) nor more than seven (7) business
days prior to such Closing Date. The Escrow Agent, after receipt of such Closing
Notice and the clearance of such checks:
(i) on or prior to the Closing Date identified in
such Closing Notice, shall liquidate any investments that shall have
been made pursuant to Section 3 to the extent of the subscription
amount to be distributed pursuant to the immediately succeeding clause
(ii);
A-3
<PAGE> 38
(ii) on such Closing Date, pay to the Company, the
Selling Stockholder and the Placement Agents, in federal or other
immediately available funds and otherwise in the manner specified by
the Company in such Closing Notice, an amount equal to the aggregate of
the subscription amounts paid by the subscribers identified in such
Closing Notice for the Securities to be sold on such Closing Date as
set forth on the list held by the Escrow Agent pursuant to Section 4;
and
(iii) promptly after the fourth business day of the
month immediately following the month in which the investments made
pursuant to Section 3 were terminated pursuant to such Closing Notice,
shall send, in the manner set forth in paragraph (d) of this Section 5,
a check to the order of each subscriber identified in such Closing
Notice in the amount of interest and other income earned and not yet
paid with respect to any investment of each such subscriber's funds
distributed on such Closing Date. At the time of such transfer, the
Escrow Agent shall identify in writing to the Company, the Selling
Stockholder and the Placement Agents the amount of the interest earned
for the account of each subscriber and the date such subscription was
received.
(c) If at any time and from time to time prior to the release
of any subscriber's total subscription amount pursuant to paragraph (a) or (b)
of this Section 5 from escrow, the Company shall deliver to the Escrow Agent a
notice, substantially in the form of Exhibit E hereto (a "Subscription
Termination Notice"), to the effect that any or all of the subscriptions of such
subscriber have been rejected by the Company (a "Rejected Subscription"), the
Escrow Agent (i) promptly after receipt of such Subscription Termination Notice
and, if such subscriber delivered a check in payment of its Rejected
Subscription, after the clearance of such check, shall liquidate, to the extent
of the sum of such subscriber's Rejected Subscription amount as set forth in the
Subscription Termination Notice, any investments that shall have been made
pursuant to Section 3 and send to such subscriber, in the manner set forth in
paragraph (d) of this Section 5, a check to the order of such subscriber in the
amount of such Rejected Subscription amount, and (ii) promptly after the fourth
business day of the month immediately following the month in which the
investments made pursuant to Section 3 were terminated pursuant to this
paragraph, shall send to such subscriber, in the manner set forth in paragraph
(e) of this Section 5, a check to the order of such subscriber in the amount of
interest and other income earned and not yet paid with respect to any investment
of such subscriber's Rejected Subscription amount. At the time of such transfer,
the Escrow Agent shall identify in writing to the Company, the Selling
Stockholder and the Placement Agents the amount of the interest earned for the
account of each subscriber and the date such subscription was received.
(d) On a date following the transfer of any interest earned
for the account of each subscriber pursuant to Section 5(a), (b) or (c), but not
later than [June ___], 1998, the Escrow Agent shall provide each subscriber with
tax form 1099 setting forth the amount of such interest.
(e) For the purposes of this Section 5, any check that the
Escrow Agent shall be required to send to any subscriber shall be sent to such
subscriber by first class mail, postage prepaid, at such subscriber's address
furnished to the Escrow Agent pursuant to Section 4.
A-4
<PAGE> 39
6. Notices. Any notice or other communication required or permitted to
be given hereunder shall be in writing and shall be (a) delivered by hand or (b)
sent by mail, registered or certified, with proper postage prepaid, and
addressed as follows:
if to the Company, to:
Krause's Furniture, Inc.
200 North Berry Street
Brea, California 92821-3903
Attention: President
with a copy to:
Morrison & Foerster LLP
555 West Fifth Street
Los Angeles, California 90013-1024
Attention: Michael J. Connell
if to the Selling Stockholder, to:
Japan Omnibus Ltd.
c/o Worms & Co., Inc.
900 Third Avenue
New York, New York 10022
Attention: Ms. Georgette Miller
if to the Placement Agents to:
Cruttenden Roth Incorporated
11150 Santa Monica Blvd., Suite 750
Los Angeles, California 90025
Attention: John Dalfonsi
and
Morgan Fuller Capital Group, LLC
[Address]
Attention:____________________
and
Black & Company, Inc.
[Address]
A-5
<PAGE> 40
Attention:___________________
with a copy to:
Snell & Wilmer L.L.P.
One Arizona Center
Phoenix, Arizona 85004-0001
Attention: Steven D. Pidgeon
if to the Escrow Agent, to:
Imperial Trust Company
201 North Figueroa
Suite 610
Los Angeles, California 90012
Attention: William F. Klepper
Telephone: 213-580-1516
Facsimile: 213-482-9016
or to such other address as the person to whom notice is to be given may have
previously furnished to the others in the above-referenced manner. All such
notices and communications, if mailed, shall be effective when deposited in the
mails, except that notices and communications to the Escrow Agent and notices of
changes of address shall not be effective until received.
7. Concerning the Escrow Agent. To induce the Escrow Agent to act
hereunder, it is further agreed by the Company, the Selling Stockholder and the
Placement Agents that:
(a) Nothing contained in this Agreement shall constitute the
Escrow Agent as trustee for any party hereto or impose on the Escrow Agent any
duties or obligations other than those for which there is an express provision
herein. Except as provided herein, the Escrow Agent shall have no responsibility
or liability for delivery of the Escrow Funds.
(b) For all purposes connected herewith the Escrow Agent shall
be entitled to assume that the persons designated by the parties hereto are
exclusively entitled to their share of the Escrow Funds in accordance with this
Agreement and the instructions provided to it hereunder (and any further
instructions given pursuant hereto) and are fully authorized and empowered,
without affecting the rights of any third parties, to appoint the Escrow Agent
as the Escrow Agent in accordance with the terms and provisions hereof.
(c) The Escrow Agent shall be obliged to render statements of
account only with respect to the Escrow Funds deposited to the parties referred
to herein and the Escrow Agent shall not be under any obligation to render
statements of account to any third parties unless the Escrow Agent so consents
in writing.
A-6
<PAGE> 41
(d) It is understood and agreed that the Escrow Agent shall
incur no liability (except for acts of gross negligence or willful misconduct)
and be under no obligation to take any steps or action (whether by commencement
of legal proceedings or otherwise) to ensure that any funds are actually
received by the Escrow Agent.
(e) None of the provisions hereof shall be construed so as to
require the Escrow Agent to expend or risk any of its own funds or otherwise
incur any liability in the performance of its duties under this Agreement and it
shall be under no obligation to make any payment except out of the funds
received by it (after deduction of its fees and expenses).
(f) If it becomes illegal or impossible for the Escrow Agent
to carry out any of the provisions hereof, the Escrow Agent shall incur no
liability as a consequence of the enforceability or lack thereof of any
agreements referred to herein.
