<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 11, 1998
REGISTRATION NO. 333-43111
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
KRAUSE'S FURNITURE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 5710 77-0310773
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYEE
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
200 NORTH BERRY STREET
BREA, CALIFORNIA 92821-3903
(714) 990-3100
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
PHILIP M. HAWLEY
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
KRAUSE'S FURNITURE, INC.
200 NORTH BERRY STREET
BREA, CALIFORNIA 92821-3903
(714) 990-3100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES OF ALL COMMUNICATIONS TO BE SENT TO:
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<S> <C>
JUDITH OLSON LASKER, ESQ. STEVEN D. PIDGEON, ESQ.
KRAUSE'S FURNITURE, INC. MICHAEL B. MALEDON, ESQ.
200 NORTH BERRY STREET, J. MICHAEL CHRISTOPHER, ESQ.
BREA, CALIFORNIA 92821-3903 SNELL & WILMER LLP
714-990-3100 ONE ARIZONA CENTER
AND PHOENIX, ARIZONA 85004-0000
MICHAEL J. CONNELL, ESQ. 602-382-6000
MORRISON & FOERSTER LLP
555 WEST FIFTH STREET
LOS ANGELES, CALIFORNIA 90013-1024
213-892-5200
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this registration statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
CALCULATION OF REGISTRATION FEE
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<S> <C> <C> <C> <C>
=================================================================================================================================
TITLE OF EACH CLASS OF AMOUNT OF
SECURITIES AMOUNT TO BE PROPOSED MAXIMUM OFFERING PROPOSED MAXIMUM AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED(1) PRICE PER UNIT(1) OFFERING PRICE(1) FEE(1)(2)
- ---------------------------------------------------------------------------------------------------------------------------------
Common Stock, par value
$.001..................... 4,840,000 shares $3.00 $14,520,000 $4,283.40
=================================================================================================================================
</TABLE>
(1) Estimated solely for purpose of calculating the amount of the registration
fee, based on the average of the high and low prices for the Common Stock as
reported on the Nasdaq SmallCap Market on December 18, 1997 in accordance
with Rule 457(c) under the Securities Act of 1933.
(2) Includes $3,982.50 already paid.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES
MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE
REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR
SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH
OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR
QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION DATED MARCH 11, 1998
PROSPECTUS
4,400,000 SHARES
(KRAUSE'S FURNITURE, INC. LOGO)
COMMON STOCK
------------------------
Of the 4,400,000 shares of common stock, par value $.001 per share (the
"Common Stock"), offered hereby, 2,303,889 shares are being offered by Krause's
Furniture, Inc. (the "Company") and 2,096,111 shares are being offered by a
stockholder of the Company (the "Selling Stockholder"). The Company will not
receive any of the proceeds from the sale of shares by the Selling Stockholder.
See "Principal and Selling Stockholders." The Common Stock is quoted on the
Nasdaq SmallCap Market under the symbol "SOFA." On March 10, 1998, the last
reported sale price of the Common Stock, as quoted on the Nasdaq SmallCap Market
was $3.00. See "Price Range of Common Stock." The Company has applied to list
the Common Stock on the American Stock Exchange under the symbol "KFI." This
listing is expected to become effective concurrently with the completion of the
offering, at which time the Common Stock will be withdrawn from the Nasdaq
SmallCap Market.
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 9.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
================================================================================
<TABLE>
<CAPTION>
UNDERWRITING,
PRICE TO DISCOUNTS AND PROCEEDS TO PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2) SELLING STOCKHOLDER
<S> <C> <C> <C> <C>
======================================================================================================================
Per Share.................... $ $ $ $
- ----------------------------------------------------------------------------------------------------------------------
Total(3)..................... $ $ $ $
======================================================================================================================
</TABLE>
(1) The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(2) Before deducting expenses payable by the Company estimated at $ ,
including $100,000 for specified out-of-pocket expenses and a
non-accountable expense allowance payable to the Representatives. See
"Underwriting."
(3) The Company has granted the Underwriters a 45-day option to purchase up to
440,000 additional shares of Common Stock on the same terms and conditions
as the securities offered hereby solely to cover over-allotments, if any. To
the extent that the option is exercised, the Underwriters will offer the
additional shares at the Price to Public shown above. If such option is
exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."
The shares of Common Stock are being offered severally by the Underwriters,
subject to prior sale, when, as, and if delivered to and accepted by the
Underwriters and subject to the right to reject any order in whole or in part
and certain other conditions. It is expected that delivery of the shares will be
made against payment therefor at the offices of Cruttenden Roth Incorporated,
Irvine, California, or the facilities of the Depository Trust Company, on or
about , 1998.
CRUTTENDEN ROTH
INCORPORATED
BLACK & COMPANY, INC.
MORGAN FULLER CAPITAL GROUP, LLC
THE DATE OF THIS PROSPECTUS IS MARCH , 1998
<PAGE> 3
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF
THE COMPANY, INCLUDING ENTERING STABILIZING BIDS, EFFECTING SYNDICATE COVERING
TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."
2
<PAGE> 4
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus. Unless otherwise indicated, all information in
this prospectus assumes no exercise of the Underwriters' over-allotment option
and references to the "Company" are to Krause's Furniture, Inc. and its wholly
owned subsidiaries.
This Prospectus contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including statements
regarding (i) the anticipated performance of the Company's new management team,
(ii) the effect of the Company's remodeling and expansion program, (iii) the
Company's efforts to improve efficiency, (iv) the Company's intention to
capitalize on its brand names to increase sales and market share, and (v) the
Company's efforts to improve its financial performance. These statements involve
risks and uncertainties and actual results could differ materially from those
discussed in the forward-looking statements as a result of certain of the
factors set forth in "Risk Factors" and for the reasons described elsewhere in
this Prospectus. All forward-looking statements and reasons why results may
differ included in this Prospectus are made as of the date hereof, and the
Company assumes no obligation to update any such forward-looking statement or
reason why actual results might differ.
THE COMPANY
The Company is a leading vertically integrated manufacturer and retailer of
custom-crafted upholstered furniture and accessories. The Company operates 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 Jersey
and Connecticut. Customers can choose from more than 60 styles and 40 sizes of
sofas, incliners, recliners, sectionals, sofabeds and chairs, which they can
customize with 800 fabrics and 50 leathers. The Company believes it has
developed a reputation for delivering high quality, custom-crafted upholstered
furniture at prices comparable to those of mass-produced, sold-as-shown
furniture. In recent periods, the Company has undergone significant changes,
raising substantial new capital, hiring a new management team with extensive
expertise in retailing, and changing the Company's business strategy from a
factory-direct orientation to a retail-oriented approach with updated styles and
fabrics offering greater appeal to its customer base.
RECENT DEVELOPMENTS
In the spring of 1996, General Electric Capital Corporation ("GECC") and
Philip M. Hawley, the former Chairman and Chief Executive Officer of The
Broadway Stores, Inc. (formerly Carter Hawley Hale Stores, Inc.), undertook an
evaluation of the Company and determined that it had strong brand name
recognition, good retail locations in strong markets, a demonstrated
manufacturing capability and a unique niche. They perceived that the Company
presented an opportunity for growth by remodeling existing showrooms, opening
new showrooms in existing markets and penetrating new markets. Beginning in
August 1996, GECC and certain other investors led by Mr. Hawley invested
approximately $22 million in debt and equity in the Company. The Company hired
new executives with retail experience and Mr. Hawley became its Chairman and
Chief Executive Officer.
Under the leadership of Mr. Hawley, the Company has embarked on a major
remodeling and expansion program, and has developed a marketing and
merchandising strategy designed to increase its appeal to its existing broad
customer base by promoting the Company's wide selection of products, styles and
fabrics, as well as quality and value. Under this program, the Company has
remodeled 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 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
3
<PAGE> 5
and improving manufacturing efficiencies, and to reduce expenses by implementing
budgetary 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, are beginning 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%.
Improved 1997 results were achieved despite delays in raw materials from a
fabric supplier, which reduced fourth quarter sales by approximately $1.2
million. The Company anticipates that these delays will be rectified during
fiscal 1998. In addition, gross profit increased from 49.9% to 51.3% of net
sales in fiscal 1997 compared to fiscal 1996. The Company has opened three new
showrooms, one of which was opened during fiscal 1997, featuring its new
showroom 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 ratios are positioned to increase market share.
The Company believes it possesses a number of strengths that enable it to
compete effectively in its markets and that should help it gain market share,
including the following:
- Reputation for Value and Selection; Brand Names. The Company believes it
has attained a reputation for high quality, custom-crafted furniture at
prices comparable to those of mass-produced, sold-as-shown furniture.
Over 25 and 65 years, respectively, Krause's and Castro Convertibles have
developed a reputation for selection, quality and price. The Company
believes that its reputation and strong brand recognition influence
customer purchasing decisions and will help the Company expand its
distribution in existing markets and penetrate new markets.
- New, Experienced Management Team. 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.
- 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 three
to four weeks from the date ordered. Vertical integration also enables
the Company to control the introduction of new products and to capture
profits at both the manufacturing and retail level, with minimal
inventory risk because the manufacturing process does not begin until a
customer places an order. Further, the Company can use the available
capacity of its manufacturing facility to accommodate planned sales
growth.
- Well Located Retail Distribution Network. As of February 1, 1998, the
Company operated 81 showrooms, primarily in California and the New York
City metropolitan area, and in selected other
4
<PAGE> 6
markets in the Southwest, Northwest and Midwest. The Company believes
that its showrooms are in many markets that have favorable demographics
and upward economic trends, and that a substantial majority of its
showrooms are located in high traffic areas. In addition, many showrooms
are near other furniture retailers, where the Company believes it can
benefit from increased traffic of furniture customers and from comparison
shopping, typically by shoppers who compare Company products to those of
sold-as-shown retailers or premium-priced custom manufacturers.
- Focus on Gross Margins and Cost Controls. In recent periods, the Company
has taken a number of steps to improve its gross margin and reduce
expenses by reducing discounts and other special pricing programs,
improving its manufacturing processes, introducing budgetary controls,
revising its sales commission structure, consolidating selling, general
and administrative expenses and cutting costs. As a result, the Company
has developed an organization focused on gross margin improvement,
expense control and operating efficiency.
BUSINESS STRATEGY
The Company intends to leverage its competitive strengths in order to
increase its sales volumes, improve its overall financial performance and
enhance its market position. The Company will seek to achieve these objectives
through the following strategies:
- Remodel Existing Showrooms. The Company has embarked upon a major
remodeling program to update its showrooms, imbue a sense of fashion and
excitement, and move away from the Company's traditional factory-direct
orientation. The Company has developed new store layout, design and
visual presentation themes to center attention on fabric selection and
customization options, present merchandise by life style as complete room
environments and enhance lighting and color in order to add drama and
create excitement throughout its showrooms. Plans call for remodeling
approximately 65 showrooms which will incorporate the new layout, design
and visual presentation themes. 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.
- 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. 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.
- Relocate Under Performing Showrooms. The Company estimates that it has
between 10 and 15 showrooms that are in good market areas but in poor
locations within these market areas. As the leases on these showrooms
expire, the Company plans to seek more suitable locations and incorporate
into the new showrooms the same new layout, design and visual
presentation themes that it has developed in the remodeling program.
- Revamp Marketing and Sales Promotion. The Company has revamped its
marketing and sales promotion with the goal of better defining its market
niche and differentiating it from its competitors. A major focus of this
effort is a shift away from a factory-direct orientation to that of
customization and craftsmanship with emphasis on value rather than price.
To this end, the Company has changed the name it does business under from
Krause's Sofa Factory to Krause's Custom Crafted Furniture and has
developed a new, modern logo. Another focus of this effort has been to
create an advertising format and message and to use larger ads in an
effort to better attract customers.
- Develop New Products; Increase Sales of Complementary Products. The
Company has put in place a new product development program, which will
accomplish a freshening of showroom inventories and introduce a number of
new styles designed to increase its appeal to customers; during the
fiscal year 1997, the Company introduced 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
5
<PAGE> 7
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.
- Leverage the Castro Franchise. In 1993, the Company acquired certain
assets principally related to the retail operations of Castro Convertible
Corporation, including the "Castro Convertibles" tradename and trademark
and retail store locations. Castro Convertibles, which started business
in 1931, has been known throughout the East Coast for its quality sofabed
products and was an early pioneer in developing the tri-fold sofabed
mechanism. The Company plans to leverage this strong brand awareness by
adding a Castro Convertibles gallery in all of its Krause's remodeled and
new showrooms.
- Increase Showroom Productivity. For the year ended February 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.
The Company's executive offices are located at 200 North Berry Street,
Brea, California 92821-3903; its telephone number is 714-990-3100, and its
facsimile number is 714-990-3561. The Company was incorporated in Delaware in
1992. The Company's Common Stock is currently traded in the Nasdaq SmallCap
Market under the symbol "SOFA". The Company has applied to list the Common Stock
on the American Stock Exchange under the symbol "KFI." It is expected that this
listing will be effective concurrently with the completion of this offering.
6
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THE OFFERING
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Common Stock Offered by the Company......................... 2,303,889 shares
Common Stock Offered by the Selling Stockholder............. 2,096,111 shares
Common Stock to be Outstanding After the Offering........... 21,324,428 shares(1)
Use of Proceeds............................................. To remodel showrooms, to open
new showrooms and for working
capital and other general
corporate purposes
American Stock Exchange Symbol.............................. KFI
</TABLE>
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(1) Based upon the number of shares outstanding on February 1, 1998, excluding
5,147,740 shares of Common Stock issuable upon exercise of outstanding
options, deferred stock units and warrants. See "Description of Capital
Stock."
RISK FACTORS
An investment in the Common Stock involves various risks, and investors
should consider carefully the matters discussed under "Risk Factors." Among the
significant risks are the following: the Company has reported losses from
operations in each of the last five years and has a significant working capital
deficiency; the Company may violate covenants in its loan agreements, which
could restrict its ability to raise additional capital; the Company depends on a
small number of suppliers, and disruptions in delivery of supplies have
occasionally affected and could in the future adversely affect the Company; and
future performance of the Company is substantially dependant upon the success of
its remodeling and expansion program.
7
<PAGE> 9
SUMMARY CONSOLIDATED 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 January 28, 1996 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 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 Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
------------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998(2) 1997(2) 1996(2)
-------------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
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RESULTS OF OPERATIONS:
Net sales.............................. $115,201 $112,737 $122,319
Gross profit........................... 59,048 56,247 62,467
Loss from operations................... (5,594) (12,447) (9,388)
Net loss............................... (7,480) (13,389) (8,715)
Net loss per share(1).................. $ (0.39) $ (1.28) $ (2.21)
Number of shares used in computing loss
per share(1)........................ 19,021 10,445 3,950
</TABLE>
<TABLE>
<CAPTION>
FEBRUARY 1, 1998 FEBRUARY 2, JANUARY 28,
ACTUAL AS ADJUSTED(3) 1997 1996
------- -------------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets........................... $45,312 $47,235 $43,087 $46,866
Inventories............................ 16,013 16,013 14,013 14,627
Working capital deficiency............. (922) 1,001 (2,182) (6,878)
Intangible assets...................... 15,557 15,557 16,890 18,236
Short-term debt........................ 22 22 41 19
Long-term debt......................... 13,731 9,919 6,306 5,584
Stockholders' equity................... 9,892 15,627 15,543 13,985
</TABLE>
- ---------------
(1) Per share amounts reflect the adoption of SFAS 128 and represent basic and
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) 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.
(3) Adjusted to reflect the sale of 2,303,889 shares of Common Stock offered by
the Company in this offering based on an assumed offering price of $3.00 per
share, the last reported sales price of the Common Stock on March 10, 1998
(after deducting the underwriting discounts and estimated offering expenses
payable by the Company) and the anticipated application of the estimated net
proceeds therefrom. See "Use of Proceeds" and "Capitalization."
8
<PAGE> 10
RISK FACTORS
In addition to the other information in this Prospectus, investors should
carefully consider the following risk factors in evaluating an investment in the
Common Stock offered hereby. This Prospectus contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including statements regarding (i) the anticipated performance of the Company's
new management team, (ii) the effect of the Company's remodeling and expansion
program, (iii) the Company's efforts to improve efficiency, (iv) the Company's
intention to capitalize on its brand name to increase sales and market share,
and (v) the Company's efforts to improve its financial performance. These
statements involve risks and uncertainties and actual results could differ
materially from those discussed in the forward-looking statements as a result of
certain of the risk factors set forth below and for the reasons described
elsewhere in this Prospectus. All forward-looking statements and reasons why
results may differ included in this Prospectus are made as of the date hereof,
and the Company assumes no obligation to update any such forward-looking
statement or reason why actual results might differ.
LACK OF PROFITABLE OPERATIONS; ACCUMULATED AND WORKING CAPITAL DEFICITS
The Company has reported losses from operations in each of the past five
years and 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
this 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.
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
9
<PAGE> 11
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.
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
10
<PAGE> 12
Mr. Hawley for a term ending on August 25, 1999. The Company has agreed to
extend this agreement to January 31, 2001. See "Management -- Employment
Agreements."
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.
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."
11
<PAGE> 13
COMPETITION
The home furnishings industry is highly competitive and fragmented, and
includes competition from traditional furniture retailers, department stores and
discount and warehouse outlets. Certain companies which compete directly with
the Company have greater financial and other resources than the Company. The
Company competes on a national level with Ethan Allen Inc., Levitz Furniture,
Leather Center, Inc., Expressions and traditional department stores, among
others. The Company also competes on a regional basis. In New York, New Jersey
and Chicago, the Company's primary competitor is Jennifer Convertibles, Inc.,
and in the Western United States the Company's primary regional competitors
include Homestead House, Inc., The Leather Factory and Norwalk Furniture
Corporation (the latter of which also competes in the Midwest market). In
Houston, Texas, the Company's primary regional competitor is Star Furniture
Company. Expressions, Norwalk Furniture Corporation and Ethan Allen Inc., like
the Company, manufacture their own upholstered products and offer custom-crafted
furniture similar to that provided by the Company. Levitz Furniture primarily
addresses the low to middle end "as shown" market, whereas traditional
department stores typically focus on the middle to upper end "as shown" market.
CYCLICAL NATURE OF THE FURNITURE INDUSTRY
The home furnishings industry historically has been cyclical, fluctuating
significantly with general economic cycles. After economic downturns, the home
furnishings industry tends to recover more slowly than the general economy. The
Company believes that the industry is significantly influenced by economic
conditions generally and particularly by consumer behavior and confidence, the
level of personal discretionary spending, housing activity, interest rates and
credit availability. A prolonged economic downturn would have a material adverse
effect on the Company.
DEPENDENCE ON REGIONAL ECONOMIES
The Company's markets are concentrated in California and the New York City
metropolitan area, where 50% 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
12
<PAGE> 14
which provides, in part, that the stockholders who are parties to the
Stockholders Agreement will vote their shares in any election of directors in a
manner that assures the election of directors designated by each of them. The
Stockholders Agreement also prohibits the Company from taking certain actions,
such as mergers, liquidations or dissolutions, without the approval of the
member of the Board of Directors designated by GECC. See "Certain Transactions"
and "Description of Capital Stock -- Stockholders Agreement." It is unlikely
that any principal stockholder or group of public stockholders acting in concert
would be in the position to influence corporate policy, particularly where any
such policy could have a detrimental effect on GECC or others of the public
stockholders. These factors may have the effect of delaying, deferring or
preventing a change in control of the Company.
POSSIBLE LIMIT ON USE OF OPERATING LOSS CARRYFORWARDS RESULTING FROM CHANGE IN
CONTROL
As of February 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 this offering, the Company will have
experienced a cumulative ownership change of approximately 42% as defined in
Section 382. These factors may have the effect of delaying, deferring or
preventing a change in control of the Company.
MARKET FOR THE COMPANY'S COMMON STOCK; POTENTIAL VOLATILITY OF STOCK PRICE
The Company's Common Stock has been reported and traded on the Nasdaq
SmallCap Market, and the Company intends to list its shares on the American
Stock Exchange. Nevertheless, there can be no assurances as to the extent or
nature of the market for the Company's Common Stock (which is currently thinly
traded) or as to the price at which the Company's Common Stock will trade. The
market price of the Company's Common Stock may be significantly affected by
various factors such as quarterly variations in the Company's operating results,
changes in revenue growth rates for the Company as a whole or for specific
geographic areas or products, earnings estimates or changes in estimates by
market analysts, speculation in the press or analyst community 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 intends to list its shares for trading on the American Stock
Exchange prior to the consummation of this offering. The American Stock Exchange
may at its discretion suspend or delist the securities of a company without
notice if, in the opinion of the exchange, certain circumstances apply,
including any one of the following: the financial condition and/or operating
results of the company appear to be unsatisfactory; it appears that the extent
of public distribution or the aggregate market value of the security has become
so reduced as to make further dealings on the exchange inadvisable; the Company
has sold or otherwise disposed of its principal operating assets, or has ceased
to be an operating company; the company has failed to comply with the listing
requirements of the exchange; or any other event has occurred or condition
exists that makes further trading on the exchange unwarranted. Because many of
these circumstances lie beyond the control of the Company, and because the
American Stock Exchange may determine at its discretion whether cause for
suspension or delisting exists, there is a risk that the Company may no longer
be able to list its shares for trading on the American Stock Exchange or any
other stock exchange or market system. In that event, the price of the Common
Stock would be materially, adversely affected and the ability of investors to
sell their shares of the Common Stock could be seriously impaired.
13
<PAGE> 15
POTENTIAL ADVERSE MARKET IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock in the public
market following this offering could adversely affect the market price for the
Common Stock. Upon completion of this offering, the Company will have 21,324,428
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.
In addition to the shares of Common Stock currently outstanding, the
Company also has outstanding options, warrants, and deferred stock units to
purchase an aggregate of 5,147,740 shares of Common Stock. In connection with
prior financings and subject to future contingencies, warrants to purchase an
additional 1,000,000 shares of Common Stock may become issued by the Company.
See "Description of Capital Stock" and "Certain Transactions."
ANTITAKEOVER EFFECTS OF CERTAIN CHARTER PROVISIONS AND DELAWARE LAW
Certain provisions of the Company's Certificate of Incorporation and of
Delaware law could discourage potential acquisition proposals and could delay or
prevent a change in control of the Company. Such provisions could diminish the
opportunities for stockholders to participate in tender offers, including tender
offers at a price above the then current market value of the Company's Common
Stock. See "Description of Capital Stock -- Section 203 of the Delaware General
Corporation Law." Such provisions may also inhibit fluctuations in the market
price of Company Common Stock that could result from takeover attempts. In
addition, while the Company currently has no plans to issue any preferred stock,
the Company's Certificate of Incorporation, as amended, authorizes the Board of
Directors to issue up to 666,667 shares of Preferred Stock without further
stockholder approval. Issuance of preferred stock could have the effect of
delaying, deterring or preventing a change in control of the Company. The
issuance of additional series of preferred stock could 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.
14
<PAGE> 16
DILUTION
Purchasers of the shares of Common Stock offered hereby will experience
immediate and substantial dilution in the net tangible book value of their
investment from the offering price. Additional dilution will occur upon exercise
of outstanding options or warrants. See "Dilution."
ABSENCE OF DIVIDENDS
The Company has not paid cash dividends on its Common Stock and does not
anticipate that it will do so in the foreseeable future. Furthermore, dividends
are subject to limitations and restrictions under the terms of the Company's
indebtedness to various institutional lenders, including a prohibition on the
payment of dividends without the prior written consent of the lenders.
15
<PAGE> 17
USE OF PROCEEDS
The net proceeds from the sale of the 2,303,889 shares of Common Stock
offered by the Company hereby (assuming an offering price of $3.00 per share) is
estimated to be $5,735,334 after deducting the Underwriters' fees and the
estimated offering expenses ($6,936,534 million if the Underwriters' over-
allotment option is exercised in full). The principal purpose of this offering
is to fund the remodeling of existing showrooms, to fund the opening of new
showrooms and for other general corporate purposes. Projected capital
expenditures in 1998 to remodel approximately 26 existing showrooms and to open
approximately 20 new showrooms, which will be leased, is $7.3 million. Pending
the application of the net proceeds, the Company intends to pay down its secured
revolving credit notes, which bear a current interest rate of 9.5%.
The Company will not receive any of the net proceeds from the sale of
Common Stock being offered by the Selling Stockholder.
DIVIDEND POLICY
The Company has never declared or paid dividends on its Common Stock and
anticipates that all earnings will be retained for use in its business. The
payment of any future dividends will be at the discretion of the Board of
Directors and will continue to be subject to certain limitations and
restrictions under the terms of the Company's indebtedness to various
institutional lenders, including a prohibition on the payment of dividends
without the prior written consent of such lenders.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock trades on the Nasdaq SmallCap Market under the
ticker symbol SOFA. The following table sets forth the high and low prices for
the Company's Common Stock for each quarter during the 1997 (52 weeks ended
February 1, 1998), 1996 (53 weeks ended February 2, 1997) and 1995 (52 weeks
ended January 28, 1996) fiscal years. Quotations are as reported by Nasdaq,
adjusted for periods prior to August 1, 1995 to reflect a one for three reverse
stock split, effective on that date.
<TABLE>
<CAPTION>
1997 1996 1995
-------------- -------------- --------------
QUARTER HIGH LOW HIGH LOW HIGH LOW
------- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
First...................... $2.06 $1.25 $2.56 $ .88 $6.75 $4.87
Second..................... 1.81 1.48 1.63 .69 6.37 3.00
Third...................... 4.19 1.50 2.19 .50 4.37 2.00
Fourth..................... 3.25 2.13 2.13 1.00 3.00 1.63
</TABLE>
As of March 2, 1998, there were approximately 355 holders of record of the
Company's Common Stock.
The Company intends to list its shares on the American Stock Exchange
concurrently with the consummation of this offering and cease trading of its
shares on the Nasdaq SmallCap Market.
16
<PAGE> 18
DILUTION
As of February 1, 1998, the net tangible book value per share of the
Company's Common Stock was negative $.30. Net tangible book value per share
represents the amount of the Company's tangible assets, less the amount of its
liabilities, divided by the number of shares of Common Stock outstanding.
After giving effect to the issuance of the 2,303,889 shares of Common Stock
offered hereby at an assumed offering price of $3.00 per share and after
deduction of the Underwriters' fees and the estimated offering expenses payable
by the Company, and the receipt of the proceeds therefrom and assuming no
exercise of any outstanding stock options or warrants, the net tangible book
value per share of Common Stock as of February 1, 1998 would have been $0. This
would result in dilution to the new investors of $3.00 per share, which is equal
to the assumed offering price. The following table illustrates the per share
dilution:
<TABLE>
<S> <C> <C>
Public offering price per share(1).......................... $3.00
Net tangible book deficit per share as of February 1,
1998...................................................... $(.30)
Decrease in net tangible deficit per share attributable to
the sale by the Company of the shares offered hereby...... .30
Pro forma net tangible book value per share after the
offering(2)............................................... 0.00
-----
Dilution of net tangible book value per share to new
investors................................................. $3.00
=====
</TABLE>
- ---------------
(1) Before deducting the Underwriters' fees and estimated offering expenses to
be paid by the Company.
(2) Assumes no exercise of the warrants or options to purchase Common Stock that
were outstanding at February 1, 1998. Outstanding options, all of which were
issued under option plans prior to February 1, 1998, cover the purchase of
an aggregate of 2,043,958 shares at a weighted average exercise price of
$1.29. If these options are exercised, they will be dilutive to the
Company's stockholders, including the new investors. Outstanding warrants
include warrants to purchase an aggregate of 3,065,502 shares at an average
exercise price of $1.10. If these warrants are exercised, they will be
dilutive to the Company's shareholders, including the new investors.
Giving effect to the exercise of all warrants and options referenced, with
the exception of anti-dilutive warrants and options, the adjusted net tangible
book value per share of the Common Stock as of February 1, 1998 after the
offering would have been $.19. This would result in dilution to the new
investors of $2.81 per share.
17
<PAGE> 19
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
February 1, 1998, and as adjusted to give effect to the sale of 2,303,889 shares
of Common Stock offered by the Company at an assumed offering price of $3.00 per
share and the application of net proceeds therefrom. See "Use of Proceeds." The
table should be read in conjunction with the consolidated financial statements
and notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FEBRUARY 1, 1998
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Current portion of notes payable............................ $ 22 $ 22
Long-term notes payable:
Secured revolving credit notes............................ 3,812 --
Subordinated notes payable to stockholders, net of $2,435
of unamortized debt discount........................... 9,566 9,566
Other notes, excluding current portion.................... 353 353
-------- --------
Total long-term notes payable.......................... 13,731 9,941
-------- --------
Stockholders' equity:
Preferred stock, $.001 par value; 666,667 shares
authorized, no shares outstanding...................... -- --
Common stock, $.001 par value; 35,000,000 shares
authorized, 19,020,539 shares outstanding (21,324,428
shares outstanding as adjusted)(1)..................... 19 21
Capital in excess of par value............................ 51,703 57,436
Accumulated deficit....................................... (41,830) (41,830)
-------- --------
Total stockholders' equity............................. 9,892 15,627
-------- --------
Total capitalization................................... $ 23,645 $ 25,568
======== ========
</TABLE>
- ---------------
(1) Excludes 2,043,958 shares issuable upon exercise of options, 3,065,502
shares issuable upon exercise of warrants and 38,280 shares issuable
pursuant to deferred stock rights. See "Description of Capital Stock."
BACKGROUND OF THE COMPANY
The Company is a combination of two pre-existing furniture manufacturing
and retailing businesses. Krause's Custom Crafted Furniture Corp., formerly
known as Krause's Sofa Factory ("Krause's"), was started in San Diego,
California in 1973. In April 1991, the Company acquired a controlling interest
in Krause's, and in October 1993, the Company acquired the remaining minority
interest in Krause's.
Castro Convertible Corporation, which was started in 1931, has developed a
reputation throughout the East Coast for its quality sofabed products and was an
early pioneer in developing the tri-fold sofabed mechanism. The Company acquired
certain assets related to the retail operations of Castro Convertible
Corporation including the "Castro Convertibles" tradename and trademark and
retail store locations in May 1993.
