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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 or
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from February 1, 1999 to December 26, 1999
Commission file number 0-17868
KRAUSE'S FURNITURE, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0310773
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 NORTH BERRY STREET, BREA, CALIFORNIA 92821-3903
(Address of principal executive offices) (Zip Code)
(714) 990-3100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE AMERICAN STOCK EXCHANGE
(Title of Class) (Name of each exchange where registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports, and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. [ ]
As of April 1, 2000 the aggregate market value of Registrant's $.001 par
value common stock held by non-affiliates was approximately $49,423,828 based on
the closing price for the stock. As of April 1, 2000 there were 22,050,328
shares of $.001 par value common stock outstanding.
Documents Incorporated by Reference: Proxy Statement for 2000 Annual
Meeting of Stockholders with respect to information required in Part III.
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This Annual Report on Form 10-K, particularly the discussions under the
headings "Description of Business" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations," includes forward-looking
statements within the meaning of the Private Securities Reform Act of 1995.
These statements include those related to the Company's plans for sales through
e-commerce and business-to-business channels; management's strategy for opening
new stores, remodeling existing stores and improving the Company's marketing
approach; and those related to management's expectation that the company will
return to profitability. They also include statements throughout the report
using such forward-looking terminology as "may," "will," "expect," "anticipate,"
"continue," "estimate," or the negative of these terms or other comparable
terminology. These statements involve risks and uncertainties which may cause
results to differ materially from those set forth in these statements. Among
other things,
o we lack experience in e-commerce and business-to-business
sales;
o demand for and acceptance of the Company's products could
decrease;
o the market for furniture sales over the internet may not grow;
o the retail environment and the ability of the Company to
execute its operating strategies could deteriorate;
o the company's planned marketing and promotional campaigns may
not be successful; and
o developer delays, weather and other conditions could slow the
opening of new stores; and competition from existing and new
competitors could increase.
These risks and the other economic, competitive and other factors noted
elsewhere in this Form 10-K and in filings recently made by the Company with the
Securities and Exchange Commission, including the Company's Form 10-Q and a
Registration Statement on Form S-1, which became effective on March 30, 1998,
constitute cautionary statements that identify risks and uncertainties that
could cause actual results to differ materially from those contained in the
forward-looking statements.
PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
THE COMPANY. The Company is a leading vertically integrated
manufacturer, retailer and wholesaler of made-to-order upholstered furniture and
accessories. At December 26, 1999, the Company operated ninety-one furniture
showrooms under the Krause's (seventy-nine showrooms) and Castro Convertibles
(twelve showrooms) brand names in twelve states, with fifty-four of those
showrooms in California and in the New York City metropolitan area, including
New York, New Jersey and Connecticut. Customers can choose from more than sixty
styles and forty sizes of sofas, incliners, recliners, sectionals, sofabeds and
chairs, which they can customize with eight hundred fabrics and fifty leathers.
The Company believes that it has developed a reputation for delivering high
quality, custom-crafted furniture at prices comparable to those of mass-produced
sold-as-shown furniture. In recent periods, the Company has undergone
significant changes, raising substantial new capital, hiring a new management
team with extensive expertise in retailing, and changing the Company's business
strategy from a factory-direct orientation to a retail-oriented, fashion
conscious approach.
In September 1999, the Company launched its Contract Division. This
division seeks to obtain large orders from customers in the hospitality industry
as they build new properties or remodel existing ones. The product offering is
similar to the upholstered products found within the Company's furniture
showrooms.
In conjunction with a $19 million private placement of its Series A
Convertible Preferred Stock completed on January 18, 2000, the Company is
presently developing an e-Commerce strategy and business plan centered around
Business-to-Business ("B2B") opportunities that will leverage the Company's
existing manufacturing and distribution assets and expertise. The Company
expects to have this strategy developed and implemented during the second
quarter of fiscal 2000.
RECENT DEVELOPMENTS.
On January 4, 2000, the Company's Board of Directors voted to change its
fiscal year end to the Sunday closest to December 25, effective as of December
26, 1999. All references to fiscal 1999 refer to the forty-seven weeks ended
December 26, 1999. The current fiscal year will end on December 24, 2000.
On January 14 and 19, 2000, the Company completed a $19 million private
placement of its Series A Convertible Preferred Stock which was led by TH
Lee.Putnam Internet Partners, L.P.("THLi") and GE Capital Equity Investments,
Inc.("GECC"). $10 million of the offering is designated for developing and
implementing an e-Commerce strategy focusing on B2B opportunities utilizing the
internet and other electronic methods and the remainder was used to pay down
revolving debt.
INDUSTRY OPPORTUNITY AND COMPETITIVE STRENGTHS. The Company believes a
number of macroeconomic factors influence furniture sales, including existing
home sales, housing starts, consumer confidence, availability of credit,
interest rates and demographic trends. Management believes favorable fundamental
trends in home building and demography will continue to drive long-term growth
in the furniture industry.
The furniture market is large and diversified. Because the market for
custom crafted furniture is highly fragmented, the Company believes that
manufacturers with strong brand name recognition, broad distribution and good
value to price ratio are positioned to increase market share.
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- - Reputation for Value and Selection; Brand Names. The Company believes
that it has attained a reputation for high quality, custom-crafted
furniture at prices comparable to those of mass-produced, sold-as-shown
furniture. For over 27 and 69 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.
- - Experienced Management Team. The Company has hired an experienced
management team with extensive retailing experience, led by Philip M.
Hawley, the former Chairman and Chief Executive Officer of The Broadway
Stores, Inc. This management team 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, retailer and wholesaler
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
expand the current capacity of its manufacturing facility to accommodate
planned sales growth.
- - Well Located Retail Distribution Network. As of December 26, 1999, the
Company operated 91 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 is attempting to
achieve these objectives by pursuing the following strategies:
- - Add New Showrooms in Existing and New Markets. The Company plans to
expand its presence in markets where it has an existing base of
showrooms so that it can leverage its brand name recognition and
marketing efforts as well as its existing distribution network and
management. The Company estimates that it has not less than 35-40
opportunities to open showrooms in existing markets. Since August 1996,
the Company has opened twenty-three new showrooms, thirteen of which
were opened during fiscal 1999, and expects to open approximately
sixteen to twenty additional showrooms each year in the foreseeable
future. In addition, the Company has identified expansion opportunities
in several new markets including Atlanta, Georgia; Portland, Oregon; and
Minneapolis, Minnesota. The Company plans to open at least four new
stores in fiscal 2000 in new markets. The Company plans to utilize
cross-docking to distribute its merchandise to its customers in these
new markets.
- - Relocate Under-Performing Showrooms. The Company estimates that it has
approximately one dozen showrooms that are in good market areas but in
poor locations within these market areas. As the leases on these
showrooms expire, the Company plans to seek more suitable locations and
incorporate into the new showrooms the same new layout, design and
visual presentation themes that it has developed in the remodeling
program. During fiscal 1999, the Company closed ten showrooms of which 5
were relocated to nearby locations.
- - Remodel Existing Showrooms. The Company has completed a substantial
portion of its remodeling program to update its showrooms, imbue a sense
of fashion and excitement and move away from the Company's former
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.
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- - 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 itself from its competitors. A major
focus of this effort was a shift away from a factory-direct orientation
to that of customization and craftsmanship with emphasis on value rather
than price. To this end, the Company changed the name under which it
does business from Krause's Sofa Factory to Krause's Custom Crafted
Furniture and developed a new, modern logo. Another focus of this effort
has been to create an advertising format and message utilizing color
circulars in an effort to better attract customers by showing the
Company's many product offerings in groupings by life style and as
complete room environments similar to how the customer might purchase
them.
- - Develop New Products; Increase Sales of Complementary Products. The
Company has put in place a new product development program, which is
freshening showroom inventories and introducing a number of new styles
designed to increase its appeal to customers. In addition, although the
Company intends to continue to focus on the manufacture and sale of
upholstered products, as a part of its new merchandising approach it has
increased the promotion and sale of other products, including
accessories supplied by third parties such as tables, lamps,
entertainment centers, area rugs and wall decor, custom-made chairs,
recliners and promotionally priced leather sofas and loveseats. The
Company believes these additional merchandise classifications have
broadened the Company's offerings and contributed to increased 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 has leveraged 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 forty-seven week transition
period ended December 26, 1999, the Company's sales per square foot of
selling space averaged $120. To further increase showroom productivity,
the Company is in the process of gradually reducing the average size of
its showrooms from approximately 12,100 square feet of selling space to
approximately 10,000 square feet, which it believes is the optimal size
to show and sell the Company's products. In addition, the Company
intends to increase same-store sales by continuing to (i) add new
products, including accessory products manufactured by third parties,
and (ii) increase the effective sales prices of its products through
reduced promotional discounting.
- - Develop and Implement e-Commerce Strategy. Under the terms of the Series
A Convertible Preferred Stock Purchase Agreement, the Company must
submit an e-Commerce business plan to its Board of Directors and receive
approval on or before April 13, 2000. The Company has retained NOVO(TM),
relationship architects for e-Business (TM), as its strategic Web
development partner. The first phase of the relationship will
concentrate on the Company's B2B initiatives.
SHOWROOMS, CONTRACT DIVISION AND MERCHANDISING. Showrooms. The Company
sells its products exclusively through leased retail showrooms in 12 states and
its Contract Division. Retail showrooms in California, Colorado, Arizona,
Nevada, Texas, New Mexico, Washington and Illinois operate under the name
KRAUSE'S CUSTOM CRAFTED FURNITURE(R), 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(R). Retail showrooms in New York, New
Jersey, Connecticut and Florida are operated under the name CASTRO
CONVERTIBLES(R). The Company intends to convert all of these showrooms to
operate under the name CASTRO CUSTOM FURNITURE AND CONVERTIBLES(R). One new
showroom opened in January 2000 in Georgia operates under the name KRAUSE'S
CUSTOM CRAFTED FURNITURE(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 12,000 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 factory in Brea, California for manufacturing.
Contract Division. The Company, through its Contract Division sales
force, calls on current and prospective hospitality industry clients to make
proposals for their remodel and new property furnishing requirements. The
Company also expects to be an exhibitor at various industry trade shows.
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REMODELING AND EXPANSION. The Company has completed a substantial
portion of its 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 38
showrooms and expects to complete the remodeling program over the next
twenty-four months. Only a small number of KRAUSE'S SOFA FACTORY(R) or KRAUSE'S
SOFAS(R) showrooms remain to be remodeled and renamed; however, twelve of the
CASTRO CONVERTIBLES(R) showrooms remain to be remodeled and renamed. 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 signature carpeting. The Company anticipates that it will recover the cost
of each remodeled store in approximately one year through increased sales after
the remodeling.
The Company is also seeking to expand its presence in existing markets
to increase sales and market share. This will enable the Company to leverage its
brand name recognition and take advantage of some 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
twenty-three new showrooms, thirteen of which were opened during fiscal 1999,
since it began its expansion program and intends to open approximately sixteen
to twenty additional showrooms per year for the foreseeable future. In addition,
as leases expire on showrooms that are not located in prime retail areas, but
are in favorable markets, the Company will attempt to move those showrooms to
more suitable locations.
The Company plans to open at least four of the sixteen to twenty planned
new showrooms in fiscal 2000 in new markets which have the demographics and
psychographics for which it looks. The first of two new showrooms in the
Atlanta, Georgia market was opened in January 2000 and two new showrooms are
planned for the greater Portland, Oregon market in the second quarter of fiscal
2000.
MERCHANDISING AND ADVERTISING. The Company has implemented new
merchandising programs designed to further leverage and enhance the strength of
the Krause's and Castro Convertibles brand names. In addition to implementing
its expansion and remodeling program designed to enhance the Company's appeal to
its existing broad customer base, the Company has further enhanced and leveraged
the strength of the Krause's and Castro Convertibles brand names through new
advertising and merchandising programs that emphasize the selection, features
and value of its products. The Company is seeking to use its strong brand
awareness to initially increase its share of existing markets and ultimately to
penetrate new markets. As an integral part of its new and remodeled Krause's
Custom Crafted Furniture showrooms, the Company has added a section dedicated to
its Castro Convertibles products to further leverage this product line and brand
name.
The Company primarily advertises through print media, in newspapers,
color circulars and by direct mail. It also employs targeted radio advertising
from time to time in selected markets. The Company has freshened the appearance
of its advertising to give more consistent placement of the Krause's and Castro
Convertibles brand names, to play down the Company's previous factory-direct
image, and to appeal to a more fashion-conscious buyer. While the Company has
continued 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 and
promotionally priced leather sofas and loveseats 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, entertainment
centers, custom-made chairs and recliners. These furniture products and
accessories, which are supplied to the Company by outside vendors, complement
the Company's upholstered furniture products and help to create the room setting
displays. Because the Company typically views sales of these furniture products
and accessories as incremental to, rather than in lieu of, sales of the
Company's own upholstered furniture products, the Company has increased the
promotion and sale of these complimentary furniture products and accessories.
Merchandise purchased from other suppliers currently accounted for approximately
13.6%, 10.7% and 9.2% of net sales in the fiscal 1999, 1998 and 1997,
respectively.