(g) The Escrow Agent shall not be required to take or be bound
by notice of default of any person, or to take any action with respect to such
default involving any expense or liability, unless written notice of such
default is given to Escrow Agent by the undersigned or any of them, and unless
the Escrow Agent is indemnified in a manner reasonably satisfactory to it
against such expense or liability.
(h) The Escrow Agent shall not be liable to any party hereto
in acting upon any written notice, request, waiver, consent, receipt or other
paper or document believed by the Escrow Agent in good faith to be signed by the
proper party or parties. The Escrow Agent will be entitled to treat as genuine
and as the document it purports to be any letter, paper, telex or other document
furnished or caused to be furnished to the Escrow Agent by the Company, the
Selling Stockholder as the Placement Agents, and believed by the Escrow Agent to
be genuine and to have been transmitted by the proper party or parties. The
Escrow Agent shall have no liability with respect to any good faith action taken
or allowed by it hereunder.
(i) The Escrow Agent shall not be liable for any error or
judgment or for act done or step taken or omitted by it in good faith or for any
mistake of fact or law (except for acts of gross negligence or willful
misconduct), or for anything which it may do or refrain from doing in connection
herewith, and the Escrow Agent shall have no duties to anyone except those
signing this Agreement.
(j) The Escrow Agent may consult with legal counsel in the
event of any dispute or questions as the interpretation or construction of this
Agreement or the Escrow Agent's duties hereunder, and the Escrow Agent shall
incur no liability and shall be fully protected in acting in good faith in
accordance with the opinion and instructions of counsel.
(k) In the event of any disagreement between the undersigned
or any person or persons named in this Agreement, and any other person,
resulting in adverse claims and demands being made in connection with or for any
money involved herein or affected hereby, the Escrow
A-7
<PAGE> 42
Agent shall be entitled at its option to refuse to comply with any such claims
or demands, so long as such disagreement shall continue, and in so doing the
Escrow Agent shall not be or become liable for damages or interest to the
undersigned or any of them, or to any person named in this Agreement, for its
refusal to comply with such conflicting or adverse demands; and the Escrow Agent
shall be entitled to continue so to refrain and refuse so to act until:
(i) the rights of the adverse claimants have been
finally adjudicated in a court assuming and having jurisdiction of the parties
and the money involved herein and affected hereby; or
(ii) all differences have been adjudicated by
agreement and the Escrow Agent has been notified thereof in writing by all of
the persons interested.
(l) In the event of such disagreement, the Escrow Agent, in
its discretion, may file a suit in interpleader or for declaratory relief for
the purpose of having the respective rights of the claimants adjudicated, and
deposit with the court all documents and property held hereunder, and the
Company agrees to pay the Escrow Agent's fee and all reasonable costs and
reasonable counsel fees incurred in such action and said costs and fees shall be
included in the judgment of any such action.
(m) The Escrow Agent (and any successor escrow agent) at any
time may be discharged from its duties and obligations hereunder by the delivery
to it of notice of termination signed by the Company, the Selling Stockholder
and the Placement Agents or at any time may resign by giving written notice to
such effect to the Company, the Selling Stockholder and the Placement Agents.
Upon any such termination or resignation, the Escrow Agent shall deliver the
Escrowed Property to any successor escrow agent jointly designated by the other
parties hereto in writing, or to any court of competent jurisdiction if no such
successor escrow agent is agreed upon, whereupon the Escrow Agent shall be
discharged of and from any and all further obligations arising in connection
with this Escrow Agreement. The termination or resignation of the Escrow Agent
shall take effect on the earlier of (i) the appointment of a successor
(including a court of competent jurisdiction) or (ii) the day that is 30 days
after the date of delivery: (A) to the Escrow Agent of the other parties' notice
of termination or (B) to the other parties hereto of the Escrow Agent's written
notice of resignation. If at that time the Escrow Agent has not received a
designation of a successor escrow agent, the Escrow Agent's sole responsibility
after that time shall be to keep the Escrowed Property safe until receipt of a
designation of successor escrow agent or a joint written disposition instruction
by the other parties hereto or any enforceable order of a court of competent
jurisdiction.
(n) As consideration for its agreement to act as Escrow Agent
as herein described, the Company agrees to pay the Escrow Agent an escrow fee of
$2,500, plus $10 per disbursement. In addition, the Company agrees to reimburse
the Escrow Agent for all reasonable expenses, disbursements and advances
incurred or made by the Escrow Agent in performance of its duties hereunder
(including reasonable fees, expenses and disbursements of its counsel).
A-8
<PAGE> 43
(o) All parties hereto irrevocably (i) submit to the
jurisdiction of any state or federal court sitting in Los Angeles County or
Orange County, California in any action or proceeding arising out of or relating
to this Escrow Agreement, (ii) agree that all claims with respect to such action
or proceeding shall be heard and determined in such state or federal court and
(iii) waive, to the fullest extent possible, the defense of an inconvenient
forum. The other parties hereby consent to and grant any such court jurisdiction
over the persons of such parties and over the subject matter of any such dispute
and agree that delivery or mailing of process or other papers in connection with
any such action or proceeding in the manner provided hereinabove, or in such
other manner as may be permitted by law, shall be valid and sufficient service
thereof.
(p) No printed or other matter in any language (including,
without limitation, the Prospectus, notices, reports and promotional material)
which mentions the Escrow Agent's name or the rights, powers, or duties of the
Escrow Agent shall be issued by the other parties hereto or on such parties'
behalf unless the Escrow Agent shall first have given its specific written
consent thereto. The Escrow Agent hereby consents to the use of its name and the
reference to the escrow arrangement in the Prospectus.
8. Miscellaneous. (a) This Escrow Agreement shall be binding upon and
inure solely to the benefit of the parties hereto and their respective
successors and assigns, heirs, administrators and representatives, and the
subscribers of the Securities and shall not be enforceable by or inure to the
benefit of any other third party except as provided in paragraph (i) of Section
7 with respect to the termination of, or resignation by, the Escrow Agent. No
party may assign any of its rights or obligations under this Escrow Agreement
without the written consent of the other parties.
(b) This Escrow Agreement shall be construed in accordance
with and governed by the internal law of the State of California (without
reference to its rules as to conflicts of law).
(c) This Escrow Agreement may only be modified by a writing
signed by all of the parties hereto and consented to by the subscribers of the
Securities adversely affected by such modifications. No waiver hereunder shall
be effective unless in a writing signed by the party to be charged.
(d) This Escrow Agreement shall terminate upon the payment
pursuant to Section 5 of all amounts held in the Escrow Account.
(e) The section headings herein are for convenience only and
shall not affect the construction thereof. Unless otherwise indicated,
references to Sections are to Sections contained herein.