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<PAGE> 20
SELECTED CONSOLIDATED 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. This summary data should be read
in conjunction with the consolidated financial statements and notes thereto
appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MONTH ENDED
--------------------------------------------------------------------- -------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28, DECEMBER 31, DECEMBER 31, JANUARY 29, JANUARY 30,
1998(4) 1997(4) 1996(4) 1994 1993 1995(4)(5) 1994(5)
----------- ----------- ----------- ------------ ------------ ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS:
Net sales................. $115,201 $112,737 $122,319 $116,471 $96,894 $ 7,179 $ 7,326
Gross profit.............. 59,048 56,247 62,467 62,949 50,792 3,532 3,807
Loss from operations...... (5,594) (12,447) (9,388) (2,398) (7,852) (3,231) (2,041)
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) (3,221) (2,185)
Extraordinary items(3).... -- -- -- (436) (221) -- --
Net income (loss)......... (7,480) (13,389) (8,715) 5,395 (9,972) (3,221) (2,185)
Income (loss) per
share(1):
Income (loss) before
extraordinary items... (0.39) (1.28) (2.21) 1.08 (3.88) (.87) (.63)
Extraordinary items..... -- -- -- (0.08) (0.09) -- --
Net income (loss)....... $ (0.39) $ (1.28) $ (2.21) $ 1.00 $ (3.97) $ (0.87) $ (.63)
Number of shares used in
computing income (loss)
per share(1)............ 19,021 10,445 3,950 5,394 2,510 3,685 3,490
</TABLE>
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2, JANUARY 28, JANUARY 29, DECEMBER 31,
1998 1997 1996 1995 1993
----------- ----------- ----------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
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.
19
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto included elsewhere in this
Prospectus. This Prospectus contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding (i) the anticipated performance of the Company's new
management team, (ii) the effect of the Company's remodeling and expansion
program, (iii) the Company's efforts to improve efficiency, (iv) the Company's
intention to capitalize on its brand names to increase sales and market share,
and (v) the Company's efforts to improve its financial performance. These
statements involve risks and uncertainties and actual results could differ
materially from those discussed in the forward-looking statements as a result of
certain factors, including but not limited to the reasons discussed in "Risk
Factors" and elsewhere in this Prospectus.
The Company has reported losses from operations in each of the past five
fiscal years 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 below under "Liquidity and Capital Resources,"
has developed a strategic plan for the business which provides, among other
things, for remodeling existing showrooms to provide a more appealing setting
for customers, adding new showrooms in existing markets, increasing product
prices to competitive levels, reducing promotional discounting, reconfiguring
selling commissions, remerchandising, refocusing advertising, improving the
manufacturing processes and reducing expenses through budgetary controls. 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.
20
<PAGE> 22
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain items from
the Company's Consolidated Statement of Operations as a percentage of net sales.
<TABLE>
<CAPTION>
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>
STORE (SHOWROOM) DATA
<TABLE>
<CAPTION>
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 (in
thousands)(1)........................... $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.
21
<PAGE> 23
Gross Profit. Gross profit was 51.3% of net sales in fiscal 1997 compared
with 49.9% of net sales in fiscal 1996. The increase in gross profit resulted
primarily from the Company's decision in the third quarter of fiscal 1996 to
raise prices to competitive levels and reduce promotional discounting.
Selling Expenses. Selling expenses were $54,481,000 or 47.3% of net sales
in fiscal 1997 and were $57,573,000 or 51.1% of net sales in fiscal 1996. The
decrease of $3,092,000 in selling expenses was primarily due to a decrease of
$1,737,000 in variable selling payroll, resulting from a new commission
structure, and decreases of $1,044,000 and $554,000 in store non-payroll
expenses and delivery expenses, respectively, resulting primarily from tighter
cost controls, offset in part by increased advertising costs of $574,000.
General and Administrative Expenses. General and administrative expenses
for fiscal 1997 were $9,141,000 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 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 (i) an industrywide
softness in retail sales, (ii) insufficient cash during the first eight months
of fiscal 1996 to timely purchase raw materials needed for the manufacture of
customer orders, and (iii) the Company's decision in the third quarter of fiscal
1996 to raise prices to competitive levels and reduce promotional discounting.
Gross Profit. Gross profit was 49.9% of net sales in fiscal 1996 as
compared to 51.1% in fiscal 1995. Lower gross profit in fiscal 1996 resulted
from extensive promotional discounting during the first half of 1996 and changes
in the mix of products sold. As noted above, the Company increased product
prices and reduced promotional discounting in the second half of fiscal 1996
which contributed to an overall improvement in gross profit from 47.1% for the
26 weeks ended July 28, 1996 to 52.7% for the 27 weeks ended February 2, 1997.
Selling Expenses. Selling expenses for fiscal 1996 were $57,573,000,
representing a decrease of $2,684,000 from fiscal 1995. Selling expenses were
51.1% of net sales in fiscal 1996 as compared to 49.3% in
22
<PAGE> 24
fiscal 1995. Selling expenses increased as a percentage of sales primarily due
to fixed showroom expenses applied to lower sales volume. Also, commissions,
delivery expenses and advertising expenses were higher as a percentage of sales,
offset in part by certain expenses which were lower as a result of having fewer
stores operating in fiscal 1996. Showroom pre-opening expenses are a component
of the Company's selling expenses. The Company has historically capitalized
these expenses and amortized them over periods ranging from 12-24 months
subsequent to the opening of the showroom. 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 $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
below under the caption "Liquidity and Capital Resources."
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, by borrowings under the
Company's revolving credit facility, and by the proceeds to the Company of the
sales of its shares in this offering.
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%
subordinated promissory note in the principal amount of $5 million, together
with a warrant to purchase 1.4 million shares at $.001 per share. Also in
connection with this financing, the holders of shares of the Company's
pre-existing Preferred Stock agreed to convert their shares into approximately
1.2 million shares of Common Stock. See "Certain Transactions."
On August 14, 1997, the Company completed transactions with two investors
in which it issued $3 million of subordinated notes with (i) warrants to
purchase an aggregate of 740,000 shares of common stock at $1.25 per share and
(ii) warrants to purchase an aggregate amount of up to 1 million shares of
23
<PAGE> 25
common stock at $0.01 per share which warrants may be completely or partially
cancelled depending on the economic performance of the Company in fiscal 1999.
Also, the Company arranged a standby credit facility of $3.5 million which the
Company drew down on December 30, 1997. At the time the standby credit facility
was drawn down, the Company issued to the investors warrants to purchase 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 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 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 the net proceeds from this offering, combined
with 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 significant funds. The Company
currently contemplates that other sources of capital would be available,
although this situation could change.
The aggregate annual maturities of long-term debt during each of the five
fiscal years subsequent to February 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.
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 (the cash loss from operations for the
first half of fiscal 1996 was $8,638,000 and $1,572,000 for the second half) and
decreases in accounts payable and other liabilities of $6,081,000, offset
principally by a decrease in inventories of $614,000 and collections of income
tax refund receivables of $1,467,000. Investing activities during the year
included capital expenditures of $806,000, principally for additions to
leasehold improvements at certain retail
24
<PAGE> 26
showrooms. Financing activities during fiscal 1996 were comprised principally of
proceeds from issuances of common stock of $10,669,000 less expenses of
$448,000, proceeds of $2,950,000 from issuances of convertible and demand notes
(subsequently converted into common stock, together with interest of $116,000)
and the issuance of a subordinated note of $5,000,000, offset by net payments of
$3,516,000 under the Company's revolving credit facility.
1995 Cash Flow. During fiscal 1995 cash and cash equivalents decreased by
$616,000. Operating activities used net cash of $3,177,000, principally from a
cash loss from operations of $4,752,000 offset by a net change in operating
assets and liabilities of $1,575,000. Inventories and other operating assets
were reduced by $3,389,000 and $147,000, respectively, while accounts payable
and accrued liabilities were reduced by $1,961,000. Investing activities during
the year included capital expenditures of $1,883,000, primarily related to the
opening of four new showrooms and remodeling of four showrooms partially offset
by $1,039,000 of proceeds from the sale-leaseback of a showroom in Texas.
Financing activities in fiscal 1995 of $3,405,000 were principally net
borrowings under Krause's revolving credit agreement which was entered into in
January 1995.
YEAR 2000 ISSUES
During fiscal 1997, the Company initiated a plan to implement new business
information systems, which will address all year 2000 issues, as well as enhance
Company operations. This implementation may result in significant capital
expenditures during fiscal 1998 and 1999. In the event that this implementation
is not completed prior to the year 2000, the Company has a contingency plan,
pursuant to which, existing systems will be modified to eliminate remaining year
2000 issues. Expenditures related to this contingency plan will be expensed as
incurred and are not expected to have a significant impact on the Company's
results of operations.
CHANGE IN AUDITOR
As previously disclosed, the Board of Directors of the Company, upon the
recommendation of the Audit Committee of the Board on September 19, 1997,
terminated the Company's relationship with Ernst & Young LLP and engaged Arthur
Andersen LLP as its new independent public 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.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective in fiscal 1998, the Company will be required to adopt SFAS No.
130 "Reporting Comprehensive Income" and SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information." The impact of adoption of
these pronouncements is not expected to be material to the Company's financial
position or results of operations.
25
<PAGE> 27
QUARTERLY OPERATING RESULTS
The following tables set forth certain unaudited consolidated financial
information for each of the four quarters in fiscal 1996 and fiscal 1997. In
management's opinion, this unaudited quarterly information has been prepared on
the same basis as the audited consolidated financial statements and includes all
necessary adjustments, consisting only of normal recurring adjustments, that
management considered necessary for a fair presentation of the unaudited
quarterly results when read in conjunction with the Consolidated Financial
Statements and Notes thereto included elsewhere in this Prospectus. The Company
believes that quarter-to-quarter comparisons of its financial results are not
necessarily meaningful and should not be relied upon as an indication of future
performance.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------------------------------
FEBRUARY 1, NOVEMBER 2, AUGUST 3, MAY 4, FEBRUARY 2, OCTOBER 27, JULY 28, APRIL 28,
1998 1997 1997 1997 1997(1) 1996 1996 1996
----------- ----------- --------- ------- ----------- ----------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............... $29,632 $30,159 $27,768 $27,642 $29,999 $26,865 $26,236 $29,637
Cost of sales........... 14,313 14,560 14,005 13,275 14,126 12,781 13,860 15,723
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 15,319 15,599 13,763 14,367 15,873 14,084 12,376 13,914
Operating costs and
expenses:
Selling............... 13,923 13,698 13,832 13,028 14,017 14,081 15,006 14,469
General and
administrative...... 2,361 2,191 2,293 2,296 2,249 2,084 3,072 2,696
Amortization of
goodwill............ 255 255 255 255 255 255 255 255
------- ------- ------- ------- ------- ------- ------- -------
16,539 16,144 16,380 15,579 16,521 16,420 18,333 17,420
------- ------- ------- ------- ------- ------- ------- -------
Loss from operations.... (1,220) (545) (2,617) (1,212) (648) (2,336) (5,957) (3,506)
Interest expense........ (546) (467) (370) (340) (448) (296) (304) (182)
Other income
(expense)............. (105) (35) (8) (15) 81 111 45 51
------- ------- ------- ------- ------- ------- ------- -------
Net loss................ $(1,871) $(1,047) $(2,995) $(1,567) $(1,015) $(2,521) $(6,216) $(3,637)
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) All quarters are for a period of 13 weeks except the quarter ended February
2, 1997 which is for a period of 14 weeks.
The Company's operating results are subject to various risks and
uncertainties, including risks and uncertainties related to management's ability
to implement its business strategy, the Company's ability to service fixed
charges and to raise additional capital, economic conditions, competitive
pressures, availability and cost of supplies, the composition, timing and volume
of orders, overhead costs, manufacturing or production difficulties, certain
nonrecurring charges and other factors. Accordingly, the Company's operating
results may vary materially from quarter to quarter. Because a high percentage
of the Company's operating expenses are relatively fixed, if anticipated sales
and shipments in any quarter do not occur as expected, the Company's operating
results may be adversely affected and fall significantly short of expectations.
Any unanticipated decline in growth of the Company's net revenue, without a
corresponding and timely reduction in the growth of operating expenses, could
have an adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that, in the event of any
shortfall of sales or reduction in gross margin in a quarter, the Company will
be able to control expenses sufficiently or promptly to meet profitability
objectives for that quarter. See "Risk Factors" for a discussion of other
factors that may adversely affect the Company's operating results in any given
quarter.
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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.
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
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furniture accounted for approximately $8.4 billion in shipments in 1996,
according to the American Furniture Manufacturers Association.
The furniture market is large and diversified. Because the market for
custom crafted furniture is highly fragmented, the Company believes that
manufacturers with strong brand name recognition, broad distribution and good
value to price ratio are positioned to increase market share.
- Reputation for Value and Selection; Brand Names. The Company believes
that it has attained a reputation for high quality, custom-crafted
furniture at prices comparable to those of mass-produced, sold-as-shown
furniture. Over 25 and 65 years, respectively, Krause's and Castro
Convertibles have developed a reputation for selection, quality, price
and service. The Company believes that its reputation and strong brand
recognition influence customer purchasing decisions and will help the
Company expand its distribution in existing markets and penetrate new
markets.
- New, Experienced Management Team. 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.
- Vertically Integrated Manufacturer and Distributor of Custom
Furniture. The Company is a leading combined manufacturer and retailer of
made-to-order upholstered furniture. This vertical integration enables
the Company to manufacture high-quality, competitively priced custom
upholstered furniture and deliver it to the customer usually within two
to four weeks from the date ordered. Vertical integration also enables
the Company to capture profits at both the manufacturing and retail
level, with minimal inventory risk. Further, the Company can use the
available capacity of its manufacturing facility to accommodate planned
sales growth.
- Well Located Retail Distribution Network. As of 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.
- Focus on Gross Margins and Cost Controls. In recent periods, the Company
has taken a number of steps to improve its gross margin and reduce
expenses by reducing discounts and other special pricing programs,
improving its manufacturing processes, introducing budgeting controls,
revising its sales commission structure, consolidating selling, general
and administrative expenses and cutting costs. As a result, the Company
has developed an organization focused on gross margin improvements,
expense control and operating efficiency.
BUSINESS STRATEGY
The Company intends to leverage its competitive strengths in order to
increase its sales volumes, improve its overall financial performance and
enhance its market position. The Company will seek to achieve these objectives
by pursuing the following strategies:
- Remodel Existing Showrooms. The Company has embarked upon a major
remodeling program to update its showrooms, imbue a sense of fashion and
excitement and move away from the Company's traditional factory-direct
orientation. The Company has developed new store layout, design and
visual presentation themes to center attention on fabric selection and
customization options, present merchandise by life style as complete room
environments and enhance lighting and color in order to add drama and
create excitement throughout its showrooms. Plans call for remodeling
approximately
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<PAGE> 30
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.
- 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.
- Relocate Under-Performing Showrooms. The Company estimates that it has
between 10 and 15 showrooms that are in good market areas but in poor
locations within these market areas. As the leases on these showrooms
expire, the Company plans to seek more suitable locations and incorporate
into the new showrooms the same new layout, design and visual
presentation themes that it has developed in the remodeling program.
- Revamp Marketing and Sales Promotion. The Company has revamped its
marketing and sales promotion with the goal of better defining its market
niche and differentiating it from its competitors. A major focus of this
effort is a shift away from a factory-direct orientation to that of
customization and craftsmanship with emphasis on value rather than price.
To this end, the Company has changed the name it does business under from
Krause's Sofa Factory to Krause's Custom Crafted Furniture and has
developed a new, modern logo. Another focus of this effort has been to
create an advertising format and message and to use larger ads in an
effort to better attract customers.
- Develop New Products; Increase Sales of Complementary Products. The
Company has put in place a new product development program, which will
accomplish a freshening of showroom inventories and introduce a number of
new styles designed to increase its appeal to customers; during the
fiscal year 1997, the Company introduced 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.
- Leverage the Castro Franchise. In 1993, the Company acquired certain
assets principally related to the retail operations of Castro Convertible
Corporation, including the "Castro Convertibles" tradename and trademark
and retail store locations. Castro Convertibles, which started business
in 1931, has been known throughout the East Coast for its quality sofabed
products and was an early pioneer in developing the tri-fold sofabed
mechanism. The Company plans to leverage this strong brand awareness by
adding a Castro Convertibles gallery in all of its Krause's remodeled and
new showrooms.
- Increase Showroom Productivity. For the year ended February 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.
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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.
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
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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.
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
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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.
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EMPLOYEES
The majority of the Company's employees are not unionized and many have
worked for the Company for more than 10 years. A union contract 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.
COMPETITION
The home furnishings industry is highly competitive and fragmented, and
includes competition from traditional furniture retailers, department stores and
discount and warehouse outlets. Certain companies which compete directly with
the Company have greater financial and other resources than the Company. The
Company competes on a national level with Ethan Allen Inc., Levitz Furniture,
Leather Center, Inc., Expressions and traditional department stores, among
others. The Company also competes on a regional basis. In New York, New Jersey
and Chicago, the Company's primary competitor is Jennifer Convertibles, Inc.,
and in the Western United States the Company's primary regional competitors
include Homestead House, Inc., The Leather Factory and Norwalk Furniture
Corporation (the latter of which also competes in the Midwest market). In
Houston, Texas, the Company's primary regional competitor is Star Furniture
Company. Expressions, Norwalk Furniture Corporation and Ethan Allen Inc., like
the Company, manufacture their own upholstered products and offer
"made-to-order" customization similar to that provided by the Company. Levitz
Furniture primarily addresses the low to middle end "as shown" market, whereas
traditional department stores typically focus on the middle to upper end "as
shown" market.
PROPERTIES
The Company maintains its administrative offices and manufacturing plant in
a leased 250,000 sq. ft. facility at 200 North Berry Street, Brea, California.
The lease has a remaining term of 11 years with four five-year options and
grants the Company certain options to purchase the facility. The Company also
leases approximately 275,000 sq. ft. for warehouse and distribution facilities.
The Company leases all its retail showrooms, with rents either fixed or with
fixed minimums coupled with contingent rents based on the Consumer Price Index
or a percentage of sales. The Company's 81 showrooms occupy approximately
980,000 sq. ft. of selling space.
LEGAL PROCEEDINGS
On May 27, 1994, the Company was served with a complaint in the case
captioned Miriam Brown v. Mr. Coffee, inc. et al. (Civil Action No. 13531), in
the Delaware Court of Chancery, New Castle County. The complaint names the
Company, Mr. Coffee and certain individuals including Jean R. Perrette and
Kenneth W. Keegan, both former directors and officers of the Company, as
defendants in a purported class action lawsuit. The complaint alleges that the
individuals named as co-defendants breached their fiduciary duties as directors
of Mr. Coffee by, among other things, their alleged efforts to entrench
themselves in office and prevent Mr. Coffee's public shareholders from
maximizing the value of their holdings, engaging in plans and schemes unlawfully
to thwart offers and proposals from third parties, and approving or causing the
Company and others to agree to vote in favor of a merger with Health o meter
Products, Inc. The Company is alleged to have participated in and advanced the
alleged breaches. The plaintiff originally sought to enjoin the merger; however,
plaintiff withdrew such action and the merger was completed in August 1994. The
Company and the Mr. Coffee directors filed motions to dismiss the complaint on
August 11, 1994. On October 9, 1996, the plaintiff filed a second amended
complaint. All defendants subsequently joined in filing a motion to dismiss the
complaint. The plaintiff seeks compensatory damages and costs and disbursements
in connection with the action, including attorneys' and experts' fees, and such
other further relief as the court deems just and proper.
For a number of reasons, including the extensive solicitation and
negotiation process which preceded the acceptance by Mr. Coffee's Board of
Directors of the Health o meter offer, the Company believes that the plaintiff's
allegations are without merit. Management believes that any liability in the
event of final adverse determination of any of this matter would not be material
to the Company's consolidated financial position or results of operations.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions of the Company's directors and officers are
as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Philip M. Hawley.................... 72 Chairman of the Board and Chief Executive Officer
Thomas M. DeLitto................... 44 Vice Chairman of the Board
Robert A. Burton.................... 57 Senior Vice President and Chief Financial Officer
Herbert J. Friedman................. 47 Senior Vice President of Merchandising, Product
Development, Marketing and Stores
K. James McTaggart.................. 35 Senior Vice President of Manufacturing and
Distribution
Klaus Tabar......................... 44 Senior Vice President of Real Estate and Construction
Kamal G. Abdelnour.................. 61 Director
Jeffrey H. Coats.................... 40 Director
Peter H. Dailey..................... 67 Director
John A. Gavin....................... 66 Director
</TABLE>
Philip M. Hawley has been Chairman of the Board and Chief Executive Officer
since August 1996. He served as Chairman and Chief Executive Officer of The
Broadway Stores, Inc. (formerly Carter Hawley Hale Stores, Inc.) from 1977 to
1993. Mr. Hawley is also a director of Johnson & Johnson, Weyerhauser Company
and Aeromovel, U.S.A.
Thomas M. DeLitto has been Vice Chairman of the Board since December 1994
and a director since June 1991. He was Chief Executive Officer from April 1995
to August 1996, President and Chief Executive Officer from July 1992 to December
1994, and Executive Vice President and Chief Operating Officer from June 1991 to
July 1992. Mr. DeLitto has been a Director and President of Permal Capital
Management, Inc., a wholly owned subsidiary of Worms & Co., Inc. (a wholly owned
subsidiary of Worms & Cie, a principal stockholder of the Company), since
October 1990; in this capacity he oversees operations of that company's direct
investment activities. Mr. DeLitto has served as Executive Vice President of
Worms & Co., Inc. since February 1996.
Robert A. Burton has been Senior Vice President and Chief Financial Officer
since December 1996. Mr. Burton was an independent financial consultant from
January 1995 to November 1996, and from November 1987 to December 1994 he was
Senior Vice President and Chief Financial Officer of John Breuner Company, a
home furnishings company. John Breuner Company filed for bankruptcy in October
1993 and emerged in July 1994.
Herbert J. Friedman has been Senior Vice President of Merchandising,
Product Development, Marketing and Stores since September 1996. Mr. Friedman was
Senior Vice President of Strategic Planning from April 1995 to September 1996
and Vice President of Merchandising from June 1989 to April 1995.
K. James McTaggart has been Senior Vice President of Manufacturing and
Distribution since April 1996. Mr. McTaggart was Vice President of Distribution
and Logistics from February 1996 to March 1996. Mr. McTaggart was formerly the
Vice President of Distribution/Logistics at Stanley-Works-Door Systems from
March 1995 to February 1996, and served in other positions in Stanley
Works-Door-Systems from November 1985 to March 1995.
Klaus Tabar is Senior Vice President of Real Estate and Construction. Mr.
Tabar was Senior Vice President of Real Estate and Store Construction from
September 1996 to April 1997 and Senior Vice President of Real Estate and
Administration from April 1996 to September 1996. He joined the Company as Vice
President of Real Estate in January 1989.
Kamal G. Abdelnour has been a director since September 1996. He had been a
director from February 1993 to August 1996 when he resigned in connection with
the Company's recapitalization.
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Mr. Abdelnour has been President and Chief Executive Officer of ATCO
Development, Inc. ("ATCO") since 1980. ATCO is engaged in the business of
investments, real estate ownership and management, and export sales. Since 1989,
Mr. Abdelnour has served as a director of Permal Capital Management, Inc., a
wholly-owned subsidiary of Worms & Co., Inc., which is a wholly owned subsidiary
of Worms & Cie, a principal stockholder of the Company.
Jeffrey H. Coats has been a Director since August 1996. He has been a
Managing Director of GE Capital Equity Capital Group, Inc., a wholly owned
subsidiary of GECC, since April 1996. He was also a Managing Director of GE
Capital Corporate Finance Group, Inc., a wholly owned subsidiary of GECC, from
June 1987 to April 1993. From March 1994 to April 1996, Mr. Coats was President
of Maverick Capital Equity Partners, LLC and from April 1993 to January 1994, he
was Managing Director and a Partner of Veritas Capital, Inc., both of which are
investment firms. Mr. Coats is the Chairman of the Board of The Hastings Group,
Inc., a clothing retailer, which filed for bankruptcy in October 1995. The
Hastings Group, Inc. currently is in the process of formulating a plan of
liquidation under Chapter 11.
Hon. Peter H. Dailey has been a director since September 1996. He is also
the Chairman of the Board and Chief Executive Officer of Memorex Telex, NV, a
world-wide technology company headquartered in Amsterdam, the Netherlands and
has served in those roles since April 1996. He served as Ambassador to Ireland
from 1982 to 1984, and was special Presidential envoy to NATO countries. From
1985 to 1988, Mr. Daily served as counselor to the Director of the Central
Intelligence Agency. From 1985 to 1992 he was a member of President's Advisory
Committee on Arms Control and Disarmament. He also serves as founder and
Chairman of the Board of Enniskerry Financial, Inc., a private investment
company founded in 1968, and has been a principal of Gavin, Dailey and Partners,
an international capital and consulting firm, since 1991. Mr. Dailey is a member
of the Board of Directors of Chicago Title and Trust Company, Sizzler, Inc.,
Pinkerton's, Inc., and Jacobs Engineering Group, Inc. Prior to returning to
government service he served as a director of the Walt Disney Co. and the
Interpublic Group of Companies. Memorex Telex Corp., the U.S. Subsidiary of
Memorex Telex, NV, filed for bankruptcy in 1996 and is in the process of
liquidation.
Hon. John A. Gavin has been a director since September 1996. He founded and
has been the Chairman of Gamma Services Corporation and a principal of Gavin,
Dailey and Partners, both international capital and consulting firms, since 1968
and 1991, respectively. He has also been affiliated with Hicks, Muse, Tate and
Furst (Latin America) as Managing Director since 1995. Mr. Gavin is a member of
the Board of Directors of Atlantic Richfield Company, Dresser Industries,
Pinkerton's, Inc., International Wire Group and KAP Resources.
All Directors are elected annually and serve until the next annual meeting
of stockholders or until the election and qualification of their successors.
Nomination and election of the Board of Directors of the Company is subject to a
Stockholders Agreement. See "Capital Stock -- Stockholders Agreement." At
present, all directors have been elected pursuant to the Stockholders Agreement.
In this regard, Jeffrey H. Coats is the GECC designee, Thomas M. DeLitto is the
designee of the Permal group of stockholders and Kamal G. Abdelnour, Peter H.
Dailey and John A. Gavin are joint designees. Mr. Abdelnour has also been
elected as a director of the Company in accordance with a contractual
undertaking by the Company to nominate him. This contract was entered into at
the time the Company issued and sold shares of capital stock to ATCO Holdings
Limited. See "Principal and Selling Stockholders."
In December 1997, a Succession Agreement was entered into by the Company
and the following stockholders: Philip M. Hawley, its Chairman, his sons John F.
Hawley and Dr. Philip M. Hawley, Jr., GECC and Permal Capital Management. The
parties to the Succession Agreement agreed that if Philip M. Hawley ceases to
serve on the Board of Directors, the stockholder parties would take all
necessary action to ensure that John F. Hawley, or his nominee if he is
unavailable, is elected to serve as a director. See "Certain Transactions."
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has created an Executive Committee, an Audit
Committee, a Compensation Committee and a Nominating Committee. The Executive
Committee is composed of Philip M. Hawley, Thomas M. DeLitto and Jeffrey H.
Coats, and except to the extent prohibited by law has all power and
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<PAGE> 37
authority to manage the business and affairs of the Company on behalf of the
Board of Directors as may be necessary between regular meetings of the Board.
The Audit Committee is composed of John A. Gavin, Peter H. Dailey and Kamal G.
Abdelnour, and is charged with reviewing the Company's annual audit and meeting
with the Company's independent accountants to review the Company's internal
controls and financial management practices. The Compensation Committee, which
is composed of Kamal G. Abdelnour, John A. Gavin and Peter H. Dailey, recommends
to the Board of Directors compensation for the Company's key employees and
administers certain employee benefit plans. The Nominating Committee is composed
of Philip M. Hawley, Thomas M. DeLitto, Jeffrey H. Coats and Kamal G. Abdelnour,
and is charged with reviewing the qualifications of and recommending candidates
to the Board of Directors for election as directors of the Company. The
Nominating Committee also acts on other matters pertaining to membership on the
Board of Directors, including terms of tenure and compensation for Directors and
issues involving potential conflict of interests. It also reviews the
qualifications of, and recommends to the Board of Directors, individuals for
senior management positions with the Company.
DIRECTOR COMPENSATION
All directors were reimbursed for travel and other expenses related to
their activities as directors during fiscal year 1997, and will continue to be
so reimbursed. The four non-employee directors other than Jeffrey H. Coats were
each paid a fee of $10,000 and were each granted deferred stock units valued at
$10,000 under the Company's 1997 Stock Incentive Plan (see "Stock Plans" below)
for services rendered as directors during fiscal year 1997. Each non-employee
director (other than Mr. Coats) will also be paid a fee of $10,000, payable
quarterly, for his services during fiscal year 1998. Also, additional deferred
stock units valued at $10,000 will be granted to each non-employee director
(other than Mr. Coats) in office on December 31, 1998 and on December 31 of each
year thereafter during the term of the 1997 Stock Incentive Plan.
SUMMARY COMPENSATION TABLE
The following table sets forth all compensation paid by the Company during
fiscal 1997, 1996, and 1995 to (i) each of the individuals serving as the
Company's Chief Executive Officer during fiscal 1997 and (ii) the four other
most highly compensated executive officers of the Company during fiscal 1997
(collectively referred to as the "Named Executive Officers").
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL ---------------
COMPENSATION SECURITIES ALL OTHER
------------------------------- UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS/SARS(#) ($)
--------------------------- ---- --------- ---------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Philip M. Hawley.................. 1997 233,842 --
Chairman of the Board and Chief 1996 101,959 1,234,000
Executive Officer
Robert A. Burton.................. 1997 155,160 50,000
Senior Vice President and 1996 28,978 50,000 50,000(1)
Chief Financial Officer
Herbert J. Friedman............... 1997 156,959 50,000 39,119(2)
Senior Vice President of 1996 152,301 50,000
Merchandising, Product 1995 136,770 1,200 1,000
Development, Marketing and
Stores
K. James McTaggart................ 1997 135,633 40,000
Senior Vice President of 1996 121,953 45,000
Manufacturing
and Distribution
Klaus Tabar....................... 1997 155,159 17,030 50,000
Senior Vice President of 1996 141,645 34,030 50,000
Real Estate and Construction 1995 117,899 13,505 1,000
</TABLE>
- ---------------
(1) Represents reimbursement for out-of-pocket relocation costs.
(2) Represents payment for prior years accrued but unused vacation.