In order to be responsive to changing customer demands, the Company will
continue to develop new products. Since 1996, the Company has introduced 37 new
sofa styles and 15 new chair styles. In addition, the Company is committed to
periodically update its inventory of 800 fabrics by replacing slow-moving,
out-of-style fabrics with more contemporary designs.
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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
makes the Foreverflex(R) cushion insert to strict Company specifications and
provides a lifetime guarantee. Every piece of finished upholstered furniture
undergoes a quality control inspection during production and again prior to
shipment from the factory to the local distribution center.
The Company generally has adequate inventories of raw materials and
other supplies on hand to fill customer orders, and expects its suppliers to
satisfy its requirements shortly before materials are used in production.
The Company builds approximately 650 pieces of upholstered furniture per
day in two shifts. This output represents approximately 60% of double shift
manufacturing capacity. The level of production primarily reflects customer
orders, because the Company does not manufacture units for inventory.
When an order has completed the manufacturing or outside purchasing
process, it is shipped to a regional warehouse for the final preparation and
delivery to the customer. The Company uses outside delivery services, as well as
its own personnel in certain areas, for deliveries.
BACKLOG. The Company turns its manufacturing backlog approximately every
23 to 28 days. Backlog as of December 26, 1999 was approximately $8.6 million
compared to approximately $11.3 million at January 31, 1999 and approximately
$7.9 million at December 27, 1998.
SUPPLIERS AND MATERIALS. Many suppliers currently provide the Company
with the materials used in manufacturing its upholstered furniture products. The
Company's ten largest suppliers provided it with 60.0% of its purchased raw
materials during the fiscal year ended December 26, 1999, including two such
suppliers that provided approximately 12.4% and 10.1%. The Company is dependent
on the continued supply of components and raw materials, including frame
components, fabrics, leather, foam and sofabed and motion mechanisms. Management
constantly seeks new suppliers and better prices through competitive bidding and
the qualification of alternative sources of supply. If the Company could not
develop alternative sources of supply when needed or failed to obtain sufficient
single-source products, components and raw materials, the resulting loss in
production capability would adversely affect the Company's sales and operating
results.
TRADEMARKS AND PATENTS. The Company holds trademarks and patents
registered in the United States for some of its products and processes. The
Company has a registered trademark and/or servicemark in the United States for
the Krause's Sofa Factory(R), Krause's Custom Crafted Furniture(R) and Castro
Convertibles(R) names and logos and the name Foreverflex(R). Trademarks which
the Company considers important to its business have expiration dates ranging
from May 13, 2002 to July 19, 2009, 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.
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GOVERNMENT REGULATIONS. The Company's facilities are subject to numerous
federal, state and local laws and regulations designed to protect the
environment from waste emissions and from hazardous substances. The Company is
also subject to the federal Occupational Safety and Health Act and other laws
and regulations affecting the safety and health of employees in the production
areas of its facilities. Management believes that it is in compliance in all
material respects with all applicable environmental and occupational safety
regulations.
EMPLOYEES. The majority of the Company's employees are not unionized and
many have worked for the Company for more than ten years. A union contract
covers approximately 38 retail employees in the greater New York area. At
December 26, 1999, the total work force numbered approximately 1,153, with
approximately 476 working in manufacturing, 583 in retail and warehousing
operations, and 94 in administration.
COMPETITION. The home furnishings industry is highly competitive and
fragmented, and includes competition from traditional furniture retailers,
department stores, discount and warehouse outlets as well as internet retailers,
most of whom do not have a bricks and mortar presence. Certain companies which
compete directly with the Company have greater financial and other resources
than the Company. The Company competes on a national level with Ethan Allen
Inc., Levitz Furniture, Leather Center, Inc., Expressions and traditional
department stores, among others. The Company also competes on a regional basis.
In New York, New Jersey and Chicago, the Company's primary competitor is
Jennifer Convertibles, Inc., and in the Western United States the Company's
primary regional competitors include Homestead House, Inc., The Leather Factory
and Norwalk Furniture Corporation (the latter of which also competes in the
Midwest market). In Houston, Texas, the Company's primary regional competitor is
Star Furniture Company. Expressions, Norwalk Furniture Corporation and Ethan
Allen Inc., like the Company, manufacture their own upholstered products and
offer "made-to-order" customization similar to that provided by the Company.
Levitz Furniture primarily addresses the low to middle end "as shown" market,
whereas traditional department stores typically focus on the middle to upper end
"as shown" market.
INSURANCE. The Company purchases occurrence-based product liability
insurance in an amount it believes is adequate.
RISK FACTORS RELATING TO THE BUSINESS
LACK OF PROFITABLE OPERATIONS; ACCUMULATED DEFICITS. The Company has
reported losses from operations in each of the past five years and had an
accumulated deficit of $56.4 million at December 26, 1999. If losses from
operations continue, they could adversely affect the market price for the common
stock and the Company's ability to maintain existing financing and obtain new
financing. There can be no assurance that the Company will achieve profitability
in the future.
CAPITAL REQUIREMENTS; RESTRICTIONS ON COMPANY'S ABILITY TO OBTAIN
ADDITIONAL CAPITAL. The Company believes that borrowings under its Revolving
Credit Facility, the proceeds from its recently completed $19 million Series A
Convertible Preferred Stock private placement and internally generated funds
will be sufficient to fund its requirements for working capital, capital
expenditures, and e-Commerce strategy development and deployment through the end
of fiscal 2000. The Company may need to raise additional funds to finance its
expansion program and e-Commerce strategy through either debt or equity
financing, and there can be no assurance that the Company's financial
performance will generate sufficient funds. Beginning in fiscal 2001, the
Company will require funds to begin making required principal payments on its
subordinated debt.
The Company's existing secured revolving credit facility provides for
borrowings of up to $15 million, is subject to maturity in March 2002, imposes
borrowing base limitations, requires the Company to maintain financial covenants
for adjusted net worth and working capital and limits it from incurring future
additional indebtedness from third parties. 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. Substantially all of the Company's assets are
pledged as collateral for repayment of existing indebtedness. The Company's
collateral pledge may make it more difficult for the Company to obtain
additional financing on advantageous terms, if at all.
CAPITAL REQUIREMENTS; ELECTION TO DEFER INTEREST EXPENSE ON SUBORDINATED
DEBT. If no dividends have been paid on the Company's Series A Convertible
Preferred Stock, the Company may elect to defer interest payments on its
existing subordinated debt for any period of time beginning December 1, 1999 and
ending on or prior to December 31, 2000. If the Company elects to defer any such
interest, the holders of the subordinated debt may elect to receive the deferred
interest either in cash at the June 30, 2003 final maturity or in shares of
Series A Convertible Preferred Stock at $50 per share on December 31, 2000. If
the Company elects to defer interest on its subordinated debt and the holders of
this debt elect to receive the deferred interest in shares of Series A
Convertible Preferred Stock, the interests of the Company's stockholders may be
diluted and the Company may need to recognize additional non-cash interest
expense in accordance with generally accepted accounting principles.
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LEVERAGE AND ABILITY TO SERVICE FIXED CHARGES. At December 26, 1999, the
Company had $ 23.3 million of long-term debt and had a negative tangible net
worth (stockholders' equity less intangible assets) of $8.8 million. For the
forty-seven week transition period ended December 26, 1999, earnings before
interest, taxes, depreciation and amortization were negative $4.1 million. A
high percentage of the Company's operating expenses are relatively fixed,
including approximately $1.7 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 additional equity or to pay
cash dividends on or repurchase common stock; and (iv) funds available for
working capital, capital expenditures, acquisitions and general corporate
purposes will be limited.
Any default under the documents governing indebtedness of the Company
could have a significant adverse effect on the market value of the common stock.
NO ASSURANCE OF SUCCESSFUL IMPLEMENTATION OF BUSINESS STRATEGIES. The
Company's near-term business strategies include (i) revamping marketing and
sales promotion with the goal of better defining the Company's market niche and
differentiating the Company from its competitors; (ii) developing new products,
which will accomplish a freshening of inventories and see the introduction of a
number of new styles, designed to increase customer appeal (iii) enhancing and
leveraging the strength of its brand names, (iv) opening approximately sixteen
to twenty showrooms per year for the foreseeable future; and (v) developing and
implementing a successful e-Commerce strategy. 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 as well as the market
value of its common stock. 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 and new markets; the availability of financing for
expansion; the rapid rate of change in the world wide web and the number of new
web sites offering furniture for sale; 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. The Company has an Employment Agreement with Mr. Hawley,
pursuant to which the Company has agreed to employ Mr. Hawley for a term ending
on January 28, 2001.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. Because the Company sells
most of its products on a made-to-order basis with a two-to-four week delivery
cycle, it typically operates with about 30 days of backlog. As a result,
quarterly sales and operating results generally depend on the volume and timing
of orders and the Company's ability to fulfill orders within a quarter, which
are difficult to forecast. 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
development and implementation of its e-Commerce strategy. To the extent that
such expenditures precede or are not subsequently followed by increased
revenues, the Company's business, operating results and financial condition will
be materially adversely affected. In addition, the Company's operating results
are affected by a variety of factors, including consumer tastes, housing
activity, interest rates, credit availability and general economic conditions in
its selected market. It is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts and
investors. In that event, the price of the common stock would likely be
materially adversely affected.
DEPENDENCE ON SUPPLIERS. The Company obtains its raw materials and some
manufactured products from various outside sources and generally has had no
difficulty obtaining them. However, the Company is dependent on the continued
supply from relatively few suppliers of certain products, components and raw
materials, including fabrics, leather, foam, and sleeper and motion mechanisms.
Specifically, the Company's 10 largest suppliers accounted for approximately
60.0% of its aggregate purchases of raw
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materials in the fiscal year ended December 26, 1999. During the forty-seven
week transition period ended December 26, 1999, approximately 32.8% of these
aggregate purchases of raw materials represented fabric, with one supplier
constituting approximately 30.8% of the fabric purchases made by the Company
during this period; approximately 18.2% of these purchases represented leather,
with one supplier constituting approximately 31.4% of the leather purchases made
by the Company during this period; and approximately 14.0% of these purchases
consisted of wood and pre-cut wood components, with one supplier constituting
approximately 88.5% of the wood and pre-cut wood purchases made by the Company
during this period. The Company has no supply contract with these large
suppliers, but instead makes each purchase under a separate purchase order. Both
leather and pre-cut wood components are commodities the Company believes it can
readily obtain from alternative sources, and from time to time the Company has
purchased such commodities from alternative sources. If the Company could not
develop alternative sources of supply of leather, pre-cut wood components or
certain other raw materials and products when needed, or could not obtain
sufficient single-source products, components and raw materials when needed, the
resulting loss of production capability, would adversely affect the Company's
results of operations. Fabric is obtainable from many different sources,
however, it is subject to changing fashion and not all styles are available from
every mill.
In addition, commodity raw materials are subject to fluctuations in
price. Because raw materials make up a substantial part of the cost of goods
sold by the Company, price fluctuations could have a material adverse effect on
the Company's results of operations. Although the Company has historically
absorbed gradual increases in raw material prices, there can be no assurance
that the Company will continue to be able to do so in the future. In addition,
sharp increases in material prices are more difficult to pass through to the
customer in a short period of time and may negatively impact the short-term
financial performance of the Company. See "Business -- Manufacturing."
COMPETITION. The home furnishings industry is highly competitive and
fragmented, and includes competition from traditional furniture retailers,
department stores, discount and warehouse outlets as well as internet retailers,
most of whom do not have a bricks and mortar presence. 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 51%
and 15%, respectively, of the Company's sales in the forty-seven week transition
period ended December 26, 1999 originated. Consequently, an economic downturn in
either of those states would likely have a disproportionately negative impact on
the financial condition of the Company. Management believes the economic
indicator most relevant to its operations is consumer confidence. In January
1999, the consumer confidence index, as reported by the Conference Board, for
the Middle Atlantic Region, which includes New York, was 119.1, the index for
the Pacific Region, which includes California, was 137.1, and the average index
for the United States as a whole, was 136.7.
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 has taken steps 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 several months into the process of replacing
its computer system with a new Oracle enterprise resource planning system to
improve order configuration, manufacturing scheduling, distribution processes
and financial reporting. In the event that the Company does not replace its
current computer system, or fails to promptly implement and integrate the new
Oracle enterprise resource planning system, there would be a material adverse
affect on the Company.
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CONTROL BY PRINCIPAL STOCKHOLDERS. The current management, directors and
other principal stockholders of the Company own securities that entitle them to
vote in the aggregate approximately 71% of the voting power of the issued and
outstanding common stock of the Company. Furthermore, the Company has entered
into an Amended and Restated Stockholders Agreement (the "Stockholders
Agreement") with certain of its stockholders which provides, in part, that the
stockholders who are parties to the Stockholders Agreement will vote their
shares in any election of directors in a manner that assures the election of
directors designated by each of them. The Stockholders Agreement also prohibits
the Company from taking certain actions, such as entering into a merger,
liquidation, dissolution, or entering into joint ventures, issuing new equity
securities, or issuing new debt securities in excess of $200,000 without the
approval of the members of the Board of Directors designated by THLi and GECC.