(f) This Escrow Agreement may be executed in one or more
counterparts but all such separate counterparts shall be deemed an original and
all of which together shall constitute one and the same instrument; provided
that, although executed in counterparts, the executed signature
A-9
<PAGE> 44
pages of each such counterpart may be affixed to a single copy of this Agreement
which shall constitute an original.
IN WITNESS WHEREOF, the parties hereto have caused this Escrow
Agreement to be executed as of the day and year first above written.
KRAUSE'S FURNITURE, INC.
By:
------------------------------------------
Name:
Title:
JAPAN OMNIBUS LTD.
By:
------------------------------------------
Name:
Title:
CRUTTENDEN ROTH INCORPORATED
MORGAN FULLER CAPITAL GROUP, LLC
BLACK & COMPANY, INC.
By: CRUTTENDEN ROTH INCORPORATED
By:
------------------------------------------
Name:
Title:
IMPERIAL TRUST COMPANY
By:
------------------------------------------
Name:
Title:
A-10
<PAGE> 45
EXHIBIT A
(Account Information)
[TO BE SUPPLIED]
A-1
<PAGE> 46
EXHIBIT B
SUMMARY OF CASH RECEIVED
NEW PARTICIPANT DEPOSIT
Date: ______________________
Deposit Date: List Number: ______________________
Investment Date: Page ___ of ______________________
Batch Number: Approved By:______________________
For Bank use only
TITLE: ________________________________________
<TABLE>
<CAPTION>
NUMBER OF TAX ID NO./ FOR BANK
NAME DEPOSIT SHARES ADDRESS SOC. SEC. NO. USE ONLY
---- ------- ------ ------- ------------- --------
<S> <C> <C> <C> <C> <C>
TAX CODE
EXEMPT (Y/N)
W-9 (YR) NRA
W-8 (YR)
1008 (87)
Broker Misc. II Misc. III TAX CODE
Misc EXEMPT (Y/N)
W-2 (YR) NRS
W-8 (YR)
1008 (87)
Broker Misc. II Misc. III TAX CODE
Misc EXEMPT (Y/N)
W-2 (YR) NRS
W-8 (YR)
1008 (87)
Broker Misc. II Misc. III TAX CODE
Misc EXEMPT (Y/N)
W-2 (YR) NRS
W-8 (YR)
1008 (87)
Broker Misc. II Misc. III
Misc
</TABLE>
B-1
<PAGE> 47
EXHIBIT C
[Form of Offering Termination Notice]
Imperial Trust Company
201 North Figueroa
Suite 610
Los Angeles, California 90012
Attention: William F. Klepper
Dear Mr. Klepper:
Pursuant to Section 5(a) of the Escrow Agreement dated as of March ___,
1998 (the "Escrow Agreement") among Krause's Furniture, Inc. (the "Company"),
Japan Omnibus Ltd., Cruttenden Roth Incorporated, Morgan Fuller Capital Group,
LLC and Black & Company, Inc., and you, the Company hereby notifies you of the
termination of the offering of the Securities (as that term is defined in the
Escrow Agreement) and directs you to make payments to subscribers as provided
for in Section 5(a) of the Escrow Agreement.
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:
------------------------------------------------
Name:
Title:
C-1
<PAGE> 48
EXHIBIT D
[Form of Closing Notice]
[Date]
Imperial Trust Company
201 North Figueroa
Suite 610
Los Angeles, California 90012
Attention: William F. Klepper
Dear Mr. Klepper:
Pursuant to Section 5(b) of the Escrow Agreement dated as of March ___,
1998 (the "Escrow Agreement") among Krause's Furniture, Inc. (the "Company"),
Japan Omnibus Ltd. (the "Selling Stockholder") Cruttenden Roth Incorporated,
Morgan Fuller Capital Group, LLC and Black & Company, Inc. (the "Placement
Agents") and you, the Company hereby certifies that it has received
subscriptions for the Securities (as that term is defined in the Escrow
Agreement) and the Company and the Selling Stockholder will sell and deliver
Securities to the subscribers or purchasers thereof at a closing to be held on
March ___, 1998 (the "Closing Date"). The names of the subscribers concerned,
the number of Securities subscribed for by each of such subscribers and the
related subscription amounts are set forth on the schedule annexed hereto.
We hereby request that the aggregate subscription amount be paid to the
Placement Agents and us as follows:
[To be inserted].
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:
----------------------------------------
Name:
Title:
D-1
<PAGE> 49
JAPAN OMNIBUS LTD.
By:
----------------------------------------------
Name:
Title:
CRUTTENDEN ROTH INCORPORATED
MORGAN FULLER CAPITAL GROUP, LLC
BLACK & COMPANY, INC.
By: Cruttenden Roth Incorporated
By:
----------------------------------------------
Name:
Title:
D-2
<PAGE> 50
EXHIBIT E
[Form of Subscription Termination Notice]
Imperial Trust Company
201 North Figueroa
Suite 610
Los Angeles, California 90012
Attention: William F. Klepper
Dear Klepper:
Pursuant to Section 5(c) of the Escrow Agreement dated as of March ___,
1998 (the "Escrow Agreement") among Krause's Furniture, Inc. (the "Company"),
Japan Omnibus Ltd., Cruttenden Roth Incorporated, Morgan Fuller Capital Group,
LLC and Black & Company, Inc. and you, the Company hereby notifies you that the
following subscription(s) have been rejected:
Amount of Subscribed
Name of Subscriber(s) Securities Rejected
$
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:
-----------------------------------------
Name:
Title:
E-1
<PAGE> 51
EXHIBIT B
List of persons from whom Lock Up Letters received:
General Electric Capital Corporation
Permal Group
Permal Capital Management, Inc.
Permal Services, Inc.
Permal Capital Partners, L.P.
Permal Asset Management
Permal Special Opportunities, Ltd.
Jean R. Perette
Isaac Robert Souede
Thomas M. DeLitto
Thomas M. DeLitto and Donna S. DeLitto
United Gulf Bank (B.S.C.) B.C.
Kuwait Investment Projects
ATCO Holdings, Ltd.
ATCO Development, Inc.
Worms & Cie
Worms & Co., Inc.
<PAGE> 52
JAPAN OMNIBUS LTD.
(Name of Selling Stockholder -
Please Print or Type)
CUSTODY AGREEMENT AND POWER OF ATTORNEY
FOR SALE OF COMMON STOCK OF
KRAUSE'S FURNITURE, INC.
Krause's Furniture, Inc.
200 North Berry Street
Brea, California 92821-3963
[CUSTODIAN]
Ladies and Gentlemen:
Krause's Furniture, Inc., a Delaware corporation (the "Company"),
and the undersigned, Japan Omnibus Ltd. (hereinafter sometimes referred to as
"Selling Stockholder"), propose to sell certain shares of Common Stock, $0.001
par value per share, of the Company ("Common Stock") to certain investors (the
"Investors") under a Registration Statement on Form S-1 (the "Registration
Statement") at a price and on terms to be hereafter determined. Cruttenden Roth
Incorporated, Morgan Fuller Capital Group, LLC and Black & Company, Inc. (the
"Placement Agents") will be acting as placement agents of the Company and the
Selling Stockholder. It is understood that there will be no commitment on the
part of the Placement Agents to purchase any shares of Common Stock and no
assurance that an offering of Common Stock will take place. The shares of Common
Stock which the undersigned proposes to sell to the Investors pursuant to the
Placement Agency Agreement hereinafter mentioned are referred to herein as the
"Shares."
