10-Q 1 form10q_15432.txt FORM 10-Q DATED AUGUST 4, 2007 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 ----------------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 4, 2007 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File No. 1-10892 HAROLD'S STORES, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Oklahoma 73-1308796 -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 5919 Maple Avenue Dallas, Texas 75235 (214) 366-0600 -------------------------------------------------------------------------------- (Address of principal executive (Registrant's telephone number, offices)(Zip Code) including area code) 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 whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [_] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of August 31, 2007, the registrant had 6,223,508 shares of Common Stock outstanding. ================================================================================ Harold's Stores, Inc. & Subsidiaries Index to Quarterly Report on Form 10-Q For the Period Ended August 4, 2007 Part I - FINANCIAL INFORMATION Page ------------------------------ ---- Item 1. Financial Statements Consolidated Balance Sheets - August 4, 2007 (unaudited) and February 3, 2007............... 3 Consolidated Statements of Operations - Thirteen and Twenty-six Weeks ended August 4, 2007 (unaudited) and July 29, 2006, (unaudited).................... 5 Consolidated Statements of Cash Flows - Twenty-six Weeks ended August 4, 2007 (unaudited) and July 29, 2006, (unaudited)................................ 6 Notes to Interim Consolidated Financial Statements................ 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................... 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 25 Item 4. Controls and Procedures........................................... 26 Part II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings................................................. 26 Item 1A. Risk Factors...................................................... 26 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 26 Item 3. Defaults Upon Senior Securities................................... 26 Item 4. Submission of Matters to a Vote of Security Holders............... 26 Item 5. Other Information................................................. 26 Item 6. Exhibits.......................................................... 26 Signatures........................................................ 27 2 PART I ------ ITEM 1. FINANCIAL STATEMENTS HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS (In Thousands)

~~Part~~August I4, -February ~~FINANCIAL~~3, ~~INFORMATION~~2007 ~~Page~~2007 ------------ ------------~~------~~ ~~---- Item 1. Financial Statements Consolidated Balance Sheets - May 5, 2007~~ (~~unaudited~~Unaudited) ~~and~~Current ~~February~~assets: 3,Cash ~~2007....................~~and 3cash ~~Consolidated~~equivalents ~~Statements~~$ of889 ~~Operations~~$ -979 ~~Thirteen~~Trade ~~Weeks~~accounts ~~ended May 5~~receivable, ~~2007~~less ~~(unaudited)~~allowance ~~and~~for ~~April~~doubtful ~~29,~~accounts ~~2006,~~of ~~(unaudited).........~~$75 5as ~~Consolidated Statements~~ of ~~Cash~~August ~~Flows - Thirteen Weeks ended May 5~~4, 2007 ~~(unaudited)~~ and ~~April~~February 293, ~~2006~~2007 5,162 ~~(unaudited).........~~ 6,074 ~~Notes~~Note ~~to Interim Consolidated Financial Statements............................................ 7 Item 2. Management's Discussion~~ and ~~Analysis~~other ofreceivables ~~Financial~~1 ~~Condition~~1 ~~and~~Merchandise ~~Results~~inventories ~~of Operations.........~~ 18,362 ~~Item~~19,389 3.Prepaid ~~Quantitative~~expenses ~~and~~2,006 ~~Qualitative~~2,136 ~~Disclosures~~------------ ~~About~~------------ ~~Market~~Total ~~Risk....................................~~current 25assets ~~Item 4. Controls and Procedures.......................................................................~~ 26,420 ~~Part~~28,579 II - ~~OTHER INFORMATION~~ ----------- ------------~~----~~ ~~Item~~Property 1.and ~~Legal~~equipment, ~~Proceedings.............................................................................~~at 26cost ~~Item~~42,456 ~~1A.~~44,078 ~~Risk~~Less ~~Factors..................................................................................~~accumulated 26depreciation ~~Item 2. Unregistered Sales of Equity Securities~~ and ~~Use~~amortization of(33,764) ~~Proceeds...................................~~(34,157) 26------------ ~~Item~~------------ 3.Net ~~Defaults~~property ~~Upon~~and ~~Senior~~equipment ~~Securities...............................................................~~8,692 269,921 ~~Item~~------------ 4.------------ ~~Submission~~Total ofassets ~~Matters~~$ to35,112 a$ ~~Vote~~38,500 of============ Security Holders........................................... 26 Item 5. Other Information............................................................................. 26 Item 6. Exhibits...................................................................................... 26 Signatures.................................................................................... 27============

The accompanying notes are an integral part of the interim consolidated financial statements. 3 HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' DEFICIT (In Thousands Except Share Data)

~~May~~August 54, February 3, 2007 2007 ------------ ------------ (Unaudited) Current liabilities: Accounts payable $ 67,~~233~~493 $ 9,765 Redeemable gift certificates ~~954~~894 1,220 Accrued payroll expenses and bonuses ~~673~~642 565 Accrued rent expense ~~382~~364 384 Deferred gain on sale of building 3718 55 Current maturities of long-term debt 24,~~234~~578 22,502 ------------ ------------ Total current liabilities 3233,~~513~~989 34,491 ------------ ------------ Accrued rent expense, net of current 43,~~215~~921 4,527 Stock warrant liability (See Note 8) ~~832~~847 818 Long-term debt, net of current maturities (See Note 5) 8,~~576~~510 7,583 ------------ ------------ Total long-term liabilities 13,~~623~~278 12,928 ------------ ------------ Total liabilities 4647,~~136~~267 47,419 Commitments and contingencies (See Note 7) Convertible preferred stock of $.01 par value (See Note 8) Amended Series 2001-A, authorized 500,000 shares, issued and outstanding 342,653 as of ~~May~~August 54, 2007 and February 3, 2007 6,853 6,853 Series 2002-A, authorized 300,000 shares, issued and outstanding 231,550 as of ~~May~~August 54, 2007 and February 3, 2007 4,631 4,631 Series 2003-A, authorized 100,000 shares, issued and outstanding 56,742 as of ~~May~~August 54, 2007 and February 3, 2007 5,674 5,674 Series 2006-A, authorized 75,000 shares, issued and outstanding 25,000 as of ~~May~~August 54, 2007 and February 3, 2007 2,~~491~~492 2,490 Series 2006-B, authorized 15,000 shares as of ~~May~~August 54, 2007 and 25,000 as of February 3, 2007, none issued and outstanding as of ~~May~~August 54, 2007 and February 3, 2007 -- -- Series 2007-A, authorized 5,000 shares as of ~~May~~August 54, 2007 and none as of February 3, 2007, issued and outstanding 2,000 as of ~~May~~August 54, 2007 and none as of February 3, 2007 21,~~000~~987 -- Series 2007-B, authorized 5,000 shares as of ~~May~~August 54, 2007 and none as of February 3, 2007, none issued and outstanding as of ~~May~~August 54, 2007 and February 3, 2007 -- -- 2001-A and 2002-A entitled to $20.00 per share; 2003-A and 2006-A entitled to $100.00 per share; and 2006-B, 2007-A and 2007-B entitled to $1,000 per share; in each case plus accrued but unpaid dividends in the event of liquidation: aggregate liquidation value as of ~~May~~August 54, 2007 of $2324,~~525~~032,~~217~~166 ------------ ------------ 21,~~649~~637 19,648 Stockholders' deficit: Common stock of $.01 par value Authorized 25,000,000 shares; issued and outstanding 6,223,508 as of ~~May~~August 54, 2007 and February 3, 2007 62 62 Additional paid-in capital 34,~~607~~630 34,585 Accumulated deficit (6368,~~702~~482) (63,212) ------------ ------------ (2933,~~033~~790) (28,565) Less: Treasury stock of 205 shares as of ~~May~~August 54, 2007 and February 3, 2007 recorded at cost (2) (2) ------------ ------------ Total stockholders' deficit (2933,~~035~~792) (28,567) ------------ ------------ Total liabilities and stockholders' deficit $ 3835,~~750~~112 $ 38,500 ============ ============

The accompanying notes are an integral part of the interim consolidated financial statements. 4 HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands Except Per Share Data)

13 Weeks Ended 26 Weeks Ended ---------------------------- ~~May~~---------------------------- 5August 4, ~~April~~July 29, August 4, July 29, 2007 2006 2007 2006 ------------ ------------ ~~Cash~~------------ ~~flows~~------------ ~~from~~Sales ~~operating~~$ ~~activities:~~17,528 ~~Net~~$ ~~loss~~19,283 $ ~~(489)~~39,960 $ ~~(931)~~40,391 ~~Adjustments~~Costs toand ~~reconcile~~expenses: ~~net~~Costs ~~loss~~of togoods ~~net~~sold ~~cash~~(including ~~used~~occupancy inand ~~operating~~central ~~activities:~~buying ~~Depreciation~~expenses, ~~and~~exclusive ~~amortization~~of ~~822~~items ~~852~~shown ~~Gain~~separately onbelow) ~~sale~~14,386 of16,541 ~~assets~~28,320 29,952 ------------ ~~(19)~~------------ ~~Recognition~~------------ of------------ ~~deferred~~Gross ~~gain~~margin on3,142 ~~sale~~2,742 of11,640 ~~building~~10,439 ~~(18)~~Selling, ~~(18)~~general ~~Stock~~and ~~options~~administrative ~~expense~~expenses 226,056 --6,345 ~~Stock~~13,332 ~~warrants~~13,668 ~~expense~~Depreciation 67and --amortization ~~Changes~~933 in864 ~~assets~~1,756 ~~and~~1,716 ~~liabilities:~~------------ ~~Increase~~------------ in------------ ~~trade~~------------ ~~and~~Operating ~~other~~loss ~~accounts receivable~~ (~~965~~3,847) (~~617~~4,467) ~~Decrease~~ (~~increase~~3,448) ~~in merchandise inventories 424~~ (34,~~810~~945) ~~Decrease~~Interest inexpense ~~prepaid~~946 ~~expenses~~597 ~~100~~1,855 631,068 ~~Decrease~~Gain inon ~~accounts~~sale ~~payable~~of building (~~3,532~~18) (~~2,053~~18) ~~Decrease in accrued expenses~~ (~~491~~37) (~~534~~36) ------------ ------------ ~~Net~~------------ ~~cash~~------------ ~~used~~928 in579 ~~operating activities (4~~1,~~060)~~818 (71,~~067)~~032 ------------ ------------ ~~Cash~~------------ ~~flows~~------------ ~~from~~Loss ~~investing~~before ~~activities:~~income ~~Acquisition~~taxes of(4,775) ~~property~~(5,046) ~~and equipment~~ (~~282~~5,266) (~~999~~5,977) ~~Proceeds~~Benefit ~~from~~for ~~disposal~~income oftaxes ~~property~~-- ~~and~~-- ~~equipment~~ -- ~~18 Payments received for notes receivable~~ -- 5 ------------ ------------ ~~Net cash used in investing activities (282) (976)~~ ------------ ------------ ~~Cash~~Net ~~flows~~loss ~~from~~$ ~~financing~~(4,775) ~~activities:~~$ ~~Borrowings on long-term debt 1~~(5,~~000~~046) --$ ~~Payments on long-term debt~~ (865,266) $ (335,977) ~~Advances~~============ on============ ~~revolving~~============ ~~line~~============ ofNET ~~credit~~LOSS ~~27,609~~APPLICABLE ~~30,585~~TO ~~Payments~~COMMON onSTOCKHOLDERS: ~~revolving~~Net ~~line~~loss of$ ~~credit~~ (254,~~872~~775) $ (215,~~894~~046) ~~Proceeds~~$ ~~from~~(5,266) ~~issuance~~$ ~~of preferred stock 2~~(5,~~000~~977) --Less: Preferred stock dividends --and ~~(151)~~accretion ~~----------~~of ~~----------~~preferred ~~Net~~stock ~~cash~~issuance ~~provided~~costs by509 ~~financing~~389 ~~activities~~949 ~~4,651~~758 ~~8,507~~ ------------ ------------ ~~Net increase in cash and cash equivalents 309 464 Cash and cash equivalents at beginning of period 979 636~~ ------------ ------------ ~~Cash~~Net ~~and~~loss ~~cash~~applicable ~~equivalents~~to atcommon ~~end~~stockholders of$ ~~period~~(5,284) $ 1(5,~~288~~435) $ 1(6,~~100~~215) $ (6,735) ============ ============ ~~Non-cash~~============ ~~investing~~============ ~~and~~Net ~~financing~~loss ~~activities:~~per ~~Preferred~~common ~~stock~~share: ~~dividends~~Basic ~~paid~~$ in(0.85) ~~shares~~$ of(0.87) ~~preferred~~$ --(1.00) ~~218~~$ ~~stock~~(1.08) ~~Equipment~~============ ~~purchased~~============ ~~under~~============ ~~capital~~============ ~~lease~~Diluted ~~obligations~~$ 21(0.85) --$ ~~Supplemental~~(0.87) ~~cash~~$ ~~flow~~(1.00) ~~information:~~$ ~~Cash~~(1.08) ~~paid~~============ ~~for~~============ ~~interest~~============ ~~514 346~~============