It is unlikely that any principal stockholder or group of public stockholders
acting in concert would be in the position to influence corporate policy,
particularly where any such policy could have a detrimental effect on THLi or
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 December 26, 1999, the Company had approximately $45
million of federal net operating loss carryforwards including approximately $11
million which is currently limited by Section 382 and other provisions 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 December 26, 1999, the Company experienced a
cumulative ownership change of approximately 42% as defined in Section 382.
However, after giving effect to the issuance of Series A Convertible Preferred
Stock on January 18, 2000, the cumulative ownership change increased to
approximately 45.9% at that date. These factors may have the effect of delaying,
deferring or preventing a use of some of the net operating loss carryforwards of
the Company.
MARKET FOR THE COMPANY'S COMMON STOCK; POTENTIAL VOLATILITY OF STOCK
PRICE. The Company's common stock began trading on the American Stock Exchange
on March 31, 1998. Prior to that date the Company's common stock traded on the
Nasdaq SmallCap Market. There can be no assurances as to the extent or nature of
the market for the Company's common stock (which is generally 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.
MAINTAINING LISTING ON AMERICAN STOCK EXCHANGE. The Company has traded
on the American Stock Exchange (the "AMEX") since March 31, 1998. The AMEX has
notified the Company that because of its losses in the last five fiscal years it
falls below the continued listing standards of the AMEX, and its continued
listing is being reviewed. (The Company had a five-year history of losses at the
time of its original listing.) The AMEX has the discretion to continue listing
the Company or to delist it. Based on the January 2000 financing, which
strengthened the Company's general financial position, and on the improvement in
the Company's financial results since it was first admitted to listing on the
AMEX, the Company has requested that the AMEX continue to list the Company's
shares for trading. If the Company's common stock were to be removed from
listing on the AMEX, it is possible that any alternative listing may result in a
reduction in the trading price of the Company's common stock, and the Company's
stockholders may find it harder to sell their shares.
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. Such provisions may also inhibit fluctuations in the market price of
Company Common Stock that could result from takeover attempts. 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
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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.
In January 2000, the Company designated 450,000 of its authorized shares
of preferred stock as Series A Convertible Preferred Stock. 380,000 shares of
the Series A Convertible Preferred Stock were sold to raise capital for the
Company and not to discourage any takeover effort. However, the Series A
Convertible Preferred Stock has features that in some circumstances could
discourage a takeover. In particular, Series A Convertible Preferred Stock will
be redeemable at its original issue price on any change in control, which would
include a merger or sale of the corporation, and the Company may not merge with
or be acquired by another company without the approval of holders of 66 2/3% of
the Series A Convertible Preferred Stock.
As a result of the above transaction, there remains issuable by the
Board of Directors of the Company 286,667 shares of Preferred Stock without
further stockholder approval.
GOVERNMENTAL REGULATION. The Company's operations must meet federal,
state and local regulatory standards in the areas of safety, health and
environmental pollution and waste control. If the Company fails to comply with
these regulations, the Company could be subject to liability ranging from
monetary fines and charges to injunctive actions, any of which would adversely
affect the Company. Future changes in these regulations could also have a
material adverse effect on the Company.
ABSENCE OF DIVIDENDS. The Company has not paid cash dividends on its
Common Stock and does not anticipate that it will do so in the foreseeable
future. Furthermore, Common Stock 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.
No cash dividend is payable on the Company's Series A Convertible
Preferred Stock that was issued in January 2000.
ITEM 2. PROPERTIES
The Company maintains its administrative offices and manufacturing plant
in a leased 250,000 sq. ft. facility at 200 North Berry Street, Brea,
California. The lease has a remaining term of nine 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 91 showrooms occupy approximately
1,090,000 sq. ft. of selling space.
ITEM 3. LEGAL PROCEEDINGS
On May 27, 1994, the Company was served with a complaint in the case
captioned Miriam Brown v. Mr. Coffee, inc. et al. (Civil Action No. 13531), in
the Delaware Court of Chancery, New Castle County. The complaint names the
Company, Mr. Coffee and certain individuals including Jean R. Perrette and
Kenneth W. Keegan, both former directors and officers of the Company, as
defendants in a purported class action lawsuit. The complaint alleges that the
individuals named as co-defendants breached their fiduciary duties as directors
of Mr. Coffee by, among other things, their alleged efforts to entrench
themselves in office and prevent Mr. Coffee's public shareholders from
maximizing the value of their holdings, engaging in plans and schemes unlawfully
to thwart offers and proposals from third parties, and approving or causing the
Company and others to agree to vote in favor of a merger with Health o meter
Products, Inc. The Company is alleged to have participated in and advanced the
alleged breaches. The plaintiff originally sought to enjoin the merger; however,
plaintiff withdrew such action and the merger was completed in August 1994. The
Company and the Mr. Coffee directors filed motions to dismiss the complaint on
August 11, 1994. On October 9, 1996, the plaintiff filed a second amended
complaint. All defendants subsequently joined in filing a motion to dismiss the
complaint. The Court dismissed the action without prejudice on November 22,
1999.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
On March 31, 1998, the Company's common stock began trading on the
American Stock Exchange under the ticker symbol KFI. Prior to that date the
Company's common stock traded on the Nasdaq SmallCap Market under the ticker
symbol SOFA. The following table sets forth the high and low per share prices
for the Company's Common Stock for each quarter during the 1999 and 1998 fiscal
years.
<TABLE>
<CAPTION>
1999 1998
---------------- ----------------
Quarter High Low High Low
----- ----- ----- -----
<S> <C> <C> <C> <C>
First ......... $1.81 $1.00 $4.44 $2.43
Second ........ 3.44 1.12 4.12 1.50
Third ......... 2.38 1.25 1.75 0.69
Fourth* ....... 2.00 0.75 1.94 0.94
</TABLE>
*Fourth quarter of 1999 represents 8 weeks ended December 26, 1999.
As of March 27, 2000, there were approximately 334 holders of record of
the Company's common stock. The Company has paid no dividends to date and does
not expect to do so in the foreseeable future.
SALE OF THE COMPANY'S SERIES A CONVERTIBLE PREFERRED STOCK. On January
14, 2000, the Company sold 280,000 shares of its Series A Convertible Preferred
Stock (the "Series A Preferred") and sold an additional 100,000 shares on
January 19, 2000. The purchase price of the Series A Preferred was $50 per
share, for an aggregate purchase price of $19,000,000. The Company sold the
Series A Preferred directly, without the services of an underwriter, in a
private placement made in reliance on Rule 506 of Regulation D under the
Securities Act of 1933. All of the purchasers were accredited investors within
the meaning of Regulation D. The Company received net proceeds of approximately
$18,700,000 after expenses related to the placement.
Each share of Series A Preferred is convertible into approximately 45.45
shares of the Company's common stock at the conversion rate of $1.10 per share
of common stock. The Company does not have sufficient authorized common stock to
permit the conversion of the Series A Preferred. Once the additional common
stock is authorized by the stockholders, holders of the Series A Preferred will
have the right to convert their shares into common stock at any time. The Series
A Preferred will be converted automatically into common stock if the Company
completes a public offering of its shares with gross proceeds in excess of
$25,000,000, and at a price per share of Common Stock of at least $3.30. The
Series A Preferred will also be converted automatically if holders of 66 2/3% of
the Series A Preferred agree to do so.
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ITEM 6. SELECTED FINANCIAL DATA
The following data as of and for the forty-seven week transition period
ended December 26, 1999 and the fiscal years ended January 31, 1999 and February
1, 1998 has been derived from consolidated financial statements appearing
elsewhere herein that have been audited by Arthur Andersen LLP, independent
public accountants. The following data as of February 2, 1997 and January 28,
1996 and for the years ended February 2, 1997 and January 28, 1996 has been
derived from audited consolidated financial statements not included herein. The
information set forth below is not necessarily indicative of the results of
future operations and should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere in this Annual Report
on Form 10-K.
<TABLE>
<CAPTION>
Forty-Seven
Week
Transition
Period Fiscal Year Ended
Ended ------------------------------------------------------------------
December 26, January 31, February 1, February 2, January 28,
1999(2) 1999(2) 1998(2) 1997(2) 1996(2)
--------- --------- --------- --------- ---------
(in thousands except per share data)
<S> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS:
Net sales $ 130,310 $ 130,447 $ 115,201 $ 112,737 $ 122,319
Gross profit 70,074 69,460 59,048 56,247 62,467
Loss from operations (6,655) (2,534) (5,709) (12,447) (9,388)
--------- --------- --------- --------- ---------
Net loss $ (9,435) $ (5,134) $ (7,480) $ (13,389) $ (8,715)
--------- --------- --------- --------- ---------
Loss per share $ (0.43) $ (0.24) $ (0.39) $ (1.28) $ (2.21)
========= ========= ========= ========= =========
Number of shares used in computing
loss per share(1) 22,009 21,490 19,021 10,445 3,950
========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
December 26, January 31, February 1, February 2, January 28,
1999 1999 1998 1997 1996
-------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets $ 57,761 $ 52,506 $ 45,312 $ 43,087 $ 46,866
Inventories 25,289 20,413 16,013 14,013 14,627
Working capital (deficiency) (1,596) 2,858 (922) (2,182) (6,878)
Intangible assets 13,112 14,261 15,557 16,890 18,236
Short-term debt 491 542 22 41 19
Long-term debt 23,346 17,990 13,731 6,306 5,584
Stockholders' equity 4,265 12,229 9,892 15,543 13,985
</TABLE>
(1) Per share amounts are calculated in accordance with SFAS No. 128 and
represent basic and diluted per share amounts. See Note 1 to the
Consolidated Financial Statements.
(2) In January 2000, the Company changed its fiscal year from the Sunday
closest to January 31 to the Sunday closest to December 25. The fiscal
years ended January 31, 1999, February 1, 1998 and January 28, 1996 are
52-week periods and the fiscal year ended February 2, 1997 is a 53-week
period.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere herein.
The Company has reported losses from operations in each of its past five
fiscal periods. As a result of such losses, the Company had an accumulated
deficit of $56,399,000 at December 26, 1999.
In 1997, management implemented 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 both in existing and new
markets and closing underperforming showrooms. To date, 38 showrooms have been
remodeled, 25 showrooms have been opened, and 14 showrooms have been closed. In
the opinion of management, this plan is expected to ultimately return the
Company to profitability; however, there can be no assurance that the Company
will achieve profitability.
On January 4, 2000, the Company's Board of Directors voted to change its
fiscal year end to the Sunday closest to December 25, effective as of December
26, 1999. Accordingly, all references to fiscal 1999 refer to the forty-seven
week transition period ended December 26, 1999.
As more fully described in Note 10 to the Consolidated Financial
Statements, on January 14 and 19, 2000, the Company completed a private
placement of 380,000 shares of Series A Convertible Preferred Stock, net
proceeds from which totaled $18,700,000. Management believes this investment
will more rapidly enable the Company to leverage its considerable manufacturing
and distribution assets by becoming a leading retail e-Commerce provider in
custom upholstered furniture while also providing B2B solutions for other
furniture e-tailers and independent furniture retailers served by Internet
alliance customers; however, there can be no assurance that the Company will be
successful in this regard.
Management believes that the Company has sufficient capital to fund its
plan to remodel showrooms and open new showrooms throughout fiscal 2000 as well
as to support the launch of its business-to-business and e-Commerce initiatives;
however, if this proves not to be 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 or available on terms acceptable to the
Company. The Company's long-term success is dependent upon management's ability
to successfully execute its plans and, ultimately, to achieve sustained
profitable operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal cash needs are for funding capital expenditures
to open new showrooms and remodel existing showrooms; for manufacturing samples
of upholstered furniture for display in its new and existing showrooms as well
as to purchase merchandise from other manufacturers that complement the
upholstered furniture manufactured and displayed by the Company; for funding
capital expenditures related to the improvement and maintenance of its
management information systems; and to fund the development and deployment of
the Company's e-Commerce strategy. The cash required for funding production and
fulfillment of customer orders is typically provided by the Company's customers
from a deposit made at the time an order is placed. Beginning in fiscal 2001,
the Company will also require capital to make the scheduled principal payments
on its subordinated notes.
In March 1999, the Company's existing revolving line of credit with
Congress Financial Corporation (Western) was amended (the "Revolving Credit
Facility") to increase the maximum commitment available from $10 million to $15
million, subject to borrowing base limitations, and to extend the maturity date
to March 31, 2002. The Revolving Credit Facility accrues interest at a rate of
prime plus a margin ranging from .5% to 1% based upon the Company's performance
and is secured by substantially all of the Company's assets. As of December 26,
1999, the Company had unused borrowing capacity of approximately $2.2 million
under the terms of its Revolving Credit Facility.
Under the terms of the agreements related to the Company's subordinated
notes, as well as under the terms of the Revolving Credit Facility, the Company
is required to maintain certain financial covenants and is prohibited from
incurring additional indebtedness from third parties.
In recent periods, the Company has incurred additional debt and raised
equity capital to cover operating deficits; to finance the remodeling and
expansion of its showrooms; and fund the costs related to the upgrade of its
management information systems presently underway. In fiscal 2000, management
plans to add approximately sixteen to twenty additional showrooms, at an
aggregate cost of approximately $3.6 million. In addition, current plans call
for the closing of approximately six showrooms in fiscal 2000.