1. Appointment and Powers of Attorneys-in-Fact.
A. The undersigned hereby irrevocably constitutes and appoints
________________ and ______________ (the "Attorneys-in-Fact"), and each of them,
as its agent and Attorneys-in-Fact, with full power of substitution, with
respect to all matters arising in connection with the public offering and sale
of the Shares, including, but not limited to, the power and authority on behalf
of the undersigned to do or cause to be done any of the following things:
(i) negotiate, determine and agree upon (a) the price at
which the Shares will be initially offered and sold by the Selling Stockholder
to the Investors or public pursuant to the Placement Agency Agreement, as
hereinafter defined, and (b) the fees payable to the Placement Agents with
respect to the Shares;
<PAGE> 53
(ii) prepare, execute and deliver a Placement Agency
Agreement and a related Escrow Agreement, a form of which is attached to the
Placement Agency Agreement (collectively, the "Placement Agency Agreement"),
substantially in the form agreed to by and among the Company, the Selling
Stockholder and the Placement Agents, delivered to the undersigned concurrently
herewith, receipt of which is acknowledged, but with such insertions, changes,
additions or deletions as the Attorneys-in-Fact shall approve as not materially
adverse to the undersigned (which may include a decrease, but not an increase,
in the number of shares of Common Stock to be sold by the undersigned), such
approval to be conclusively evidenced by the execution and delivery of the
Placement Agency Agreement by an Attorney-in-Fact, including the exercise of all
authority thereunder vested in the undersigned;
(iii) sell, assign, transfer and deliver the Shares
pursuant to the Placement Agency Agreement and deliver to the Placement Agents
certificates for the Shares so sold;
(iv) take any and all steps deemed necessary or desirable
by the Attorneys-in-Fact in connection with the registration of the Shares
under the Securities Act of 1933, as amended (the "Securities Act"), the
Securities Exchange Act of 1934, as amended, and under the securities or "Blue
Sky" laws of various states and jurisdictions, including, without limitation,
the giving or making of such undertakings, representations and agreements and
the taking of such other steps as the Attorneys-in-Fact may deem necessary or
advisable;
(v) instruct the Company and the Custodian, as hereinafter
defined, on all matters pertaining to the sale of the Shares and delivery of
certificates therefor;
(vi) provide, in accordance with the Placement Agency
Agreement, for the payment of expenses of the offering and sale of the Common
Stock covered by the Registration Statement;
(vii) retain legal counsel for the Selling Stockholder,
which may also be legal counsel for the Company, in connection with all matters
contemplated hereby and by the Placement Agency Agreement;
(viii) instruct the Custodian as to the number of Shares
to be sold by the Selling Stockholder (it being understood and agreed to by the
undersigned that the Custodian shall be entitled to rely on the instructions
from the Attorneys-in-Fact as to such number of Shares to be sold by the Selling
Stockholder); and
(ix) otherwise take all actions and do all things
necessary or proper, required, contemplated or deemed advisable or desirable by
the Attorneys-in-Fact in their discretion, including the execution and delivery
of any documents, and generally act for and in the name of the undersigned with
respect to the sale of the Shares as fully as could the undersigned if then
personally present and acting.
B. Each Attorney-in-Fact may act alone in exercising the rights
and powers conferred on the Attorneys-in-Fact by this Custody Agreement and
Power of Attorney. Each Attorney-in-Fact
2
<PAGE> 54
is hereby empowered to determine, in his sole and absolute discretion, the time
or times when, the purposes for which, and the manner in which, any power herein
conferred upon the Attorneys-in-Fact shall be exercised.
C. The Custodian, the Placement Agents, the Company and all other
persons dealing with the Attorneys-in-Fact as such may rely and act upon any
writing believed in good faith to be signed by one or more of the
Attorneys-in-Fact.
D. The Attorneys-in-Fact shall not receive any compensation for
their services rendered hereunder, except that they shall be entitled to cause
the Custodian to pay, from the proceeds payable to the undersigned, the
undersigned's proportionate share of any out-of-pocket expenses incurred under
this Custody Agreement and Power of Attorney (this "Agreement") and similar
instruments executed by the Selling Stockholder.
2. Appointment of Custodian; Deposit of Shares.
A. In connection with and to facilitate the sale of the Shares,
the undersigned hereby appoints ________________________ as custodian (the
"Custodian") and herewith deposits with the Custodian one or more certificates
for Common Stock, which represent not less than the total number of Shares to be
sold by the undersigned, which number is set forth on Schedule I hereto. Each
such certificate so deposited shall be in negotiable and proper deliverable form
endorsed in blank with the signature of the undersigned thereon guaranteed by an
eligible guarantor institution, such as a bank, stockbroker, savings and loan
association or credit union, with membership in an approved medallion signature
guarantee program, or shall be accompanied by a duly executed stock power or
powers in blank, bearing the signature of the undersigned so guaranteed. The
Custodian is hereby authorized and directed, subject to the instructions of the
Attorneys-in-Fact, (a) to hold in custody the certificate or certificates
deposited herewith, (b) to deliver or to authorize the Company's Transfer Agent
to deliver the certificate or certificates deposited hereunder (or replacement
certificate(s) for the Shares) to or at the direction of the Attorneys-in-Fact
in accordance with the terms of the Placement Agency Agreement and (c) to return
or cause the Company's Transfer Agent to return to the undersigned new
certificate(s) for the shares of Common Stock represented by any certificate
deposited hereunder which are not sold pursuant to the Placement Agency
Agreement.
B. Until the Shares have been delivered to the Investors against
payment therefor in accordance with the Placement Agency Agreement, the
undersigned shall retain all rights of ownership with respect to the Shares
deposited hereunder, including the right to vote and to receive all dividends
and payment thereon, except the right to retain custody of or dispose of such
Shares, which right is subject to this Agreement and the Placement Agency
Agreement.
C. The Custodian shall assume no responsibility to any person
other than to deal with the certificates for the Shares and the proceeds from
the sale of the Shares represented thereby in accordance with the provisions
hereof, and the Selling Stockholder hereby agrees to indemnify the Custodian for
and to hold the Custodian harmless against, any and all losses, claims, damages
or liabilities incurred on its part arising out of or in connection with it
acting as the Custodian pursuant hereto, as well as the cost and expenses of
investigating and defending any such losses, claims,
3
<PAGE> 55
damages or liabilities incurred on its part arising out of or in connection with
it acting as the Custodian pursuant hereto, except to the extent such losses,
claims, damages or liabilities are due to the negligence or bad faith of the
Custodian. The Custodian's acceptance of this Agreement by the execution hereof
shall constitute an acknowledgment by the Custodian of the authorization herein
confirmed and shall evidence the Custodian's agreement to carry out and perform
this Agreement in accordance with its terms.