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<PAGE> 38
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options and
deferred stock units granted during fiscal 1997 to the Named Executive Officers.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
% OF TOTAL VALUE AT ASSUMED
NUMBER OF OPTIONS/SARS ANNUAL RATES
SECURITIES GRANTED TO OF STOCK PRICE
UNDERLYING EMPLOYEES IN EXERCISE OR APPRECIATION
OPTIONS/SARS FISCAL BASE PRICE EXPIRATION FOR OPTION TERM
NAME GRANTED(#) YEAR(1) ($/SH) DATE 5%($) 10%($)
---- ------------ ------------ ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Philip M. Hawley.......... -- -- -- -- -- --
Robert A. Burton.......... 50,000 11.6% 1.56 08/14/07 127,140 202,020
Herbert J. Friedman....... 50,000 11.6% 1.56 08/14/07 127,140 202,020
K. James McTaggart........ 40,000 9.3% 1.56 08/14/07 101,712 161,616
Klaus Tabar............... 50,000 11.6% 1.56 08/14/07 127,140 202,020
</TABLE>
- ---------------
(1) The Company granted options for a total of 13,664 deferred stock units to
directors and 417,000 shares of Common Stock to employees of the Company
during 1997. All of the options and deferred stock units were granted under
the 1997 Stock Incentive Plan.
YEAR-END OPTION/SAR VALUES
The following table sets forth information concerning the value of
unexercised options and deferred stock units held by the Named Executive
Officers as of February 1, 1998, the end of the Company's 1997 fiscal year. No
Named Executive Officers exercised any options during fiscal 1997.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS
AT FISCAL YEAR-END AT FISCAL YEAR-END(1)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Philip M. Hawley............................. 617,000 617,000 925,500 925,500
Robert A. Burton............................. 12,500 87,500 11,000 80,000
Herbert J. Friedman.......................... 23,760 87,500 11,000 80,000
K. James McTaggart........................... 13,333 71,667 13,600 66,400
Klaus Tabar.................................. 29,700 87,500 11,000 80,000
</TABLE>
- ---------------
(1) Based on the closing price of the Common Stock as quoted on the Nasdaq
SmallCap Market of $2.50 on January 30, 1998.
1997 MANAGEMENT COMMITTEE INCENTIVE AWARD PROGRAM
The 1997 Management Committee Incentive Award Program (the "Management
Plan") was adopted by the Board of Directors to provide bonuses to certain
management employees of the Company if the Company meets certain financial
objectives. The Management Plan provided that such employees would earn eight
percent of their respective base salaries if the Company's earnings before
interest, taxes, depreciation and amortization reached $1,100,000 during the
last six months of fiscal year 1997 and additional amounts if the target was
exceeded. The target was not achieved. The plan also provided that certain
management employees may receive up to seven percent of their base salaries
based on their personal achievements. No decision has been made as to these
discretionary bonuses. The Management Plan is administered by the Compensation
Committee.
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<PAGE> 39
STOCK PLANS
1997 Stock Incentive Plan
The 1997 Stock Incentive Plan (the "1997 Plan") was approved by the Board
of Directors in January 1997 and the stockholders in May 1997. The 1997 Plan
extends for 10 years, but may be terminated at an earlier date. The 1997 Plan
provides for the issuance of awards covering up to 1,000,000 shares of Common
Stock to employees, officers, directors and consultants.
Awards under the 1997 Plan can consist of options, stock appreciation
rights, dividend equivalent rights, restricted stock, performance shares,
deferred stock units or other stock based awards. The Compensation Committee of
the Board of Directors, which includes only non-employee directors as its
members, has been designated to administer the 1997 Plan. The administrator has
the power to select employees, officers, directors and consultants to receive
awards, to make awards, to determine the terms upon which awards are made, to
approve agreements with recipients of awards, to amend awards, to interpret the
1997 Plan and to take other actions not inconsistent with the express terms of
the 1997 Plan.
Directors who are not employees of the Company (other than one non-employee
director who has indicated that he cannot accept an award because of his current
employment by a principal stockholder), receive automatic grants of deferred
stock units covering shares having a fair market value of $10,000 for each year
of service as a director. These awards provide deferred compensation to
directors equivalent to an investment in an equivalent amount of the Company's
Common Stock, based upon the fair market value of the Company's shares on the
date the award is effective. Payout of the award is made in stock following a
director's retirement from the Board of Directors or death. Normally the payment
occurs in five annual installments, but a director may elect to receive a single
payment. If a change in control of the Company occurs, the director's deferred
stock unit account will be paid in cash.
The Compensation Committee in its capacity as administrator of the 1997
Plan has broad authority to determine the type and amount of all other awards.
All awards must be set forth in an agreement. If awards are intended to qualify
as ISO's, they must conform to the requirements of the Internal Revenue Code of
1986, as amended (the "Code"). The committee may establish award exchange
programs or permit early exercise of awards. In general, awards may not have a
term of more than 10 years, and in some cases must have shorter terms. ISO's may
not be transferable except upon death or disability and then only to a limited
extent. Other awards can be transferable to the extent provided in the award
agreement. All option and other awards intended to qualify as performance based
compensation under the Code must be issued at fair market value on the date of
grant or award. The Committee is permitted to issue other awards at prices it
finds appropriate. The Company is permitted to withhold shares or other awards
to compensate it for withholding or other taxes. The Committee also can issue
new options to replace options canceled for this purpose. The Committee
determines the vesting or other timing of the exercise of an award and the
extent to which a recipient of an award or his or her successor can exercise an
award following termination of employment.
The 1997 Plan provides for adjustments in the case of stock splits, reverse
stock splits, stock dividends and other similar events. In the event of a merger
or sale of substantially all of the Company's assets in connection with a
dissolution of the Company, awards under the 1997 Plan will become fully vested,
unless they are assumed by a successor or are otherwise replaced as is provided
in the 1997 Plan. The Committee has authority to authorize full vesting if a
change of control occurs.
1994 Directors Stock Option Plan
The 1994 Directors Stock Option Plan (the "Directors Plan") was adopted by
the Board of Directors and approved by the shareholders in 1994. The Directors
Plan was terminated by the Board of Directors in January 1997, and no more
options may be granted under the Directors Plan. Options outstanding under the
Directors Plan remain in full force and effect.
Prior to its termination, the Directors Plan provided for the automatic
grant of an option to each non-employee director upon his or her election to the
Board, entitling the optionee to purchase up to a total of 5,000 shares of
Common Stock, at an exercise price equal to the fair market value for such
shares as of the
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<PAGE> 40
date of grant. On each anniversary of such first election, provided that the
individual continued to serve as a director, he or she automatically received an
additional grant of an option for the same number of shares, exercisable again
at the fair market value as of the date of the grant.
Each option granted under the Directors Plan may be exercised in whole or
in part at any time beginning upon conclusion of one year following the date of
grant until the expiration or earlier termination of the option. During his or
her lifetime, only the director who was the recipient of the option grant may
exercise the option. If a director is terminated with cause, as defined in the
Directors Plan, his or her option ceases to be exercisable and terminates upon
the effective date of termination. If a director ceases to serve on the Board
and his or her departure from the Board is not for cause, as defined, the option
is exercisable for a period of 90 days following the date when the director's
tenure on the Board ceases, but in no event later than the date of expiration of
the option in accordance with the terms of the Directors Plan. In the event a
director ceases to serve on the Board as a result of disability, as defined in
the Directors Plan, or if the director's death occurs while serving on the Board
or within 90 days following the date when he or she ceases to so serve, the
option must be exercised within 12 months following the date when the director
no longer is serving on the Board, subject to earlier expiration in accordance
with the terms of the Directors Plan. Options under the Directors Plan expire 10
years from their respective date of grant, unless subject to earlier
termination.
If any change, such as a stock split or dividend, is made in the Company's
capitalization which results in an exchange of Common Stock for a greater or
lesser number of shares without receipt of consideration, an appropriate
adjustment will be made in the exercise price of, and the number of shares
subject to, all outstanding options under the Directors Plan.
In the event of a proposed dissolution or liquidation of the Company, each
option outstanding under the Directors Plan will terminate immediately prior to
consummation of such proposed action. In the event of a sale of all or
substantially all of the assets of the Company or subsidiary of the Company or
the merger of the Company or one of its subsidiaries with or into another
corporation, unless each outstanding option will be assumed or an equivalent
option will be substituted by the successor corporation in the transaction or by
a parent or subsidiary of such successor corporation, the optionee shall have
the right to exercise the option as to all of the shares subject thereto,
including shares as to which the option would not otherwise be exercisable. In
this case, the option will be fully exercisable for a period of 30 days from the
date of such notice, and the option will terminate upon the expiration of such
period.
1990 Employees Stock Option Plan
The 1990 Employees Stock Option Plan (the "Employees Plan") was adopted by
the Board of Directors and approved by the stockholders in 1990. The Employees
Plan was terminated by the Board of Directors in January 1997, and no more
options may be granted under the Employees Plan. Options outstanding under the
Employees Plan remain in full force and effect.
Prior to its termination, under the Employees Plan, the Company was able to
grant incentive stock options ("ISOs") and nonstatutory stock options ("NSOs")
only to employees, including officers, of the Company and its subsidiaries. The
exercise price of all options granted under the Employees Plan is equal to 100%
of the fair market value of the Company's Common Stock on the date of grant,
provided that options granted to any person who owned more than 10% of the
voting power of all classes of capital stock of the Company at the date of grant
provided for an exercise price of not less than 110% of the fair market value of
the Company's Common Stock on the date of grant. Options are exercisable in
amounts and over specified periods of time as determined by the Compensation
Committee at the time of grant. The foregoing notwithstanding, all options shall
vest and be exercisable over a period not exceeding 10 years, provided that for
persons owning more than 10% of the total combined voting power of all classes
of capital stock of the Company, the maximum term is not more than five years
from the date of grant. During his or her lifetime, only the employee or officer
who is the recipient of the option grant may exercise the option. If an employee
or officer is terminated with cause, as defined in the Employees Plan, his or
her option ceases to be exercisable and terminates upon the effective date of
termination. If an employee's or officer's employment terminates and such
termination is not for cause, as defined, the option is exercisable for a period
of 90 days following the date
39
<PAGE> 41
when the termination occurs, but in no event later than the date of expiration
of the option in accordance with the terms of the Employees Plan. In the event
an employee's or officer's employment terminates as a result of disability, as
defined in the Employees Plan, or if the employee's or officer's death occurs
while employed or within 90 following the date when he or she ceases to be so
employed, the option must be exercised within 12 months following the date when
the employee or officer becomes disabled or dies, subject to earlier expiration
in accordance with the terms of the Employees Plan.
If any change, such as a stock split or dividend, is made in the Company's
capitalization which results in an exchange of Common Stock for a greater or
lesser number of shares without receipt of consideration, an appropriate
adjustment will be made in the exercise price of, and the number of shares
subject to, all outstanding options under the Employees Plan. In the event of a
merger or a consolidation of the Company with any other corporation in which the
Company is not the surviving corporation and in which the surviving corporation
does not assume the obligations of the Company under the Employees Plan, all
options outstanding under the Employees Plan will be automatically accelerated
and become exercisable. Any options not exercised prior to the merger or
consolidation will lapse.
In the event of a proposed dissolution or liquidation of the Company, each
option outstanding under the Employees Plan will terminate immediately prior to
consummation of such proposed action. In the event of a sale of all or
substantially all of the assets of the Company or subsidiary of the Company or
the merger of the Company or one of its subsidiaries with or into another
corporation, unless each outstanding option will be assumed or an equivalent
option will be substituted by the successor corporation in the transaction or by
a parent or subsidiary of such successor corporation, the optionee shall have
the right to exercise the option as to all of the shares subject thereto,
including shares as to which the option would not otherwise be exercisable. In
this case, the option will be fully exercisable for a period of 30 days from the
date of such notice, and the option will terminate upon the expiration of such
period.
Krause's Stock Option Plans
Krause's also has in effect several stock option plans which were
established prior to the time it was acquired by merger by the Company. Those
plans were terminated by the Board of Directors in January 1997, and no more
options may be granted under them. There are currently options to purchase an
aggregate of 11,880 shares of the Company's Common Stock outstanding to two
employees which will continue in full force and effect. The options were
originally granted for the purchase of Krause's stock, but were converted into
options to purchase the Company's Common Stock in connection with the merger.
EMPLOYMENT AGREEMENTS
In August 1996, the Company entered into an Employment Agreement with
Philip M. Hawley pursuant to which the Company agreed to employ Mr. Hawley for a
term ending on August 25, 1999, and to pay Mr. Hawley a base salary at the rate
of $225,000 per year and provide benefits. The Company and Mr. Hawley have
agreed to extend this agreement to January 31, 2001. If Mr. Hawley's employment
is terminated by the Company without cause (as defined in the Employment
Agreement) he is entitled to receive his full base salary and benefits for the
remaining term of the Employment Agreement. If Mr. Hawley resigns from the
Company upon a change in control (as defined in the Employment Agreement) he is
entitled to a lump sum payment equal to the greater of (i) the remaining amounts
that would be payable to him under the Employment Agreement and (ii) $225,000.
Furthermore, the Company agreed to grant Mr. Hawley an option to purchase
1,234,000 shares of Common Stock at an exercise of price of $1.00 per share with
vesting over three years. In the event of a change in control, the right to
exercise the options would accelerate. Mr. Hawley is also entitled to all other
benefits of employment available to executive officers of the Company generally,
including bonuses, retirement, vacation, deferred compensation, employee
discount, and various health related benefits.
The Company has entered into agreements with Messrs. Burton, Friedman,
McTaggart and Tabar, as well as several other officers and employees of the
Company, providing for the payment of severance benefits equal to such officers'
or employees' monthly salary plus benefits for up to 12 months if terminated
without cause.
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<PAGE> 42
CERTAIN TRANSACTIONS
During 1997, 1996 and 1995 a number of transactions occurred between the
Company and its subsidiaries and certain directors and their affiliates. The
Company believes that each such arrangement was as fair as could have been
obtained from unaffiliated persons.
1996 Notes. From May 13, 1996 to June 19, 1996, various investors loaned an
aggregate of $2,950,000 to the Company. Among the investors were Permal Capital
Management, Inc., an indirect subsidiary of Worms & Cie ($50,000 principal
amount), ATCO Development, Inc. ($150,000), Mr. DeLitto, the Company's Vice
Chairman of the Board ($25,000), and Mr. Sharpe ($25,000) and Mr. Perrette
($250,000), each a former officer of the Company. In addition, on May 21, 1996
and July 2, 1996, JOL loaned to the Company $1,500,000 and $500,000,
respectively. All indebtedness pursuant to these loans (collectively, the "1996
Notes") was payable on demand and bore interest at the annual rate of 10% for
the first year only. All amounts outstanding under the 1996 Notes were retired
in connection with the 1996 Securities Purchase Agreement described below.
1996 Securities Purchase Agreement. On August 26, 1996, and September 4,
1996, the Company entered into a securities purchase agreement (the "Securities
Purchase Agreement") whereby the Company raised an aggregate of $18,735,000 in
debt and equity. Pursuant to the Securities Purchase Agreement:
- The Company sold 10,669,000 shares of Common Stock to certain investors,
at a price of $1.00 per share. Purchasers included GECC (5,000,000
shares), ATCO Holdings Ltd. (500,000 shares), certain affiliates of Worms
& Cie (500,000 shares), Mr. Hawley, the Company's Chairman of the Board
and Chief Executive Officer and various trusts established for the
benefit of relatives of Mr. Hawley (1,080,000 shares), and Mr. DeLitto,
the Company's Vice Chairman of the Board (25,000 shares).
- The Company issued 3,066,251 shares of Common Stock to the holders of the
1996 Notes in consideration for retirement of all amounts outstanding
under the 1996 Notes, including accrued interest. Shares were issued at a
rate of one share per $1.00 of debt retired.
- GECC made a loan to the Company in the original principal amount of
$5,000,000. This indebtedness was evidenced by a note (the "Original
Note") bearing interest at the rate of 10% per annum and payable in full
on or before August 31, 2001. Pursuant to the 1997 Supplemental
Securities Agreement (described below), this note was replaced with a
note bearing interest at 9.5% per annum and payable in full on August 31,
2002. In connection with the issuance of the Original Note, the Company
issued to GECC warrants to purchase a total of 1,400,000 shares of Common
Stock at an exercise price of $.001 per share, expiring August 31, 2006.
In the event that the Company fails to meet certain financial covenants,
including failure to repay this loan, the Securities Purchase Agreement
provides, in part, that GECC may take action to appoint additional
members of the Board of Directors such that GECC will control the
majority of the Board.
- The Company converted all outstanding shares of Series A Preferred Stock
into 1,176,950 shares of Common Stock. The holders of the Preferred Stock
who received shares of Common Stock included certain affiliates of Worms
& Cie and JOL.
- The Company entered into a Registration Rights Agreement with all
investors that received shares of Common Stock pursuant to the Securities
Purchase Agreement. See "Description of Capital Stock -- Registration
Rights Agreement."
- The Company entered into a Stockholders Agreement with investors. See
"Description of Capital Stock -- Stockholders Agreement." Pursuant to the
Stockholders Agreement, Mr. Hawley was appointed Chief Executive Officer
and named Chairman of the Board. Also pursuant to the Stockholders
Agreement, (i) Mr. Coats, a managing Director of GE Capital Equity
Capital Group, a wholly-owned subsidiary of GECC, was appointed to the
Board, and (ii) Mr. DeLitto, the President of Permal Capital Management,
Inc., was appointed to the Board.
The price of $1.00 per share for shares of Common Stock issued pursuant to
the Securities Purchase Agreement was negotiated at arm's length between the
Company and GECC, the lead investor, prior to August 19, 1996, the date of the
public announcement regarding the proposed GECC financing. The average of the
high and low sales prices on the Nasdaq SmallCap Market for the Company's Common
Stock during
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<PAGE> 43
the two weeks prior to August 19, 1996, was $0.91 per share. The average of the
high and low sales prices on the Nasdaq SmallCap Market for the Company's Common
Stock on August 26, 1996, and on September 10, 1996, the closing dates of the
transactions, was $1.66 and $1.47, respectively.
1997 Supplemental Securities Purchase Agreement. On August 14, 1997, the
Company concluded a supplemental agreement to the Securities Purchase Agreement
(the "Supplemental Agreement"). Pursuant to the Supplemental Agreement:
- The Company sold subordinated notes to GECC and JOL in the principal
amounts of $2,500,000 and $500,000, respectively (together, the "1997
Notes"). The 1997 Notes bear interest at a rate of 9.5%, payable
quarterly. Principal is payable in six semi-annual installments,
commencing February, 2000. In addition, GECC and JOL were issued warrants
to purchase 600,000 shares of Common Stock and 140,000 shares of Common
Stock, respectively, at a purchase price of $1.25 per share. In the event
that the Company fails to meet certain financial covenants, including
failure to repay this loan, the Securities Purchase Agreement provides,
in part, that GECC may take action to appoint additional members of the
Board of Directors such that GECC will control the majority of the Board.
- The Company arranged for a standby credit facility under which the
Company could at its option, subject to attainment of certain financial
covenants, borrow up to an additional $3,500,000 (the "Standby Notes")
from GECC and JOL under the same terms and conditions of the 1997 Notes.
The Company borrowed funds pursuant to the Standby Notes on December 30,
1997 and issued to GECC and JOL additional warrants to purchase 400,000
and 160,000 shares of Common Stock, respectively, at $1.25 per share.
- The Company issued to GECC and JOL warrants to purchase in the aggregate
up to an additional 1,000,000 shares of Common Stock at a price of $0.01
per share (the "Performance Warrants"). The Performance Warrants first
become exercisable in April 2000 and will be canceled if the Company
meets certain economic performance targets for fiscal 1999.
- The Company issued a new 9.5% Subordinated Note due August 31, 2002 (the
"Replacement Note") in the principal amount of $5,501,091 to replace the
Original Note (which bore interest at 10% per annum and was payable in
full on or before August 31, 2001) in the principal amount of $5 million
and certain additional notes in aggregate principal amount of $501,091
reflecting accrued interest. The Replacement Note is payable semiannually
on a straight line basis over three years beginning February 2000.
- The Company amended the Registration Rights Agreement and the
Stockholders Agreement. See "Description of Capital Stock -- Registration
Rights Agreement" and "Description of Capital Stock -- Stockholders
Agreement."
Private Label Credit Card Program with Monogram Credit Card Bank of Georgia
(an Affiliate of GECC). In April 1997, the Company entered into an agreement
with Monogram Credit Card Bank of Georgia ("Monogram"), an affiliate of GECC,
pursuant to which Monogram provides a customized credit program to the Company.
Under this program, approved customers of the Company are able to purchase
products on credit through a credit card issued by Monogram. Monogram purchases
each credit from the Company and bears the risk of loss on such credit
purchases. The program is for an initial term of five years and will
automatically renew for consecutive five-year terms unless terminated by either
party at least six months prior to the end of any such five-year term.
Transactions with Permal Capital Management, Inc. (a wholly owned
subsidiary of Worms & Co., Inc., since October 1990). In 1996 and 1995, Permal
Capital Management, Inc. ("PCMI") provided various management services for the
Company and its subsidiaries, for which PCMI received $58,333 and $100,000,
respectively. PCMI's executive management services for the Company included
assistance with regard to executive management, financial consulting and
strategic planning during the year. Thomas M. DeLitto, President of PCMI, served
as President and Chief Executive Officer of the Company from January to December
1994, served as Chief Executive Officer from April 1995 to August 1996 and is
currently Vice Chairman of the Board of Directors.
42
<PAGE> 44
Succession Agreement. In December 1997, a Succession Agreement was entered
into by the Company and the following stockholders: Philip M. Hawley, its
Chairman, his sons John F. Hawley and Dr. Philip M. Hawley, Jr., GECC and Permal
Capital Management. The parties to the Succession Agreement agreed that if
Philip M. Hawley ceases to serve on the Board of Directors, the stockholder
parties would take all necessary action to ensure that John F. Hawley, or his
nominee if he is unavailable, is elected to serve as a director. Furthermore,
GECC and each of the members of the Hawley Group agreed to cooperate in
connection with the acquisition by either of Common Stock held by the Permal
Group. The agreement will continue as long as the Hawley Group owns an aggregate
of at least 1,000,000 shares of Common Stock.
43
<PAGE> 45
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to
beneficial ownership of the Company's Common Stock as of March 2, 1998 and is
adjusted to reflect the sale of the shares offered hereby by (i) each person (or
group of affiliated persons) who is known by the Company to own beneficially
more than 5% of the Company's Common Stock, (ii) each of the Company's
directors, (iii) each of the Named Executive Officers, (iv) the Selling
Stockholder, and (v) all directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY
PRIOR TO OFFERING(1) NUMBER OF OWNED AFTER OFFERING
-------------------------- SHARES ----------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT BEING OFFERED NUMBER PERCENT
- ------------------------------------ ----------- --------- ------------- --------- -------
<S> <C> <C> <C> <C> <C>
GECC................................ 7,400,000(2) 34.5% -- 7,400,000 31.2%
260 Long Ridge Road
Stamford, CT 06927
Worms & Cie......................... 5,278,818(3)(5) 27.1 -- 3,182,707(5) 14.6
55 rue la Boetie
75008 Paris, France
Japan Omnibus Ltd................... 2,396,111(4) 12.4 2,096,111(5) 300,000 1.4
Tropic Isle Building
Road Town, Tortola
British Virgin Islands
John F. Hawley and Barbara H.
Hawley, as Trustees............... 1,376,472(6) 7.2 -- 1,376,472 6.5
515 South Figueroa Street
Los Angeles, CA 900071
ATCO Holdings Limited............... 1,115,923 5.9 -- 1,115,923 5.2
c/o ATCO Development, Inc.
11777 Katy Freeway
Houston, TX 77079
Philip M. Hawley.................... 647,000(7) 3.3 -- 647,000 2.9
Thomas M. DeLitto................... 109,327(8) * -- 109,327 *
Robert A. Burton.................... 12,500(9) * -- 12,500 *
Herbert J. Friedman................. 29,981(10) * -- 29,981 *
K. James McTaggart.................. 14,333(11) * -- 14,333 *
Klaus Tabar......................... 34,837(12) * -- 34,837 *
Kamal G. Abdelnour.................. 47,520(13) * -- 47,520 *
Jeffrey H. Coats.................... -- -- -- -- --
Peter H. Dailey..................... 14,570(14) * -- 14,570 *
John A. Gavin....................... 14,570(14) * -- 14,570 *
All directors and executive officers
as a group (10 persons)........... 924,638 4.7 -- 924,638 4.2
</TABLE>
- ---------------
* Less than one percent
(1) Outstanding warrants and options held by each of the principal
stockholders, directors and executive officers which are exercisable
currently or within 60 days of the date of this table are deemed to be
outstanding shares of Common Stock for their respective calculations.
(2) Includes warrants to purchase 2,400,000 shares of Common Stock.
(3) Worms & Cie, through JOL, PCMI and certain other affiliates, may be deemed
to be the beneficial owner of 4,851,421 shares of Common Stock and warrants
to purchase 427,397 shares of Common Stock, which amounts include 1,288,040
shares and 29,442 warrants held by two former directors of the Company, and
exclude 109,327 shares, options and warrants held by Mr. DeLitto and shown
separately below. The two former directors and Mr. DeLitto are directors
and officers of affiliates of Worms & Cie. Worms & Cie disclaims ownership
of the shares held by these individuals.
(4) Includes warrants to purchase 300,000 shares of Common Stock.
44
<PAGE> 46
(5) JOL is the sole Selling Stockholder. Worms & Cie's principal business is
investing. While Worms & Cie does not directly own any shares of Common
Stock, James Hodge, who is senior vice president of Worms & Co., Inc., an
affiliate of Worms & Cie, makes investment decisions for JOL in his
capacity as its Portfolio Manager and, accordingly, Worms & Cie may be
deemed to share voting and dispositive power with respect to, and therefore
to beneficially own, the shares of Common Stock beneficially owned by JOL.
Therefore, the number of shares beneficially owned after this offering by
Worms & Cie reflects a reduction by the number of shares sold by JOL, even
though Worms & Cie is not the seller thereof.
(6) As trustees for various Hawley Trusts, John F. Hawley and Barbara H. Hawley
are deemed to be beneficial owners of such shares.
(7) Includes option to purchase 617,000 shares of Common Stock.
(8) Includes options to purchase 9,998 shares of Common Stock, 9,570 deferred
stock units and a warrant to purchase 14,721 shares of Common Stock.
(9) Represents options to purchase 12,500 shares of Common Stock.
(10) Includes options to purchase 23,760 shares of Common Stock.
(11) Includes options to purchase 13,333 shares of Common Stock.
(12) Includes options to purchase 29,700 shares of Common Stock.
(13) Includes option to purchase 5,000 shares of Common Stock, 9,570 deferred
stock units and a warrant to purchase 32,950 shares of Common Stock.
(14) Consists of options to purchase 5,000 shares of Common Stock and 9,570
deferred stock units.
45
<PAGE> 47
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, each of
the underwriters named below (the "Underwriters"), for whom Cruttenden Roth
Incorporated, Black & Company, Inc. and Morgan Fuller Capital Group, LLC are
acting as representatives (the "Representatives"), has severally agreed to
purchase from the Company and the Selling Stockholder, and the Company and the
Selling Stockholder have agreed to sell to each Underwriter, the aggregate
number of shares of Common Stock set forth opposite the name of each such
Underwriter below:
<TABLE>
<CAPTION>
NUMBER
UNDERWRITERS OF SHARES
------------ ---------
<S> <C>
Cruttenden Roth Incorporated................................
Black & Company, Inc........................................
Morgan Fuller Capital Group, LLC............................
Total.......................................................
===
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters are subject to certain conditions precedent, including conditions
that no stop order suspending the effectiveness of the Registration Statement is
in effect and no proceedings for such purpose are pending before or threatened
by the Commission, and that there has been no material adverse change in the
condition of the Company. The nature of the Underwriters' obligation is such
that they are committed to purchase and pay for all of the shares of Common
Stock if any are purchased.
The Company and the Selling Stockholder have been advised by the
Representatives that the Underwriters propose to offer shares of Common Stock
directly to the public initially at the public offering price set forth on the
cover page of this Prospectus and to certain selected dealers at such price less
a concession not in excess of $ per share. The Underwriters may allow, and
such selected dealers may reallow, a discount not in excess of $ per share
to certain other dealers. After commencement of the public offering, the
offering price and other selling terms may be changed by the Representatives. No
change in such terms shall change the amount of proceeds to be received by the
Company as set forth on the cover page of this Prospectus.
The Company has granted an option to the Underwriters, exercisable for a
period of 45 days after the date of this Prospectus, to purchase up to an
aggregate of 440,000 additional shares of Common Stock at the public offering
price set forth on the cover page of this Prospectus, less the underwriting
discounts and commissions. The Underwriters may exercise such option only to
cover over-allotments made in connection with the sale of Common Stock offered
hereby. To the extent that the Underwriters exercise such option, each of the
Underwriters will be committed, subject to certain conditions, to purchase a
number of the additional shares of Common Stock proportionate to such
Underwriters initial commitment as indicated in the preceding table. The Company
will be obligated, pursuant to such option, to sell such shares to the
Underwriters to the extent such option is exercised.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase shares of Common Stock. As
an exception to these rules, the Representatives are permitted to
46
<PAGE> 48
engage in certain transactions that stabilize the price of the Common Stock.
Such transactions may consist of bids or purchases for the purpose of pegging,
fixing or maintaining the price of the Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with the Offering (i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus), the Representatives
may reduce that short position by purchasing Common Stock in the open market.
The Representatives also may elect to reduce any short position by exercising
all or part of the over-allotment options described herein. The Representatives
also may impose a penalty bid on certain Underwriters and selling group members.
This means that, if the Representatives purchase shares of Common Stock in the
open market to reduce the Underwriters' short position or to stabilize the price
of the Common Stock, they may reclaim the amount of the selling concession from
the Underwriters and selling group members who sold those shares as part of the
offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a syndicate short position could cause the price of the security to be
higher than it might otherwise be in the absence of such purchases. The
imposition of a penalty bid might have an effect on the price of a security to
the extent that it were to discourage resales of the security by purchasers in
the offering. Neither the Company nor any of the Underwriters makes any
representation or prediction as to the direction or magnitude of any effect that
the transactions described above may have on the price of the Common Stock. In
addition, neither the Company nor any of the Underwriters makes any
representation that the Representatives will engage in such transactions or that
such transactions, once commenced, will not be discontinued without notice.