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Management expects to fund such capital expenditures by internally generated
cash and by borrowings under the Company's Revolving Credit Facility.
During fiscal 1999, the Company committed itself to a consulting
agreement and capital leases that will enable it to upgrade its management
information systems infrastructure. Fiscal 2000 capital expenditures related to
this project presently are estimated at $1.7 million.
Management believes that the Company has sufficient capital to fund its
plan to open new showrooms and remodel existing showrooms throughout fiscal
2000; continue to fund the costs related to the upgrade of its management
information systems; as well as to support the launch of its
business-to-business and e-Commerce initiatives; however, if this proves not to
be 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 or
available on terms acceptable to the Company. The Company's long-term success is
dependent upon management's ability to successfully execute its plans and,
ultimately, to achieve sustained profitable operations.
The aggregate annual maturities of long-term debt during each of the
five fiscal years subsequent to December 26, 1999 are approximately as follows:
$491,000 in 2000, $3,552,000 in 2001, $16,828,000 in 2002, $5,013,000 in 2003,
and $13,000 in 2004. Management anticipates such payments will be made out of
operating cash flow, draws under the Revolving Credit Facility or through
refinancing.
As of December 26, 1999, the Company had cash and cash equivalents of
$80,000. Cash flow activity for the fiscal years ended December 26, 1999,
February 1, 1998 and February 2, 1997 is presented in the Consolidated
Statements of Cash Flows.
1999 Cash Flow During fiscal 1999, cash and cash equivalents remained
unchanged. Operating activities used net cash of $1,070,000, principally from a
cash loss from operations of $5,030,000, an increase in inventory of $4,876,000,
and a decrease in customer deposits of $701,000, offset in part by an increase
in accounts payable and accrued liabilities of $8,615,000 and a decrease in
accounts receivable of $624,000. The increase in inventory is due to a
combination of higher levels of finished goods required in part by the addition
of new showrooms and the Company's decision to increase the amount of raw
materials as a contingency for unforeseen Y2K problems. Investing activities
during the period included capital expenditures of $4,189,000 which was used
primarily to open thirteen new showrooms and to fund capital requirements of the
ongoing upgrade of the management information systems infrastructure. Financing
activities during the period consisted of net borrowings of $5,662,000 on the
Company's Revolving Credit Facility, proceeds of $102,000 from the exercise of
certain warrants for common stock, offset by $505,000 of principal payments on
other indebtedness. Management plans to continue its strategy of adding new
showrooms. The Company expects to fund the related expenditures from internally
generated cash; from a portion of the proceeds of the Series A Convertible
Preferred Stock issued in January 2000; and from borrowings under the Company's
Revolving Credit Facility. The Company expects to incur costs of approximately
$3.6 million related to this program in fiscal 2000.
1998 Cash Flow During fiscal 1998, cash and cash equivalents decreased
by $836,000. Operating activities used net cash of $5,575,000, principally from
a cash loss from operations of $849,000 and increases in inventory and prepaid
expenses and other assets of $4,400,000 and $359,000, respectively. The increase
in inventory is principally due to the Company's expansion and remodeling
program. Investing activities during the period included capital expenditures of
$5,727,000, nearly all of which was used to remodel 22 retail showrooms and open
eight new showrooms. Financing activities during the period consisted
principally of net proceeds of $7,267,000 from the sale of 2,963,889 shares of
common stock and net borrowings of $3,180,000 under the Company's revolving
credit facility.
1997 Cash Flow During fiscal 1997, cash and cash equivalents decreased
by $311,000. Operating activities used net cash of $4,998,000, principally from
a cash loss from operations of $3,806,000 and an increase in inventory of
$2,000,000 which was partially offset by an increase in accounts payable and
other liabilities of $753,000. The increase in inventory is principally due to
the Company's decision to expand its accessories business. Investing activities
during the period included capital expenditures of $3,521,000, nearly all of
which was used to remodel 16 retail showrooms and open one new showroom.
Financing activities during the period consisted principally of $6,500,000
borrowed from GECC and JOL and net borrowings of $1,813,000 under the Company's
revolving credit facility.
Page 15
<PAGE> 16
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain items
from the Company's Consolidated Statement of Operations as a percentage of net
sales.
<TABLE>
<CAPTION>
Forty-Seven
Week
Transition Fiscal Year Ended
Period Ended -------------------------
December 26, January 31, February 1,
1999 1999 1998
------------ ----------- -----------
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of sales 46.2 46.8 48.7
------ ------ ------
Gross profit 53.8 53.2 51.3
------ ------ ------
Operating expenses:
Selling 50.6 47.2 47.4
General and administrative 7.6 7.2 7.9
Amortization of goodwill 0.7 0.8 0.9
------ ------ ------
58.9 55.2 56.2
------ ------ ------
Loss from operations (5.1) (2.0) (4.9)
Interest expense (2.2) (2.0) (1.5)
====== ====== ======
Net loss (7.3)% (4.0)% (6.4)%
====== ====== ======
</TABLE>
STORE (SHOWROOM) DATA
<TABLE>
<CAPTION>
Forty-Seven
Week
Transition Fiscal Year Ended
Period Ended -------------------------
December 26, January 31, February 1,
1999 1999 1998
------------ ----------- -----------
<S> <C> <C> <C>
Stores open at beginning of period 88 81 82
Stores opened during period 13 8 1
Stores closed during period 10 1 2
------ ------ ------
Stores open at end of period 91 88 81
Average sales per showroom(1) (in 000's) $1,452 $1,548 $1,422
Comparable store sales increase(2)(3) 4.1% 9.8% 2.7%
</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) The comparable store sales increase for the forty-seven weeks ended
December 26, 1999 is calculated based on a comparison to the forty-
seven weeks ended December 27, 1998.
47 WEEK TRANSITION PERIOD ENDED DECEMBER 26, 1999 AS COMPARED TO 52 WEEKS ENDED
JANUARY 31, 1999 (FISCAL 1998)
Net Sales. Net sales for the forty-seven week transition period ended
December 26, 1999 were $130,310,000 compared with $130,447,000 for fiscal 1998
(fifty-two weeks). Sales for the comparable forty-seven week period in fiscal
1998 totaled $116,692,000. The increase in sales of $13,618,000 or 11.7%, as
compared to the equivalent period in the prior fiscal year, was due principally
to management's continuing strategy of opening new showrooms in existing
markets, developing new products, increasing the promotion and sale of
accessories, and fine tuning the marketing and sales promotion program.
Comparable store sales increased 4.1% for the forty-seven week transition period
ended December 26, 1999.
Gross Profit. Gross profit was 53.8% of net sales in the forty-seven
week transition period ended December 26, 1999 compared with 53.2% of net sales
in fiscal 1998. The increase in gross profit was primarily the result of several
factors including higher retail prices, improved efficiency in factory
operations, reduced discounting, negotiated reductions in raw material prices
and new product acceptance by customers partially offset by an increase to the
reserve for sales returns and allowances.
Selling Expenses. Selling expenses were $65,941,000 or 50.6% of net
sales for the forty-seven week transition period ended December 26, 1999 and
were $61,544,000 or 47.2% of net sales in fiscal 1998. Selling expenses were
$55,230,000 or 47.3% for the
Page 16
<PAGE> 17
comparable forty-seven week period in fiscal 1998. The increase in selling
expenses as a percentage of net sales for the forty-seven week periods was due
primarily to higher charges recorded for closing 10 stores in fiscal 1999 and
for six stores to be closed in fiscal 2000; higher advertising expenses from the
use of more color circulars in fiscal 1999 compared to the prior year; and
higher financing costs in connection with the Company's advertising strategy.
While not having a significant effect on selling expenses as a percentage of
sales, occupancy costs and payroll costs rose in fiscal 1999 compared to the
comparable forty-seven week period in fiscal 1998 as a result of opening
thirteen new showrooms and closing ten older showrooms.
General and Administrative Expenses. General and administrative expenses
for the forty-seven week transition period ended December 26, 1999 were
$9,853,000 or 7.6% of net sales compared to $9,430,000 or 7.2% of net sales, for
fiscal 1998. General and administrative expenses for the comparable forty-seven
week period in fiscal 1998 totaled $8,412,000 or 7.2% of the related sales. The
increase in general and administrative expenses of $1,441,000, for fiscal 1999
as compared to the equivalent period in fiscal 1998 was due primarily to higher
payroll costs.
Interest Expense. Interest expense, including amortization of debt
discounts and deferred financing costs, for the forty-seven week transition
period ended December 26, 1999 increased by $247,000 over fiscal 1998 or
$517,000 over the forty-seven week period ended December 27, 1998. The increase
was due primarily to higher average revolving debt outstanding and higher
interest rates on this debt and to a lesser extent by additional amortization of
the debt discount attributable to the vesting of a performance warrant recorded
in the third and fourth quarters of fiscal 1999 (see Note 3). Amortization of
debt discounts and deferred financing costs for the forty-seven week transition
period ended December 26, 1999 and fiscal 1998, totaled $836,000 and $805,000,
respectively.
Income Taxes. The Company paid no income taxes and no income tax benefit
was recorded for either the forty-seven week transition period ended December
26, 1999 or fiscal 1998 due to uncertainties regarding the realization of
deferred tax assets available.
As of December 26, 1999 the Company has federal net operating loss
carryforwards of approximately $45 million which begin to expire in 2003, if not
utilized. As a result of various equity transactions, one of the Company's
subsidiaries has experienced a change of ownership in 1993, as defined in the
Internal Revenue Code. As a result of this ownership change and other provisions
of the Internal Revenue Code, utilization of approximately $11 million of these
net operating loss carryforwards is limited to the future income of one of the
Company's subsidiaries. In addition, the current year's net operating loss is
subject to certain restrictions as a result of the change of fiscal year. As of
December 26, 1999, approximately $17 million of the loss carryforwards were
restricted. In addition, the Company had state net operating loss carryforwards
of approximately $32 million, which begin to expire in the year beginning
December 27, 1999, if not utilized.
Net Loss. As a result of the above factors, the net loss was $9,435,000
for the forty-seven week transition period ended December 26, 1999, compared to
a net loss of $5,134,000 for fiscal 1998. Net loss per share in the 1999 period
was $0.43 based on 22,009,000 shares outstanding. In fiscal 1998 the net loss
per share was $0.24 based on 21,490,000 weighted average shares outstanding. The
net loss for the forty-seven weeks ended December 27, 1998 was $4,922,000 and
the related net loss per share was $0.23 based on 21,446,000 weighted average
shares outstanding.
52 WEEKS ENDED JANUARY 31, 1999 (FISCAL 1998) AS COMPARED TO 52 WEEKS ENDED
FEBRUARY 1, 1998 (FISCAL 1997)
Net Sales. Net sales for fiscal 1998 were $130,447,000 compared with
$115,201,000 for fiscal 1997. Sales increased $15,246,000 or 13.2% with same
store sales increasing 9.8%. The increase in sales was due to management's
strategy of continuing remodeling existing showrooms to provide a more appealing
setting for customers (22 showrooms were remodeled in fiscal 1998, compared to
16 in fiscal 1997); opening new showrooms in existing markets (eight new
showrooms were opened in fiscal 1998, compared to one in fiscal 1997); to
management's strategies of developing new products, increasing the promotion and
sale of accessories, and revamping the marketing and sales promotion program;
and to improved economies in regions where the Company operates.
Gross Profit. Gross profit was 53.2% of net sales in fiscal 1998
compared with 51.3% of net sales in fiscal 1997. The increase in gross profit as
a percentage of net sales resulted primarily from continuing improvements in the
manufacturing operations, less promotional discounting at the retail level and
negotiated reductions in raw material prices.
Selling Expenses. Selling expenses were $61,544,000 or 47.2% of net
sales in fiscal 1998 and were $54,596,000 or 47.4% of net sales in fiscal 1997.
The increase of $6,948,000 in selling expenses was primarily due to a
combination of higher sales volume and the opening of eight new showrooms in
fiscal 1998.
Page 17
<PAGE> 18
General and Administrative Expenses. General and administrative
expenses for fiscal 1998 were $9,430,000 or 7.2% of net sales compared to
$9,141,000 or 7.9% of net sales, for fiscal 1997. The increase of $289,000 was
primarily the result of higher management payroll costs. The decrease as a
percentage of net sales was the result of leveraging higher sales volume.
Interest Expense. Interest expense, including amortization of deferred
financing costs, for fiscal 1998 increased by $861,000 over fiscal 1997 due
primarily to higher average debt outstanding, partially offset by lower interest
rates on the Company's outstanding debt.
Income Taxes. The Company paid no income taxes and no income tax benefit
was recorded for either of fiscal 1998 or 1997 due to uncertainties regarding
the realization of deferred tax assets available.
Net Loss. As a result of the above factors, the net loss was $5,134,000
for fiscal 1998, compared to a net loss of $7,480,000 for fiscal 1997. Net loss
per share in the 1998 period was $0.24 based on 21,490,000 shares outstanding.
In fiscal 1997 the net loss per share was $0.39 based on 19,021,000 weighted
average shares outstanding.
