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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended February 1, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
Commission file number 0-17868
KRAUSE'S FURNITURE, INC.
(Exact name of Registrant as specified in its charter.)
DELAWARE 77-0310773
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 NORTH BERRY STREET, BREA, CALIFORNIA 92821-3903
(Address of principal executive offices) (Zip Code)
(714) 990-3100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
AMERICAN STOCK EXCHANGE
(Name of each exchange where registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports, and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. [ ]
As of March 2, 1998 the aggregate market value of Registrant's $.001 par
value Common Stock held by non-affiliates was approximately $18,849,000 based on
the closing price for the stock. As of March 2, 1998 there were 19,020,539
shares of $.001 par value Common Stock outstanding.
Documents Incorporated by Reference: Proxy Statement for 1998 Annual
Meeting of Stockholders with respect to information required in Part III.
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This Report on Form 10-K contains certain forward-looking statements that
are based on current expectations. In light of the important factors that can
materially affect results, including those set forth in this Form 10-K, the
inclusion of forward-looking information herein should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved. The Company may encounter competitive,
financial and business challenges making it more difficult than expected to
continue to develop, market, manufacture and ship products on a timely basis;
competitive conditions may change adversely; demand for the Company's products
may weaken; the market may not accept the Company's merchandising strategies and
products; the Company may be unable to retain existing key management personnel;
the Company's forecasts may not accurately anticipate customer demand; and there
may be other material adverse changes in the Company's operations or business.
Certain important factors affecting the forward-looking statements made herein
include, but are not limited to (i) timely identifying, designing, and
delivering new products as well as enhancing existing products, (ii)
implementing current strategic plans, (iii) accurately forecasting capital
expenditures, and (iv) obtaining new sources of external financing. Assumptions
relating to budgeting, marketing, advertising, product development and other
management decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experiences and business
developments, the impact of which may cause the Company to alter its marketing,
advertising, capital expenditure or other budgets, which may in turn affect the
Company's financial position and results of operations.
PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
THE COMPANY. The Company is a leading vertically integrated manufacturer
and retailer of made-to-order upholstered furniture and accessories. The Company
operates 83 furniture showrooms under the Krause's (69 showrooms) and Castro
Convertibles (14 showrooms) brand names in 12 states, with 41 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. In April 1998 the
Company raised approximately $5.7 million of equity as a result of a public
offering ("the Offering") of approximately 2.3 million additional shares. At
the same time as the Offering, the Company's shares were listed on the American
Stock Exchange and trading in the Nasdaq SmallCap Market was terminated.
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 22 existing showrooms, 16 of which were remodeled during
fiscal 1997, 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 20 additional showrooms during the balance of 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 fiscal year ended February 1, 1998 (a fifty-two week period),
same-store sales (for showrooms opened a year or more) increased 5.9% compared
to the similar number of weeks in the prior fiscal year (a fifty-three week
period), with remodeled store sales exceeding management's goal of 25%. In
addition, gross profit increased from 49.9% to 51.3% of net sales in fiscal 1997
compared to fiscal 1996. Since the management change, the Company has also
opened three new showrooms, one of which was opened during fiscal 1997,
featuring its new store design and has plans to open approximately 18 additional
showrooms during the balance of 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 ratio are positioned to increase market share.
o Reputation for Value and Selection; Brand Names. The Company believes that
it has attained a reputation for high quality, custom-crafted furniture at
prices comparable to those of mass-produced, sold-as-shown furniture. 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.
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o New, Experienced Management Team. Since the 1996 investment, the Company
has hired a strong management team with extensive retailing experience, led
by Philip M. Hawley, the former Chairman and Chief Executive Officer of The
Broadway Stores, Inc. New management has adopted business and marketing
strategies designed to leverage the Company's existing brand name
recognition and distribution system and appeal to its existing broad
customer base. The management team has a substantial equity stake in the
Company.
o Vertically Integrated Manufacturer and Distributor of Custom Furniture. The
Company is a leading combined manufacturer and retailer of made-to-order
upholstered furniture. This vertical integration enables the Company to
manufacture high-quality, competitively priced custom upholstered furniture
and deliver it to the customer usually within two to four weeks from the
date ordered. Vertical integration also enables the Company to capture
profits at both the manufacturing and retail level, with minimal inventory
risk. Further, the Company can use the available capacity of its
manufacturing facility to accommodate planned sales growth.
o Well Located Retail Distribution Network. As of February 1, 1998, 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.
o Focus on Gross Margins and Cost Controls. In recent periods, the Company
has taken a number of steps to improve its gross margin and reduce expenses
by reducing discounts and other special pricing programs, improving its
manufacturing processes, introducing budgeting controls, revising its sales
commission structure, consolidating selling, general and administrative
expenses and cutting costs. As a result, the Company has developed an
organization focused on gross margin improvements, expense control and
operating efficiency.
BUSINESS STRATEGY. The Company intends to leverage its competitive
strengths in order to increase its sales volumes, improve its overall financial
performance and enhance its market position. The Company will seek to achieve
these objectives by pursuing the following strategies:
o 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. The Company has remodeled 22 showrooms, 16 of which
were remodeled during fiscal 1997, and expects to remodel approximately 20
more showrooms during the balance of the 1998 fiscal year.
o Add New Showrooms in Existing Markets. The Company plans to expand its
presence in markets where it has an existing base of showrooms so that it
can leverage its brand name recognition and marketing efforts as well as its
existing distribution network and management. The Company estimates that it
has between 40 to 50 opportunities to open showrooms in existing markets. To
date, the Company has opened three new showrooms, one of which was opened
during fiscal 1997, and expects to open approximately 18 additional
showrooms during the balance of fiscal 1998.
o 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.
o Revamp Marketing and Sales Promotion. The Company has revamped its
marketing and sales promotion with the goal of better defining its market
niche and differentiating it from its competitors. A major focus of this
effort is a shift away from a factory-direct orientation to that of
customization and craftsmanship with emphasis on value rather than price. To
this end, the Company has changed the name it does business under from
Krause's Sofa Factory to Krause's Custom Crafted Furniture and has developed
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a new, modern logo. Another focus of this effort has been to create an
advertising format and message and to use larger ads in an effort to better
attract customers.
o Develop New Products; Increase Sales of Complementary Products. The Company
has put in place a new product development program, which 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 twelve 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 1997, accessories,
custom-made chairs and recliners accounted for 5%, 8%, and 7%, 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.
o Leverage the Castro Franchise. In 1993, the Company acquired certain assets
principally related to the retail operations of Castro Convertible
Corporation, including the "Castro Convertibles" tradename and trademark and
retail store locations. Castro Convertibles, which started business in 1931,
has been known throughout the East Coast for its quality sofabed products
and was an early pioneer in developing the tri-fold sofabed mechanism. The
Company plans to leverage this strong brand awareness by adding a Castro
Convertibles gallery in all of its Krause's remodeled and new showrooms.
o Increase Showroom Productivity. For the year ended February 1, 1998, the
Company's sales per square foot of selling space averaged $116. 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.
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 22 showrooms, 16
of which were remodeled during fiscal 1997, and has plans to remodel
approximately 20 additional showrooms during the balance 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.
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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 three new
showrooms, one of which was opened during fiscal 1997, since it began its
expansion program and intends to open approximately 18 additional showrooms
during the balance of 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 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 9% 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 12 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.
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The first step in the upholstering process is cutting and sewing the
fabric chosen by the customer. The sewn fabric is sent to the assembly line
where workers construct the frame and upholster the seats, backs and arms. The
Company employs quilters as well as special seamstresses to sew zippers, bolster
covers, ruffles, skirts and pleats.
Upholstering takes place along an assembly line. Several individuals
work on each frame, each specializing in an area of responsibility -- springs,
outside body, seat, arm, inside body and so on. While the frame is upholstered,
seat cushions are filled with the customer's selection of either down, standard
foam or a Foreverflex(R) insert (the Company's proprietary seating material).
The Foreverflex(R) cushion insert is a high-density foam cushion which is
injection molded with springs suspended within the foam. An outside supplier
makes the Foreverflex(R) cushion insert to strict Company specifications and
provides a lifetime guarantee. Every piece of finished upholstered furniture
undergoes a quality control inspection during production and again prior to
shipment from the factory to the local distribution center.
The Company generally has adequate inventories of raw materials and
other supplies on hand to fill customer orders, and expects its suppliers to
satisfy its requirements shortly before materials are used in production.
The Company builds approximately 550 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 February 1, 1998 was approximately $10.7
million compared to $10.2 million at February 2, 1997.
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 55.9% of its purchased raw
materials during the fiscal year ended February 1, 1998, including one such
supplier that provided approximately 11.5% and another that provided 9.5% 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 $1,200,000 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.
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 February 1, 1998, the total work force numbers
approximately 1,006, with approximately 384 working in manufacturing, 535 in
retail and warehousing operations, and 87 in administration.