The Company and the Selling Stockholder have agreed to pay the
Representatives a non-accountable expense allowance equal to 2% of the aggregate
Price to Public (including with respect to shares of common stock underlying the
over-allotment option, if and to the extent it is exercised) set forth on the
front cover of this Prospectus for expenses in connection with this offering,
and the Company has agreed to reimburse the Underwriters up to an additional
$100,000 for certain specified out-of-pocket expenses incurred by them in
connection with the offering. The Representatives' expenses in excess of such
allowance will be borne by the Representatives. To the extent that the expenses
of the Representatives are less than the non-accountable expense allowance, the
excess may be deemed to be compensation to the Representatives.
The Company and the Selling Stockholder have agreed to indemnify the
Underwriters and their controlling persons against certain liabilities,
including liabilities under the Securities Act or to contribute to payments that
may be required to be made in respect thereof.
The Company has agreed that for a period of 180 days from the date of this
Prospectus it will not, and certain officers, directors and affiliates of the
Company and the Selling Stockholder have agreed that for a period of 120 days
from the date of the Prospectus they will not, offer, sell or otherwise dispose
of any shares of capital stock or equity securities of the Company or any
securities convertible into, or exchangeable or exercisable for, Common Stock
(excluding those shares being sold pursuant to this offering), without the prior
written consent of the Underwriters.
Lawrence S. Black, Chairman Emeritus, Black & Company, Inc., owns 95,000
shares of the Company's common stock for his own account. The shares were
acquired from time to time in the open market prior to the involvement of Black
& Company, Inc. in the offering.
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 35,000,000 shares
of Common Stock, par value $.001 per share (the "Common Stock") and 666,667
shares of Preferred Stock par value $.001 per share (the "Preferred Stock"). As
of February 1, 1998, there were 19,020,539 shares of Common Stock issued and
outstanding. No shares of Preferred Stock are issued and outstanding.
47
<PAGE> 49
COMMON STOCK
The holders of Common Stock (but not warrant holders or optionees) are
entitled to dividends and distributions, if any, with respect to the Common
Stock when, as and if declared by the Board of Directors from funds legally
available therefor. Holders of Common Stock are entitled to one vote per share
and are not entitled to cumulative voting in the election of directors. The
holders of Common Stock have no preemptive, subscription, redemption or
conversion rights. In the event of the liquidation, dissolution or winding up of
the Company, the holders of Common Stock are entitled to share ratably in all
assets remaining after payment of all debts and other liabilities, subject to
prior distribution rights of holders of Preferred Stock, if any, then
outstanding.
PREFERRED STOCK
The Company's Board of Directors is authorized to divide the Preferred
Stock into series and, with respect to each series, to determine the
preferences, rights, qualifications, limitations and restrictions thereof,
including the dividend rights, conversion rights, voting rights, redemption
rights and terms, liquidation preferences, sinking fund provisions, number of
shares constituting a series and the designation of such series. Although the
Company currently does not have any plans to issue shares of Preferred Stock or
to designate any new series of Preferred Stock, there can be no assurance that
the Company will not do so in the future. The Board of Directors could, without
stockholder approval, issue Preferred Stock with voting and other rights that
could adversely affect the voting power of the holders of Common Stock and could
have certain anti-takeover effects.
WARRANTS AND STOCK OPTIONS
As of 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 at a exercise price of $.001 per share. Also, in
connection with the August, 1997 financing, 1,000,000 warrants were issued to
GECC and 300,000 were issued to JOL, all at an exercise price of $1.25 per
share. The remaining 365,502 warrants have exercise prices ranging from $1.32 to
$15.00 per share with expiration dates ranging from May 1998 to June 2005. The
warrants generally provide for certain anti-dilution adjustments. In addition,
in connection with the August 1997 financing, the Company agreed to issue
warrants to GECC and JOL to purchase up to 1,000,000 shares of Common Stock upon
the occurrence of certain events, and which expire August 31, 2006. See "Certain
Transactions." The Company also has 38,280 shares of Common Stock issuable upon
payment of deferred stock units and options outstanding to purchase an
additional 2,043,958 shares of Common Stock.
REGISTRATION RIGHTS
After this offering, holders of 7,244,612 shares of Common Stock will be
entitled to certain rights with respect to the registration of such shares under
the Securities Act, pursuant to a certain Registration Rights Agreement dated as
of August 26, 1996, as amended on August 14, 1997, among such holders and the
Company (the "Registration Rights Agreement"). Under the terms of the
Registration Rights Agreement, if the Company hereafter proposes to register any
of its securities under the Securities Act, either for its own account or for
the account of other security holders exercising registration rights, such
holders are entitled to notice of such registration and are entitled to include
shares of Common Stock therein. Stockholders benefiting from these rights may
also require the Company to file a registration statement under the Securities
Act with respect to their shares of Common Stock, and the Company is required to
use best efforts to effect up to two such registrations during any 12-month
period. This right is not exercisable prior to August 31, 1999, unless certain
conditions are satisfied. Further, these rights are subject to certain
conditions and limitations, among them the right of the underwriter of an
offering to limit the number of shares included in such registration and the
right of the Company not to effect a requested registration within 180 days
following the offering of the Company's securities in another public offering.
The Amendment to the Registration Rights Agreement provides for a one-time
registration right for the benefit of JOL and members of the Permal
48
<PAGE> 50
Group, as JOL may designate, whereby JOL is permitted to offer for sale or sell
a maximum of 2,096,111 shares of Common Stock in the aggregate and a minimum of
1,000,000 shares of Common Stock.
STOCKHOLDERS AGREEMENT
As of August 26, 1996, in connection with the GECC financing described
under "Certain Transactions" above, the Company entered into a stockholders
agreement (the "Stockholders Agreement") with several investors, including GECC
as well as certain other existing stockholders. The Stockholders Agreement, as
amended on August 14, 1997, provides, among other things, for certain
restrictions on the transfer of shares by those stockholders who are parties to
the Stockholders Agreement and confers rights of first offer to GECC in the
event certain of the stockholders wish to sell their shares. Furthermore, the
Stockholders Agreement allows for GECC to name one director to the Board of
Directors of the Company, allows the Permal Group (as defined in the
Stockholders Agreement) to designate another director, provides that Philip M.
Hawley will be a third director, and provides that the three remaining directors
(the "Joint Designees") will be selected by Mr. Hawley and the directors who are
designated by GECC and the Permal Group. At each meeting of the stockholders of
the Company held for the purpose of electing directors, the stockholders who are
parties to the Stockholders Agreement (with the exception of certain trusts) are
required to vote to cause the GECC designee, the Permal Group designee, Mr.
Hawley and the Joint Designees to be elected as directors. In addition, the
Company is prohibited from taking certain actions unless the GECC designee on
the Board of Directors approves such action. Such restricted actions include
mergers; liquidations and dissolutions; acquisitions of all or a substantial
portion of the business or the assets of another person; the entering into of a
joint venture or partnership arrangement; expansion into new lines of business;
the sale, lease or transfer of any assets of the Company or any of its
subsidiaries except for sales of inventory in the ordinary course of business
and the subleasing of vacant retail space; the adoption or change of any
material accounting policy; the creation of any additional indebtedness (with
certain exceptions); the granting of liens against the Company's assets; the
payment of dividends or the redemption of capital stock; the making or
commitment to make any capital expenditure in any year in excess of $50,000; the
issuance or sale of any shares of capital stock or rights to purchase capital
stock; the entering into, adoption, amendment or termination of any employment
or consulting agreement or the hiring of any person who will report directly to
the Chief Executive Officer or to whom total compensation would be in the excess
of $110,000 per year; the adoption or amendment of any employment benefit plan;
the amendment of the Company's charter documents; a change in independent
certified accountants or actuaries; the registration of any security under the
Securities Act or the granting of any registration rights therefor; certain
related party transactions; changes to the Company's annual business plan; and
any action which is required by law to be approved by the Board of Directors.
The Stockholders Agreement further provides that each member of the Permal
Group will vote all of its shares in the same manner that GECC votes its shares
with respect to each matter subject to the vote or consent of stockholders of
the Company. In the event GECC or any member of the Permal Group, pursuant to a
common plan, were to enter into any agreement to sell to any person or group in
one transaction or series of related transactions in which such group would sell
in excess of 3,000,000 shares, then each of the other stockholders party to the
Stockholders Agreement would have the right to participate in such sale. The
Stockholders Agreement will terminate at such time as GECC is no longer the
beneficial owner of at least 2,000,000 of the outstanding shares of Common Stock
or at such earlier time as may be agreed by GECC and the Permal Group.
Furthermore, the Stockholders Agreement will terminate as to any member of the
Hawley Group on the later of (i) six months after Mr. Hawley ceases to be a
Director of the Company and (ii) August 31, 1999.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), an anti-takeover law that restricts certain transactions
and business combinations between a corporation and an "Interested Stockholder"
owning 15% or more of the corporation's outstanding voting stock, for a period
of three years from the date the stockholder becomes an Interested Stockholder.
Subject to certain exceptions, unless the transaction is approved by the board
of directors and the holders of at least two-thirds of the
49
<PAGE> 51
outstanding voting stock of the corporation (excluding shares held by the
Interested Stockholder), Section 203 prohibits significant business transactions
such as a merger with, disposition of assets to, or receipt of disproportionate
financial benefits by the Interested Stockholder, or any other transaction that
would increase the Interested Stockholder's proportionate ownership of any class
or series of the corporation's stock. The statutory ban does not apply if, upon
consummation of the transaction in which any person becomes an Interested
Stockholder, the Interested Stockholder owns at least 85% of the outstanding
voting stock of the corporation (excluding shares held by persons who are both
directors and officers or by certain employee stock plans).
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is First National
Bank of Boston.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon by
Morrison & Foerster LLP, Los Angeles, California. Certain matters in connection
with this offering will be passed upon for the Underwriters by Snell & Wilmer
L.L.P., Phoenix, Arizona.
EXPERTS
The financial statements and schedule as of February 1, 1998 and for the
fiscal year then ended included in this Prospectus and Registration Statement
have been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their reports with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said reports. The
consolidated financial statements and financial statement schedule of Krause's
Furniture, Inc. as of February 2, 1997 and for the fiscal years ended February
2, 1997 and January 28, 1996 appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their reports thereon appearing elsewhere herein. The consolidated
financial statements and schedule referred to above are included in reliance
upon such reports, given upon the authority of such firms as experts in
accounting and auditing.
ADDITIONAL INFORMATION
The Company is subject to the reporting requirements of the Exchange Act,
and accordingly files annual and quarterly reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission"). The
Company has filed with the Commission a Registration Statement on Form S-1
(together with all amendments and exhibits thereto, the "Registration
Statement") under the Securities Act with respect to the shares of Common Stock
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. For further
information with respect to the Company and the shares of Common Stock offered
hereby, reference is made to the Registration Statement. Statements contained in
this Prospectus as to the contents of any contract or other document are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. Copies of
such materials may be examined without charge at, or obtained upon payment of
prescribed fees from, the Public Reference Section of the Commission at Room
1024 Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's regional offices located at 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and at 7 World Trade Center, 13th Floor, New York New
York 10048. The Commission maintains a World Wide Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission. The address of the
site is http://www.sec.gov. The Common Stock is currently traded on the Nasdaq
SmallCap Market. Reports, proxy statements and other information concerning the
Company may also be inspected at the National Association of Securities Dealers,
Inc. at 1735 K Street, N.W., Washington D.C. 20006.
50
<PAGE> 52
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Report of Arthur Andersen LLP, Independent Public
Accountants............................................... F-2
Report of Ernst & Young LLP, Independent Auditors........... F-3
Consolidated Balance Sheet at February 1, 1998 and February
2, 1997................................................... F-4
Consolidated Statement of Operations for the years ended
February 1, 1998, February 2, 1997 and January 28, 1996
.......................................................... F-5
Consolidated Statement of Stockholders' Equity for the years
ended February 1, 1998, February 2, 1997 and January 28,
1996...................................................... F-6
Consolidated Statement of Cash Flows for the years ended
February 1, 1998, February 2, 1997 and January 28, 1996... F-7
Notes to Consolidated Financial Statements.................. F-8
</TABLE>
F-1
<PAGE> 53
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
F-2
<PAGE> 54
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. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The Company has reported losses from operations in each of the past five
years, projects that it will incur a net loss for the year ending February 1,
1998 and may be required to obtain a waiver as of February 1, 1998 with respect
to compliance with covenants contained in its revolving credit agreement.
Management's plan for meeting obligations as they become due is summarized in
Note 2 to the consolidated financial statements.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Krause's Furniture, Inc. at February 2, 1997 and 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.
/s/ ERNST & YOUNG LLP
Orange County, California
March 28, 1997,
except for Note 2, as to which the date is
December 17, 1997
F-3
<PAGE> 55
KRAUSE'S FURNITURE, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2,
1998 1997
----------- -----------
<S> <C> <C>
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.
F-4
<PAGE> 56
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.
F-5
<PAGE> 57
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK CAPITAL IN TOTAL
---------------- --------------- EXCESS OF ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT PAR 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 stock............. -- -- 3,066 3 3,063 -- 3,066
Issuance of common stock for cash, net
of expenses of $448................... -- -- 10,669 11 10,210 -- 10,221
Issuance of common stock purchase
warrant............................... -- -- -- -- 1,400 -- 1,400
Compensation expense on stock option
grant................................. -- -- -- -- 293 -- 293
Repurchase of common stock.............. -- -- (12) -- (33) -- (33)
Net loss................................ -- -- -- -- -- (13,389) (13,389)
---- ------- ------ --- ------- -------- -------
Balance at February 2, 1997............. -- -- 19,021 19 49,874 (34,350) 15,543
Issuance of common stock purchase
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.
F-6
<PAGE> 58
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.
F-7
<PAGE> 59
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.
F-8
<PAGE> 60
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Inventories
Inventories are carried at the lower of cost or market using the first-in,
first-out method and are comprised of the following:
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2,
1998 1997
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
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
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
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.
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.
F-9
<PAGE> 61
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Long-lived assets and certain identifiable intangibles held and used by the
Company are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Based upon
its analysis, management believes that no impairment of the carrying value of
its long-lived assets inclusive of goodwill exists at February 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.
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
F-10
<PAGE> 62
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
F-11
<PAGE> 63
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Original Note due August 31, 2001, in the principal amount of $5,000,000 and
certain additional notes in aggregate principal amount of $501,091 reflecting
related accrued interest. The Replacement Note is payable semiannually, on a
straight-line basis over three years beginning February 2000, whereas the
Original Note was payable semiannually, on a straight-line basis over three
years beginning February 1999.
Also in August 1997, the Company renegotiated the 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
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
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>
F-12
<PAGE> 64
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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).
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.
F-13
<PAGE> 65
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax at federal statutory rate............. $ (2,543) $(4,552) $(3,414)
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
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
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,
F-14
<PAGE> 66
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the Company had state net operating loss carryforwards of approximately $30
million, which begin to expire in the year 1998, if not utilized.
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
F-15
<PAGE> 67
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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.
F-16
<PAGE> 68
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
- ----------- ----------- -------------- ---------------- ----------- -------------------
<C> <S> <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>
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.
F-17
<PAGE> 69
KRAUSE'S FURNITURE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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 ten largest suppliers
accounted for 55.9% of its aggregate purchases. One supplier represented
approximately 11.5% of aggregate purchases for fiscal 1997.
F-18
<PAGE> 70
======================================================
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THIS OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, THE SELLING STOCKHOLDER OR THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATIONS
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 9
Use of Proceeds....................... 16
Dividend Policy....................... 16
Price Range of Common Stock........... 16
Dilution.............................. 17
Capitalization........................ 18
Background of the Company............. 18
Selected Consolidated Financial
Data................................ 19
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 20
Business.............................. 27
Management............................ 34
Certain Transactions.................. 41
Principal and Selling Stockholders.... 44
Underwriting.......................... 46
Description of Capital Stock.......... 47
Legal Matters......................... 50
Experts............................... 50
Additional Information................ 50
</TABLE>
======================================================
======================================================
4,400,000 SHARES
[KRAUSE'S FURNITURE, INC. LOGO]
COMMON STOCK
-----------------
PROSPECTUS
-----------------
CRUTTENDEN ROTH
INCORPORATED
BLACK & COMPANY, INC.
MORGAN FULLER
CAPITAL GROUP, LLC
March , 1998
======================================================
<PAGE> 71
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following is an itemized list of the estimated expenses to be incurred
in connection with the offering of the securities being offered hereunder other
than underwriting discounts and commissions.
<TABLE>
<S> <C>
Registration Fee.......................................... $ *
--------
Printing and Engraving.................................... *
--------
Legal Fees and Expenses................................... *
--------
Blue Sky Fees and Expenses................................ *
--------
Accountants' Fees and Expenses............................ *
--------
Total**......................................... *
========
</TABLE>
- ---------------
* To be supplied by amendment.
** All costs to be borne by the Company.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the DGCL contains detailed provisions on indemnification of
directors and officers against expenses, judgments, fines and amounts paid in
settlement, actually and reasonably incurred in connection with legal
proceedings. Section 102(a)(7) of the DGCL permits a provision in the
certificate of incorporation of each corporation organized thereunder, such as
the Company, eliminating or limiting, with certain exceptions, the personal
liability of a director of the corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director. The Certificate of
Incorporation of the Company eliminates the liability of each of its directors
to its stockholders or the Company for monetary damages for breach of fiduciary
duty to the full extent provided by the Delaware General Corporation Law (the
"DGCL"), as such law exists or may hereafter be amended.
Indemnification applies to any threatened, pending or completed action,
suit or proceeding, whether, civil, criminal, administrative or investigative.
Indemnification may include all expenses (including attorneys' fees, judgments,
fines, ERISA excise taxes and amounts paid in settlement) reasonably incurred by
the indemnified person.
The Company maintains a directors and officers liability and reimbursement
insurance policy intended to reimburse the Company for any payments made by it
pursuant to its indemnification obligations.
The foregoing statements are subject to the detailed provisions of Section
102(a)(7) of the DGCL and the Certificate of Incorporation of the Company, as
applicable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
1. Within the past three years the Company sold an aggregate of 1,677
shares of Common Stock to one employee for consideration in the aggregate amount
of $5,150 pursuant to the Company's 1990 Employees Stock Option Plan.
2. From May 13, 1996, through June 19, 1996, the Company sold an aggregate
principal amount of $950,000 of its Series 1996-I and Series 1996-II Convertible
Promissory Notes (the "Notes") to certain directors, officers and 5%
stockholders of the Company and parties related to them. In connection with the
General Electric Capital Corporation ("GECC") financing, the holders of the
Notes converted the principle amount and accrued interest due under the Notes
into an aggregate of 970,140 shares of Common Stock at a conversion price of
$1.00 per share. The purchasers of the Notes were certain officers, directors
and affiliates of the Company.
II-1
<PAGE> 72
3. On May 21, 1996, the Company issued its Demand Promissory Note in the
principal amount of $1,500,000 to Edson Investments, Inc. ("Edson"). On July 2,
1996, the Company issued a second Demand Promissory Note in the principal amount
of $500,000 to Edson. In connection with the GECC financing, Edson acquired
2,096,111 shares of Common Stock at a price of $1.00 per share in consideration
for its cancellation of the Company's obligation to repay the principal and
accrued interest of the $96,111 owed under these Demand Promissory Notes. Edson
changed its name to Japan Omnibus Ltd. and is the Selling Stockholder in this
Registration Statement.
4. On August 26, 1996, and September 10, 1996, the Company completed a
private placement of 10,699,000 shares of Common Stock to 55 investors, some of
whom are related to each other, at a price of $1.00 per share. In addition, the
Company issued its subordinated note in the aggregate principal amount of
$5,000,000 and a warrant to purchase 1,400,000 additional shares of Common Stock
at a purchase price of $.001 per share to GECC. The purchasers of shares in this
private placement and the number of shares purchased are as follows:
<TABLE>
<CAPTION>
NO. OF SHARES NO. OF SHARES
NAME ON AUGUST 26, 1996 ON SEPTEMBER 10, 1996
---- -------------------- -----------------------
<S> <C> <C>
GECC........................... 5,000,000
Permal Noscal Ltd.............. 405,000
Zaxis Partners, L.P............ 40,000
Sidney Kimmel.................. 50,000
Quadra Appreciation Fund,
Inc.......................... 5,000
Branagh Revocable Trust........ 5,000
Sanford J. Colen............... 20,000
Jean R. Perrette............... 250,000
Isaac Robert Souede............ 250,000
Thomas M. DeLitto.............. 25,000
C. Redington Barrett, III...... 5,000
Hurley & Co.................... 35,000
United Gulf Bank............... 225,000
ATCO Holdings Ltd.............. 400,000
ATCO Development, Inc.......... 100,000
G(2) Investment Partners....... 60,000 30,000
Fairmont Services Ltd.......... 400,000
Carlton Securities N.V......... 100,000
Emmanual Bagdjian.............. 210,000
Heliopolis Inc................. 100,000
T. Michael Wallace............. 100,000 300,000
Gary S. Gladstein.............. 100,000 100,000
Peter L. Rhulen................ 100,000
Pollat, Evans & Co., Inc....... 15,000
Maureen Erin Hawley Trust I.... 112,500
Allison Booth Hawley Trust I... 112,500
Caitlin Hale Hawley Trust I.... 112,500
Shannon Follen Hawley Trust
I............................ 112,500
Hawley Family Trust............ 500,000
Philip M. Hawley............... 30,000
Dr. Philip M. Hawley, Jr....... 20,000
H.D. Investment Group, Inc..... 25,000
Morgan Adams, Inc.............. 50,000
Theodore D. Konopisos.......... 22,000
</TABLE>
II-2
<PAGE> 73
<TABLE>
<CAPTION>
NO. OF SHARES NO. OF SHARES
NAME ON AUGUST 26, 1996 ON SEPTEMBER 10, 1996
---- -------------------- -----------------------
<S> <C> <C>
William A. MacLaughlin IRA..... 25,000
Gregory M. Simon............... 20,000
Hugh H. Wilson, Jr............. 15,000
Codell Holdings Ltd............ 100,000
J. Stephen Emerson IRA......... 100,000
J. Stephen Emerson............. 100,000
Paul Marciano Trust............ 100,000
G. Tyler Runnels............... 50,000
Charles Perez.................. 100,000
JMG Capital Partners L.P....... 50,000
William C. Miller, IV.......... 25,000
Tendencia Investments
Overseas..................... 250,000
Lawrence S. Black.............. 50,000
Maureen Erin Hawley Trust II... 25,000
Allison Booth Hawley Trust
II........................... 25,000
Caitlan Hale Hawley Trust II... 25,000
Shannon Follen Hawley Trust
II........................... 25,000
Ian and Francine Jack.......... 10,000
Keith and Tanya Jacobs......... 10,000
J. Richard Cordsen............. 27,000
J.D. Yates..................... 10,000
</TABLE>
5. On August 14, 1997, the Company concluded a Supplemental Securities
Purchase Agreement (the "1997 Financing") among the Company, GECC and Japan
Omnibus Ltd. ("JOL"). Under the terms of the 1997 Financing, the Company sold
subordinated notes in an aggregate principal amount of $3,000,000 to GECC and
JOL. The Company issued warrants in conjunction with the notes, as follows: (i)
to GECC a warrant to purchase 600,000 shares of the Common Stock at a purchase
price of $1.25 per share and to JOL a warrant to purchase 140,000 shares of the
Common Stock at a purchase price of $1.25 per share; (ii) to GECC and JOL
warrants for the purchase of up to 1,000,000 shares of the Company's common
stock at a price of $0.01 per share (the "Performance Warrants"); the
Performance Warrants will be canceled if the Company meets certain economic
performance targets. The Company also agreed to issue additional warrants if it
draws on the standby credit facility. The Company borrowed funds pursuant to the
standby credit facility on December 30, 1997 and issued to GECC and JOL
additional warrants to purchase 400,000 and 160,000 shares of Common Stock,
respectively, at $1.25 per share.
Except for the issuance of the Series 1996-II Convertible Promissory Notes
and the shares of Common Stock acquired upon conversion thereof described in
item 2, the issuances of securities in the above transactions were deemed to be
exempt from registration under the Securities Act in reliance on Section 4(2)
thereof or Regulation D promulgated thereunder as transactions not involving a
public offering. The issuance of Series 1996-II convertible Promissory Notes and
the shares of Common Stock acquired upon conversion thereof described in item 2
above, were deemed exempt from registration under Securities Act in reliance on
Regulation S promulgated thereunder.
II-3
<PAGE> 74
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
<S> <C>
1 Form of Underwriting Agreement.
* 3.1 Certificate of Incorporation.(1)
* 3.1a Certificate of Amendment of Certificate of Incorporation
dated November 28, 1994.(5)
* 3.1b Certificate of Amendment of Certificate of Incorporation
dated August 1, 1995.(6)
* 3.1c Certificate of Amendment of Certificate of Incorporation
dated June 7, 1996.(7)
* 3.1d Certificate of Amendment of Certificate of Incorporation
dated August 1, 1996.(7)
* 3.2 By-laws.(1)
* 4.1 Loan and Security Agreement dated January 20, 1995 by and
between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(3)
* 4.1a First Amendment to Loan and Security Agreement dated May 10,
1996 by and between Congress Financial Corporation (Western)
and Krause's Sofa Factory and Castro Convertible
Corporation.(6)
* 4.1b Second Amendment to Loan and Security Agreement dated as of
August 26, 1996 by and between Congress Financial
Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(10)
* 4.1c Third Amendment to Loan and Security Agreement dated as of
November 25, 1996 by and between Congress Financial
Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(10)
* 4.1d Amended and Restated Subordination Agreement dated as of
August 26, 1996 by and between Congress Financial
Corporation (Western) and Krause's Furniture, Inc.(10)
* 4.1e Fourth Amendment to Loan and Security Agreement dated as of
August 14, 1997 by and between Congress Financial
Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(12)
* 4.1f Fifth Amendment to Loan and Security Agreement dated as of
December 11, 1997 by and between Congress Financial
Corporation (Western) and Krause's Custom Crafted Furniture
Corp. and Castro Convertible Corporation.(13)
* 4.1g Letter agreement between Krause's Furniture, Inc. and
Congress Financial Corporation (Western).(12)
* 4.2 Guarantee dated January 20, 1995 by Krause's Furniture, Inc.
to Congress Financial Corporation (Western).(3)
* 4.5 Certificate of Designations of Preferred Stock.(4)
** 5 Opinion of Morrison & Foerster LLP with respect to legality.
*10.1 1994 Directors Stock Option Plan.(5)
*10.2 1990 Employees Stock Option Plan.(2)
*10.3 Form of Securities Purchase Agreement between the Company
and GECC dated as of August 26, 1996.(8)
*10.4 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due
August 31, 2001.(8)
*10.5 Form of Warrant to Purchase 1,400,000 Shares of Common
Stock. (8)
*10.6 Form of Securities Purchase Agreement between the Company
and Certain Stockholders dated as of August 26, 1996.(8)
*10.7 Form of Stockholders Agreement among the Company, GECC and
certain other stockholders of the Company dated as of August
26, 1996.(8)
*10.8 Form of Registration Rights Agreement among the Company and
GECC and certain other stockholders of the Company dated as
of August 26, 1996.(8)
*10.9 Employment Agreement with Philip M. Hawley.(8)
</TABLE>
II-4
<PAGE> 75
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
<S> <C>
*10.10 1997 Stock Incentive Plan.(11)
*10.11 Supplemental Securities Purchase Agreement among Krause's
Furniture, Inc., General Electric Corporation and Japan
Omnibus Ltd., dated as of August 14, 1997.(12)
*10.12 Letter agreement dated August 14, 1997 regarding Permal
Group shares.(12)
*10.13 Letter agreement dated August 14, 1997 regarding warrant
dilution provisions.(12)
*10.14 Form of Amendment to Registration Rights Agreement and
Stockholders Agreement among the Company and GECC and
certain other stockholders of the Company dated as of August
14, 1997.
*10.15 Form of Succession Agreement by and between the Company and
Philip M. Hawley and certain other stockholders of the
Company.
11 Statement regarding computation of per share earnings.
*21 Subsidiaries.
**23.1 Consent of Morrison & Foerster LLP (included in its opinion
filed as Exhibit 5).
23.2 Consent of Ernst & Young LLP, Independent Auditors.
23.3 Consent of Arthur Andersen LLP, Independent Public
Accountants.
*24 Power of Attorney. Reference is made to page II-7 of
Registrant's Form S-1 dated December 23, 1997 (File No.
333-43111).
</TABLE>
- ---------------
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4 dated
June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form 10-K
for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K dated
as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form 10-K
dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K dated
as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1 dated
March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibit A to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K dated
August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
* Previously filed.
** To be filed by amendment.
II-5
<PAGE> 76
- ---------------
(b) FINANCIAL STATEMENT SCHEDULES
Report of Arthur Andersen LLP, Independent Public Accountants
Report of Ernst & Young LLP, Independent Auditors.
Schedule II -- Valuation and Qualifying Accounts
ITEM 17. UNDERTAKINGS
In accordance with Rule 430A of Regulation C under the Securities Act of
1933, as amended (the "Securities Act"), each of the undersigned registrants
hereby undertakes:
(a) To file during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of Prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement.
(b) That insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the provisions described under Item
15 above, or otherwise, the registrants have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrants of expenses incurred
or paid by a director, officer or controlling person of either registrant
in the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrants will, unless in the opinion of
their counsel the matter has been settled by controlling precedent, submit
to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.
(c) That, for purposes of determining any liability under the
Securities Act, the information omitted from the form of prospectus filed
as part of this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrants pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this Registration Statement as of the time it was declared
effective.
(d) That, for the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-6
<PAGE> 77
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 2 to the Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Brea, County of Orange, State of California, on March 11, 1998.