YEAR 2000
The Company undertook many actions intended to assure that its computer
systems and other equipment were capable of functioning in, and processing for,
periods for the Year 2000 and beyond. These actions were generally described in
the Company's report on Form 10-Q for the quarter ended October 31, 1999. The
Company implemented a program to address, on a timely basis, "Year 2000
Readiness" (the need for computer applications and other systems used by the
Company to function in and after the Year 2000 and to recognize and properly
perform date sensitive functions involving dates after December 31, 1999).
As of March 30, 2000, the Company has not experienced any material
consequences of failure of Year 2000 Readiness, either by the Company, its
suppliers, or its customers. However, Year 2000 Readiness has many elements and
potential consequences, some of which may not be foreseeable or may be realized
in future periods. Therefore, there can be no assurance that unforeseen
circumstances could still not arise, or that the Company will not in the future
identify equipment or systems which are not Year 2000 ready.
The Company's Year 2000 costs were approximately $7,500.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if it is, the type of hedge
transaction. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133. SFAS No. 137 delays the effective date of SFAS No.
133 to fiscal years beginning after June 15, 2000. The Company does not expect
that the adoption of SFAS Nos. 133 and 137 will have a material impact on its
consolidated financial statements because the Company does not currently hold
any derivative instruments.
MARKET RISK EXPOSURE
The Company is exposed to market risks related to fluctuations in
interest rates on its variable rate debt which consists of revolving credit
notes issued to a financial institution. The Company does not use interest rate
swaps, futures contracts or options on futures, or other types of derivative
financial instruments.
Historically, the Company has used debt financing for funding its
capital investments in new and remodeled showrooms and for funding cash used in
operations. The Company's debt consists primarily of fixed rate subordinated
debt with attached warrants, variable rate revolving credit notes and other
fixed rate notes payable.
For fixed rate debt, changes in interest rates generally affect the fair
market value, but not earnings or cash flows. Conversely, for variable rate
debt, changes in interest rates generally do not influence fair market value,
but do affect future earnings and cash flows. The Company has managed its
exposure to changes in interest rates by issuing part of its debt with fixed
interest rates and part with variable interest rates. Holding the variable rate
debt balance constant, each one percentage point increase in interest rates
occurring on the first day of the year would result in an increase in interest
expense for the coming year of approximately $127,000.
The table below details the principal amount and the average nominal
interest rates for the debt in each category based on the final maturity dates
and applicable amortization schedules for the fixed rate debt. The fair market
value estimates for debt securities are based on discounting future cash flows
using current rates the Company believes would be available to it if it were to
enter the market for debt of the same type and remaining maturity. The
subordinated debt was issued with common stock warrants. The fair value of the
subordinated debt has been determined inclusive of the warrants and using an
interest rate that the Company believes would be available to it for a similar
debt instrument issued with warrants having similar terms.
Page 18
<PAGE> 19
<TABLE>
<CAPTION>
2000 2001 2002 2003 2004 Thereafter Total
---------- ---------- ---------- ---------- ---------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed Rate Subordinated Notes - $ 3,000 $ 4,000 $ 5,001 - - $12,001
Average interest rate - 9.50% 9.50% 9.50% - - -
Variable Rate Notes - - 12,655 - - - $12,655
Average interest rate - - 9.0% - - - -
Fixed Rate Other Notes Payable $ 491 $ 552 $ 173 $ 12 $ 13 $ 95 $ 1,336
Average interest rate 9.30% 9.50% 8.5% 9.0% 9.0% 9.0% -
</TABLE>
<TABLE>
<CAPTION>
Fair Value
----------
<S> <C>
Fixed Rate Subordinated Notes $12,001
Average interest rate -
Variable Rate Notes $12,655
Average interest rate -
Fixed Rate Other Notes Payable $ 1,336
Average interest rate -
</TABLE>
The Company does not believe that the future market rate risks related
to the above securities will have a material impact on the Company or the
results of its future operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
The information required by Items 10 through 13 of this Part is
incorporated by reference to the Company's Proxy Statement, under the captions
"Election of Directors", "Security Ownership of Certain Beneficial Owners and
Management", "Compensation of Executive Officers" and "Certain Relationships and
Related Transactions", which Proxy Statement will be mailed to stockholders in
connection with the Company's annual meeting of stockholders which is scheduled
to be held in May, 2000.
Page 19
<PAGE> 20
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) and (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
Page No.
<S> <C>
Report of Arthur Andersen LLP, Independent Public Accountants 25
Consolidated Balance Sheet at December 26, 1999 and January 31, 1999 26
Consolidated Statement of Operations for the forty-seven week transition period
ended December 26, 1999, and fiscal years ended January 31, 1999 and
February 1, 1998 27
Consolidated Statement of Stockholders' Equity for the forty-seven week
transition period ended December 26, 1999, and fiscal year ended January 31,
1999 and February 1, 1998 28
Consolidated Statement of Cash Flows for forty-seven week transition period
ended December 26, 1999, and fiscal years ended January 31, 1999 and
February 1, 1998 29
Notes to Consolidated Financial Statements 30
Schedule II- Valuation and Qualifying Accounts 43
Schedules I, III, IV, and V have been omitted since they are not applicable
</TABLE>
Page 20
<PAGE> 21
(a) (3) EXHIBITS
3.1 Certificate of Incorporation.(1)
3.1(a) Certificate of Amendment of Certificate of Incorporation dated November
28, 1994.(5)
3.1(b) Certificate of Amendment of Certificate of Incorporation dated August 1,
1995.(6)
3.1(c) Certificate of Amendment of Certificate of Incorporation dated June
7,1996.(7)
3.1(d) Certificate of Amendment of Certificate of Incorporation dated August 1,
1996.(7)
3.2 By Laws.(16)
4.1 Certificate of Designations of Preferred Stock.(4)
10.1 1994 Directors Stock Option Plan.(16)
10.2 1990 Employees Stock Option Plan.(16)
10.3 1997 Stock Incentive Plan.(9)
10.4 Form of Securities Purchase Agreement between the Company, GECC and
certain other stockholders of the Company dated as if August 26,
1996.(8)
10.5 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due August 31,
2001.(8)
10.6 Form of Warrant to Purchase 1,400,000 Shares of Common Stock.(8) 10.7
Form of Securities Purchase Agreement between the Company and Certain
Stockholders dated as of August 26, 1996.(8)
10.8 Supplemental Securities Purchase Agreement among Krause's Furniture,
Inc., General Electric Corporation and Japan Omnibus Ltd., dated as of
August 14, 1997.(12)
10.9 Letter agreement dated August 14, 1997 regarding Permal Group
shares.(12)
10.10 Letter agreement dated August 14, 1997 regarding warrant dilution
provisions.(12)
10.11 Amendment to the Supplemental Securities Purchase Agreement among
Krause's Furniture, Inc., General Electric Corporation and Japan Omnibus
Ltd., dated as of March 31, 1999.(16)
10.12 Amendment to the Supplemental Securities Agreement by and among Krause's
Furniture, Inc., General Electric Capital Corporation and Japan Omnibus
Ltd., dated December 14, 1999.(16)
10.13 Agreement by and among Krause's Furniture, Inc., General Electric
Capital Corporation, and Japan Omnibus Ltd., dated January 11, 2000.(16)
10.14 Series A Convertible Preferred Stock Securities Purchase Agreement,
dated as of January 11, 2000.(18)
10.15 Amended and Restated Registration Rights Agreement by and among Krause's
Furniture, Inc.(18)
10.16 Amended and Restated Stockholders Agreement by and among Krause's
Furniture, Inc. And the Stockholders Listed on the Signature Pages
Thereof, dated as of January 14, 2000.(18)
10.17 Employment agreement with Philip M. Hawley.(8)
10.18 First amendment to employment agreement between Krause's Furniture, Inc.
And Philip M. Hawley.
10.19 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)
10.20 Guarantee dated January 20, 1995 by Krause's Furniture, Inc. to Congress
Financial Corporation (Western).(3)
10.21 First Amendment to Loan and Security Agreement dated as of May 10, 1996
by and between Congress Financial Corporation (Western) and Krause's
Sofa Factory and Castro Convertible Corporation.(6)
10.22 Second Amendment to Loan and Security Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
10.23 Third Amendment to Loan and Security Agreement dated as of November 25,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
10.24 Amended and Restated Subordination Agreement dated as of August 26, 1996
by and between Congress Financial Corporation (Western) and Krause's
Furniture, Inc.(14)
10.25 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)
10.26 Fifth Amendment to Loan and Security Agreement dated as of December 11,
1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(15)
Page 21
<PAGE> 22
10.27 Sixth Amendment to Loan and Security Agreement dated as of March 15,
1999 by and between Congress Financial Corporation (Western) and
Krause's Custom Crafted Furniture Corp. and Castro Convertible
Corporation.(16)
10.28 Letter agreement between Krause's Furniture, Inc. and Congress Financial
Corporation (Western).(12)
10.29 Seventh Amendment to Loan and Security Agreement dated as of August 23,
1999 by and between Congress Financial Corporation (Western) and
Krause's Custom Crafted Furniture Corp. and Castro Convertible
Corporation.(17)
10.30 Eighth Amendment to Loan and Security Agreement, by and between Congress
Financial Corporation (Western), Krause's Custom Crafted Furniture Corp
and its wholly owned subsidiary, Castro Convertible Corporation, dated
as of December 15, 1999.(18)
10.31 Amendment to Eighth Amendment to Loan and Security Agreement, by and
between Congress Financial Corporation (Western), and Krause's custom
Crafted Furniture, Inc., dated December 22, 1999.(18)
10.32 First Amendment to Amended and Restated Subordination Agreement, dated
as of December 15, 1999, by and between Congress Financial Corporation
(Western) and Krause's Furniture, Inc.(18)
21 Subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
27 Financial Data Schedule
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4
dated June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form
10-K for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K
dated as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form
10-K dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1
dated March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibits to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
(14) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(15) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated April 30, 1998 (File No. 0-17868).
(16) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated April 23, 1999 (File No. 0-17868).
(17) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 15, 1999 (File No. 0-17868).
(18) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of February 4, 2000 (File No. 0-17868).
(b) REPORTS ON FORM 8-K
The Registrant did not file any reports on Form 8-K during the last quarter
of the period covered by this report.
Page 22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
KRAUSE'S FURNITURE, INC.
Date: April 3, 2000 By: /s/ PHILIP M. HAWLEY
-----------------------------------------
Philip M. Hawley
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following person on behalf of the Registrant
and in the capacities and on the dates indicated.
Date: April 3 2000 /s/ PHILIP M. HAWLEY
-----------------------------------------
Philip M. Hawley
Chairman of the Board and Chief Executive
Officer
(Principal Executive Officer)
Date: April 3, 2000 /s/ THOMAS M. DELITTO
-----------------------------------------
Thomas M. DeLitto
Director and Vice Chairman of the Board
Date: April 3, 2000 /s/ ROBERT A. BURTON
-----------------------------------------
Robert A. Burton
Executive Vice President and Chief
Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
Date: April 3, 2000 /s/ KAMAL G. ABDELNOUR
----------------------------------------
Kamal G. Abdelnour
Director
Date: April 3, 2000 /s/ JEFFREY H. COATS
-----------------------------------------
Jeffrey H. Coats
Director
Date: April 3, 2000 /s/ PETER H. DAILEY
-----------------------------------------
Peter H. Dailey
Director
Date: April 3, 2000 /s/ JOHN A. GAVIN
-----------------------------------------
John A. Gavin
Director
Date: April 3, 2000 /s/ GEORGE HASHBARGER
-----------------------------------------
George Hashbarger
Director
Page 23
<PAGE> 24
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited the accompanying consolidated balance sheets of Krause's
Furniture, Inc. and subsidiaries as of December 26, 1999 and January 31, 1999,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the forty-seven week transition period ended December 26, 1999,
and the years ended January 31, 1999, and February 1, 1998. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Krause's
Furniture, Inc. and subsidiaries as of December 26, 1999 and January 31, 1999
and the results of their operations and their cash flows for the forty-seven
week transition period ended December 26, 1999, and the years ended January 31,
1999, and February 1, 1998, in conformity with accounting principles generally
accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
April 3, 2000
Page 24
<PAGE> 25
KRAUSE'S FURNITURE, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
December 26, January 31,
1999 1999
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 80 $ 80
Accounts receivable, net of allowance of $197 ($180 at
January 31, 1999)
for doubtful accounts 569 1,193
Inventories 25,289 20,413
Prepaid expenses 656 1,465
-------- --------
Total current assets 26,594 23,151
Property, equipment, and leasehold improvements, net 15,592 13,066
Goodwill, net 12,412 13,346
Leasehold interests, net 700 915
Other assets 2,463 2,028
-------- --------
$ 57,761 $ 52,506
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 14,610 $ 7,750
Accrued payroll and related expenses 2,086 2,502
Other accrued liabilities 6,054 3,849
Customer deposits 4,949 5,650
Notes payable 491 542
-------- --------
Total current liabilities 28,190 20,293
======== ========
Long-term liabilities:
Notes payable 23,346 17,990
Other 1,960 1,994
-------- --------
Total long-term liabilities 25,306 19,984
-------- --------
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; 22,050,328 shares outstanding
(21,984,428 at January 31, 1999) 22 22
Capital in excess of par value 60,642 59,171
Accumulated deficit (56,399) (46,964)
-------- --------
Total stockholders' equity 4,265 12,229
-------- --------
$ 57,761 $ 52,506
======== ========
</TABLE>
See accompanying notes.