The accompanying notes are an integral part of the interim consolidated financial statements. 5 HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) (Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements. 6 HAROLD'S STORES, INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS August 4, 2007 and July 29, 2006 (Unaudited) 1. Unaudited Interim Periods ------------------------- In the opinion of the Company's management, all adjustments (all of which are normal and recurring) have been made which are necessary to fairly state the financial position of the Company as of August 4, 2007 and the results of its operations and cash flows for the thirteen and twenty-six week periods ended August 4, 2007 and July 29, 2006. The results of operations for the thirteen and twenty-six week periods ended August 4, 2007 and July 29, 2006 are not necessarily indicative of the results of operations that may be achieved for the entire year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended February 3, 2007. 2. Definition of Fiscal Year ------------------------- The Company has a 52-53 week year which ends on the Saturday closest to January 31. The period from February 4, 2007 through February 2, 2008, has been designated as 2007. 3. Basis of Presentation --------------------- The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated. 4. Recent Accounting Pronouncements -------------------------------- In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes." This Interpretation sets forth a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The cumulative effect of adoption of FIN 48 did not result in any adjustment in the Company's liability for unrecognized income tax benefits. There have been no significant changes to the total amount of unrecognized tax benefits associated with uncertain tax positions during the thirteen weeks ended August 4, 2007. Although the Company believes it has adequately provided for all tax positions, amounts asserted by tax authorities could be greater or less than the Company's accrued position. Accordingly, the Company's provisions on federal, state and local tax-related matters to be recorded in the future may change as revised estimates are made or the underlying matters are settled or otherwise resolved. As of August 4, 2007, the Company does not believe that its estimates, as otherwise provided for, on such tax positions will significantly increase or decrease within the next twelve months. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of SFAS No. 157 are to be applied prospectively as of the beginning of the fiscal year in which it is initially applied, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the standard but does not anticipate the adoption of this standard will have a material impact on its 2007 financial statements. 7 In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities--Including an Amendment of FASB Statement No. 115" ("SFAS No. 159"). SFAS No. 159 allows companies the choice to measure many financial instruments and certain other items at fair value. This gives a company the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently reviewing the impact of SFAS No. 159 but does not anticipate the adoption of this standard will have a material impact on its 2007 financial statements. 5. Long-Term Debt -------------- The Company's original three-year credit facility with Wells Fargo Retail Finance II, LLC, ("WFRF") was entered into on February 5, 2003. As discussed below, in January 2006, the maximum available credit line was increased, and the expiration date was extended to February 5, 2010. The credit facility is secured by substantially all assets of the Company and its subsidiaries and is subject to a borrowing base calculation based primarily on inventory and accounts receivable. The facility has two financial covenants, a minimum excess availability covenant of $1.35 million, which was reduced to $1.0 million in January 2006 and reduced again to $500,000 in April 2007, and a maximum capital expenditure covenant, established at $2.8 million for 2007. Interest rates under the facility are at prime plus 0.5% or LIBOR plus 2.50%, with the ability to reduce the rate if the Company achieves certain financial criteria. The balance outstanding on the Company's line of credit at August 4, 2007 was $24,259,000 which includes the $7 million outstanding under the bridge facility discussed below. The Company's line of credit had an average balance of $23,743,000 and $23,600,000 for the twenty-six weeks ended August 4, 2007 and July 29, 2006, respectively. During the twenty-six weeks ended August 4, 2007, the WFRF line of credit had a high balance of $26,007,000. At August 4, 2007 the Company's availability under the WFRF line of credit was approximately $1,703,000 above the minimum availability requirement of $500,000 and the average interest rate on the credit line was 8.00%. In July 2003, the Company negotiated an increase of $2 million in its total borrowing availability under its existing credit facility with WFRF. The Company obtained this increase in order to provide additional working capital. The full $2 million was available for borrowing on July 15, 2003 and has been extended to the Company by WFRF based upon a loan participation agreement between WFRF and RonHow, LLC ("RonHow"), an entity established in July 2003 which is owned and controlled directly or indirectly by Ronald de Waal and W. Howard Lester. Mr. de Waal and Mr. Lester are both major beneficial owners of the Company's common and preferred stock. In order to achieve additional liquidity, in January 2006, the Company entered into an amendment to its existing credit facility with WFRF which increased the Company's borrowing availability under the facility. The amendment extended the term of the credit facility by three years, with a new expiration of February 5, 2010. The amendment also increased the maximum revolver amount from the lesser of $25 million or $22 million plus outstanding participant advances to the lesser of $28 million or $22 million plus outstanding participant advances. Additionally, the minimum required excess availability under the credit facility was reduced from $1.35 million to $1.0 million. Finally, the amendment provided for an increase of $3 million in the Company's borrowing availability under the facility based upon an increase in the existing loan participation agreement between WFRF and RonHow. WFRF will continue to serve as the lending agent for the Company under the credit facility, and the principal covenants and conditions imposed upon the Company pursuant to the WFRF credit facility agreement have not materially changed. RonHow's right to repayment of any advances under the credit facility that are attributable to its participation is generally subordinate to the repayment rights of the other credit facility lenders. However, the Company may repay these advances provided it meets certain conditions, including, for payments of up to $2 million of these advances, the maintenance of an average daily excess availability under the credit facility of at least $1.5 million for the 30 days prior to and 30 days projected immediately following the repayment, and 8 for payments of the remaining amount of these advances, the maintenance of an average daily excess availability under the credit facility of at least $2.5 million for the 30 days prior to and 30 days projected immediately following the repayment. The average excess availability requirement is higher than the excess availability otherwise required of the Company under the credit facility. In consideration for RonHow's agreement to fund the Company's additional $3 million in borrowing capacity under the credit facility, the Company granted to RonHow the right to convert any of the incremental $3 million not repaid into shares of a new series of authorized but unissued preferred stock, designated Series 2006-A Preferred Stock. The Series 2006-A Preferred Stock to be issued upon conversion of this option will be convertible into shares of common stock at a price of $0.87 per share, equal to the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the loan amendment. Additionally, the Company began paying an additional 4% fee per annum on the outstanding new participation amount up to $3 million, which commenced January 24, 2006. This fee is in addition to the additional 4% fee per annum which the Company will be obligated to pay on up to $2 million of the outstanding participation amount funded by RonHow in April 2004 commencing on March 1, 2006. In connection with the foregoing transactions, the Company and RonHow agreed upon a new repayment priority for RonHow's participations in the credit facility. Unless otherwise agreed to by the Company and RonHow at the time of any repayment, any repayments of participations will be applied first to the repayment of RonHow's first $2 million participation funded in July 2003, next to the repayment of the RonHow's second $2 million participation funded in April 2004, and finally to the repayment of RonHow's new $3 million participation funded on January 24, 2006. The parties amended the Option Agreement previously executed on April 30, 2004, to document this agreement. As part of the foregoing participation transaction, WFRF, RonHow and the Company entered into a letter of understanding which established a framework for RonHow to obtain the right to convert its aggregate $7 million participation in the Company's credit facility into a subordinated loan to the Company, subject to the negotiation of mutually acceptable definitive agreements. The Company has agreed that the options to convert to preferred stock granted by the Company to RonHow to permit RonHow to convert its new $3 million participation and its prior $2 million participation funded in April 2004 would continue to apply to any such subordinated loan to the extent such participations are converted. On August 31, 2006, the Company and RonHow entered into a $10 million Subordinated Loan Agreement ("Loan Agreement") pursuant to which RonHow loaned the Company $5.0 million (the "Loan"). The Loan is repayable at maturity on May 31, 2010 with interest payable monthly at the rate of 13.5% per year. $4.7 million of the Loan was used to pay down the principal balance of the Company's existing indebtedness under its revolving credit facility with WFRF and the $300,000 balance will be used as described below. The Company has the right to reborrow under the WFRF credit facility in accordance with its terms. In consideration of this Loan, the Company also issued to RonHow a 10-year warrant to purchase up to 1,032 shares of a new series of preferred stock, designated Series 2006-B Preferred Stock with a liquidation value of $1,000 per share, at a purchase price of $0.01 per share, which will be vested ratably over the term of the Loan and will become exercisable upon payment in full or in the event of default under the Loan. These warrants were valued by an independent appraisal firm engaged by the Company to provide such services. These warrants are included in long-term liabilities on the Company's consolidated balance sheet. See Note 5 for additional information. The Loan is also convertible into Series 2006-B Preferred Stock at the option of RonHow at the rate of $1,000 of principal or accrued interest converted for each share of Series 2006-B Preferred Stock. Under the terms of the Loan Agreement, RonHow also has the option to advance an additional $5 million. The Loan is guaranteed by the Company's subsidiaries and is secured by a security interest in all of the Company's and its subsidiaries' personal property. RonHow's rights to the collateral and to payment is subordinate to the Company's existing indebtedness to WFRF pursuant to the terms of a Subordination and Intercreditor Agreement between RonHow, WFRF and the Company. 9 In connection with the Loan, the Company and WFRF entered into an amendment to the existing credit facility to permit the new Loan from RonHow and to permit the $300,000 of additional funds loaned by RonHow to be used, at the Company's discretion and subject to certain conditions, for a transaction that would reduce the number of record holders of the Company's common stock so that the Company would no longer be required to file reports with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 (a "De-registration Transaction"). If the Company determines not to do a De-registration Transaction, the additional $300,000 will be used to pay down the balance of the existing WFRF credit facility. Other than to permit the Loan and the De-registration Transaction, there were no other material changes to the WFRF credit facility terms. On June 5, 2007, the Company filed the necessary reports with the Securities and Exchange Commission to commence this process of De-registration. The Series 2006-B Preferred Stock issuable upon conversion of the Loan or upon exercise of the warrant will be convertible into shares of common stock at a price of $0.43 per share, equal to the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the Loan. On April 3, 2007, RonHow loaned the Company an additional $2 million under the Subordinated Loan Agreement and an additional $1 million on May 2, 2007, bringing the aggregate amount outstanding to $10 million prior to converting $2 million of this debt into 2007-A Preferred Stock during April 2007. See Note 8 for further discussion of this preferred stock transaction and additional changes to the terms of the Loan Agreement. See Note 12 for additional funding received under the Subordinated Debt Agreement. These transactions were approved by the Company's independent directors. The Company was in compliance with its debt covenants for the period ended August 4, 2007. Although the Company's line of credit with WFRF does not expire until February 2010, the Company has classified its borrowings under its line of credit as current in its consolidated balance sheets due to the terms of its agreement with the lender. Under the bank agreement, there is an acceleration clause which potentially allows the bank to demand immediate payment of all outstanding borrowings upon the occurrence of a material adverse change in the Company's operations or financial position. Determination of what constitutes a material adverse change is at the discretion of the bank, however, it is subject to reasonableness standards. In addition, the Company is required to maintain a lock-box agreement with the bank whereby all cash received is applied against current borrowings. As a result of these items, the Company is required to classify its line of credit borrowings as current as proscribed by EITF 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that include both a Subjective Acceleration Clause and a Lock-Box Arrangement." 