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COMPETITION. The home furnishings industry is highly competitive and
fragmented, and includes competition from traditional furniture retailers,
department stores and discount and warehouse outlets. Certain companies which
compete directly with the Company have greater financial and other resources
than the Company. The Company competes on a national level with Ethan Allen
Inc., Levitz Furniture, Leather Center, Inc., Expressions and traditional
department stores, among others. The Company also competes on a regional basis.
In New York, New Jersey and Chicago, the Company's primary competitor is
Jennifer Convertibles, Inc., and in the Western United States the Company's
primary regional competitors include Homestead House, Inc., The Leather Factory
and Norwalk Furniture Corporation (the latter of which also competes in the
Midwest market). In Houston, Texas, the Company's primary regional competitor is
Star Furniture Company. Expressions, Norwalk Furniture Corporation and Ethan
Allen Inc., like the Company, manufacture their own upholstered products and
offer "made-to-order" customization similar to that provided by the Company.
Levitz Furniture primarily addresses the low to middle end "as shown" market,
whereas traditional department stores typically focus on the middle to upper end
"as shown" market.
INSURANCE. The Company purchases occurrence-based product liability
insurance in the aggregate amount of $17 million. Management believes that based
upon its historical liability experience, the amount of insurance it carries is
adequate.
RISK FACTORS RELATING TO THE BUSINESS
LACK OF PROFITABLE OPERATIONS; ACCUMULATED AND WORKING CAPITAL DEFICITS.
The Company has reported losses from operations in each of the past five years
and had an accumulated deficit of $41.8 million at February 1, 1998. 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
February 1, 1998, the Company had a working capital deficiency of approximately
$.9 million and current liabilities at February 1, 1998 were $19.5 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 credit facility and internally generated cash are
insufficient. The Company expects its existing capital resources, borrowings
under its revolving credit facility, internally generated cash and proceeds from
the Offering will enable it to fund its plan to remodel and upgrade
approximately 26 showrooms and open approximately 20 new showrooms during fiscal
1998 at a projected cost of approximately $7.3 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.
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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.
LEVERAGE AND ABILITY TO SERVICE FIXED CHARGES. At February 1, 1998, the
Company had $13.7 million of long-term debt and had a negative tangible net
worth (stockholders' equity less intangible assets) of $5.7 million. For the
fiscal year ended February 1, 1998, earnings before interest, taxes,
depreciation and amortization were negative $3.3 million. A high percentage of
the Company's operating expenses are relatively fixed, including approximately
$1.3 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.
6
<PAGE> 9
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. Specifically, as of February 1,
1998, the Company was out of compliance with certain of the financial covenants
contained in both of the agreements but has obtained waivers. The Company may
also be in violation of certain of these covenants as of interim periods during
1998, but has obtained agreements to waive or amend covenants related to these
potential default events. There can be no assurance that if the Company's future
financial performance again fails to keep it in compliance with these covenants
and restrictions the Company could obtain additional waivers. 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 into an Employment
Agreement with Mr. Hawley, pursuant to which the Company agreed to employ Mr.
Hawley for a term ending on August 25, 1999. The Company has agreed to extend
this agreement to January 31, 2001.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. Because the Company sells
most of its products on a made-to-order basis with a three-to-four week delivery
cycle, it typically operates with about 30 days of backlog. As a result,
quarterly sales and operating results generally depend on the volume and timing
of orders and the Company's ability to fulfill orders within a quarter, which
are difficult to forecast. For example, because one of the Company's fabric
suppliers could not supply all of the Company's needs on a timely basis,
customer orders representing approximately $1,200,000 in sales were not
completed as expected in the fourth quarter of 1997. The Company may be unable
to adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall of demand for the Company's
products in relation to the Company's expectations would have an immediate
adverse impact on the Company's business, operating results and financial
condition. In addition, the Company plans to increase certain cash expenditures
in connection with the remodeling of existing showrooms and the opening of new
showrooms. To the extent that such expenditures precede or are not subsequently
followed by increased revenues, the Company's business, operating results and
financial condition will be materially adversely affected. In addition, the
Company's operating results are affected by a variety of factors, including
consumer tastes, housing activity, interest rates, credit availability and
general economic conditions in its selected market. For example, results for the
first quarter of fiscal 1998 may be modestly affected by inclement weather in
the California market. It is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts and
investors. In that event, the price of the Common Stock would likely be
materially adversely affected.
7
<PAGE> 10
DEPENDENCE ON SUPPLIERS. The Company obtains its raw materials and some
manufactured products from various outside sources and generally has had no
difficulty obtaining them. However, the Company is dependent on the continued
supply from relatively few suppliers of certain products, components and raw
materials, including fabrics, leather, foam, and sleeper and motion mechanisms.
Specifically, the Company's 10 largest suppliers accounted for approximately
55.9% of its aggregate purchases in the fiscal year ended February 1, 1998.
During the fiscal year ended February 1, 1998, approximately 11.5% of certain
products and raw materials purchases consisted of leather purchased from a
supplier, constituting approximately 85.8% of the leather purchases made by the
Company during this period, and approximately 9.5% 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 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 $1,200,000 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."
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.
8
<PAGE> 11
CYCLICAL NATURE OF THE FURNITURE INDUSTRY. The home furnishings industry
historically has been cyclical, fluctuating significantly with general economic
cycles. After economic downturns, the home furnishings industry tends to recover
more slowly than the general economy. The Company believes that the industry is
significantly influenced by economic conditions generally and particularly by
consumer behavior and confidence, the level of personal discretionary spending,
housing activity, interest rates and credit availability. A prolonged economic
downturn would have a material adverse effect on the Company.
DEPENDENCE ON REGIONAL ECONOMIES. The Company's markets are concentrated
in California and the New York City metropolitan area, where 50% and 18%,
respectively, of the Company's sales in the fiscal year ended February 1, 1998
originated. Consequently, an economic downturn in either of those states would
likely have a disproportionately negative impact on the financial condition of
the Company. Management believes the economic indicator most relevant to its
operations is consumer confidence. In January 1998, the consumer confidence
index, as reported by the Conference Board, for the Middle Atlantic Region,
which includes New York, was 102.1, the index for the Pacific Region, which
includes California, was 132.7, and the average index for the United States as a
whole, was 128.3.
RELIANCE ON MANUFACTURING FACILITY AND COMPUTER SYSTEM; VULNERABILITY TO
EARTHQUAKES. The Company's sole manufacturing plant, as well as the central
processing facility for the computer system that contains the Company's business
records and links the showrooms to Company headquarters is located in Southern
California, an area prone to earthquakes. An earthquake or other natural
disaster or work stoppage or other event affecting the normal operations of the
business could seriously impair the Company's capacity to continue its
manufacturing and retail operations. While the Company intends to implement a
disaster recovery system to lessen the impact of such a disaster or other work
stoppage, there can be no assurance that the Company will successfully put such
a system into operation.
In addition, the Company is pursuing replacing its computer system with a
new enterprise resource planning system to improve order configuration,
manufacturing scheduling and distribution processes. In the event that the
Company undertakes to replace its current computer system, failure to promptly
implement and integrate its system could have a material adverse affect on
the Company.
CONTROL BY PRINCIPAL STOCKHOLDERS. The current management, directors and
other principal stockholders of the Company own in the aggregate approximately
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 which provides, in part, that the
stockholders who are parties to the Stockholders Agreement will vote their
shares in any election of directors in a manner that assures the election of
directors designated by each of them. The Stockholders Agreement also prohibits
the Company from taking certain actions, such as mergers, liquidations or
dissolutions, without the approval of the member of the Board of Directors
designated by GECC. It is unlikely that any principal stockholder or group of
public stockholders acting in concert would be in the position to 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 1, 1998, the Company had approximately $37
million of federal net operating loss carryforwards including approximately $10
million which is currently limited by Section 382 of the Internal Revenue Code
of 1986, as amended. Also, Section 382 would further limit the Company's use of
its operating loss carryforwards if the cumulative ownership change during any
three-year period exceeds 50%. As a result of transactions occurring through
February 1, 1998 and contemplated by the 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.
9
<PAGE> 12
MARKET FOR THE COMPANY'S COMMON STOCK; POTENTIAL VOLATILITY OF STOCK
PRICE. The Company's Common Stock began trading on the American Stock Exchange
on March 31, 1998. Prior to that date the Company's common stock traded on the
Nasdaq SmallCap Market. There can be no assurances as to the extent or nature of
the market for the Company's Common Stock (which is currently thinly traded) or
as to the price at which the Company's Common Stock will trade. The market price
of the Company's Common Stock may be significantly affected by various factors
such as quarterly variations in the Company's operating results, changes in
revenue growth rates for the Company as a whole or for specific geographic areas
or products, earnings estimates or changes in estimates by market analysts,
speculation in the press or analyst community and general market conditions or
market conditions specific to particular industries. Further, there have been
periods of extreme volatility in the stock market that, in many cases, were
unrelated to the operating performance of, or announcements concerning, the
issuers of the affected securities. General market declines or volatility in the
future could adversely affect the price of the Common Stock. There can be no
assurance that the Common Stock will maintain its current market price.