3. Sale of Shares; Remitting Proceeds. The Attorneys-in-Fact are hereby
authorized and directed to deliver or cause the Custodian or the Company's
Transfer Agent to deliver certificates for the Shares to the Placement Agents,
as provided in the Placement Agency Agreement, against delivery to the
Attorneys-in-Fact for the account of the undersigned of the purchase price of
the Shares (net of the fees payable to the Placement Agents), at the time and in
the funds specified in the Placement Agency Agreement. The Attorneys-in-Fact are
authorized, on behalf of the undersigned, to accept and acknowledge receipt of
the payment of the purchase price for the Shares and the Attorneys-In-Fact shall
promptly deposit such proceeds with the Custodian. After reserving an amount of
such proceeds for the fees payable to the Placement Agents as provided above,
the Custodian shall promptly remit to the undersigned its proportionate share of
the proceeds.
4. Representations, Warranties and Agreements. The undersigned represents
and warrants to, and agrees with, the Company, the Attorneys-in-Fact, the
Custodian, the Placement Agents, Morrison & Foerster LLP, Stroock & Stroock &
Lavan LLP and Snell & Wilmer L.L.P. as follows:
A. The undersigned has full legal right, power and authority to
enter into and perform this Agreement and the Placement Agency Agreement. If the
undersigned is acting as a fiduciary, officer, partner, or agent, the
undersigned is enclosing with this Agreement certified copies of the appropriate
instruments pursuant to which the undersigned is authorized to act hereunder.
B. The undersigned has reviewed the representations and warranties
to be made by the undersigned as a Selling Stockholder contained in the
Placement Agency Agreement, and hereby represents, warrants and covenants that
each of such representations and warranties is true and correct as of the date
hereof and, except as the undersigned shall have notified the Attorneys-in-Fact
pursuant to paragraph E of the attached instructions, will be true and correct
at all times from the date hereof through and including the time of the closing
of the sale of the Shares. The undersigned will promptly notify the
Attorneys-in-Fact of any development that would make any such representation and
warranty untrue.
C. The undersigned has reviewed the Registration Statement,
including the preliminary prospectus included therein, and (i) the undersigned
has no knowledge of any material information not disclosed in the Registration
Statement or preliminary prospectus which has adversely affected in any material
respect or, insofar as it is reasonably foreseeable, could adversely affect in
any material respect the current and prospective business and operations of the
Company or its subsidiaries and (ii) the information contained in such
Registration Statement and preliminary prospectus with respect to the
undersigned is complete and accurate.
4
<PAGE> 56
D. Other than as previously indicated to the Company in writing in
connection with the Company public offering, the undersigned is not directly or
indirectly an affiliate of or associated with any member of the National
Association of Securities Dealers, Inc.
E. Upon execution and delivery of the Placement Agency Agreement
by the Attorneys-in-Fact on behalf of the undersigned, the undersigned agrees to
indemnify and hold harmless the Placement Agents, the Company, each of its
directors and each of its officers who sign the Registration Statement, and each
person, if any, who controls the Placement Agent or the Company, and to
contribute to amounts paid as a result of losses, claims, damages, liabilities
and expenses, to the full extent provided in Section 8 of the Placement Agency
Agreement.
F. Upon execution and delivery of the Placement Agency Agreement
by the Attorneys-in-Fact on behalf of the undersigned, the undersigned agrees to
be bound by and to perform each of the covenants and agreements of the
undersigned as the Selling Stockholder in the Placement Agency Agreement.
G. The undersigned agrees to deliver to the Attorneys-in-Fact such
documentation as the Attorneys-in-Fact, the Company or the Placement Agents or
any of their respective counsel may reasonably request in order to effectuate
any of the provisions hereof or of the Placement Agency Agreement, all of the
foregoing to be in form and substance satisfactory in all respects to the
Attorneys-in-Fact.
The foregoing representations, warranties and agreements are made
for the benefit of, and may be relied upon by, the Attorneys-in-Fact, the
Company, the Custodian, the Placement Agents and their respective
representatives, agents and counsel and are in addition to, and not in
limitation of, the representations, warranties and agreements of the Selling
Stockholder in the Placement Agency Agreement.
5. Irrevocability of Instruments; Termination of this Agreement.
A. This Agreement, the deposit of the Shares pursuant hereto and
all authority hereby conferred, is granted, made and conferred subject to and in
consideration of (i) the interests of the Attorneys-in-Fact, the Placement
Agents, the Company and the other Selling Stockholder who may become parties to
the Placement Agency Agreement in and for the purpose of completing the
transactions contemplated hereunder and by the Placement Agency Agreement and
(ii) the completion of the registration of Common Stock pursuant to the
Registration Statement and the other acts of the above-mentioned parties from
the date hereof to and including the execution and delivery of the Placement
Agency Agreement in anticipation of the sale of Common Stock, including the
Shares; and the Attorneys-in-Fact are hereby further vested with an estate,
right, title and interest in and to the Shares deposited herewith for the
purpose of irrevocably empowering and securing to each of them authority
sufficient to consummate said transactions. Accordingly, this Agreement shall be
irrevocable prior to [MARCH 13], 1998, and shall remain in full force and effect
until that date. The undersigned further agrees that this Agreement shall not be
terminated by operation of law or upon the occurrence of any event whatsoever,
including the dissolution, winding up, distribution of assets or other event
affecting the legal existence of the undersigned. If any event referred to in
5
<PAGE> 57
the preceding sentence shall occur, whether with or without notice thereof to
the Attorneys-in-Fact, the Placement Agent or any other person, the
Attorneys-in-Fact shall nevertheless be authorized and empowered to deliver and
deal with the Shares deposited under the Agreement by the undersigned in
accordance with the terms and provisions of the Placement Agency Agreement and
this Agreement as if such event had not occurred.
B. If the sale of the Shares contemplated by this Agreement is not
completed by [MARCH 13, 1998], this Agreement shall terminate (without affecting
any lawful action of the Attorneys-in-Fact or the Custodian prior to such
termination), and the Attorneys-in-Fact shall cause the Custodian to return to
the undersigned all certificates for the Shares deposited hereunder.
6. Liability and Indemnification of the Attorneys-in-Fact and Custodian.
The Attorneys-in-Fact and the Custodian assume no responsibility or liability to
the undersigned or to any other person, other than to deal with the Shares, the
proceeds from the sale of the Shares and any other shares of Common Stock
deposited with the Custodian pursuant to the terms of this Agreement in
accordance with the provisions hereof. The undersigned hereby agrees to
indemnify and hold harmless the Attorneys-in-Fact and the Custodian, and their
respective officers, agents, successors, assigns and personal representatives
with respect to any act or omission of or by any of them in good faith in
connection with any and all matters contemplated by this Agreement or the
Placement Agency Agreement.