6. Income Taxes ------------ The Company's federal net operating losses ("NOL") of approximately $38.9 million will begin to expire in 2021. The Company also has state net operating losses of approximately $37.5 million which begin to expire in 2007. During 2002, the Company increased its valuation allowance to fully provide for all remaining deferred tax assets because the Company's recent history of operating losses made the realization of these assets uncertain. The Company's valuation allowance as of August 4, 2007 and February 3, 2007 is equal to 100% of its deferred tax assets. The ability of the Company to utilize net operating loss carryforwards to reduce future federal taxable income and federal income tax of the Company is subject to various limitations under the Internal Revenue Code of 1986 ("the Code"), as amended. The utilization of such carryforwards may be limited upon the occurrence of certain ownership changes, including the issuance or exercise of rights to acquire stock, the purchase or sale of stock by 5% stockholders, as defined in the Treasury regulations, and the offering of stock by the Company during any three-year period resulting in an aggregate change of more than 50% in the beneficial ownership of the Company. 10 The state tax rate decreased significantly during 2006 due to the Company's increased loss position on both a consolidated and individual company basis. In the event of an ownership change (as defined for income tax purposes), Section 382 of the Code imposes an annual limitation on the amount of a corporation's taxable income that can be offset by these carryforwards. The limitation is generally equal to the product of (i) the fair market value of the equity of the Company multiplied by (ii) a percentage approximately equivalent to the yield on long-term tax exempt bonds during the month in which an ownership change occurs. The Company's management, in consultation with its tax advisors, determined in 2004 that a change in ownership had occurred on October 1, 2002, and that this change resulted in a limitation on the Company's ability to utilize its NOLs under Section 382 of the Code. As a result of the limitation, the Company may only utilize $1.0 million per year of its total October 1, 2002 pre-change NOL of $12.5 million. Any portion of the $1.0 million annual limitation not utilized in a particular year may be carried over to the next year and added to that year's limitation. Based on the Company's taxable losses, the cumulative excess annual limitation carryover to 2007 is approximately $3.4 million. 7. Legal Proceedings ----------------- The Company is occasionally involved in various claims, administrative agency proceedings and litigation arising out of the normal conduct of its business. At August 4, 2007, there were no pending litigation matters. 8. Preferred Stock and Warrants to Purchase Preferred Stock -------------------------------------------------------- The Company has authorized 1,000,000 shares of preferred stock, par value $.01 per share. This preferred stock may be issued in one or more series and the terms and rights of such stock will be determined by the Board of Directors. As of August 4, 2007, The Board had authorized seven series of preferred stock, the Amended Series 2001-A Preferred Stock consisting of 500,000 shares, the 2002-A Preferred Stock consisting of 300,000 shares, the 2003-A Preferred Stock consisting of 100,000 shares, the 2006-A Preferred Stock consisting of 75,000 shares, the 2006-B Preferred Stock consisting of 15,000 shares, the 2007-A Preferred Stock consisting of 5,000 shares, and the 2007-B Preferred Stock consisting of 5,000 shares. On February 28, 2001, the Company executed a definitive agreement to allow an investor to purchase from the Company 300,000 shares of convertible preferred stock for a total purchase price of $6 million. Under this preferred stock agreement, each of the 300,000 initially issued shares of preferred stock is convertible into 15.6863 shares of common stock of the Company. The preferred shares have voting rights equal to the number of common shares into which they may be converted. Until converted, the preferred stock is entitled to receive quarterly dividends that cumulate annually at a rate of 10% per annum, which are reduced to 8% per annum if the Company's operating income for any fiscal year ending after February 28, 2001 exceeds $4,735,000. Dividends are payable in additional shares of preferred stock or cash as the holder of the preferred stock may elect. Shares of preferred stock issued in respect of dividends are convertible into common stock based upon an average market price of the common stock as of the respective dividend dates. The preferred shares are redeemable at the option of the Company at a price equal to the initial purchase price plus cumulated and accrued but unpaid dividends. On August 2, 2002, the Company executed a definitive agreement to allow a group of investors to purchase from the Company 200,000 shares of Series 2002-A convertible preferred stock for a total purchase price of $4 million. Under this preferred stock agreement, each of the 200,000 issued shares of preferred stock is convertible into common stock of the Company at a fixed rate of $2.72 per share. The preferred shares have voting rights equal to the number of common shares into which they may be converted. Until converted, the preferred stock is entitled to receive quarterly dividends that cumulate annually at a rate of 8% per annum, which is reduced to 6% per annum if certain profitability targets are met by the Company. Dividends are payable in additional shares of 11 preferred stock or cash as the holder of the preferred stock may elect. The Series 2002-A Preferred Stock is redeemable at the option of the Company at a price equal to the initial purchase price plus cumulated and accrued but unpaid dividends. On February 5, 2003, the Company closed on a $5 million private equity investment by Inter-Him, N.V., of which Ronald de Waal is a Managing Director, and W. Howard Lester, a director of the Company (the "Investors"). The Investors purchased an aggregate of 50,000 shares of a new series of preferred stock, designated Series 2003-A Preferred Stock, at a purchase price of $100.00 per share. The Series 2003-A Preferred Stock is convertible into common stock at a fixed rate of $1.15 per share, and otherwise provides rights and preferences substantially similar to the Company's existing 2002-A Preferred Stock. In consideration for RonHow's agreement to fund the Company's additional $3 million in borrowing capacity under the credit facility as described above, the Company granted to RonHow the right to convert any of the incremental $3 million not repaid into shares of a new series of authorized but unissued preferred stock, designated Series 2006-A Preferred Stock. The Series 2006-A Preferred Stock to be issued upon conversion of this option will be convertible into shares of common stock at a price of $0.87 per share, equal to the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the loan amendment. On June 1, 2006, the Company closed on a $2.5 million private equity investment by RonHow. RonHow purchased an aggregate of 25,000 shares of a new series of preferred stock, designated Series 2006-A Preferred Stock, at a purchase price of $100.00 per share. The Series 2006-A Preferred Stock is convertible into common stock at a fixed rate of $0.67 per share, and otherwise provides rights and preferences substantially similar to the Company's existing 2002-A and 2003-A Preferred Stock. RonHow was granted a warrant to acquire shares of Series 2006-B Preferred Stock in connection with the August 31, 2006 $5 million loan described above. The fair value of this warrant was estimated to be $847,000 at August 4, 2007, and was included in long-term liabilities. This debt discount related to this warrant will be amortized over the term of the loan as interest expense using the effective interest method. The shares of Series 2006-B Preferred Stock have a stated value of $1,000 per share. Any outstanding shares of Series 2006-B Preferred Stock will be entitled to receive quarterly dividends that cumulate annually at a rate of 8% of the stated value per annum, which will be reduced to 6% of the stated value per annum if certain profitability targets are met. Dividends payable on the first July 1 and October 1 following the original issuance of Series 2006-B Preferred Stock will be payable in additional shares of Series 2006-B Preferred Stock, while dividends payable on the first January 1 and April 1 following the original issuance of Series 2006-B Preferred Stock will be payable in cash. After the first anniversary of the original issuance of Series 2006-B Preferred Stock, dividends will be payable in additional shares of Series 2006-B Preferred Stock or cash as the holder may elect. Following the third anniversary of the original issuance date, the Series 2006-B Preferred Stock will be redeemable at the option of the Company at a price equal to the stated value plus cumulated and accrued but unpaid dividends. If and when issued, the Series 2006-B Preferred Stock will rank prior to the Company's existing Amended Series 2001-A Preferred Stock, Series 2002-A Preferred Stock, Series 2003-A Preferred Stock and Series 2006-A Preferred Stock for purposes of dividends and distribution of assets on liquidation. The holders of the Series 2006-B Preferred Stock, voting as a class, will have the right to designate a proportionate number of members of the board of directors equal as nearly as possible to the percentage of the Company's outstanding common stock on an as-converted basis represented by the Series 2006-B Preferred Stock. The Series 2006-B Preferred Stock will also vote with the common stock on an as-converted basis for the election of the remaining directors and on all other matters on which the common stock votes. In addition to the rights the holders of Series 2006-B Preferred Stock will have to designate directors, the holders of the Company's Amended Series 2001-A Preferred Stock and Series 2002-A Preferred Stock, voting together as a single class, and the holders of the Company's 12 Series 2003-A Preferred Stock and Series 2006-A Preferred Stock, voting separately, also have similar rights to designate directors. Following the issuance of Series 2006-B Preferred Stock, if and for so long as the outstanding shares of Series 2006-B Preferred Stock in the aggegate represent on an as-converted basis at least 10% of the Company's outstanding common stock, the Company may not take certain actions without the prior approval of the holders of a majority of the outstanding Series 2006-B Preferred Stock, including amendment of the Company's Certificate of Incorporation or Bylaws, changes in the size of the Company's authorized board of directors, redemption of or payment of dividends with respect to common stock or other securities junior to the Series 2006-B Preferred Stock, amendment or adoption of employee stock option or purchase plans, authorization of certain mergers or sales of substantially all of the Company's assets, entering into transactions with affiliates, and incurring indebtedness or making acquisitions or capital expenditures in excess of certain dollar amounts. The holders of the Series 2006-B Preferred Stock are also expected to be entitled to registration rights with respect to the common stock issuable upon conversion of the Series 