Short-term trading strategies of certain investors can have a significant effect
on the price of specific securities. Due to sporadic trading, the Company does
not believe that an established trading market exists for its Common Stock.
MAINTAINING LISTING ON AMERICAN STOCK EXCHANGE. The Company began trading
on the American Stock Exchange on March 31, 1998. The American Stock Exchange
may at its discretion suspend or delist the securities of a company without
notice if, in the opinion of the exchange, certain circumstances apply,
including any one of the following: the financial condition and/or operating
results of the company appear to be unsatisfactory; it appears that the extent
of public distribution or the aggregate market value of the security has become
so reduced as to make further dealings on the exchange inadvisable; the Company
has sold or otherwise disposed of its principal operating assets, or has ceased
to be an operating company; the company has failed to comply with the listing
requirements of the exchange; or any other event has occurred or condition
exists that makes further trading on the exchange unwarranted. Because many of
these circumstances lie beyond the control of the Company, and because the
American Stock Exchange may determine at its discretion whether cause for
suspension or delisting exists, there is a risk that the Company may no longer
be able to list its shares for trading on the American Stock Exchange or any
other stock exchange or market system. In that event, the price of the Common
Stock would be materially, adversely affected and the ability of investors to
sell their shares of the Common Stock could be seriously impaired.
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
the Offering could adversely affect the market price for the Common Stock. Upon
completion of the Offering, the Company will have 21,324,428 shares of Common
Stock outstanding. Of these shares, 8,436,154 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.
10
<PAGE> 13
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.
ANTITAKEOVER EFFECTS OF CERTAIN CHARTER PROVISIONS AND DELAWARE LAW.
Certain provisions of the Company's Certificate of Incorporation and of Delaware
law could discourage potential acquisition proposals and could delay or prevent
a change in control of the Company. Such provisions could diminish the
opportunities for stockholders to participate in tender offers, including tender
offers at a price above the then current market value of the Company's Common
Stock. See "Description of Capital Stock -- Section 203 of the Delaware General
Corporation Law." Such provisions may also inhibit fluctuations in the market
price of Company Common Stock that could result from takeover attempts. In
addition, while the Company currently has no plans to issue any preferred stock,
the Company's Certificate of Incorporation, as amended, authorizes the Board of
Directors to issue up to 666,667 shares of Preferred Stock without further
stockholder approval. Issuance of preferred stock could have the effect of
delaying, deterring or preventing a change in control of the Company. The
issuance of additional series of preferred stock could also adversely affect the
voting power of the holders of Common Stock, including the loss of voting
control to others. The Board of Directors also has the authority to fix and
determine the relative rights and preferences of preferred shares, as well as
the authority to issue such shares, without further stockholder approval. As a
result, the Board of Directors could authorize the issuance of a series of
Preferred Stock which would grant to holders preferred rights to the assets of
the Company upon liquidation, the right to receive dividends before dividends
would be declared to holders of Common Stock, and the right to the redemption of
such shares, together with a premium, prior to the redemption of the Common
Stock, or such other preferred provisions as the Board of Directors may in its
sole discretion deem appropriate. Holders of Common Stock have no redemption
rights or other preferences.
GOVERNMENTAL REGULATION. The Company's operations must meet federal,
state and local regulatory standards in the areas of safety, health and
environmental pollution and waste control. If the Company fails to comply with
these regulations, the Company could be subject to liability ranging from
monetary fines and charges to injunctive actions, any of which would adversely
affect the Company. Future changes in these regulations could also have a
material adverse effect on the Company.
ABSENCE OF DIVIDENDS. The Company has not paid cash dividends on its
Common Stock and does not anticipate that it will do so in the foreseeable
future. Furthermore, dividends are subject to limitations and restrictions under
the terms of the Company's indebtedness to various institutional lenders,
including a prohibition on the payment of dividends without the prior written
consent of the lenders.
ITEM 2. PROPERTIES
The Company maintains its administrative offices and manufacturing plant
in a leased 250,000 sq. ft. facility at 200 North Berry Street, Brea,
California. The lease has a remaining term of 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.
ITEM 3. LEGAL PROCEEDINGS
On May 27, 1994, the Company was served with a complaint in the case
captioned Miriam Brown v. Mr. Coffee, inc. et al. (Civil Action No. 13531), in
the Delaware Court of Chancery, New Castle County. The complaint names the
Company, Mr. Coffee and certain individuals including Jean R. Perrette and
Kenneth W. Keegan, both former directors and officers of the Company, as
defendants in a purported class action lawsuit. The complaint alleges that the
individuals named as co-defendants breached their fiduciary duties as directors
of Mr. Coffee by, among other things, their alleged efforts to entrench
themselves in office and prevent Mr. Coffee's public shareholders from
maximizing the value of their holdings, engaging in plans and schemes unlawfully
to thwart offers and proposals from third parties, and approving or causing the
Company and others to agree to vote in favor of a merger with Health o meter
Products, Inc. The Company is alleged to have participated in and advanced the
alleged breaches. The plaintiff
11
<PAGE> 14
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
On March 31, 1998 the Company's stock began trading on the American Stock
Exchange under the ticker symbol KFI. Prior to that date the Company's common
stock traded on the Nasdaq SmallCap Market under the ticker symbol SOFA. The
following table sets forth the high and low per share prices for the Company's
Common Stock for each quarters during the 1997 and 1996 fiscal years. Quotations
are as reported by Nasdaq.
<TABLE>
<CAPTION>
1997 1996
------------- ------------
Quarter High Low High Low
------- ----- ----- ----- -----
<S> <C> <C> <C> <C>
First ................ $2.06 $1.25 $2.56 $ .88
Second ............... 1.81 1.48 1.63 .69
Third ................ 4.19 1.50 2.19 .50
Fourth ............... 3.25 2.13 2.13 1.00
</TABLE>
As of March 2, 1998, there were approximately 355 holders of record of the
Company's common stock. The Company has paid no dividends to date and does not
expect to do so in the foreseeable future.
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<PAGE> 15
ITEM 6. SELECTED FINANCIAL DATA
The following data as of and for the year ended February 1, 1998 has been
derived from consolidated financial statements appearing elsewhere herein that
have been audited by Arthur Andersen LLP, independent public accountants. The
following data as of February 2, 1997 and for each of the two years in the
period ended February 2, 1997 has been derived from consolidated financial
statements appearing elsewhere herein that have been audited by Ernst & Young
LLP, independent auditors. The following data as of January 28, 1996, January
29, 1995 and December 31, 1993 and for the years ended December 31, 1994 and
1993 and for the month ended January 29, 1995 has been derived from audited
consolidated financial statements not included herein. The following data for
the month ended January 30, 1994 is unaudited. The information set forth below
is not necessarily indicative of the results of future operations and should be
read in conjunction with the consolidated financial statements and notes thereto
appearing elsewhere in this Annual Report on Form 10-K.
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------------------------------------------------
February 1, February 2, January 28, December 31, December 31,
1998 (4) 1997 (4) 1996 (4) 1994 1993
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(in thousands except per share data)
RESULTS OF OPERATIONS:
Net sales $ 115,201 $ 112,737 $ 122,319 $ 116,471 $ 96,894
Gross profit 59,048 56,247 62,467 62,949 50,792
Loss from operations (5,594) (12,447) (9,388) (2,398) (7,852)
Gain from sale of Mr.
Coffee stock (2) ___ ___ ___ 12,115 ___
Income (loss) before
extraordinary items (7,480) (13,389) (8,715) 5,831 (9,751)
Extraordinary items (3) ___ ___ ___ (436) (221)
Net income (loss) (7,480) (13,389) (8,715) 5,395 (9,972)
Income (loss) per share (1):
Income (loss) before
extraordinary items (0.39) (1.28) (2.21) 1.08 (3.88)
Extraordinary items ___ ___ ___ (0.08) (0.09)
Net income (loss) (0.39) (1.28) (2.21) 1.00 (3.97)
Number of shares used in
computing income (loss)
per share (1) 19,021 10,445 3,950 5,394 2,510
</TABLE>
<TABLE>
<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
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>
February 1, February 2, January 28, January 29, December 31,
1998 1997 1996 1995 1993
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(in thousands)
BALANCE SHEET DATA:
Total assets $ 45,312 $ 43,087 $ 46,866 $ 53,750 $ 64,749
Inventories 16,013 14,013 14,627 18,016 14,690
Working capital deficiency (922) (2,182) (6,878) (3,751) (1,404)
Intangible assets 15,557 16,890 18,236 19,910 22,826
Short-term debt (2) 22 41 19 17 1,147
Long-term debt (2) 13,731 6,306 5,584 2,181 17,700
Stockholders' equity 9,892 15,543 13,985 22,700 20,626
</TABLE>
(1) Per share amounts reflect the adoption of SFAS 128 and represents diluted
per share amounts. See Note 1 to the Consolidated Financial Statements.
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 while the
fiscal years ended February 1, 1998 and January 28, 1996 are 52-week
periods.
