10-K 1 d01-34829.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------------- FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: June 30, 2001 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 number 0-24352 INTERIORS, INC. --------------- (Exact Name of Registrant as Specified in its Charter) Delaware 13-3590047 -------------------------------- ----------------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 320 Washington Street Mt. Vernon, New York 10553 -------------------------------- ----------------------------- (Address of Principal (Zip Code) Executive Offices) Registrant's telephone number, including area code: (914) 665-5400 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, $.001 par value per share ----------------------------------------------- (Title or Class) Series A 10% Cumulative Convertible Preferred Stock, $.01 par value per share ----------------------------------------------------------------------------- (Title or Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the closing price of such stock on October 11, 2000, was approximately $2,327,893. As of October 7, 2001, the registrant had outstanding 58,453,474 shares of Class A Common Stock, $.001 par value per share ("Class A Shares"), and 2,455,000 shares of Class B Common Stock, $.001 par value per share ("Class B Shares"). DOCUMENTS INCORPORATED BY REFERENCE: Portions of the definitive proxy statement of the registrant, which is to be filed with the Securities and Exchange Commission (the "Commission") within 120 days of the end of the fiscal year, are incorporated by reference into Part III of this Annual Report on Form 10-K. INTERIORS, INC. 2001 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I Item 1. Description of Business ........................................... 1 Item 2. Properties ........................................................ 9 Item 3. Legal Proceedings ................................................. 9 Item 4. Submission of Matters to a Vote of Security Holders ............... 10 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ........................................................... 11 Item 6. Selected Financial Data ........................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................................. 14 Item 7A. Quantitative and Qualitative Disclosures About Market Risk ....... 22 Item 8. Financial Statements and Supplementary Data ....................... 22 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure .............................................. 22 PART III Item 10. Directors and Executive Officers of the Registrant ............... 23 Item 11. Executive Compensation ........................................... 23 Item 12. Security Ownership of Certain Beneficial Owners and Management ... 23 Item 13. Certain Relationships and Related Transactions ................... 23 PART IV Item 14. Exhibits, Financial Statements and Reports on Form 8-K ........... 23 PART I Item 1. Description of Business Overview Interiors, Inc., a Delaware corporation ("Interiors" or the "Company"), is a designer, manufacturer and marketer of museum-quality traditional and contemporary picture frames, framed wall mirrors, oil paintings and prints under glass for the residential, commercial, institutional and contract markets. The Company primarily markets its products to museums, art galleries, designers, interior decorators and custom frame retailers. The Company's principal operations are located in Mount Vernon, New York. Interiors was originally incorporated in New York in October 1990 under the name A.P.F. Holdings, Inc., which subsequently merged with and into Interiors, Inc., a Delaware corporation, in March 1994. A.P.F. Holdings, Inc. was formed for the purpose of acquiring the assets of the picture framing business previously operated by a subsidiary of Collectors' Guild International, a New York corporation formed in 1976. The Company's principal executive offices are located at 320 Washington Street, Mount Vernon, New York 10553; its telephone number is (914) 665-5400. Ability to Continue as a Going Concern The report of the Company's independent public accountants in connection with the Company's financial statements as of and for the years ended June 30, 2001 and 2000 contain an explanatory paragraph as to Company's ability to continue as a going concern. See "Additional Factors to Consider - Ability to Continue as a Going Concern." Discontinued Operations During the fiscal year ended June 30, 2001 the Company completed the sales of certain assets of Troy Lighting, Inc. ("Troy"), CSL Lighting Manufacturing, Inc. ("CSL"), Windsor Art, Inc. ("Windsor") and sold all of the capital stock of Model Home Interiors, Inc. ("Model Home"). The Company completed the sale of stock of Artisan House, Inc. ("Artisan House") in August 2001 and the sale of certain assets of Stylecraft Lamps, Inc. ("Stylecraft") in October 2001. As of October 8, 2001, the Company's wholly owned subsidiaries, Petals, Inc. ("Petals") and Concepts 4, Inc. ("Concepts"), which remain to be sold, are also considered discontinued operations. Unless otherwise described herein, the information in this annual report relates to the Company's continuing operations, which consist primarily of its APF Master Framemakers division. See Note 3 "Discontinued Operations" to the accompanying financial statements filed with this Annual Report on Form 10-K. Acquisition History From 1994 through early 1998, Interiors' principal operating division was A.P.F. Master Framemakers, a manufacturer of antique and contemporary picture and mirror frames for museums, art galleries, interior designers, collectors, frame retailers, and upscale furniture and department stores. Starting in 1998, the Company embarked on an aggressive acquisition strategy in an attempt to become the premier, national single-source provider of decorative accessories to the home furnishings industry. From March 1998 until December 1999, the Company acquired several businesses that design, manufacture and distribute decorative accessories throughout the United States. During such time, the Company acquired Vanguard Studios, Inc. ("Vanguard"), a manufacturer of framed mirrors, paintings and prints, lighting products, sculptures and tabletop accessories, which was merged during the first quarter of fiscal 2001 into Windsor, a manufacturer of framed painting and prints and framed mirrors. The Company also acquired Troy, a manufacturer of fixed lighting products, Model Home, a company that provides design, merchandising and leasing services to the homebuilding industry, Stylecraft, a manufacturer of portable lighting products, CSL , a publicly traded manufacturer of fixed lighting products, Petals, a manufacturer and retailer of permanent botanicals and decorative accessories, and Concepts, an interior and architectural design company which distributes products to the hospitality industry. As a result of these transactions, the Company's business included the design, manufacture and distribution of a broad range or decorative accessories. Sales of Businesses Throughout 1999 and 2000, the Company had difficulty integrating many of the businesses it had recently acquired. The Company also defaulted on high interest rate debt obligations undertaken to finance its acquisition strategy. Therefore, in an effort to generate cash needed to reduce the Company's debt and maximize shareholder value, the Board of Directors abandoned the Company's acquisition strategy and adopted a formal plan during the second half of 2000 to sell substantially all of the acquired businesses. The Company retained DN Partners, an investment-banking firm, to assist in the sale of the various businesses. As described below, as of October 8, 2001, the Company had completed the sales of all of these businesses with the exception of Petals and Concepts. Following these transactions, the Company's business will primarily consist of its APF Master Framemakers division located in Mount Vernon, New York. On February 2, 2001, the Company completed the sales of substantially all the assets of Troy and CSL to Troy-CSL Lighting, Inc. The purchase prices consisted of $1,200,000 in cash, the assumption of approximately $1,700,000 of liabilities. The cash proceeds of the sale were used to pay down debt obligations owed to the Company's secured lender, Foothill Capital Corporation ("Foothill"). The loss on the disposal of these operations was approximately $3,500,000. On April 12, 2001, the Company sold all of the capital stock of Model Home to the former shareholders of Model Home. The purchase price consisted of $2,350,000 in cash, 7,358,000 Class A Common stock of the Company valued at $588,000 and the forgiveness of approximately $2,400,000 of intercompany receivables due from Interiors and other consolidated operations. The cash proceeds of the sale were used to pay down debt obligations owed to Foothill. The loss on this transaction was approximately $2,800,000. On June 29, 2001, the Company completed the sale of substantially all the assets of Windsor (including those formerly held by Vanguard) to AFDASI, dba Aesthetic Frame and Art Services. The purchase price consisted of $2,126,750 in cash, a 10% promissory note in the amount of $304,500 and the assumption of approximately $362,800 of liabilities. The cash proceeds of the sale were used to pay down debt obligations owed to Foothill. The loss on this transaction was approximately $22,700,000. On August 29, 2001, Decor Group, Inc., ("Decor"), a consolidated affiliate of the Company, completed the sale of stock of its wholly owned subsidiary Artisan House. The purchase price consisted of $605,000 in cash plus an 8% note for $35,000. The cash proceeds of the sale were used to pay down debt obligations owed to Foothill. The loss on this transaction was approximately $1,100,000. On October 1, 2001, the Company completed the sale of substantially all of the assets of Stylecraft to Stylecraft Acquisition, Inc. for $24,700,000 in cash. The cash proceeds were used to repay debt owed to Foothill in the amount of $9,900,000, the Investors Note (as defined below) in the amount of $5,200,000, the Limeridge Note and the Endeavour Note (both as defined below) in the aggregate amount of $2,800,000, a real estate mortgage owed to Bank of America in the amount of $2,200,000 and the Landis Note (as defined below) in the amount of $500,000. As part of the transaction, a personal loan of Max Munn, the Company's Chief Executive Officer, in the amount of $250,000 plus interest, owed to Jimmy Webster, the Chief Executive of Stylecraft, was transferred to the Company and the Company set up a corresponding receivable from Mr. Munn. The Company also paid an aggregate of approximately $1,200,000 out of $2,400,000 of retention incentives owed to its executive officers. The Company paid approximately $600,000 in fees and expenses. The remaining balance of approximately $2,300,000 was used for general working capital purposes of the Company. The gain on this transaction was approximately $16,200,000. In connection with the sale of the above businesses, the Company is required to indemnify the purchasers for certain liabilities relating to the businesses that were sold. The term of these obligations typically survive after the consummation of the transaction for a period of twelve to eighteen months. The obligations relate to potential breaches of representations and warranties for such matters as title to the assets, employee benefits issues, environmental liabilities, litigations and other known and unknown liabilities. If a material amount of indemnification obligations were to materialize, this would have a material adverse effect on the Company. Defaults on Senior Securities At June 30, 2001, including borrowings of discontinued operations, the Company had $27,070,000 of long term debt classified as current liabilities because the Company had defaulted on certain requirements set forth in its debt instruments. Included in these amounts are the 29% Secured Convertible Note due September 29, 2004 in favor of Limeridge LLC with a 2 current principal amount of $12,990,626 (the "Limeridge Note") and the 29% Secured Convertible Note due September 29, 2004 in favor of The Endeavour Capital Investment Fund S.A. with a principal amount of $1,744,518 (the "Endeavour Note"). Also included is the Company's senior revolving credit facility in the amount of $11,835,000 and bank term loans of $500,000 with Foothill Capital Corporation ("Foothill"). The nature of the defaults under the Foothill agreements relate to financial covenants, repayment of over-advances and cross defaults under the Limeridge Note and the Endeavour Note. The nature of the defaults under the Limeridge Note and the Endeavour Note relate to registration rights, the de-listing of the Company's securities from the Nasdaq SmallCap Market and the failure to pay approximately $6,133,000 in accrued interest as of June 30, 2001. The Company has recorded $2,652,000 as of June 30, 2001 representing the default penalty of 2% per month on the Limeridge Note for $2,338,000 and the Endeavor Note for $314,000, which has been recorded as interest expense in discontinued operations. On February 5, 2001, Limeridge LLC ("Limeridge"), formally notified the Company of its default and requested acceleration with respect to approximately $12,990,626 principal amount of secured convertible notes, plus accrued interest and penalties. The Company entered into a Forbearance and Acknowledgement Agreement dated April 26, 2001 with Limeridge and Endeavour (the "Limeridge/Endeavour Forbearance Agreement") pursuant to which Limeridge and Endeavour agreed not to take any action to collect any amounts owed to them until the earlier of (i) July 31, 2001, (ii) the date upon which the proceeds from the sale of the assets or capital stock of the Company's subsidiaries are sufficient to satisfy the Limeridge Note and the Endeavour Note or (iii) a default under the Limeridge/Endeavour Forbearance Agreement. From time to time, the Company is required to prepay the Limeridge Note and the Endeavour Note out of the proceeds of the sale of the assets or capital stock of the Company's subsidiaries. The Company is also required to pay to Limeridge and Endeavour fifty percent (50%) of the Company's excess cash flow, if any, for each quarter. The Limeridge/Endeavour Forbearance Agreement expired by its terms on July 31, 2001. As part of the Stylecraft transaction, the Company entered into the Comprehensive Amendment, Guaranty and Security Agreement dated as of September 28, 2001, pursuant to which the Company granted Limeridge and Endeavour a security interest in substantially all of the Company's assets in exchange for such parties' forbearance from foreclosing on the Limeridge Note and the Endeavour Note until December 31, 2001 notwithstanding that the Company remains in default with respect to the Limeridge Note and the Endeavour Note. The security interest is subordinated to the security interests securing the Foothill debt, the Investors Note and the Landis Note. As of June 30, 2001, the Company had $704,000 and $18,000 of accrued and unpaid dividends that were required to be paid on its Series A Preferred Shares and Series E Preferred Shares, respectively. All of the Company's Series E Preferred Shares are held by the spouse of Max Munn, the Company's Chairman, President and Chief Executive Officer. Industry Wall decor consists of three segments: framed art, framed mirrors and miscellaneous wall objects such as metal sculpture. The market for wall decor has been growing rapidly in recent years. According to the most recent bi-annual Universe Study conducted by Home Accents Today, domestic retail sales of wall decor, which were $3.8 billion in 1997, increased by 13% in 1998 to $4.3 billion. The bi-annual Home Accents Today Universe Study estimated growth for 1999 at 10%, resulting in anticipated total sales in excess of $4.8 billion in 1999. This represents a compound annual growth rate of 11.5% since 1997. The growth in the decorative accessory industry is being driven in part by demographic changes. The "baby boomer" generation, which represents the largest population group in the country, is entering their 40s and 50s, their peak earnings years. The baby boomers have traded up from starter homes into their dream homes, and are spending more on home improvements, additions, and furnishings to make their homes more luxurious. Products Picture Frames and Framed Mirrors. Interiors is a leader in producing high-end, custom frames for paintings, prints and mirrors. The Company also restores frames. The Company's frames are primarily reproductions of antique frames made to look as distressed as genuine frames from that period would look today. Customers select any combination of elements from the Company's library of approximately 1,500 elements to generate the frame style best suited for the picture or mirror and/or their decorating needs. These elements have been collected over decades, mostly through the Company's restoration activities, and primarily represent features from antique frames, many of which cannot be replicated. The Company's skilled 3 craftspeople hand produce the frame based on the elements selected by the customer. Frame prices range from $300 to $52,000, but more typically are between $800 and $4,000. Picture frames and mirror frames are made with the same tools, dies and molds. Mirror frames differ from picture frames in that mirror frames are constructed in the traditional design, with a top that is different from the sides and bottom. In comparison, picture frames have the same design throughout the four sides of the frame. The Company's mirror prices range from $1,000 to $8,000. The Company's picture frames and framed mirrors are sold primarily under the trade name of A.P.F. Master Framemakers. Raw Materials and Suppliers The primary raw materials used by Interiors in manufacturing and distributing its products are wood, composite resins, paint, glass, plexiglass, corrugated packaging materials, matboards and gold leaf. The Company purchases its raw materials from a wide variety of domestic and foreign suppliers. Interiors has at least two, and often more, suppliers for each item used in its manufacturing process, and has chosen to limit the majority of its purchases to those vendors with whom it has developed long-term relationships. Interiors believes that there are a relatively large number of other suppliers of raw materials available, which enable Interiors to obtain competitive prices for its raw materials. Interiors does not anticipate, nor has it experienced, any difficulty in obtaining any of its raw materials, and is not dependent upon any one supplier. Interiors generally does not enter into long-term contracts with its suppliers. Significant increases in the costs of raw materials could have a negative effect on Interiors' gross margins for its products if Interiors were unable to build these costs into the prices of its products or to offset such raw material cost increases through cost reductions. Manufacturing All of the Company's products are either manufactured directly by the Company or specifically on its behalf. The Company operates one manufacturing and distribution facility located in Mount Vernon, New York. Management estimates that approximately 85% of the Company's finished products are manufactured at its production facility. The balance of the Company's products and certain components and raw materials utilized by the Company are manufactured by third parties primarily in Mexico. The Company's manufacturing processes vary greatly among product lines, and include wood cutting and joining, finishing processes (including painting, polishing and etching) and hand painting. Certain of the Company's manufacturing processes utilize sophisticated computerized equipment, including mat cutting, acetate generation, and advanced primer and paint application systems. The Company's distribution facility is located adjacent to its manufacturing facility. The Company believes that coordination of the manufacturing, packaging and distribution functions allows for greater quality control and production efficiencies. Sales and Marketing The Company's primary customers are museums, art galleries, designers, interior decorators and custom frame retailers. The Company's products are marketed and sold through a network of independent manufacturers' representatives, who are often agencies employing a number of sales personnel. These representatives are paid on a commission-only basis, which the Company believes makes them highly motivated. None of the Company's present manufacturers' representatives are exclusive to the Company, and any representative could terminate its relationship with the Company at any time for any reason. In addition, manufacturers' representatives typically represent and distribute other non-competing decorative accessories. Given the large number of accounts, the Company believes that the use of independent representatives is an effective and cost-efficient means to distribute its products. The Company's manufacturer's representatives are supported by an in-house team of sales and marketing personnel. In addition, the Company maintains an in-house support staff consisting of order entry personnel as well as pre-sale and post-sale customer service personnel. The Company believes that its relationships with its sales representatives taken as a whole are generally good. 4 To supplement its sales efforts to the home furnishings industry and specialty account customers, the Company uses a variety of means to advertise and promote its products, including product brochures, trade shows and cooperative advertising with some of its accounts. Competition The wall decor decorative industry is highly competitive, and includes a large number of domestic and foreign manufacturers, none of which dominate the market. A number of the companies, which compete directly with the Company, are well established and have financial and other resources greater than those of the Company. Interiors ability to develop a competitive advantage in this market due to its extensive collection of tools, dies, and molds developed over time from restoration of genuine antique frames. Interiors believes that it would be extremely difficult for a competitor to build a comparable collection of these elements. In addition, Interiors has a work force of skilled crafts people that would be difficult to replicate. Intellectual Property Rights Many of the Company's products and their designs, as well as the design of many of the tools, dies and molds used in manufacturing certain of the Company's products, are proprietary to Interiors. In addition, the Company has sought to establish certain proprietary rights with respect to the marks under which its products and product categories are marketed. Consequently, the business of the Company is dependent, to a certain extent, on the Company's ability to establish and protect its intellectual property rights with respect to its products, designs, trademarks and trade names under which it does business. The Company believes that it owns or has the right to use all designs and proprietary technology necessary to manufacture and market its existing and planned products. Designs with respect to its products are generally created by employees and artists on a work-for-hire basis (i.e., the design automatically becomes the property of the Company upon creation) or purchased or licensed from independent designers on a consulting or royalty basis. The Company has no knowledge that it is infringing on any existing copyright, trademark or patent such that it would be liable for material damages or be prevented from manufacturing or marketing its products that account for a significant portion of its revenues. In the event the Company's right to market any of its products were to be successfully challenged, the Company may be required to discontinue certain products and the Company's business and prospects may be adversely affected if acceptable alternative products were not available. Regulatory Matters Interiors is subject to a wide range of federal, state and local laws and regulations relating to protection of the environment, worker health and safety and the emission, discharge, storage, treatment and disposal of hazardous materials. These laws include the Clean Air Act of 1970, as amended, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act and the Comprehensive Environmental, Response, Compensation and Liability Act. Certain of the Company's operations use materials containing chemicals that are considered hazardous under various environmental laws. Accordingly, management closely monitors the Company's environmental performance at all of its manufacturing facilities. Management believes that the Company is in substantial compliance with all environmental laws. While the Company may be required to make capital investments at some of its facilities to ensure compliance, Interiors believes that it will continue to meet all applicable requirements in a timely fashion and that any investment required to meet these requirements will not materially affect its financial condition or results of operations. However, legal and regulatory requirements in these areas have been increasing, and there can be no assurance that significant costs and liabilities will not be incurred in the future due to regulatory noncompliance. 5 Employees As of June 30, 2001, the Company's continuing operations employed 123 full-time persons, 71 of whom were subject to a collective bargaining agreement, which expires in March 2003. None of the Company's employees have been on strike, or threatened to strike, since the Company's inception and the Company believes that its relations with its employees are generally good. Directors, Executive Officers and Significant Employees The following table sets forth the directors, executive officers and significant employees of the Company and their respective ages and positions: Name Age Position(s) Held with the Company ---- --- --------------------------------- Max Munn 57 President, Chief Executive Officer, Chairman of the Board, and Director Robert J. Conologue 53 Chief Financial Officer and Executive Vice President Richard P. Belenski 46 Executive Vice President, and President of Petals, a subsidiary of the Company David A. Schwartz 34 General Counsel, Executive Vice President and Secretary Roger Lourie 56 Director Richard Josephberg 54 Director Management Biographies Brief biographies of the directors, executive officers, and key personnel of the Company are set forth below. All Directors hold office until their resignation, retirement, removal, disqualification, death or until their successors have been elected and qualified. Vacancies in the existing Board of Directors are filled by majority vote of the remaining directors. Officers of the Company serve at the will of the Board of Directors. Max Munn has been a director of Interiors since March 1994 and Chairman of the Board, Chief Executive Officer and President since September 1995. At various times since September 1995, Mr. Munn was Chief Financial Officer of Interiors. Mr. Munn previously held the positions of Executive Vice President, Operations and Secretary of Interiors from February 1994 through September 1995. Mr. Munn served as Vice President of A.P.F. Holdings, Inc. from May 1993 until A.P.F. Holdings, Inc. merged with Interiors in March 1994. Since June 1996, Mr. Munn has served as a director and officer of Decor Group, Inc., which has been consolidated with Interiors since October 1999. Since March 1999, Mr. Munn has served as a director and an officer of CSL Lighting Manufacturing, Inc., which was acquired by Interiors in March 1999. Robert J. Conologue has served as Chief Financial Officer and Executive Vice President of Interiors since May 2000. From May 1999 to April 2000, Mr. Conologue served as Senior Vice President, Chief Financial Officer and Chief Operating Officer of the Sportswear Division of Warnaco Group, Inc. ("Warnaco"). Prior to that Mr. Conologue held the positions of Senior Vice President, Finance and Controller of Warnaco. From May 1995 through early 1997, Mr. Conologue served as Vice President Finance and Control of Southern New England Telecommunications Corp. From 1989 to 1995, Mr. Conologue held various financial positions, most recently Group Vice President, Finance, with Avon Products, Inc. Richard P. Belenski has served as President of Petals since May 1999 and Executive Vice President of Interiors since October 1998. Mr. Belenski served as Vice President and Chief Financial Officer of Petals from December 1996 through October 1998. From October 1998 until May 2000, Mr. Belenski served as Chief Financial Officer of Interiors. Mr. Belenski has over 20 years experience in the management of retail, direct marketing and manufacturing companies. From October 1986 6 through May 1996, Mr. Belenski served as Vice President of Finance and Chief Financial Officer for operating divisions of the J. Crew Group, Inc., an international catalog and retail company with total revenues of $900 million. Mr. Belenski was also Director of Budgeting and Financial Analysis at Lincoln Center for the Performing Arts, Inc. from March 1985 through October 1996 and held management positions with J.C. Penney Company, Inc. from February 1978 through August 1980. From March 1999 until January 2000, Mr. Belenski served as a director and officer of CSL Lighting Manufacturing, Inc. Mr. Belenski received a BA degree from Lycoming College in 1977 and holds an MBA from Fairleigh Dickinson University. David A. Schwartz has served General Counsel, Executive Vice President and Secretary of Interiors since February 1999. From April 1996 until January 1999, Mr. Schwartz served as Corporate Counsel and Assistant Secretary for Complete Management, Inc. From late 1993 until March 1996, Mr. Schwartz was an associate at Skadden Arps Slate Meagher & Flom, LLP. From March 1999 until January 2000, Mr. Schwartz served as a director and officer of CSL Lighting Manufacturing, Inc., an affiliate of Interiors. Mr. Schwartz holds a JD degree from the Boston University School of Law and received a BA degree from the State University of New York at Binghamton. Roger Lourie has served as a director of Interiors since May 1995. Since 1980, Mr. Lourie has been a General Partner of Tremont Associates, a private equity investment fund, and since 1980 has served as President of Misty Ridge Associates, another private equity investment fund. Mr. Lourie is also Chairman of the Board of Directors of Pneumatic Tool, Inc., a tool manufacturer and Devon-Adair Publishing, Inc., a book publisher. Mr. Lourie received a B.S. degree in engineering from Rensselaer Polytechnic Institute of Technology and MBA and MIA degrees from Columbia University in New York. Richard Josephberg has served as a director of Interiors since October 1995. Since 1986, Mr. Josephberg has served as the Chairman of Josephberg Grosz & Co., Inc., a New York-based investment banking firm specializing in providing private institutional capital to emerging growth companies. From 1969 through 1975, Mr. Josephberg served as a security analyst with Goldman Sachs & Co. Additionally, from 1985 through 1990, Mr. Josephberg served as a member of the New York Stock Exchange. Mr. Josephberg received a BBA degree from the University of Cincinnati, and attended the MBA program at Bernard Baruch Graduate School of Business in New York. There are no material proceedings to which any director, officer or affiliate of the Company, any owner of record or beneficially of more than five percent of any class of voting securities of the Company, or any associate of any such director, officer, affiliate of the Company or security holder is a party adverse to the Company or any of its subsidiaries or has a material interest adverse the Company or any of its subsidiaries. 7 ADDITIONAL FACTORS TO CONSIDER Ability to Continue as a Going Concern The report of the Company's independent public accountants in connection with the Company's financial statements as of and for the years ended June 30, 2001 and 2000 contain an explanatory paragraph as to Company's ability to continue as a going concern. Among the factors contributing to the substantial doubt about the Company's ability to continue as a going concern are recurring net losses and the Company's default with respect to significant debt obligations. For the years ended June 30, 2001, 2000 and 1999, the Company had net losses of $39,192,000, $18,581,000 and $8,771,000, respectively, see Note 3 - Discontinued Operations. The net loss for the year ended June 30, 2001 of $39,192,000 includes a charge of $28,600,000 for the estimated loss on the disposal of businesses. The Company had operating cash flow of $193,000 for the year ended June 30, 2001 but had negative operating cash flows of $920,000 and $31,540,000 (which was used primarily for acquisitions), for the years ended June 30, 2000 and 1999, respectively. As of June 30, 2001, the Company had classified $27,070,000 of its long term debt, including debt applicable to discontinued operations of $24,428,000, as current liabilities because of its failure to meet requirements contained in the instruments governing these debt obligations. Such amount can currently be accelerated by the holders of these instruments as a result of the defaults. These factors raise substantial doubt about the Company's ability to continue as a going concern. Limited Liquidity At June 30, 2001, the Company had negative working capital of approximately $16,818,000. The Company continues to experience working capital limitations which materially impair its ability to generate positive cash flow. The cash proceeds received from the sales of various business units were required to be used to repay debt. The Company's credit facility provides for availability based upon inventory and account receivable levels and, accordingly, the Company has experienced limitations on the availability under this facility. The sales of Petals and Concepts during fiscal 2002 will be required to repay outstanding debt obligations. If the Company continues to experience working capital limitations it will materially impact the Company's financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Estimated Loss on Disposal of Businesses; Failure to Satisfy Obligations The Company currently estimates that as a result of the disposal of all discontinued operations the Company will incur a net loss. In addition, as of June 30, 2001, the Company's continuing operations had a working capital deficit of $8,110,000 and reported a net loss of $11,714,000. Accordingly, the Company does not expect that there will be sufficient proceeds from the sale of its remaining discontinued operations or results of continuing operations to satisfy all of its remaining obligations. The Company will be forced to seek additional financing alternatives or seek a liquidation of its remaining assets. Significant Financing Costs The Company has incurred significant costs in the financing of its business operations and acquisition strategy. As of June 30, 2001, the Company, including debt applicable to discontinued operations of $38,119,000, had total debt in the aggregate principal amount of approximately $43,603,000. As a consequence of the Company's significant financing costs, a substantial portion of the Company's cash flow from operations and cash proceeds from the sales of business units is committed to the payment of debt service and is not available to the Company for other purposes. The Company is currently in default with respect to $28,599,000 of debt obligations. Substantial decreases in the proceeds from the businesses to be sold and in operating cash flow or an increase in expenses would make it even more difficult for the Company to meet its other debt service requirements and force it to modify its operations. If this event were to occur, it would have a material adverse effect on the Company's financial position and results of operations. Delisting of Securities; Limited Trading Market In August 2000, the Company received a notice from the Nasdaq Stock Market of its intention to delist the Company's securities from the Nasdaq Small Cap Market because of the Company's failure to maintain at least $2.0 million in net tangible assets and a bid price of $1.00 per share. Marketplace Rule 4310(c)(2)(B) requires that an issuer have net tangible assets of at least $2,000,000 or a market capitalization of $35,000,000 or net income of $500,000. Marketplace Rule 4310(c)(4) requires that the Company's securities maintain a minimum bid price of $1.00 per share. The Company does not currently satisfy these criteria. On October 11, 2000, the Company received notice from Nasdaq that it had determined to delist the Company's 8 securities. The Company securities are now traded on the OTC Bulletin Board. There can be no assurance that there will continue to be a market maker for the Company's securities or that an active market will develop on the OTC Bulletin Board. "Penny Stock" Regulations May Impose Certain Restrictions on Marketability of the Company's Securities The Securities and Exchange Commission (the "Commission") has adopted regulations which generally define a "penny stock" to be any equity security that has a market price of less than $5.00 per share, subject to certain exemptions such as being listed on the Nasdaq SmallCap Market. As a result of being delisted, the Company's securities are subject to rules, which impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally, those persons with assets in excess of $1,000,000 or annual income exceeding $200,000, or $300,000 together with their spouse). For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of the securities and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell the securities and adversely affect the marketability of the Company's securities. Item 2. Properties Interiors' manufacturing, distribution and corporate offices are located in a 70,000 square ft. building located in Mount Vernon, New York under a five-year lease expiring at the end of 2006. The Company also leases showroom facilities in New York, New York, and Southport, Connecticut that are each approximately 1,500 square feet. The Company remains liable for a lease covering a facility in Vernon, California relating to its discontinued operations. The lease expires in 2008. The Company has vacated the premises and returned the property to the landlord. The landlord and the Company are currently negotiating to resolve this remaining liability. If the Company is unable to successfully reach a resolution of this matter, this liability will have a material adverse effect on the Company. Item 3. Legal Proceedings Interiors, Inc. v. Gilliam et al. This matter was brought by the Company to enforce the conversion of debt obligations in the amount of approximately $675,000. It is in the Supreme Court of State of New York, County of New York. The defendants claim that they rescinded their conversion notices. The Company does not expect the amount of its liability to exceed the amount of the debt. Market Square LLC v. Interiors, Inc. This matter was brought by the plaintiff in the General Court of Justice, Superior Court Division in the State of North Carolina, County of Guilford and relates to alleged non-payment of rent. The Company has several defenses relating to an alleged breach of the lease by the landlord and will vigorously defend itself. The landlord is alleging approximately $228,000 in damages. At this time, the Company is unable to predict the amount of any liability. Matrix Funding Corporation v. Stylecraft Lamps, Interiors, Inc and Petals, Inc. This matter was brought by the plaintiff in the Third Judicial District Court of Salt Lake County, Salt Lake Department, State of Utah and relates to the non-payment of a computer equipment lease. The equipment covered by the lease is not integral to the Company's business. The plaintiff is seeking approximately $1,400,000 in damages. The plaintiff has offered to settle the matter for significantly less than the amount of the alleged damages. The Company is currently considering this offer. Following the sale of the assets of Windsor, several actions were filed in the state courts of California against Windsor and Interiors for unpaid accounts payable. The buyer of the assets is protected from these claims because the sale transaction was accomplished in accordance with the bulk sale statute of the State of California. Windsor does not have any additional assets to satisfy these claims because the entire cash proceeds were used to repay secured debt obligations owed to Foothill. Interiors believes that the creditors of Windsor must only look to the assets of Windsor and not Interiors to satisfy any claims 9 they may have against Windsor. There can be no assurance, however, that a court will agree with the Company's analysis. If a court were to determine that Interiors is liable for a portion or all of these claims, it may have a material adverse effect on the Company. Interiors is subject to other claims and litigation arising in the ordinary course of its business. In management's opinion, Interiors is not presently a party to any such litigation or claims the outcome of which would have a material adverse effect on its financial position or its results of operations. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 2001. 10 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's Class A Shares are currently traded on the OTC Bulletin Board. The Class A Shares had been traded on the Nasdaq Small Cap Market ("NASDAQ") under the symbol INTXA from June 23, 1994 until October 11, 2000. Prior to that date, there was no public market for the Company's Class A Shares. The Class B Shares are not traded on any public market. The high and low closing prices of the Class A Shares on NASDAQ set forth below represent interdealer prices without retail markups, markdowns or commissions, and may not necessarily represent actual transactions: Fiscal Year Ending June 30, 2001 High Low ---- --- First Quarter .................................... $ .75 $ .25 Second Quarter ................................... $ .44 $ .06 Third Quarter .................................... $ .23 $ .06 Fourth Quarter ................................... $ .09 $ .06 Fiscal Year Ending June 30, 2000 High Low ---- --- First Quarter..................................... $1.75 $1.00 Second Quarter.................................... $1.38 $0.72 Third Quarter .................................... $1.31 $0.75 Fourth Quarter.................................... $1.06 $0.63 As of October 7, 2001, there were 227 holders of record of the Company's Class A Shares and one holder of record of the Company's Class B Shares. On October 8, 2001, the last reported sale price on the OTC Bulletin Board for the Company's Class A Shares was $0.04 See "Additional Factors to Consider - Delisting of Securities; Limited Trading Market." The Company has never declared or paid cash dividends on its Class A Shares or Class B Shares. The Company's ability to pay dividends is limited by restrictions under various debt obligations and by factors the Board of Directors deems relevant, including results of operations, financial condition and capital and surplus requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." In addition, pursuant to the Company's Certificate of Designations Rights and Preferences, (a) the Company's Series A Preferred Shares are entitled to a dividend, prior to any payment of dividends on the Class A Shares, of $0.50 per share per annum payable in cash or Class A Shares in semi-annual installments of $0.25 per share and (b) the Company's Series E Preferred Shares, having a liquidation value of $1,000, are entitled to a dividend, prior to any payment of dividends on the Class A Shares, at a rate of 9% per year and are convertible into 3,333 Class B Shares if such shares are available for issuance. The Company had accrued but unpaid dividends of $722,000 on its Series A and Series E Preferred shares. As of June 30, 2001, the Company had accrued but unpaid dividends of $704,000 on its Series A Preferred Shares. The dividends on the Series A Preferred Shares are payable in cash or Class A Shares at the Company's option. The dividend payable on the Series E Preferred Shares of $18,000 is net of the interest on the $500,000 note received as partial proceeds from the sale of the stock. Unregistered Offerings In August 2000, the Company issued 3,164,321 Class A Shares for deposit into the escrow established in connection with the acquisition of Concepts. In August, September and November 2000, the Company issued 2,162,837, 753,114 and 2,419,100 Class A Shares, respectively, for deposit into the escrow established in connection with the acquisition of Model Home. These shares were subsequently returned to the Company upon the sale of Model Home. In October 2000, the Company issued to Limeridge LLC 1,747,565 Class A Shares upon conversion of $550,000 principal amount of the Limeridge Note. 11 In October 2000, Seaside Partners, L.P. exercised the Series B Warrant resulting in the issuance of 2,000,000 Class A Shares at $0.75 per share. The exercise price of $1,500,000 was paid by the return to the Company of 150,000 Series B Preferred Shares held by Seaside. Seaside also converted its remaining 50,000 Series B Preferred Shares having a liquidation value of $500,000 and $213,485 in accrued dividends through October 11, 2000 into 303,610 Class A Shares at $2.35 per share. In addition, the Seaside note in the amount of $1,000,000 principal amount and $9,863 in accrued interest through June 30, 2000 were converted into 4,039,452 Class A Shares at $0.25 per share. Seaside has agreed to vote such shares in support of the election of the nominees of Board of Directors as long as Seaside Partners holds these Class A Shares. In December 2000, the Company issued 2,000,000 Class A Shares to the Troy Purchasers in partial satisfaction a $517,000 obligation. On January 11, 2001, the Board of Directors authorized the creation of 2,000 shares of a new class of preferred stock designated Series E Convertible Preferred Stock ("Series E Preferred Shares"). Each Series E Preferred Share has a liquidation value of $1,000, is entitled to receive a 9% quarterly dividend and convertible into 3,333 Class B Shares if such shares are available for issuance. Until such time as the Company pays all accrued dividends on the Series E Preferred Shares, each Series E Preferred Share is entitled to five votes for each Class B Share into which it could have been converted if such shares were available for issuance. On January 16, 2001, the Company issued 1,000 Series E Preferred Shares to Laurie Munn, wife of Max Munn, the Company's Chief Executive Officer, in exchange for $500,000 cash and a promissory note in the amount of $500,000 (the "Series E Note"). The Series E Note is secured by the 1,000 Series E Preferred Shares, accrues interest at 11% per annum, which is payable at maturity, and matures on January 16, 2005. In addition, Mr. and Mrs. Munn agreed to guarantee up to $3,000,000 of accounts payable owed by one of the Company's subsidiaries, Stylecraft Lamps, Inc. ("Stylecraft"). The Company also agreed to subordinate its security interest in the 1,000 Series E Preferred Shares behind a security interest securing a $250,000 promissory note of Mrs. Munn executed in favor of Jimmy Webster, the Chief Executive Officer of Stylecraft. The Company also subordinated to Jimmy Webster its security interest in 2,445,000 Class B Shares owned by Mrs. Munn, which shares secure the Consolidated Promissory Note due November 1, 2005 in favor of the Company in the principal amount of $2,504,000 and accrued interest at 6.5% of $458,000, is payable at maturity (the "Munn Consolidated Note"). The Company does not accrue interest on this note. As part of the sale of Stylecraft, the $250,000 promissory note owed by Mr. Munn to Mr. Webster was transferred to the Company and Mr. Munn's personal guarantees were discharged. The Company set up a corresponding receivable from Mr. Munn. See "Sales of Businesses." These issuances were exempt from registration under Section 4(2) of the Securities Act as transactions by the issuer not involving any public offering because of one or more of the following factors: (i) the offering was limited to a small number of persons, (ii) such persons had a pre-existing relationship with the Company and access to information that would be required in a registration statement, (iii) the offering was made through direct negotiations and did not include general advertising or solicitation, or (iv) such persons had sophisticated representatives. No underwriters were engaged by the Company in connection with any of the issuances described above and, accordingly, no underwriting discounts or commissions were paid. 12 Item 6. Selected Financial Data. The following table presents consolidated financial data, derived from the Company's audited financial statements, as restated for discontinued operations, for the five-year period ended June 30, 2001. Selected Financial Data (in thousands, except per share data)