KRAUSE'S FURNITURE, INC
By: /s/ ROBERT A. BURTON
------------------------------------
Robert A. Burton
Senior Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 2 to the Registration Statement on Form S-1 has been signed
on March 11, 1998 by the following persons or their respective attorneys-in-fact
in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ PHILIP M. HAWLEY * Chairman of the Board and Chief Executive
- ----------------------------------------------------- Officer
Philip M. Hawley
/s/ ROBERT A. BURTON Senior Vice President and Chief Financial
- ----------------------------------------------------- Officer (Principal Financial Officer,
Robert A. Burton Principal Accounting Officer)
/s/ THOMAS M. DELITTO * Vice Chairman of the Board
- -----------------------------------------------------
Thomas M. DeLitto
/s/ KAMAL G. ABDELNOUR * Director
- -----------------------------------------------------
Kamal G. Abdelnour
/s/ JEFFREY H. COATS * Director
- -----------------------------------------------------
Jeffrey H. Coats
/s/ PETER H. DAILEY * Director
- -----------------------------------------------------
Peter H. Dailey
/s/ JOHN A. GAVIN * Director
- -----------------------------------------------------
John A. Gavin
</TABLE>
*By: /s/ ROBERT A. BURTON
-------------------------------
Robert A. Burton
Attorney-In-Fact
II-7
<PAGE> 78
REPORT OF ARTHUR ANDERSEN LLP,
INDEPENDENT PUBLIC ACCOUNTANTS
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements of Krause's Furniture, Inc. as of and for the
year ended February 1, 1998, included in this Registration Statement and have
issued our report thereon dated March 11, 1998. Our audit was made for the
purpose of forming an opinion on the basic consolidated financial statements
taken as a whole. The schedule listed in Item 16(b) 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
consolidated 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 consolidated 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 consolidated financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 11, 1998
S-1
<PAGE> 79
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the consolidated balance sheet of Krause's Furniture, Inc.
as of February 2, 1997 and the related consolidated statements of operations,
stockholders' equity and cash flows for the fiscal years ended February 2, 1997
and January 28, 1996 and have issued our report thereon dated March 28, 1997,
except for Note 2, as to which the date is December 17, 1997 (included elsewhere
in this Registration Statement). Our audits also included the financial
statement schedule listed in Item 16(b) of this Registration Statement. This
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on this schedule based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/s/ ERNST & YOUNG LLP
Orange County, California
March 28, 1997,
except for Note 2, as to which the date is
December 17, 1997
S-2
<PAGE> 80
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.
S-3
<PAGE> 81
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
1 Form of Underwriting Agreement.
* 3.1 Certificate of Incorporation.(1)
* 3.1a Certificate of Amendment of Certificate of Incorporation
dated November 28, 1994.(5)
* 3.1b Certificate of Amendment of Certificate of Incorporation
dated August 1, 1995.(6)
* 3.1c Certificate of Amendment of Certificate of Incorporation
dated June 7, 1996.(7)
* 3.1d Certificate of Amendment of Certificate of Incorporation
dated August 1, 1996.(7)
* 3.2 By-laws.(1)
* 4.1 Loan and Security Agreement dated January 20, 1995 by and
between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(3)
* 4.1a First Amendment to Loan and Security Agreement dated May 10,
1996 by and between Congress Financial Corporation (Western)
and Krause's Sofa Factory and Castro Convertible
Corporation.(6)
* 4.1b Second Amendment to Loan and Security Agreement dated as of
August 26, 1996 by and between Congress Financial
Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(10)
* 4.1c Third Amendment to Loan and Security Agreement dated as of
November 25, 1996 by and between Congress Financial
Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(10)
* 4.1d Amended and Restated Subordination Agreement dated as of
August 26, 1996 by and between Congress Financial
Corporation (Western) and Krause's Furniture, Inc.(10)
* 4.1e Fourth Amendment to Loan and Security Agreement dated as of
August 14, 1997 by and between Congress Financial
Corporation (Western) and Krause's Sofa Factory and Castro
Convertible Corporation.(12)
* 4.1f Fifth Amendment to Loan and Security Agreement dated as of
December 11, 1997 by and between Congress Financial
Corporation (Western) and Krause's Custom Crafted Furniture
Corp. and Castro Convertible Corporation.(13)
* 4.1g Letter agreement between Krause's Furniture, Inc. and
Congress Financial Corporation (Western).(12)
* 4.2 Guarantee dated January 20, 1995 by Krause's Furniture, Inc.
to Congress Financial Corporation (Western).(3)
* 4.5 Certificate of Designations of Preferred Stock.(4)
** 5 Opinion of Morrison & Foerster LLP with respect to legality.
*10.1 1994 Directors Stock Option Plan.(5)
*10.2 1990 Employees Stock Option Plan.(2)
*10.3 Form of Securities Purchase Agreement between the Company
and GECC dated as of August 26, 1996.(8)
*10.4 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due
August 31, 2001.(8)
*10.5 Form of Warrant to Purchase 1,400,000 Shares of Common
Stock.(8)
*10.6 Form of Securities Purchase Agreement between the Company
and Certain Stockholders dated as of August 26, 1996.(8)
*10.7 Form of Stockholders Agreement among the Company, GECC and
certain other stockholders of the Company dated as of August
26, 1996.(8)
*10.8 Form of Registration Rights Agreement among the Company and
GECC and certain other stockholders of the Company dated as
of August 26, 1996.(8)
*10.9 Employment Agreement with Philip M. Hawley.(8)
</TABLE>
<PAGE> 82
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
*10.10 1997 Stock Incentive Plan.(11)
*10.11 Supplemental Securities Purchase Agreement among Krause's
Furniture, Inc., General Electric Corporation and Japan
Omnibus Ltd., dated as of August 14, 1997.(12)
*10.12 Letter agreement dated August 14, 1997 regarding Permal
Group shares.(12)
*10.13 Letter agreement dated August 14, 1997 regarding warrant
dilution provisions.(12)
*10.14 Form of Amendment to Registration Rights Agreement and
Stockholders Agreement among the Company and GECC and
certain other stockholders of the Company dated as of August
14, 1997.
*10.15 Form of Succession Agreement between the Company and Philip
M. Hawley and certain other stockholders of the Company.
11 Statement regarding computation of per share earnings.
*21 Subsidiaries.
**23.1 Consent of Morrison & Foerster LLP (included in its opinion
filed as Exhibit 5).
23.2 Consent of Ernst & Young LLP, Independent Auditors.
23.3 Consent of Arthur Andersen LLP, Independent Public
Accountants.
*24 Power of Attorney. Reference is made to page II-7 of
Registrant's Form S-1 dated December 23, 1997 (File No.
333-43111).
</TABLE>
- ---------------
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4 dated
June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form 10-K
for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K dated
as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form 10-K
dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K dated
as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1 dated
March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibit A to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K dated
August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
* Previously filed.
** To be filed by amendment.
<PAGE> 1
EXHIBIT 1
KRAUSE'S FURNITURE, INC.
4,400,000 SHARES OF COMMON STOCK, PAR VALUE $0.001 PER SHARE
UNDERWRITING AGREEMENT
March __, 1998
Cruttenden Roth Incorporated
Morgan Fuller Capital Group, LLC
Black & Company, Inc.
c/o Cruttenden Roth Incorporated
11150 Santa Monica Boulevard
Suite 750
Los Angeles, California 90025
Ladies and Gentlemen:
Krause's Furniture, Inc., a Delaware corporation (the "Company"),
proposes to sell to the Underwriters named in Schedule 1 hereto (the
"Underwriters") 2,303,889 shares (the "Shares") of the Company's common stock,
par value $0.001 per share ("Common Stock"), and Japan Omnibus Ltd. (the
"Selling Stockholder") proposes to sell to the Underwriters 2,096,011 shares of
Common Stock (the "Selling Stockholder Shares" and, collectively with the
Shares, the "Firm Shares"). In addition, the Company proposes to grant to the
Underwriters an option to purchase an additional 440,000 shares of Common Stock
(the "Option Shares") on the terms and for the purposes set forth in Section 3
hereof. The Firm Shares and the Option Shares, if purchased, are hereinafter
collectively called the "Underwritten Shares." This is to confirm the agreement
concerning the purchase of the Underwritten Shares from the Company and the
Selling Stockholder by the Underwriters.
1. Representations and Warranties of the Company. The Company represents
and warrants to and covenants with the Underwriters that:
(a) The Company has prepared and filed with the Securities and
Exchange Commission (the "Commission") a registration statement on Form S-1
(Registration No. 333-43111) which has or will become effective, covering the
registration of the Underwritten Shares under the Securities Act of 1933, as
amended (the "1933 Act") and the rules and regulations of the Commission
thereunder (the "1933 Act Regulations"). The Commission has not issued any order
preventing or suspending the effectiveness or use of the Prospectus or the
Preliminary Prospectus (as defined below). The term "Preliminary Prospectus" as
used herein means a preliminary prospectus relating to the Underwritten Shares
as contemplated by Rule 430 or Rule 430A ("Rule 430A") of the 1933 Act
Regulations included at any time as part of the Registration Statement. Copies
of such Registration Statement and amendments thereto and of each related
Preliminary
<PAGE> 2
Prospectus have been delivered to the Underwriters. If such Registration
Statement has not become effective, a further amendment to such Registration
Statement, including a form of final Prospectus, necessary to permit such
Registration Statement to become effective will be filed promptly by the Company
with the Commission. If such Registration Statement has become effective, a
final Prospectus relating to the Underwritten Shares containing information
permitted to be omitted at the time of effectiveness by Rule 430A will be filed
by the Company with the Commission in accordance with Rule 424(b) of the 1933
Act Regulations promptly after execution and delivery of this Agreement. The
term "Registration Statement" means the registration statement as amended at the
time it became effective, including the most recent post-effective amendment
thereto at the time such post-effective amendment became or becomes effective
(the "Effective Date"), including all material incorporated by reference therein
and any information deemed to be included by Rule 430A and any additional
registration statement filed pursuant to Rule 462(b) of the Rules and
Regulations ("Rule 462(b)") with respect to the Underwritten Shares ("Rule
462(b) Registration Statement"). The term "Prospectus" means the prospectus
relating to the Underwritten Shares as first filed with the Commission pursuant
to Rule 424(b) of the Rules and Regulations or, if no such filing is required,
the form of final prospectus relating to the Underwritten Shares included in the
Registration Statement at the Effective Date. Any reference herein to the
Registration Statement, the Prospectus or any Preliminary Prospectus shall be
deemed to refer to and include the documents incorporated by reference therein
pursuant to Form S-1 and Regulation S-K under the 1933 Act which were filed
under the Securities Exchange Act of 1934, as amended (the "1934 Act") and the
rules and regulations of the Commission thereunder (the "1934 Act Regulations"),
on or before the date of this Agreement, or the issue date of the Prospectus or
any Preliminary Prospectus, as the case may be; and any reference herein to the
terms "amend," "amendment" or "supplement" with respect to the Registration
Statement, the Prospectus or any Preliminary Prospectus shall be deemed to refer
to and include the filing of any document under the 1934 Act after the date of
this Agreement, or the issue date of the Prospectus or any Preliminary
Prospectus, as the case may be, and deemed to be incorporated therein by
reference. For purposes of this Agreement, all references to the Registration
Statement, any Preliminary Prospectus, or any Prospectus, or any amendment or
supplement to any of the foregoing, shall be deemed to include the copy, if any,
filed with the Commission pursuant to its Electronic Data Gathering Analysis and
Retrieval system ("EDGAR").
(b) On the first date that any Preliminary Prospectus was used,
the date the Prospectus is first filed with the Commission pursuant to Rule
424(b) (if required), at all times subsequent to and including the Delivery Date
(as defined in Section 5 below) and when any post-effective amendment to the
Registration Statement becomes effective or any amendment or supplement to the
Prospectus is filed with the Commission, the Registration Statement, each
Preliminary Prospectus and the Prospectus (as amended or as supplemented if the
Company shall have filed with the Commission any amendment or supplement
thereto), including the financial statements included in the Prospectus, did or
will comply with all applicable provisions of the 1933 Act and the 1933 Act
Regulations and did or will contain all statements required to be stated therein
in accordance with the 1933 Act and the 1933 Act Regulations. On the Effective
Date and when any post-effective amendment to the Registration Statement becomes
effective, no part of the Registration Statement or any such amendment did or
will contain any untrue statement of a material
2
<PAGE> 3
fact or omit to state a material fact required to be stated therein or necessary
in order to make the statements therein, in light of the circumstances under
which they were made, not misleading. At the Effective Date and at the date the
Prospectus or any amendment or supplement to the Prospectus is filed with the
Commission and at the Delivery Date the Prospectus did not or will not contain
any untrue statement of a material fact or omit to state a material fact
necessary to make the statements therein, in the light of the circumstances
under which they were made, not misleading. The Company has not distributed any
written offering material in connection with the offering or sale of the
Underwritten Shares other than the Registration Statement, the Preliminary
Prospectus and the Prospectus. Each Registration Statement, Preliminary
Prospectus and Prospectus filed with the Commission, including those filed by
electronic transmission pursuant to EDGAR (except as may be permitted by
Regulation S-T under the 1933 Act), was identical to the copy thereof delivered
to the Underwriters for use in connection with the offer and sale of the
Underwritten Shares.
(c) Ernst & Young LLP and Arthur Andersen LLP, who have expressed
their opinion with respect to the financial statements and supporting schedules
and related notes included in the Registration Statement and the Prospectus, are
independent public accountants with respect to the Company as required by the
1933 Act and the 1933 Act Regulations.
(d) The financial statements of the Company and the related notes
thereto, included or incorporated by reference in the Registration Statement and
the Prospectus present fairly the consolidated financial position of the Company
and its subsidiaries, Krause's Custom Crafted Furniture Corp. (formerly Krause's
Sofa Factory) and KMC Enterprises, Inc. (collectively, the "Subsidiaries" and
each a "Subsidiary") as of the respective dates of such financial statements,
and their consolidated statement of operations and statement of cash flows for
the respective periods covered thereby; said financial statements and related
notes have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis as certified by the independent
accountants named in subsection 3(c) above; and the supporting schedules
included in the Registration Statement present fairly the information required
to be stated therein. No other financial statements or schedules are required to
be included in the Registration Statement. The selected financial and
statistical data set forth in the Prospectus under the captions "Capitalization"
and "Selected Financial Data" fairly present the information set forth therein
on the basis stated in the Registration Statement and have been prepared on an
accounting basis consistent with the consolidated financial statements of the
Company.
(e) Since the respective dates as of which information is given
in the Registration Statement and the Prospectus, except as otherwise stated
therein, (i) there has been no material adverse change or any development
involving a prospective material adverse change in or affecting the condition,
financial or otherwise, or in the earnings, business affairs, or business
prospects of the Company and the Subsidiaries, whether or not arising in the
ordinary course of business, (ii) there have been no transactions entered into
by the Company or the Subsidiaries, other than those in the ordinary course of
business, which are material with respect to the Company and the Subsidiaries,
and (iii) there has been no dividend or distribution of any kind declared, paid
or made by the
3
<PAGE> 4
Company or the Subsidiaries on any class of their capital stock. The Company and
the Subsidiaries have no material contingent obligations which are not disclosed
in the Registration Statement.
(f) The Company and the Subsidiaries have been duly incorporated
and are validly existing as corporations in good standing under the laws of
their respective jurisdictions of incorporation, with corporate power and
authority to own, lease and operate their properties and to conduct their
businesses as described in the Prospectus and, in the case of the Company, to
enter into and perform its obligations under this Agreement; the Company and the
Subsidiaries are duly qualified as foreign corporations to transact business and
are in good standing in each jurisdiction in which such qualification is
required, whether by reason of the ownership or leasing of property or the
conduct of business, except where the failure to so qualify would not, singly or
in the aggregate, have a material adverse effect on the condition, financial or
otherwise, or the earnings, business affairs, results of operations or business
prospects of the Company and the Subsidiaries, taken as a whole (a "Material
Adverse Effect"). Other than in the Subsidiaries, or as disclosed in the
Registration Statement pursuant to Item 601 of Regulation S-K, the Company does
not own, directly or indirectly, any shares of capital stock or any other equity
securities of any corporation or have any equity interest in any firm,
partnership, joint venture, association or other entity.
(g) The authorized, issued and outstanding capital stock of the
Company is as set forth in the Prospectus under "Capitalization" and
"Description of Capital Stock" (except for subsequent issuances, if any,
pursuant to this Agreement or pursuant to reservations, agreements, employee or
director benefit plans or the exercise of convertible securities referred to in
the Prospectus); the shares of issued and outstanding capital stock of the
Company have been duly authorized and validly issued and are fully paid and
nonassessable and have not been issued in violation of or are not otherwise
subject to any preemptive or other similar rights; the Company owns,
beneficially and of record, all of the outstanding capital stock of the
Subsidiaries; the Shares and the Option Shares have been duly authorized for
issuance and sale to the Underwriters pursuant to this Agreement and, when
issued and delivered by the Company pursuant to this Agreement against payment
of the consideration set forth herein, will be validly issued and fully paid and
nonassessable; the certificates evidencing the Underwritten Shares are in due
and proper form under Delaware law; the authorized capital stock of the Company,
including the Underwritten Shares, conforms to all statements relating thereto
contained in the Prospectus; and the issuance of the Underwritten Shares is not
subject to preemptive or other similar rights. There are no outstanding
subscriptions, options, warrants, convertible or exchangeable securities or
other rights granted to or by the Company to purchase shares of capital stock or
other securities of the Company and there are no commitments, plans or
arrangements to issue any shares of capital stock or any security convertible
into or exchangeable for capital stock, in each case other than as described in
the Prospectus.
(h) The Company and the Subsidiaries: (i) are in material
compliance with any and all applicable foreign, United States, state and local
environmental laws, rules, regulations, treaties, statutes and codes promulgated
by any and all governmental authorities relating to the protection of human
health and safety, the environment or toxic substances or wastes, pollutants or
4
<PAGE> 5
contaminates, and all amendments or modifications thereto ("Environmental
Laws"); (ii) have received all permits, licenses or other approvals required of
them under applicable Environmental Laws to conduct their business as currently
conducted, the absence of which would have a Material Adverse Effect; and (iii)
are in compliance in all material respects with all terms and conditions of any
such permit, license or approval. No action, proceeding, revocation proceeding,
writ, injunction or claim is pending or, to the knowledge of the Company,
threatened against the Company or the Subsidiaries relating to the Environmental
Laws or to the activities of the Company or the Subsidiaries involving Hazardous
Materials. The terms "Hazardous Materials" as used in this Agreement means any
material or substance that: (i) is prohibited or regulated by any Environmental
Laws; or (ii) has been designated or regulated by any governmental authority as
radioactive, toxic, hazardous or otherwise a danger to health, reproduction or
the environment.
(i) Where the Company or any Subsidiary is engaged in the
generation, use, manufacture, transportation or storage of any Hazardous
Materials on any of the properties or former properties of the Company or the
Subsidiaries, the Company and its Subsidiaries have complied in all material
respects with all Environmental Laws relevant to such activities. No Hazardous
Materials have been treated or disposed of on any properties of the Company or
the Subsidiaries, or on properties formerly owned or leased by the Company or
the Subsidiaries, in each case by the Company or, to the knowledge of the
Company, by any other Person, except in material compliance with Environmental
Laws. No spills, discharges, releases, deposits, emplacements, leaks or disposal
of any Hazardous Materials have occurred on or under or have emanated from any
of the Company's properties or former properties of the Company or the
Subsidiaries either as a result of actions by the Company or, to the knowledge
of the Company, by any other Person, for which the cost of remediation would
materially and adversely affect the Company.
(j) Neither the Company nor any Subsidiary is in violation of its
respective charter or bylaws or similar governing instruments or is in default
in the performance or observance of any obligation, agreement, covenant or
condition contained in any contract, indenture, mortgage, loan agreement, deed,
trust, note, lease, sublease, voting agreement, voting trust, or other
instrument or agreement to which the Company or the Subsidiaries are a party or
by which the Company or the Subsidiaries may be bound, or to which any of the
property or assets of the Company or the Subsidiaries are subject, unless
irrevocable waiver shall have been obtained with respect to such default and
such default and the waiver thereof shall have been disclosed in writing to the
Underwriters, and the execution, delivery and performance of this Agreement and
the consummation of the transactions contemplated herein and compliance by the
Company with its obligations hereunder have been duly authorized by all
necessary corporate action and will not conflict with or constitute a breach of,
or default under, or result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or the Subsidiaries
pursuant to, any contract, indenture, mortgage, loan agreement, deed, trust,
note, lease, sublease, voting agreement, voting trust or other instrument or
agreement to which the Company or the Subsidiaries is a party or by which they
may be bound, or to which any of the property or assets of the Company or the
Subsidiaries are subject, nor will such action result in any violation of the
provisions of the charter
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<PAGE> 6
or bylaws of the Company or any applicable statute, law, rule, regulation,
ordinance, decision, directive or order.
(k) No labor dispute with the employees of the Company or the
Subsidiaries exists or, to the knowledge of the Company, is imminent; and the
Company is not aware of any existing or imminent labor disturbance by the
employees of any of its principal suppliers, manufacturers or contractors.
(l) There is no action, suit or proceeding before or by any court
or governmental agency or body, domestic or foreign, now pending, or, to the
knowledge of the Company, threatened, against or affecting the Company or the
Subsidiaries, which is required to be disclosed in the Registration Statement
(other than as disclosed therein), or which, singly or in the aggregate, might
result in any Material Adverse Effect or which might materially and adversely
affect the consummation of this Agreement; all pending legal or governmental
proceedings to which the Company or the Subsidiaries are a party or of which any
of their respective properties or assets is the subject which are not described
in the Registration Statement, including ordinary routine litigation incidental
to the business, are, considered in the aggregate, not material; and there are
no contracts or documents of the Company or the Subsidiaries which are required
to be filed as exhibits to the Registration Statement by the 1933 Act or by the
1933 Act Regulations which have not been so filed.
(m) No relationship, direct or indirect, exists between or among
the Company and any Subsidiary on the one hand, and the directors, officers,
shareholders, customers or suppliers of the Company and any Subsidiary on the
other hand, that is required by the 1933 Act or the 1933 Act Regulations to be
described in the Registration Statement and the Prospectus or documents
incorporated by reference therein that is not described as so required.
(n) The Company and the Subsidiaries own or are licensed to use
all patents, patent applications, inventions, trademarks, trade names,
applications for registration of trademarks, service marks, service mark
applications, copyrights, know-how, manufacturing processes, formulae, trade
secrets, licenses and rights in any thereof and any other similar intangible
property and assets (herein called the "Proprietary Rights") which are material
to the businesses of the Company or the Subsidiaries as now conducted and as
proposed to be conducted, in each case as described in the Prospectus. The
description of the Proprietary Rights is correct in all material respects and
fairly and correctly describes the Company's rights with respect thereto.
Neither the Company nor any Subsidiary has any knowledge of, and neither the
Company nor any Subsidiary has given or received any notice of, any pending
conflicts with or infringement of the rights of others with respect to any
Proprietary Rights or with respect to any license of Proprietary Rights. No
action, suit, arbitration, or legal, administrative or other proceeding, or
investigation is pending, or, to the knowledge of the Company, threatened, which
involves any Proprietary Rights. Neither the Company nor any Subsidiary is
subject to any judgment, order, writ, injunction or decree of any court or any
Federal, state, local, foreign or other governmental department, commission,
board, bureau, agency or instrumentality, domestic or foreign, or any
arbitrator, or has entered into or is a party to any contract
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<PAGE> 7
which restricts or impairs the use of any such Proprietary Rights in a manner
which would adversely affect the use of any of the material Proprietary Rights.
To the knowledge of the Company, no Proprietary Rights used by the Company or
the Subsidiaries, and no services or products sold by the Company or the
Subsidiaries, conflict with or infringe upon any proprietary rights available to
any third party. The Company has not received written notice of any pending
conflict with or infringement upon such third party proprietary rights. Neither
the Company nor any Subsidiary has entered into a consent, indemnification,
forbearance to sue or settlement agreement with respect to Proprietary Rights.
No claims have been asserted against the Company by written notice or formal
proceedings or, to the knowledge of the Company, by other means, by any person
with respect to the validity of the ownership or right to use the Proprietary
Rights of the Company or the Subsidiaries and, to the knowledge of the Company,
there is no reasonable basis for any such claim to be successful. No
registration relating to the Proprietary Rights has lapsed, expired or been
abandoned or canceled or is the subject of cancellation or other adversarial
proceedings, and all applications therefor are pending and are in good standing.
The Company and the Subsidiaries have complied, in all material respects, with
their respective contractual obligations relating to the protection of the
Proprietary Rights used pursuant to licenses. To the knowledge of the Company,
no person is infringing on or violating the Proprietary Rights owned or used by
the Company or the Subsidiaries.
(o) No registration, authorization, approval, qualification or
consent of any court or governmental authority or agency is necessary in
connection with the offering, issuance or sale of the Underwritten Shares
hereunder, except such as may be required under the 1933 Act or the 1933 Act
Regulations or state securities or Blue Sky laws (or such as may be required by
the National Association of Securities Dealers, Inc. ("NASD").
(p) Except as otherwise disclosed in the Prospectus, the Company
and the Subsidiaries now hold and at the Delivery Date will hold, all licenses,
certificates, approvals and permits from all state, United States, foreign and
other regulatory authorities, and any foreign regulatory authorities performing
similar functions, that are material to the conduct of the businesses of the
Company and the Subsidiaries (as such businesses are currently conducted),
except for such licenses, certificates, approvals and permits the failure of
which to hold would not have a Material Adverse Effect, all of which are in
effect (and there is no proceeding pending or, to the knowledge of the Company,
threatened which may cause any such license, certificate, approval or permit to
be withdrawn, canceled, suspended or not renewed). Neither the Company nor any
Subsidiary is in violation of any law, order, rule, regulation, writ, injunction
or decree of any court or governmental agency or body, and neither the Company
nor any Subsidiary has received any notice of proceedings relating to the
revocation or modification of any such permit or any circumstance which would
lead them to believe that such proceedings are, singularly or in the aggregate,
reasonably likely to have or which, if the subject of an unfavorable decision,
ruling or finding, would have a Material Adverse Effect.
(q) The Company has all corporate power and authority to enter
into this Agreement and to perform its obligations hereunder, and all consents,
authorizations, approvals and
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<PAGE> 8
orders required in connection herewith have been obtained, except such as may be
required under state securities or Blue Sky laws or the bylaws and rules of the
NASD and, if the Registration Statement is not effective under the 1933 Act as
of the time of execution hereof, such as may be required (and shall be obtained
as provided in this Agreement) under the 1933 Act. This Agreement has been duly
executed and delivered by the Company and constitutes a valid and binding
obligation of the Company, enforceable against the Company in accordance with
its terms, except as limited by applicable bankruptcy, insolvency,
reorganization, moratorium or other laws nor or hereafter in effect relating to
or affecting creditors, rights generally or by general principles of equity
relating to the availability of remedies and except as rights to indemnity and
contribution hereunder may be limited by federal or state securities laws or the
public policy underlying such laws.
(r) There are no persons with registration or other similar
rights to have any securities (i) registered pursuant to the Registration
Statement or (ii) otherwise registered by the Company under the 1933 Act, other
than, with respect to (i) and (ii) above, those rights whose holders have
received proper notice of the filing of the Registration Statement and have
declined to assert such registration rights (and who now no longer have a right
to do so), those rights which have been waived or are no longer entitled to be
asserted, or other than, with respect to (ii) above, those described in the
Prospectus.
(s) No order preventing or suspending the use of any Preliminary
Prospectus or the Prospectus has been issued and no proceedings for that purpose
are pending, or, to the knowledge of the Company, threatened or contemplated by
the Commission; and no order suspending the offering of the Underwritten Shares
in any jurisdiction designated by the Underwriters pursuant to Section 6(f) of
this Agreement has been issued and no proceeding therefor has been instituted
or, to the knowledge of the Company, are any such proceedings threatened or
contemplated. The Company has complied to the Commission's and any state
securities commission's satisfaction with all requests of the Commission and
such state securities commission with all requests for additional or
supplemental information.
(t) The Company and the Subsidiaries have good and marketable
title to their respective properties, free and clear of all material security
interests, mortgages, pledges, liens, charges, encumbrances, claims and equities
of record, except as disclosed in the Prospectus. The properties of the Company
and the Subsidiaries are, in the aggregate, in good repair (reasonable wear and
tear excepted), and suitable for their respective uses. Any real properties held
under lease by the Company and the Subsidiaries are held by it under valid,
subsisting and enforceable leases with such exceptions as are not material and
do not interfere with the conduct of the business of the Company or the
Subsidiaries.
(u) The Company maintains a system of internal accounting
controls sufficient to provide reasonable assurances that (i) transactions are
executed in accordance with management's general or specific authorization, (ii)
transactions are recorded as necessary to permit preparation of financial
statements in conformity with generally accepted accounting principles and to
maintain accountability for assets, (iii) access to assets is permitted only in
accordance with management's
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<PAGE> 9
general or specific authorization, and (iv) the recorded accountability for
assets is compared with the existing assets at reasonable intervals and
appropriate action is taken with respect to any differences.
(v) The Company and the Subsidiaries have conducted and are
conducting their businesses in material compliance with all applicable Federal,
state, local and foreign statutes, laws, rules, regulations, ordinances, codes,
decisions, decrees, directives and orders.
(w) Neither the Company nor any Subsidiary nor, to the Company's
or any Subsidiary's knowledge, any employee or agent of the Company or any
Subsidiary, has, directly or indirectly, made any payment of funds of the
Company or the Subsidiaries or received or retained any funds in violation of
any law, rule or regulation, which payment, receipt or retention of funds is of
a character required to be disclosed in the Prospectus, including, without
limitation, any unlawful contribution to any candidate for public office, or
failed to disclose fully contributions in violation of law, or other payments to
any federal, state or foreign governmental officer or official, or other person
charged with similar public or quasi-public duties, other than payments required
or permitted by the laws of the United States, any foreign jurisdiction, or any
jurisdiction thereof.
(x) The Company is not now, and after sale of the Shares or the
Option Shares to be sold by it hereunder and application of the net proceeds
from such sale as described in the Prospectus under the caption "Use of
Proceeds" will not be, an "investment company" within the meaning of the
Investment Company Act of 1940, as amended.
(y) All offers and sales of capital stock and other securities of
the Company made within the three years prior to the date hereof were at all
relevant times duly registered or exempt from the registration requirements of
the 1933 Act and were duly registered or qualified or subject to an available
exemption from the registration or qualification requirements of the applicable
state securities or Blue Sky laws. No Person who purchased a security from the
Company prior to the date hereof has any right to rescind his or her purchase or
otherwise seek recovery of the purchase price from the Company.
(z) The Common Stock is registered pursuant to Section 12(g) of
the 1934 Act. The Underwritten Shares have been accepted for listing on the
American Stock Exchange ("AMEX"). The Company has taken no action designed to,
or likely to have the effect of, terminating the registration of the
Underwritten Shares or the Common Stock under the 1934 Act or delisting the
Underwritten Shares or the Common Stock from the AMEX, nor has the Company
received any notification that the Commission or the AMEX is contemplating
terminating such registration or listing.
(aa) Neither the Company, nor, to its knowledge, any of its
officers, directors or affiliates has taken and at the Delivery Date, neither
the Company nor, to its knowledge, any of its officers, directors or affiliates
will have taken, directly or indirectly, any action which has constituted, or
might reasonably be expected to constitute, the stabilization or manipulation of
the
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<PAGE> 10
price of the Common Stock to facilitate the sale or resale of the Underwritten
Shares in connection with the offering of the Underwritten Shares pursuant to
the Registration Statement.