(5) Average weekly sales (shipments) in January are lower than other months
due to seasonally low order rates in the last three weeks of December.
Therefore, the operating loss reported in January is higher than other
months in the fiscal years presented.
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<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere herein.
The Company has reported losses from operations in each of the past five
years due to inefficiencies within its operations and due to an industry-wide
softness in retail sales. As a result of such losses, the Company had an
accumulated deficit of $41,830,000 and a working capital deficiency of $922,000
at February 1, 1998.
The Company's management, which underwent a substantial restructuring
after the 1996 financings discussed under "Liquidity and Capital Resources," has
developed a strategic plan for the business which provides, among other things,
for remodeling showrooms to provide a more appealing setting for customers,
adding new showrooms 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. These
plans have been 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
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 fiscal 1998, management plans to remodel and upgrade approximately 26
existing showrooms, as well as add approximately 20 additional showrooms, at an
aggregate cost of approximately $7.3 million. Management expects to fund such
capital expenditures by internally generated cash and by borrowings under the
Company's revolving credit facility. 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.
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 drew down on December 30, 1997. At the time the standby credit facility
was drawn down, the Company issued to the investors warrants to purchase an
aggregate of up to 560,000 additional shares of common stock at $1.25 per share.
Also in August 1997, the Company renegotiated the terms of its existing
revolving line of credit with Congress Financial Corporation 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. As of February 1, 1998, the Company had unused borrowing capacity under
its credit facility of approximately $4 million.
Under the terms of the agreement related to the Company's subordinated
notes, as well as under the terms of the revolving credit agreement, 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. As of February 1, 1998, the Company was out of compliance
14
<PAGE> 17
with certain of the financial covenants contained in both of the agreements but
has obtained waivers. The Company may also be in violation of certain of these
covenants as of interim periods during 1998, but has obtained agreements to
waive or amend covenants related to these potential default events. Management
believes that it will be in compliance with other covenants, but in the event of
noncompliance, the Company also believes it can obtain waivers. However, there
can be no assurance that additional waivers will be obtained if the Company
fails to maintain compliance.
The Company believes that borrowings under its credit facility and
internally generated funds will be sufficient to fund its requirements for
working capital and capital expenditures through the end of fiscal year 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
sufficient funds. The Company currently contemplates that other sources of
capital would be available, although this situation could change.
The aggregate annual maturities of long-term debt during each of the five
fiscal years subsequent to February 1, 1998 are approximately as follows:
$22,000 in 1998, $60,000 in 1999, $7,879,000 in 2000, $4,227,000 in 2001, and
$4,000,000 in 2002. Management anticipates such payments will be made out of
operating cash flow or refinancing.
As of February 1, 1998, the Company had cash and cash equivalents of
$916,000 and borrowing capacity under its revolving credit agreement of
$4,000,000. Cash flow activity for the fiscal years ended February 1, 1998,
February 2, 1997 and January 28, 1996 is presented in the Consolidated
Statements of Cash Flows.
During April 1998, the Company completed the sale of 2,963,889 shares and
received net proceeds of approximately $7.5 million.
1997 Cash Flow During fiscal 1997, cash and cash equivalents decreased by
$311,000. Operating activities used net cash of $4,998,000, principally from a
cash loss from operations of $3,806,000 and an increase in inventory of
$2,000,000 which was partially offset by an increase in Accounts Payable and
Other Liabilities of $753,000. The increase in inventory is principally due to
the Company's decision to expand its accessories business. Investing activities
during the period included capital expenditures of $3,521,000, nearly all of
which was used to remodel certain retail showrooms and open one new showroom.
Financing activities during the period consisted principally of net borrowings
of $1,813,000 under the Company's revolving credit facility and $6,500,000
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 $7,300,000 related
to this program 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 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.
15
<PAGE> 18
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>
Fiscal Year Ended
------------------------------------------
February 1, February 2, January 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of sales 48.7 50.1 48.9
------------ ------------ ------------
Gross profit 51.3 49.9 51.1
Operating expenses:
Selling 47.3 51.1 49.3
General and administrative 7.9 9.0 8.7
Amortization of goodwill 0.9 0.9 0.8
------------ ------------ ------------
56.1 61.0 58.8
------------ ------------ ------------
Loss from operations (4.8) (11.1) (7.7)
Interest expense (1.5) (1.1) (0.6)
Other income (expense) (0.1) 0.3 0.1
------------ ------------ ------------
Loss before income taxes (6.4) (11.9) (8.2)
Income tax benefit -- -- (1.1)
------------ ------------ ------------
Net loss (6.4)% (11.9)% (7.1)%
============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
STORE (SHOWROOM) DATA Fiscal Year Ended (3)
-------------------------------------------
February 1, February 2, January 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Stores open at beginning of period 82 83 89
Stores opened during period 1 1 4
Stores closed during period 2 2 10
------------ ------------ ------------
Stores open at end of period 81 82 83
Average sales per showroom (1)(in 000's) 1,422 1,361 1,432
Comparable store sales increase (decrease) (2) 2.7% (6.0%) (2.9%)
</TABLE>
(1) Based upon the weighted average number of stores open during the period
indicated.
(2) Comparable store sales are calculated by excluding the net sales of any
store for any month of the period if the store was not open during the
same month of the prior period. Also, a store opened at any time during
the month is deemed to have been open for the entire month.
(3) Fiscal 1997 and 1995 were 52 week years while fiscal 1996 was a 53 week
year.
52 WEEKS ENDED FEBRUARY 1, 1998 (FISCAL 1997) AS COMPARED TO 53 WEEKS ENDED
FEBRUARY 2, 1997 (FISCAL 1996)
Net Sales. Net sales for fiscal 1997, a 52 week fiscal period, were
$115,201,000 compared with $112,737,000 for fiscal 1996, a 53 week fiscal
period. Sales for the 53rd week of fiscal 1996 totaled $3,417,000; on a
comparable 52 week basis, sales increased $5,881,000 or 5.4% with same store
sales increasing 5.9%. The increase in sales is due principally to management's
strategy of remodeling existing showrooms to provide a more appealing setting
for customers (16 showrooms were remodeled in fiscal 1997), to management's
strategies of developing new products, increasing the promotion and sale of
accessories and revamping the marketing and sales promotion program and to
improved economies in selected regions where the Company operates
Gross Profit. Gross profit was 51.3% of net sales in fiscal 1997 compared
with 49.9% of net sales in fiscal 1996. The increase in gross profit resulted
primarily from the Company's decision in the third quarter of fiscal 1996 to
raise prices to competitive levels and reduce promotional discounting.
Selling Expenses. Selling expenses were $54,481,000 or 47.3% of net sales
in fiscal 1997 and were $57,573,000 or 51.1% of net sales in fiscal 1996. The
decrease of $3,092,000 in selling expenses was primarily due to a decrease of
$1,737,000 in variable selling
16
<PAGE> 19
payroll, resulting from a new commission structure, and decreases of $1,044,000
and $554,000 in store non-payroll expenses and delivery expenses, respectively,
resulting primarily from tighter cost controls, offset in part by increased
advertising costs of $574,000.
General and Administrative Expenses. General and administrative expenses
for fiscal 1997 were $9,141,000 compared to $10,101,000, for fiscal 1996, a
decrease of $960,000. This decrease was primarily the result of lower costs
generally and specifically lower professional fees, contract labor costs and
computer rental and maintenance costs which were offset in part by higher
management payroll costs.
Interest Expense. Interest expense for fiscal 1997 increased by $493,000
over fiscal 1996 due to higher average debt outstanding.
Income Taxes. The Company paid no taxes and no tax benefit was recorded
for either of fiscal 1997 or 1996 due to uncertainties regarding the realization
of deferred tax assets available.
As of February 1, 1998, the Company had federal net operating loss
carryforwards of approximately $37 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 1, 1998, approximately $4 million of
the limited losses were available. In addition, the Company had state net
operating loss carryforwards of approximately $30 million which begin to expire
in the year 1998, if not utilized.
The valuation allowance for deferred tax assets totaled $16,304,000 at
February 1, 1998 and $13,643,000 at February 2, 1997. The valuation allowance
increased since the realization of net deferred tax assets is uncertain.
Net Loss. As a result of the above factors, the net loss was $7,480,000
for fiscal 1997 as compared to a net loss of $13,389,000 for fiscal 1996. Net
loss per share in the 1997 period was $0.39 based on 19,021,000 shares
outstanding. In fiscal 1996 the net loss per share was $1.28 based on 10,445,000
weighted average shares outstanding.
53 WEEKS ENDED FEBRUARY 2, 1997 (FISCAL 1996) AS COMPARED TO 52 WEEKS ENDED
JANUARY 28, 1996 (FISCAL 1995)
Net Sales. Net 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 (1) an
industry-wide softness in retail sales, (2) insufficient cash during the first
eight months of fiscal 1996 to timely purchase raw materials needed for the
manufacture of customer orders, and (3) 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 preopening 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. After 1996 the Company amortized 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
17
<PAGE> 20
$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.