2006-B Preferred Stock and will be entitled to preemptive rights in connection with future sales of common stock or other equity securities by the Company. On April 26, 2007, the Company completed the following transactions between the Company and RonHow LLC as described below: - RonHow and the Company amended the existing Subordinated Loan Agreement ("Loan Agreement") to increase the amount of the loan (the "Loan") to $12 million, to the extent advanced in the discretion of RonHow, plus any interest converted into principal as permitted under the terms of the Loan, and to increase the interest rate on the $2 million advanced on April 3, 2007 and the additional $1 million advanced on April 26, 2007 (collectively, the "Additional Advance") to 18% retroactively, to April 3, 2007. - RonHow agreed to defer $1 million in cash interest payments on all of the outstanding principal of the Loan, which will be added to the principal of the Loan as permitted under the existing terms and be payable at maturity. - RonHow converted $2 million of the existing Loan bearing interest at 13.5% into a new series of preferred stock with $2 million of stated value, 2007-A Senior Preferred Stock, and cancelled the existing option to convert the same amount into existing Series 2006-B Preferred Stock, resulting in the Loan balance after the conversion being $5 million bearing interest at 13.5% and $3 million bearing interest at 18%. - RonHow and the Company agreed that the Additional Advance and any accrued but unpaid interest will be convertible at RonHow's option into $3 million of stated value of another new series of preferred stock, 2007-B Senior Preferred Stock. Dividends on the new preferred stocks will accrue for the Series 2007-A at 13.5% of stated value and for the Series 2007-B at 18.0% of stated value, in each case in the same manner as the Company's authorized Series 2006-B. RonHow will have the option to elect whether each quarterly dividend is cumulated or paid in cash or additional shares ("PIK"), or a combination of cash and PIK shares. The shares will initially be convertible on the date such shares are issued by the Company either directly, in the case of Series 2007-A, or, in the case of Series 2007-B, pursuant to RonHow's exercise of its option to acquire Series 2007-B. For PIK shares issued in lieu of cash dividends, the conversion price will be 66.667% of the trailing 20-day average market price at time of payment of such PIK shares. The 2007-A Preferred Stock is initially convertible at $0.2357 per share. The Series 2007-A and Series 2007-B Senior Preferred Stock will have equal priority, and will have priority over all other equity securities of the Company, including other series of preferred stock outstanding, as to dividends and proceeds upon liquidation, and will have voting and other rights substantially identical to the existing Series 2006-B Preferred Stock, including voting rights on an as-converted basis. 13 Under the terms of a voting agreement between Inter-Him, N.V. (an entity controlled by Mr. de Waal), Mr. Lester and Becky Casey (a former officer and director of the Company and a member of the Powell family), Inter-Him, N.V. and Mr. Lester agreed to vote their shares and the shares of any affiliate, including RonHow, in favor of a director designated by Ms. Casey so long as the Powell family owned on a fully-diluted basis, assuming full conversion of all shares of preferred stock outstanding, at least 10% of the common stock of the Company. The issuance of the Series 2007-A Preferred Stock resulted in the Powell family's ownership falling below this 10% threshold which terminated Ms. Casey's rights under this voting agreement. Accordingly, Ms. Casey no longer has the right to designate a director. The Company also entered into an amendment to its existing loan agreement with Wells Fargo Retail Finance II, LLC to permit the transactions described above and to reduce the excess availability requirement from $1,000,000 to $500,000, which provides the Company with an additional $500,000 in credit. In connection with the authorization of the Series 2007-A Preferred Stock, the Company amended the existing Certificate of Designation of its Series 2006-A Preferred Stock to reduce the number of authorized shares of Series 2006-B Preferred Stock from 25,000 shares to 15,000 shares, to permit 5,000 shares to be designated as Series 2007-A Senior Preferred Stock and 5,000 shares to be designated as Series 2007-B Senior Preferred Stock. As of August 4, 2007, no shares of Series 2006-B Preferred Stock and Series 2007-B Senior Preferred Stock were outstanding. None of the preferred shares are included in the stockholders' equity section of the balance sheet because the preferred shareholders have special voting rights that empower them to elect a majority of the board of directors and maintain effective control over the Company. As a result of their ownership of the Company's outstanding preferred stock which votes on an as-converted basis, Mssrs. Lester and de Waal, collectively, have voting rights equal to 81.3% of the total shares entitled to vote. For an indefinite period which began on May 1, 2006, the Company's Board of Directors has not authorized dividends to be paid on any series of preferred stock either in cash or stock. During this period, dividends will cumulate. As of August 4, 2007, approximately $2,374,000 of dividends had cumulated with approximately $2,359,000 cumulating in additional shares of preferred stock and approximately $15,000 cumulating in cash. In prior periods, these dividends were paid in cash or stock on each applicable dividend payment date. See Note 8 for discussion of the Company's stock warrants. 9. Stock Options ------------- Effective January 29, 2006, the Company adopted the provisions of Statement of Financial Accounting Standard ("SFAS") No. 123R, "Share-Based Payment" ("SFAS 123R") using the modified prospective method. The stock-based compensation expense for share-based awards recognized during the thirteen weeks ended August 4, 2007 and July 29, 2006 was approximately $22,000 and zero, respectively. The Company uses the Black-Scholes option-pricing model to value the Company's stock options. Using this option-pricing model, the fair value of each stock option award is estimated on the date of grant. The fair value of the Company's stock option awards, which are subject to pro-rata vesting generally over four years, is expensed on a straight-line basis over the vesting period of the stock options. The expected volatility assumption is based on the historical volatility of the Company's stock over a term equal to the expected term of the option granted. The expected term of stock option awards granted is derived from historical exercise experience. The expected term assumption incorporates the contractual term of an option grant, which is ten years, as well as the vesting period 14 of an award, which is generally pro-rata vesting over four years. The risk-free interest rate is based on the implied yield on a U.S. Treasury constant maturity with a remaining term equal to the expected term of the option granted. The weighted average assumptions relating to the valuation of the Company's stock options for the twenty-six weeks ended August 4, 2007 and July 29, 2006 were as follows: 26 Weeks Ended ---------------------------- August 4, July 29, 2007 2006 ------------ ------------ Weighted average fair value of grants $0.28 $0.46 Expected volatility 89.15% 81.30% Expected term (years) 7 7 Risk-free interest rate 4.71% 5.18% Expected dividend yield N/A N/A The following table presents a summary of the Company's stock options activity for the twenty-six weeks ended August 4, 2007: Number Weighted Average of Shares Exercise Price ------------ ------------ Outstanding, beginning of period 3,331,746 $1.31 Granted -- -- Exercised -- -- Canceled or expired 33,050 7.61 ------------ Outstanding, end of period 3,298,696 $1.25 ============ Exercisable at August 4, 2007 1,725,664 $1.99 ============ 10. Revenue Recognition ------------------- Sales from store locations represented approximately 94.0% and 93.5%of the Company's total sales for the thirteen and twenty-six weeks, respectively, ended August 4, 2007. This compares to store location sales of approximately 93.6% and 94.1% for the thirteen and twenty-six week periods, respectively, of the prior year. These sales are recognized at the time of the customer's purchase. The Company's direct catalog and internet sales represented about 6.0% and 6.5% of the total sales for the thirteen and twenty-six weeks, respectively, ended August 4, 2007. This compares to approximately 6.4% and 5.9% for the thirteen and twenty-six week periods, respectively, of the prior year. These sales are recognized at the time the order is shipped to the customer. Gift card sales are recognized as revenue when the gift card is redeemed, not when it is sold. 11. Earnings per Share ------------------ Outstanding shares for purposes of basic and diluted earnings per share were calculated as follows: 15

Approximately 3,298,696 shares and 1,852,656 shares for the thirteen weeks ended August 4, 2007 and July 29, 2006, respectively, and approximately 3,298,696 shares and 1,852,656 shares for the twenty-six weeks ended August 4, 2007 and July 29, 2006, respectively, related to outstanding employee stock options, were not included in the calculation of diluted earnings per average common share because the effect of including those shares is anti-dilutive as the exercise price of the stock options exceeded the average common stock market price during the respective period. Approximately 657,945 and 655,945 preferred shares convertible into 24,260,526 and 15,775,163 common shares, respectively, for the thirteen weeks ended August 4, 2007 and July 29, 2006, were not included in the calculation of diluted earnings per average common share because the effect of including those shares is anti-dilutive. Approximately 657,945 and 655,945 preferred shares convertible into 24,260,526 and 15,775,163 common shares, respectively, for the twenty-six weeks ended August 4, 2007 and July 29, 2006, were not included in the calculation of diluted earnings per average common share because the effect of including those shares is anti-dilutive. 12. Subsequent Events ----------------- On August 23, 2007, the Company's principal investor, RonHow, LLC, advanced an additional $2 million under the existing Subordinated Loan Agreement, bringing the total amount outstanding under the agreement to $10 million. It is anticipated that another $2.4 million of funding under the agreement will be completed once all necessary documentation is prepared. The Company owns one property, an outlet in Austin, Texas. In August 2007 the Company entered into an agreement to sell the property to an unrelated third party. The agreement is subject to due diligence and closing periods. There can be no assurance that the sale will be concluded. If the sale were to occur, the Company would expect to continue to lease the facility for a predetermined period and would receive approximately $1.3 million in proceeds, net of a related mortgage obligation on the property. Such proceeds, if received, would reduce the outstanding balance of the Company's line of credit with WFRF thereby increasing available funds for business operations. Subsequent to the end of the second quarter 2007, the Company has had further exchanges with the Securities and Exchange Commission regarding its De-registration Transaction discussed in Note 5 above. This process continues to progress and the Company believes it will be completed during the current fiscal year. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS From time to time, the Company may publish forward-looking statements relating to certain matters including anticipated financial performance, business prospects, the future opening or closing of stores, inventory levels, anticipated capital expenditures, and other matters. All statements other than statements of historical fact contained in this Form 10-Q or in any other report of the Company are forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of that safe harbor, the Company notes that a variety of factors, individually or in the aggregate, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. These risk factors are all described in the Company's annual report on Form 10-K for the year ended February 3, 2007. The Company disclaims any intent or obligation to update those forward-looking statements. OVERVIEW Harold's is a multi-channel specialty retailer of ladies' and men's apparel, including accessories and footwear. Harold's markets its merchandise through retail stores, catalogs and its website at www.harolds.com. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of net sales represented by items in the Company's statements of operations.