(ab) The Company maintains insurance of the types and in amounts
that it reasonable believes are adequate for its and its Subsidiaries'
businesses and are consistent with insurance coverage maintained by similar
companies in similar businesses, including but not limited to, insurance
covering product liability and real and personal property owned or leased
against theft, damage, destruction, acts of vandalism and all other risks
customarily insured against, all of which insurance is in full force and effect.
(ac) The Company and the Subsidiaries have filed all necessary
federal, state and foreign tax returns required to be filed by them and have
paid or accrued all taxes shown as due thereon, which returns are true and
correct in all material respects, and neither the Company nor any Subsidiary is
in default in the payment of any taxes, including penalties and interest,
assessments, fees and other charges, shown thereon due or otherwise assessed,
other than those being contested in good faith and for which adequate reserves
have been provided or those currently payable without interest which were
payable pursuant to said returns or any assessments with respect thereto.
(ad) To the knowledge of the Company, if any full-time employee
identified in the Prospectus has entered into any non-competition,
non-disclosure, confidentiality or other similar agreement with any party other
than the Company or any Subsidiaries, such employee is neither in violation
thereof nor is expected to be in violation thereof as a result of the business
conducted or expected to be conducted by the Company or the Subsidiaries as
described in the Prospectus or such person's performance of his obligations to
the Company or any Subsidiaries; neither the Company nor any Subsidiary has
received written notice that any consultant or employee of the Company or the
Subsidiaries is in violation of any noncompetition, non-disclosure,
confidentiality or similar agreement.
(ae) The Company has delivered or caused to be delivered to the
Underwriters an agreement in the form of Attachment A hereto (with respect to
the Company) and in the form of Attachment B hereto (with respect to the
officers, directors and certain affiliates of the Company listed on Attachment C
hereto) to the effect that neither the Company nor any of the officers,
directors or affiliates listed on Attachment C hereto will, without the prior
written consent of the Underwriters, offer, sell, or otherwise dispose of any
shares of capital stock or equity securities of the Company or securities
convertible into, or exchangeable or exercisable for, shares of capital stock of
the Company (other than the Underwritten Shares) for a period of 180 days (with
respect to the Company) and 120 days (with respect to the officers, directors
and affiliates of the Company) after the Delivery Date, subject to the
exceptions set forth in Attachment A with respect to the Company.
2. Representations, Warranties and Covenants of the Selling Stockholder.
The Selling Stockholder represents, warrants and covenants to the Company and to
the Underwriters that:
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<PAGE> 11
(a) The Selling Stockholder is, and at the First Delivery Date
(as defined in Section 5 below) will be, duly organized, validly existing and in
good standing under the laws of the jurisdiction of its organization with
corporate power and authority to own, lease and operate its properties and to
conduct its business.
(b) The Selling Stockholder has all corporate power and authority
to enter into this Agreement and to carry out all the terms and provisions
hereof to be carried out by it. All authorizations and consents necessary for
the execution and delivery by the Selling Stockholder of this Agreement have
been given. This Agreement has been duly authorized, executed and delivered by
or on behalf of the Selling Stockholder and constitutes the valid and binding
agreement of the Selling Stockholder and is enforceable against the Selling
Stockholder in accordance with its terms, except as limited by applicable
bankruptcy, insolvency, reorganization, moratorium or other laws now or
hereafter in effect relating to or affecting creditors' rights generally or by
general principles of equity relating to the availability of remedies and except
as rights to indemnity or contribution may be limited by federal or state
securities laws and the public policy underlying such laws.
(c) The Selling Stockholder has placed in custody under a custody
agreement (the "Custody Agreement") with [First National Bank of Boston], as
custodian (the "Custodian"), for delivery under this Agreement, certificates in
negotiable form (with signature guaranteed by a commercial bank or trust company
having an office or correspondent in the United States or a member firm of the
New York or American Stock Exchange) representing the Firm Shares to be sold by
the Selling Stockholder hereunder.
(d) The Selling Stockholder has duly and irrevocably executed and
delivered a power of attorney (the "Power of Attorney") appointing the Custodian
and one or more other persons, as attorneys-in-fact, with full power of
substitution, and with full authority (exercisable by any one or more of them)
to execute and deliver this Agreement and to take such other action as may be
necessary or desirable to carry out the provisions hereof on behalf of the
Selling Stockholder.
(e) The Selling Stockholder has full power and authority to enter
into the Power of Attorney in the form heretofore furnished to the Selling
Stockholder and the Custody Agreement in the form heretofore furnished to the
Selling Stockholder and to carry out all the terms and provisions thereof to be
carried out by it. All authorizations and consents necessary for the execution
and delivery by the Selling Stockholder of the Power of Attorney and the Custody
Agreement have been given. Each of the Power of Attorney and the Custody
Agreement has been duly authorized, executed and delivered by the Selling
Stockholder and is enforceable against the Selling Stockholder in accordance
with the terms thereof, except as limited by applicable bankruptcy, insolvency,
reorganization, moratorium or other laws now or hereafter in effect relating to
or affecting creditors' rights generally or by general principles of equity
relating to the availability of remedies.
(f) The Selling Stockholder now has, and at the First Delivery
Date will have, (i) good and marketable title to the Selling Stockholder Shares
to be sold to the Underwriters by the Selling Stockholder hereunder, free and
clear of all encumbrances and adverse claims, and (ii) full
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<PAGE> 12
legal right and power, and all authorizations and approvals required by law, to
sell, transfer and deliver the Selling Stockholder Shares to the Underwriters
and to make the representations, warranties and agreements made by the Selling
Stockholder herein, and upon delivery of such Selling Stockholder Shares and
payment therefor pursuant hereto, good and marketable title to such shares, free
and clear of all encumbrances and adverse claims, will pass to the Underwriters.
(g) None of the execution, delivery or performance of this
Agreement, the Power of Attorney or the Custody Agreement or the consummation of
the transactions contemplated herein or therein by the Selling Stockholder
conflicts or will conflict with or results or will result in any breach or
violation of any of the terms or provisions of, or constitute a default under,
or result in the creation or imposition of any encumbrance upon, any property or
assets of the Selling Stockholder pursuant to (i) the terms of its
organizational documents; (ii) the terms of any contract or other agreement to
which the Selling Stockholder is a party or by which it is bound or to which any
of its properties is subject, which conflict, breach, violation or default would
adversely affect the Selling Stockholder's ability to perform its obligations
hereunder; (iii) any statute, rule or regulation of any governmental body having
jurisdiction over the Selling Stockholder or any of its activities or
properties; or (iv) the terms of any judgment, decree or order of any
arbitration or governmental body having such jurisdiction.
(h) No consent, approval, authorization or order of, or any
filing or declaration with any governmental body is required for the
consummation by the Selling Stockholder of the transactions on its part
contemplated herein or in the Power of Attorney or Custody Agreement, except
such as may be required under the Exchange Act and applicable state securities
laws in connection with the purchase and distribution of the Underwritten Shares
by the Underwriters, and such as have been obtained under the state securities
or Blue Sky laws and under the NASD rules.
(i) The sale of the Selling Stockholder Shares proposed to be
sold by the Selling Stockholder is not prompted by the Selling Stockholder's
knowledge of any material adverse information concerning the Company or its
Subsidiaries which is not set forth or described in the Prospectus.
(j) On the Effective Date, the date of the Preliminary Prospectus
and the date of the Prospectus, and on the First Delivery Date, the information
with respect to the Selling Stockholder included therein did not contain any
untrue statement of a material fact or omit to state a material fact required to
be stated therein or necessary in order to make the statements therein not
misleading.
(k) On the first date that any Preliminary Prospectus was used,
the date the Prospectus is first filed with the Commission pursuant to Rule
424(b) (if required), at all times subsequent to and including the First
Delivery Date, all information with respect to the Selling Stockholder included
in the Registration Statement, each Preliminary Prospectus and the Prospectus
(as amended or as supplemented if the Company shall have filed with the
Commission any amendment or supplement thereto), did or will comply with all
applicable provisions of the 1933 Act
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<PAGE> 13
and the 1933 Act Regulations and did or will contain all statements required to
be stated therein in accordance with the 1933 Act and the 1933 Act Regulations.
(l) The Selling Stockholder has delivered to the Underwriters an
agreement in the form of Attachment B hereto to the effect that it will not,
without the prior written consent of Cruttenden Roth Incorporated, Black &
Company, Inc. and Morgan Fuller Capital Group LLC, as representatives of the
several Underwriters (the "Representatives"), offer, sell, or otherwise dispose
of any shares of capital stock or equity securities of the Company or securities
convertible into, or exchangeable or exercisable for, shares of capital stock of
the Company (excluding the Selling Stockholder Shares) for a period of 120 days
after the Delivery Date.
(m) The Selling Stockholder has not taken and will not take,
directly or indirectly, any action which has constituted, or might reasonably be
expected to constitute, the stabilization or manipulation of the price of the
Common Stock to facilitate the sale or resale of the Underwritten Shares in
connection with the offering thereof pursuant to the Registration Statement.
3. Purchase of the Underwritten Shares by the Underwriters. On the basis
of the representations and warranties contained in, and subject to the terms and
conditions of, this Agreement, the Company hereby agrees to sell 2,303,889
shares of the Firm Shares and the Selling Stockholder hereby agrees to sell
2,096,111 shares of the Firm Shares, severally and not jointly, to the several
Underwriters and each of the Underwriters, severally and not jointly, agrees to
purchase the number of the Firm Shares set opposite that Underwriter's name in
Schedule 1 hereto. Each Underwriter shall be obligated to purchase from the
Company, and from the Selling Stockholder, that number of Firm Shares which
represents the same proportion of the number of Firm Shares to be sold by the
Company, and by the Selling Stockholder, as the number of Firm Shares set forth
opposite the name of such Underwriter in Schedule 1 represents of the total
number of shares of the Firm Shares to be purchased by all of the Underwriters
pursuant to this Agreement. The respective purchase obligations of the
Underwriters with respect to the Firm Shares shall be rounded among the
Underwriters to avoid fractional shares, as the Representatives may determine.
In addition, the Company grants to the Underwriters an option to
purchase up to 440,000 Option Shares. Such option is granted solely for the
purpose of covering over-allotments in the sale of Firm Shares and is
exercisable as provided in Section 5 hereof. Option Shares shall be purchased
severally for the account of the Underwriters in proportion to the number of
Firm Shares Stock set opposite the name of such Underwriters in Schedule 1
hereto. The respective purchase obligations of each Underwriter with respect to
the Option Shares shall be adjusted by the Representatives so that no
Underwriter shall be obligated to purchase Option Shares other than in 100 share
amounts. The price of both the Firm Shares and any Option Shares payable to the
Company and the Selling Stockholder, as applicable, shall be $__________ per
share.
The Company and the Selling Stockholder shall not be obligated to
deliver any of the Underwritten Shares to be delivered on the First Delivery
Date or the Second Delivery Date (as
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<PAGE> 14
hereinafter defined), as the case may be, except upon payment for the
Underwritten Shares to be purchased on such Delivery Date as provided herein.
4. Offering of Stock by the Underwriters. Upon authorization by the
Representatives of the release of the Firm Shares, the several Underwriters
propose to offer the Firm Shares for sale at the public offering price set forth
on the cover page of and on the terms and conditions set forth in the
Prospectus.
5. Delivery of and Payment for the Underwritten Shares. Delivery of and
payment for the Firm Shares shall be made at the office of Morrison & Foerster
LLP, at 7:00 a.m., New York City time, on the third full business day following
the date of this Agreement or at such other date or place as shall be determined
by agreement between the Representatives and the Company. This date and time are
sometimes referred to as the "First Delivery Date." On the First Delivery Date,
the Company and the Selling Stockholder shall deliver or cause to be delivered
certificates representing the Firm Shares to the Representatives for the account
of each Underwriter against payment to or upon the order of the Company and the
Selling Stockholder of the purchase price by wire transfer of immediately
available (same day) funds. Time shall be of the essence, and delivery at the
time and place specified pursuant to this Agreement is a further condition of
the obligation of each Underwriter hereunder. Upon delivery, the Firm Shares
shall be registered in such names and in such denominations as the
Representatives shall request in writing not less than two full business days
prior to the First Delivery Date. For the purpose of expediting the checking and
packaging of the certificates for the Firm Shares, the Company and the Selling
Stockholder shall make the certificates representing the Firm Stock available
for inspection by the Representatives in Los Angeles, California, not later than
2:00 p.m., New York City time, on the business day prior to the First Delivery
Date. If the Representatives so elect, delivery of the Firm Shares may be made
by credit through full fast transfer to the accounts at the Depositary Trust
Company designated by the Representatives.
At any time on or before the forty-fifth day after the date of this
Agreement the option granted in Section 3 may be exercised by written notice
being given to the Company by the Representatives. Such notice shall set forth
the aggregate number of Option Shares as to which the option is being exercised,
the names in which the Option Shares are to be registered, the denominations in
which the Option Shares are to be issued and the date and time, as determined by
the Representatives, when the Option Shares are to be delivered; provided,
however, that this date and time shall not be earlier than the First Delivery
Date nor earlier than the second business day after the date on which the option
shall have been exercised nor later than the fifth business day after the date
on which the option shall have been exercised. The date and time the Option
Shares are delivered are sometimes referred to as the "Second Delivery Date,"
and the First Delivery Date and the Second Delivery Date are sometimes each
referred to as a "Delivery Date."
Delivery of and payment for the Option Shares shall be made at the place
specified in the first sentence of the first paragraph of this Section 5 (or at
such other place as shall be determined by agreement between the Representatives
and the Company) at 7:00 a.m., New York City time, on the
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<PAGE> 15
Second Delivery Date. On the Second Delivery Date, the Company shall deliver or
cause to be delivered the certificates representing the Option Shares to the
Representatives for the account of each Underwriter against payment to or upon
the order of the Company of the purchase price by wire transfer of immediately
available (same day) funds. Time shall be of the essence, and delivery at the
time and place specified pursuant to this Agreement is a further condition of
the obligation of each Underwriter hereunder. Upon delivery, the Option Shares
shall be registered in such names and in such denominations as the
Representatives shall request in the aforesaid written notice. For the purpose
of expediting the checking and packaging of the certificates for the Option
Shares, the Company shall make the certificates representing the Option Shares
available for inspection by the Representatives in Los Angeles, California not
later than 2:00 p.m., New York City time, on the business day prior to the
Second Delivery Date. If the Representatives so elect, delivery of the Option
Shares may be made by credit through full fast transfer to the accounts at the
Depositary Trust Company designated by the Representatives.
6. Further Agreements of the Company and the Selling Stockholder. The
Company (as to Sections 6(a)-(l)) and the Selling Stockholder (as to Sections
6(i), 6(k), 6(m)) and 6(n) covenant and agree with the Underwriters as follows:
(a) The Company will not, either prior to the Effective Date or
thereafter during such period as, in the opinion of counsel for the
Underwriters, the Prospectus would be required by law to be delivered in
connection with sales of the Underwritten Shares by an underwriter or dealer,
file any amendment or supplement to the Registration Statement or the
Prospectus, unless a copy thereof shall first have been submitted to the
Underwriters within a reasonable period of time prior to the filing thereof and
the Underwriters shall not have objected thereto in good faith.
(b) If the Registration Statement has not been declared effective
prior to the execution of this Agreement, the Company will use its best
commercial efforts to cause the Registration Statement to become effective, and
will notify the Underwriters promptly, and will confirm such advice in writing,
(1) when the Registration Statement has become effective and when any
post-effective amendment thereto becomes effective, (2) of any request by the
securities or other governmental authority (including, without limitation, the
Commission) of any jurisdiction for amendments or supplements to the
Registration Statement or the Prospectus or for additional or supplemental
information, (3) of the issuance by any securities or other governmental
authority (including, without limitation, the Commission) of any jurisdiction of
any stop order suspending the effectiveness of the Registration Statement or the
initiation of any proceedings for that purpose or the threat thereof, (4) of the
happening of any event during the period mentioned in Section 6(a) that in the
judgment of the Company makes any statement made in the Registration Statement
or the Prospectus untrue or that requires the making of any changes in the
Registration Statement or the Prospectus in order to make the statements
therein, in light of the circumstances in which they are made, not misleading
and (5) of receipt by the Company or any representative or attorney of the
Company of any other communication from the securities or other governmental
authority (including, without limitation, the Commission) of any jurisdiction
relating to any of the Registration Statement, any Preliminary Prospectus or the
Prospectus. If at any time any securities or other
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<PAGE> 16
governmental authority (including, without limitation, the Commission) of any
jurisdiction shall issue any order suspending the effectiveness of the
Registration Statement, the Company will make every reasonable effort to obtain
the withdrawal of such order at the earliest possible moment. If the Company has
omitted any information from the Registration Statement, pursuant to Rule 430A,
it will use its best efforts to comply with the provisions of and make all
requisite filings with the Commission pursuant to said Rule 430A and to notify
the Underwriters promptly of all such filings. If the Company elects to rely on
Rule 462(b), the Company shall both file a Rule 462(b) Registration Statement
with the Commission in compliance with Rule 462(b) and pay the applicable filing
fees in accordance with Rule 111 of the 1933 Act Regulations by the earlier of
(A) 10:00 p.m., New York time, on the date of this Agreement and (B) the time
confirmations are sent or given, as specified by Rule 462(b)(2).
(c) If, at any time when a Prospectus relating to the
Underwritten Shares is required to be delivered under the 1933 Act, any event
occurs as a result of which the Prospectus, as then amended or supplemented,
would, in the judgment of counsel to the Company or counsel to the Underwriters,
include any untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading, or the Registration
Statement, as then amended or supplemented, would, in the judgment of counsel to
the Company or counsel to the Underwriters, include any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
therein not misleading, or if for any other reason it is necessary, in the
judgment of counsel to the Company or counsel to the Underwriters, at any time
to amend or supplement the Prospectus or the Registration Statement to comply
with the 1933 Act or the 1933 Act Regulations, the Company will promptly notify
the Underwriters and, subject to Section 6(a) hereof, will promptly prepare and
file with the Commission, at the Company's expense, an amendment to the
Registration Statement or an amendment or supplement to the Prospectus that
corrects such statement or omission or effects such compliance and will deliver
to the Underwriters, without charge, such number of copies thereof as the
Underwriters may reasonably request. The Company consents to the use of the
Prospectus or any amendment or supplement thereto by the Underwriters.
(d) The Company will furnish to the Underwriters and their
counsel, without charge, (i) an aggregate of three manually signed copies of the
registration statement described in Section 3(a) hereof and each pre-effective
amendment thereto, including financial statements and schedules, and all
exhibits thereto, and any registration statement filed pursuant to Rule 462(b)
and (ii) so long as a prospectus relating to the Underwritten Shares is required
to be delivered under the 1933 Act, as many copies of each Preliminary
Prospectus or the Prospectus or any amendment or supplement thereto as the
Underwriters may reasonably request.
(e) The Company will comply with all the undertakings contained
in the Registration Statement and shall file, on a timely basis, with the
Commission, the NASD, the AMEX and any other securities exchange on which the
securities of the Company are then listed, all periodic and other reports and
documents required to be filed under the Exchange Act.
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<PAGE> 17
(f) Prior to the sale of the Underwritten Shares to the
Underwriters, the Company and the Selling Stockholder will cooperate with the
Underwriters and their counsel in connection with the registration or
qualification of the Underwritten Shares for offer and sale under the state
securities or Blue Sky laws of such jurisdictions as the Underwriters may
request; provided, that in no event shall the Company be obligated to qualify to
do business in any jurisdiction where it is not now so qualified or to take any
action which would subject it to general service of process in any jurisdiction
where it is not now so subject. The Company will advise the Underwriters
promptly of the suspension of the qualification or registration of (or any
exemption relating to) the Underwritten Shares for offering, sale or trading in
any jurisdiction or any initiation or threat of any proceedings for such
purpose, and in the event of the issuance of any order suspending such
qualification or registration or exemption, the Company shall use its best
efforts to obtain the withdrawal thereof at the earliest possible time.
(g) During the period of three years commencing on the Effective
Date, the Company will furnish to the Underwriters: (i) as soon as practicable
after the end of each fiscal year of the Company, copies of the Annual Report of
the Company containing the balance sheet of the Company as of the close of such
fiscal year and statements of income, stockholders' equity and cash flows for
the fiscal year then ended and the opinion thereon of the Company's independent
public or certified public accountants; (ii) as soon as practicable after the
filing thereof, copies of each proxy statement, Annual Report on Form 10-K (or
Form 10-KSB, if applicable), Quarterly Report on Form 10-Q (or Form 10-QSB, if
applicable), Current Report on Form 8-K, or other report filed by the Company
with the Commission, the NASD, the AMEX, or any other securities exchange; and
(iii) as soon as available, copies of any reports or communications of the
Company mailed generally to holders of its capital stock.
(h) As soon as practicable, but in any event not later than 45
days after the end of the 12-month period beginning on the day after the end of
the fiscal quarter of the Company during which the Effective Date of the
Registration Statement occurs (90 days in the event that the end of such fiscal
quarter is the end of the Company's fiscal year), the Company will make
generally available to its security holders, in the manner specified in Rule
158(b) of the 1933 Act Regulations, and to the Underwriters, an earnings
statement which will be in the detail required by, and will otherwise comply
with, the provisions of Section 11(a) of the 1933 Act and Rule 158(a) of the
19933 Act Regulations, which statement need not be audited unless required by
the 1933 Act or the 1933 Act Regulations, covering a period of at lest 12
consecutive months after the Effective Date of the Registration Statement.
(i) Neither the Company nor the Selling Stockholder will, at any
time, directly or indirectly, take any action intended, or which might
reasonably be expected, to cause or result in, or which will constitute,
stabilization or manipulation of the price of the Common Stock to facilitate the
sale or resale of any of the Underwritten Shares.
(j) Prior to the Delivery Date, the Company shall furnish to the
Underwriters, as soon as they have been prepared, copies of any unaudited
interim consolidated financial statements
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<PAGE> 18
of the Company, for any periods subsequent to the periods covered by the
financial statements appearing in the Registration Statement and the Prospectus.
(k) Prior to the Delivery Date, the Company and the Selling
Stockholder will issue no press release or other communications directly or
indirectly and hold no press conferences with respect to the Company, the
condition, financial or otherwise, or the earnings, business affairs or business
prospects of the Company, or the offering of the Underwritten Shares, without
the prior written consent of the Underwriters unless in the opinion of legal
counsel to the Company, and after reasonable advance notification to the
Underwriters, such press release or communication is required by law.
(l) The Company will apply the net proceeds from the offering and
sale of the Shares in the manner set forth in the Prospectus under the caption
"Use of Proceeds."
(m) The Selling Stockholder will deliver to the Representatives
prior to or on the First Delivery Date a properly completed and executed United
States Treasury Department Form W-9 or W-8, as applicable (or other applicable
form or statement specified by Treasury Department regulations in lieu thereof).
(n) The Selling Stockholder agrees that the Selling Stockholder
Shares, which are represented by certificates held in custody for the Selling
Stockholder, is subject to the interest of the Underwriters, and that the
arrangements made by the Selling Stockholder for such custody are to that extent
irrevocable, and that the obligations of the Selling Stockholder hereunder shall
not be terminated by any act of the Selling Stockholder, by operation of law, or
the occurrence of any other event.
You may waive in writing the performance by the Company of any one or
more of the foregoing covenants or extend the time for their performance.
7. Expenses.
(a) Whether or not the transactions contemplated by this
Agreement are consummated or this Agreement is terminated, the Company will pay
all accountable out-of-pocket costs and Expenses incident to the performance of
the obligations of the Company and the Underwriters under this Agreement,
including but not limited to costs and Expenses of or relating to (1) the
preparation, printing and filing of the Registration Statement (including each
pre- and post-effective amendment thereto) and exhibits thereto, any
registration statement filed pursuant to Rule 462(b), each Preliminary
Prospectus, the Prospectus and any amendment or supplement to the Prospectus,
including all fees, disbursements and other charges of counsel to the Company,
(2) the preparation and delivery of certificates representing the Underwritten
Shares, (3) furnishing (including costs of shipping and mailing) such copies of
the Registration Statement (including all pre- and post-effective amendments
thereto), the Prospectus and any Preliminary Prospectus, and all amendments and
supplements to the Prospectus, as may reasonably be requested for use in
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<PAGE> 19
connection with the offering and sale of the Underwritten Shares, (4) the
listing of the Common Stock on the AMEX and withdrawal of the Common Stock from
the Nasdaq SmallCap Market, (5) any filings required to be made by the
Underwriters with the NASD and the registration or qualification of the
Underwritten Shares for offer and sale under the state securities or Blue Sky
laws of such jurisdictions designated pursuant to Section 6(f), including the
reasonable fees, disbursements and other charges of counsel to the Underwriters
in connection therewith and with the preparation and printing of preliminary,
supplemental and final Blue Sky memoranda, (6) fees, disbursements and other
charges of counsel to the Company and the Company's independent public or
certified public accountants and other advisors, (7) all expenses incident to
the issuance and delivery of the Underwritten Shares (including all printing and
engraving costs), (8) all fees and expenses of the registrar and transfer agent
of the Common Stock, (9) all necessary issue, transfer and other stamp taxes in
connection with the delivery of the Underwritten Shares, and (10) all other
fees, costs and expenses referred to in Item 13 of Part II of the Registration
Statement. The Company shall reimburse the Underwriters for all their
accountable travel expenses, reasonable legal fees, disbursements and other
charges and other out-of-pocket Expenses incurred in connection with the
engagement hereunder, up to a maximum of $100,000, regardless of whether or not
the public offering of the Underwritten Shares is consummated as contemplated
hereby.
(b) The Company, in addition to its other obligations under
Section 7(a) above, and the Selling Stockholder will pay to the Representatives
(individually and not in their capacity as Representatives) a nonaccountable
expense allowance equal to 2.0% of the gross sales price of the Underwritten
Shares to the public, each to pay on a pro rata basis in proportion to the
number of the Underwritten Shares sold by each to the Underwriters. This
nonaccountable expense allowance with respect to the Firm Shares shall be paid
to the Representatives on the First Delivery Date and the nonaccountable
expenses with respect to the Option Shares, if any, shall be paid to the
Representatives on the Second Delivery Date (and shall be contingent on the
closing of the sale of the Option Shares), and liability for such payments shall
be several and not joint. The Company has previously paid to the Representatives
a fee of $____________ (the "Deposit") which shall be credited to this
nonaccountable expense allowance. If the sale of the Firm Shares is not
completed for any reason, including the failure of the Underwriters to complete
the offering contemplated by this Agreement (except if the Company prevents such
completion or if the failure to complete the offering is the result of the
breach by the Company of any representation, warranty or agreement contained
herein), the Representatives will return the Deposit, less any actual
out-of-pocket expenses incurred by the Underwriters.
(c) If, within three months after the termination of this
Agreement, the Company or the Selling Stockholders shall sell any shares of
Common Stock to investors previously identified and/or contacted by the
Underwriters in their capacity as such, as set forth on a list furnished to the
Company and the Selling Stockholder within a reasonable period of time after
such termination, then the Company and/or the Selling Stockholder, as
appropriate, shall pay the Underwriters, at the time of each such sale, an
amount equal to the underwriting discounts or commissions otherwise contemplated
with respect to the gross proceeds to the Company or the Selling Stockholder
from each such sale.
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<PAGE> 20
8. Conditions of the Obligations of the Underwriters. The obligations of
the Underwriters hereunder are subject to the following conditions:
(a) Notification that the Registration Statement has become
effective shall be received by the Underwriters not later than 5:30 p.m., Los
Angeles time, on the date of this Agreement or at such later date and time as
shall be consented to by the Representatives and all filings required by Rule
424 of the Rules and Regulations and Rule 430A shall have been made.
(b) (i) No stop order suspending the effectiveness of the
Registration Statement shall have been issued, and no proceedings for that
purpose shall be pending or threatened by any securities or other governmental
authority (including, without limitation, the Commission), (ii) no order
suspending the effectiveness of the Registration Statement or the qualification
or registration of the Underwritten Shares under the securities or Blue Sky laws
of any jurisdiction shall be in effect and no proceeding for such purpose shall
be pending before or threatened or contemplated by any securities or other
governmental authority (including, without limitation, the Commission), (iii)
any request for additional information on the part of the staff of any
securities or other governmental authority (including, without limitation, the
Commission) shall have been complied with to the satisfaction of the staff of
the Commission or such authorities and (iv) after the date hereof no amendment
or supplement to the Registration Statement or the Prospectus shall have been
filed unless a copy thereof was first submitted to the Underwriters and the
Underwriters did not object thereto in good faith, and the Underwriters shall
have received certificates, dated the Delivery Date and signed by the President
and Chief Executive Officer or the Chairman of the Board of Directors of the
Company, and the Chief Financial Officer of the Company (who may, as to
proceedings threatened, rely upon the best of their information and belief), to
the effect of clauses (i), (ii) and (iii) above.
(c) Since the respective dates as of which information is given
in the Registration Statement and the Prospectus, (i) there shall not have been
a material adverse change in the general affairs, business, prospects,
properties, management, condition (financial or otherwise) or results of
operations of the Company and the Subsidiaries, taken as a whole, whether or not
arising from transactions in the ordinary course of business, in each case other
than as set forth in or contemplated by the Registration Statement and the
Prospectus and (ii) neither the Company nor any Subsidiary shall have sustained
any material loss or interference with its business or properties from fire,
explosion, flood or other casualty, whether or not covered by insurance, or from
any labor dispute or any court or legislative or other governmental action,
order or decree, which is not set forth in the Registration Statement and the
Prospectus, if in the judgment of the Underwriters any such development makes it
impracticable or inadvisable to consummate the sale and delivery of the
Underwritten Shares to the public at the public offering price.
(d) Since the respective dates as of which information is given
in the Registration Statement and the Prospectus, there shall have been no
litigation or other proceeding instituted against the Company or the
Subsidiaries or any of its officers or directors in their capacities as such,
before or by any Federal, state or local court, commission, regulatory body,
administrative agency
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<PAGE> 21
or other governmental body, domestic or foreign, in which litigation or
proceeding an unfavorable ruling decision or finding would have a Material
Adverse Effect.
(e) Each of the representations and warranties of the Company and
the Selling Stockholder contained herein shall be true and correct at the
Delivery Date, as if made on such date, and all covenants and agreements herein
contained to be performed on the part of the Company and the Selling Stockholder
and all conditions herein contained to be fulfilled or complied with by the
Company at or prior to the Delivery Date shall have been duly performed,
fulfilled or complied with.