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. 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
above.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As previously disclosed, the Board of Directors of the Company, upon the
recommendation of the Audit Committee of the Board on September 19, 1997,
terminated the Company's relationship with Ernst & Young LLP and engaged Arthur
Andersen LLP as its new independent accountants to audit the Company's
consolidated financial statements. The reports of Ernst & Young LLP on the
Company's consolidated financial statements for the 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
advice was sought. The Company did not perceive that there were any differences
with regard to substantive accounting issues between Arthur Andersen LLP and the
Company's prior auditors.
The Company has supplied a copy of this disclosure to both Ernst & Young
LLP and Arthur Andersen LLP and neither has indicated to the Company that it
objects or disagrees with this disclosure.
PART III
The information required by Items 10 through 13 of this Part is
incorporated by reference from the Company's Proxy Statement, under the captions
"Election of Directors", "Security Ownership of Certain Beneficial Owners and
Management", "Compensation of Executive Officers" and "Certain Relationships and
Related Transactions", which Proxy Statement will be mailed to stockholders in
connection with the Company's annual meeting of stockholders which is scheduled
to be held in June, 1998.
18
<PAGE> 21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) and (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Report of Arthur Andersen LLP, Independent Public Accountants 23
Report of Ernst & Young LLP, Independent Auditors 24
Consolidated Balance Sheet at February 1, 1998 and February 2, 1997 25
Consolidated Statement of Operations for the years ended February 1, 1998,
February 2, 1997 and January 28, 1996 26
Consolidated Statement of Stockholders' Equity for the years ended February 1, 1998,
February 2, 1997 and January 28, 1996 27
Consolidated Statement of Cash Flows for the years ended February 1, 1998,
February 2, 1997 and January 28, 1996 28
Notes to Consolidated Financial Statements 29
Schedule II- Valuation and Qualifying Accounts 40
Schedules I, III, IV, and V have been omitted since they are not applicable.
</TABLE>
19
<PAGE> 22
(a) (3) EXHIBITS
3.1 Certificate of Incorporation. (1)
3.1(a) Certificate of Amendment of Certificate of Incorporation dated
November 28, 1994. (5)
3.1(b) Certificate of Amendment of Certificate of Incorporation dated August
1, 1995.(6)
3.1(c) Certificate of Amendment of Certificate of Incorporation dated June
7,1996.(7)
3.1(d) Certificate of Amendment of Certificate of Incorporation dated August
1, 1996.(7)
3.2 By Laws.(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)
4.1(a) First Amendment to Loan and Security Agreement dated as of May 10,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(6)
4.1(b) Second Amendment to Loan and Security Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
4.1(c) Third Amendment to Loan and Security Agreement dated as of November
25, 1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
4.1(d) Amended and Restated Subordination Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Furniture, Inc.(14)
4.1(e) Fourth Amendment to Loan and Security Agreement dated as of August 14,
1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(12)
4.1(f) Fifth Amendment to Loan and Security Agreement dated as of December
11, 1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.
4.1(g) Letter agreement between Krause's Furniture, Inc. and Congress
Financial Corporation (Western).(12)
4.2 Guarantee dated January 20, 1995 by Krause's Furniture, Inc. to
Congress Financial Corporation (Western). (3)
4.5 Certificate of Designations of Preferred Stock. (4)
10.1 1994 Directors Stock Option Plan. (5)
10.2 1990 Employees Stock Option Plan. (2)
10.3 Form of Securities Purchase Agreement between the Company, GECC and
certain other stockholders of the Company dated as if August 26,
1996.(8)
10.4 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due August 31,
2001.(8)
10.5 Form of Warrant to Purchase 1,400,000 Shares of Common Stock.(8) 10.6
Form of Securities Purchase Agreement between the Company and Certain
Stockholders dated as of August 26, 1996.(8)
10.7 Form of Stockholders Agreement among the Company, GECC and certain
other stockholders of the Company dated as of August 26, 1996.(8)
10.8 Form of Registration Rights Agreement among the Company and GECC and
certain other stockholders of the Company dated as of August 26,
1996.(8)
10.9 Employment agreement with Philip M. Hawley.(8)
10.10 1997 Stock Incentive Plan. (9)
10.11 Supplemental Securities Purchase Agreement among Krause's Furniture,
Inc., General Electric Corporation and Japan Omnibus Ltd., dated as of
August 14, 1997. (12)
10.12 Letter agreement dated August 14, 1997 regarding Permal Group
shares.(12)
10.13 Letter agreement dated August 14, 1997 regarding warrant dilution
provisions.(12)
11 Statement regarding computation of per share earnings.
21 Subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2 Consent of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule.
- ---------------
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4
dated June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form 10-K
for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K dated
as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
20
<PAGE> 23
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form 10-K
dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1
dated March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibits to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
(14) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of May 2, 1997 (File No. 0-17868)
(b) REPORTS ON FORM 8-K
The Registrant did not file any reports on Form 8-K during the last
quarter of the period covered by this report.
21
<PAGE> 24
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
KRAUSE'S FURNITURE, INC.
Date: April 30, 1998 By: /s/ Philip M. Hawley
-------------------------------
Philip M. Hawley
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following person on behalf of the Registrant
and in the capacities and on the dates indicated.
Date: April 30, 1998 /s/ Philip M. Hawley
-------------------------------
Philip M. Hawley
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: April 30, 1998 /s/ Thomas M. DeLitto
-------------------------------
Thomas M. DeLitto
Director and Vice Chairman of the Board
Date: April 30, 1998 /s/ Robert A. Burton
-------------------------------
Robert A. Burton
Senior Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting
Officer)
Date: April 30, 1998 /s/ Kamal G. Abdelnour
-------------------------------
Kamal G. Abdelnour
Director
Date: April 30, 1998 /s/ Jeffrey H. Coats
-------------------------------
Jeffrey H. Coats
Director
Date: April 30, 1998 /s/ Peter H. Dailey
-------------------------------
Peter H. Dailey
Director
Date: April 30, 1998 /s/ John A. Gavin
-------------------------------
John A. Gavin
Director
22
<PAGE> 25
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
3.1 Certificate of Incorporation. (1)
3.1(a) Certificate of Amendment of Certificate of Incorporation dated
November 28, 1994. (5)
3.1(b) Certificate of Amendment of Certificate of Incorporation dated August
1, 1995.(6)
3.1(c) Certificate of Amendment of Certificate of Incorporation dated June
7,1996.(7)
3.1(d) Certificate of Amendment of Certificate of Incorporation dated August
1, 1996.(7)
3.2 By Laws.(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)
4.1(a) First Amendment to Loan and Security Agreement dated as of May 10,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(6)
4.1(b) Second Amendment to Loan and Security Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.
4.1(c) Third Amendment to Loan and Security Agreement dated as of November
25, 1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.
4.1(d) Amended and Restated Subordination Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Furniture, Inc.
4.1(e) Fourth Amendment to Loan and Security Agreement dated as of August 14,
1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(12)
4.1(f) Fifth Amendment to Loan and Security Agreement dated as of December
11, 1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.
4.1(g) Letter agreement between Krause's Furniture, Inc. and Congress
Financial Corporation (Western).(12)
4.2 Guarantee dated January 20, 1995 by Krause's Furniture, Inc. to
Congress Financial Corporation (Western). (3)
4.5 Certificate of Designations of Preferred Stock. (4)
10.1 1994 Directors Stock Option Plan. (5)
10.2 1990 Employees Stock Option Plan. (2)
10.3 Form of Securities Purchase Agreement between the Company, GECC and
certain other stockholders of the Company dated as if August 26,
1996.(8)
10.4 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due August 31,
2001.(8)
10.5 Form of Warrant to Purchase 1,400,000 Shares of Common Stock.(8) 10.6
Form of Securities Purchase Agreement between the Company and Certain
Stockholders dated as of August 26, 1996.(8)
10.7 Form of Stockholders Agreement among the Company, GECC and certain
other stockholders of the Company dated as of August 26, 1996.(8)
10.8 Form of Registration Rights Agreement among the Company and GECC and
certain other stockholders of the Company dated as of August 26,
1996.(8)
10.9 Employment agreement with Philip M. Hawley.(8)
10.10 1997 Stock Incentive Plan. (9)
10.11 Supplemental Securities Purchase Agreement among Krause's Furniture,
Inc., General Electric Corporation and Japan Omnibus Ltd., dated as of
August 14, 1997. (12)
10.12 Letter agreement dated August 14, 1997 regarding Permal Group
shares.(12)
10.13 Letter agreement dated August 14, 1997 regarding warrant dilution
provisions.(12)
11 Statement regarding computation of per share earnings.
21 Subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2 Consent of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule.