7. Interpretation.
A. The representations, warranties and agreements of the
undersigned contained herein and in the Placement Agency Agreement shall survive
the sale and delivery of the Shares and the termination of this Agreement.
B. The validity, enforceability, interpretation and construction
of this Agreement shall be determined in accordance with the laws of the State
of California applicable to contracts made and to be performed within the State
of California, and this Agreement shall inure to the benefit of, and be binding
upon, the undersigned and the undersigned's heirs, executors, administrators,
successors and assigns, as the case may be.
C. Wherever possible each provision of this Agreement shall be
interpreted in such manner as to be effective and valid under applicable law,
but if any such provision shall be prohibited by or invalid under applicable
law, it shall be ineffective only to the extent of such prohibition or
invalidity, without invalidating the remainder of such provision or the
remaining provisions of this Agreement.
D. The use of the masculine gender in this Agreement includes the
feminine and neuter, and the use of the singular includes the plural, wherever
appropriate.
E. This Agreement may be executed in various counterparts, each of
which when so executed and delivered shall be an original, but all such
counterparts shall together constitute one and the same instrument.
6
<PAGE> 58
IN WITNESS WHEREOF, the undersigned has executed this Custody
Agreement and Power of Attorney this ____ day of February, 1998.
JAPAN OMNIBUS LTD.
By:
----------------------------
Its: Signature of Selling Stockholder guaranteed by:
(PLEASE SIGN EXACTLY AS YOUR
NAME APPEARS ON YOUR STOCK
CERTIFICATE(S))
Name and address to which
notices and funds shall
be sent: By:
--------------------------------
- ------------------------------- (Note: The signature MUST BE GUARANTEED by an
(Name) eligible guarantor institution, such as a bank,
- ------------------------------- stock broker, savings and loan association, or
(Street) credit union, with membership in an approved
- ------------------------------- medallion signature program)
(City) (State) (Zip)
- -------------------------------
(Country)
ACCEPTED by the Attorneys-in-Fact ACCEPTED by the Custodian as
as of the date set forth above: of the above date set forth:
[CUSTODIAN]
- --------------------------------- By:
By: -----------------------------------------
Title:
-----------------------------------------
- ---------------------------------
By:
SEE THE ATTACHED INSTRUCTIONS
7
<PAGE> 59
SCHEDULE I
Certificate(s) for Shares of Common/Preferred Stock of
KRAUSE'S FURNITURE, INC.
deposited under
Custody Agreement and Power of Attorney
<TABLE>
<CAPTION>
Type of Maximum Number of
Security Number of Shares of Shares of Common Stock
Certificate (i.e., Common, Common Stock Represented from this Certificate
Number Preferred) by Certificate to be Sold*
- ----------- ------------- ----------------------- ----------------------
<S> <C> <C> <C>
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
Total: ----------------------
</TABLE>
*If fewer than all shares represented by a certificate are to be sold, indicate
below, if desired for income tax purposes, the date of purchase or purchase
price of the particular shares to be sold.
<PAGE> 60
PAYMENT AUTHORIZATION
To: [CUSTODIAN]
In connection with the sale by the undersigned of shares of Common Stock
of Krause's Furniture, Inc., the undersigned hereby authorizes [CUSTODIAN], as
custodian (the "Custodian") to pay the undersigned the proceeds from such sale,
less applicable deductions, in the following manner:
MANNER OF PAYMENT
CASHIER'S CHECK MADE PAYABLE TO: _________________________________________
To be sent to the following address:
_____________________________________
_____________________________________
_____________________________________
To be sent by: [ ] First Class Mail [ ] Overnight Delivery
(Please specify service and
account number: _________________)
WIRE TRANSFER OF FUNDS TO THE FOLLOWING ACCOUNT:
Account number: ___________________________
Bank: _____________________________________
ABA number: _______________________________
Bank address: _____________________________
Name on account: __________________________
Name and telephone number of
contact person to confirm
receipt: ________________________________
OTHER (PLEASE SPECIFY)
_____________________________________
_____________________________________
_____________________________________
The undersigned authorizes the Custodian to deduct from the proceeds of sale of
the undersigned's Common Stock any costs incurred in connection with carrying
out the foregoing instructions.
By: ______________________________________
Name: ____________________________________
Title: ___________________________________
Date: _________________ , 1998
<PAGE> 1
EXHIBIT 10.14
AMENDMENT TO
REGISTRATION RIGHTS AGREEMENT
AND STOCKHOLDERS AGREEMENT
THIS AMENDMENT TO REGISTRATION RIGHTS AGREEMENT AND STOCKHOLDERS
AGREEMENT is entered into as of August 14, 1997 among KRAUSE'S FURNITURE, INC.,
a Delaware corporation the "COMPANY"), and the parties listed on the signature
pages hereof (the "CONSENTING STOCKHOLDERS"), with reference to the Stockholders
Agreement dated as of August 26, 1996 among the Company and the stockholders of
the Company referred to therein as the "Stockholders" the ("STOCKHOLDERS
AGREEMENT") and the Registration Rights Agreement dated as of August 26, 1996
among the Company and the stockholders of the Company referred to therein as
"Investors", as such agreement has been previously amended (the "REGISTRATION
RIGHTS AGREEMENT"), and with reference to the following facts:
A. As of the date hereof the Company, General Electric Capital
Corporation ("GECC") and Japan Omnibus Ltd. ("JOL") entered into a Supplemental
Securities Purchase Agreement (the "SUPPLEMENTAL PURCHASE Agreement") whereby
GECC and JOL purchased, in the aggregate, $3,000,000 in new securities of the
Company and agreed to purchase, under certain circumstances, an additional
$3,500,000 in new securities of the Company.
B. As a condition to, and as a material inducement for, the investment
and commitment of JOL under the Supplemental Purchase Agreement, the Company,
GECC, JOL and certain representatives of the Permal Group (as defined in the
Stockholders Agreement) agreed that JOL would be entitled to a one-time
registration of shares of the Company's Common Stock, par value $0.01 per share
( the "SHARES") held by JOL, and that the Permal Group would, in certain
circumstances, be entitled to participate in such registration with respect to
up to 1,000,000 Shares; provided that in no event would JOL and Permal Group be
entitled to register or sell, in the aggregate, in excess of the number of
Shares held by JOL.
C. The agreement of the parties was evidenced by that certain letter
dated the date hereof from GECC to the Permal Group, as confirmed and agreed by
the Company and JOL (the "LETTER AGREEMENT"), which the parties thereto agree
inaccurately referenced the number of JOL Shares by approximation at 2,000,000.