* As restated, see Note 2 of the notes to the consolidated financial statements. ** For fiscal year ended June 30, 1998, weighted average shares for diluted earnings per share purposes was 8,154,000 which would not change the per share amount. 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the financial statements of the Company and the related notes thereto, and the other financial information included elsewhere in this Form 10-K. Overview Interiors, Inc., a Delaware corporation ("Interiors" or the "Company"), is a designer, manufacturer and marketer of museum-quality traditional and contemporary picture frames, framed wall mirrors, oil paintings and prints under glass for the residential, commercial, institutional and contract markets. The Company primarily markets its products to museums, art galleries, designers, interior decorators and custom frame retailers. The Company's principal operations are located in Mount Vernon, New York. Ability to Continue as a Going Concern The report of the Company's independent public accountants in connection with the Company's financial statements as of and for the years ended June 30, 2001 and 2000 contain an explanatory paragraph as to Company's ability to continue as a going concern. See "Additional Factors to Consider - Ability to Continue as a Going Concern." Discontinued Operations During the fiscal year ended June 30, 2001, the Company sold the net assets of CSL, Troy and Windsor. In addition, the Company sold the stock of Model Home. As of June 30, 2001, the Company's wholly owned subsidiaries, Stylecraft, Petals, and Concepts, as well as its consolidated affiliate, Artisan House are considered discontinued operations. In August 2001, the Company sold the stock of Artisan House and on October 1 2001, the Company completed the sale of certain net assets of Stylecraft. Unless otherwise described herein, the information in this annual report relates to the Company's continuing operations, which consist primarily of its APF Master Framemakers division. See Note 3 "Discontinued Operations" to the accompanying financial statements filed with this Annual Report on Form 10-K. As of June 30, 2001, the losses incurred on the sales of businesses which occurred as of such date and the anticipated sales of the other businesses were estimated to result in a net loss. During the first quarter of fiscal 2002, the Company sold the stock of Artisan House and, on October 1, 2001, it sold the assets of Stylecraft. The Company will attempt to complete the sales of Petals and Concepts in the second quarter of fiscal 2002. The estimated loss of $28,600,000 on the disposal of all businesses was recorded in the fourth quarter of fiscal 2001. This estimated loss includes losses on businesses sold during the third quarter of fiscal 2001, which had been previously deferred in accordance with EITF 85-36 since, at that time, it was anticipated that the sales of all the businesses would result in a net gain. The change to an estimated net loss is due to actual sale prices of businesses sold during the fourth quarter of fiscal 2001 and in early fiscal 2002 being lower than previously estimated. The sales prices have decreased because of poor operating results and deteriorating general economic conditions since the decision was made to sell these businesses. The results of operations of discontinued operations since December 31, 2000 were deferred and included in the loss on disposal of the businesses. The estimated loss of $28,600,000 is comprised of the following: (a) actual losses of approximately $29,000,000 on businesses sold prior to June 30, 2001, (b) actual losses of $5,900,000 for the results of operations of discontinued operations from December 31, 2000 until the date of disposition if prior to June 30, 2001, (c) estimated losses of approximately $15,500,000 for the results of operations (including interest on debt obligations, estimated investment fees and retention incentives) from June 30, 2001 until the actual or anticipated date of disposition of businesses not disposed of as of June 30, 2001 and (d) estimated net gains of approximately $21,800,000 on the sales of businesses not disposed of as of June 30, 2001. 14 The results of operations for the fiscal years ended June 30, 2001 (through December 31, 2000), 2000 and 1999, are summarized as follows:

West Coast is comprised of the operations of Troy, CSL, Windsor and Decor. Revenues for the business segments are from external sales. Inter-segment sales totaled $417,000 and $635,000 in the fiscal years 2001 and 2000, respectively, and are reported under Other. There were no inter-segment sales for fiscal year 1999. Inter-segment sales were not significant for any business segment. Depreciation and amortization assigned to the business units represents amounts applicable to fixed assets and other intangible assets, excluding goodwill which is presented separately. Also reported under the Other category is the interest expense and default penalty under the Limeridge Note and the Endeavor Note, interest expense on acquisition debt instruments as well as the depreciation expense on a computer system that is no longer being implemented. Results of Operations The Company's continuing operations consist of its APF Master Framemakers division and the rug and accessories business located in Mount Vernon, New York. The rug and accessories businesses was commenced during the third quarter of fiscal 2000 and has been wound down. The results of continuing operations presented below exclude the performance of Petals, Stylecraft, Habitat Solutions and the West Coast operations because these businesses are being presented as discontinued operations in the accompanying financial statements. Comparison of Fiscal Years ended June 30, 2001 and 2000. Net sales for the fiscal year ended June 30, 2001 were $9,021,000 as compared to $8,235,000 for the same period in fiscal 2000, an increase of $786,000 primarily due to higher sales in the rug and accessory business. The Company has made the decision to wind down the rug and accessory business. As of June 30, 2001, the Company is winding up this business. Cost of goods sold for the fiscal year ended June 30, 2001 increased to $7,448,000 from $6,282,000 for the same period in fiscal 2000, an increase of $1,116,000, which includes $733,000 related to the write down of the rug and accessory inventory. Cost of goods sold for the fiscal year end June 30, 2000 includes $800,000 of start up related costs. Cost of goods sold includes 15 the costs directly related to the recognition of the Company's net sales. The increase in costs of good sold was primarily due to the rugs and accessory business. As percentage of net sales, cost of goods sold for the fiscal year ended June 30, 2001 increased to 82.6% from 76.3% for the same period of the prior year. The decrease in profit margin resulted primarily from the decision to wind down the lower margin rug and accessory business. Selling, general and administrative expenses for the fiscal year ended June 30, 2001 was $11,155,000, which includes $616,000 for sample products primarily the new vision mirrors and picture frame corner samples and $1,797,000 representing the estimated write off to liquidate the rug and accessory business, compared to $11,978,000 for the comparable period of fiscal 2000, which includes $2,500,000 of start up expenses for the rug and accessory businesses. General and administrative expenses represent overhead and administrative expenses excluding costs directly related to operations and the recognition of the Company's net sales. The higher selling, general and administrative expenses is due to the higher expenses in the rug and accessory businesses and higher administrative expenses were also incurred as a result of higher costs incurred in the management of the various operations, which are reported in discontinued operations. Interest expense applicable to continuing operations increased to $2,132,000 for the fiscal year ended June 30, 2001 from $1,035,000 for the same period in fiscal 2000 principally due to the higher average borrowings, including the funding of the rug and accessory businesses and higher administrative expenses. Comparison of Fiscal Years Ended June 30, 2000 and 1999 Net sales for the fiscal year ended June 30, 2000 were $8,235,000 as compared to $6,401,000 for the 1999 fiscal year, an increase of $1,834,000 primarily due to the commencement of the rug and accessory businesses. Cost of goods sold for the fiscal year ended June 30, 2000 increased to $6,282,000 from $3,717,000 for the same period in 1999, an increase of $2,565,000. Costs of goods sold for the fiscal year ended June 30, 2000 includes $800,000 of start up related costs. Cost of goods sold includes the costs directly related to net sales. As a percentage of net sales, cost of goods sold for the fiscal year ended June 30, 2000 increased slightly to 76.3% from the 58.1% for the prior year due to the lower margin rug and accessory business. Selling, general and administrative expenses increased to $11,978,000 for the fiscal year ended June 30, 2000 as compared to $7,147,000 for the 1999 fiscal year, an increase of $4,831,000, which includes $2,500,000 of start up expenses for the rug and accessory businesses. General and administrative expenses represent overhead and administrative expenses excluding costs directly related to the cost of products sold. The increase in general and administrative expenses was, in part, due to the Company's $2,500,000 of start up expenses for two new brands were incurred in the current fiscal year. In addition, higher expenses associated with the rug and accessory businesses and increased administrative expenses, incurred in the management of the various businesses. Interest expense decreased to $1,035,000 for the fiscal year ended June 30, 2000 from $1,082,000 for the same period in fiscal 1999 principally due to lower deferred financing fees partially off set by higher borrowings resulting from the commencement of rug and accessory business and the higher administrative expenses. 16 Liquidity and Capital Resources The consolidated financial statements that accompany this Form 10-K have been prepared on a going concern basis that contemplates the realization of assets and the satisfaction of liabilities as discussed below and in Note 3 - "Discontinued Operations." In an effort to generate the cash needed to cure the Company's defaults, reduce its high interest rate debt and maximize shareholder value, the Company hired DN Partners, an investment banking firm, to act as a financial advisor to assist the Board of Directors in the implementation of a formal plan to divest the Company of substantially all of its businesses, except for its APF Master Framemakers division ("APF"). See Item 1 "Business -- Acquisition History" and "-- Sales of Businesses." The Company's ability to generate the necessary cash proceeds will be materially effected by the order and timing of the sales of its businesses, as well as the amount of sale proceeds. For the fiscal years ended June 30, 2001, 2000 and 1999, the Company had losses from continuing operations of $11,714,000, $11,060,000 and $5,545,000, respectively. The Company had positive cash flow from operations of $193,000, for the year ended June 30, 2001, but had negative operating cash flows of $920,000 and $31,540,000 (which were primarily used for acquisitions) for the years ended June 30, 2000 and 1999, respectively. In addition, the Company classified a significant portion of its long-term debt as current liabilities because of its failure to meet certain requirements contained in the agreements governing its debt instruments. These factors, as well as those discussed elsewhere herein, raise substantial doubt about the Company's ability to continue as a going concern. See "Additional Factors to Consider." The Company's primary sources of cash during this period have been borrowings under the Foothill revolving loan agreement, the Investors Note, the sale of Series E Preferred Shares and from operations. At June 30, 2001, the Company had working capital deficit of $16,818,000. Included in current liabilities of $19,921,000 as of June 30, 2001 is net liabilities of business held for disposition of $8,708,000. Excluding the net liabilities of business held for disposition, the Company had a working capital deficit of $8,110,000. Net cash used in continuing operating activities during the year ended June 30, 2001 and 2000 was $8,054,000 and $11,473,000, respectively. The lower net cash usage during the year ended June 30, 2001 compared to the same period of 2000, is principally due to a decrease in inventories, a smaller increase in accounts payable and an increase in accounts receivable. Partially offsetting these lower cash usages was an increase in the loss from continuing operations. The year ended June 30, 2001 had a net loss from continuing operations of $11,714,000 compared to the net loss from continuing operations of $11,060,000 for the comparable period of 2000. The loss from continuing operations for the year ended June 30, 2000 included a non-cash charge of $1,467,000 related to the write down of the rug and accessory businesses. Net cash used in investing activities during the year ended June 30, 2001 and 2000 was $335,000 and $209,000, respectively, for capital expenditures. Net cash provided by financing activities during the year ended June 30, 2001 was $440,000 primarily from funds provided under the Foothill agreement of $2,230,000, the Investors Note of $450,000 and the sale of Series E Preferred Shares of $500,000. Cash in the amount of $2,729,000 was used for the repurchase of shares from the former owners of Concepts 4. At June 30, 2001, including the borrowings of discontinued operations, the Company had $27,070,000 of long term debt classified as current liabilities because the Company had defaulted on certain requirements governing its debt instruments. Included in these amounts are the 29% Secured Convertible Note due September 29, 2004 in favor of Limeridge LLC with a current principal amount of $12,990,626 (the "Limeridge Note") and the 29% Secured Convertible Note due September 29, 2004 in favor of The Endeavour Capital Investment Fund S.A. with a principal amount of $1,744,518 (the "Endeavour Note"). Also included is the Company's senior revolving credit facility in the amount of $11,835,000 and bank term loans of $500,000 with Foothill Capital Corporation ("Foothill"). The nature of the defaults under the Foothill agreements relate to financial covenants, repayment of over-advances and cross defaults under the Limeridge Note and the Endeavour Note. The nature of the defaults under the Limeridge Note and the Endeavour Note relate to registration rights, the de-listing of the Company's securities from the Nasdaq SmallCap Market and the failure to pay approximately $6,133,000 in accrued interest as of June 30, 2001. As of August 15, 2000, the Company entered into Amendment No. 1 to Loan Documents with Foothill (the "Foothill Amendment No. 1") pursuant to which Foothill agreed to extend the Company an overadvance of $500,000 until September 1, 2000 and forbear from taking any action to collect the amounts owed to them until the earlier to occur of (i) June 30, 2001 or (ii) 17 a default under the Foothill Amendment No. 1. As of October 13, 2000, the Company entered into Amendment No. 2 to Loan Documents and Waiver with Foothill (the "Foothill Amendment No. 2") pursuant to which Foothill agreed to amend certain financial covenants and to waive cross defaults under the Limeridge Note and Endeavour Note until the earlier to occur of (i) October 1, 2000 or (ii) a default under the Foothill Amendment No. 2. The fee charged by Foothill for such amendment was $15,000. As of March 19, 2001, the Company entered into Amendment No. 3 to Loan Documents and Forbearance Agreement with Foothill (the "Foothill Amendment No. 3") pursuant to which Foothill agreed to forbear from taking any action to collect the amounts owed to them until June 30, 2001 or (ii) a default under the Foothill Amendment No. 3. The fee charged by Foothill for such amendment was $150,000. The Company's interest rate was also increased to 2.5% per annum over the prime rate and its maximum borrowing under its credit facility was reduced from $25,000,000 to $17,000,000. As of June 29, 2001, the Company entered into Amendment No. 4 to Loan Documents and Extended Forbearance Agreement with Foothill (the "Foothill Amendment No. 4") pursuant to which Foothill agreed to extend the Company an overadvance of $650,000 until August 24, 2001, amend certain financial covenants and forbear from taking any action to collect the amounts owed to them until August 31, 2001 or (ii) a default under the Foothill Amendment No. 4. The fee charged by Foothill for such amendment was $50,000. The Company's interest rate was also increased to 2.5% per annum over the prime rate and its maximum borrowing under its credit facility was reduced from $17,000,000 to $16,500,000. In addition, the Company was charged an early termination fee of $600,000, which is payable upon termination of the credit facility. As of August 31, 2001, the Company entered into Amendment No. 5 to Loan Documents and Second Extended Forbearance Agreement with Foothill (the "Foothill Amendment No. 5") pursuant to which Foothill agreed to forbear from taking any action to collect the amounts owed to them until September 28, 2001 or (ii) a default under the Foothill Amendment No. 5. The fee charged by Foothill for such forbearance was $65,000. The Company's maximum borrowing under its credit facility was reduced from $16,500,000 to $13,500,000. As of October 1, 2001, the Company entered into Amendment No. 6 to Loan Documents and Third Extended Forbearance Agreement with Foothill (the "Foothill Amendment No. 6") pursuant to which Foothill agreed to forbear from taking any action to collect the amounts owed to them until December 14, 2001 or (ii) a default under the Foothill Amendment No. 6. The fee charged by Foothill for such forbearance was $300,000. The Company's maximum borrowing under its credit facility was reduced from $13,500,000 to $2,335,000. In April 2001, the Company entered into a Forbearance and Acknowledgement Agreement with Limeridge and Endeavour (the "Limeridge/Endeavour Forbearance Agreement") pursuant to which Limeridge and Endeavour agreed not to take any action to collect any amounts owed to them until the earlier of (i) July 31, 2001, (ii) the date upon which the proceeds from the sale of the assets or capital stock of the Company's subsidiaries are sufficient to satisfy the Limeridge Note and the Endeavour Note or (iii) a default under the Limeridge/Endeavour Forbearance Agreement. The Limeridge/Endeavour Forbearance expired by its terms on July 31, 2001. As part of the Stylecraft transaction, the Company entered into the Comprehensive Amendment, Guaranty and Security Agreement dated as of September 28, 2001, pursuant to which the Company granted Limeridge and Endeavour a security interest in substantially all of the Company's assets in exchange for such parties' forbearance from foreclosing on the Limeridge Note and the Endeavour Note until December 31, 2001 notwithstanding that the Company remains in default with respect to the Limeridge Note and the Endeavour Note. The security interest is subordinated to the security interests securing the Foothill debt, the Investors Note and the Landis Note. On March 19, 2001, Petals and Stylecraft, wholly owned subsidiaries of the Company, executed a Senior Subordinated Secured Note due March 14, 2002 (the "Investors Note") in favor of Interiors Investors, LLC, a Delaware limited liability company ("Interiors Investors") in the original principal amount of $5,000,000. The Investors Note is subordinated to the Company's obligations owed to Foothill, secured by substantially all of the Company's assets and guaranteed by Interiors and the Company's Chairman, President and Chief Executive Officer and his spouse. The Investors Note accrues interest at 16% per annum until September 30, 2001 and 18% thereafter and is payable monthly commencing May 31, 2001. From time to time, the Company is required to prepay the Investors Note out of the proceeds of the sale of the assets or capital stock of the Company's subsidiaries. Interiors Investors is owned by Robert Berman, who controls Berman Industries, Inc., Stylecraft's largest vendor ("Berman Industries"), and Jimmy Webster, Stylecraft's Chief Executive Officer. The Company received net proceeds of $4,941,000, of which $2,000,000 was loaned to Stylecraft to pay accounts payable owed to Berman Industries, $2,941,000 was 18 loaned to Petals for working capital requirements, of which $450,000 was paid to Foothill on behalf of Interiors to pay down the revolving loan. In connection with the sale of Stylecraft, the Company repaid $3.0 million principal amount of the Investors Note and the interest rate was increased to 20.0% On March 19, 2001, Petals, Stylecraft and Interiors Investors entered into a letter agreement (the "Investors Letter Agreement") pursuant to which upon the sale of the assets or capital stock of Petals and/or Stylecraft, the Company is obligated to pay Interiors Investors $2,200,000 plus $125,000 for each calendar month after October 1, 2001 until such event occurs. The Investors Letter Agreement expires on March 19, 2004. The amount is included as part of the calculation of a gain or loss on discontinued operations. In connection with the Stylecraft transaction, the Company paid Interiors Investors $2,200,000 to satisfy its obligations under the Investors Letter Agreement. As part of the sale of Stylecraft, on September 28, 2001, Petals, Stylecraft and Interiors Investors entered into a letter agreement (the "Second Investors Letter Agreement") pursuant to which upon the sale of the assets or capital stock of Petals, the Company is obligated to pay Interiors Investors $200,000 plus $30,000 for each calendar month after April 1, 2002 until such event occurs. The Second Investors Letter Agreement expires on September 28, 2004. The amount will be included as part of the calculation of a gain or loss on discontinued operations. In addition, Petals issued a promissory note due March 31, 2002 in the amount of $224,894 in favor of Berman Industries, Inc., Stylecraft's largest vendor. On October 12, 2000, the Company and the former shareholders of Concepts amended the terms of the purchase agreement pursuant to which the Company acquired all of the common stock of Concepts. Pursuant to the amended terms, the Company paid the former shareholders $3,388,000 during the second quarter of 2000. The Company also has purchase price obligations consisting of (a) a cash payment of $770,000 payable on December 15, 2000, which was satisfied by the delivery of a note as discussed below, (b) a cash payment of $1,218,000 payable on December 15, 2001, (c) a cash payment of $1,218,000 payable on December 15, 2002, and (e) a cash payment of $1,007,289 payable on March 10, 2003. Pursuant to the transaction, the Company also agreed to pay the former shareholders up to $4,500,000 upon the attainment of certain earnings goals by the Company. The amount, if any, will be determined by the earnings of Concepts for the fiscal years 2000, 2001 and 2002. For the calendar year 2000, the earnout was $1,289,000 which was recorded as additional goodwill. All purchase price obligations of the Company can be satisfied by the delivery of twelve month promissory notes bearing interest at 8% per annum and all earnout obligations can be satisfied by the delivery of eighteen month promissory notes bearing interest at 8% per annum. The December 15, 2000 payment of $770,000 and the earnout of $1,289,000 were satisfied by the issuance of promissory notes to the former shareholders of Concepts. During the third and fourth quarters of fiscal 2001, $351,000 has been paid on the $770,000 promissory note. The Company has also agreed to maintain an escrow account containing Class A Shares in an amount sufficient to satisfy all purchase price and earnout obligations relating to Concepts as they become due under the terms of the transaction. The former shareholders have agreed to vote such shares in support of the election of the nominees of Board of Directors as long as the Company is not in default under the amended purchase agreements. As of June 30, 2001, there was an aggregate of 9,999,999 Class A Shares held in the escrow account. The former shareholders have the option of removing Class A Shares from the escrow account in an amount necessary to satisfy any outstanding purchase price obligations or promissory notes delivered in connection therewith. The Company does not expect the shareholders to exercise this option given the current trading price of the Class A Shares. On October 11, 2000, the Company issued to Limeridge 1,747,565 Class A Shares upon conversion of $550,000 principal amount of the Limeridge Note. Due to a decrease in the price of the Class A Shares, during the first quarter and second quarter of fiscal 2001, the Company deposited an additional 2,915,951 and 2,419,100 Class A Shares, respectively, into an escrow account established to secure purchase price and future earnout obligations in connection with the Company's acquisition of Model Homes Interiors, Inc. ("Model Home"). In January 2001, the Company released from escrow 2,515,368 Class A Shares to the former owners of Model Home, valued at $325,000, representing the earnout for calendar year 2000 in accordance with the original acquisition agreement. The amount was recorded as additional goodwill related to the acquisition. In April 2001, these shares were returned to the Company when Model Home was sold by the Company to the former owners of Model Home. See Item 1 - "Sales of Businesses." In July 1999, the former shareholders of Troy agreed to sell 650,000 Class A Shares (the "Troy Merger Shares") obtained from the Company to Dominion Capital Fund, Ltd., Dominion Investment Fund, LLC and Sovereign Partners, L.P. (collectively, the "Troy Purchasers") for $1,000,000. Since the Troy Merger Shares were worth less $1,150,000 based on the 19 sixty-day average of the Class A Shares following January 25, 2000, the Company must either pay cash or issue additional Class A Shares to the Troy Purchasers in the amount of the shortfall. The determination to pay shares or issue stock is based upon, among other things, the price of the Class A Shares and the liquidity needs of the Company at the time of payment. On December 7, 2000, the Company issued 2,000,000 shares to the Troy Purchasers in satisfaction $300,000 of such shortfall. The parties have agreed that the remaining balance is $200,739. The Company will attempt to complete its plan to discontinue certain of its operations within one year. The completion of such plan is dependent on numerous factors beyond the control of the Company, including without limitation, the marketability of the Company's subsidiaries and divisions, other comparable assets being offered by other sellers, interest rates, the Company's ability to find willing buyers, the capital markets, the continued performance of the Company's subsidiaries and divisions, and the Company's defaults under senior debt instruments and lack of capital resources needed to accomplish such sales. Notwithstanding the Company's ability to complete the sale of its discontinued obligations, it will not have sufficient proceeds to satisfy all of its obligations. The Company will be forced to seek additional financing alternatives or seek a liquidation of its remaining assets. See "Additional Factors to Consider - Estimated Loss on Disposal of Business; Failure to Satisfy Obligations." Impact of Inflation The Company does not believe that inflation has had a material adverse effect on sales or income during the past several years. Increases in supplied and other operating costs could adversely effect the Company's operations, however, the Company believes that it should be able to increase prices to offset increases in cost of goods sold or other operating costs. Sales Variations The Company's net sales are not generally subject to seasonal fluctuations experienced by certain retailers, however, the Company does experience some minor variations in the level of sales during the year. The first quarter of the Company's fiscal year (July through September) is generally the Company's slowest sales period due to the fact that the summer is typically when retailers are in their slowest purchasing period. During this time, the Company's warehouse and factory close for three to five days to take annual physical inventories and to consolidate vacation periods for certain of the Company's employees. Additional Disclosure In fiscal 1998, the Company issued to Laurie Munn, wife of the Company's Chief Executive Officer, 1,350,000 options purchase Class B Shares at $1.19 per share. The options were exercised in fiscal 1999. The Company has recorded compensation expense of $896,000 for the fair value of the options. The Company has amortized $149,000 of such expense in fiscal 1998 and the balance of $747,000 in fiscal 1999. The financial statements accompanying this Form 10-K has been restated to reflect these items. In fiscal 1998, the