Page 25
<PAGE> 26
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Forty-Seven
Week Transition Fiscal Year Ended
Period Ended --------------------------
December 26, January 31, February 1,
1999 1999 1998
--------- --------- ---------
<S> <C> <C> <C>
Net sales $ 130,310 $ 130,447 $ 115,201
Cost of sales 60,236 60,987 56,153
--------- --------- ---------
Gross profit 70,074 69,460 59,048
--------- --------- ---------
Operating expenses:
Selling 65,941 61,544 54,596
General and administrative 9,853 9,430 9,141
Amortization of goodwill 935 1,020 1,020
--------- --------- ---------
76,729 71,994 64,757
--------- --------- ---------
Loss from operations (6,655) (2,534) (5,709)
Interest expense (2,831) (2,584) (1,723)
Other income (expense) 51 (16) (48)
--------- --------- ---------
Net loss $ (9,435) $ (5,134) $ (7,480)
--------- --------- ---------
Basic and diluted loss per share $ (0.43) $ (0.24) $ (0.39)
========= ========= =========
Number of shares used in computing loss per share 22,009 21,490 19,021
========= ========= =========
</TABLE>
See accompanying notes.
Page 26
<PAGE> 27
KRAUSE'S FURNITURE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
Capital in
Excess of Total
Common Stock Par Accumulated Stockholders'
Shares Amount Value Deficit Equity
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at February 2, 1997 19,021 $ 19 $ 49,874 $(34,350) $ 15,543
Issuance of common stock purchase warrants - - 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
Issuance of common stock for cash,
net of expenses of $1,625 2,963 3 7,264 - 7,267
Compensation expense on stock option grant - - 204 - 204
Net loss - - - (5,134) (5,134)
-------- -------- -------- -------- --------
Balance at January 31, 1999 21,984 22 59,171 (46,964) 12,229
Stock purchase warrants exercised 66 - 102 - 102
Vesting of common stock purchase warrants - - 1,250 - 1,250
Compensation expense on stock option grant - - 119 - 119
Net loss - - - (9,435) (9,435)
-------- -------- -------- -------- --------
Balance at December 26, 1999 22,050 $ 22 $ 60,642 $(56,399) $ 4,265
======== ======== ======== ======== ========
</TABLE>
See accompanying notes.
Page 27
<PAGE> 28
KRAUSE'S FURNITURE, INC
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Forty-Seven
Week Transition Fiscal Year Ended
Period Ended --------------------------
December 26, January 31, February 1,
1999 1999 1998
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (9,435) $ (5,134) $ (7,480)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 3,021 3,019 2,431
Other non-cash charges 1,384 1,266 1,243
Change in assets and liabilities:
Accounts receivable 624 (45) (28)
Inventories (4,876) (4,400) (2,000)
Prepaid expenses and other assets 298 (359) 283
Accounts payable and accrued liabilities 8,615 (151) 753
Customer deposits (701) 229 (200)
--------- --------- ---------
Net cash used by operating activities (1,070) (5,575) (4,998)
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures (4,189) (5,727) (3,521)
--------- --------- ---------
Net cash used by investing activities (4,189) (5,727) (3,521)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 149,575 157,316 145,458
Principal payments on long-term borrowings (144,418) (154,117) (137,250)
Proceeds from issuance of common stock - 7,267 -
Proceeds from exercise of stock purchase warrants 102 - -
--------- --------- ---------
Net cash provided by financing activities 5,259 10,466 8,208
--------- --------- ---------
Net decrease in cash - (836) (311)
Cash and cash equivalents at beginning of period 80 916 1,227
--------- --------- ---------
Cash and cash equivalents at end of period $ 80 $ 80 $ 916
========= ========= =========
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 1,995 $ 1,752 $ 754
Noncash investing and financing activities:
Capital lease obligations incurred 597 850 -
Vesting of common stock purchase warrants 1,250 - 1,625
</TABLE>
See accompanying notes.
Page 28
<PAGE> 29
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.
("Krause's"). In January 2000, the Company changed its fiscal year from the
Sunday closest to January 31 to the Sunday closest to December 25. All
references to fiscal 1999 refer to the current year transition period which
includes the forty-seven week transition period ended December 26, 1999. The
fiscal years ended January 31, 1999 (fiscal 1998) and February 1, 1998 (fiscal
1997) are 52-week periods. All significant intercompany transactions and
balances have been eliminated. Certain prior year items have been changed to
conform to current year presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Business
Krause's manufactures made-to-order sofas, sofabeds, loveseats and
chairs, and sells these products through its own chain of retail showrooms and
Contract Division. In addition, the Company also purchases for sale certain
merchandise that is complementary to its manufactured merchandise. As of
December 26, 1999 there were 91 Company-owned showrooms, all of which are
leased, located in 12 states. The Company's manufacturing facility and 41
showrooms are located in California.
Cash and cash equivalents
Cash and cash equivalents include cash on hand, cash in money market
accounts and certificates of deposit with original maturities of less than three
months, carried at cost, which approximates fair value.
Fair values of financial instruments
Fair values of cash and cash equivalents approximate cost due to the
short period of time to maturity. The fair values of the secured revolving
credit note, the subordinated notes (when considering equity instruments related
thereto), 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.
Cash Management
The Company has a cash management program that processes cash receipts
and provides for centralized cash disbursements using certain zero-balance
disbursement accounts. At December 26, 1999 and January 31, 1999, such negative
cash balances total approximately $1.5 million and $.3 million, respectively,
and are included in accounts payable. Inventories
Inventories are carried at the lower of cost or market using the
first-in, first-out method and are comprised
29
<PAGE> 30
of the following:
<TABLE>
<CAPTION>
December 26, January 31,
1999 1999
------- -------
(in thousands)
<S> <C> <C>
Manufactured finished goods $ 7,991 $ 8,263
Finished goods purchased from others 10,370 7,729
Work in progress
180 47
Raw materials
6,748 4,374
------- -------
$25,289 $20,413
======= =======
</TABLE>
Closed store expenses
Future expenses, such as rent and real estate taxes, net of estimated
sublease recovery, and remaining net-book-value of fixed assets, relating to
closed showrooms are charged to operations upon a formal decision to close the
showroom. Closed store expenses were $1,255,000, $422,000, and $115,000, for
fiscal 1999, 1998 and 1997, respectively, and are included in selling expenses
in the accompanying statements of operations.
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 $1,831,000 in fiscal 1999,
$1,633,000 in fiscal 1998, and $1,099,000 in fiscal 1997. Property, equipment
and leasehold improvements are summarized as follows:
<TABLE>
<CAPTION>
December 26, January 31,
1999 1999
-------- --------
(in thousands)
<S> <C> <C>
Leasehold improvements $ 16,649 $ 14,038
Construction in progress 3,642 2,490
Machinery and equipment 1,983 1,919
Office and store furniture 978 873
-------- --------
23,252 19,320
Less accumulated depreciation and amortization (7,660) (6,254)
-------- --------
$ 15,592 $ 13,066
======== ========
</TABLE>
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 $7,915,000 as of December 26,
1999 and $6,980,000 as of January 31, 1999.
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
December 26, 1999. The Company's analysis at December 26, 1999 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
1999, 1998 and 1997 indicate that it is at least reasonably possible that such
30
<PAGE> 31
circumstances could arise in fiscal 2000.
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 $2,622,000
as of December 26, 1999 and $2,407,000 as of January 31, 1999.
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,
color circulars and radio spots, are charged to expense as incurred. Advertising
expenses in the fiscal years ended December 26, 1999, January 31, 1999 and
February 1, 1998 were $13,457,000, $12,272,000 and $11,758,000, 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.
Comprehensive Income
There are no differences between the Company's net loss, as reported,
and comprehensive loss as defined, for the periods presented as of December 26,
1999.
Segment Reporting
The Company has also adopted SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" in fiscal 1998. The Company believes
it currently operates in only one business segment.
Pre-Opening Costs
31
<PAGE> 32
During the first quarter of fiscal 1998, the American Institute of
Certified Public Accountants issued Statement of Position (SOP) No. 98-5
"Reporting on the Costs of Start-Up Activities." This Statement provides
guidance on the financial reporting of start-up costs and organization costs.
The Company adopted this SOP in fiscal 1998 and it did not materially impact the
Company's Consolidated Financial Statements.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if it is, the type of hedge
transaction. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133". SFAS No. 137 delays the effective date of SFAS No.
133 to fiscal years beginning after June 15, 2000. The Company does not expect
that the adoption of SFAS Nos. 133 and 137 will have a material impact on its
consolidated financial statements because the Company does not currently hold
any derivative instruments.
Loss per share
Loss per share for fiscal 1999, 1998 and 1997 was computed based on the
weighted average number of common shares outstanding during each period since
common stock equivalents were antidilutive.
The Company calculates loss per share in accordance with SFAS No. 128,
"Earnings Per Share". This statement requires the presentation of both basic and
diluted net income (loss) per share. Basic net income (loss) per share is
computed by dividing income (loss) available to common stockholders by the
weighted average number of common shares outstanding. Diluted net income (loss)
per share includes the effect of the potential shares outstanding, including
dilutive stock options and warrants using the treasury stock method. Because the
impact of stock options, warrants and deferred stock units totaling 5,620,728
were antidilutive, there is no difference between the loss per share amounts
computed for basic and diluted purposes.
Credit risk
Finance options are offered to customers through non-affiliated third
parties, at no material risk to the Company. Non-financed retail consumer
receivables are collected during the normal course of operations. There is no
significant concentration of credit risk and credit losses have been minimal.
2. OPERATIONS
The Company has reported losses from operations in each of its past five
fiscal periods. As a result of such losses, the Company had an accumulated
deficit of $56,399,000 at December 26, 1999.
In 1997, management implemented 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 both in existing and new
markets and closing underperforming showrooms. To date, 38 showrooms have been
remodeled, 25 showrooms have been opened, and 14 showrooms have been closed.
As more fully described in Note 10, on January 14 and 19, 2000, the
Company completed a private
32
<PAGE> 33
placement of 380,000 shares of Series A Convertible Preferred Stock, net
proceeds from which totaled $18,700,000; of this amount, $10,000,000 is
restricted to the development and implementation of its internet business
initiatives. Management believes this investment will more rapidly enable the
Company to leverage its considerable manufacturing and distribution assets by
becoming a leading retail e-Commerce provider in custom upholstered furniture
while also providing business-to-business solutions for other furniture
e-retailers and independent furniture retailers served by internet alliance
customers; however, there can be no assurance that the Company will be
successful in this regard.
Management believes that the Company has sufficient capital to fund its
plan to remodel showrooms and open new showrooms throughout fiscal 2000, as well
as to support the launch of its business-to-business and e-Commerce initiatives;
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 or available on terms acceptable to the Company. The
Company's long-term success is dependent upon management's ability to
successfully execute its plans and, ultimately, to achieve sustained profitable
operations. In the opinion of management, the plans discussed above are expected
to ultimately return the Company to profitability; however, there can be no
assurance that the Company will achieve profitability.
3. NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
December 26, January 31,
1999 1999
-------- --------
(in thousands)
<S> <C> <C>
Secured revolving credit notes $ 12,655 $ 6,992
Subordinated notes payable to shareholders, unsecured 12,001 12,001
Unamortized debt discount, net of accumulated
amortization of $2,120,000 at December 26, 1999
and $1,320,000 at January 31, 1999 (2,155) (1,705)
Other notes 1,336 1,244
-------- --------
23,837 18,532
Less current portion 491 542
-------- --------
$ 23,346 $ 17,990
======== ========
</TABLE>
The secured revolving credit notes were issued under a revolving credit
agreement, which was most recently amended March 31, 2000, (the "Revolving
Credit Facility") between Krause's and a financial institution that expires
March 2002. The Revolving Credit Facility provides for revolving loans of up to
$15 million, based on the value of eligible inventories. Available borrowing
capacity under the terms of the Revolving Credit Facility at December 26, 1999
was $2,177,000. Substantially all of Krause's assets are pledged as collateral
for the loan that is guaranteed by the Company. Interest on the loan is payable
monthly at a margin ranging from .5% to 1.0% in excess of the prime rate (8.50%
at December 26, 1999) which margin varies depending on the Company's
performance.
The subordinated notes payable to shareholders, which bear interest at
9.5% per annum, were issued pursuant to a Supplemental Securities Purchase
Agreement which was most recently amended April 3, 2000 (the "Agreement").
The Agreement provides, among other things, that if no dividends have been paid
on the Company's Series A Convertible Preferred Stock (Note 10), the Company may
elect to defer interest payments on the subordinated notes payable to
shareholders for any period of time beginning December 1, 1999 and ending on or
prior to December 31, 2000. If the Company elects to defer any such interest,
the holders of the subordinated debt may elect to receive the deferred interest
either in cash at the June 30, 2003 final maturity or in shares of Series A
Convertible Preferred Stock at $50 per share on December 31, 2000. Repayment of
principal is scheduled in quarterly payments commencing March 31, 2001 with the
final payment due June 30, 2003; a previous agreement provided for quarterly
payments of principal commencing April 30, 2000 with the final payment due July
30, 2002. The Agreement also requires the Company to pay 50% of its quarterly
excess cash flow from retail operations, as defined in
33
<PAGE> 34
the Agreement, up to a maximum of $4 million and apply it to principal in the
inverse order of scheduled principal payments.