(1) Second quarter is historically the Company's lowest gross margin quarter as it is traditionally a spring and summer clearance period. For this reason, more markdowns are generally taken during the second quarter than in the year-to-date period causing gross margin to be lower as a percentage of sales when compared to the year-to-date period. 17 The following table reflects the sources of the changes in Company sales for the periods indicated, with percentage changes compared to the comparable period of the prior year.

(1) The Company considers a store comparable if it has been open for 12 full months and has not changed its square footage by more than 20%. Closed and relocated stores are excluded from the comparable calculation beginning in the month in which the store is closed or relocated. Renovated stores are considered comparable as long as the store square footage does not change by more than 20%. One new outlet store was opened in Oklahoma City, Oklahoma during the thirteen weeks ended August 4, 2007 and no stores were relocated or closed. No stores were opened, relocated or closed during the thirteen weeks ended July 29, 2006. During the 26-week 2007 period, the Company opened one new outlet store in Oklahoma City, Oklahoma, and no stores were relocated or closed. During the 26-week 2006 period, the Company opened one new store in Montgomery, Alabama and no stores were relocated or closed. The decrease in comparable store sales for the thirteen weeks ended August 4, 2007 can be primarily attributed to three factors: strategically planned lower spring and summer inventory levels, primarily in sale and clearance merchandise, that did not achieve targeted sell through rates at full price or clearance; reduced spending on marketing to the Company's core customers; and the unseasonably cool and rainy weather in the Company's core markets of Texas and Oklahoma that had a negative impact on summer merchandise sales. Direct (internet and catalog) sales were approximately $1.0 million for the thirteen weeks ended August 4, 2007, 16% below last year's level of $1.2 million for the comparable reporting period, due to lower internet clearance sales. The sales decline for the twenty-six weeks ended August 4, 2007 is primarily attributed to the reasons mentioned above. Direct (internet and catalog) sales were approximately $2.6 million for the twenty-six weeks ended August 4, 2007, approximately 8% above the levels of $2.4 million for the same period of the prior year. Gross margin represents net sales less cost of products, merchandising functions and store occupancy costs for retail stores. Cost of products and merchandising consists primarily of product and operating costs (e.g., product development, sourcing, inbound freight, merchandising, inventory control, inspection, warehousing, internal transfer, purchasing and receiving costs, inventory markdowns and occupancy costs for the Company's retail stores). The Company's second quarter 2007 gross margin of 17.9% was an improvement from the 14.2% in the same period of last year. The gross margin for the twenty-six week period August 4, 2007 increased to 29.1% from 25.8% during the same period of the prior year. Gross margin increased during the thirteen and twenty-six week periods due to fewer markdowns incurred to sell spring and summer merchandise, principally due to lower initial purchase levels. 18 Selling, general and administrative expenses consist primarily of retail store selling costs, costs to produce, print and distribute direct response catalogs, as well as corporate administrative costs. Selling, general and administrative expenses (including advertising and catalog production costs) increased to 34.5% of sales for the second quarter of 2007 compared to 32.9% for the second quarter of 2006 and decreased slightly to 33.4% of sales for the twenty-six weeks ended August 4, 2007 compared to 33.8% for the twenty-six weeks ended July 29, 2006. Selling, general and administrative expenses were slightly lower in the aggregate but were higher as a percentage of sales due to the sales declines. Depreciation and amortization expense increased to 5.3% of sales for the second quarter of 2007 from 4.5% for the second quarter of 2006 and increased to 4.4% for the twenty-six weeks ended August 4, 2007 from 4.2% for the twenty-six weeks ended July 29, 2006. This increase is attributable to the adjustment to write-down leasehold improvement balances of the Company's impaired locations. The average balance of total outstanding debt was $32,343,000 for the twenty-six weeks ended August 4, 2007 compared to $24,839,000 for the same period of 2006. This increase in average balances resulted principally from additional long-term borrowing from the Company's preferred shareholders. Interest expense increased as a percentage of sales due to a combination of the Company's higher average debt balance and increased borrowing from preferred shareholders at a higher interest rate. The weighted average interest rate on the Company's WFRF indebtedness was 8.00% at August 4, 2007 compared to 7.54% at July 29, 2006. The weighted average interest rate on the Company's subordinated debt with RonHow was 15.19% at August 4, 2007 and did not exist at July 29, 2006. RonHow agreed to defer $1 million in cash interest payments on all of the outstanding principal of the subordinated debt, which will be added to the principal of the subordinated debt as permitted under the existing terms and be payable at maturity. The Company reported a net loss applicable to common stockholders of $5,284,000 or $0.85 per basic and diluted share during the second quarter of 2007 compared to a net loss of $5,435,000 or $0.87 per basic and diluted share for the second quarter of last year. For the twenty-six weeks ended August 4, 2007, the Company reported a net loss applicable to common stockholders of $6,215,000 or $1.00 per basic and diluted share compared to a net loss of $6,735,000 or $1.08 per basic and diluted share for the same period last year. The reduction in the current year loss is the result of an improvement in gross margin and a slight reduction in operating expenses. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital needs arise primarily from the need to support costs incurred in advance of revenue generation, such as inventory acquisition and direct response catalog development, production and mailing costs. Other liquidity needs relate to the revolving customer charge accounts on the Company's proprietary credit card, the need to cover operating cash flow deficits and to invest in remodeling, fixtures and equipment. The Company recognizes two selling seasons that correspond to the fashion seasons. The spring season begins in January and ends in July. The fall season begins in July and ends in January. The Company has relied on its bank credit facility to meet these needs as well as proceeds from preferred stock investments of $6 million in February 2001, $4 million in August 2002, $5 million in February 2003, $2.5 million in June 2006 and $2 million in April 2007. The Company has also received funding from loan participations made by significant shareholders in the amounts of $2 million in 2003, $2 million in 2004 and $3 million in January 2006. The Company also received proceeds of a subordinated loan of $5 million in September 2006, $2 million in January 2007, $2 million in March 2007 and $1 million in April 2007. Of the $10 million lent to the Company under this subordinated loan, $2 million was converted to a new Series 2007-A Senior Preferred Stock in April 2007. The Company experienced deficit operating cash flows of $4,484,000 for the twenty-six weeks ended August 4, 2007 compared to deficit operating cash flows of $7,560,000 for the twenty-six weeks ended July 29, 2006. This improvement in cash flow is principally related to the decrease of the Company's inventories for 2007 of $1,027,000 at August 4, 2007 compared to an 19 increase of $1,950,000 at July 29, 2006. The inventories declined due to planned lower purchase levels and less ownership of prior season inventories. The lower purchases were partially offset by a related decrease in accounts payable at August 4, 2007 compared to July 29, 2006. See "Strategy and Liquidity Update" below for additional information. The Company's ability to achieve positive cash flows from operating activities depends on its ability to improve sales and gross margin which may allow the Company to achieve a return to future operating profitability. Additionally, the Company may experience needs for additional capital. While the Company has been successful in covering cash flow deficits through line of credit borrowings, private equity investments and subordinated loans from its principal shareholders, there can be no assurances that these, or any other financing resources, will be available for future needs. Changes in the Company's investing activities relate primarily to the capital expenditures incurred for the opening of stores in Montgomery, Alabama and Atlanta, Georgia and progress billings on construction of a new store in Little Rock, Arkansas during 2006. One new outlet was opened during the twenty-six weeks ended August 4, 2007, and a major remodel of the Ft. Worth, Texas store was completed. The budgeted capital expenditures for 2007 are approximately $2.0 million which are expected to be used principally for a new store location, one store relocation and existing store enhancements. The Company's original three-year credit facility with Wells Fargo Retail Finance II, LLC, ("WFRF") was entered into on February 5, 2003. As discussed below, in January 2006, the maximum available credit line was increased, and the expiration date was extended to February 5, 2010. The credit facility is secured by substantially all assets of the Company and its subsidiaries and is subject to a borrowing base calculation based primarily on inventory and accounts receivable. The facility has two financial covenants, a minimum excess availability covenant of $1.35 million, which was reduced to $1.0 million in January 2006 and reduced again to $500,000 in April 2007, and a maximum capital expenditure covenant, established at $2.8 million for 2007. Interest rates under the facility are at prime plus 0.5% or LIBOR plus 2.50%, with the ability to reduce the rate if the Company achieves certain financial criteria. The balance outstanding on the Company's line of credit at August 4, 2007 was $24,259,000 which includes the $7 million outstanding under the bridge facility discussed below. The Company's line of credit had an average balance of $23,743,000 and $23,600,000 for the twenty-six weeks ended August 4, 2007 and July 29, 2006, respectively. During the twenty-six weeks ended August 4, 2007, the WFRF line of credit had a high balance of $26,007,000. At August 4, 2007 the Company's availability under the WFRF line of credit was approximately $1,703,000 above the minimum availability requirement of $500,000 and the average interest rate on the credit line was 8.00%. In July 2003, the Company negotiated an increase of $2 million in its total borrowing availability under its existing credit facility with WFRF. The Company obtained this increase in order to provide additional working capital. The full $2 million was available for borrowing on July 15, 2003 and has been extended to the Company by WFRF based upon a loan participation agreement between WFRF and RonHow, LLC ("RonHow"), an entity established in July 2003 which is owned and controlled directly or indirectly by Ronald de Waal and W. Howard Lester. Mr. de Waal and Mr. Lester are both major beneficial owners of the Company's common and preferred stock. In order to achieve additional liquidity, in January 2006, the Company entered into an amendment to its existing credit facility with WFRF which increased the Company's borrowing availability under the facility. The amendment extended the term of the credit