Company issued to Mrs. Munn 730,000 Class B Shares at $0.70 per share while the Class A Shares were trading at $1.00 per share. The Company has determined to record a compensation expense of $219,000 in fiscal year 1998 for the $0.30 discount from the Class A Shares on January 9, 1998, the date that the Board approved the issuance. The financial statements accompanying this Form 10-K has been restated to reflect these items. As a result of a transaction in July 1998, the Company recorded an extraordinary gain in the amount of $1,370,500. The Company's gain was determined by allocating the cash and other assets that were paid by the Company in the transaction ($2,634,000) equally between the 1,500,000 Class A Shares returned to the Company and the obligations of the Company that were extinguished. The Company then deducted the book value of the assets that it transferred and its costs in the transaction from these amounts to determine the amount of its extraordinary gain. During the first three quarters and part of the fourth quarter of fiscal year 2000, Mr. Munn, the Company Chairman, President and Chief Executive Officer, managed the Company's west coast operations from the Company's headquarters in Mt Vernon, NY. Mr. Munn attempted to directly supervise lower level west coast personnel in integrating several acquired businesses while also attempting to grow the businesses' revenues. During June 2000, the Company hired a consultant to take a lead role in continuing Mr. Munn's plans for the west coast businesses. Upon a thorough review of the operations of these businesses conducted by the consultant, however, the consultant subsequently informed the Company that due to limitations in west coast personnel, existing business models and the need for additional capital infusions by the Company, the future prospects 20 or these businesses were not as promising as previously anticipated. Therefore, the Company determined to (a) sell its lighting businesses located on the west coast, (b) significantly reduce the number of SKUs, including lighting products, that would be sold by its decorative accessories businesses, (c) outsource the bulk of its manufacturing processes located on the west coast and (d) reduce the number of employees on the west coast to an appropriate amount given the above changes to its businesses. As a result of these decisions, the Company dramatically changed the direction of its west coast decorative accessories businesses, thereby reducing the scale and related cash-flow of these business, making it impossible to recover the related assets. See Note 18 "Operations Quarterly Financial Data Unaudited" to the financial statements accompanying this Form 10-K. In the fourth quarter of fiscal year 2001, the Company recorded an estimated loss on the disposal of business of $28,600,000. During the fourth quarter the Company disposed of Model Home and Windsor operations. The Company had also received indications of interest for the other businesses to be disposed of, i.e. Petals, Stylecraft, Artisan House and Concepts. These indications of interest have been lower than previous estimates the Company believed the businesses could be sold for, in part due to the recent economic environment. The Company is continuing to evaluate the indications of interest for Petals and Concepts. During the first quarter of fiscal 2002, the Company sold the stock of Artisan House and on October 1, 2001 the Company sold certain net assets of Stylecraft. Based on the losses realized on the sale of businesses sold during the second and third quarters of fiscal 2001, which had been deferred in accordance with EITF 85-36 - "Discontinued Operations with Expected Gain and Interim Losses", in anticipation of a net gain on the disposal of all businesses, as well as lower earnings for the business to be disposed of, the Company recognized an estimated loss on the disposal of businesses. Forward - Looking Statements When used in this Annual Report on Form 10-K, the words "may," "will," "should," "expect," "believe," "anticipate," "continue," "estimate," "project," "intend" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act regarding events, conditions and financial trends that may affect the Company's future plans of operations, business strategy, results of operations and financial condition. The Company wishes to ensure that such statements are accompanied by meaningful cautionary statements pursuant to the safe harbor established in the Private Securities Litigation Reform Act of 1995. Prospective investors are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors. Such forward-looking statements should, therefore, be considered in light of various important factors, including those set forth herein and others set forth from time to time in the Company's reports and registration statements filed with the Securities and Exchange Commission. The Company disclaims any intent or obligation to update such forward-looking statements. In particular, the Company has adopted a formal plan to sell substantially all of its assets and anticipates that such transactions in the aggregate will result in a net loss to the Company. The ability of the Company to complete these sales are dependent on numerous factors beyond the control of the Company, including without limitation, the marketability of the Company's subsidiaries and divisions, other comparable assets being offered by other sellers, interest rates, the Company's ability to find willing buyers, the capital markets, the continued performance of the Company's subsidiaries and divisions, and the Company's defaults under senior debt instruments and lack of capital resources needed to accomplish such sales. 21 Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to market risk related to changes in interest rates based primarily on its financing activities. As of June 30, 2001, approximately $13,085,000 of the Company's total liabilities was subject to floating rates of which $10,443,000 is applicable to discontinued operations and $2,642,000 is applicable to continuing operations. The Company does not enter into financial instruments for hedging, speculation or for trading purposes. Item 8. Financial Statements and Supplementary Data Reference is made to the Index to Consolidated Financial Statements on page F-1 for the Company's consolidated financial statements and notes thereto. Supplementary schedules for the Company have been omitted as not required or not applicable because the information required to be presented is included in the consolidated financial statements and related notes. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Not Applicable. 22 PART III Item 10. Directors and Executive Officers of the Registrant The information required by Item. 10 is incorporated by reference from the Company's definitive Proxy Statement to be filed by the Company with the Commission within 120 days of the end of the fiscal year. Item 11. Executive Compensation The information required by Item. 11 is incorporated by reference from the Company's definitive Proxy Statement to be filed by the Company with the Commission within 120 days of the end of the fiscal year. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by Item. 12 is incorporated by reference from the Company's definitive Proxy Statement to be filed by the Company with the Commission within 120 days of the end of the fiscal year. Item 13. Certain Relationships and Related Transactions The information required by Item. 13 is incorporated by reference from the Company's definitive Proxy Statement to be filed by the Company with the Commission within 120 days of the end of the fiscal year. PART IV Item 14. Exhibits, Financial Statements, Supplementary Schedules and Reports on Form 8-K (a) The following documents are filed as part of this Report: 1. Financial Statements: The Financial Statements are incorporated herein as part of Item 8 of this Report. 2. Exhibits: See Index on Page 24 of this Report. (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the last quarter of fiscal year ended June 30, 2001. 23 EXHIBIT INDEX Exhibit No. Description of Exhibit --- ---------------------- 2.1 Stock Purchase Agreement, dated as of March 1, 1999, by and between Interiors, Inc. ("Interiors") and CSL Lighting Manufacturing, Inc. ("CSL"). 1/ 2.2 Agreement and Plan of Merger dated December 31, 1998 by and between MHI Acquisition Corp., Interiors and Model Home Interiors, Inc. 2/ 2.3 Stock Purchase Agreement dated August 27, 1998 by and among Interiors, Jimmy D. Webster, Jr., Bettye Jo Webster and Henry L. Gray. 3/ 2.4 Agreement and Plan of Merger, dated July 2, 1998, by and among Troy Acquisition Corp., Interiors, Troy, Barry R. Jackson, and Todd R. Langner ("Langner"). 4/ 2.5 Stock Purchase Agreement dated July 7, 1998, by and between Interiors and Bentley. 5/ 2.6 Purchase Agreement dated December 11, 1999 by and among Interiors, and Mark N. Sklar, Drew M. Brown, the Bennett Dorrance Trust, the Bennett Dorrance, Jr. Trust, the Ashley Dorrance Trust, the Dorrance 1995 Issue Trust and DMB Property Ventures Limited Partnership. 6/ 2.7 Stock Purchase Agreement dated October 27, 1999 by and among Interiors, Inc., Jerry Howard, Dennis Darlington, and the Mamer Family Trust dated October 1, 1997 14/ 2.8 First Amendment to Stock Purchase Agreement dated December 15, 1999 by and among Interiors, Inc., Jerry Howard, Dennis Darlington and the Mamer Family Trust dated October 1, 1997 14/ 2.9 Second Amendment to Stock Purchase Agreement among Interiors, Inc and Concepts 4, Inc., et al 15/ 3.1 Certificate of Incorporation of Interiors. 7/ 3.2 Certificate of Ownership and Merger between Interiors, Inc. and A.P.F. Holdings, Inc. 7/ 3.3 Certificate of Amendment of Certificate of Incorporation of Interiors. 8/ 3.4 Certificate of Designations, Rights and Preferences of Series A Preferred Stock. 8/ 3.5 Certificate for Restoration, Renewal and Revival of the Certificate of Incorporation. 9/ 3.6 Certificate of Merger of Interiors, Inc. into Interiors Holdings, Inc. 9/ 3.7 By-Laws of Interiors. 7/ 3.8 Certificate of Designations, Rights and Preferences of Series B Preferred Stock. 10/ 3.9 Certificate of Designations, Rights and Preferences of Series C Preferred Stock. 10/ 3.10 Certificate of Designation, Rights and Preferences of Series E Preferred Stock 16/ 4.1 Specimen Class A Preferred Stock Certificate. 8/ 4.2 Specimen Class A Common Stock Certificate. 8/ 4.3 Specimen Class B Common Stock Certificate. 8/ 4.4 7% Convertible Debenture due July 26, 2001, dated July 27, 1998, in the amount of $500,000, issued by Interiors to Dominion Capital Fund, Ltd. ("Dominion"). 9/ 4.5 7% Convertible Debenture due July 26, 2001, dated July 27, 1998, in the amount of $500,000, issued by Interiors to Sovereign Partners, L.P. ("Sovereign"). 9/ 4.6 7% Convertible Debenture due July 29, 2001, dated July 30, 1998, in the amount of $1,250,000, issued by Interiors to RBB Bank AG ("RBB"). 9/ 4.7 Common Stock Purchase Warrant A to Purchase 214,286 Shares of Common Stock of Interiors, dated July 27, 1998, issued by Interiors to Dominion. 9/ 4.8 Common Stock Purchase Warrant A to Purchase 214,286 Shares of Common Stock of Interiors, dated July 27, 1998, issued by Interiors to Sovereign. 9/ 24 4.9 Common Stock Purchase Warrant A to Purchase 535,714 Shares of Common Stock of Interiors, dated July 30, 1998, issued by Interiors to RBB. 9/ 4.10 Common Stock Purchase Warrant B to Purchase 50,000 Shares of Common Stock of Interiors, dated July 27, 1998, issued by Interiors to Cardinal Capital Management Inc. ("Cardinal"). 9/ 4.11 Common Stock Purchase Warrant B to Purchase 62,500 Shares of Common Stock of Interiors, dated July 30, 1998, issued by Interiors to Cardinal. 9/ 4.12 Registration Rights Agreement, dated July 27, 1998, by the Holders listed therein and Interiors. 9/ 4.13 Common Stock Purchase Warrant A to Purchase 187,500 Shares of Common Stock of Interiors, dated August 25, 1998, issued by Interiors to Sovereign. 9/ 4.14 Common Stock Purchase Warrant A to Purchase 187,500 Shares of Common Stock of Interiors, dated August 25, 1998, issued by Interiors to Dominion. 9/ 4.15 7% Convertible Debenture due August 24, 2001, in the amount of $375,000, issued by Interiors to Sovereign. 9/ 4.16 7% Convertible Debenture due August 24, 2001, in the amount of $375,000, issued by Interiors to Dominion. 9/ 4.17 Registration Rights Agreement, dated August 25, 1998, by the Holders listed therein and Interiors. 9/ 4.18 Escrow Agreement dated July 2, 1998 by and among Buyer, U.S. First Trust, a national association, and Barry R. Jackson. 10/ 4.19 The Windsor Art, Inc. Voting Trust Agreement No. 1 dated July 30, 1998 by and among Lloyd R. Abrams and Max Munn, Buyer and Bentley. 10/ 4.20 Series B Warrant to purchase up to 2,000,000 Class A Shares issued to Seaside Partners, L.P. 10/ 4.21 Form of 12% Convertible Promissory Notes. 10/ 4.22 Form of Registration Rights Agreement by and among Interiors and minority shareholders of Petals. 10/ 4.23 Form of Warrant to Purchase Class A Shares issued to minority shareholders of Petals. 10/ 4.24 10% Convertible Promissory Note dated March 23, 1999 in the amount of $2,000,000 issued to majority shareholder of Petals. 10/ 4.25 Secured Convertible Note Purchase Agreement dated as of September 30, 1999 between Limeridge LLC and Interiors, Inc. 14/ 4.26 Secured Convertible Note dated as of September 30, 1999 in favor of Limeridge LLC 14/ 4.27 Common Stock Purchase Warrant dated as of September 30, 1999 in favor of Limeridge LLC. 14/ 4.28 Convertible Note Exchange Agreement December 31, 1999, by and between Interiors, Inc. and Endeavour Capital Fund SA 14/ 4.29 Secured Convertible Note due September 29, 2004 in favor of Endeavour Capital Fund, SA 14/ 4.30 Common Stock Purchase Warrant dated as of December 31, 1999 and Endeavour Capital Fund, SA 14/ 10.1 Security Agreement, dated November 13, 1990, between Interiors and United Credit Corporation and amendments thereto dated November 13, 1990, January 7, 1992, October 11, 1991, December 15, 1992 and June 23, 1993. 7/ 10.2 Standstill Agreement, dated as of March 1, 1999, by and between Interiors, Inc. ("Interiors") and CSL Lighting Manufacturing, Inc. ("CSL"). 1/ 10.3 1994 Stock Option and Appreciation Rights Plan. 11/ 10.4 1994 Director Stock Option and Appreciation Rights Plan. 12/ 10.5 Revised form of Warrant Exercise Fee Agreement. 11/ 10.6 Consulting Agreement, dated October 1, 1993, between Morris Munn and Interiors. 11/ 25 10.7 Employment Agreement, dated November 1, 1998, between Interiors and Max Munn. 10.8 Promissory Note, dated March 10, 1998, made by Interiors in favor of Michael H. Greeley ("Greeley"), in the principal sum of $794,379. 9/ 10.9 Non-Negotiable Promissory Note, dated July 30, 1998, made by Interiors in favor of Bentley, in the principal sum of $3,300,300. 5/ 10.10 Non-Negotiable Promissory Note, dated July 30, 1998, made by Interiors in favor of Bentley, in the principal sum of $2,000,000. 5/ 10.18 Consulting Agreement, dated July 30, 1998, by and among Windsor, Lloyd R. Abrams, and Interiors. 5/ 10.19 Securities Purchase and Registration Rights Agreement, dated July 30, 1998, by and among Max Munn, Bentley, and Interiors. 5/ 10.20 Employment Agreement, dated March 10, 1998, by and between Greeley and Henlor. 13/ 10.21 Employment Agreement, dated August 14, 1998, by and between Interiors and Langner. 4/ 10.22 Stock Purchase Agreement dated as of July 30, 1999 by and among Interiors, Barry R. Jackson, U.S. Bank Trust and the entities listed on Schedule A annexed thereto.* 10.23 Letter Agreement dated August 2, 1999 by and among Interiors, Sovereign, Dominion and Dominion Investment Fund, LLC. 14/ 10.24 Registration Rights Agreement dated as of September 30, 1999 between Limeridge LLC and Interiors, Inc. 14/ 10.25 Security Agreement dated as of September 30, 1999 between Limeridge LLC, Interiors, Inc. and Petals, Inc. 14/ 10.26 Registration Rights Agreement dated as of December 31, 1999 between Endeavour Capital Fund, SA and Interiors, Inc. 14/ 10.27 Security Agreement dated as of December 31, 1999 between Endeavour Capital Fund, SA, Interiors, Inc. and Petals, Inc. 14/ 10.28 Letter Agreement dated August 2, 1999 by and among Interiors, Sovereign, Dominion and Dominion Investment Fund, LLC. 14/ 10.29 Conversion Agreement between Seaside Partners, L.P. and Interiors, Inc. 15/ 10.30 Consolidated Promissory Note dated November 1, 2000 in the principal amount of $2,504,000 executed by Laurie Munn in favor of Interiors, Inc. 16/ 10.31 Pledge Agreement dated November 1, 2000 executed by Laurie Munn in favor of Interiors, Inc. 16/ 10.32 Promissory Note dated January 16, 2001 in the principal amount of $500,000 executed by Laurie Munn in favor of Interiors, Inc. 16/ 10.33 Subordinated Pledge Agreement dated January 16, 2001 executed by Laurie Munn in favor of Interiors, Inc. 16/ 10.34 Promissory Note dated as of March 19, 2001 issued by Stylecraft Lamps, Inc. and Petals, Inc. in favor of Interiors Investors, LLC 17/ 10.35 Security Agreement dated as of March 19, 2001 executed by Petals, Inc. in favor of Interiors Investors, LLC 17/ 10.36 Security Agreement dated as of March 19, 2001 executed by Stylecraft Lamps, Inc. in favor of Interiors Investors, LLC 17/ 10.37 Security Agreement dated as of March 19, 2001 executed by Interiors, Inc., et al in favor of Interiors Investors, LLC 17/ 10.40 Guaranty dated as of March 19, 2001 executed by Interiors, Inc. in favor of Interiors Investors, LLC 17/ 10.41 Guaranty dated as of March 19, 2001 executed by affiliates of Interiors, Inc. in favor of Interiors Investors, LLC 17/ 10.42 Personal Guaranty dated March 19, 2001 executed by Max Munn and Laurie Munn in favor of Interiors Investors, LLC 17/ 10.43 Letter Agreement dated March 19, 2001 by and among Interiors Investors, LLC, Stylecraft Lamps, Inc. and Petals, Inc. 17/ 26 10.44 Forbearance and Acknowledgement Agreement dated as of April 26, 2001 by and among Interiors, Inc., Petals, Inc., Stylecraft Lamps, Inc., Habitat Solutions, Inc., Limeridge LLC, The Endeavour Capital Fund, S.A. and The Endeavour Capital Investment Fund, S.A. 17/ 10.45 Guaranty of Obligations dated as of April 26, 2001 by and between Max Munn, Laurie Munn, Limeridge LLC, The Endeavour Capital Fund, S.A. and The Endeavour Capital Investment Fund, S.A. 17/ 10.46 Amendment No. 3 to Loan Documents and Forbearance Agreement dated as of March 19, 2001 by and among Interiors, Inc., et al and Foothill Capital Corporation 17/ 11.1 Statement re: computation of per share earnings. 21.1 Subsidiaries of the Registrant. 14/ 99.1 U.S. Patent and Trademark Office Trademark Reg. No. 1,736,623. 7/ 99.2 U.S. Patent and Trademark Office Service Mark Reg. No. 1,783,694. 7/ * Filed herewith. 1/ Previously filed as an exhibit to Interiors' Current Report on Form 8-K filed March 4, 1999 (File No. 00-24352), as amended, which exhibit is incorporated herein by reference. 2/ Previously filed as an exhibit to Interiors' Current Report on Form 8-K filed March 9, 1999 (File No. 00-24352) which exhibit is incorporated herein by reference. 3/ Previously filed as an exhibit to Interiors' Current Report on Form 8-K filed March 9, 1999 (File No. 00-24352), as amended, which exhibit is incorporated herein by reference. 4/ Previously filed as an exhibit to Interiors' Current Report on Form 8-K filed August 14, 1998 (File No. 00-24352), as amended, which exhibit is incorporated herein by this reference. 5/ Previously filed as an exhibit to Interiors' Current Report on Form 8-K filed August 10, 1998 (File No. 00-24352), as amended, which exhibit is incorporated herein by this reference. 6/ Previously filed as an exhibit to Interiors' Current Report on Form 8-K filed April 9, 1999 (File No. 00-24352), as amended, which exhibit is incorporated herein by reference. 7/ Previously filed as an exhibit to the Registration Statement on Form SB-2 (the "Registration Statement") (Registration No. 33-77288-NY), which exhibit is incorporated herein by reference. 8/ Previously filed as an exhibit to Amendment No. 1 to the Registration Statement (Registration No. 33-77288-NY), which exhibit is incorporated herein by reference. 9/ Previously filed as an exhibit to Annual Report on Form 10-KSB for fiscal year ended June 30, 1998 (File No. 0-24352), which exhibit is incorporated herein by this reference. 10/ Previously filed as an exhibit to Amendment No. 1 to the Registration Statement on Form S-3 (Registration No. 333-63207), which exhibit is incorporated herein by reference. 11/ Previously filed as an exhibit to Annual Report on Form 10-KSB for fiscal year ended June 30, 1994 (File No. 0-24352), which exhibit is incorporated herein by this reference. 12/ Previously filed as an exhibit to Amendment No. 3 to the Registration Statement (Registration No. 33-7728-NY), which exhibit is incorporated by reference. 13/ Previously filed as an exhibit to Current Report on Form 8-K filed March 10, 1998 (File No. 00-24352), which exhibit is incorporated herein by reference. 27 14/ Previously filed as an exhibit to Annual Report on Form 10-K for fiscal year ended June 30, 2000 (File No. 0-24352), which exhibit is incorporated herein by this reference. 15/ Previously filed as an exhibit to Quarterly Report on Form 10-Q for fiscal quarter ended September 30, 2000 (File No. 0-24352), which exhibit is incorporated herein by this reference. 16/ Previously filed as an exhibit to Quarterly Report on Form 10-Q for fiscal quarter ended December 31, 2000 (File No. 0-24352), which exhibit is incorporated herein by this reference. 17/ Previously filed as an exhibit to Quarterly Report on Form 10-Q for fiscal quarter ended March 31, 2001 (File No. 0-24352), which exhibit is incorporated herein by this reference. 28 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereto duly authorized. INTERIORS, INC. By: /s/ MAX MUNN ------------------------------------ Name: Max Munn Title: Chairman, President and Chief Executive Officer In accordance with the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. Signature Title Date --------- ----- ---- /s/ MAX MUNN Chairman, President, Chief October 15, 2001 --------------------------- Executive Officer, and Director Max Munn /s/ ROBERT J. CONOLOGUE Chief Financial Officer, October 15, 2001 --------------------------- Executive Vice President Robert J. Conologue and Principal Accounting Officer /s/ ROGER LOURIE Director October 15, 2001 --------------------------- Roger Lourie /s/ RICHARD JOSEPHBERG Director October 15, 2001 ---------------------------- Richard Josephberg 29 PART IV Item 14. Index to Consolidated Financial Statements of Interiors, Inc. and Subsidiaries Page ---- Report of Independent Public Accountants.....................................F-2 Consolidated Financial Statements: Consolidated Balance Sheets as of June 30, 2001 and 2000.....................F-3 Consolidated Statements of Operations for the Years Ended June 30, 2001, 2000 and 1999.....................................F-4 Consolidated Statements of Stockholders' (Deficit) Equity for the Years Ended June 30, 2001, 2000 and 1999......................F-5 Consolidated Statements of Cash Flows for the Years Ended June 30, 2001, 2000 and 1999.................................F-8 Notes to Consolidated Financial Statements...................................F-9 Financial Statement Schedule: Schedule II. Valuation and Qualifying Accounts and Reserves..................S-1 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission which are not included with this additional financial data have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto. F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and the Board of Directors of Interiors, Inc.: We have audited the accompanying consolidated balance sheets of Interiors, Inc. (a Delaware corporation) and subsidiaries as of June 30, 2001 and 2000 (as restated in Note 2), and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended June 30, 2001, June 30, 2000 and June 30, 1999 (as restated in Note 2). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Interiors, Inc. and subsidiaries as of June 30, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2001, in conformity with accounting principles generally accepted in the United States. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has experienced recurring net losses and negative cash flows from continuing operations and at June 30, 2001, had a net working capital deficit and negative stockholders' equity. In addition, as discussed in Notes 1 and 3, the Company is discontinuing a majority of its operations and the ultimate amount of sale proceeds from such disposition is not currently expected to satisfy its liabilities. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1 and Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen, LLP New York, New York October 11, 2001 F-2 INTERIORS, INC. AND SUBSIDIARIES Consolidated Balance Sheets June 30, 2001 and 2000 (amounts in thousands, except share data)