Concurrent with the 1996 sale of its subordinated notes, the Company
issued to the note holders warrants to purchase an aggregate of 2,700,000 shares
of common stock. The fair value of the warrants, which totals $3,025,000, was
reflected in the consolidated financial statements as a discount on the
subordinated notes and an increase in capital in excess of par value; such
discount is being amortized to interest expense using the effective interest
method over the term of the notes. Also, concurrent with the 1997 sale of
certain of its subordinated notes, the Company issued to the note holders
warrants to purchase an aggregate amount of up to 1,000,000 shares of the
Company's common stock which warrants were completely or partially cancellable
depending upon the Company achieving certain performance targets in 1999. The
performance targets were not met, and the warrants vested at an estimated fair
value of $1,250,000. This value has been reflected in the consolidated financial
statements as a discount on the subordinated notes and an increase in capital in
excess of par value; such discount is being amortized to interest expense using
the effective interest method over the remaining term of the notes.
Pursuant to the terms of the Agreement and the Revolving Credit
Facility, the Company and Krause's are required to maintain certain financial
ratios and minimum levels of net worth and working capital. In addition, the
Company and Krause's are restricted from entering into certain transactions or
making certain payments and dividend distributions without the prior consent of
the lenders. As of December 26, 1999, the Company and Krause's were in
compliance with the terms and conditions of these agreements.
The aggregate annual maturities of long-term debt during each of the
five fiscal years subsequent to December 26, 1999, are approximately as follows:
$491,000 in 2000, $3,552,000 in 2001, $16,828,000 in 2002, $5,013,000 in 2003,
and $13,000 in 2004.
34
<PAGE> 35
4. INCOME TAXES
Income tax benefits differ from the amounts computed by applying the
federal statutory rate of 34% to the loss before income taxes, as follows:
<TABLE>
<CAPTION>
Forty-Seven
Week Transition Fiscal Year Ended
Period Ended --------------------------
December 26, January 31, February 1,
1999 1999 1998
--------------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Tax at federal statutory rate $(3,208) $(1,745) $(2,543)
Goodwill amortization 319 347 347
State income tax, net of federal benefit (438) (280) (390)
Other 826 245 (75)
Adjustment of valuation allowance 2,501 1,433 2,661
--------- --------- ---------
$- $- $-
========= ========= =========
</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>
December 26, January 31,
1999 1999
------------ -----------
(in thousands)
<S> <C> <C>
Deferred tax liabilities $- $-
Deferred tax assets:
Net operating loss carryforwards 16,916 15,043
Reserves and accruals not currently deductible for
tax purposes 3,322 2,694
------- -------
Total deferred tax assets 20,238 17,737
Valuation allowance for deferred tax assets (20,238) (17,737)
------- -------
Net deferred tax assets - -
------- -------
Net deferred taxes $- $-
======= =======
</TABLE>
The change in the valuation allowance was a net increase of $2,501,000
for the fiscal year ended December 26, 1999, and a net increase of $1,433,000
for the fiscal year ended January 31, 1999. The valuation allowance was
increased since the realization of net deferred tax assets is uncertain.
As of December 26, 1999 the Company has federal net operating loss
carryforwards of approximately $45 million which begin to expire in 2003, if not
utilized. As a result of various equity transactions, one of the Company's
subsidiaries has experienced a change of ownership in 1993, as defined in the
Internal Revenue Code. As a result of this ownership change and other provisions
of the Internal Revenue Code, utilization of approximately $11 million of these
net operating loss carryforwards is limited to the future income of one of the
Company's subsidiaries. In addition, the current year's net operating loss
subject to certain restrictions as a result of the change of fiscal year. As of
December 26, 1999, approximately $17 million of the loss carryforwards were
limited. In addition, the Company had state net operating loss carryforwards of
approximately $32 million, which begin to expire in the year beginning December
27, 1999, if not utilized.
5. STOCKHOLDERS' EQUITY
35
<PAGE> 36
In April, 1998, the Company completed a public offering of 2,963,889
shares of its common stock at a price of $3.00 per share. Proceeds of the
offering totaled $7,267,000 after deducting underwriters' fees and offering
expenses. The purpose of this offering was to fund the remodeling of the
Company's existing showrooms, to fund the opening of new showrooms, and for
general corporate purposes.
During 1999, warrants to purchase 65,900 shares of common stock were
exercised at a price of $1.55 per share, and, at December 26, 1999, the Company
had warrants outstanding to purchase an aggregate amount of 2,712,045 shares of
common stock. Of these warrants, 1,400,000 have an exercise price of $0.001 and
expire in 2006, 1,300,000 have an exercise price of $1.25 and expire in 2006,
and the balance of 12,045 have an exercise price of $1.32 and expire in 2005.
The warrants generally provide for certain anti-dilution adjustments. In
addition, in connection with the 1997 sale of certain of its subordinated notes
to shareholders, the Company issued a warrant to such shareholders to purchase
an aggregate amount of 1,000,000 shares of common stock at a price of $0.01 per
share; such warrant was completely or partially cancellable depending upon the
Company achieving certain performance targets in 1999. The performance targets
were not met, and the warrant vested for the full 1,000,000 shares and is
exercisable through August, 2006.
The Company also has 85,225 shares of common stock issuable upon payment
of deferred stock units and options outstanding to purchase an additional
2,823,458 shares of common stock.
As of December 26, 1999, 6,025,728 shares of the Company's authorized
common stock are reserved for issuance upon exercise of warrants and stock
options (see Note 6) and upon payment of deferred stock units. At its annual
meeting in May, 2000, the Company will request shareholder approval to increase
the number of authorized common shares so as to provide for the conversion of
its Series A Convertible Preferred Stock (see Note 10) .
6. STOCK OPTION PLANS
The Company has elected to follow APB 25, "Accounting for Stock Issued
to Employees" and related interpretations in accounting for its employee stock
options because, as discussed below, the alternative fair value accounting
provided for under SFAS No. 123, "Accounting for Stock-Based Compensation"
requires use of option valuation models that were not developed for use in
valuing employee stock options.
The 1997 Stock Incentive Plan provides for the issuance of awards
covering up to 2,000,000 shares of Common Stock to employees, officers,
directors, and consultants. Awards under this plan can consist of options, stock
appreciation rights, dividend equivalent rights, restricted stock, performance
shares, deferred stock units or other stock based awards.
Directors who are not employees of the Company, other than one
non-employee director who has indicated that he cannot accept an award because
of his current employment by a stockholder, receive automatic grants of deferred
stock units covering shares having a fair market value of $10,000 for each year
of service as a director. These awards provide deferred compensation to
directors equivalent to an investment in shares on the date the award is
effective. Payout of the award is made in stock following a director's
retirement from the Board of Directors or death. Normally the payment is made in
five annual installments, but a director may elect to receive a single payment.
In August 1996, the Company awarded the Chief Executive Officer of the
Company an option to purchase 1,234,000 shares of common stock at an exercise
price of $1.00 per share with vesting over three years. Compensation expense was
recorded in the amount of $119,000, $204,000 and $204,000 in fiscal 1999, 1998
and 1997, respectively, based upon the vesting provisions and the market value
of the stock on the date of grant.
Pro forma information regarding net loss and loss per share is required
by SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for fiscal
1999, 1998 and 1997; risk-free interest rates of 5.46%, 5.67% and 6.28%,
dividend yields of 0% for all periods, volatility factors of the expected market
price of the Company's common stock of 84%, 80% and 82%; and a weighted-average
life of the options of 7.0 years for
36
<PAGE> 37
all periods.
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 Company's
pro forma information follows (in thousands, except for per share information):
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- ---------
<S> <C> <C> <C>
Pro forma net loss $(10,180) $ (5,564) $ (7,700)
Pro forma net loss per share $ (0.46) $ (0.26) $ (0.40)
</TABLE>
As of December 26, 1999, under all option plans, a total of 3,228,458
shares of common stock are reserved for future issuance, options to purchase
2,823,458 shares of common stock were outstanding, options to purchase 1,803,458
were exercisable, at a weighted average exercise price of $1.37, and options for
405,000 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 February
2, 1997 to December 26, 1999.
<TABLE>
<CAPTION>
Weighted
Number of Actual Average
Options Exercise Exercise
Price Price
--------- ------------ ------------
<S> <C> <C> <C>
Outstanding February 2, 1997 1,722,457 $ .78-$7.13 $1.35
Granted 417,000 $ 1.56 $1.56
Forfeited (95,499) $2.16-$7.13 $3.54
---------
Outstanding February 1, 1998 2,043,958 $ .78-$6.38 $1.29
Granted 165,000 $ 3.25 $3.25
Forfeited (500) $ 3.18 $3.18
---------
---------
Outstanding January 31, 1999 2,208,458 $ .78-$6.38 $1.44
Granted 680,000 $1.44-$3.00 $1.90
Forfeited (65,000) $1.56-$3.25 $1.97
---------
Outstanding December 26, 1999 2,823,458 $ .78-$6.38 $1.48
=========
</TABLE>
The weighted average grant date fair value of options granted during
fiscal 1999 and 1998, for options where the exercise price on the date of grant
was equal to the stock price on that date, was $1.14 and $2.62, respectively.
The following table reflects the weighted average exercise price of
options outstanding, weighted average remaining contractual life of options
outstanding, number of shares exercisable and the weighted average exercise
price of exercisable options as of December 26, 1999.
37
<PAGE> 38
<TABLE>
<CAPTION>
Weighted Weighted
Average Average Exercise
Number of Actual Weighted Remaining Number of Price of
Options Exercise Average Contractual Options Exercisable
Outstanding Price Range Exercise Price Life Exercisable Options
- ------------- -------------- ---------------- ---------------- ------------ -----------------
<S> <C> <C> <C> <C> <C>
2,359,000 $0.78-$1.62 $1.26 7.0 years 1,609,000 $1.13
464,458 $1.88-$6.38 $2.94 8.7 years 194,458 $3.38
- ------------- ---------
2,823,458 $0.78-$6.38 $1.48 7.3 years 1,803,458 $1.37
============= =========
</TABLE>
7. RETIREMENT PLAN
The Company has a 401(k) retirement plan 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 for fiscal 1999, 1998 or 1997.
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 nine 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 December 26, 1999 under operating leases require
approximate future minimum annual rental payments as follows:
<TABLE>
<CAPTION>
Total
Fiscal Year (in thousands)
--------------
<S> <C>
2000 $20,830
2001 20,009
2002 18,267
2003 16,002
2004 13,641
Thereafter 52,293
========
$141,042
========
</TABLE>
Total rent expense under all operating leases was approximately
$16,318,000, $17,278,000 and $15,456,000 for the fiscal 1999, 1998 and 1997,
respectively.
Litigation
The Company and its subsidiaries are also parties to various legal
actions and proceedings incident to normal business activity. Management
believes that any liability in the event of final adverse determination of any
of these matters would not be material to the Company's consolidated financial
position, liquidity or results of operations.
9. MAJOR SUPPLIERS
During fiscal 1999, the Company's 10 largest suppliers accounted for
60.3% of its aggregate purchases. Two suppliers represented approximately 12.4%
and 10.1% of aggregate purchases for fiscal 1999.
38
<PAGE> 39
10. SUBSEQUENT EVENT
On January 14 and 19, 2000, the Company completed a private placement of
380,000 shares of Series A Convertible Preferred Stock at a price of $50.00 per
share. Proceeds from the private placement totaled $18,700,000 after deducting
legal fees and related expenses. Pursuant to the terms of a Securities Purchase
Agreement between the Company and the purchasers of the Series A Convertible
Preferred Stock, the Company and the purchasers have agreed that $10 million of
the proceeds will be used to launch the Company's business to business and
e-Commerce activities, including commerce related to transactions on the
internet, and that the balance of the proceeds will be used to pay down debt, to
fund the opening of new showrooms, and for general corporate purposes.
Each share of Series A Convertible Preferred Stock is convertible into
approximately 45.45 shares of common stock at any time at the option of the
holder; has voting rights equal to approximately 45.45 shares of common stock;
has certain redemption features; and does not pay a dividend. Conversion is
mandatory upon the occurrence of a qualified public offering, as defined. In the
event of a voluntary or involuntary liquidation, the holders of the Series A
Convertible Preferred Stock have, as to any distribution of assets, a preference
to the holders of common stock in an amount aggregating $19 million. Holders of
the Series A Convertible Preferred Stock may not request redemption prior to
January, 2005, except in the event of a change in control of the Company or a
default, prior to January, 2002, under the Securities Purchase Agreement; an
event of default includes the Company's failure to receive approval of the Board
of Directors of its e-Commerce business plan and its failure to use $10 million
of proceeds from the private placement for its e-Commerce business plan. The
redemption price of the Series A Convertible Preferred Stock is equal to $50.00
per share. The Company has no right to call or redeem any shares of the Series A
Convertible Preferred Stock.