- ----------------
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4
dated June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form 10-K
for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K dated
as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
<PAGE> 26
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form 10-K
dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1
dated March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibits to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
<PAGE> 27
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the accompanying consolidated balance sheet of Krause's
Furniture, Inc. as of February 1, 1998, and the related consolidated statements
of operations, stockholders' equity and cash flows for the year then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Krause's
Furniture, Inc. as of February 1, 1998 and the results of their operations and
their cash flows for the year then ended in conformity with generally accepted
accounting principles.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 11, 1998
23
<PAGE> 28
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the accompanying consolidated balance sheet of Krause's
Furniture, Inc. as of February 2, 1997, and the related consolidated statements
of operations, stockholders' equity and cash flows for the fiscal years ended
February 2, 1997 and January 28, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14(a) as it relates to the fiscal
years ended February 2, 1997 and January 28, 1996. These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedule 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 the consolidated results of its
operations and its cash flows for the fiscal years ended February 2, 1997 and
January 28, 1996, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, as it relates to
the fiscal years ended February 2, 1997 and January 28, 1996, 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
24
<PAGE> 29
KRAUSE'S FURNITURE, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
February 1, February 2,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 916 $ 1,227
Accounts receivable, net of allowance for doubtful
accounts of $164 ($327 at February 2, 1997) 1,148 1,120
Inventories 16,013 14,013
Prepaid expenses 515 1,193
------------ ------------
Total current assets 18,592 17,553
Property, equipment, and leasehold improvements, net 8,577 6,389
Goodwill, net 14,366 15,386
Leasehold interests, net 1,191 1,504
Other assets 2,586 2,255
------------ ------------
$ 45,312 $ 43,087
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,111 $ 7,506
Accrued payroll and related expenses 1,993 1,468
Other accrued liabilities 3,967 5,099
Customer deposits 5,421 5,621
Notes payable 22 41
------------ ------------
Total current liabilities 19,514 19,735
Long-term liabilities:
Notes payable 13,731 6,306
Other 2,175 1,503
------------ ------------
Total long-term liabilities 15,906 7,809
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.001 par value; 666,667 shares
authorized; no shares outstanding -- --
Common stock, $.001 par value; 35,000,000 shares authorized;
19,020,539 shares outstanding 19 19
Capital in excess of par value 51,703 49,874
Accumulated deficit (41,830) (34,350)
------------ ------------
Total stockholders' equity 9,892 15,543
------------ ------------
$ 45,312 $ 43,087
============ ============
</TABLE>
See accompanying notes.
25
<PAGE> 30
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Fiscal Years Ended
------------------------------------------------
February 1, February 2, January 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 115,201 $ 112,737 $ 122,319
Cost of sales 56,153 56,490 59,852
------------ ------------ ------------
Gross profit 59,048 56,247 62,467
Operating expenses:
Selling 54,481 57,573 60,257
General and administrative 9,141 10,101 10,578
Amortization of goodwill 1,020 1,020 1,020
------------ ------------ ------------
64,642 68,694 71,855
------------ ------------ ------------
Loss from operations (5,594) (12,447) (9,388)
Interest expense (1,723) (1,230) (721)
Other income (expense) (163) 288 67
------------ ------------ ------------
Loss before income taxes (7,480) (13,389) (10,042)
Income tax benefit -- -- (1,327)
------------ ------------ ------------
Net loss $ (7,480) $ (13,389) $ (8,715)
============ ============ ============
Basic and diluted loss per share $ (0.39) $ (1.28) $ (2.21)
============ ============ ============
Number of shares used in computing
loss per share 19,021 10,445 3,950
============ ============ ============
</TABLE>
See accompanying notes.
26
<PAGE> 31
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(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 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 -- -- 3,066 3 3,063 -- 3,066
stock
Issuance of common stock for
cash, net of expenses of $448 -- -- 10,669 11 10,210 -- 10,221
Issuance of common stock
purchase warrant -- -- -- -- 1,400 -- 1,400
Compensation expense on
stock option grant -- -- -- -- 293 -- 293
Repurchase of common stock -- -- (12) -- (33) -- (33)
Net loss -- -- -- -- -- (13,389) (13,389)
-------- -------- -------- -------- -------- -------- --------
Balance at February 2, 1997 -- -- 19,021 19 49,874 (34,350) 15,543
Issuance of common stock
purchase warrant -- -- -- -- 1,625 -- 1,625
Compensation expense on
stock option grant -- -- -- -- 204 -- 204
Net loss -- -- -- -- -- (7,480) (7,480)
-------- -------- -------- -------- -------- -------- --------
Balance at February 1, 1998 -- $ -- 19,021 $ 19 $ 51,703 $(41,830) $ 9,892
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes.
27
<PAGE> 32
KRAUSE'S FURNITURE, INC
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Fiscal Years Ended
-----------------------------------------------
February 1, February 2, January 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (7,480) $ (13,389) $ (8,715)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 2,431 2,561 2,760
Deferred income taxes -- -- 920
Other non-cash charges 1,243 618 283
Change in assets and liabilities:
Accounts receivable (28) (334) 404
Inventories (2,000) 614 3,389
Prepaid expenses and other assets 283 229 1,210
Income tax refund receivable -- 1,467 (1,467)
Accounts payable and accrued liabilities 753 (4,688) (2,166)
Customer deposits (200) (1,393) 205
----------- ----------- -----------
Net cash used by operating activities (4,998) (14,315) (3,177)
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures (3,521) (806) (1,883)
Proceeds from sale-leaseback -- -- 1,039
----------- ----------- -----------
Net cash used by investing activities (3,521) (806) (844)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from long-term borrowings 145,458 143,002 141,371
Principal payments on long-term debt (137,250) (138,178) (137,966)
Proceeds from issuance of common stock -- 10,221 --
Other -- (33) --
----------- ----------- -----------
Net cash provided by financing activities 8,208 15,012 3,405
----------- ----------- -----------
Net decrease in cash (311) (109) (616)
Cash and cash equivalents at beginning of year 1,227 1,336 1,952
----------- ----------- -----------
Cash and cash equivalents at end of year $ 916 $ 1,227 $ 1,336
=========== =========== ===========
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 754 $ 466 $ 543
Income taxes -- 9 --
Noncash investing and financing activities:
Preferred stock converted into common stock -- 7,523 2,932
Exchange of notes payable and related accrued
interest for common stock -- 3,066 --
Issuance of common stock purchase warrant 1,625 1,400 --
</TABLE>
See accompanying notes.
28
<PAGE> 33
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements include the accounts of Krause's
Furniture, Inc., (the "Company") and its wholly owned subsidiaries, including
the Company's principal subsidiary, Krause's Custom Crafted Furniture Corp.,
formerly known as Krause's Sofa Factory ("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
fiscal year ended February 1, 1998 (fiscal 1997) is a 52-week period; the fiscal
year ended February 2, 1997 (fiscal 1996) is a 53-week period; and the fiscal
year ended January 28, 1996 (fiscal 1995) is a 52-week period. 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 1997 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. As of February 1, 1998 there were 81
Company-owned showrooms, all of which are leased, located in 12 states.
Cash and cash equivalents
Cash and cash equivalents include cash on hand, cash in money market
accounts and certificates of deposit with original maturities of less than three
months, carried at cost, which approximates fair value.
Fair values of financial instruments
Fair values of cash and cash equivalents approximate cost due to the short
period of time to maturity. The fair values of the secured revolving credit
note, the subordinated notes, and other notes are based on borrowing rates
currently available to the Company for loans with similar terms or maturity and
approximate the carrying amounts reflected in the accompanying consolidated
financial statements.
29
<PAGE> 34
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 1, February 2,
1998 1997
------------ ------------
<S> <C> <C>
(in thousands)
Finished goods $ 12,368 $ 10,693
Work in progress 66 254
Raw materials 3,579 3,066
------------ ------------
$ 16,013 $ 14,013
============ ============
</TABLE>
Showroom pre-opening expenses
Showroom pre-opening expenses are capitalized and amortized over periods
of up to 12 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 $1,099,000 in fiscal 1997,
$1,073,000 in fiscal 1996, and $1,100,000 in fiscal 1995. Property, equipment
and leasehold improvements are summarized as follows:
<TABLE>
<CAPTION>
February 1, February 2,
1998 1997
------------ ------------
<S> <C> <C>
(in thousands)
Leasehold improvements $ 10,708 $ 9,241
Construction in progress 1,922 463
Machinery and equipment 3,014 2,962
Office and store furniture 886 872
------------ ------------
16,530 13,538
Less accumulated depreciation and amortization (7,953) (7,149)
------------ ------------
$ 8,577 $ 6,389
============ ============
</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.
30
<PAGE> 35
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 $5,960,000 as of February 1, 1998
and $4,940,000 as of February 2, 1997.
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 1, 1998. The Company's analysis at February 1, 1998 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
1997, 1996, and 1995 indicate that it is at least reasonably possible that such
circumstances could arise in fiscal 1998.
Leasehold interests
Leasehold interests represent the present value of the excess of fair
market value lease rates on certain retail facility leases as compared to the
stated lease rates contained in the leases as determined at the date the leases
were acquired. Amortization of leasehold interests is on a straight-line basis
over the remaining lease terms. Accumulated amortization amounted to $2,132,000
as of February 1, 1998 and $1,819,000 as of February 2, 1997.