D. The parties now wish to further memorialize their agreement set
forth in the Letter Agreement and to amend the provisions of the Stockholders
Agreement and the Registration Rights Agreement to permit the registration and
sale of Shares in the manner contemplated in the Letter Agreement.
NOW, THEREFORE, IN CONSIDERATION OF the foregoing facts and the
covenants herein, the parties hereto agree that the Registration Rights
Agreement and the Stockholders Agreement are hereby amended to provide for
certain registration and sale rights as follows:
1
<PAGE> 2
1. One-Time Registration and Sale. Notwithstanding any provision of the
Stockholders Agreement, the Registration Rights Agreement or the Letter
Agreement, (i) JOL shall be permitted to offer for sale or sell a maximum of
2,096,111 Shares in the aggregate and a minimum of 1,000,000 Shares and (ii)
members of the Permal Group shall be permitted to offer for sale or sell a
maximum amount of Shares in the aggregate (with such shares being allocated
among the members of the Permal Group as JOL may determine) equal to (x)
2,096,111 minus (y) the amount of Shares that JOL elects to offer for sale or
sell under this amendment, at any time after the date of this amendment,
pursuant to a registration statement of the Company under the Securities Act (as
defined in the Registration Rights Agreement).
2. No Rights in Others. The right to offer for sale or sell Shares set
forth in Section 1 shall be notwithstanding any right of first offer set forth
in the Stockholders Agreement (including, without limitation, Section 4 thereof)
or the Registration Rights Agreement, and any right of first offer set forth in
either such agreement shall not apply to any offer or sale of Shares under the
provisions of this amendment. The one-time registration right set forth in
Section 1 is solely for the benefit of JOL and members of the Permal Group as
JOL may designate, shall not be a registration on request under Section 2.1(a)
of the Registration Rights Agreement or a registration subject to Section 2.2 of
the Registration Rights Agreement and, except for JOL and members of the Permal
Group as JOL may designate, no Investors (as defined in the Registration Rights
Agreement) shall have any right to have Shares owned by them participate in such
registration.
3. Registration on JOL Request. Upon written request of JOL for itself,
or for itself and for members of the Permal Group, that the Company effect the
registration under the Securities Act of not less than 1,000,000 Shares and not
more than 2,096,111 Shares, the Company will use its best efforts to effect the
registration under the Securities Act of the Shares as to which such
registration has been requested.
4. Terms of Registration. Any registration of Shares hereunder shall be
subject to the terms and conditions of Section 2.1(b), (c), (d), (e) and (f) of
the Registration Rights Agreement, with the Shares requested to be so registered
hereunder being deemed to be the Registrable Securities for purposes of such
provisions. In addition, for purposes of all other Sections of the Registration
Rights Agreement, any registration hereunder shall be subject to such provisions
as if the registration hereunder were a registration under Section 2.1 of the
Registration Rights Agreement. Notwithstanding the foregoing, for purposes of
Section 2.8(a), GECC hereby consents to a single registration as provided in
this amendment at such time as is elected by JOL. If the managing underwriter of
any underwritten offering undertaken pursuant to this amendment shall advise the
Company that, in its opinion, the offering should be for not less than 2,096,111
shares and should include a "greenshoe" option for sale of additional shares,
the parties consent that GECC may, by written consent, agree to the inclusion of
up to 400,000 Shares in the registered offering. Any such additional Shares
shall be drawn from the holdings of JOL or, in JOL's discretion, members of the
Permal Group designated by JOL.
5. Effectiveness; No Other Amendment. This amendment shall be effective
on execution by stockholders holding not less than a majority of all Registrable
Securities,
2
<PAGE> 3
and provided that GECC is one of the signatories. Except as specifically set
forth herein, the terms and conditions of the Stockholders Agreement and the
Registration Rights Agreement shall continue in full force and effect.
6. Counterparts. This agreement may be executed in two or more
counterparts and by different parties hereto in separate counterparts, with the
same effect as if all parties had signed the same document. All such
counterparts shall be deemed an original, shall be construed together and shall
constitute one and the same instrument.
Remainder Of Page Intentionally Left Blank
3
<PAGE> 4
IN WITNESS WHEREOF, the undersigned have executed Amendment to
Registration Rights Agreement and Stockholders Agreement effective as of the
date first set forth above.
KRAUSE'S FURNITURE, INC.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
GENERAL ELECTRIC CAPITAL
CORPORATION
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
JAPAN OMNIBUS LIMITED.
(formerly known as Edson Investments, Inc.)
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
4
<PAGE> 5
IN WITNESS WHEREOF, the undersigned have executed Amendment to
Registration Rights Agreement and Stockholders Agreement effective as of the
date first set forth above.
PERMAL CAPITAL MANAGEMENT, INC.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
PERMAL SERVICES, INC.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
PERMAL CAPITAL PARTNERS, LP
By:
-------------------------------
Permal Management Corporation
Investment Manager
PERMAL ASSET MANAGEMENT
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
PERMAL SPECIAL OPPORTUNITIES, LTD.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
5
<PAGE> 6
IN WITNESS WHEREOF, the undersigned have executed Amendment to
Registration Rights Agreement and Stockholders Agreement effective as of the
date first set forth above.
UNITED GULF BANK (B.S.C.) E.C.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
KUWAIT INVESTMENT PROJECTS COMPANY
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
ATCO HOLDINGS LTD.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
ATCO DEVELOPMENT, INC.
By:
-------------------------------
Name:
-----------------------------
Title:
----------------------------
6
<PAGE> 7
IN WITNESS WHEREOF, the undersigned have executed Amendment to
Registration Rights Agreement and Stockholders Agreement effective as of the
date first set forth above.
- -----------------------------
JEAN R. PERRETTE
- -----------------------------
ISSAC ROBERT SOUDE
- -----------------------------
THOMAS M. DeLITTO
- -----------------------------
THOMAS M. & DONNA S. DeLITTO
7
<PAGE> 8
IN WITNESS WHEREOF, the undersigned have executed Amendment to
Registration Rights Agreement and Stockholders Agreement effective as of the
date first set forth above.
MAUREEN ERIN HAWLEY TRUST I
ALLISON BOOTH HAWLEY TRUST I
CAITLIN HALE HAWLEY TRUST I
SHANNON FOLLEN HAWLEY TRUST I
HAWLEY FAMILY TRUST
MAUREEN ERIN HAWLEY TRUST II
ALLISON BOOTH HAWLEY TRUST II
CAITLIN HALE HAWLEY TRUST II
SHANNON FOLLEN HAWLEY TRUST II
By:
-----------------------------
JOHN F. HAWLEY, Trustee
- --------------------------------
PHILIP M. HAWLEY
- --------------------------------
PHILIP M. HAWLEY, Jr.