39
<PAGE> 40
11. RESULTS FOR FORTY-SEVEN WEEKS ENDED DECEMBER 27, 1998 (UNAUDITED)
The results for the forty-seven weeks ended December 27, 1998 are as
follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Net sales $ 116,692
Cost of sales 54,705
---------
Gross profit 61,987
Operating expenses:
Selling 55,230
General and administrative 8,412
Amortization of goodwill 935
---------
64,577
---------
Loss from operations (2,590)
Interest expense (2,314)
Other expense (18)
---------
Net loss $ (4,922)
=========
Basic and diluted loss per share $ (0.23)
Number of shares used in computing loss per share 21,446
</TABLE>
40
<PAGE> 41
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Krause's Furniture, Inc.
We have audited in accordance with auditing standards generally accepted
in the United States, the financial statements of Krause's Furniture, Inc. as of
December 26, 1999 and January 31, 1999 and for the forty-seven week transition
period ended December 26, 1999, and the years ended January 31, 1999 and
February 1, 1998, included in this Form 10-K and have issued our report thereon
dated April 3, 2000. Our audit was made for the purpose of forming an opinion on
the basic financial statements taken as a whole. The schedule listed in the
index above is the responsibility of the Company's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
April 3, 2000
41
<PAGE> 42
KRAUSE'S FURNITURE, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FORTY-SEVEN WEEK TRANSITION PERIOD ENDED DECEMBER 26, 1999
AND FISCAL YEARS ENDED JANUARY 31, 1999 AND FEBRUARY 1, 1998
<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>
Forty-Seven Week $180,367 $199,000 $- $182,116 $197,251
Transition Period Ended
December 26, 1999
Fiscal 1998 163,924 286,000 - 269,557 180,367
Fiscal 1997 326,807 180,736 - 343,619 163,924
</TABLE>
(a) Represents accounts written off.
42
<PAGE> 43
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3.1 Certificate of Incorporation.(1)
3.1(a) Certificate of Amendment of Certificate of Incorporation dated November
28, 1994.(5)
3.1(b) Certificate of Amendment of Certificate of Incorporation dated August 1,
1995.(6)
3.1(c) Certificate of Amendment of Certificate of Incorporation dated June
7,1996.(7)
3.1(d) Certificate of Amendment of Certificate of Incorporation dated August 1,
1996.(7)
3.2 By Laws.(16)
4.1 Certificate of Designations of Preferred Stock.(4)
10.1 1994 Directors Stock Option Plan.(16)
10.2 1990 Employees Stock Option Plan.(16)
10.3 1997 Stock Incentive Plan.(9)
10.4 Form of Securities Purchase Agreement between the Company, GECC and
certain other stockholders of the Company dated as if August 26,
1996.(8)
10.5 Form of $5,000,000 10% Subordinated Pay-In-Kind Note due August 31,
2001.(8)
10.6 Form of Warrant to Purchase 1,400,000 Shares of Common Stock.(8) 10.7
Form of Securities Purchase Agreement between the Company and Certain
Stockholders dated as of August 26, 1996.(8)
10.8 Supplemental Securities Purchase Agreement among Krause's Furniture,
Inc., General Electric Corporation and Japan Omnibus Ltd., dated as of
August 14, 1997.(12)
10.9 Letter agreement dated August 14, 1997 regarding Permal Group
shares.(12)
10.10 Letter agreement dated August 14, 1997 regarding warrant dilution
provisions.(12)
10.11 Amendment to the Supplemental Securities Purchase Agreement among
Krause's Furniture, Inc., General Electric Corporation and Japan Omnibus
Ltd., dated as of March 31, 1999.(16)
10.12 Amendment to the Supplemental Securities Agreement by and among Krause's
Furniture, Inc., General Electric Capital Corporation and Japan Omnibus
Ltd., dated December 14, 1999.(16)
10.13 Agreement by and among Krause's Furniture, Inc., General Electric
Capital Corporation, and Japan Omnibus Ltd., dated January 11, 2000.(16)
10.14 Series A Convertible Preferred Stock Securities Purchase Agreement,
dated as of January 11, 2000.(18)
10.15 Amended and Restated Registration Rights Agreement by and among Krause's
Furniture, Inc.(18)
10.16 Amended and Restated Stockholders Agreement by and among Krause's
Furniture, Inc. And the Stockholders Listed on the Signature Pages
Thereof, dated as of January 14, 2000.(18)
10.17 Employment agreement with Philip M. Hawley.(8)
10.18 First amendment to employment agreement between Krause's Furniture, Inc.
And Philip M. Hawley.
10.19 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)
10.20 Guarantee dated January 20, 1995 by Krause's Furniture, Inc. to Congress
Financial Corporation (Western).(3)
10.21 First Amendment to Loan and Security Agreement dated as of May 10, 1996
by and between Congress Financial Corporation (Western) and Krause's
Sofa Factory and Castro Convertible Corporation.(6)
10.22 Second Amendment to Loan and Security Agreement dated as of August 26,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
10.23 Third Amendment to Loan and Security Agreement dated as of November 25,
1996 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(14)
10.24 Amended and Restated Subordination Agreement dated as of August 26, 1996
by and between Congress Financial Corporation (Western) and Krause's
Furniture, Inc.(14)
10.25 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)
10.26 Fifth Amendment to Loan and Security Agreement dated as of December 11,
1997 by and between Congress Financial Corporation (Western) and
Krause's Sofa Factory and Castro Convertible Corporation.(15)
<PAGE> 44
10.27 Sixth Amendment to Loan and Security Agreement dated as of March 15,
1999 by and between Congress Financial Corporation (Western) and
Krause's Custom Crafted Furniture Corp. and Castro Convertible
Corporation.(16)
10.28 Letter agreement between Krause's Furniture, Inc. and Congress Financial
Corporation (Western).(12)
10.29 Seventh Amendment to Loan and Security Agreement dated as of August 23,
1999 by and between Congress Financial Corporation (Western) and
Krause's Custom Crafted Furniture Corp. and Castro Convertible
Corporation.(17)
10.30 Eighth Amendment to Loan and Security Agreement, by and between Congress
Financial Corporation (Western), Krause's Custom Crafted Furniture Corp
and its wholly owned subsidiary, Castro Convertible Corporation, dated
as of December 15, 1999.(18)
10.31 Amendment to Eighth Amendment to Loan and Security Agreement, by and
between Congress Financial Corporation (Western), and Krause's custom
Crafted Furniture, Inc., dated December 22, 1999.(18)
10.32 First Amendment to Amended and Restated Subordination Agreement, dated
as of December 15, 1999, by and between Congress Financial Corporation
(Western) and Krause's Furniture, Inc.(18)
21 Subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
27 Financial Data Schedule
(1) Incorporated herein by reference to Exhibits to Registrant's Form S-4
dated June 19, 1992 (File No. 33-48725).
(2) Incorporated herein by reference to Exhibit 10.2 to Registrant's Form
10-K for the year ended December 31, 1990 (File No. 0-17868).
(3) Incorporated herein by reference to Exhibit to Registrant's Form 8-K
dated as of January 20, 1995 (File No. 0-17868).
(4) Incorporated herein by reference to Exhibit 4.3 to Registrant's Form 8-K
dated as of October 7, 1993 (File No. 0-17868).
(5) Incorporated herein by reference to Exhibit 10.1 to Registrant's Form
10-K dated as of December 31, 1994 (File No. 0-17868).
(6) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated as of January 28, 1996 (File No. 0-17868).
(7) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of July 28, 1996 (File No. 0-17868).
(8) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 26, 1996 (File No. 0-17868).
(9) Incorporated herein by reference to Exhibits to Registrant's Form S-1
dated March 12, 1997 (File No. 333-19485).
(10) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(11) Incorporated herein by reference to Exhibits to Registrant's Proxy
Statement on Schedule 14A dated May 7, 1997 (File No. 0-17868).
(12) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of August 14, 1997 (File No. 0-17868).
(13) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 17, 1997 (File No. 0-17868).
(14) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated May 2, 1997 (File No. 0-17868).
(15) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated April 30, 1998 (File No. 0-17868).
(16) Incorporated herein by reference to Exhibits to Registrant's Form 10-K
dated April 23, 1999 (File No. 0-17868).
(17) Incorporated herein by reference to Exhibits to Registrant's Form 10-Q
dated as of December 15, 1999 (File No. 0-17868).
(18) Incorporated herein by reference to Exhibits to Registrant's Form 8-K
dated as of February 4, 2000 (File No. 0-17868).
<PAGE> 1
FIRST AMENDMENT TO
EMPLOYMENT AGREEMENT
Exhibit 10.18
BETWEEN
KRAUSE'S FURNITURE, INC.
AND
PHILIP M. HAWLEY
This First Amendment to Employment Agreement is effective as of February
13, 1998, between Krause's Furniture, Inc. ("KFI") and Philip M. Hawley, is
entered into to amend the Employment Agreement between the parties hereto dated
as of August 26, 1996 (the "Employment Agreement"), with reference to the
following facts:
A. Mr. Hawley has served as the Chairman of the Board and Chief Executive
Officer, the position of senior responsibility and authority within the
KFI Organization since his appointment pursuant to the Employment
Agreement.
B. The purpose of this Agreement is to express the terms upon which KFI and
Mr. Hawley agree to extend the term of employment of Mr. Hawley as
Chairman of the Board and Chief Executive Officer of KFI.
C. Mr. Hawley's services to KFI as Chief Executive are extremely valuable
to KFI and the importance of his leadership and the extraordinary
responsibilities and demands of his role in the affairs of KFI warrant
contractual arrangements of the nature herein provided.
D. Each of KFI and Mr. Hawley wishes to extend the term of Mr. Hawley's
employment by KFI in his current capacity as Chairman of the Board and
Chief Executive, subject to the provisions herein.
1. Amendment to Employment Agreement. The Employment Agreement shall be and
it hereby is amended as follows:
1.1. Extension of Employment Term. Section II.C. of the Employment
Agreement is hereby amended and restated in its entirety to read
as follows:
"II.C. Term Mr. Hawley is hereby employed for a period commencing
on August 26, 1996 and ending on January 28, 2001."
Other Termination. Section II.G. of the Employment Agreement is amended to
insert in the fourth line of the third paragraph thereof, in place of the date
"August 26, 1999", the date January 29, 2001".
2. No Other Changes. Except as specifically modified and amended hereby,
the Employment Agreement and all terms, covenants and conditions therein
shall remain in
<PAGE> 2
full force and effect in the form in which executed.
3. References to Employment Agreement. From and after the date hereof any
reference in the Employment Agreement or in other materials to the
Employment Agreement and to any time from or after the date hereof shall
mean and refer to the Employment Agreement as modified and amended
hereby, unless otherwise specifically provided.
4. Entire Agreement. With respect to the matters covered herein the
Employment Agreement, as modified and amended by this Amendment,
contains the entire agreement and understanding between Mr. Hawley and
KFI and supersedes all prior or and written agreements, understandings,
commitments and practices between the parties, including all prior
employment agreements, whether or not fully performed by Mr. Hawley
before the effective date hereof. No amendments to this Employment
Agreement or this Amendment may be made except by a writing signed by
both parties.
5. Titles and Headings. Title and headings in this Amendment are for ease
of reference and convenience and shall not be used to affect the meaning
of any provision of this Amendment or the Employment Agreement.
IN WITNESS WHEREOF, the parties hereto have executed this First
Amendment to Employment Agreement as of the day and year first above written.
/s/ Philip M. Hawley
-----------------------------------------
PHILIP M. HAWLEY
KRAUSE'S FURNITURE, INC.
By: /s/ Thomas M. DeLitto____
-----------------------------------------
Name: Thomas M. DeLitto
Title: Vice Chairman of the Board
Date: 5/27/98
<PAGE> 1
Exhibit 21
SUBSIDIARIES OF REGISTRANT
<TABLE>
<CAPTION>
Name of Subsidiary State of Incorporation
- ------------------ ----------------------
<S> <C>
Krause's Custom Crafted Furniture Corp. California
(business operated under the names
"Krause's Custom Crafted Furniture Corp." , "Krause's Sofa Factory",
"Sofa Factory", and "Castro Convertibles")
KMC Enterprises, Inc. Delaware
</TABLE>
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorportation of
our reports included in this Form 10-K, into the Company's previously filed
Registration Statements File Nos. 33-81168 and 333-59317.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
April 3, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-26-1999
<PERIOD-START> FEB-01-1999
<PERIOD-END> DEC-26-1999
<CASH> 80
<SECURITIES> 0
<RECEIVABLES> 766
<ALLOWANCES> 197
<INVENTORY> 25,289
<CURRENT-ASSETS> 26,594
<PP&E> 23,252
<DEPRECIATION> 7,660
<TOTAL-ASSETS> 57,761
<CURRENT-LIABILITIES> 28,190
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 4,243
<TOTAL-LIABILITY-AND-EQUITY> 57,761
<SALES> 130,310
<TOTAL-REVENUES> 130,310
<CGS> 60,236
<TOTAL-COSTS> 60,236
<OTHER-EXPENSES> 76,729
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,831
<INCOME-PRETAX> (9,435)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,435)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,435)
<EPS-BASIC> (0.43)
<EPS-DILUTED> (0.43)
</TABLE>