*As restated, see Notes 2 and 3. The accompanying notes are an integral part of these consolidated financial statements. F-3 INTERIORS, INC. AND SUBSIDIARIES Consolidated Statements Of Operations For the Years Ended June 30, 2001, 2000 and 1999 (amounts in thousands, except per share data)

* As restated, see Notes 2 and 3 The accompanying notes are an integral part of these consolidated financial statements. F-4 INTERIORS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' (Deficit) Equity For the Years Ended June 30, 2001, 2000 and 1999 (amounts in thousands)

F-5 INTERIORS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' (Deficit) Equity (continued) For the Years Ended June 30, 2001, 2000 and 1999 (amounts in thousands)

F-6 INTERIORS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Deficit) Equity (Concluded) For the Years Ended June 30, 2001, 2000 and 1999 (amounts in thousands)

*As restated, see Note 2. In addition, amounts reported in Additional Paid in Capital column include the amounts reported in accreted dividends on series B Redeemable convertible Preferred Stock and Additional Paid in Capital on the accompanying Consolidated Balance Sheets. The accompanying notes are an integral part of these consolidated financial statements. F-7 INTERIORS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended June 30, 2001, 2000 and 1999 (amounts in thousands)

*As restated, see Notes 2 and 3 The accompanying notes are an integral part of these consolidated financial statements. F-8 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Description of Business and Going Concern Matters Business Interiors, Inc., a Delaware corporation ("Interiors" or the "Company"), is a designer, manufacturer and marketer of museum-quality traditional and contemporary picture frames, framed wall mirrors, oil paintings and prints under glass for the residential, commercial, institutional and contract markets. The Company primarily markets its products to museums, art galleries, designers, interior decorators and custom frame retailers. The Company's operations are primarily located in Mount Vernon, New York. From 1994 through early 1998, Interiors' principal operating division was A.P.F. Master Framemakers, a manufacturer of antique and contemporary picture and mirror frames for museums, art galleries, interior designers, collectors, frame retailers, and upscale furniture and department stores. From March 1998 until December 1999, the Company rapidly acquired additional businesses in the decorative accessories industry. The Company acquired various different businesses. Throughout 1999 and 2000, the Company had difficulty integrating many of the businesses it had recently acquired. The Company also defaulted on the high interest rate debt obligations undertaken to finance its acquisition strategy. Therefore, in an effort to generate cash needed to reduce the Company's debt and maximize shareholder value, the Board of Directors adopted a formal plan during the second half of 2000 to sell substantially all of the recently acquired businesses. The Company retained DN Partners, an investment-banking firm, to assist in the sale of the various businesses. The proceeds from the sale of these businesses were used to repay Foothill debt. As of October 8, 2001, the Company had completed the sales of all of these businesses with the exception of Petals and Concepts. See Note 3 - Discontinued Operations. Following these transactions, the Company's business will once again primarily consist of its APF Master Framemakers division located in Mount Vernon, New York. Going Concern Matters General The accompanying consolidated financial statements have been prepared on a going concern basis that contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying consolidated financial statements, for the years ended June 30, 2001 and 2000, the Company had net losses of $39,192,000 and $18,581,000, respectively. The net loss for the fiscal year 2001 includes $28,600,000 representing estimated loss on the disposal of businesses. See Note 3 - Discontinued Operations. The Company had operating cash flow of $193,000 in fiscal 2001 but had negative operating cash flows of $920,000 and $31,540,000 (which was used for acquisitions) for the years ended June 30, 2000 and 1999, respectively. In addition, as of June 30, 2001 and 2000, the Company classified $27,070,000 and $30,772,000 of its long term debt as current liabilities, including debt applicable to discontinued operations, because of its failure to meet certain requirements contained in the agreements governing these instruments. These factors and the items discussed below raise substantial doubt about the Company's ability to continue as a going concern. Limited Liquidity At June 30, 2001, the Company had negative working capital of approximately $16,818,000. The Company continues to experience working capital limitations which materially impair its ability to generate positive cash flow. The cash proceeds received from the sales of various business units were required to be used to repay debt. The Company's credit facility provides for availability based upon inventory and account receivable levels and, accordingly, the Company has experienced limitations on the availability under this facility. The sales of Petals and Concepts during fiscal 2002 will be required to repay outstanding debt obligations. If the Company continues to experience working capital limitations it will materially impact the Company's financial condition and results of operations. F-9 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Estimated Loss on Disposal of Businesses; Failure to Satisfy Obligations The Company currently estimates that as a result of the disposal of all discontinued operations the Company will incur a net loss. In addition, as of June 30, 2001, the Company's continuing operations had a working capital deficit of $8,110,000 and reported a loss of $11,714,000. The Company will attempt to complete its plan to discontinue certain of its operations within one year. The completion of such plan is dependent on numerous factors beyond the control of the Company, including without limitation, the marketability of the Company's subsidiaries and divisions, other comparable assets being offered by other sellers, interest rates, the Company's ability to find willing buyers, the capital markets, the continued performance of the Company's subsidiaries and divisions, and the Company's defaults under senior debt instruments and lack of capital resources needed to accomplish such sales. Notwithstanding the Company's ability to complete the sale of its discontinued obligations, it will not have sufficient proceeds to satisfy all of its obligations. The Company will be forced to seek additional financing alternatives or seek a liquidation of its remaining assets. 2. Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements include the accounts of Interiors, Inc. and its wholly-owned and majority owned subsidiaries, which are presented as discontinued operations. Accordingly, significant inter-company accounts and transactions have been eliminated in the consolidated financial statements. Continuing operations in the consolidated financial statements represents Interiors, Inc. comprised of the framemaking, rug and accessory businesses and the corporate functions. See Note 3 - Discontinued Operations. Revenue Recognition The Company's revenue is generally recognized at the time finished goods, whether standard product or custom work, is shipped. Payments received for merchandise not yet shipped or accepted are reflected within current liabilities. Sales returns have not historically been significant. Cash and Cash Equivalents Cash equivalents are comprised of deposits in banks and cash invested temporarily in various instruments with maturities of three months or less at time of purchase. Inventories Inventories are valued at the lower of cost or market, with cost determined using the first-in, first-out method. Finished goods consist of those items available for shipping. Property and Equipment Property and equipment is stated at cost. The cost of additions and improvements and the costs incurred in the construction of castings and the related master molds are capitalized. Expenditures for repairs and maintenance are expensed in the period incurred. Depreciation and amortization of property and equipment is provided utilizing straight-line and accelerated methods over the estimated useful lives of the respective assets as follows: YEARS ------------ Machinery and equipment................................... 3 - 10 Computer equipment and software........................... 5 Furniture and fixtures.................................... 7 - 10 F-10 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Leasehold improvements are amortized over the shorter of the remaining term of the lease or the useful life of the improvement utilizing the straight-line method. Income Taxes The Company uses the liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Deferred income taxes have been provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. A valuation allowance is recorded against deferred tax assets when it is more likely than not that such deferred tax asset will not be realized. Goodwill and Other Long-Lived Assets In connection with acquisitions, amounts were paid in excess of the fair market value of the net identifiable assets acquired. These amounts have been recorded as goodwill and are being amortized over 40 years. As of June 30, 2001, all goodwill is reflected as part of discontinued operations, see Note 3. The Company continually reviews its long-lived assets for events or changes in circumstances that might indicate the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of assets by determining whether the amortization of such assets over their remaining lives can be recovered through projected undiscounted cash flows. The amount of impairment, if any, is measured based on projected discounted future cash flows using a discount rate reflecting the Company's average cost of funds. For the fiscal year ended June 30, 2000, the Company recognized a $3,000,000 asset impairment related to certain subsidiaries, which was reported in discontinued operations as a reduction to goodwill in the accompanying financial statements. Deferred Financing Costs Debt financing costs are deferred and amortized over the term of the related debt. As of June 30, 2001 and 2000, unamortized deferred financing costs, which are included in Other Assets, were $106,000 and $383,000, respectively. The amortization expense for the years ended June 30, 2001, 2000 and 1999 was $328,000, 334,000 and $575,000, respectively. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates included in the consolidated financial statements are the estimated loss on the disposal of businesses. Fair Value of Financial Instruments The Company has determined the estimated fair value of its financial instruments using appropriate market information and valuation methodologies. Considerable judgment is required to develop the estimates of fair value; thus, the estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The Company's financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable and debt. The carrying value of these assets and liabilities represents the estimated fair market values at June 30, 2001 and 2000, respectively. Earnings (Loss) Per Common Share Net earnings (loss) per share amounts ("basic EPS") were computed by dividing net earnings (loss) by the weighted average number of common shares outstanding, and excluding any potential dilution. F-11 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For purposes of this calculation, common shares of the Company include both Class A Common Stock, par value $.001 per share ("Class A Shares") and Class B Common Stock, par value $.001 per share ("Class B Shares"). Net earnings per diluted share amounts ("diluted EPS") were computed assuming potential dilution from the exercise of outstanding stock options, warrants and other securities. Where appropriate, the periods presented include a deduction for the dividend requirement of the Company's 10% Series A Cumulative Convertible Preferred Stock, par value $.01 per share ("Series A Preferred Shares"), Series B Preferred Stock, par value $.01 per share ("Series B Preferred Shares"), Series C Preferred Stock, par value $.01 per share ("Series C Preferred Shares") and Series E Preferred Stock, $1,000 liquidation value ("Series E Preferred Shares"). The Series C Preferred Shares were exchanged for the Limeridge Note and the Endeavour Note (both as defined below) during fiscal year 2000 and, accordingly, there are no Series C Preferred Shares outstanding as of June 30, 2001 and 2000. The Series B Preferred shares were returned to the Company with 150,000 Series B Preferred Shares representing $1,500,000 as the exercise price paid by Seaside Partners on the exercise of Series B Warrant resulting in the issuance of 2,000,000 Class A Shares at $.75 per share. Seaside also converted its remaining 50,000 Series B Preferred Shares having a liquidation value of $500,000 and $213,485 in accrued dividends through October 11, 2000 into 303,610 Class A Shares at $2.35 per share. As of June 30, 2001, the Company had 4,095,000 shares covered by options which were not included in the diluted earnings per share calculation since the option exercise prices were higher than the average stock price during the year. Recent Accounting Pronouncements In June 2000, the Financial Accounting Standards Board issued, SFAS No. 138, "Accounting for Derivative Instruments and Hedging Activities", which amends SFAS No. 133 as amended in SFAS No. 137 which is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities on the statement of financial position and measure those instruments at fair value. The adoption of SFAS No. 133 did not have an impact on the Company's financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS No. 142 effective January 1, 2002. Currently, all goodwill associated with the various acquisitions is recorded as part of the discontinued operations. See Note 3. SFAS No. 142 will have no effect on the Company's results of continuing operations and financial position. Restatements In fiscal 1998, the Company issued to Laurie Munn, wife of the Company's Chief Executive Officer, 1,350,000 options purchase Class B Shares at $1.19 per share. The options were exercised in fiscal 1999. The Company has recorded compensation expense of $896,000 for the fair value of the options. The Company has amortized $149,000 of such expense in fiscal 1998 and the balance of $747,000 in fiscal 1999. In fiscal 1998, the Company issued to Mrs. Munn 730,000 Class B Shares at $0.70 per share while the Class A Shares were trading at $1.00 per share. The Company has determined to record a compensation expense of $219,000 in fiscal year 1998 for the $0.30 discount from the Class A Shares on January 9, 1998, the date that the Board approved the issuance. The income statement for the fiscal year 1999 has been restated to reflect the charge of $747,000, or $.03 per share, as additional selling, general and administrative expense. The accumulated deficit as of June 30, 1998 has been restated to reflect the charges totaling $368,000 applicable to the year ended June 30, 1998, with a corresponding increase to additional paid in capital. F-12 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Reclassifications Certain prior year amounts have been reclassified to conform to current year presentation. 3. Discontinued Operations In an effort to generate cash needed to reduce the Company's high interest rate debt and maximize shareholder value, during the second quarter of fiscal 2001, the Company's Board of Directors adopted a formal plan to sell various businesses including, without limitation, Petals, Inc. ("Petals"), Stylecraft Lamps, Inc. ("Stylecraft"), Habitat Solutions, Inc. ("Habitat Solutions") and the West Coast operations. Following the contemplated transactions, the Company's business will primarily consist of its APF Master Framemakers division located in Mt. Vernon, New York. The Company retained DN Partners, an investment-banking firm, to assist in the sale of the various businesses. The West Coast is comprised of the operations of Troy and CSL, which were sold in February 2001, Windsor Art, Inc. ("Windsor"), which was sold in June 2001, and Artisan House, Inc. ("Artisan House"), a wholly owned subsidiary of Decor Group, Inc. ("Decor"), which as sold in August 2001. Habitat Solutions is comprised of Concepts 4, Inc. ("Concepts") and Model Home Interiors, Inc. ("Model Home"), which was sold in April 2001. The Company's lighting products are sold by Stylecraft which was sold on October 1, 2001, its silk floral and tree products are sold by Petals, its architectural and design services are provided by Habitat Solutions and its wall decor products were sold by Windsor and Artisan. As of June 30, 2001, the Company's wholly owned subsidiaries, Petals and Concepts 4, which remain to be sold, were also considered discontinued operations. During the second quarter of fiscal 2001, the Company accounted for these business units as discontinued operations. The consolidated financial statements for the prior periods have been restated to reflect the discontinued operations. On February 2, 2001, the Company completed the sales of certain net assets of Troy and CSL. The aggregate purchase prices consisted of $1,200,000 in cash and the assumption of approximately $1,700,000 of liabilities. The entire proceeds from these transactions were used to reduce outstanding debt owed to Foothill. The loss on the disposal of these operations was approximately $3,500,000. On April 12, 2001, the Company sold all of the capital stock of Model Home to the former shareholders of Model Home. The purchase price of $2,938,000 consisted of approximately $2,350,000 in cash and $588,000 representing the fair market value of the 7,358,000 Class A shares returned to the Company. The 7,358,000 Class A Shares, including the 2,515,368 shares issued in payment for the calendar year 2000 earnout, were returned to the Company at the current market price of $0.08 valued at approximately $588,000. The cash of $2,350,000 was used for the repayment of outstanding Foothill borrowings. In addition, there was forgiveness of approximately $2,400,000 of intercompany receivables due from Interiors and other consolidated operations. The loss on this transaction was approximately $2,800,000. On June 29, 2001, the Company completed the sale of certain net assets of Windsor, including the assumption of $282,000 of liabilities by the purchaser. The aggregate purchase price was $2,431,000 comprised of cash of $2,126,000 and a 10% note for $305,000. The maturity date of the note is June 1, 2004. As of June 30, 2001, the cash was in escrow due to the late closing time on the sale. The cash became available in early July and was used to repay Foothill debt. As of June 30, 2001, the sale proceeds of $2,431,000 was reported in net liabilities held for sale in the accompanying consolidated balance sheet. The loss on the disposal of this business unit was approximately $22,700,000. The Company remains liable for a lease covering a facility in Vernon, California relating to this operation. The lease expires in 2008. The Company has vacated the premises and returned the property to the landlord. The landlord and the Company are currently negotiating to resolve this remaining liability. If the Company is unable to successfully reach a resolution of this matter, this liability will have a material adverse effect on the Company. F-13 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of the Troy, CSL, MHI, and Windsor assets, less liabilities assumed and the write-off of other net assets, primarily goodwill, were comprised of the following: (amounts in thousands) ---------------------- Accounts receivable, net .......................................... $ 4,066 Inventory ......................................................... 5,837 Fixed assets, net ................................................. 6,959 Goodwill, net ..................................................... 18,091 Other assets ...................................................... 888 Accounts payable and accrued expenses ............................. (6,977) -------- Net assets disposed ............................................. 28,864 -------- Add: Debt assumed ................................................. 6,705 Less: Cash received ............................................... (5,676) Note receivable .............................................. (305) Class A common shares valued at fair market value ............... (588) -------- Proceeds, net of debt assumed ..................................... (136) -------- Loss on sale of net assets ........................................ $(29,000) ======== Cash received of $5,676,000 was used to repay outstanding borrowings under the Foothill revolving loans of which $3,550,000 was used to repay Foothill revolving loans as of June 30, 2001 and $2,126,000 became available from escrow in early July 2001 and was also used to repay Foothill revolving loans. In August 2001, the Company completed the sale of stock of Artisan House, a wholly owned subsidiary of Decor, receiving net proceeds of $640,000 comprised of cash of $605,000 and an 8% note for $35,000. Decor retained $463,000 of Foothill debt, which was repaid with the proceeds from the sale. The loss on the disposal of this business unit was approximately $1,100,000. On October 1, 2001, the Company completed the sale of substantially all of the assets of Stylecraft to Stylecraft Acquisition, Inc. for $24,700,000 in cash. The cash proceeds were used to repay debt owed to Foothill in the amount of $9,900,000, the Investors Note (as defined below) in the amount of $5,200,000, the Limeridge Note and the Endeavour Note (both as defined below) in the aggregate amount of $2,800,000, a real estate mortgage owed to Bank of America in the amount of $2,200,000 and the Landis Note (as defined below) in the amount of $500,000. As part of the transaction, a personal loan of Max Munn, the Company's Chief Executive Officer, in the amount of $250,000, owed to Jimmy Webster, the Chief Executive of Stylecraft, was transferred to the Company and the Company set up a corresponding receivable from Mr. Munn. The Company also paid an aggregate of approximately $1,200,000 out of $2,400,000 of retention incentives owed to its executive officers. The Company paid approximately $600,000 in fees and expenses. The remaining balance of approximately $2,300,000 was used for general working capital purposes of the Company. The gain on the disposal of this business unit was approximately $16,200,000. As of June 30, 2001, the losses incurred on the sales of businesses which occurred as of such date and the anticipated sales of the other businesses were estimated to result in a net loss. During the first quarter of fiscal 2002, the Company sold the stock of Artisan House and, on October 1, 2001, it sold the assets of Stylecraft. The Company will attempt to complete the sales of Petals and Concepts in the second quarter of fiscal 2002. The estimated loss of $28,600,000 on the disposal of all businesses was recorded in the fourth quarter of fiscal 2001. This estimated loss includes losses on businesses sold during the third quarter of fiscal 2001, which had been previously deferred in accordance with EITF 85-36 - "Discontinued Operations With Expected Gain and Interim Losses" since, at that time, it was anticipated that the sales of all the businesses would result in a net gain. The change to an estimated net loss is due to actual sale prices of businesses sold during the fourth quarter of fiscal 2001 and in early fiscal 2002 being lower than previously estimated. The sales prices have decreased because of poor operating results and deteriorating general economic conditions since the decision was made to sell these businesses. The results of operations of discontinued operations since December 31, 2000 were deferred and included in the loss on disposal of the businesses. The estimated loss of $28,600,000 is comprised of the following: (a) actual losses of approximately $29,000,000 on businesses sold prior to June 30, 2001, (b) actual losses of $5,900,000 for the results of operations F-14 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of discontinued operations from December 31, 2000 until the date of disposition if prior to June 30, 2001, (c) estimated losses of approximately $15,500,000 for the results of operations (including interest on debt obligations, estimated investment fees and retention incentives) from June 30, 2001 until the actual or anticipated date of disposition of businesses not disposed of as of June 30, 2001 and (d) estimated net gains of approximately $21,800,000 on the sales of businesses not disposed of as of June 30, 2001. The results of the discontinued operations for the fiscal years ended June 30, 2001 (through December 31, 2000), 2000 and 1999, are summarized as follows: (amounts in thousands) ------------------------------ Year Ended June 30, ------------------------------ 2001 2000 1999 -------- -------- -------- Net sales ................................... $ 85,848 $161,953 $ 74,032 Gross profit ................................ 35,850 60,262 27,299 Interest expense ............................ 5,065 7,543 4,678 Depreciation/amortization ................... 2,071 4,387 1,394 Amortization of goodwill .................... 416 1,059 529 Write down of goodwill ...................... -- 3,000 -- Impairment loss on investment and non operating receivable ................. -- -- 6,088 Extraordinary item gain on extinguishment of debt ................... -- -- 870 Interest expense and default penalties due under the Limeridge Note and the Endeavor Note, as well as the depreciation expense on a computer system that is no longer being implemented by the discontinued operations are reported in discontinued operations. Depreciation and amortization assigned to the businesses reported as discontinued operations represents the amounts applicable to fixed assets and other intangible assets, excluding goodwill, which is presented separately. During the fiscal year ended June 30, 1999, the Company had an extraordinary gain from early extinguishment of debt in the amount of $870,000, which includes the gain of $1,371,000 resulting from repurchase of the Windsor Note and Windsor Shares, as discussed in Note 5. Offsetting the gain was $501,000, of net losses on other debt extinguishments including the write-off of unamortized deferred financing charges associated with the debt extinguishment. Net assets (liabilities) of discontinued operations in the accompanying consolidated balance sheets as of June 30, 2001 and 2000 are comprised of the following:

F-15 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amortization of goodwill was $416,000, $1,059,000 and $529,000 in fiscal year 2001, 2000 and 1999, respectively. Debt applicable to discontinued operations as of June 30, 2001 and 200, is as follows:

(a) In June 2000, the Company and Foothill Capital Corporation ("Foothill") entered into a Loan and Security Agreement ("Foothill Agreement") pursuant to which Foothill agreed to make revolving credit loans and advances based on agreed upon percentages of eligible accounts receivable and inventory of Artisan House, Inc., CSL, Model Home, Petals, Stylecraft, Troy, Vanguard and Windsor (collectively with Interiors, the "Borrowers"). The credit facility is a combination of revolving loans and two thirty-two (32) month term loans. See Note 10 for information regarding the revolving loans applicable to continuing operations. The interest rates on the revolving loans and term loans were prime plus 1.25% and prime plus 1.50%, respectively. As of March 1, 2001, the interest rates were increased to prime plus 2.50% on both the revolving and term loans. At June 30, 2001 and 2000, the prime rate was 6.75% and 9.50%, respectively, announced by Wells Fargo Bank. Borrowings under the credit facility are secured by substantially all of the assets of the Company, including accounts receivable and inventory. The credit facility contains financial and other covenants, including minimum net worth, and earnings before interest, income taxes and depreciation and amortization. The Foothill Agreement is in default and related borrowings are included in current liabilities in the accompanying financial statements because Foothill has the right to accelerate these obligations. As of August 15, 2000, the Company entered into Amendment No. 1 to Loan Documents with Foothill (the "Foothill Amendment No. 1") pursuant to which Foothill agreed to extend the Company an overadvance of $500,000 until September 1, 2000 and forbear from taking any action to collect the amounts owed to them until the earlier to occur of (i) June 30, 2001 or (ii) a default under the Foothill Amendment No. 1. As of October 13, 2000, the Company entered into Amendment No. 2 to Loan Documents and Waiver with Foothill (the "Foothill Amendment No. 2") pursuant to which Foothill agreed to amend certain financial covenants and to waive cross defaults under the Limeridge Note and Endeavour Note until the earlier to occur of (i) October 1, 2000 or (ii) a default under the Foothill Amendment No. 2. The fee charged by Foothill for such amendment was $15,000. As of March 19, 2001, the Company entered into Amendment No. 3 to Loan Documents and Forbearance Agreement with Foothill (the "Foothill Amendment No. 3") pursuant to which Foothill agreed to forbear from taking any action to collect the amounts owed to them until June 30, 2001 or (ii) a default under the F-16 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Foothill Amendment No. 3. The fee charged by Foothill for such amendment was $150,000. The Company's interest rate was also increased to 2.5% per annum over the prime rate and its maximum borrowing under its credit facility was reduced from $25,000,000 to $17,000,000. As of June 29, 2001, the Company entered into Amendment No. 4 to Loan Documents and Extended Forbearance Agreement with Foothill (the "Foothill Amendment No. 4") pursuant to which Foothill agreed to extend the Company an overadvance of $650,000 until August 24, 2001, amend certain financial covenants and forbear from taking any action to collect the amounts owed to them until August 31, 2001 or (ii) a default under the Foothill Amendment No. 4. The fee charged by Foothill for such amendment was $50,000. The Company's interest rate was also increased to 2.5% per annum over the prime rate and its maximum borrowing under its credit facility was reduced from $17,000,000 to $16,500,000. In addition, the Company was charged an early termination fee of $600,000, which is payable upon termination of the credit facility. As of August 31, 2001, the Company entered into Amendment No. 5 to Loan Documents and Second Extended Forbearance Agreement with Foothill (the "Foothill Amendment No. 5") pursuant to which Foothill agreed to forbear from taking any action to collect the amounts owed to them until September 28, 2001 or (ii) a default under the Foothill Amendment No. 5. The fee charged by Foothill for such forbearance was $65,000. The Company's maximum borrowing under its credit facility was reduced from $16,500,000 to $13,500,000. As of October 1, 2001, the Company entered into Amendment No. 6 to Loan Documents and Third Extended Forbearance Agreement with Foothill (the "Foothill Amendment No. 6") pursuant to which Foothill agreed to forbear from taking any action to collect the amounts owed to them until December 14, 2001 or (ii) a default under the Foothill Amendment No. 6. The fee charged by Foothill for such forbearance was $300,000. The Company's maximum borrowing under its credit facility was reduced from $13,500,000 to $2,335,000. (b) In October 1999, the Company consummated a transaction with Limeridge LLC ("Limeridge") pursuant to which $5,027,000 principal amount of Series C Preferred Shares, plus accrued and unpaid dividends in the amount of $215,000, were exchanged for a Secure Convertible Note due September 30, 2004 bearing interest at 17% per annum (the "Limeridge Note"). The Company also received aggregate proceeds of $7,500,000 and after certain fees and expenses, net proceeds of approximately $7,500,000 in the transaction. In addition, the Company owed Limeridge an additional $799,000 which consisted primarily of penalties. The Limeridge Note has a principal amount of $13,541,000, is secured by the common stock of Petals, Inc., a wholly owned subsidiary of the Company ("Petals"), and convertible after September 30, 2000 into Class A Shares at the fair market value of such securities at the time of conversion. Interest on the Limeridge Note is not payable until the earlier of a redemption, conversion or default of such security, however, the Company is required to pay an administrative fee in connection with the Limeridge Note equal to 1% of the outstanding principal amount of the security per month until the earlier of a redemption, conversion or default of such security. The 1% administrative fee is recorded as interest expense in the accompanying consolidated financial statements. In connection therewith, the Company issued a warrant to purchase 1,000,000 Class A Shares at an exercise price of $2.00 per share (the "Limeridge Warrant"). At any time, the Company may redeem the Limeridge Note at its face value, plus all accrued and unpaid interest, and redeem the Limeridge Warrant at $0.25 per warrant share. The fair market value of the Limeridge Warrant of approximately $629,000 is being amortized over the term of the Limeridge Note as a deferred financing charge. In December 1999, the Company consummated a transaction with Endeavour Capital Fund, SA ("Endeavour") pursuant to which $1,500,000 principal amount of Series C Preferred Shares, plus accrued and unpaid dividends in the amount of $65,000, and accrued and unpaid interest in the amount of $180,000 were exchanged for a Secured Convertible Note due September 30, 2004 bearing interest at 17% per annum (the "Endeavour Note"). The Endeavour Note has a principal amount of $1,745,000, is secured by the common stock of Petals, and convertible after September 20, 2000 into Class A Shares at fair market value of such securities at the time of conversion. Interest on the Endeavour Note is not payable until the earlier of a redemption, conversion or default of such security, however, the Company is required F-17 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS to pay an administrative fee in connection with the Endeavour Note equal to 1% of the outstanding principal amount of the security per month until the earlier of a redemption, conversion or default of such security. The 1% administrative fee is recorded as interest expense. In connection therewith, the Company issued a warrant to purchase 110,000 Class A Shares at an exercise price of $2.00 per share (the "Endeavour Warrant"). At any time, the Company may redeem the Endeavour Note at its face value, plus all accrued and unpaid interest, and redeem the Endeavour Warrant at $0.25 per warrant share. The fair market value of the Endeavour Warrant of approximately $33,000 is being amortized over the term of the Endeavour Note as a deferred financing cost. Pursuant to the registration rights agreements with Limeridge and Endeavour, (a) the Limeridge Note, the Endeavour Note, the Limeridge Warrant and the Endeavour Warrant were required to be covered by an effective registration statement by September 30, 2000 and (b) the Company is required to keep its Class A Shares listed on the Nasdaq SmallCap Market or its equivalent. As of September 30, 2000, the securities were not covered by an effective registration statement and the Company had received a notice from NASDAQ of its intention to delist the Class A Shares. Accordingly, the Company is subject to liquidated damages in the amount of 2% per month after such date on the principal amount of the Limeridge Note and the Endeavour Note and such parties are entitled to accelerate the entire principal amount of the notes. As of June 30, 2000 and the Company was also in arrears on interest payments in the aggregate amount of $542,000, which also entitles Limeridge and Endeavor to accelerate its note, subject to the Company's right to cure. As a result these rights to accelerate, the Limeridge Note and the Endeavour Note are classified as current liabilities in the Company's consolidated balance sheet as of June 30, 2000. In April 2001, the Company entered into a Forbearance and Acknowledgement Agreement with Limeridge and Endeavour (the "Limeridge/Endeavour Forbearance Agreement") pursuant to which Limeridge and Endeavour agreed not to take any action to collect any amounts owed to them until the earlier of (i) July 31, 2001, (ii) the date upon which the proceeds from the sale of the assets or capital stock of the Company's subsidiaries are sufficient to satisfy the Limeridge Note and the Endeavour Note or (iii) a default under the Limeridge/Endeavour Forbearance Agreement. The Limeridge/Endeavour Forbearance expired by its terms on July 31, 2001. Pursuant to the Limeridge/Endeavour Forbearance Agreement, Petals, Stylecraft and Habitat Solutions became primary obligors on these obligations. The proceeds from the sale of assets of these businesses are required to repay this debt. As part of the Stylecraft transaction, the Company entered into the Comprehensive Amendment, Guaranty and Security Agreement dated as of September 28, 2001, pursuant to which the Company granted Limeridge and Endeavour a security interest in substantially all of the Company's assets in exchange for such parties' forbearance from foreclosing on the Limeridge Note and the Endeavour Note until December 31, 2001 notwithstanding that the Company remains in default with respect to the Limeridge Note and the Endeavour Note. The security interest is subordinated to the security interests securing the Foothill debt, the Investors Note and the Landis Note. The Limeridge Note and the Endeavor Note represent funds that the Company had originally received from the issuance of Series C Preferred Shares (as defined below). The funds were used in the acquisitions of Stylecraft and CSL. The Series C Preferred Shares were subsequently exchanged for the Limeridge Note and the Endeavor Note. At the time of exchange, an additional $7,200,000 principal amount was also issued. These additional funds were used for the financing of the West Coast operations and in the Concepts acquisition. (c) Issued to DMB Property Ventures LP in connection with the acquisition of Petals, Inc. The note was originally due March 23, 2001 and convertible into Class A Shares at $2.00 per share. (d) In June 2000, the Company issued a $2,300,000 promissory note at 8.97% to Bank of America. The note is due July 1, 2005 and secured by the Company's real estate located in Mississippi. Foothill has a second mortgage on the property. The note is payable in 59 equal monthly payments of $23,000 and one last payment of $1,872,000. As of March 31, 2001 the Bank of America mortgage loan maturity date has been accelerated to September 30, 2001 and the monthly payments has been increased to $24,049 and the F-18 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS interest rate was increased to 9.47%. On October 1, 2001, as part of the sale of Stylecraft, this loan was repaid out of the proceeds of the sale. (e) On March 19, 2001, Petals and Stylecraft, wholly owned subsidiaries of the Company, executed a Senior Subordinated Secured Note due March 14, 2002 ("Investors Note") in favor of Interiors Investors, LLC, a Delaware limited liability company ("Interiors Investors") in the original principal amount of $5,000,000. The Investors Note is subordinated to the Company's obligations owed to Foothill, secured by substantially all of the Company's assets and guaranteed by Interiors and the Company's Chairman, President and Chief Executive Officer and his spouse. The Investors Note accrues interest at 16% per annum until September 30, 2001 and 18% thereafter and is payable monthly commencing May 31, 2001. From time to time, the Company is required to prepay the Investors Note out of the proceeds of the sale of the assets or capital stock of the Company's subsidiaries. Interiors Investors is owned by Robert Berman, who controls Berman Industries, Inc., Stylecraft's largest vendor ("Berman Industries"), and Jimmy Webster, Stylecraft's Chief Executive Officer. The Company received net proceeds of $4,941,000, of which $2,000,000 was loaned to Stylecraft to pay accounts payable owed to Berman Industries, $2,941,000 was loaned to Petals for wording capital requirements, of which $450,000 was paid to Foothill on behalf of Interiors to pay down the revolving loan. In connection with the sale of Stylecraft, the Company repaid $3,000,000 principal amount of the Investors Note and the interest rate was increased to 20.0%. As part of the sale of Stylecraft, on September 28, 2001, Petals, Stylecraft and Interiors Investors entered into a letter agreement (the "Second Investors Letter Agreement") pursuant to which upon the sale of the assets or capital stock of Petals, the Company is obligated to pay Interiors Investors $200,000 plus $30,000 for each calendar month after April 1, 2002 until such event occurs. The Second Investors Letter Agreement expires on September 28, 2004. The amount will be included as part of the calculation of a gain or loss on discontinued operations. In addition, Petals issued a promissory note due March 31, 2002 in the amount of $224,894 in favor of Berman Industries, Inc., Stylecraft's largest vendor. (f) Issued in connection with the acquisition of Vanguard. The note was due December 1, 2000 and required quarterly principal payments of $63,000, plus interest. (g) During fiscal year 2001, the Company issued 8% notes due to the former owners of Concepts totaling $2,059,000 comprised of the December 2000 purchase price payment of $770,000 and the calendar year 2000 earnout of $1,289,000. These notes are due in December 2001 and June 2002, respectively. During the second half of fiscal year 2001, payments of $351,000 were made on the December 2000 note of $770,000. (h) Includes $1,718,000 and $2,098,000 of capital lease obligations as of June 30, 2001 and 2000, respectively. It is anticipated that the proceeds from the sales of businesses during fiscal year 2002 will be used in part to repay these obligations. F-19 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. Investment In Affiliates The information described below regarding transactions with affiliates during the three year period ended June 30, 2001, were considered as discontinued operations as of December 31, 2000, as discussed in Note 3 - Discontinued Operations. In the formation of Decor Group, Inc. ("Decor"), a separate publicly-held corporation, the Company's intention was to create a company with a corporate identity separate and distinct from that of Interiors. Accordingly, in March 1996, the Company issued 200,000 Class A Shares, 200,000 Series A Preferred Shares and agreed to guarantee indebtedness of Decor in exchange for 83,333 shares of Series A Non-Voting Convertible Preferred Stock and an option to purchase 6,666,667 shares of Series B Non-Convertible Voting Preferred Stock (the "Option Shares") of Decor. The 83,333 shares of Series A Non-Voting Convertible Preferred Stock were sold by Interiors in February 1997 and later reacquired in January 1999 for $190,000. The 200,000 Class A Shares and 200,000 Series A Preferred Shares were sold by Decor. During the months of August and September 1996, the Company purchased 18,311 shares of Series C Non-Voting Convertible Preferred Stock, which are convertible into three shares of Decor's common stock, at a cost of $824,000. Effective with the Company's acquisition of the Option Shares in September 1996 for $2,000, the Company executed a Voting Agreement (the "Voting Agreement") to vest the power to vote the Option Shares in a Voting Trust until the repayment of $600,000 of indebtedness. Pursuant to the Voting Trust, the Company did not have the power to exercise control over Decor. The Voting Agreement terminated in October 2000 upon the repayment of such indebtedness and the Company commenced the consolidation of Decor in its financial statements. The Company's holding in Decor had been recorded on the Company's financial statements under the cost method of accounting. The cost method was used because Interiors control of Decor was subject to the Voting Agreement. Interiors had no residual common equity interest and the minority owners of Decor were entitled to 100% of Decor's profits and losses. In fiscal 1999, the Company entered into an agreement, which was subsequently terminated, to acquire Decor. In connection with such potential acquisition, the Company allocated and capitalized costs of investment banking services in the amount of $350,000 during fiscal 1998 based on the fair value of the trading securities received, 100,000 Class A Shares and 100,000 Series A Preferred Shares, as direct consulting fees. During the third quarter of fiscal 1999, the Company recorded an impairment loss of its entire investment; approximately $3,300,000 in Decor because the Company believed that based on Decor's financial condition its investment had been permanently impaired. The Company had established reserves for the uncollectibility of its entire receivable, approximately $1,000,000 owed to the Company by Decor and the possibility that the Company would be required to pay up to $300,000 pursuant to its guaranty of approximately $580,000 of indebtedness of Decor owed to Austin Financial. For the fiscal year 1999, the Company recognized consulting and management fee income of $115,000. The 1999 and 1998 management fee income and resulting receivable was written off during 1999 as discussed above. The Company consummated certain transactions during the fiscal year ended June 30, 1997 with Photo-To-Art, Ltd. ("Photo-to-Art"), a company that converts photographs into paintings, whereby the Company agreed to sell $1,140,000 worth of certain canvas related assets and other goods and consulting services to Photo-to-Art in exchange for 270,000 shares of common stock of Photo-to-Art and 120,000 warrants to purchase additional shares at $4.50 per share. The valuation ascribed to this transaction by the Company was comparable to the values received by unrelated investors in private placement transactions between those investors and Photo-to-Art. Interiors also received $50,000 in cash for use of its mailing lists. During the fourth quarter of fiscal 1999, the Company recorded an impairment loss of its entire investment, approximately $1,100,000 in Photo-to-Art because the Company believed that, based on Photo-to-Art's financial condition its investment had been permanently impaired. In addition, a $250,000 reserve had been recorded against non-operating receivables from Photo-to-Art of the approximately $325,000, owed to the Company from Photo-to-Art. During fiscal 2000, the Company wrote-off its remaining receivable from Photo-to-Art recognizing an additional loss of $75,000. Photo-to-Art was liquidated under Chapter 7 of the Bankruptcy Code. See Note 14 - "Related Party Transactions." F-20 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Acquisitions The information described below regarding various acquisitions during the three year period ended June 30, 2001, were considered as discontinued operations as of December 31, 2000, as discussed in Note 3 - Discontinued Operations. Vanguard. On March 10, 1998, the Company consummated the transactions contemplated by a merger agreement among the Company, an acquisition subsidiary of the Company, Henlor, Inc. ("Henlor"), and the shareholders of Henlor. Pursuant to the agreement, the Company's acquisition subsidiary merged with and into Henlor with Henlor continuing as the surviving corporation. Henlor also merged with its subsidiary Vanguard Studios, Inc. ("Vanguard"). The merger consideration paid by the Company consisted of (i) a cash payment of $705,000, (ii) an 8% sinking fund promissory note in the aggregate principal amount of $794,000 due December 1, 2000, of which $125,000 is outstanding as of June 30, 2000 and was paid during fiscal 2001and (iii) the issuance of 299,581 Class A Shares valued at $500,000 to the former shareholders of Henlor. This acquisition has been accounted for under the purchase method of accounting and the results of the operations have been included in the consolidated financial statements since the date of acquisition. The excess of purchase price over the fair values of net assets acquired was approximately $3.0 million. Artmaster. On March 23, 1998, the Company consummated the transactions contemplated by a merger agreement among the Company, Merchandise Sales, Inc. ("MSI"), Artmaster Studios, Inc. ("Artmaster"), and certain shareholders of MSI. Pursuant to the agreement, MSI merged with and into Artmaster, with Artmaster continuing as the surviving corporation. The merger consideration paid by the Company consisted of a 10% subordinated note of the Company in the amount of $537,000 and 779,302 Class A Shares valued at $1,250,000 (the "MSI Merger Shares"). In addition, the Company agreed to repay indebtedness of MSI owed to certain creditors of MSI in the aggregate amount of $1,023,000 (which payment consisted of a cash payment of $750,000 and a 10% subordinated promissory note in the amount of $273,000). The Company repaid the $273,000 and $537,000 promissory notes on July 31, 1998 and March 31, 1999, respectively. In May 1999, the former shareholders of MSI transferred the MSI Merger Shares to Aberdeen Avenue, LLC in consideration for $1,250,000, and the Company was released from all continuing obligations under the merger agreement. This acquisition has been accounted for under the purchase method of accounting. The excess of purchase price over the fair values of net assets acquired was approximately $3,800,000. Windsor. On July 30, 1998, the Company consummated the transactions contemplated by a stock purchase agreement between the Company and Bentley International, Inc. ("Bentley"), a publicly-traded Missouri corporation. Pursuant to the agreement, the Company purchased all of the issued and outstanding shares of Windsor Art, Inc. ("Windsor"). The purchase price consisted of $1,707,000 in cash and two secured subordinated 8% promissory notes, one in the amount of $3,300,000 and the other in the amount of $2,000,000 (collectively, the "Windsor Notes"). Concurrently with the purchase of the shares of Windsor, the Company purchased 150,000 shares of common stock of Bentley (the "Bentley Shares") valued at $2,531,000 and a warrant to purchase 300,000 shares of common stock of Bentley (the "Bentley Warrant") in exchange for the issuance of 1,500,000 Class A Shares (the "Windsor Shares"). In addition, an officer of Bentley entered into a consulting agreement with Windsor pursuant to which he received warrants to purchase 100,000 Class A Shares. One of the Windsor Notes, in the amount of $3,300,000, was repaid on September 30, 1998. On December 1, 1998, the other Windsor Note, in the amount of $2,000,000, and the Windsor Shares were repurchased by the Company in exchange for $2,442,000, the transfer, on behalf of Bentley, of 110,000 Bentley Shares and 100,000 Class A Shares to a former officer of Bentley, and some furniture. In addition, an officer of Bentley agreed to terminate his consulting agreement with Windsor, as well as warrants to purchase 50,000 Class A Shares, in exchange for $125,000, 40,000 Bentley Shares and the Bentley Warrant. This repurchase transaction resulted in an extraordinary gain of approximately $1,371,000, which was offset by $500,000 of net losses on other debt extinguishments including the write-off of unamortized deferred financing charges associated with the debt extinguished. The Windsor Shares were retired by the Company on February 22, 1999. This acquisition has been accounted for under the purchase method of accounting. The excess of purchase price over the fair values of net assets acquired was approximately $8,200,000. Troy. On August 14, 1998, the Company consummated the transactions contemplated by a July 2, 1998 merger agreement among the Company, Troy Lighting, Inc. ("Troy"), and the former shareholders of Troy. Pursuant to the agreement, a wholly-owned subsidiary of the Company merged with and into Troy, with Troy F-21 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continuing as the surviving corporation. The merger consideration paid by the Company consisted of a cash payment of $250,000 and the issuance of 650,000 Class A Shares valued at $975,000 (the "Troy Merger Shares"). In addition, the Company agreed to cause Troy to repay $1,700,000 in indebtedness to certain former shareholders of Troy. The indebtedness was repaid. This acquisition has been accounted for under the purchase method of accounting. The excess of purchase price over the fair values of net assets acquired was approximately $3,300,000. On or about July 31, 1999, the former shareholders of Troy agreed to sell the Troy Merger Shares to Dominion Capital Fund, Ltd., Dominion Investment Fund, LLC and Sovereign Partners, L.P. (collectively, the "Troy Purchasers") for $1,000,000. Contemporaneously therewith, the Company and the Troy Purchasers entered into a letter agreement pursuant to which the Troy Purchasers agreed not to sell or otherwise transfer the Troy Merger Shares for a period of six months. If the Troy Merger Shares were worth less $1,150,500 based on the sixty-day average of the Class A Shares following January 25, 2000, the Company would be required to either pay cash or issue additional Class A Shares to the Troy Purchasers in the amount of the shortfall. The determination to pay shares or issue stock is based upon, among other things, the price of the Class A Shares and the liquidity needs of the Company at the time of payment. The amount of the shortfall was approximately $470,000, which pursuant to the agreement is accruing liquidated damages at a rate of 2% per month. The Company has not paid such shortfall or issued shares and is currently negotiating with the Troy Purchasers to settle this outstanding obligation. The Company has accrued the additional cost, including interest as of June 30, 2000. Of the $470,000 additional cost, $319,000 was recognized as additional goodwill; $151,000 as accretion of interest plus accrued interest at the rate of 2% per month, resulting in additional accrued interest of $47,000 as of June 30, 2000. The accretion of interest was recorded as interest expense with a corresponding increase to additional paid in capital. During the fiscal year 2001, $300,000 of the obligation was repaid. Model Home. On February 26, 1999, the Company consummated the transactions contemplated by a merger agreement among the Company, MHI and a wholly owned subsidiary of the Company. Pursuant to the Agreement, the Company's wholly owned subsidiary merged with and into MHI, with MHI continuing as the surviving corporation merger. The purchase price paid by the Company consisted of a cash payment of $2,000,000, promissory notes aggregating $231,000, which were repaid during the fiscal year ended June 30, 2000, and Class A Shares having a fair market value of $2,300,000 (the "MHI Merger Shares"). Additionally, the Company agreed to issue Class A Shares with a maximum fair market value of $2,000,000 (the "Earnout Shares") upon the attainment of certain earnings goals by MHI during the calendar years 2000, 2001 and 2002. The excess of purchase price over the fair values of net assets acquired was approximately $1,450,000 and has been recorded as goodwill in the consolidated balance sheets, and is being amortized over forty years. During the fiscal years ended June 30, 2001 and 2000 the earnouts were $325,000 and $644,000, respectively, which were recorded as additional goodwill. Stylecraft. On February 22, 1999, the Company consummated the transactions contemplated by a stock purchase agreement among the Company and the former shareholders of Stylecraft pursuant to which the Company acquired all of the outstanding capital stock of Stylecraft for $10,319,000 in cash. This acquisition has been accounted for under the purchase method of accounting and the results of the operations have been included in the consolidated financial statements since the date of acquisition. The excess of purchase price over the fair values of net assets acquired was approximately $5,400,000. CSL. On March 2, 1999, the Company consummated the transactions contemplated by a stock purchase agreement between the Company and CSL Lighting Manufacturing, Inc. ("CSL"). Pursuant to the agreement, the Company acquired 1,191,752 newly-issued shares of common stock, par value $.001 per share, of CSL (the "CSL Shares"), representing approximately 51% of the issued and outstanding shares of common stock of CSL. The purchase price for the CSL Shares consisted of $600,000 in cash paid to CSL and the issuance of 1,927 Series C Preferred Shares valued at $1,927,000 to certain creditors of CSL in exchange for the cancellation of debt of CSL having a principal amount of $1,028,000. This acquisition has been accounted for under the purchase method of accounting. The excess of purchase price over the fair values of net assets acquired was approximately $2,500,000. As a result of applying the purchase method of accounting, the Company recognized a minority interest of $172,000 at the date of acquisition. During fiscal years 1999 and 2000, the Company has recognized a benefit for the allocation of losses of CSL to the minority interest of $117,000 and $55,000, respectively. During fiscal year 2000, CSL's net losses allocated to the minority interest was limited to the balance remaining in minority interest at June 30, 1999 resulting in the Company's 51% interest absorbing a significantly higher portion of the total loss. F-22 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During fiscal year 1999, the Company loaned CSL an aggregate of $355,000 in exchange for two 6.75% promissory notes due April 30, 2001 and convertible into common stock of CSL at $0.345 per share. Petals. On March 23, 1999, the Company consummated the transactions contemplated by a stock purchase agreement among the majority stockholders of Petals, and the Company pursuant to which the Company acquired Petals in exchange for the cancellation of $2,440,000 of debt owed by Petals to one of the stockholders, an aggregate of $4,000,000 in cash and a 8% convertible note in the original principal amount of $2,000,000 due March 23, 2001. The note is convertible at any time into Class A Shares at $2.00 per share. The Company also issued an aggregate of 100,000 three-year warrants to purchase Class A Shares at an exercise price of $3.50 per share to the minority stockholders ("Petals Warrants"). In connection with the transaction, Petals redeemed the interests of the minority stockholders for aggregate consideration of approximately $3.9 million in cash and $263,000 paid over nine months as severance payments. This acquisition has been accounted for under the purchase method of accounting. The excess of purchase price over the fair values of net assets acquired was approximately $5,200,000. Concepts 4, Inc. In December 1999, the Company acquired all of the outstanding capital stock of Concepts, a company that employs interior designers, architects and merchandisers to the hospitality industry. The purchase price consisted of (a) a cash payments of $4,600,000, (b) a payment of $2,823,000 which was payable on March 10, 2000 in cash or stock ("March 2000 Payment"), (c) a cash payment of $770,000 payable on December 15, 2000, (d) a cash payment of $1,218,000 payable on December 15, 2001, (e) a cash payment of $1,218,000 payable on December 15, 2002, and (f) a cash payment of $1,007,000 payable on March 10, 2003. The Company also agreed to issue Class A Shares with a maximum fair market value of $4,500,000 ("Earnout Shares") upon the attainment of certain earnings goals by Concepts. The amount of the Earnout Shares, if any, issued to the former shareholders will be determined by the earnings of the operations for the calendar years 2000, 2001 and 2002. The present value of the future purchase price obligations was approximately $5,732,000. On October 12, 2000, the Company and the former shareholders of Concepts amended the terms of the purchase agreement. Pursuant to the amended terms, the Company paid the former shareholders $3,388,000 during the second quarter of 2000. For calendar year 2001, the earnout was $1,289,000, which was recorded as additional goodwill. All purchase price obligations of the Company can be satisfied by the delivery of twelve month promissory notes bearing interest at 8% per annum and all earnout obligations can be satisfied by the delivery of eighteen month promissory notes bearing interest at 8% per annum. The December 15, 2000 payment of $770,000 and the earnout of $1,289,000 were satisfied by the issuance of promissory notes. During the second half of fiscal 2001, $351,000 was paid on the $770,000 promissory note. In satisfaction of the March 2000 Payment, the Company delivered to an escrow account ("Escrow Account") Class A Shares having a fair market value of $2,823,000 ("Escrow Shares"). If at any time the fair market value of the Escrow Shares falls below 80% of this amount, the Company is required to deliver additional Class A Shares to the Escrow Account so that the fair market value of the Escrow Account equals $2,823,000. The Company had the right ("Call Option"), but not the obligation, to redeem the Escrow Shares until September 10, 2000 for $3,105,000 in cash or thereafter until March 10, 2001 at which time it is obligated to pay cash or shares valued at of $3,388,000. Due to a decrease in the price of the Class A Shares, during the first quarter and second quarter of fiscal 2001, the Company deposited an additional 3,164,321 and 2,454,123 Class A Shares, respectively, into an escrow account established to secure future purchase price and earnout obligations in connection with the Company's acquisition of Concepts. During the second quarter of fiscal 2001, the Company paid $3,388,000 and the 7,545,886 shares were returned to the escrow account by the former owners of Concepts. As of June, 30, 2001, there were 9,999,999 Class A Shares held in this escrow account as collateral for future obligations that would be payable under the original acquisition agreement. This acquisition has been accounted for under the purchase method of accounting and the results of the operations have been included in the consolidated financial statements since the date of acquisition. The excess purchase price over the fair values of net assets acquired was approximately $8,646,000. F-23 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. Inventories The components of inventory are as follows:

7. Other Current Assets Included in other current assets as of June 30, 2001 and 2000 of $408,000 and $598,000, respectively are amounts due from the Company's employees, salespeople and an officer. During fiscal year 1999, the Company made advances aggregating $458,000 to the Company's Chief Executive Officer. In September 1999, this entire amount was repaid to the Company. During fiscal year 2000, new advances were made and, as of June 30, 2000, the balance was $283,000. During fiscal 2001, additional net advances of $15,000 were made. As of June 30, 2001, the balance was $298,000. In October 2001, in connection with the Stylecraft sale a personal loan of Max Munn in the principal amount of $250,000 owed to Jimmy Webster was also transferred to the Company and the Company set up a corresponding receivable from Mr. Munn. While these advances bear interest at 6.5% per annum, the Company does not accrue interest on these advances in the accompanying consolidated financial statements. 8. Property and Equipment, net The components of property and equipment are as follows:

Depreciation expense was $328,000, $448,000 and $300,000 for the years ended June 30, 2001, 2000 and 1999, respectively. F-24 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. Accrued Liabilities The components of accrued liabilities are as follows:

10. Debt Debt outstanding as of June 30, 2001, 2000 is as follows:

(a) In June 2000, the Company and Foothill entered into the Foothill Agreement as more fully discussed in Note 3 - Discontinued Operations. The interest rates on the revolving loans is prime plus 1.25% and on the term loans is prime plus 1.50%. As of March 1, 2001, the interest rates were increased to prime plus 2.5% on the revolving loans. At June 30, 2000, the prime rate was 6.75% and 9.50%, respectively, announced by Wells Fargo Bank. The credit facility contains financial and other covenants, including minimum net worth, and earnings before interest, income taxes and depreciation and amortization. Borrowings under the credit facility are secured by substantially all the assets of the Company, including accounts receivable and inventory. This debt is classified as current liabilities because Foothill has the right to accelerate this obligation in the event other debt obligations which are currently in default were accelerated by other lenders. (b) Issued to four accredited investors and convertible into Class A Shares at $1.50 per share. (c) Issued to five accredited investors and convertible into Class A Shares at $1.125 per share and accrued interest. (d) In July 2000, the Company issued to Donald M. Landis a $2,000,000 promissory note due July 27, 2001 (the "Landis Note"). The note requires the payment of monthly interest at an annual rate of 14%, accrues interest at 4%, which is payable at maturity, and is secured by the assets of the Company. The note replaces two separate $1,000,000 promissory notes with 24% and 16% interest rates previously issued to Mr. Landis and the Landis Brothers Corporation, respectively. The note is personally guaranteed by Mr. Munn, Chairman, President and Chief Executive Officer of the Company, and his spouse. F-25 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (e) In May 2000, the Company issued to Seaside Partners, L.P. a $1,000,000 promissory note due May 2002, (the "Seaside Note") which accrues interest at 8% and is payable upon maturity, default or conversion. The note is convertible into common stock of Interiors.com, Inc., a newly formed subsidiary of the Company ("Interiors.com"), subject to the occurrence of one of the following transactions: (i) an underwritten initial public offering of Interiors.com, (ii) a merger or consolidation of Interiors.com with a publicly-held corporation in which Interiors.com is not the surviving entity or (iii) a rights offering of Interiors.com securities to the shareholders of the Company. The conversion rights terminate if Interiors.com is unable to secure financing of at least $5,000,000 on or before December 31, 2000 or (ii) Interiors.com fails to consummate a transaction described in the previous sentence by October 2001. On October 12, 2000, Seaside Partners, L.P. exercised the Series B Warrant resulting in the issuance of 2,000,000 Class A Shares at $0.75 per share. The exercise price of $1,500,000 was paid by the return to the Company of 150,000 Series B Preferred Shares held by Seaside. Seaside also converted its remaining 50,000 Series B Preferred Shares having a liquidation value of $500,000 and $213,485 in accrued dividends through October 11, 2000 into 303,610 Class a Shares at $2.35 per share. In addition, the Seaside Note in the amount of $1,000,000 principal amount and $9,863 in accrued interest through June 30, 2000 were converted into 4,039,452 Class A Shares at $0.25 per share which must be voted in support of the election of the nominees of Board of directors as long as Seaside Partners holds these Class A Shares. At June 30, 2001, the Company had $2,642,000 of long term debt, excluding debt of the business to be sold, classified as current liabilities because the Company was not in compliance with certain requirements governing these instruments. 11. Stockholders Equity Description of Securities Common Stock Class A Shares. The Certificate of Incorporation of the Company authorizes the issuance of up to 60,000,000 Class A Shares. Each Class A Share is entitled to one non-cumulative vote per share on all matters on which stockholders' may vote at meetings of stockholders. The Class A Shares are not convertible into any other securities of the Company. Class B Shares. The Certificate of Incorporation of the Company authorizes the issuance of up to 2,500,000 Class B Shares. Each Class B Share is entitled to five non-cumulative votes per share on all matters on which stockholders may vote at meetings of stockholders. The Class B Shares are convertible on a one-for-one basis at any time after issuance at the option of the holder into Class A Shares. The holders of Class A Shares and Class B Shares (collectively, "Common Stock"): (i) have equal ratable rights to dividends from funds legally available therefor, when, as and if declared by the Board of Directors of the Company; (ii) are entitled to share ratably in all of the assets of the Company available for distribution to holders of Common Stock, upon liquidation, dissolution or winding up of the affairs of the Company; and (iii) do not have preemptive or subscription rights and there are no redemption or sinking fund provisions applicable thereto. All shares of Common Stock issued and outstanding are duly authorized, fully paid and non-assessable. Except as otherwise required by law, the holders of Common Stock shall vote together as a single class on all matters. Preferred Stock The Certificate of Incorporation of the Company authorizes the issuance of up to 5,300,000 shares of Preferred Stock, $.01 par value per share. Of this amount 2,870,000 shares have been designated as Series A 10% Cumulative Convertible Preferred Stock (the "Series A Preferred Shares"), 200,000 shares have been designated Series B Preferred Stock ("Series B Preferred Shares"), 6,527 shares have been designated Series C Preferred Stock ("Series C Preferred Shares"), 625,000 shares have been designated Series D Preferred Stock ("Series D Preferred F-26 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Shares") and 2,000 shares have been designated Series E Preferred Stock ("Series E Preferred Shares").. The Board of Directors is authorized to issue shares of Preferred Stock from time to time in one or more series and, subject to the limitations contained in the Certificate of Incorporation and any limitations prescribed by law, to establish and designate any such series and to fix the number of shares and the relative conversion rights, voting rights and terms of redemption (including sinking fund provisions) and liquidation preferences. If shares of Preferred stock are issued with voting rights, such issuance could affect the voting rights of the holders of the Company's Class A Shares by increasing the number of outstanding shares having voting rights, and by the creation of class or series voting rights. Shares of Preferred Stock with conversion rights could potentially increase the number of Class A Shares outstanding. Issuance of Preferred Stock could, under certain circumstances, have the effect of delaying or preventing a change in control of the Company and may adversely affect the rights of holders of Class A Shares. Also, Preferred Stock could have preferences over the Class A Shares (and other series of stock) with respect to dividends and liquidation rights. Series A Preferred Shares The Series A Preferred Stock consists of 2,870,000 shares. After September 17, 2000, each Series A Preferred Share is redeemable by the Company in whole or in part at $5.50 per share upon 30 days prior written notice. Each Series A Preferred Share is convertible, subject to adjustment, into three Class A Shares of the Company. The Series A Preferred Stock is entitled to a dividend, prior to any payment of dividends on the Class A Shares or Class B Shares, of $0.50 per share per annum payable in semi-annual installments of $0.25 per share. If the dividend on the Series A Preferred Shares is not paid, it accumulates until paid in full to date. The Company may elect to pay the dividend either in cash or in Class A Shares, which Class A Shares shall be issued for such purposes on the basis of the average closing prices of the Class A Shares for the ten business days prior to the date of declaration of the dividend. The Series A Preferred Shares shall not have any right to vote except to the extent, if any, required by Delaware law. Upon liquidation of the Company, each Series A Preferred Share is entitled to receive $5.00 plus accrued and unpaid dividends before any payment is made to the holders of Common Stock. During fiscal years 2001 and 2000, approximately 46,000 and 205,000 Series A Preferred Shares were converted into approximately 138,000 and 615,000 Class A Shares, respectively. In September 1999, the Company declared a $0.25 dividend on its Series A Preferred Shares for holders of record at December 10, 1999. The dividend of $192,000 was paid by the issuance of 225,344 Class A Shares. On September 30, 1998 and May 24, 1999, the Company's Board of Directors declared stock dividends equivalent to $0.25 per share on its Series A Preferred Shares to stockholders of record as of the close business on December 10, 1998 and June 10, 1999, respectively. Accordingly, a total of 344,510 Class A Shares were issued for this purpose and accumulated deficit was charged $449,000 in conjunction with the issuance of these securities. As of June 30, 2001 and 2000, the Company had not declared or established a record date for accrued dividends on its Series A Preferred Shares in the amount of $0.875 and $0.375, respectively. Cumulative but unpaid dividends on Series A Preferred Shares are approximately $704,000 and $319,000, respectively, which is recorded in accrued liabilities in the accompanying financial statements. Series B Preferred Shares On January 22, 1999, in order to provide it with additional working capital, the Company completed a private placement with one accredited investor of newly designated Series B Preferred Shares and redeemable three year warrants to purchase up to 2,000,000 Class A Shares at an exercise price of $0.75 per share (the "Series B Warrants"). The Company received $2,020,000 of gross proceeds from the sale of the Series B Preferred Shares and Series B Warrants. The Company incurred expenses of $15,000 in connection with the issuance of these securities. The Series B Preferred Shares consist of 200,000 shares, each of which is convertible into approximately 4.26 Class A Shares for an aggregate of 851,064 Class A Shares. The holders of the Series B Preferred Shares were granted certain registration rights with respect to the underlying Class A Shares issuable upon conversion of the Series B Preferred Shares or exercise of the Series B Warrants. The Series B Warrants were valued at the estimated fair market value on the date of issuance, approximately $2,000,000, which was amortized as accreted dividends over the term of the security. F-27 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Series B Preferred Shares rank in parity with the Company's Series A Preferred Shares with respect to dividends and liquidation, pays an 8% annual dividend, payable quarterly in cash or by the issuance of additional shares of Series B Preferred Shares, and is convertible by the holder at any time on or after January 31, 2000 into Class A Shares at a conversion price of $2.35 per share. Under certain limited conditions relating to a sale of the Company, through merger, sale of substantially all of its assets or tender offer, the Series B Preferred Shares may be converted into Class A Shares by the holder. At June 30, 1999, $1,000,000 of Series B Preferred Shares was classified outside the stockholders' equity section of the Company's consolidated balance sheet. As of January 31, 2000, the right to seek mandatory redemption with respect to $1,000,000 of the Series B Preferred Shares expired without exercise. Accordingly, such amount has been reclassified as stockholders' equity in the Company's consolidated balance sheets since March 31, 2000. The conversion price and the number of Class A Shares issuable upon conversion of the Series B Preferred Shares is subject to adjustment to protect the holder against dilution. Series C Preferred Shares On February 18, 1999, in order to provide it with the capital resources to complete pending acquisitions, the Company completed a private placement with four accredited investors of 6,427 newly designated Series C Preferred Shares. The Series C Preferred Shares have a liquidation value of $1,000 per share. In consideration for the issuance of 4,500 Series C Preferred Shares, the Company received $4,500,000 in gross proceeds. The Company incurred expenses of $20,000 in connection with the issuance of these securities. In addition, two of the purchasers of the Series C Preferred Shares, who were also holders of $1,028,000 of 7% notes previously issued to them by CSL Lighting Manufacturing, Inc., an affiliate of the Company, canceled such notes in exchange for the issuance of 1,927 Series C Preferred Shares. The Company also issued 100 Series C Preferred Shares as a fee in connection with the acquisition of CSL. The Series C Preferred Shares were exchanged for the Limeridge Note and the Endeavour Note during fiscal year 2000 and, accordingly, there are no longer any Series C Preferred Shares outstanding. Series D Preferred Shares In January 2000, the Company announced that its Board of Directors adopted a Rights Plan designed to protect the Company's stockholders in the event of takeover action that would deny them the full value of their investment. The terms of the Rights Plan provide for a dividend distribution of one right for each share of common stock to holders of record at the close of business on February 11, 2000. The rights will become exercisable only in the event, with certain exemptions, an acquiring party accumulates ten percent or more of the Company voting stock, or if a party announces an offer to acquire thirty percent or more of such stock. The rights will expire on November 30, 2009. Each right will entitle the holder to buy one one-hundredth of a share Series D Preferred Shares, par value $.001 per share, at a price of $25.00. In addition, upon the occurrence of certain events, holders of the rights will be entitled to purchase Interiors stock or shares in an "acquiring entity" at half of the market value. The Company is entitled to redeem the rights at $0.01 per right at any time until the tenth day following the acquisition of a ten percent position in the voting stock. Series E Preferred Shares On January 11, 2001, the Board of Directors authorized the creation of 2,000 shares of a new class of preferred stock designated Series E Convertible Preferred Stock ("Series E Preferred Shares"). Each Series E Preferred Share has a liquidation value of $1,000, is entitled to receive a 9% per year, payable quarterly, dividend and convertible into 3,333 Class B Shares if such shares are available for issuance. Until such time as the Company pays all accrued dividends on the Series E Preferred Shares, each Series E Preferred Share is entitled to five votes for each Class B Share into which it could have been converted if such shares were available for issuance. Currently, the Company has 200,000 Class B Shares authorized and available for issuance. On January 16, 2001, the Company issued 1,000 Series E Preferred Shares to Laurie Munn, wife of Max Munn, the Company's Chief Executive Officer, in exchange for $500,000 cash and a promissory note in the amount of $500,000 (the "Series E Note"). The Series E Note is secured by the 1,000 Series E Preferred Shares, F-28 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS accrues interest at 11% per annum, which is payable at maturity, and matures on January 16, 2005. In addition, Mr. and Mrs. Munn agreed to guarantee up to $3.0 million of accounts payable owed by one of the Company's subsidiaries, Stylecraft Lamps. The Company also agreed to subordinate its security interest in the 1,000 Series E Preferred Shares behind a security interest securing a $250,000 promissory note of Mrs. Munn executed in favor of Jimmy Webster, the Chief Executive Officer of Stylecraft. The Company also subordinated to Jimmy Webster its security interest in 2,445,000 Class B Shares owned by Mrs. Munn, which shares secure the Consolidated Promissory Note due November 1, 2005 in favor of the Company in the principal amount of $2,504,000 and accrued interest at 6.5%, which is payable at maturity (the "Munn consolidated Note"). The 9% Series E Preferred Shares dividends are reduced by the 11% interest on the $500,000 note receivable received as partial payment for the stock. In connection with the sale of Stylecraft, the personal loan of Mr. Munn owed to Mr. Webster was transferred to the Company and the Company set up a corresponding receivable from Mr. Munn. As of June 30, 2001, the Company had not declared or established a record date for accrued dividends on its Series E Preferred Shares. Cumulative but unpaid dividends on Series B Preferred Shares are approximately $18,000, which is recorded as accrued liabilities in the accompanying financial statements. The accrued dividend is net of interest on the note received as partial proceeds from the sale of the stock. Other Equity Transactions On September 21, 1998, the Company placed 5,000,000 Class A Shares into escrow to secure the Company's obligation to Ann Stevens, sister of the Company's Chairman, President and Chief Executive Officer. These shares were returned from escrow when the obligation to Ann Stevens was paid. During the period the shares were in escrow, the shares were not considered as issued and outstanding for accounting purposes since they were used as collateral for the obligation. On or about October 7, 1998, the Company issued 125,000 Class A Shares to Laurie Munn upon conversion of 125,000 Class B Shares. On or about October 22, 1998, the Company issued 10,000 Series A Preferred Shares to SJP Contractors of New York, Inc. in settlement of litigation against the Company. On or about October 22, 1998, the Company issued 10,000 Class A Shares to Jules L. Marx in settlement of litigation against the Company's Chief Executive Officer. On November 11, 1998, the Company issued 44,431 Class A Shares to James McCorry as a $75,000 bonus. On November 16, 1998, the Company issued 38,820 Class A Shares to Todd Langner as a $50,000 bonus. On or about November 23, 1998, the Company issued 10,000 Class A Shares to Roger Lourie, a director of the Company, and 10,000 Class A Shares to various designees named by Richard Josephberg, a director of the Company. On November 23, 1998, the Company issued 15,000 Class A Shares to JG Partners LP in connection with certain investment banking services provided by Josephberg Grosz & Co., Inc. ("Josephberg Grosz"), an affiliate of Mr. Josephberg. On February 9, 1999, the Company issued to Pauline Raschella, an employee of Windsor, an incentive bonus of 100,000 Class A Shares. On March 1, 1999, the Company issued to Earley Kielty and Associates, Inc., an executive search firm, 26,666 Class A Shares in connection with a search related to MHI. On March 11, 1999, the Company issued to Maria Matos, a former employee of the Company, 10,000 Class A Shares as a severance payment. On such date, the Company also issued to Judith E. Schneider, 6,250 Class A Shares in consideration for certain consulting services. During fiscal year 1999, the Company issued an aggregate of 3,206,342 Class A Shares relating to various acquisitions. In addition, the Company retired 1.5 million Class A Shares that were being held in escrow related to the acquisition of Windsor. See Note 5 - "Acquisitions." During fiscal year 1999, holders of 6% Convertible Notes issued in March and April 1998 with a principal amount of $1,700,000 and holders of 12% Convertible Demand Notes with a principal amount of $235,000 issued in March 1998, converted these notes into an aggregate of 2,130,900 Class A Shares. F-29 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In August 1999, the Company issued to James McCorry, President of Habitat Solutions, Inc., a wholly owned subsidiary of the Company, an incentive bonus of 53,343 Class A Shares valued at $75,000. During fiscal year 2000, the Company added 1,633,271 Class A Shares to the escrow established in connection with the Company's acquisition of MHI. In December 1999, the Company acquired and subsequently retired 10,000 Series A Preferred Shares in exchange for $25,000. Such shares were originally issued in connection with the settlement of litigation SJP Contractors of New York, Inc. In addition, the Company retired 4,833 Class A Shares issued as dividends related thereto. In January 2000, the right to seek mandatory redemption with respect to 100,000 Series B Preferred Shares expired without exercise. Accordingly, these 100,000 shares valued at $1,000,000 has been reclassified from Redeemable Series B Preferred Stock to Stockholders' Equity in the accompanying financial statements. No underwriters were engaged by the Company in connection with any of the issuance's described above and, accordingly, no underwriting discounts or commissions were paid. Warrants and Other In July 1998, warrants were exercised at $1.50 resulting in the issuance of 240,517 Class A Shares and total proceeds of $360,000. In October 2000, Seaside Partners, L.P. exercised the Series B Warrant resulting in the issuance of 2,000,000 Class A Shares at $0.75 per share. The exercise price of $1,500,000 was paid by the return to the Company of 150,000 Series B Preferred Shares held by Seaside. Seaside also converted its remaining 50,000 Series B Preferred Shares having a liquidation value of $500,000 and $213,485 in accrued dividends through October 11, 2000 into 303,610 Class A Shares at $2.35 per share. In addition, the Seaside note in the amount of $1,000,000 principal amount and $9,863 in accrued interest through June 30, 2000 were converted into 4,039,452 Class A Shares at $0.25 per share. Seaside has agreed to vote such shares in support of the election of the nominees of Board of Directors as long as Seaside Partners holds these Class A Shares. In March 1999, the Company redeemed 916,591 warrants for Class A Shares and 103,610 warrants for Series A Preferred Shares for aggregate consideration of $10,000 or $0.01 per warrant. As a result of the redemption, there are no longer any outstanding publicly traded warrants. Prior to redemption, an amount of warrants for Class A Shares and Series A Preferred Shares were exercised at $2.00 and $5.50, respectively, resulting in the issuance of 2,796,032 Class A Shares and 2,322,355 Series A Preferred Shares, and the Company received gross proceeds of approximately $18,200,000. In connection with the redemption, the Company paid a fee of $175,000. During fiscal year 1999, other warrants were exercised at prices ranging from $1.38 to $1.75 resulting in the issuance of 826,905 Class A Shares and total proceeds of $1,151,309. During fiscal years 2001 and 2000, there were no warrants exercised. As of June 30, 2001, the Company had outstanding warrants on 1,133,214 Class A Common Shares as follows: Number of Expiration Warrants Average Price ------------------------ --------------- ------------- Fiscal Year 2002 100,000 $ 3.25 Fiscal Year 2003 135,000 $ 1.75 Fiscal Year 2004 848,214 $ 1.52 Fiscal Year 2008 50,000 $ 1.59 --------------- 1,133,214 =============== F-30 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Number of Shares Reconciliation of the share activity during the three-year period ended June 30, 2001, is as follows:

F-31 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

F-32 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock Option Plans The 1994 Plan. On June 20, 1994, the Company adopted the Interiors, Inc. 1994 Stock Option and Appreciation Rights Plan (the "1994 Plan"), which, as amended, currently provides for the granting of options to officers, employees and consultants to purchase not more than an aggregate of 250,000,000 Class A Shares. Directors of the Company are not eligible to participate in the 1994 Plan. The 1994 Plan provides for the grant of options intended to qualify as "incentive stock options" under the Internal Revenue Code of 1986, as amended (the "Code") as well as options, which do not so qualify. The Director Plan. On June 20, 1994 the Board of Directors approved the 1994 Director Stock Option and Appreciation Rights Plan (the "Director Plan"), which, as amended, currently provides for the granting of options to directors to purchase not more than an aggregate of 750,000 Class A Shares. The Director Plan was adopted to provide an incentive to Directors through automatic and discretionary grants of stock options. The Director Plan provides for the grant of options intended to qualify as "incentive stock options" under the Code as well as options which do not so qualify. The Director Plan provides that on the second Monday of May of each year each person who is then a director of the Company shall be automatically granted an option to purchase 10,000 of the Company's Class A Shares, subject to adjustment as provided for by the Director Plan. The aggregate number of shares for which options may be issued pursuant to the Director Plan is 250,000 shares. The exercise price for options granted under the Director Plan must be equal to the fair market value per Class A Share on the date of grant. Each option granted under the Director Plan expires ten years after the date of grant, unless a shorter period is specified by the option committee administering the plan. The status of the Company's stock option plans as of June 30, 2001, 2000 and 1999, respectively is summarized below:

Of the 4,095,525 options outstanding as of June 30, 2001: (a) 63,025 options have an exercise price of $.001, weighted average fair market values on the date of grant of $1.16 and remaining contractual lives of 7.5 years. 20,000 options granted during fiscal year 2001 have an exercise price of $.09, which approximates the weighted average fair market value on the date of grant and remaining contractual lives of ten years. (b) 1,412,500 options have exercise prices ranging from $.88 to $2.13, weighted average exercise price of $1.40, which approximates the weighted average fair market values on the dates of grant and weighted average remaining contractual lives of 8.5 years. F-33 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (c) 2,600,000 options (excluding options to purchase 250,000 Series A Preferred Shares with an exercise price of $3.63, fair market value on the date of grant of $2.88 and remaining contractual lives of 9.5 years, each of which is convertible into three Class A Shares) were granted outside of the Company's stock option plans. These options are not exercisable until November 2008, however, 275,000 of the options may become exercisable each year that the Company reaches certain specified earnings targets. During fiscal year 2001, the targets were not met. Exercise prices for these options range from $1.16 to $3.63 and increase at a rate of 10% per annum. As of June 30, 2001 2,500,000 of these options have exercise prices of $1.16, fair market values on the dates of grant of $.98 and remaining contractual lives of 9.5 years; and 100,000 of these options have an exercise price of $1.00, which was the fair market value on date of grant and these options vested immediately. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumption used for those options granted in 2000 and 1999, respectively: Dividend yield of 0% in all fiscal years, expected volatility of 73% and 91%, risk-free interest rates ranging from 0% to 6.5%, and expected lives of 3 years, 10 years and 5 years, respectively. The Company accounts for its plans under APB Opinion No. 25, "Accounting for Stock Issued to Employees", under which no compensation cost is recognized for options granted at or above fair market value on the date of grant. Compensation expense of $75,000, in connection with the issuance of incentive stock options to an officer of the Company, has been charged to expense for the fiscal year-ended June 30, 2000 and 1999. There was no comparable expense for the fiscal year ended June 30, 2001. Had compensation expense been determined based upon fair values at the grant dates for options granted under those plans in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the loss for both basic and diluted loss per share from continuing operations for the fiscal years ended June 30, 2001, would not have changed. For the fiscal years ended June 30, 2000 and 1999 loss for both basic and diluted loss per share from continuing operations would have increased $.02 and .03, respectively. F-34 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Earnings (Loss) Per Share Reconciliation between the numerators and denominators of the basic and diluted EPS computations for net earnings for the fiscal years ended June 30, 2001, 2000 and 1999, respectively is as follows:

* 7,500,000 Class A Shares that were held in escrow during the year were not included in Basic EPS computation as their ultimate status was uncertain and were retired by the Company during fiscal year 1999. For the fiscal years ended June 30, 2001 and 2000, the conversion of 804,937 and 850,802, respectively, Series A Preferred Shares and for the fiscal year ended June 30, 2000, 200,000 Series B Preferred Shares were not included for computation purposes since the effect would be antidilutive. For the fiscal year ended June 30, 2001, the 200,000 Series B Preferred Shares for the period prior to conversion were not included for computation purposes since the effect would be antidilutive. Also not included in the computation were options on approximately 4.1 million shares since the exercise price was higher than the market price of the Company's stock price. 13. Commitments and Contingencies Operating Leases The operating leases of the Company primarily are for facilities. The Company's headquarters are located in Mount Vernon, New York, in leased facilities consisting of 70,000 square feet of manufacturing and warehouse space together with executive offices and a showroom. The facility is occupied under a five-year lease expiring in December 2006. F-35 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In addition, the Company leases showroom facilities in New York, New York, and Southport, Connecticut that are each approximately 1,500 square feet. The approximate future minimum lease payments per fiscal year under operating leases for the fiscal years are as follows: 2002 - $353,000; 2003 - $110,000; 2004 - $43,000 and 2005 - $4,000. In addition to the minimum base payments for various facilities, a facility had a contingent rental which was based on a per charge for per piece of merchandise handled. This facility was used in the rug and accessory business which is being wound down. During the first quarter of fiscal 2002, this facility is no longer being utilized. Rent expense charged to operations for the fiscal years 2001, 2000 and 1999 was approximately $447,000, $456,000 and $352,000, respectively. Union Agreement The Company is party to a collective bargaining agreement. None of the Company's employees have been on strike, or threatened to since the Company's inception and the Company believes its relationship with all of its personnel is satisfactory. As of June 30, 2001, the Company owed a union $39,000. The last payment was made on March 31, 2000. Consulting Arrangements Refer to Note 14 for discussion of these arrangements. Legal Proceedings Interiors, Inc. v. Gilliam et al. This matter was brought by the Company to enforce the conversion of debt obligations in the amount of approximately $675,000. It is in the Supreme Court of State of New York, County of New York. The defendants claim that they rescinded their conversion notices. The Company does not expect the amount of its liability to exceed the amount of the debt. Market Square LLC v. Interiors, Inc. This matter was brought by the plaintiff in the General Court of Justice, Superior Court Division in the State of North Carolina, County of Guilford and relates to alleged non-payment of rent. The Company has several defenses relating to an alleged breach of the lease by the landlord and will vigorously defend itself. The landlord is alleging approximately $228,000 in damages. At this time, the Company is unable to predict the amount of any liability. Matrix Funding Corporation v. Stylecraft Lamps, Interiors, Inc and Petals, Inc. This matter was brought by the plaintiff in the Third Judicial District Court of Salt Lake County, Salt Lake Department, State of Utah and relates to the non-payment of a computer equipment lease. The equipment covered by the lease is not integral to the Company's business. The plaintiff is seeking approximately $1,400,000 in damages. The plaintiff has offered to settle the matter for significantly less than the amount of the alleged damages. The Company is currently considering this offer. Following the sale of the assets of Windsor, several actions were filed in the state courts of California against Windsor and Interiors for unpaid accounts payable. The buyer of the assets is protected from these claims because the sale transaction was accomplished in accordance with the bulk sale statute of the State of California. Windsor does not have any additional assets to satisfy these claims because the entire cash proceeds were used to repay secured debt obligations owed to Foothill. Interiors believes that the creditors of Windsor must only look to the assets of Windsor and not Interiors to satisfy any claims they may have against Windsor. There can be no assurance, however, that a court will agree with the Company's analysis. If a court were to determine that Interiors is liable for a portion or all of these claims, it may have a material adverse effect on the Company. F-36 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Interiors is subject to other claims and litigation arising in the ordinary course of its business. In management's opinion, Interiors is not presently a party to any such litigation or claims the outcome of which would have a material adverse effect on its financial position or its results of operations. 14. Related Party Transactions From time to time, the Company has entered into transactions with parties related to the Company. As of June 30, 2001 and 2000 the Company had no investments in affiliates. During fiscal year 1999, the Company generated management fees in the amount of $115,000 in connection with the provision of management services to Decor Group, Inc., a publicly-held affiliate ("Decor") which the Company began consolidating in its financial statements in October 1999 (Note 3). The Company owns 83,333 shares of Series A Non-Voting Convertible Preferred Stock, 6,666,667 shares of Series B Non-Convertible Voting Preferred Stock and 18,311 shares of Series C Non-Voting Convertible Preferred Stock of Decor. Such ownership amounts to approximately 78% of the voting securities of Decor. Mr. Munn is a director of Decor. In fiscal 1999, the Company entered into an agreement, which was subsequently terminated, to acquire Decor. In connection with such potential acquisition, the Company capitalized costs of investment banking services in the amount of $725,000 during fiscal 1998 based on the fair value of the trading securities received, 100,000 Class A Shares and 100,000 Series A Preferred Shares, as direct consulting fees. During the third quarter of fiscal 1999, the Company recorded an impairment loss of its entire investment; approximately $3,300,000 in Decor because the Company believed that based on Decor's financial condition its investment had been permanently impaired. The Company had established reserves for the uncollectibility of its entire receivable, approximately $1,000,000 owed to the Company by Decor and the possibility that the Company would be required to pay up to $300,000 pursuant to its guaranty of approximately $580,000 of indebtedness of Decor owed to Austin Financial. For the fiscal years 1999, the Company recognized consulting and management fee income of $115,000 which was subsequently written off. During fiscal year 1999, the Company loaned $275,000 to Photo-to-Art, Ltd. ("Photo-to-Art"). In addition, the Company was paid $76,000 from Photo-to-Art in connection with the sublease of certain space in the Company's facility located in Mount Vernon and $216,000 for the purchase of merchandise. The Company owns 270,000 shares, or approximately 0.5%, of the common stock of Photo-to-Art and warrants to purchase 120,000 common shares of Photo-to-Art at $4.50 per share. As of June 30, 1999, Photo-to-Art owed the Company $325,000 for which a $250,000 reserve had been established. Mr. Munn, the Company's Chairman, President and Chief Executive Officer, had personally guaranteed debt of Photo-to-Art owed to a third party in the amount of approximately $180,000. The Company acquired $28,000 of such debt. During fiscal 2000, the Company wrote off its remaining receivable from Photo-to-Art recognizing an additional loss of $75,000. During fiscal 2001, Photo-to-Art was currently being liquidated under Chapter 7 of the Bankruptcy Code. During fiscal year 1999, the Company earned $442,000 of management fees from entities that were subsequently acquired, which was included in discontinued operations. During fiscal year 1999, the Company issued 375,000 Class B Shares to Laurie Munn, wife of the Company's Chief Executive Officer, in consideration for her personal guarantee of $5,300,000 of the Company's obligations in connection with its acquisitions of Windsor and Troy. In addition, the Company issued 1,350,000 Class B Shares to Ms. Munn upon the exercise of an option. The exercise price for the option was $1,350 in cash and a promissory note in the amount of $1,606,000. The note bears interest at a rate of 6.5% per annum and matures on December 8, 2005. As of June 30, 1999, Ms. Munn owes the Company $2,555,000 principal amount all of which is secured by a lien on 2,455,000 Class B Shares, and Ms Munn guarantees debt of the Company in the amount of $2,400,000. On January 11, 2001, the Board of Directors authorized the creation of 2,000 shares of a new class of preferred stock designated Series E Convertible Preferred Stock ("Series E Preferred Shares"). Each Series E Preferred Share has a liquidation value of $1,000, is entitled to receive a 9% quarterly dividend and convertible into 3,333 Class B Shares if such shares are available for issuance. Until such time as the Company pays all accrued dividends on the Series E Preferred Shares, each Series E Preferred Share is entitled to five votes for each Class B Share into which it could have been converted if such shares were available for issuance. Currently, the Company has 45,000 Class B Shares authorized and available for issuance. The Company is not accruing any interest on this obligation. F-37 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On January 16, 2001, the Company issued 1,000 Series E Preferred Shares to Laurie Munn, wife of Max Munn, the Company's Chief Executive Officer, in exchange for $500,000 cash and a promissory note in the amount of $500,000 (the "Series E Note"). The Series E Note is secured by the 1,000 Series E Preferred Shares, accrues interest at 11% per annum, which is payable at maturity, and matures on January 16, 2005. In addition, Mr. and Mrs. Munn agreed to guarantee up to $3.0 million of accounts payable owed by Stylecraft. The Company also agreed to subordinate its security interest in the 1,000 Series E Preferred Shares behind a security interest securing a $250,000 promissory note of Mrs. Munn executed in favor of Jimmy Webster, the Chief Executive Officer of Stylecraft. The Company also subordinated to Jimmy Webster is security interest in 2,445,000 Class B Shares owned by Mrs. Munn, which shares secure the Consolidated Promissory Note due November 1, 2005 in favor of the Company in the principal amount of $2,504,000 and accruing interest at 6.5%, which is payable at maturity (the "Munn Consolidated Note"). The 9% Series E preferred Shares dividends are reduced by the 11% interest on the $500,000 note receivable received as partial payment for the stock. In connection with the sale of Stylecraft, the $250,000 personal loan of Mr. Munn owed to Jimmy Webster, was transferred to the Company. In January 2001, the Company released from escrow 2,515,368 Class A Shares to the former owners of Model Home, valued at $325,000, representing the earnout for calendar year 2000 in accordance with the original acquisition agreement. The amount was recorded as additional goodwill related to the acquisition. In April 2001, these shares were returned to the Company when Model Home was sold by the Company to the former owners of Model Home. During fiscal years 2001, 2000 and 1999, the Company paid Morris Munn, father of the Company's Chairman, President and Chief Executive Officer, $118,838.84, $71,000 and $64,000, respectively, for consulting services pursuant to a five-year agreement commencing June 30, 1996. The agreement has been extended for a period of five years until June 30, 2006. In June 1999, Decor paid Morris Munn $152,000 in settlement of a consolidated arbitration proceedings and other litigation involving Decor, Interiors, Max Munn, Laurie Munn, Morris Munn and Ann Stevens, sister of Max Munn. During fiscal year 1999, 3,750,000 Class A Shares were transferred out of escrow to an accredited investor as collateral for the $500,000 paid to Ann Stevens, sister of Max Munn, the Company's Chairman, President and Chief Executive Officer, as part of the Company's settlement agreement related to an employment agreement with Stevens. Of these shares, 1,250,000 Class A Shares were converted from Class B Shares previously held in escrow and 2,500,000 Class A Shares were issued out of such escrow. Total proceeds resulting from the transfer was $3,975,000, of which $3,700,000 was paid in cash and $275,000 was paid by satisfying a promissory note. In addition, the Company retired 10,000,000 Class A Shares previously held in such escrow. In connection with certain investment banking services provided during fiscal year 1999 by Josephberg Grosz, an affiliate of Richard Josephberg, a director of the Company, the Company issued (a) a four-year warrant to purchase 135,000 Class A Shares at $1.75 per share, 4,650 Class A Shares and $30,000 cash to JG Capital, Inc., (b) 15,000 Class A Shares to JG Partners, LP (c) 5,350 Class A Shares to various designees named by Richard Josephberg. The shares were valued at the fair market value on the date of issuance. During fiscal year 1999, the Company made advances aggregating $458,000 at 6.5% interest to Mr. Munn, the Company's Chairman, President and Chief Executive Officer. In September 1999, this entire amount was repaid to the Company and the Company forgave all related interest. Subsequently, the Company made advances aggregating $283,000 at 6.5% interest during fiscal year 2000, and an additional $15,000 during fiscal year 2001 which all remain outstanding as of June 30, 2000. The Company is not accruing any interest on this obligation. The Company will not permit loans or other transactions among the Company and the officers, directors, principal shareholders, or affiliates of any of them for other than bona fide business purposes or on terms no less favorable than could be obtained from third parties, unless approved by a majority of the disinterested directors and the independent directors, if any, of the Company. F-38 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. Benefit Plans In fiscal year 1996, the Company started a 401(k) Savings Plan which provides for employees contributing up to 15% for non-highly compensated employees and up to 5% for highly compensated employees ($80,000) of their salaries. In fiscal year 1992, the Company started a Qualified Profit Sharing Plan for all nonunion employees. The Qualified Profit Sharing Plan was effectually closed in March of 2000 and employee accounts were either transferred to the 401(k) Savings Plan or distributed, as the employee elected. In January 2001, the Company expanded the 401(k) Savings Plan to cover all employees of the Company. The Company's matching contribution is 20% of the employees contribution, which is up to 6% of the annual salary subject to limitations as described in the plan documents. The Company's matching contribution for the fiscal year 2001 was $7,033. 16. Provision For Income Taxes There is no provision for Federal or state income tax expense or benefit recorded in fiscal year 2001, 2000 or 1999. In addition to incurring a net operating loss each year, the Company is not expected to have any future income to utilize the net operating loss carryforward and deferred tax assets. Therefore the effective tax rate for these years is zero. Deferred taxes represent the differences between financial statement amounts and the tax basis of assets. The majority of the Company's deferred tax assets are generated for the fiscal year 2001 and 2000 by bad debt expense, inventory reserve, legal reserve and a net operating carryforward. However, the deferred tax assets have been completely reserved through a valuation allowance resulting in no deferred tax asset for the fiscal year 2001 and 2000. The Company is not likely to have future income to utilize the asset. The benefit from the Company's net operating loss carryforward for Federal income tax purposes is approximately $22,582,000 (which expires in 2019 through 2021). Currently the Company is under sales and use tax audits. The Company is not sure what the outcome of these audits will be. The Company expects to file its fiscal 2000 tax returns by October 31, 2001. In addition, extensions have been filed for the fiscal 2001 tax returns, which are due March 15, 2002. F-39 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. Supplemental Cash Flow Information Supplemental cash flow information relating to continuing operations, is as follows:

F-40 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cash flow information related to discontinued operations, is as follows:

F-41 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

F-42 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. Operations Quarterly Financial Data Unaudited Summarized quarterly financial data is as follows:

(a) The operating results of continuing operations for the second quarter of fiscal 2001 includes $2,530,000 related to the write down of rug and accessories inventory of $733,000 and the write off to liquidate the rug and accessory business of $1,797,000. In addition, the operating results of the discontinued operations for the second quarter of fiscal 2001 have been restated from the amounts previously reported reflecting a correction to inventory reserves. (b) The sum of net income per share for the four quarters may not equal earnings per share for the total year due to changes in the average number of common shares outstanding The operating results for the quarters of fiscal 2000 have been restated from the amounts previously reported reflecting the discontinued operations as discussed in Note 3. Fourth Quarter Adjustments In the fourth quarter of fiscal year 2001, the Company recorded an estimated loss on the disposal of business of $28,600,000. During the fourth quarter the Company disposed of Model Home and Windsor operations. The Company had also received indications of interest for the other businesses to be disposed of, i.e. Petals, Stylecraft, Artisan House and Concepts. These indications of interest have been lower than previous estimates the Company believed the businesses could be sold for, in part due to the recent economic environment. The Company F-43 INTERIORS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS is continuing to evaluate the indications of interest for Petals and Concepts. During the first quarter of fiscal 2002, the Company sold the stock of Artisan House and in October 2001 sold certain net assets of Stylecraft. Based on the losses realized on the sale of businesses sold during the second and third quarters of fiscal 2001, which had been deferred in accordance with EITF 85-36 in anticipation of a net gain on the disposal of all business, as well as lower earnings for the business to be disposed of, the Company recognized an estimated loss during the fourth quarter of fiscal 2001 on the disposal of all businesses. In the fourth quarter of fiscal year 2000, the Company recorded approximately $8,700,000 of adjustments of which $2,500,000 applicable to continuing operations and $6,200,000 was applicable to discontinued operations. The $2,500,000 applicable to continuing operations represented the start up of the rug and tabletop accessory business operation of which $800,000 was recorded in cost of sales and $1,700,000 was recorded in selling, general and administrative expenses. The $6,200,000 of adjustments applicable to discontinued operations related primarily to an impairment loss of $3,000,000 related to the Troy and CSL operations resulting in an impairment write down of the goodwill previously established at the purchase dates; the recording of reserves for inventory of $2,300,000 and accounts receivable of $700,000 and the recording of severance costs of $200,000. F-44 INTERIORS, INC. AND SUBSIDIARIES SCHEDULE II VALUATION & QUALIFYING ACCOUNTS & RESERVES* (amounts in thousands)

------------------------------- * As restated, see Note 3 of the notes to the consolidated financial statements. (1) Allowances are primarily charged to income as incurred. The allowance is adjusted at the end of each period, by a charge or credit to income, for the estimated discounts and allowances applicable to the account receivable then outstanding. The above reserves are deducted from the related assets in the consolidated balance sheets. S-1

INTERIORS INC 10-K