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 1, 1998, February 2, 1997, and January 28, 1996 were
$11,758,000, $11,184,000 and $11,181,000, 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.
31
<PAGE> 36
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130 (SFAS 130), "Reporting
Comprehensive Income", and No. 131 (SFAS 131), "Disclosures About Segments of an
Enterprise and Related Information." These statements are effective for fiscal
years commencing after December 15, 1997. The Company will be required to comply
with the provisions of these statements in fiscal 1998. The impact of adoption
of these pronouncements is not expected to be material to the Company's
financial position or results of operations.
Loss per share
Loss per share for fiscal 1997, 1996 and 1995 was 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 February 2, 1997 and January 28, 1996, had occurred
at the beginning of the years, the net loss per share would have been $1.20 and
$2.11, respectively.
The Company has adopted SFAS 128, "Earnings Per Share", and applied this
pronouncement to all periods presented. This statement requires the presentation
of both basic and diluted net income (loss) per share for financial statement
purposes. Basic net income (loss) per share is computed by dividing income
(loss) available to common stockholders by the weighted average number of common
shares outstanding. Diluted net income (loss) per share includes the effect of
the potential shares outstanding, including dilutive stock options and warrants
using the treasury stock method. Because the impact of options and warrants are
antidilutive, there is no difference between the loss per share amounts computed
for basic and diluted purposes. Also, the adoption of SFAS 128 resulted in no
change in amounts previously reported.
Credit risk
Finance options are offered to customers through non-affiliated third
parties, at no material risk to the Company. Non-financed retail consumer
receivables are collected during the normal course of operations. There is no
significant concentration of credit risk and credit losses have been minimal.
2. OPERATIONS
The Company has reported losses from operations in each of the past five
years due to inefficiencies within its operations and due to an industry-wide
softness in retail sales. As a result of such losses, the Company had an
accumulated deficit of $41,830,000 and a working capital deficiency of $922,000
at February 1, 1998.
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 (the "Original 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 drew down on December 30, 1997. At the time the standby credit facility
was drawn down, the Company issued to the investors warrants to purchase 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 Original Note due
August 31, 2001, in the principal amount of $5,000,000 and certain additional
notes in aggregate principal amount of
32
<PAGE> 37
$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 terms of its revolving
credit agreement by, among other things, making a change in the advance rate
which provided greater borrowing capacity.
Under the terms of the agreement related to the Company's subordinated
notes, as well as under the terms of the revolving credit agreement, 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. As of February 1, 1998, the Company was out of compliance with
certain of the financial covenants contained in both of the agreements but has
obtained waivers. The Company may also be in violation of certain of these
covenants as of interim periods during 1998, but has obtained agreements to
waive or amend covenants related to these potential default events. Management
believes it will be in compliance with other covenants, but in the unlikely
event of noncompliance, the Company also believes it can obtain waivers.
However, there can be no assurance that additional 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 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. NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
February 1, February 2,
1998 1997
----------- -----------
<S> <C> <C>
(in thousands)
Secured revolving credit notes $ 3,812 $ 1,999
Subordinated notes payable to shareholders 12,001 5,133
Unamortized debt discount, net of accumulated amortization of
$590,000 at February 1, 1998 and $137,000 at February 2, 1997 (2,435) (1,263)
Other notes 375 478
----------- -----------
13,753 6,347
Less current portion 22 41
----------- -----------
$ 13,731 $ 6,306
=========== ===========
</TABLE>
The secured revolving credit notes were issued under a revolving credit
agreement between Krause's and a financial institution (the "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 February 1,1998, borrowing
under the revolving credit facility was limited to approximately $7.8 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 February 1, 1998).
33
<PAGE> 38
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 warrants of $925,000 was reflected in
the consolidated financial statements as a discount on the subordinated notes
and an increase in capital in excess of par value. This discount is being
amortized to interest expense using the effective interest method over the term
of the subordinated notes. The Company also issued to GECC and JOL a warrant to
purchase an aggregate amount of up to 1,000,000 shares of the Company's common
stock at a price of $0.01 per share which warrant may be completely or partially
cancelled depending on the economic performance of the Company in fiscal 1999.
Also, under the Agreement, on December 30, 1997, the Company drew on a
standby credit facility with GECC and JOL by selling additional 9.5%
subordinated notes in an aggregate principal amount of $3,500,000. As part of
the agreement, the Company issued to GECC and JOL warrants to purchase an
aggregate of up to 560,000 shares of common stock of the Company at a purchase
price of $1.25 per share. The fair value of the warrants of $700,000 was
reflected in the consolidated financial statements as a discount on the
subordinated notes and an increase in capital in excess of par value. This
discount is being amortized to interest expense using the effective interest
method over the term of the subordinated notes.
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 Original Note was payable semiannually, on a straight-line basis
over three years beginning February 1999.
Pursuant to the terms of the Agreement and the revolving credit agreement,
the Company and Krause's are required to maintain certain financial ratios and
minimum levels of tangible net worth and working capital as well as to achieve
certain levels of earnings before interest, taxes, depreciation and
amortization. In addition, the Company and Krause's are restricted from entering
into certain transactions or making certain payments and dividend distributions
without the prior consent of the lenders. As of February 1, 1998, the Company
and Krause's were not in compliance with certain of the covenants contained in
the agreements but have obtained waivers.
The aggregate annual maturities of long-term debt during each of the five
fiscal years subsequent to February 1, 1998 are approximately as follows:
$22,000 in 1998, $60,000 in 1999, $7,879,000 in 2000, $4,227,000 in 2001, and
$4,000,000 in 2002.
34
<PAGE> 39
4. INCOME TAXES
The income tax benefit recorded for the fiscal year ended January 28, 1996
consists of the following (in thousands):
<TABLE>
<S> <C>
Current federal $(2,247)
Deferred federal 920
=======
$(1,327)
=======
</TABLE>
Income tax benefits differ from the amounts computed by applying the
federal statutory rate of 34% to the loss before income taxes, as follows:
<TABLE>
<CAPTION>
Fiscal Years Ended
--------------------------------------------
February 1, February 2, January 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
(in thousands)
Tax at federal statutory rate $ (4,552) $ (3,414) $ (2,543)
Goodwill amortization 347 347 346
Adjustment of valuation allowance 2,661 5,333 2,144
State income tax, net of federal benefit (390) (742) (557)
Other (75) (386) 154
------------ ------------ ------------
$ -- $ -- $ (1,327)
============ ============ ============
</TABLE>
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 1, February 2,
1998 1997
------------ ------------
<S> <C> <C>
(in thousands)
Deferred tax liabilities $ -- $ --
Deferred tax assets:
Net operating loss carryforwards 14,200 12,075
Reserves and accruals not currently deductible for
tax purposes 2,104 1,443
Other -- 125
------------ ------------
Total deferred tax assets 16,304 13,643
Valuation allowance for deferred tax assets (16,304) (13,643)
------------ ------------
Net deferred tax assets -- --
------------ ------------
Net deferred taxes $ -- $ --
============ ============
</TABLE>
The change in the valuation allowance was a net increase of $2,661,000 for
the fiscal year ended February 1, 1998, and a net increase of $5,333,000 for the
fiscal year ended February 2, 1997. The valuation allowance was increased since
the realization of net deferred tax assets is uncertain.
As of February 1, 1998 the Company has federal net operating loss
carryforwards of approximately $37 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 1, 1998, approximately $4 million of
the limited loss carryforwards was available. In addition, the Company had state
net operating loss carryforwards of approximately $30 million, which begin to
expire in the year 1998, if not utilized.
35
<PAGE> 40
5. STOCKHOLDERS' EQUITY
At February 1, 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 in fiscal 1996 at a exercise price of $.001 per
share and 1,300,000 were issued to GECC and JOL in fiscal 1997 at a exercise
price of $1.25 (see further discussion in Note 3). The remaining 365,502
warrants have exercise prices ranging from $1.32 to $15.00 per share and
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 issued warrants to GECC and JOL to
purchase up to 1,000,000 shares of Common Stock upon the occurrence of certain
events; such warrants expire August 31, 2006. 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.
As of February 1, 1998, 5,347,740 shares of the Company's common stock are
reserved for issuance upon exercise of warrants and stock options (see Note 6)
and upon the payment of deferred stock units.
6. STOCK OPTION PLANS
The Company has elected to follow APB 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its employee stock
options because, as discussed below, the alternative fair value accounting
provided for under SFAS 123, "Accounting for Stock-Based Compensation" requires
use of option valuation models that were not developed for use in valuing
employee stock options.
The 1997 Stock Incentive Plan provides for the issuance of awards covering
up to 1,000,000 shares of Common Stock to employees, officers, directors, and
consultants. Awards under this plan can consist of options, stock appreciation
rights, dividend equivalent rights, restricted stock, performance shares,
deferred stock units or other stock based awards.