8
<PAGE> 1
EXHIBIT 10.15
SUCCESSION AGREEMENT
THIS SUCCESSION AGREEMENT (this "Agreement") is made as of
__________, 1997, by and between KRAUSE'S FURNITURE, INC., a Delaware
corporation (the "Corporation"), and PHILIP M. HAWLEY ("Hawley"), JOHN F. HAWLEY
("John Hawley"), as Trustee of the Trusts named on the signature page hereof
(the "Hawley Trusts"), DR. PHILIP M. HAWLEY, JR., GENERAL ELECTRIC CAPITAL
CORPORATION ("GECC") and PERMAL CAPITAL MANAGEMENT, INC. ("Permal"), and each of
the other stockholders of the Corporation whose name is set forth on the
signature page(s) hereof (all of such parties other than the Corporation,
collectively, the "Stockholders"), with reference to the following facts:
A. The Stockholders and the Corporation, among others, are
parties to that certain Stockholders Agreement dated August 26, 1996 by and
among the Corporation and certain of its stockholders (the "Stockholders
Agreement"), which sets forth certain rights and obligations of certain
stockholders of the Corporation, including the designation of Philip M. Hawley
("Hawley") as a director and Chairman of the Board of Directors of the
Corporation (the "Board") for so long as he serves as Chief Executive Officer of
the Corporation and certain rights of first refusal among the parties thereto.
B. Hawley has requested that the other parties hereto agree to
a designated successor that will represent the interests of the Hawley Group on
the Board if Hawley no longer serves as a director of the Corporation and, in
reliance on the agreement thereto by certain of the parties hereto, the persons
composing the Hawley Group entered into the Stockholders Agreement.
C. The Stockholders own a majority of the issued and
outstanding shares of the Common Stock of the Corporation (the "Shares") and
deem it to be in their best interests and in the best interest of the
Corporation to provide for the designation of a successor to Hawley in his
capacity as a member of the Board of the Corporation (but not as Chairman of the
Board).
D. The members of the Hawley Group and GECC have determined
that it is in their best interests to enter into an agreement with respect to
any purchase of any Common Stock offered by members of the Permal Group.
NOW, THEREFORE, IN CONSIDERATION OF the foregoing facts and
the mutual interests of the parties hereto in the success of the Company, and in
reliance hereon, the parties agree as follows:
1. Definitions. Any capitalized term used in this Agreement
without definition shall have the meaning ascribed to that term in the
Stockholders Agreement.
2. Voting. If Hawley ceases to serve as a member of the Board,
each Stockholder shall vote such Stockholder's shares of the Corporation and
shall take all actions
1
<PAGE> 2
necessary and within its power to insure that John Hawley is elected to fill the
vacancy created by Hawley's absence as soon as practicable after Hawley has
ceased to serve, and to vote such Stockholder's shares and take all actions
necessary to insure that John Hawley continues to serve as a member of the Board
thereafter. If John Hawley is unavailable to serve as director or ceases to
serve as director, then each Stockholder shall vote such Stockholder's shares of
the Corporation and shall take all actions necessary to insure that the
individual nominated by John Hawley's successor as Trustee of the Hawley Trusts
and having qualifications similar to those of John Hawley or any other director
of the Corporation serves as director under the same terms that would have
applied to John Hawley hereunder.
3. No Change in Directors. The parties shall take all
appropriate measures to cause the number of directors of the Corporation to
remain at a level that will permit the continued service of Hawley or a
successor as designated herein as a member of the Board of Directors of the
Corporation.
4. Permal Shares. GECC and each of the members of the Hawley
Group, each in favor of the others, covenants that if any of them (for purposes
of this Section, an "Offeree") has the opportunity to purchase any Common Stock
owned by any member of the Permal Group, whether by offer to the Offeree from a
member of the Permal Group or due to a solicitation by the Offeree, or
otherwise, the Offeree shall promptly notify the parties subject of this Section
of the opportunity and shall allow them the right to participate in such
purchase and acquire Common Stock sold by any member of the Permal Group. The
number of Shares that may be purchased by each of them, respectively, shall be
(i) as between GECC and all of the members of the Hawley Group together, in
proportion with the number of shares of Common Stock owned by GECC or the Hawley
Group, respectively, as a percentage of the aggregate Common Stock then owned by
GECC and all Hawley Group together, and (ii) as among the members of the Hawley
Group, in proportion with the number of shares of Common Stock owned by such
member as a percentage of the Common Stock then owned by all Hawley Group
members electing to purchase Common Stock hereunder. The rights in this Section
are in addition to and subordinate to the provisions of the Stockholders
Agreement, which are not amended or altered hereby. Any failure to exercise the
rights in this Section within 15 days of receipt of notice shall be deemed a
waiver of such rights.
5. Duration. The obligations of the Stockholders under this
Agreement shall continue so long as (a) the Hawley Group owns an aggregate of at
least (i) 1,000,000 shares of the Common Stock.
6. Counterparts. This agreement may be executed in two or more
counterparts and by different parties hereto in separate counterparts, with the
same effect as if all parties had signed the same document. All such
counterparts shall be deemed an original, shall be construed together and shall
constitute one and the same instrument.
2
<PAGE> 3
IN WITNESS WHEREOF, the parties hereto have executed this
Succession Agreement as of the date first above written.
KRAUSE'S FURNITURE, INC.
a Delaware corporation
By:______________________________
Philip M. Hawley, President
Stockholders:
Dated _____________, 1997 _____________________________________
PHILIP M. HAWLEY
Dated _____________, 1997 _____________________________________
DR. PHILIP M. HAWLEY, JR.
Dated _____________, 1997 _____________________________________
JOHN F. HAWLEY, as Trustee of the
following Trusts
ALLISON BOOTH HAWLEY TRUST I
CAITLIN HALE HAWLEY TRUST I
MAUREEN ERIN HAWLEY TRUST I
SHANNON FOLLEN HAWLEY TRUST I
HAWLEY FAMILY TRUST
GENERAL ELECTRIC CAPITAL CORPORATION
Dated _____________, 1997 By:__________________________________
Name:
Title:
PERMAL CAPITAL MANAGEMENT, INC.
Dated _____________, 1997 By:__________________________________
Thomas M. DeLitto, President
PERMAL CAPITAL PARTNERS, LP
By: PERMAL MANAGEMENT CORPORATION
Its: Investment Manager
Dated _____________, 1997 By:__________________________________
Thomas M. DeLitto, President
3
<PAGE> 4
JAPAN OMNIBUS LIMITED
(formerly known as Edson Investments, Inc.)
Dated _____________, 1997 By:__________________________________
Name:
Title:
Dated _____________, 1997 _____________________________________
JEAN R. PERRETTE
Dated _____________, 1997 _____________________________________
ISAAC ROBERT SOUEDE
Dated _____________, 1997 _____________________________________
THOMAS M. DELITTO
ATCO HOLDINGS, LTD.
Dated _____________, 1997 By:__________________________________
Kamal Abdelnour, Authorized Agent
ATCO DEVELOPMENT, INC.
Dated _____________, 1997 By:__________________________________
Kamal Abdelnour, President/CEO
4