facility by three years, with a new expiration of February 5, 2010. The amendment also increased the maximum revolver amount from the lesser of $25 million or $22 million plus outstanding participant advances to the lesser of $28 million or $22 million plus outstanding participant advances. Additionally, the minimum required excess availability under the credit facility was reduced from $1.35 million to $1.0 million. Finally, the amendment provided for an increase of $3 million in the Company's borrowing availability under the facility based upon an increase in the existing loan participation agreement between WFRF 20 and RonHow. WFRF will continue to serve as the lending agent for the Company under the credit facility, and the principal covenants and conditions imposed upon the Company pursuant to the WFRF credit facility agreement have not materially changed. RonHow's right to repayment of any advances under the credit facility that are attributable to its participation is generally subordinate to the repayment rights of the other credit facility lenders. However, the Company may repay these advances provided it meets certain conditions, including, for payments of up to $2 million of these advances, the maintenance of an average daily excess availability under the credit facility of at least $1.5 million for the 30 days prior to and 30 days projected immediately following the repayment, and for payments of the remaining amount of these advances, the maintenance of an average daily excess availability under the credit facility of at least $2.5 million for the 30 days prior to and 30 days projected immediately following the repayment. The average excess availability requirement is higher than the excess availability otherwise required of the Company under the credit facility. In consideration for RonHow's agreement to fund the Company's additional $3 million in borrowing capacity under the credit facility, the Company granted to RonHow the right to convert any of the incremental $3 million not repaid into shares of a new series of authorized but unissued preferred stock, designated Series 2006-A Preferred Stock. The Series 2006-A Preferred Stock to be issued upon conversion of this option will be convertible into shares of common stock at a price of $0.87 per share, equal to the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the loan amendment. Additionally, the Company began paying an additional 4% fee per annum on the outstanding new participation amount up to $3 million, which commenced January 24, 2006. This fee is in addition to the additional 4% fee per annum which the Company will be obligated to pay on up to $2 million of the outstanding participation amount funded by RonHow in April 2004 commencing on March 1, 2006. In connection with the foregoing transactions, the Company and RonHow agreed upon a new repayment priority for RonHow's participations in the credit facility. Unless otherwise agreed to by the Company and RonHow at the time of any repayment, any repayments of participations will be applied first to the repayment of RonHow's first $2 million participation funded in July 2003, next to the repayment of the RonHow's second $2 million participation funded in April 2004, and finally to the repayment of RonHow's new $3 million participation funded on January 24, 2006. The parties amended the Option Agreement previously executed on April 30, 2004, to document this agreement. As part of the foregoing participation transaction, WFRF, RonHow and the Company entered into a letter of understanding which established a framework for RonHow to obtain the right to convert its aggregate $7 million participation in the Company's credit facility into a subordinated loan to the Company, subject to the negotiation of mutually acceptable definitive agreements. The Company has agreed that the options to convert to preferred stock granted by the Company to RonHow to permit RonHow to convert its new $3 million participation and its prior $2 million participation funded in April 2004 would continue to apply to any such subordinated loan to the extent such participations are converted. On August 31, 2006, the Company and RonHow entered into a $10 million Subordinated Loan Agreement ("Loan Agreement") pursuant to which RonHow loaned the Company $5.0 million (the "Loan"). The Loan is repayable at maturity on May 31, 2010 with interest payable monthly at the rate of 13.5% per year. $4.7 million of the Loan was used to pay down the principal balance of the Company's existing indebtedness under its revolving credit facility with WFRF and the $300,000 balance will be used as described below. The Company has the right to reborrow under the WFRF credit facility in accordance with its terms. In consideration of this Loan, the Company also issued to RonHow a 10-year warrant to purchase up to 1,032 shares of a new series of preferred stock, designated Series 2006-B Preferred Stock with a liquidation value of $1,000 per share, at a purchase price of $0.01 per share, which will be vested ratably over the term of the Loan and will become exercisable upon payment in full or in the event of default under the Loan. See Note 8 for further discussion of these warrants. The Loan is also convertible into Series 2006-B Preferred Stock at the option of RonHow at the rate of $1,000 of principal or accrued interest converted for each share of Series 2006-B Preferred Stock. Under the terms of the Loan Agreement, RonHow also has the option to advance an additional $5 million. The Loan is guaranteed by the Company's subsidiaries and is 21 secured by a security interest in all of the Company's and its subsidiaries' personal property. RonHow's rights to the collateral and to payment are subordinate to the Company's existing indebtedness to WFRF pursuant to the terms of a Subordination and Intercreditor Agreement between RonHow, WFRF and the Company. In connection with the Loan, the Company and WFRF entered into an amendment to the existing credit facility to permit the new Loan from RonHow and to permit the $300,000 of additional funds loaned by RonHow to be used, at the Company's discretion and subject to certain conditions, for a transaction that would reduce the number of record holders of the Company's common stock so that the Company would no longer be required to file reports with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 (a "De-registration Transaction"). If the Company determines not to do a De-registration Transaction, the additional $300,000 will be used to pay down the balance of the existing WFRF credit facility. Other than to permit the Loan and the De-registration Transaction, there were no other material changes to the WFRF credit facility terms. On June 5, 2007, the Company filed the necessary reports with the Securities and Exchange Commission to commence this process of De-registration. The Series 2006-B Preferred Stock issuable upon conversion of the Loan or upon exercise of the warrant will be convertible into shares of common stock at a price of $0.43 per share, equal to the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the Loan. On April 3, 2007, RonHow loaned the Company an additional $2 million under the Subordinated Loan Agreement and an additional $1 million on May 2, 2007, bringing the aggregate amount outstanding to $10 million prior to converting $2 million of this debt into 2007-A Preferred Stock during April 2007. In conjunction with these transactions, the Company entered into amendments to the facility with the Company's primary lender, Wells Fargo Retail Finance II, LLC ("WFRF"). WFRF agreed to reduce the block on daily excess availability from $1 million to $500,000, effectively providing the Company with an additional $500,000 of borrowing capacity. On August 23, 2007, the Company's principal investor, RonHow, LLC, advanced an additional $2 million under the existing Subordinated Loan Agreement, bringing the total amount outstanding under the agreement to $10 million. It is expected that another $2.4 million of funding under the agreement will be completed once all necessary documentation is prepared, which is estimated to be by September 30, 2007. These transactions were approved by the Company's independent directors. The Company was in compliance with its debt covenants for the period ended August 4, 2007. Although the Company's line of credit with WFRF does not expire until February 2010, the Company has classified its borrowings under its line of credit as current in its consolidated balance sheets due to the terms of its agreement with the lender. Under the bank agreement, there is an acceleration clause which potentially allows the bank to demand immediate payment of all outstanding borrowings upon the occurrence of a material adverse change in the Company's operations or financial position. Determination of what constitutes a material adverse change is at the discretion of the bank, however, it is subject to reasonableness standards. In addition, the Company is required to maintain a lock-box agreement with the bank whereby all cash received is applied against current borrowings. As a result of these items, the Company is required to classify its line of credit borrowings as current as proscribed by EITF 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that include both a Subjective Acceleration Clause and a Lock-Box Arrangement." 22 The Company considers the following as measures of liquidity and capital resources as of the dates indicated: August 4, February 3, July 29, 2007 2007 2006 -------- -------- -------- Working capital (000's) $ (7,569) $ (5,912) $ (7,751) Current ratio .78:1 .83:1 .77:1 Ratio of working capital to total assets (.22):1 (.15):1 (.22):1 Ratio of total debt to stockholders' deficit (2.72):1 (3.37):1 (6.75):1 STRATEGY AND LIQUIDITY UPDATE In the Company's Form 10-Ka filing for the year ending February 3, 2007, a Strategy and Liquidity Update was provided within Management's Discussion and Analysis of Financial Condition and Results of Operation. The Company is updating this disclosure as follows regarding key strategic initiatives that have been undertaken to improve its financial results and liquidity. During the second quarter of 2007, the Company's total sales decreased 9.2% over the same time during the prior year. For the first half of 2007, total sales were down 1.1%. The second quarter was far more challenging than the first quarter of 2007, which experienced an increase of 6.2% over the first quarter of 2006. It is believed that second quarter results were impacted by: o Lower inventory levels, principally in the sale and clearance area. At the end of the second quarter, the Company owned 25% less units of spring and summer clearance merchandise. While the Company owned less inventory in first quarter as well, clearance and sale are not as meaningful to first quarter sales as second quarter which is a traditional clearance period. The Company planned lower purchase levels of spring and summer merchandise but did not achieve targeted sale through rates at either full price or clearance resulting in a decline in total and comparable store sales. o Unseasonably cool and rainy weather in the Company's core markets of Texas and Oklahoma that had a negative impact on summer merchandise sales. o Reduced spending on marketing to the Company's core customers. While marketing spending was down approximately 5% in the second quarter, efforts were undertaken to reach more customers but with a reduced mailing content to what the core customers would have received in the prior year. Despite the sales decreases, reported gross margin improved to 17.9% of sales in second quarter 2007, from 14.2% in the prior year's second quarter. For the 26-week period of 2007, reported gross margin increased to 29.1%, from 25.8% in the prior year 26-week period. The Company's efforts to purchase quantities of merchandise more appropriate to projected sales have been the primary contributor