Directors who are not employees of the Company, other than one
non-employee director who has indicated that he cannot accept an award because
of his current employment by a stockholder, receive automatic grants of deferred
stock units covering shares having a fair market value of $10,000 for each year
of service as a director. These awards provide deferred compensation to
directors equivalent to an investment in shares on the date the award is
effective. Payout of the award is made in stock following a director's
retirement from the Board of Directors or death. Normally the payment is made in
five annual installments, but a director may elect to receive a single payment.
In August 1996, the Company awarded the Chief Executive Officer of the
Company an option to purchase 1,234,000 shares of common stock at an exercise
price of $1.00 per share with vesting over three years. Compensation expense was
recorded in fiscal 1997 and 1996 in the amount of $204,000 and $293,000,
respectively, based upon the vesting provisions and the market value of the
stock on the date of grant.
Options to purchase the Company's common stock are outstanding under the
Company's 1990 Employees Stock Option Plan, 1994 Directors Stock Option Plan,
and various plans established by Krause's prior to the time it was acquired by
the Company. All of these plans have been cancelled and no further grants may be
made under them.
Pro forma information regarding net loss and loss per share is required by
SFAS 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 1997
and 1996; risk-free interest rates of 6.28% and 6.85%, dividend yields of 0% for
both periods, volatility factors of the expected market price of the Company's
common stock of 82% and 68%; and a weighted-average life of the options of 7.0
and 6.5 years, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
36
<PAGE> 41
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The pro forma
disclosures are not likely to be representative of the effects on reported net
income (loss) for future years since only options granted since fiscal 1995 are
considered. The Company's pro forma information follows (in thousands, except
for per share information):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Pro forma net loss $ 7,700 $13,188
Pro forma net loss per share $ 0.40 $ 1.26
</TABLE>
As of February 1, 1998, under all option plans, a total of 2,243,958
shares of common stock are reserved for future issuance, options to purchase
2,043,958 shares of common stock were outstanding, options to purchase 758,541
were exercisable, at a weighted average exercise price of $1.27, and options for
200,000 shares were available for future grants.
The following table reflects option activity and related exercise prices,
actual and weighted average, under all stock option plans from December 31, 1994
to February 1, 1998.
<TABLE>
<CAPTION>
Weighted
Number of Actual Average
Options Exercise Price Exercise Price
--------- -------------- --------------
<S> <C> <C> <C>
Outstanding December 31, 1994 359,843 $3.09 - $8.34 $ 5.40
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
Granted 417,000 $ 1.56 $ 1.56
Forfeited (95,499) $2.16 - $7.13 $ 3.54
---------
Outstanding February 1, 1998 2,043,958 $.78 - $6.38 $ 1.29
=========
</TABLE>
The weighted average grant-date fair value of options granted during 1997
and 1996, for options where the exercise price on the date of grant was equal to
the stock price on that date, was $1.22 and $2.14, 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 1, 1998.
<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>
2,009,000 $ .78 - $1.62 $1.22 9.0 years 723,583 $1.08
34,958 $3.09 - $6.38 $5.23 3.7 years 34,958 $5.23
- ------------ -----------
2,043,958 $ .78 - $6.38 $1.29 8.9 years 758,541 $1.27
============ ===========
</TABLE>
37
<PAGE> 42
7. RETIREMENT PLAN
The Company has a 401(k) retirement plan (effective January 1, 1994) to
which eligible employees may contribute up to 18% of their annual earnings. At
its discretion the Company matches employees' contributions. The Company's
contributions were not significant in fiscal 1997, 1996 and 1995.
8. COMMITMENTS AND CONTINGENCIES
Leases
The Company and its subsidiaries lease production, office and retail
facilities and equipment under operating leases. Lease terms range from three to
25 years and most leases contain renewal options and certain leases contain
purchase options. The Company's administrative offices and manufacturing
facilities lease has a remaining term of 11 years with four five-year renewal
options. Retail showrooms are all leased with rents either fixed or with fixed
minimums coupled with contingent rents based on the Consumer Price Index or a
percentage of sales.
Commitments as of February 1, 1998 under operating leases require
approximate future minimum annual rental payments as follows:
<TABLE>
<CAPTION>
Total
Fiscal Year (in thousands)
--------------
<S> <C>
1998 $15,550
1999 14,088
2000 12,091
2001 9,793
2002 8,191
Thereafter 21,882
-------
$81,595
=======
</TABLE>
Total rent expense under all operating leases was approximately
$15,456,000, $15,389,000, and $15,631,000 for the fiscal years ended February 1,
1998, February 2, 1997 and January 28, 1996, respectively.
Litigation
The Company and its subsidiaries are also parties to various legal actions
and proceedings incident to normal business activity. Management believes that
any liability in the event of final adverse determination of any of these
matters would not be material to the Company's consolidated financial position,
liquidity or results of operations.
Year 2000 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.
Letter of Credit
The Company has a $1,000,000 letter of credit outstanding at February 1,
1998 related to the lease of its headquarters.
38
<PAGE> 43
9. RELATED PARTY TRANSACTIONS
In fiscal 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 services for the Company
included assistance with regard to executive management, financial consulting
and strategic planning. Thomas M. DeLitto, President of PCMI, served as
President and Chief Executive Officer of the Company from January to December
1994, served as Chief Executive Officer from April 1995 to August 1996 and is
currently Vice Chairman of the Company's Board of Directors.
10. MAJOR SUPPLIERS
During the year ended February 1, 1998, the Company's 10 largest suppliers
accounted for 55.9% of its aggregate purchases. One supplier represented
approximately 11.5% of aggregate purchases for fiscal 1997.
39
<PAGE> 44
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited in accordance with generally accepted auditing standards,
the financial statements of Krause's Furniture, Inc. as of and for the year
ended February 1, 1998, included in this Form 10-K and have issued our report
thereon dated March 11, 1998. Our audit was made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedule listed
in the index above is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule, for the year ended February 1, 1998, has been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 11, 1998
<PAGE> 45
KRAUSE'S FURNITURE, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FISCAL YEARS ENDED FEBRUARY 1, 1998, FEBRUARY 2, 1997 AND
JANUARY 28, 1996
<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 1997 $ 326,807 $ 180,736 $ - $343,619 $163,924
Fiscal 1996 291,487 244,613 - 209,293 326,807
Fiscal 1995 616,148 218,414 - 543,075 291,487
</TABLE>
(a) Represents accounts written off.
40
<PAGE> 1
EXHIBIT 11
KRAUSE'S FURNITURE, INC.
COMPUTATION OF NET LOSS PER SHARE
(In thousands, except per share data)
<TABLE>
<CAPTION>
Fiscal Years Ended
---------------------------------------------
February 1, February 2, January 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net loss $ (7,480) $ (13,389) $ (8,715)
============ ============ ============
Weighted average number of
shares outstanding: 19,021 10,445 3,950
============ ============ ============
Basic and diluted loss per share $ (0.39) $ (1.28) $ (2.21)
============ ============ ============
</TABLE>
(A) Common stock equivalents are excluded from the calculation in loss years
since they are anti-dilutive.
<PAGE> 1
Exhibit 21
SUBSIDIARIES OF REGISTRANT
<TABLE>
<CAPTION>
Name of Subsidiary State of Incorporation
- ------------------ ----------------------
<S> <C>
Krause's Custom Crafted Furniture Corp California
(business operated under the names
"Krause's Custom Crafted Furniture Corp" , "Krause's Sofa Factory",
"Sofa Factory", and "Castro Convertibles")
KMC Enterprises, Inc. Delaware
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K, into the Company's previously filed
Registration Statement File No. 33-81168.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
April 29, 1998
<PAGE> 1
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-3 No. 33-81168) of Krause's Furniture, Inc. and in the related prospectus of
our report dated March 28, 1997, except for Note 2, as to which the date is
December 17, 1997, with respect to the consolidated financial statements and
schedule of Krause's Furniture, Inc. included in this Annual Report (Form 10K)
for the year ended February 1, 1998.
/s/ ERNST & YOUNG LLP
Orange County, California
April 29, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-01-1998
<PERIOD-START> FEB-03-1997
<PERIOD-END> FEB-01-1998
<CASH> 916
<SECURITIES> 0
<RECEIVABLES> 1,312
<ALLOWANCES> 164
<INVENTORY> 16,013
<CURRENT-ASSETS> 18,592
<PP&E> 16,526
<DEPRECIATION> 7,949
<TOTAL-ASSETS> 45,312
<CURRENT-LIABILITIES> 23,326
<BONDS> 0
0
0
<COMMON> 19
<OTHER-SE> 9,873
<TOTAL-LIABILITY-AND-EQUITY> 45,312
<SALES> 115,201
<TOTAL-REVENUES> 115,201
<CGS> 56,153
<TOTAL-COSTS> 56,153
<OTHER-EXPENSES> 64,642
<LOSS-PROVISION> 180
<INTEREST-EXPENSE> 1,723
<INCOME-PRETAX> (7,480)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,480)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,480)
<EPS-PRIMARY> (0.39)
<EPS-DILUTED> (0.39)
</TABLE>