(f) The Underwriters shall have received:
(i) The favorable opinion, dated as of the Delivery Date,
of Morrison & Foerster LLP, counsel for the Company, in form and
substance satisfactory to counsel for the Underwriters, to the effect
that:
(A) The Company and the Subsidiaries have been duly
incorporated and are validly existing as corporations in good
standing under the laws of their respective jurisdictions of
incorporation.
(B) The Company and the Subsidiaries have corporate
power and authority to own their properties and carry on their
businesses as described in the Registration Statement and the
Prospectus and the Company has corporate power and authority to
enter into and perform its obligations under this Agreement.
(C) The Company is duly qualified to transact
business and is in good standing in each state of the United
States in which the conduct of its business or the ownership or
leasing of property requires such qualification, except to the
extent that the failure to be so qualified or be in good standing
would not materially and adversely affect the Company or its
business, properties, financial condition or results of
operations.
(D) The authorized, issued and outstanding number
of shares of capital stock of the Company is as set forth under
the caption "Capitalization" in the Prospectus and in the
Preliminary Prospectus as of the dates therein. The issued and
outstanding capital stock of the Company has been duly
authorized, validly issued, fully paid and is non-assessable and
has not been issued in violation of or is not otherwise subject
to any preemptive rights set forth in the Certificate of
Incorporation, Bylaws or any agreement or other arrangement known
to counsel. All offers and sales of the Company's capital stock
or securities since January 1, 1992, including all offers and
sales of securities described in Item 15 of Part II of the
Registration Statement, were either duly registered or qualified
under the 1933 Act or were exempt from the registration
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<PAGE> 22
requirements of the 1933 Act, assuming that all representations
made to the Company by any purchaser of such capital stock were
true and correct when made.
(E) Issuance and sale of the Underwritten Shares to
be sold by the Company to the Underwriters under the terms of
this Agreement have been duly authorized by the Company and, when
such shares are issued and delivered by the Company, pursuant to
the terms of this Agreement and the Company receives the
consideration recited herein, such Underwritten Shares will be
validly issued, and fully paid and non-assessable and the
issuance of the Underwritten Shares is not subject to preemptive
or, to their knowledge, other similar rights granted by the
Company.
(F) To their knowledge, except as described in the
Prospectus, (i) there are no outstanding options, warrants or
other rights granted to or by the Company to purchase shares of
Common Stock or other securities of the Company or the
Subsidiaries, and (ii) there are no commitments, plans or
arrangements to issue any shares of Common Stock or other
securities of the Company or the Subsidiaries.
(G) This Agreement has been duly authorized,
executed and delivered by the Company.
(H) The form of certificate evidencing the
Underwritten Shares is in due and proper form under Delaware law.
(I) To their knowledge, except as described in the
Registration Statement or in the Prospectus, there are no
actions, suits or proceedings pending or threatened to which the
Company or the Subsidiaries are a party that are required to be
described in the Registration Statement or the Prospectus and are
not so described.
(J) The information set forth in the Prospectus
under the captions "Risk Factors - Control by Principal
Stockholders," "Risk Factors - Potential Adverse Market Impact of
Shares Eligible for Future Sale," "Risk Factors Antitakeover
Effects of Certain Charter Provisions, and Delaware Law,"
"Business Trademarks and Patents," "Business - Governmental
Regulations," "Business - Legal Proceedings," "Management - 1997
Management Committee Incentive Award Program," "Management -
Stock Plans," "Management - Employment Agreements," "Certain
Transactions," and "Description of Capital Stock," and in Part II
of the Registration Statement under the captions "Indemnification
of Directors and Officers," and "Recent Sales of Unregistered
Securities," to the extent that they constitute a summary of
legal matters, documents or proceedings referred to therein, have
been reviewed by us and fairly present and summarize, in all
material respects, the information called for respect to such
legal matters, documents and proceedings under the 1933 Act and
the 1933 Act Regulations.
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<PAGE> 23
(K) To their knowledge, there are no agreements,
contracts, leases or other documents to which the Company is a
party of a character required to be described or referred to in
the Registration Statement or Prospectus or to be filed as an
exhibit to the Registration Statement which are not described or
referred to therein or filed as required and, to their knowledge,
the Company is not in default in the due performance or
observance of any material obligation, agreement, covenant or
condition contained in any material instrument or agreement filed
as an exhibit to the Registration Statement.
(L) No consent, approval, authorization or order of
or qualification with any court, government or governmental
agency or body having jurisdiction over the Company or over any
of its properties or operations is necessary in connection with
the consummation by the Company of the transactions contemplated
in this Agreement and the compliance by the Company with its
obligations thereunder on the Delivery Date, other than the
filing of the Registration Statement and the Prospectus with the
Commission and the issuance of an effectiveness order by the
Commission with respect to the Registration Statement, all of
which have been, or will prior to the Delivery Date be,
completed.
(M) Neither the execution and delivery nor the
performance of this Agreement by the Company (i) conflicts with
any provision of the Certificate Incorporation or Bylaws of the
Company, (ii) violates any law applicable to the Company, or
(iii) results in a breach or violation of, or constitutes a
default under, any term of any agreement or instrument filed as
an exhibit to the Registration Statement or of any order, writ or
decree, of which they have knowledge, of any court, governmental
agency or body.
(N) To their knowledge, there are no proceedings,
pending or threatened before any regulatory body or agency, which
if the subject of an unfavorable decision, ruling or finding,
would have a Material Adverse Effect.
(O) To their knowledge, all holders of securities
of the Company who have rights to the registration of Common
Stock or other securities because of the filing of the
Registration Statement by the Company have waived such rights or
have received proper notice of the filing of the Registration
Statement and have not asserted, and no longer have the right to
assert, such rights.
(P) The Company is not an "investment company" or a
company "controlled" by an "investment company" within the
meaning of the Investment Company Act of 1940, as amended.
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(Q) The Registration Statement has become effective
under the 1933 Act; any required filing of the Prospectus, and
any supplements thereto pursuant to Rule 424(b) has been made in
the manner and within the time period required; and to their
knowledge and information, no stop order suspending the
effectiveness of the Registration Statement or any part thereof
has been issued and no proceedings therefor have been instituted
or are pending or contemplated under the 1933 Act.
Following their opinions required by subsection (f)(i) of
this Section 8, Morrison & Foerster LLP shall additionally state that
nothing has come to their attention that leads them to believe that the
Registration Statement (except for financial statements and schedules
and other financial and statistical information included therein, as to
which counsel need make no statement), at the time it became effective,
contained an untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were
made, not misleading or that the Prospectus (except for financial
statements and schedules and other financial and statistical information
included therein, as to which counsel need make no statement), as of its
date (unless the term "Prospectus" refers to a prospectus which has been
provided to the Underwriters by the Company for use in connection with
the offering of the Underwritten Shares which differs from the
Prospectus on file at the Commission at the time the Registration
Statement becomes effective, in which case at the time it is first
provided to the Underwriters for such use) or at the Delivery Date,
included or includes an untrue statement of a material fact or omitted
or omits to state a material fact necessary in order to make the
statements therein, in the light of the circumstances under which they
were made, not misleading.
(ii) The favorable opinion, dated the Delivery Date, of
Judith O. Lasker, Esquire, counsel for the Company, in form and
substance satisfactory to the Underwriters, to the effect that:
(A) Except as described in the Registration
Statement or in the Prospectus, there are no actions, suits or
proceedings pending or, to counsel's knowledge, threatened to
which the Company or the Subsidiaries are a party that are
reasonably likely to have a Material Adverse Effect.
(B) Except as disclosed in writing to the
Representatives there are no proceedings, pending or, to
counsel's knowledge, threatened before any regulatory body or
agency to which the Company is a party or otherwise involving the
Company.
(C) The Company is in compliance with and has
conducted its businesses (and the businesses of its Subsidiaries)
in material conformity with all applicable laws and regulations
relating to the operation of such businesses as described in the
Registration Statement.
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<PAGE> 25
Following her opinions required by subsection (f)(ii) of
this Section 8, Judith O. Lasker, Esquire shall additionally state that
nothing has come to her attention that leads her to believe that the
Registration Statement (except for financial statements and schedules
and other financial and statistical information included therein, as to
which counsel need make no statement), at the time it became effective,
contained an untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were
made, not misleading or that the Prospectus (except for financial
statements and schedules and other financial and statistical information
included therein, as to which counsel need make no statement), as of its
date (unless the term "Prospectus" refers to a prospectus which has been
provided to the Underwriters by the Company for use in connection with
the offering of the Underwritten Shares which differs from the
Prospectus on file at the Commission at the time the Registration
Statement becomes effective, in which case at the time it is first
provided to the Underwriters for such use) or at the Delivery Date,
included or includes an untrue statement of a material fact or omitted
or omits to state a material fact necessary in order to make the
statements therein, in the light of the circumstances under which they
were made, not misleading.
(iii) The favorable opinion, dated the Delivery Date, of
Stroock & Stroock & Lavan LLP, counsel for the Selling Stockholder, in
form and substance satisfactory to the Underwriters, to the effect that:
(A) To such counsel's knowledge, the Selling
Stockholder has full right, power and authority to enter into
this Agreement, the Power of Attorney and the Custody Agreement;
the execution, delivery and performance of this Agreement, the
Power of Attorney and the Custody Agreement by the Selling
Stockholder and the consummation by the Selling Stockholder of
the transactions contemplated hereby and thereby will not
conflict with or result in a breach or violation of any of the
terms or provisions of, or constitute a default under, any
statute, any indenture, mortgage, deed of trust, loan agreement
or other agreement or instrument known to such counsel to which
the Selling Stockholder is a party or by which the Selling
Stockholder is bound or to which any of the property or assets of
the Selling Stockholder is subject, which breach, violation or
default is reasonably likely to have a material adverse effect on
the performance of such Selling Stockholder's obligations
hereunder, nor will such actions result in any violation of any
statute or any order, rule or regulation known to such counsel of
any court or governmental agency or body having jurisdiction over
the Selling Stockholder or the property or assets of the Selling
Stockholder, and, except for the registration of the Selling
Stockholder Shares under the Securities Act and such consents,
approvals, authorizations, registrations or qualifications as may
be required under the Exchange Act and applicable state
securities laws in connection with the purchase of the Selling
Stockholder Shares by the Underwriters and the distribution of
such shares by the
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<PAGE> 26
Underwriters, no consent, approval, authorization or order of, or
filing or registration with, any such court or governmental
agency or body (except for those consents, approvals,
authorizations, orders, filings or registrations, which, if not
secured, filed or registered, as applicable, would not have a
material adverse effect on the performance of such Selling
Stockholder's obligations hereunder) is required for the
execution, delivery and performance of this Agreement, the Power
of Attorney or the Custody Agreement by the Selling Stockholder
and the consummation by the Selling Stockholder of the
transactions contemplated hereby and thereby;
(B) This Agreement has been duly executed and
delivered by or on behalf of the Selling Stockholder;
(C) A Power-of-Attorney and a Custody Agreement
have been duly executed and delivered by the Selling Stockholder
and, to such counsel's knowledge, constitute valid and binding
agreements of such Selling Stockholder, enforceable in accordance
with their respective terms subject to the effect of bankruptcy,
insolvency, fraudulent conveyance, reorganization, moratorium and
similar laws relating to or affecting creditor's rights generally
(and court decisions with respect thereto), equitable principles
(whether considered in a proceeding in equity or at law) or an
implied covenant of good faith and fair dealing;
(D) Immediately prior to the date of this Agreement
and the First Delivery Date, the Selling Stockholder had, to such
counsel's knowledge, full right, power and authority to sell,
assign, transfer and deliver such shares to be sold by such
Selling Stockholder hereunder; and
(E) All rights of the Selling Stockholder in the
Selling Stockholder Shares have been transferred to the
Underwriters and, in addition, each Underwriter (whom such
counsel may assume to be a "protected purchaser") has acquired
its interest in the Selling Stockholder Shares to be acquired by
it free of any "adverse claim" (as such terms are defined in the
Uniform Commercial Code and interpretations thereof as in effect
in the State of New York).
Following their opinions required by subsection (f)(iii) of this
Section 8, Stroock & Stroock & Lavan LLP shall additionally state that no facts
have come to the attention of such counsel which lead it to believe that the
Registration Statement, as of the Effective Date, contained any untrue statement
of a material fact relating to the Selling Stockholder or omitted to state such
a material fact required to be stated therein or necessary in order to make the
statements therein not misleading (other than financial statements and related
schedules and other financial and statistical information contained therein as
to which such counsel need express no opinion), or that the Prospectus contains
any untrue statement of a material fact relating to the Selling Stockholder or
omits to state such a material fact required to be stated therein or necessary
in order to make the statements therein, in light of the circumstances under
which they were made, not misleading.
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<PAGE> 27
(g) At the time of the execution of this Agreement, the
Underwriters shall have received from Ernst & Young LLP, former independent
public accountants for the Company, and from Arthur Andersen LLP, independent
accountants for the Company, as appropriate, a letter dated such date and
addressed to the Underwriters, in form and substance satisfactory to the
Underwriters, containing statements and information of the type ordinarily
included in accountants' "comfort letters" to underwriters, delivered according
to Statement of Auditing Standards No. 72 (or any successor bulletin), with
respect to the audited and unaudited financial statements and certain financial
and capital stock information contained in the Registration Statement and the
Prospectus.
(h) The Underwriters shall have received from Ernst & Young LLP,
former independent accountants for the Company, and from Arthur Andersen LLP,
independent accountants for the Company, as appropriate, a letter addressed to
the Underwriters, and in form and substance satisfactory to the Underwriters,
dated as of the Delivery Date, to the effect that they reaffirm the statements
made in the letters furnished pursuant to subsection (g) of this Section 8.
(i) At the Delivery Date, there shall be furnished to the
Underwriters a certificate, dated the date of its delivery, signed by each of
the Chief Executive Officer and the Chief Financial Officer of the company, in
form and substance satisfactory to the Underwriters, to the effect that:
(i) Each signer of such certificate has carefully examined
the Registration Statement and the Prospectus and (i) as of the date of
such certificate, (x) the Registration Statement does not contain any
untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary in order to make the
statements therein, in light of the circumstances under which they were
made, not misleading and (y) the Prospectus does not contain any untrue
statement of a material fact or omit to state a material fact required
to be stated therein or necessary in order to make the statements
therein, in the light of the circumstances under which they were made,
not misleading and (ii) since the Effective Date, no event has occurred
as a result of which it is necessary to amend or supplement the
Prospectus in order to make the statements therein not untrue or
misleading in any material respect.
(ii) Each of the representations and warranties of the
Company contained in this Agreement were, when originally made, and are,
at the time such certificate is delivered, true and correct in all
material respects.
(iii) Each of the covenants required herein to be
performed by the Company on or prior to the date of such certificate has
been duly, timely and fully performed and each condition herein required
to be complied with by the Company on or prior to the delivery of such
certificate has been duly, timely and fully complied with.
(iv) No stop order suspending the effectiveness of the
Registration Statement or of any part thereof has been issued and no
proceedings for that purpose have been instituted or, to their
knowledge, are contemplated by the Commission.
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<PAGE> 28
(v) Subsequent to the date of the most recent financial
statements in the Prospectus, there has been no material adverse change
in the financial position or results of operations of the Company or the
Subsidiaries, except as set forth in or contemplated by the Prospectus.
(j) The Underwritten Shares shall be qualified for sale in such
states as the Underwriters may reasonably request, each such qualification shall
be in effect and not subject to any stop order or other proceeding on the
Delivery Date.
(k) The Common Stock (including Underwritten Shares) shall have
been approved for listing on the AMEX, and, contingent upon such approval,
withdrawn from the Nasdaq SmallCap Market.
(l) The Underwriters and counsel for the Underwriters shall have
been furnished with such documents and opinions as they may require in order to
evidence the accuracy of any of the representations or warranties or the
fulfillment of any of the conditions herein contained; and all proceedings taken
by the Company in connection with the issuance and sale of the Underwritten
Shares as herein contemplated shall be satisfactory in form and substance to the
Underwriters and counsel for the Underwriters. Any certificate or document
signed by any officer of the Company and delivered to you or to your counsel
shall be deemed a representation and warranty by the Company to each of you as
to the statements made therein and such statements are true and correct except
where the inaccuracy of such statements alone or in the aggregate would not have
a Material Adverse Effect.
(m) The Selling Stockholder shall have furnished to the
Underwriters such certificates, in addition to those specifically mentioned
herein, as the Underwriters may have reasonably requested as to the accuracy and
completeness at the Delivery Date of any statement in the Registration Statement
or the Prospectus regarding the Selling Stockholder, as to the accuracy at the
Delivery Date of the representations and warranties of the Selling Stockholder,
as to the performance by the Selling Stockholder of its obligations hereunder,
or as to the fulfillment of the conditions concurrent and precedent to the
obligations hereunder of the Underwriters.
(n) The NASD shall have raised no objection to the fairness and
reasonableness of the underwriting terms and agreements.
(o) As of the date hereof the Company, its directors and
officers, and certain affiliates of the Company (as designated on Attachment C
hereto by the Company), and the Selling Stockholder, shall have furnished to the
Underwriters "lock-up" agreements substantially in the forms of Attachment A and
Attachment B hereto, and such agreements shall be in full force and effect on
the Delivery Date.
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<PAGE> 29
9. Indemnification.
(a) The Company shall indemnify and hold harmless the
Underwriters and the Selling Stockholder, the directors, officers, employees and
agents of the Underwriters and the Selling Stockholder and each person, if any,
who controls the Underwriters or the Selling Stockholder within the meaning of
Section 15 of the 1933 Act or Section 20 of the 1934 Act from and against any
and all losses, claims, liabilities, expenses and damages, joint or several
(including any and all investigative, reasonable legal and other expenses
reasonably incurred in connection with, and any amount paid in settlement of,
any action, suit or proceeding or any claim asserted), to which any of them may
become subject under the 1933 Act, the 1934 Act, or other Federal or state
statutory law or regulation, at common law or otherwise. Such indemnity shall
not, however, cover any such loss, claim, damage, liability, cost or expense
which is held in a final judgment of a court to have arisen primarily out of the
gross negligence or willful misconduct of the Underwriters, or the failure of
the Underwriters to deliver a Prospectus if it fails to correct such deficiency
under the 1933 Act. This indemnity agreement will be in addition to any
liability which the Company may otherwise have. The Company will not, without
the prior written consent of the Underwriters or the Selling Stockholder (which
consent shall not be unreasonably withheld), settle or compromise or consent to
the entry of any judgment in any pending or threatened claim, action, suit or
proceeding in respect of which indemnification has been sought hereunder
(whether or not such Underwriters or the Selling Stockholder or any person who
controls such Underwriters or the Selling Stockholder within the meaning of
Section 15 of the 1933 Act or Section 20 of the 1934 Act is a party to each
claim, action, suit or proceeding), unless such settlement, compromise or
consent includes an unconditional release of the Underwriters and the Selling
Stockholder and each such controlling person from all liability arising out of
such claim, action, suit or proceeding and does not impair or alter the business
or affairs of the Underwriters or the Selling Stockholder.
(b) The Selling Stockholder shall indemnify and hold harmless the
Underwriters and the Company, the directors, officers, employees and agents of
the Underwriters and the Company and each person, if any, who controls the
Underwriters or the Company within the meaning of Section 15 of the 1933 Act or
Section 20 of the 1934 Act from and against any and all losses, claims,
liabilities, expenses and damages, joint or several (including any and all
investigative, reasonable legal and other expenses reasonably incurred in
connection with, and any amount paid in settlement of, any action, suit or
proceeding or any claim asserted), to which any of them may become subject under
the 1933 Act, the 1934 Act, or other Federal or state statutory law or
regulation, at common law or otherwise, insofar as such losses, claims, damages,
liabilities or expenses (or actions in respect thereof as contemplated below)
arise out of or are based on a breach of the terms and conditions of this
Agreement, or arise out of or are based upon the inaccuracy of any
representation made by the Selling Stockholder herein or any untrue or alleged
untrue statement of any material fact contained in the Registration Statement,
the Prospectus, or any amendment or supplement thereto, or arise out of or are
based upon the omission or alleged omission to state therein a material fact
required to be stated therein or necessary to make the statements therein not
misleading, in each case to the extent, but only to the extent, that such untrue
statement or alleged untrue statement or omission or alleged omission was made
in the Registration Statement, the
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<PAGE> 30
Prospectus, or any amendment or supplement thereto, in reliance upon and in
conformity with written information furnished to the Company by or on behalf of
the Selling Stockholder expressly for use therein, and provided further that, in
the event the sale of the Selling Stockholder Shares is not consummated and this
Agreement is terminated, the liability of the Selling Stockholder shall be
limited to the reimbursement of the Selling Stockholder's proportionate share of
the accountable expenses of the Underwriters as provided in Section 7 hereof.
This indemnity agreement will be in addition to any liability which the Selling
Stockholder may otherwise have. The Selling Stockholder will not, without the
prior written consent of the Underwriters or the Company (which consent will not
be unreasonably withheld), settle or compromise or consent to the entry of any
judgment in any pending or threatened claim, action, suit or proceeding in
respect of which indemnification has been sought hereunder (whether or not such
Underwriters or the Company or any person who controls such Underwriters or the
Company within the meaning of Section 15 of the 1933 Act or Section 20 of the
1934 Act is a party to such claim, action, suit or proceeding), unless such
settlement, compromise or consent includes an unconditional release of the
Underwriters and the Company and each such controlling person from all liability
arising out of such claim, action, suit or proceeding. Such indemnity shall not,
however, cover any such loss, claim, damage, liability, cost or expense which is
held in a final judgment of a court to have arisen primarily out of the gross
negligence or willful misconduct of the Underwriters or the failure of the
Underwriters to deliver a Prospectus if it fails to correct such deficiency
under the 1933 Act. This indemnity agreement will be in addition to any
liability which the Selling Stockholder may otherwise have. The liability of the
Selling Stockholder under this section shall be limited to an amount equal to
the aggregate public offering price of the Selling Stockholder Shares sold by
the Selling Stockholder.
(c) Each Underwriter will severally (and not jointly) indemnify
and hold harmless the Company, its directors, each of its officers who signed
the Registration Statement, the Selling Stockholder and each person, if any, who
controls the Company or the Selling Stockholder within the meaning of Section 15
of the 1933 Act or Section 20 of the 1934 Act from and against any losses,
claims, liabilities, expenses and damages (including any and all investigative,
reasonable legal and other expenses reasonably incurred in connection with, and
any amount paid in settlement of, any action, suit or proceeding or any claim
asserted if such settlement is effected with the written consent of the
Underwriters), to which any of them may become subject under the 1933 Act or
other Federal or state statutory law or regulation, at common law or otherwise,
insofar as such losses, claims, damages, liabilities or expenses (or actions in
respect thereof as contemplated below) arise out of or are based upon any untrue
or alleged untrue statement of any material fact contained in the Registration
Statement, the Prospectus, or any amendment or supplement thereto, or arise out
of or are based upon the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein, in light of the circumstances in which it was made, not misleading, in
each case to the extent, but only to the extent, that such untrue statement or
alleged untrue statement or omission or alleged omission was made in the
Registration Statement, the Prospectus, or any amendment or supplement thereto,
in reliance upon and in conformity with written information concerning such
Underwriter furnished to the Company through the Representatives by or on behalf
of that Underwriter expressly for use therein. It is expressly acknowledged and
agreed by the Company and the Selling Stockholder that the only written or other
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<PAGE> 31
information furnished to the Company and the Selling Stockholder by or on behalf
of the Underwriters for use in the Registration Statement, the Prospectus, or
any amendment or supplement thereto is the information set forth on the cover
page of the Prospectus with respect to the public offering price, the legend
concerning over-allotments on the inside front cover page of the Prospectus, and
the information set forth in the Prospectus under the caption "Underwriting."
The liability of each Underwriter under this section shall be limited to an
amount equal to the underwriting discounts and commissions received by it under
this Agreement.
(d) Any party that proposes to assert the right to be indemnified
under this Section 9 will, promptly after receipt of notice of commencement of
any action against such party in respect of which a claim is to be made against
an indemnifying party or parties under this Section 9, notify each such
indemnifying party of the commencement of such action, enclosing a copy of all
papers served, but the omission so to notify such indemnifying party will not
relieve it from any liability that it may have to any indemnified party under
the foregoing provisions of this Section 9 unless, and only to the extent that,
such omission results in the forfeiture of substantive rights or defenses by, or
otherwise prejudices, the indemnifying party. If any such action is brought
against any indemnified party and it notifies the indemnifying party of its
commencement, the indemnifying party will be entitled to participate in and, to
the extent that it elects by delivering written notice to the indemnified party
promptly after receiving notice of the commencement of the action from the
indemnified party, jointly with any other indemnifying party similarly notified,
to assume the defense of the action, with counsel satisfactory to the
indemnified party, and after notice from the indemnifying party to the
indemnified party of its election to assume the defense, the indemnifying party
will not be liable to the indemnified party for any legal or other expenses
except as provided below and except for the reasonable costs of investigation
incurred by the indemnified party in connection with the defense. The
indemnified party will have the right to employ its own counsel in any such
action, but the fees, expenses and other charges of such counsel will be at the
expense of such indemnified party unless (1) the employment of counsel by the
indemnified party has been authorized in writing by the indemnifying party, (2)
the indemnified party has reasonably concluded that a conflict exists (based on
advice of counsel to the indemnified party) between the indemnified party and
the indemnifying party that would prevent the counsel selected by the
indemnifying party from representing the indemnified party (in which case the
indemnifying party will not have the right to direct the defense of such action
on behalf of the indemnified party) or (3) the indemnifying party has not in
fact employed counsel to assume the defense of such action within a reasonable
time after receiving notice of the commencement of the action, in each of which
cases the reasonable fees, disbursements and other charges of counsel will be
paid by the indemnifying party or parties. It is understood that the
indemnifying party or parties shall not, in connection with any proceeding or
related proceedings in the same jurisdiction, be liable for the reasonable fees,
disbursements and other charges of more than one separate firm admitted to
practice in such jurisdiction at any one time for all such indemnified party or
parties. All such fees, disbursements and other charges will be reimbursed by
the indemnifying party promptly as they are incurred and demand delivered
therefor. No indemnifying party will, without the prior written consent of the
indemnified parties (which consent will not be unreasonably withheld), settle or
compromise or consent to the entry of any judgment in any pending or threatened
claim, action, suit or proceeding in respect of which
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<PAGE> 32
indemnification has been sought hereunder (whether or not the indemnified
parties are parties to such claim, action, suit or proceeding), unless such
settlement, compromise or consent includes an unconditional release of each
indemnified party from all liability arising out of such claim, action, suit or
proceeding. An indemnifying party will not be liable for any settlement of any
action or claim effected without its written consent (which consent will not be
unreasonably withheld).
(e) In order to provide for just and equitable contribution in
circumstances in which the indemnification provided for in the foregoing
paragraphs of this Section 9 is applicable in accordance with its terms but for
any reason is held to be unavailable from the Company, the Selling Stockholder
or the Underwriters, each indemnifying party will contribute to the total
losses, claims, liabilities, expenses and damages (including any investigative,
legal and other expenses reasonably incurred in connection with, and any amount
paid in settlement of, any action, suit or proceeding or any claim asserted, but
after deducting any contribution received by the Company from persons other than
the Underwriters such as persons who control the Company within the meaning of
the 1933 Act or the 1934 Act, officers of the Company who signed the
Registration Statement and directors of the Company, who also may be liable for
contribution) to which the Company, the Selling Stockholder and the Underwriters
may be subject in proportion to the relative benefits received by the Company,
the Selling Stockholder and the Underwriters and the relative fault of the
Company, the Selling Stockholder and the Underwriters, with respect to the
statements or omissions which resulted in such loss, claim, liability, expense
or damage, or action in respect thereof, as well as any other relevant equitable
considerations with respect to such offering. The relative benefits received by
the Company, the Selling Stockholder and the Underwriters shall be deemed to be
in the same proportion as the total net proceeds from the offering (before
deducting Company expenses) received by the Company and the Selling Stockholders
as set forth in the table on the cover page of the Prospectus bear to the
underwriting discounts and commissions received by the Underwriters hereunder.
The relative fault shall be determined by reference to whether the untrue or
alleged untrue statement of a material fact or omission or alleged omission to
state a material fact relates to information supplied by the Company, the
Selling Stockholder or the Underwriters, the intent of the parties and their
relative knowledge, access to information and opportunity to correct or prevent
such statement or omission. The Company, the Selling Stockholder and the
Underwriters agree that it would not be just and equitable if contribution
pursuant to this Section 9(e) were to be determined by pro rata allocation or by
any other method of allocation which does not take into account the equitable
considerations referred to herein. Notwithstanding the provisions of this
Section 9(e), the Underwriters shall not be required to contribute any amount in
excess of the underwriting discounts and commissions received by them under this
Agreement, the Selling Stockholder shall not be required to contribute any
amount in respect of which it would not have had an indemnification obligation
under Section 9(b) above, and no person found guilty of fraudulent
misrepresentation (within the meaning of Section ll(f) of the 1933 Act) will be
entitled to contribution from any person who was not guilty of such fraudulent
misrepresentation. For purposes of this Section 9(e), any person who controls a
party to this Agreement within the meaning of the 1933 Act or the 1934 Act will
have the same rights to contribution as that party, and each director of the
Company and each officer of the Company who signed the Registration Statement
will have the same rights to contribution as the Company, subject
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<PAGE> 33
in each case to the provisions hereof. Any party entitled to contribution,
promptly after receipt of notice of commencement of any action against such
party in respect of which a claim for contribution may be made under this
Section 9(e), will notify any such party or parties from whom contribution may
be sought, but the omission so to notify will not relieve the party or parties
from whom contribution may be sought from any other obligation it or they may
have under this Section 9(e). No party will be liable for contribution with
respect to any action or claim settled without its written consent (which
consent will not be unreasonably withheld).