to the gross margin improvement, combined with enhanced merchandise content. In addition to gross margin improvement, the Company's selling, general and administrative expenses declined approximately $300,000 in the aggregate for both the thirteen and 26-week periods of 2007 due to cost control measures, as compared to the comparable reporting period in 2006, although they were higher as a percentage of sales due to the noted sales declines. As a result of the second quarter financial performance and the overall retail climate, in August 2007, after the end of the quarter, the Company implemented a corporate restructuring that is expected to achieve significant annualized expense savings. This included the elimination of two executive officer positions. Additionally, the Company took steps to enhance its working capital by entering into additional financings with RonHow, LLC ("RonHow"). This is an entity jointly owned by the Company's principal investors, Ronald de Waal and W. Howard Lester. On August 23, 2007, RowHow advanced 23 an additional $2 million under its existing subordinated loan agreement with the Company, bringing the total amount outstanding to $10 million. It is expected that another $2.4 million of funding will be completed by September 30, 2007 once all necessary documentation has been prepared. All advances made during 2007 under the Subordinated Loan Agreement bear interest at an annual rate of 18.0%. Until the Company is able to restore its profitability, it will remain dependent on RonHow for additional financing. The Company owns one property, an outlet in Austin, Texas. In August 2007 the Company entered into an agreement to sell the property to an unrelated third party. The agreement is subject to due diligence and closing periods. There can be no assurance that the sale will be concluded. If the sale were to occur, The Company would expect to continue to lease the facility for a predetermined period and would receive approximately $1.3 million in proceeds, net of a related mortgage obligation on the property. Such proceeds, if received, would reduce the outstanding balance of the Company's line of credit with WFRF thereby increasing available funds for business operations. The Company believes that prior to 2007 its merchandise has been over-assorted, leading to a confusing customer shopping experience, and that the quantity of merchandise purchased has exceed our ability to sell at profitable margins resulting in significant markdowns. The Company believes that in 2007 the number of items offered and the amount of inventory purchased has been adjusted to more appropriate levels as part of a long-term strategic plan expected to optimize in 2008. In October 2006, Ron Staffieri was hired as the Company's Chief Executive Officer. Mr. Staffieri replaced interim leadership from the Company's Board of Directors that had been in place since August 2005 when the prior CEO departed the Company. Mr. Staffieri has extensive experience as a retail Chief Executive Officer and President prior to joining the Company. Additionally, during April 2007 the Company hired Cherryl Sergeant to the position of Executive Vice President and Chief Merchandising Officer. Ms. Sergeant has an extensive senior apparel retail merchandising background. During 2007, the Company has opened a new outlet store in Oklahoma City, Oklahoma, anticipates the relocation of a store in Houston, TX and plans to close its store in Oakbrook Center in Chicago, IL and open a new store in Rogers, AR. The Company believes that in addition to refining its merchandise and related planning and allocation, it is also important to continually improve the store base in an effort to return the Company to profitability. The Company owns one property, an outlet in Austin, Texas. In August 2007 the Company entered into an agreement to sell the property to an unrelated third party. The agreement is subject to due diligence and closing periods. There can be no assurance that the sale will be concluded. If the sale were to occur, the Company would expect to continue to lease the operations for a predetermined period and would receive approximately $1.3 million in proceeds net of a related mortgage obligation on the property. Such proceeds, if received, would be used to reduce the Company's line of credit with WFRF thereby increasing available funds for business operations. If the Company can properly execute the initiatives outlined above, this may result in improvement in operating performance in the future. No assurances can be provided that the initiatives will result in improvement. DEREGISTRATION TRANSACTION The Board of the Company has approved a proposed Deregistration Transaction designed to reduce the number of the Company's shareholders of record below 300, which will permit the Company to no longer file reports with the Securities and Exchange Commission ("SEC"). The Board has determined that the costs of public reporting and internal control compliance specifically due to 24 Sarbanes-Oxley are not warranted by any benefit to the Company and our shareholders. In light of our current size and resources, the lack of analyst coverage, the nominal price of our Common Stock and the limited trading activity in shares of our Common Stock, the Board believes that the Company and our shareholders receive little benefit from being a public reporting company. The Board believes that it is in the Company's best interests to eliminate the administrative and financial burdens associated with being and remaining a public company. The Company has filed a preliminary proxy statement with the SEC relating to the Deregistration Transaction and has responded to comment letters from the SEC regarding the filing. Upon SEC approval of the filing, the Deregistration Transaction will be considered at the annual meeting of shareholders at a date yet to be determined. If approved at the annual meeting as currently proposed, each shareholder owning less than 1,000 shares of common stock would receive $0.30 per share and would no longer be a shareholder. Complete details of the proposal will be mailed to the shareholders at a later date. Interested shareholder may also review the Company's preliminary proxy statement and related Schedule 13E-3, which is available on the SEC's website at www.sec.gov. SEASONALITY The Company's business is subject to seasonal influences, with the major portion of sales realized during the fall season (third and fourth quarters) of each year, which includes the back-to-school and holiday selling seasons. In light of this pattern, selling, general and administrative expenses are typically higher as a percentage of sales during the spring season (first and second quarters) of each year. INFLATION Inflation affects the costs incurred by the Company in its purchase of merchandise and in certain components of its selling, general and administrative expenses. The Company attempts to offset the effects of inflation through price increases and control of expenses, although the Company's ability to increase prices is limited by competitive factors in its markets. Inflation has had no meaningful effect on the Company's operations. CRITICAL ACCOUNTING ESTIMATES AND COMMITMENTS There have been no material changes in the Company's critical accounting estimates or in its commitments from those disclosed in the Company's Annual Report on Form 10-K for the year ended February 3, 2007. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary objective of this disclosure is to provide forward-looking quantitative and qualitative information about the Company's potential exposure to market risks. The term "market risk" for the Company refers to the risk of loss arising from adverse changes in interest rates and various foreign currencies. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. During the first half of 2007, the Company's average debt levels increased to $32,343,000 as compared to $24,839,000 for the same period of the prior year. In addition, interest rates have increased from an average of 7.54% at July 29, 2006 to an average of 8.00% at August 4, 2007. The Company's most recent borrowings have been at higher interest rates with $5 million of the investor loan participation bearing interest at four percent above the bank's lending rates and the most recent subordinated debt closed on April 26, 2007 bears an interest rate of 18%. 25 ITEM 4. CONTROLS AND PROCEDURES The Company's Principal Executive Officer and Principal Financial Officer have reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 240.13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to make timely decisions regarding required disclosures. Based on that evaluation, the Principal Executive Officer and the Principal Financial Officer have concluded that the Company's current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. No change in the Company's internal control over financial reporting occurred during the twenty-six week period ended August 4, 2007 that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II ------- ITEM 1. LEGAL PROCEEDINGS None. ITEM 1A. RISK FACTORS There have been no material changes in the risk factors from those disclosed in the Annual Report on Form 10-K for the year ending February 3, 2007. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS Previously reported on Form 8-K. ITEM 3. DEFAULTS UPON SENIOR SECURITIES For the period from May 1, 2006 through an indefinite period, the Company's Board of Directors have determined that no dividends will be paid on any series of preferred stock either in cash or stock. During this period, dividends will cumulate. As of September 18, 2007, approximately $2,374,000 of dividends had cumulated with approximately $2,359,000 cumulating in additional shares of preferred stock and approximately $15,000 cumulating in cash. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS See the Exhibit Index accompanying this report. 26 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized. HAROLD'S STORES, INC. By: /s/ Ronald S. Staffieri ----------------------------- Ronald S. Staffieri Chief Executive Officer By: /s/ Jodi L. Taylor ----------------------------- Jodi L. Taylor Chief Financial Officer Date: September 18, 2007 27 INDEX TO EXHIBITS No. Description --- ----------- 3.1 Certificate of Incorporation of the Company, as amended (Incorporated by reference to Exhibit 3.1 to Form 10-K for the year ended February 3, 2001). 3.2 By-laws of the Company (Incorporated by reference to Exhibit 3.2 to Form 8-B Registration Statement, Registration No. 1-10892). 4.1 Specimen Certificate for Common Stock (Incorporated by reference to Exhibit 4.1 to Form S-1 Registration Statement, Registration No. 33-15753). 4.2 Certificate of Elimination of Designations of the Series 2001-A Preferred Stock (Incorporated by reference to Exhibit 4.1 to Form 8-K dated August 2, 2002). 4.3 Certificate of Designations of the Amended Series 2001-A Preferred Stock (Incorporated by reference to Exhibit 4.2 to Form 8-K dated August 2, 2002). 4.4 Certificate of Designations of the Series 2002-A Preferred Stock (Incorporated by reference to Exhibit 4.3 to Form 8-K dated August 2, 2002). 4.5 Amendment to the Certificate of Designation of the Amended Series 2001-A Preferred Stock ($0.01 Par Value) of Harold's Stores, Inc., dated February 4, 2003 (Incorporated by reference to Exhibit 4.1 to Form 8-K dated February 4, 2003). 4.6 Certificate of Designations of the Series 2003-A Preferred Stock (Incorporated by reference to Exhibit 4.2 to Form 8-K dated February 4, 2003). 4.7 Amendment to the Certificate of Designation of the Amended Series 2001-A Preferred Stock ($0.01 Par Value) of Harold's Stores, Inc., dated January 24, 2006 (Incorporated by reference to Exhibit 4.3 to Form 8-K dated January 24, 2006). 4.8 Certificate of Designations of the Series 2006-A Preferred Stock (Incorporated by reference to Exhibit 4.4 to Form 8-K dated January 24, 2006). 4.9 Amendment to the Certificate of Designation of the Series 2006-A Preferred Stock ($0.01 Par Value) of Harold's Stores, Inc., dated August 31, 2006 (Incorporated by reference to Exhibit 4.1 to Form 8-K dated August 31, 2006). 4.10 Certificate of Correction to the Certificate of Designation of the Series 2006-A Preferred Stock dated August 31, 2006 (Incorporated by reference to Exhibit 4.2 to Form 8-K dated August 31, 2006). 4.11 Certificate of Designations of the Series 2006-B Preferred Stock of Harold's Stores, Inc., dated August 31, 2006 (Incorporated by reference to Exhibit 4.3 to Form 8-K dated August 31, 2006). 4.12 Certificate of Amendment to Certificate of Designation of the Series 2006-B Preferred Stock, dated April 26, 2007 (Incorporated by reference to Exhibit 4.1 to Form 8-K dated April 26, 2007). 4.13 Certificate of Designations of the Series 2007-A Senior Preferred Stock., dated April 26, 2007 (Incorporated by reference to Exhibit 4.2 to Form 8-K dated April 26, 2007). 4.14 Certificate of Designations of the Series 2007-B Senior Preferred Stock., dated April 26, 2007 (Incorporated by reference to Exhibit 4.3 to Form 8-K dated April 26, 2007). 10.1 Lease Agreement effective May 1, 1996 between Company and Carousel Properties, Inc. (Campus Corner Store, Norman, Oklahoma) (Incorporated by reference to Exhibit 10.7 to Form S-2 Registration Statement, Registration No. 333-04117) and amendment to Lease Agreement dated April 4, 2002. (Incorporated by reference to Exhibit 10.1 to Form 10-Q for the quarter ended May 4, 2002). 28 10.2 Amended and Restated Lease Agreement dated as of June 3, 1996 between Company and 329 Partners II Limited Partnership (East Lindsey Warehouse Facility, Norman, Oklahoma) (Incorporated by reference to Exhibit 10.13 to Amendment No. 1 to Form S-2 Registration Statement, Registration No. 333-04117). 10.3 Amended and Restated Lease Agreement dated as of June 20, 2001 between Company and 329 Partners II Limited Partnership (Outlet Store, Norman, Oklahoma) (Incorporated by reference to Exhibit 10.6 to Form 10-K for the year ended February 2, 2002). 10.4* 2002 Performance and Equity Incentive Plan of Company. (Incorporated by reference to Definitive Proxy Statement dated May 17, 2002, for annual meeting of shareholders held on June 20, 2002.) 10.5* Employment Agreement dated February 9, 2004 between Company and Clark Hinkley (Incorporated by reference to Exhibit 10.6 to Form 10-K for the year ended January 31, 2004). 10.6* Stock Option Agreement dated February 23, 2001 between Company and Clark Hinkley (Incorporated by reference to Exhibit 10.12 to Form 10-K for the year ended February 3, 2001). 10.7* First Amendment to Stock Option Agreement dated February 9, 2004 between Company and Clark Hinkley (Incorporated by reference to Exhibit 10.8 to Form 10-K for the year ended January 31, 2004). 10.8 Investor Rights Agreement dated February 28, 2001 between Company and Inter-Him N.V. (Incorporated by reference to Exhibit 10.2 to Form 8-K dated February 28, 2001). 10.9 Right of First Refusal Agreement dated February 28, 2001 among Company, Inter-Him N.V. and the other stockholders named therein (Incorporated by reference to Exhibit 10.4 to Form 8-K dated February 28, 2001). 10.10 First Amendment to Investor Rights Agreement dated as of August 2, 2002, by and among Harold's Stores, Inc., Inter-Him, N.V., W. Howard Lester, William E. Haslam, Clark J. Hinkley and Margaret A. Gilliam (Incorporated by reference to Exhibit 10.2 to Form 8-K dated August 2, 2002). 10.11 First Amendment to Right of First Refusal Agreement dated as of August 2, 2002, by and among Harold's Stores, Inc., Inter-Him, N.V., W. Howard Lester, Harold G. Powell, Anna M. Powell, Rebecca Powell Casey, H. Rainey Powell, Lisa Powell Hunt, Clay M. Hunt and Arvest Trust Company, N.A. (Incorporated by reference to Exhibit 10.3 to Form 8-K dated August 2, 2002). 10.12 Second Amendment to Investor Rights Agreement dated as of February 5, 2003, by and among Harold's Stores, Inc., Inter-Him N.V. and W. Howard Lester (Incorporated by reference to Exhibit 10.2 to Form 8-K dated February 4, 2003). 10.13 Loan and Security Agreement dated as of February 5, 2003, by and among Wells Fargo Retail Finance, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's Stores of Georgia, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.3 to Form 8-K dated February 4, 2003). 10.14 Form of Indemnification Agreement between Company and members of its Board of Directors (Incorporated by reference to Exhibit 10.36 to Form 10-K for the year ended February 1, 2003). 10.15 Form of Waiver of Claims and Covenant Not to Sue Directors between principal shareholders of the Company and members of the Company's Board of Directors (Incorporated by reference to Exhibit 10.37 to Form 10-K for the year ended February 1, 2003). 10.16 Amended and Restated Participation Agreement dated as of April 29, 2004, by and between Wells Fargo Retail Finance II, LLC and RonHow, LLC (Incorporated by reference to Exhibit 10.28 to Form 10-K for the year ended January 31, 2004). 29 10.17 Assignment and Assumption of Lease Agreement and Third Amendment to Lease Agreement dated October 1, 2003 by and between Company and 329 Partners-II Limited Partnership (Dallas Buying Office, Dallas, Texas) (Incorporated by reference to Exhibit 10.1 to Form 10-Q dated November 1, 2003). 10.18 Option Agreement between Company and RONHOW LLC dated April 30, 2004 (Incorporated by reference to Exhibit 10.30 to Form 10-K for the year ended January 31, 2004). 10.19 First Amendment to Loan and Security Agreement dated as of February 5, 2003, by and among Wells Fargo Retail Finance, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's Stores of Georgia, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.31 to Form 10-K for the year ended January 31, 2004). 10.20 Second Amendment to Loan and Security Agreement dated as of April 29, 2004, by and among Wells Fargo Retail Finance, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's Stores of Georgia, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.32 to Form 10-K for the year ended January 31, 2004). 10.21 Third Amendment to Loan and Security Agreement dated as of January 24, 2006, by and among Wells Fargo Retail Finance II, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.4 to Form 8-K dated January 24, 2006). 10.22 Second Amended and Restated Participation Agreement dated as of January 24, 2006, by and between Wells Fargo Retail Finance II, LLC and RonHow, LLC (Incorporated by reference to Exhibit 10.6 to Form 8-K dated January 24, 2006). 10.23 First Amendment to Option Agreement dated January 24, 2006 between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.8 to Form 8-K dated January 24, 2006). 10.24 Option Agreement dated January 24, 2006 between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.9 to Form 8-K dated January 24, 2006). 10.25 Letter of Understanding dated January 24, 2006 by and among Wells Fargo Retail Financce II, LLC, Harold's Stores, Inc. and RonHow, LLC (Incorporated by reference to Exhibit 10.10 to Form 8-K dated January 24, 2006). 10.26 Series 2006-A Preferred Stock Purchase Agreement dated as of June 1, 2006, by and among Harold's Stores, Inc., Inter-Him N.V. and W. Howard Lester (Incorporated by Reference to Exhibit 10.1 to Form 8-K dated June 1, 2006). 10.27 Third Amendment to Investor Rights Agreement dated as of June 1, 2006, by and among Harold's Stores, Inc., Inter-Him N.V. and W. Howard Lester (Incorporated by Reference to Exhibit 10.2 to Form 8-K dated June 1, 2006). 10.28 Amendment No. 4 to Loan and Security Agreement dated as of June 1, 2006, by and among Wells Fargo Retail Finance II, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P. and Harold's of Jackson, Inc. (Incorporated by Reference to Exhibit 10.3 to Form 8-K dated June 1, 2006). 10.29 Amendment No. 5 to Loan and Security Agreement dated as of August 31, 2006, by and among Wells Fargo Retail Finance II, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.1 to Form 8-K dated August 31, 2006). 10.30 Subordinated Loan Agreement dated August 31, 2006 between Harold's Stores, Inc. and RonHow LLC. (Incorporated by reference to Exhibit 10.3 to Form 8-K dated August 31, 2006). 30 10.31 Subordinated Note dated August 31, 2006 in the principal amount of $10 million from Harold's Stores, Inc. in favor of RonHow LLC (Incorporated by reference to Exhibit 10.4 to Form 8-K dated August 31, 2006). 10.32 Subordinated Security Agreement dated August 31, 2006 between Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's of Jackson, Inc., The Corner Properties, Inc., Harold's Limited Partners, Inc., HSTX, Inc. and RonHow LLC. (Incorporated by reference to Exhibit 10.5 to Form 8-K dated August 31, 2006). 10.33 Subordination and Intercreditor Agreement dated August 31, 2006 between Harold's Store's Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's of Jackson, Inc., The Corner Properties, Inc., Harold's Limited Partners, Inc., HSTX, Inc., RonHow LLC and Wells Fargo Retail Finance II, LLC (Incorporated by reference to Exhibit 10.7 to Form 8-K dated August 31, 2006). 10.34 Option Agreement dated August 31, 2006, by and between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.8 to Form 8-K dated August 31, 2006). 10.35 Warrant Agreement dated August 31, 2006, by and between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.9 to Form 8-K dated August 31, 2006). 10.36 Employment Agreement dated October 6, 2006, between Harold's Stores, Inc. and Ronald S. Staffieri (Incorporated by reference to Exhibit 10.1 to Form 8-K dated October 6, 2006). 10.37 Stock Option Agreement dated October 6, 2006 between Harold's Stores, Inc. and Ronald Staffieri (Incorporated by reference to Exhibit 10.2 to Form 8-K dated October 6, 2006). 10.38 First Amendment to Subordination and Intercreditor Agreement by and among RonHow, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's of Jackson, Inc., The Corner Properties, Inc., Harold's DBO, Inc., Harold's Limited Partners, Inc., HSTX, Inc., and Wells Fargo Retail Finance II, LLC (Incorporated by reference to Exhibit 10.1 to Form 8-K dated April 26, 2007). 10.39 Amended and Restated Subordinated Secured Promissory Note by Harold's Stores, Inc. in favor of RonHow, LLC (Incorporated by reference to Exhibit 10.2 to Form 8-K dated April 26, 2007). 10.40 Global Amendment and Reaffirmation of Subordinated Debt Documents by and among RonHow, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's of Jackson, Inc., The Corner Properties, Inc., Harold's DBO, Inc., Harold's Limited Partners, Inc., and HSTX, Inc. (Incorporated by reference to Exhibit 10.3 to Form 8-K dated April 26, 2007). 10.41 Amendment No. 6 to Loan and Security Agreement by and among Wells Fargo Retail Finance II, LLC, Harold's Stores, Inc, Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P. and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.4 to Form 8-K dated April 26, 2007). 10.42 Option Agreement by and between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.6 to Form 8-K dated April 26, 2007). 10.43 Amendment No. 1 to Option Agreements by and between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.7 to Form 8-K dated April 26, 2007). 10.44 Preferred Stock Purchase Agreement for Series 2007-A Senior Preferred Stock by and between RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.8 to Form 8-K dated April 26, 2007). 10.45 Fourth Amendment to Investor Rights Agreement by and among Inter-Him, N.V., W. Howard Lester RonHow, LLC and Harold's Stores, Inc. (Incorporated by reference to Exhibit 10.9 to Form 8-K dated April 26, 2007). 22.1 Subsidiaries of Company (Incorporated by Reference to Exhibit 22.1 to Form 8-B Registration Statement, Registration No. 1-10892). 31 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 --------------------------- * Constitutes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. 32

Filing Compare · HAROLDS STORES INC