10. Termination. The obligations of the Underwriters under this
Agreement may be terminated at any time prior to the delivery of and payment for
the Underwritten Shares, by notice to the Company from the Representatives,
without liability on the part of the Underwriters to the Company or the Selling
Stockholder if, prior to delivery and payment for the Underwritten Shares, in
the sole judgment of the Representatives (i) trading in the Common Stock of the
Company shall have been suspended by the Commission, by Nasdaq, or by the AMEX,
(ii) trading in securities generally on the New York Stock Exchange, the AMEX,
or the Nasdaq National Market shall have been suspended or limited or minimum or
maximum prices shall have been generally established on any of such exchanges,
or additional material governmental restrictions, not in force on the date of
this Agreement, shall have been imposed upon trading in securities generally by
any of such exchanges or by order of the Commission or any court or other
governmental authority, (iii) a general banking moratorium shall have been
declared by Federal or New York State authorities or (iv) any material adverse
change in the financial or securities markets in the United States or any
outbreak or material escalation of hostilities or declaration by the United
States of a national emergency or war or other calamity or crisis shall have
occurred, the effect of any of which is such as to make it, in the sole judgment
of the Underwriters, impracticable or inadvisable to market the Underwritten
Shares on the terms and in the manner contemplated by the Prospectus.
11. Defaulting Underwriters. If, on either Delivery Date, any
Underwriter defaults in the performance of its obligations under this Agreement,
the remaining non-defaulting Underwriters shall be obligated to purchase the
Underwritten Shares which the defaulting Underwriter agreed but failed to
purchase on such Delivery Date in the respective proportions which the number of
Firm Shares set opposite the name of each remaining non-defaulting Underwriter
in Schedule 1 hereto bears to the total number of Firm Shares set opposite the
names of all the remaining non-defaulting Underwriters in Schedule 1 hereto;
provided, however, that the remaining non-defaulting Underwriters shall not be
obligated to purchase any of the Underwritten Shares on such Delivery Date if
the total number of Underwritten Shares which the defaulting Underwriter or
Underwriters agreed but failed to purchase on such date exceeds 9.09% of the
total number of Underwritten Shares to be purchased on such Delivery Date, and
any remaining non-defaulting Underwriter shall not be obligated to purchase more
than 110% of the number of Underwritten Shares which it agreed to purchase on
such Delivery Date pursuant to the terms of Section 5. If the foregoing maximums
are exceeded, the remaining non-defaulting Underwriters, or those other
underwriters satisfactory to the Representatives who so agree, shall have the
right, but shall not be obligated, to purchase, in such proportion as may be
agreed upon among them, all the Underwritten Shares to be purchased on such
Delivery Date. If the remaining Underwriters or other underwriters satisfactory
to the
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<PAGE> 34
Representatives do not elect to purchase the shares which the defaulting
Underwriter or Underwriters agreed but failed to purchase on such Delivery Date,
this Agreement (or, with respect to the Second Delivery Date, the obligation of
the Underwriters to purchase, and of the Company to sell, the Option Shares)
shall terminate without liability on the part of any non-defaulting Underwriter
or the Company or the Selling Stockholder, except that the Company will continue
to be liable for the payment of expenses to the extent set forth in Section 7.
As used in this Agreement, the term "Underwriter" includes, for all purposes of
this Agreement unless the context requires otherwise, any party not listed in
Schedule 1 hereto who, pursuant to this Section 11, purchases Underwritten
Shares which a defaulting Underwriter agreed but failed to purchase.
Nothing contained herein shall relieve a defaulting Underwriter of any
liability it may have to the Company and the Selling Stockholders for damages
caused by its default. If other Underwriters are obligated or agree to purchase
the Stock of a defaulting or withdrawing Underwriter, either the Representatives
or the Company may postpone the Delivery Date for up to seven full business days
in order to effect any changes that in the opinion of counsel for the Company or
counsel for the Underwriters may be necessary in the Registration Statement, the
Prospectus or in any other document or arrangement.
12. Notices. Notice given pursuant to any of the provisions of this
Agreement shall be in writing and, unless otherwise specified, shall be mailed
or delivered (a) if to the Company, at the office of the Company, 200 North
Berry Street, Brea, California 92821-3963, Attention: Judith O. Lasker, Esquire
or (b) if to the Underwriters, at the office of Cruttenden Roth Incorporated,
11150 Santa Monica Boulevard, Suite 750, Los Angeles, California 90025,
Attention: Christopher Jennings or (c) if to the Selling Stockholder, at the
office of Worms & Co., Inc., 900 Third Avenue, New York, New York 10022,
Attention: Ms. Georgette Miller. Any such notice shall be effective only upon
receipt. Any notice under Section 9 may be made by facsimile or telephone, but
if so made shall be subsequently confirmed in writing.
13. Survival. The respective representations, warranties, agreements,
covenants, indemnities and other statements of the Company, its officers, the
Selling Stockholder and the Underwriters set forth in this Agreement or made by
or on behalf of them, respectively, pursuant to this Agreement shall remain in
full force and effect, regardless of (i) any investigation made by or on behalf
of the Company, any of its officers or directors, the Selling Stockholder, the
Underwriters or any controlling person referred to in Section 9 hereof and (ii)
delivery of and payment for the Underwritten Shares. The respective agreements,
covenants, indemnities and other statements set forth in Sections 7 and 9 hereof
shall remain in full force and effect, regardless of any termination or
cancellation of this Agreement.
14. Successors. This Agreement shall inure to the benefit of and shall
be binding upon the Underwriters, the Selling Stockholder, the Company and their
respective successors and legal representatives, and nothing expressed or
mentioned in this Agreement is intended or shall be construed to give any other
person any legal or equitable right, remedy or claim under or in respect of this
Agreement, or any provisions herein contained, this Agreement and all conditions
and
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<PAGE> 35
provisions hereof being intended to be and being for the sole and exclusive
benefit of such persons and for the benefit of no other person except that (i)
the indemnification and contribution contained in Sections 9(a) and (e) of this
Agreement shall also be for the benefit of the directors, officers, employees
and agents of the Underwriters and any person or persons who control the
Underwriters within the meaning of Section 15 of the 1933 Act or Section 20 of
the 1934 Act and (ii) the indemnification and contribution contained in Sections
9(b), (c) and (e) of this Agreement shall also be for the benefit of the
directors of the Company, the officers of the Company who have signed the
Registration Statement and any person or persons who control the Company within
the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act. No
Person shall be deemed a successor because of his or its purchase of any
Underwritten Shares.
15. Headings. Section headings in this Agreement are for convenience of
reference only, do not constitute a part of this Agreement, and shall not affect
its interpretation.
16. Changes. This Agreement may not be modified or amended except
pursuant to an instrument in writing signed by the Company, the Selling
Stockholder and the Underwriters.
17. Applicable Law. The validity and interpretations of this Agreement,
and the terms and conditions set forth herein, shall be governed by and
construed in accordance with the laws of the State of California, without giving
effect to any provisions relating to conflicts of laws.
18. Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
[SIGNATURES APPEAR ON FOLLOWING PAGE; REMAINDER OF THIS
PAGE LEFT INTENTIONALLY BLANK]
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If the foregoing is in accordance with your understanding of our
agreement, kindly sign and return to us the enclosed duplicate hereof, whereupon
it will become a binding agreement between the Company, the Selling Stockholder
and the Underwriters in accordance with its terms.
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:_______________________________________________
Name:
Title:
JAPAN OMNIBUS LTD.
By:_______________________________________________
As Attorney-in Fact for the Selling Stockholder
The foregoing Underwriting
Agreement is hereby confirmed
and accepted as of the date first
above written.
CRUTTENDEN ROTH INCORPORATED
MORGAN FULLER CAPITAL GROUP, LLC
BLACK & COMPANY, INC.
By: Cruttenden Roth Incorporated
By:_______________________________
Name:
Title:
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<PAGE> 37
ATTACHMENT A
Cruttenden Roth Incorporated
11150 Santa Monica Blvd., Suite 750
Los Angeles, CA 90025
Morgan Fuller Capital Group, LLC
[ADDRESS]
Black & Company, Inc.
[ADDRESS]
Ladies and Gentlemen:
Reference is made to the Underwriting Agreement (the "Underwriting
Agreement"), which will be executed between Krause's Furniture, Inc., a Delaware
corporation (the "Company"), Japan Omnibus Ltd., and Cruttenden Roth
Incorporated, Black & Company, Inc. and Morgan Fuller Capital Group LLC, as
Representatives of the several Underwriters named therein (the "Underwriters").
All capitalized terms not otherwise defined herein shall have the meanings given
to such terms in the Underwriting Agreement.
In consideration of the Underwriting Agreement, the undersigned hereby
agrees not to, without the prior written consent of the Underwriters, offer,
sell or otherwise dispose of any shares of the Company's Common Stock, par value
$0.001 per share (the "Common Stock") (other than the Shares or Option Shares)
or any other equity securities of the Company, including securities convertible
into or exercisable or exchangeable for Common Stock, for a period of 180 days
after the Delivery Date, except with respect to (i) the issuance of securities
pursuant to contractual obligations of the Company in effect on November 10,
1997 to the extent disclosed in writing to the Underwriters prior to the
effective date of the Registration Statement , (ii) the issuance of shares of
Common Stock or stock options to purchase shares of Common Stock under any
employee benefit or purchase plan of the Company in effect on November 10, 1997,
or (iii) securities of the Company issued on a pro rata basis to all holders of
a class of outstanding equity securities of the Company.
It is understood that, if the Underwriting Agreement does not become
effective, the undersigned will be released from his obligations under this
letter agreement.
Dated: _____________, 1998
Very truly yours,
KRAUSE'S FURNITURE, INC.
By:_____________________________________
Name:
Title:
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<PAGE> 38
ATTACHMENT B
Cruttenden Roth Incorporated
11150 Santa Monica Blvd., Suite 750
Los Angeles, CA 90025
Morgan Fuller Capital Group, LLC
[ADDRESS]
Black & Company, Inc.
[ADDRESS]
Ladies and Gentlemen:
Reference is made to an Underwriting Agreement (the "Underwriting
Agreement"), which will be executed between Krause's Furniture, Inc., a Delaware
corporation (the "Company"), Japan Omnibus Ltd., and Cruttenden Roth
Incorporated, Black & Company, Inc. and Morgan Fuller Capital Group LLC, as
Representatives of the several Underwriters named therein (the "Underwriters").
All capitalized terms not otherwise defined herein shall have the meanings given
to such terms in the Underwriting Agreement.
In consideration of the Underwriting Agreement, the undersigned hereby
agrees not to, without the prior written consent of the Underwriters, offer,
sell or otherwise dispose of any shares of the Company's Common Stock, par value
$0.001 per share (the "Common Stock") (other than the Selling Stockholder
Shares), or any other equity securities of the Company, including securities
convertible into or exercisable or exchangeable for Common Stock, for a period
of 120 days after the Delivery Date.
It is understood that, if the Underwriting Agreement does not become
effective, the undersigned will be released from his or its obligations under
this letter agreement.
Dated: _____________, 1998
Very truly yours,
By:_________________________________
Name:
Title:
38
<PAGE> 39
ATTACHMENT C
List of persons from whom Lock-Up Letters received:
General Electric Capital Corporation
Permal Group
Permal Capital Management, Inc.
Permal Services, Inc.
Permal Capital Partners, L.P.
Permal Asset Management
Permal Special Opportunities, Ltd.
Jean R. Perette
Isaac Robert Souede
Thomas M. DeLitto
Thomas M. DeLitto and Donna S. DeLitto
United Gulf Bank (B.S.C.) B.C.
Kuwait Investment Projects
ATCO Holdings, Ltd.
ATCO Development, Inc.
Worms & Cie
Worms & Co., Inc.
<PAGE> 40
JAPAN OMNIBUS LTD.
(Name of Selling Stockholder -
Please Print or Type)
CUSTODY AGREEMENT AND POWER OF ATTORNEY
FOR SALE OF COMMON STOCK OF
KRAUSE'S FURNITURE, INC.
Krause's Furniture, Inc.
200 North Berry Street
Brea, California 92821-3963
[CUSTODIAN]
Ladies and Gentlemen:
Krause's Furniture, Inc., a Delaware corporation (the "Company"),
and the undersigned, Japan Omnibus Ltd. (hereinafter sometimes referred to as
"Selling Stockholder"), propose to sell certain shares of Common Stock, $0.001
par value per share, of the Company ("Common Stock") to the Underwriters (the
"Underwriters") for whom Cruttenden Roth Incorporated, Black & Company, Inc. and
Morgan Fuller Capital Group, LLC (the "Representatives") will act as
representatives for distribution under a Registration Statement on Form S-1 (the
"Registration Statement") to the public at a price and on terms to be hereafter
determined. It is understood that at this time there is no commitment on the
part of the Underwriters to purchase any shares of Common Stock and no assurance
that an offering of Common Stock will take place. The shares of Common Stock
which the undersigned proposes to sell to the Underwriters pursuant to the
Underwriting Agreement hereinafter mentioned are referred to herein as the
"Shares."
1. Appointment and Powers of Attorneys-in-Fact.
A. The undersigned hereby irrevocably constitutes and appoints
________________ and ______________ (the "Attorneys-in-Fact"), and each of them,
as its agent and Attorneys-in-Fact, with full power of substitution, with
respect to all matters arising in connection with the public offering and sale
of the Shares, including, but not limited to, the power and authority on behalf
of the undersigned to do or cause to be done any of the following things:
(i) negotiate, determine and agree upon (a) the price at
which the Shares will be initially offered to the public by the Underwriters
pursuant to the Underwriting Agreement, as hereinafter defined, (b) the
underwriting discounts and commissions with respect to the Shares, and (c) the
price at which the Shares will be sold to the Underwriters by the Selling
Stockholder pursuant to the Underwriting Agreement;
<PAGE> 41
(ii) prepare, execute and deliver an Underwriting
Agreement the "Underwriting Agreement"), substantially in the form agreed to by
and among the Company, the Selling Stockholder and the Underwriters, delivered
to the undersigned concurrently herewith, receipt of which is acknowledged, but
with such insertions, changes, additions or deletions as the Attorneys-in-Fact
shall approve as not materially adverse to the undersigned (which may include a
decrease, but not an increase, in the number of shares of Common Stock to be
sold by the undersigned), such approval to be conclusively evidenced by the
execution and delivery of the Underwriting Agreement by an Attorney-in-Fact,
including the exercise of all authority thereunder vested in the undersigned;
(iii) sell, assign, transfer and deliver the Shares to
the Underwriters pursuant to the Underwriting Agreement and deliver to the
Underwriters certificates for the Shares so sold;
(iv) take any and all steps deemed necessary or desirable
by the Attorneys-in-Fact in connection with the registration of the Shares
under the Securities Act of 1933, as amended (the "Securities Act"), the
Securities Exchange Act of 1934, as amended, and under the securities or "Blue
Sky" laws of various states and jurisdictions, including, without limitation,
the giving or making of such undertakings, representations and agreements and
the taking of such other steps as the Attorneys-in-Fact may deem necessary or
advisable;
(v) instruct the Company and the Custodian, as hereinafter
defined, on all matters pertaining to the sale of the Shares and delivery of
certificates therefor;
(vi) provide, in accordance with the Underwriting
Agreement, for the payment of expenses of the offering and sale of the Common
Stock covered by the Registration Statement;
(vii) retain legal counsel for the Selling Stockholder,
which may also be legal counsel for the Company, in connection with all matters
contemplated hereby and by the Underwriting Agreement;
(viii) instruct the Custodian as to the number of Shares
to be sold by the Selling Stockholder (it being understood and agreed to by the
undersigned that the Custodian shall be entitled to rely on the instructions
from the Attorneys-in-Fact as to such number of Shares to be sold by the Selling
Stockholder); and
(ix) otherwise take all actions and do all things
necessary or proper, required, contemplated or deemed advisable or desirable by
the Attorneys-in-Fact in their discretion, including the execution and delivery
of any documents, and generally act for and in the name of the undersigned with
respect to the sale of the Shares to the Underwriters and the reoffering of the
Shares by the Underwriters as fully as could the undersigned if then personally
present and acting.
B. Each Attorney-in-Fact may act alone in exercising the rights
and powers conferred on the Attorneys-in-Fact by this Custody Agreement and
Power of Attorney. Each Attorney-in-Fact
2
<PAGE> 42
is hereby empowered to determine, in his sole and absolute discretion, the time
or times when, the purposes for which, and the manner in which, any power herein
conferred upon the Attorneys-in-Fact shall be exercised.
C. The Custodian, the Representatives, the Company and all other
persons dealing with the Attorneys-in-Fact as such may rely and act upon any
writing believed in good faith to be signed by one or more of the
Attorneys-in-Fact.
D. The Attorneys-in-Fact shall not receive any compensation for
their services rendered hereunder, except that they shall be entitled to cause
the Custodian to pay, from the proceeds payable to the undersigned, the
undersigned's proportionate share of any out-of-pocket expenses incurred under
this Custody Agreement and Power of Attorney (this "Agreement") and similar
instruments executed by the Selling Stockholder.
2. Appointment of Custodian; Deposit of Shares.
A. In connection with and to facilitate the sale of the Shares, to
the Underwriters the undersigned hereby appoints ________________________ as
custodian (the "Custodian") and herewith deposits with the Custodian one or more
certificates for Common Stock, which represent not less than the total number of
Shares to be sold by the undersigned to the Underwriters, which number is set
forth on Schedule I hereto. Each such certificate so deposited shall be in
negotiable and proper deliverable form endorsed in blank with the signature of
the undersigned thereon guaranteed by an eligible guarantor institution, such as
a bank, stockbroker, savings and loan association or credit union, with
membership in an approved medallion signature guarantee program, or shall be
accompanied by a duly executed stock power or powers in blank, bearing the
signature of the undersigned so guaranteed. The Custodian is hereby authorized
and directed, subject to the instructions of the Attorneys-in-Fact, (a) to hold
in custody the certificate or certificates deposited herewith, (b) to deliver or
to authorize the Company's Transfer Agent to deliver the certificate or
certificates deposited hereunder (or replacement certificate(s) for the Shares)
to or at the direction of the Attorneys-in-Fact in accordance with the terms of
the Underwriting Agreement and (c) to return or cause the Company's Transfer
Agent to return to the undersigned new certificate(s) for the shares of Common
Stock represented by any certificate deposited hereunder which are not sold
pursuant to the Underwriting Agreement.
B. Until the Shares have been delivered to the Underwriters
against payment therefor in accordance with the Underwriting Agreement, the
undersigned shall retain all rights of ownership with respect to the Shares
deposited hereunder, including the right to vote and to receive all dividends
and payment thereon, except the right to retain custody of or dispose of such
Shares, which right is subject to this Agreement and the Underwriting Agreement.
C. The Custodian shall assume no responsibility to any person
other than to deal with the certificates for the Shares and the proceeds from
the sale of the Shares represented thereby in accordance with the provisions
hereof, and the Selling Stockholder hereby agrees to indemnify the Custodian for
and to hold the Custodian harmless against, any and all losses, claims, damages
or liabilities incurred on its part arising out of or in connection with it
acting as the Custodian pursuant hereto, as well as the cost and expenses of
investigating and defending any such losses, claims,
3
<PAGE> 43
damages or liabilities incurred on its part arising out of or in connection with
it acting as the Custodian pursuant hereto, except to the extent such losses,
claims, damages or liabilities are due to the negligence or bad faith of the
Custodian. The Custodian's acceptance of this Agreement by the execution hereof
shall constitute an acknowledgment by the Custodian of the authorization herein
confirmed and shall evidence the Custodian's agreement to carry out and perform
this Agreement in accordance with its terms.
3. Sale of Shares; Remitting Proceeds. The Attorneys-in-Fact are hereby
authorized and directed to deliver or cause the Custodian or the Company's
Transfer Agent to deliver certificates for the Shares to the Representatives, as
provided in the Underwriting Agreement, against delivery to the
Attorneys-in-Fact for the account of the undersigned of the purchase price of
the Shares (net of the Underwriters discounts, commissions and other discounts
payable to the Underwriters), at the time and in the funds specified in the
Underwriting Agreement. The Attorneys-in-Fact are authorized, on behalf of the
undersigned, to accept and acknowledge receipt of the payment of the purchase
price for the Shares and the Attorneys-In-Fact shall promptly deposit such
proceeds with the Custodian. After reserving an amount of such proceeds for the
fees payable to the Underwriters as provided above, the Custodian shall promptly
remit to the undersigned its proportionate share of the proceeds.
4. Representations, Warranties and Agreements. The undersigned represents
and warrants to, and agrees with, the Company, the Attorneys-in-Fact, the
Custodian, the Underwriters, Morrison & Foerster LLP, Stroock & Stroock &
Lavan LLP and Snell & Wilmer L.L.P. as follows:
A. The undersigned has full legal right, power and authority to
enter into and perform this Agreement and the Underwriting Agreement. If the
undersigned is acting as a fiduciary, officer, partner, or agent, the
undersigned is enclosing with this Agreement certified copies of the appropriate
instruments pursuant to which the undersigned is authorized to act hereunder.
B. The undersigned has reviewed the representations and warranties
to be made by the undersigned as a Selling Stockholder contained in the
Underwriting Agreement, and hereby represents, warrants and covenants that each
of such representations and warranties is true and correct as of the date hereof
and, except as the undersigned shall have notified the Attorneys-in-Fact
pursuant to paragraph E of the attached instructions, will be true and correct
at all times from the date to the Underwriters hereof through and including the
time of the closing of the sale of the Shares to the Underwriters. The
undersigned will promptly notify the Attorneys-in-Fact of any development that
would make any such representation and warranty untrue.
C. The undersigned has reviewed the Registration Statement,
including the preliminary prospectus included therein, and (i) the undersigned
has no knowledge of any material information not disclosed in the Registration
Statement or preliminary prospectus which has adversely affected in any material
respect or, insofar as it is reasonably foreseeable, could adversely affect in
any material respect the current and prospective business and operations of the
Company or its subsidiaries and (ii) the information contained in such
Registration Statement and preliminary prospectus with respect to the
undersigned is complete and accurate.
4
<PAGE> 44
D. Other than as previously indicated to the Company in writing in
connection with the Company public offering, the undersigned is not directly or
indirectly an affiliate of or associated with any member of the National
Association of Securities Dealers, Inc.
E. Upon execution and delivery of the Underwriting Agreement by
the Attorneys-in-Fact on behalf of the undersigned, the undersigned agrees to
indemnify and hold harmless the Underwriters, the Company, each of its directors
and each of its officers who sign the Registration Statement, and each person,
if any, who controls the Underwriters or the Company, and to contribute to
amounts paid as a result of losses, claims, damages, liabilities and expenses,
to the full extent provided in Section 9 of the Underwriting Agreement.
F. Upon execution and delivery of the Underwriting Agreement
by the Attorneys-in-Fact on behalf of the undersigned, the undersigned agrees to
be bound by and to perform each of the covenants and agreements of the
undersigned as the Selling Stockholder in the Underwriting Agreement.
G. The undersigned agrees to deliver to the Attorneys-in-Fact such
documentation as the Attorneys-in-Fact, the Company or the Underwriters or
any of their respective counsel may reasonably request in order to effectuate
any of the provisions hereof or of the Underwriting Agreement, all of the
foregoing to be in form and substance satisfactory in all respects to the
Attorneys-in-Fact.
The foregoing representations, warranties and agreements are made
for the benefit of, and may be relied upon by, the Attorneys-in-Fact, the
Company, the Custodian, the Underwriters and their respective representatives,
agents and counsel and are in addition to, and not in limitation of, the
representations, warranties and agreements of the Selling Stockholder in the
Underwriting Agreement.
5. Irrevocability of Instruments; Termination of this Agreement.
A. This Agreement, the deposit of the Shares pursuant hereto and
all authority hereby conferred, is granted, made and conferred subject to and in
consideration of (i) the interests of the Attorneys-in-Fact, the Underwriters
and the Company in and for the purpose of completing the transactions
contemplated hereunder and by the Underwriting Agreement and (ii) the completion
of the registration of Common Stock pursuant to the Registration Statement and
the other acts of the above-mentioned parties from the date hereof to and
including the execution and delivery of the Underwriting Agreement in
anticipation of the sale of Common Stock, including the Shares, to the
Underwriters; and the Attorneys-in-Fact are hereby further vested with an
estate, right, title and interest in and to the Shares deposited herewith for
the purpose of irrevocably empowering and securing to each of them authority
sufficient to consummate said transactions. Accordingly, this Agreement shall be
irrevocable prior to __________, 1998, and shall remain in full force and effect
until that date. The undersigned further agrees that this Agreement shall not be
terminated by operation of law or upon the occurrence of any event whatsoever,
including the dissolution, winding up, distribution of assets or other event
affecting the legal existence of the undersigned. If any event referred to in
5
<PAGE> 45
the preceding sentence shall occur, whether with or without notice thereof to
the Attorneys-in-Fact, the Underwriters or any other person, the
Attorneys-in-Fact shall nevertheless be authorized and empowered to deliver and
deal with the Shares deposited under the Agreement by the undersigned in
accordance with the terms and provisions of the Underwriting Agreement and
this Agreement as if such event had not occurred.
B. If the sale of the Shares contemplated by this Agreement is not
completed by [________, 1998], this Agreement shall terminate (without affecting
any lawful action of the Attorneys-in-Fact or the Custodian prior to such
termination), and the Attorneys-in-Fact shall cause the Custodian to return to
the undersigned all certificates for the Shares deposited hereunder.
6. Liability and Indemnification of the Attorneys-in-Fact and Custodian.
The Attorneys-in-Fact and the Custodian assume no responsibility or liability to
the undersigned or to any other person, other than to deal with the Shares, the
proceeds from the sale of the Shares and any other shares of Common Stock
deposited with the Custodian pursuant to the terms of this Agreement in
accordance with the provisions hereof. The undersigned hereby agrees to
indemnify and hold harmless the Attorneys-in-Fact and the Custodian, and their
respective officers, agents, successors, assigns and personal representatives
with respect to any act or omission of or by any of them in good faith in
connection with any and all matters contemplated by this Agreement or the
Underwriting Agreement.
7. Interpretation.
A. The representations, warranties and agreements of the
undersigned contained herein and in the Underwriting Agreement shall survive
the sale and delivery of the Shares and the termination of this Agreement.
B. The validity, enforceability, interpretation and construction
of this Agreement shall be determined in accordance with the laws of the State
of California applicable to contracts made and to be performed within the State
of California, and this Agreement shall inure to the benefit of, and be binding
upon, the undersigned and the undersigned's heirs, executors, administrators,
successors and assigns, as the case may be.
C. Wherever possible each provision of this Agreement shall be
interpreted in such manner as to be effective and valid under applicable law,
but if any such provision shall be prohibited by or invalid under applicable
law, it shall be ineffective only to the extent of such prohibition or
invalidity, without invalidating the remainder of such provision or the
remaining provisions of this Agreement.
D. The use of the masculine gender in this Agreement includes the
feminine and neuter, and the use of the singular includes the plural, wherever
appropriate.
E. This Agreement may be executed in various counterparts, each of
which when so executed and delivered shall be an original, but all such
counterparts shall together constitute one and the same instrument.
6
<PAGE> 46
IN WITNESS WHEREOF, the undersigned has executed this Custody
Agreement and Power of Attorney this ____ day of March, 1998.
JAPAN OMNIBUS LTD.
By:
----------------------------
Its: Signature of Selling Stockholder guaranteed by:
(PLEASE SIGN EXACTLY AS YOUR
NAME APPEARS ON YOUR STOCK
CERTIFICATE(S))
Name and address to which
notices and funds shall
be sent: By:
--------------------------------
- ------------------------------- (Note: The signature MUST BE GUARANTEED by an
(Name) eligible guarantor institution, such as a bank,
- ------------------------------- stock broker, savings and loan association, or
(Street) credit union, with membership in an approved
- ------------------------------- medallion signature program)
(City) (State) (Zip)
- -------------------------------
(Country)
ACCEPTED by the Attorneys-in-Fact ACCEPTED by the Custodian as
as of the date set forth above: of the above date set forth:
[CUSTODIAN]
- --------------------------------- By:
By: -----------------------------------------
Title:
-----------------------------------------
- ---------------------------------
By:
SEE THE ATTACHED INSTRUCTIONS
7
<PAGE> 47
SCHEDULE I
Certificate(s) for Shares of Common/Preferred Stock of
KRAUSE'S FURNITURE, INC.
deposited under
Custody Agreement and Power of Attorney
<TABLE>
<CAPTION>
Type of Maximum Number of
Security Number of Shares of Shares of Common Stock
Certificate (i.e., Common, Common Stock Represented from this Certificate
Number Preferred) by Certificate to be Sold*
- ----------- ------------- ----------------------- ----------------------
<S> <C> <C> <C>
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
- ----------- ------------- ----------------------- ----------------------
Total: ----------------------
</TABLE>
*If fewer than all shares represented by a certificate are to be sold, indicate
below, if desired for income tax purposes, the date of purchase or purchase
price of the particular shares to be sold.
<PAGE> 48
PAYMENT AUTHORIZATION
To: [CUSTODIAN]
In connection with the sale by the undersigned of shares of Common Stock
of Krause's Furniture, Inc., the undersigned hereby authorizes [CUSTODIAN], as
custodian (the "Custodian") to pay the undersigned the proceeds from such sale,
less applicable deductions, in the following manner:
MANNER OF PAYMENT
CASHIER'S CHECK MADE PAYABLE TO: _________________________________________
To be sent to the following address:
_____________________________________
_____________________________________
_____________________________________
To be sent by: [ ] First Class Mail [ ] Overnight Delivery
(Please specify service and
account number: _________________)
WIRE TRANSFER OF FUNDS TO THE FOLLOWING ACCOUNT:
Account number: ___________________________
Bank: _____________________________________
ABA number: _______________________________
Bank address: _____________________________
Name on account: __________________________
Name and telephone number of
contact person to confirm
receipt: ________________________________
OTHER (PLEASE SPECIFY)
_____________________________________
_____________________________________
_____________________________________
The undersigned authorizes the Custodian to deduct from the proceeds of sale of
the undersigned's Common Stock any costs incurred in connection with carrying
out the foregoing instructions.
By: ______________________________________
Name: ____________________________________
Title: ___________________________________
Date: _________________ , 1998
<PAGE> 1
EXHIBIT 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.
(B) All share and per share amounts have been restated to reflect a
one-for-three reverse stock split effected August 1, 1995.
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions, "Summary
Consolidated Financial Data," "Selected Consolidated Financial Data," "Change in
Auditor" and "Experts" and to the use of our reports 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 Amendment No. 2 to the Registration Statement (Form S-1 No.
333-43111) and related Prospectus of Krause's Furniture, Inc. for the
registration of 4,840,000 shares of its common stock.
/s/ ERNST & YOUNG LLP
Orange County, California
March 11, 1998
<PAGE> 1
EXHIBIT 23.3
CONSENT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports and to all references to our Firm included in or made a part of this
registration statement.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 11, 1998
