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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 (No fee required effective October 7, 1996)
For the fiscal year ended January 30, 1999
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period from _________________ to
___________________________.
Commission file no. 0-19536
THE RIGHT START, INC.
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(Exact name of registrant as specified in its charter)
California 95-3971414
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(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
5388 Sterling Center Dr., Unit C, Westlake Village, California 91361
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code
(818) 707-7100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
--------------------------
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. [ ]
As of April 19, 1999, approximately 2,595,487 shares of the Registrant's Common
Stock held by non-affiliates were outstanding and the aggregate market value of
such shares was approximately $17,519,537. As of April 19, 1999 there were
outstanding 5,051,820 shares of Common Stock, no par value, with no treasury
stock.
Portions of the Registrant's definitive Proxy Statement for the Annual Meeting
of Stockholders to be held on June 29, 1999 (the "Proxy Statement") are
incorporated by reference into Part III hereof.
This Annual Report on Form 10-K contains "forward-looking statements"
within the meaning of Section-27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Discussions
containing such forward-looking statements may be found in the material set
forth under Item 1. Business and Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as within this Annual
Report generally (including any document incorporated by reference herein).
Also, documents subsequently filed by the Company with the Securities and
Exchange Commission may contain forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements as a
result of the risk factors identified herein or in other public filings by the
Company, including but not limited to, the Company's Registration Statement on
Form S-3 (File No. 333-08175).
PART I
ITEM 1. BUSINESS
General
The Right Start, Inc., a California corporation ("The Right Start" or "the
Company") is a leading merchant offering unique, high-quality products for
infants and young children. The Company markets its products through 41 retail
stores and through The Right Start catalog. The Company is a market leader
offering approximately 800 items targeting infants and children from pre-birth
up to age four. Products offered are carefully selected to meet parents' baby
care needs in such categories as Travel, Developmental Toys, Books/Music/Video,
Feeding, Nursery, Health/Safety and Bath/Potty.
History
The Company was formed in 1985 to capitalize upon growing trends towards
the use of mail order catalogs and the demand for high quality infants' and
children's goods. Until the formation of the Company, new parents' alternatives
were low-service mass merchandise stores or sparsely-stocked, high-priced
infants' and children's specialty stores. To counter this, The Right Start
carefully screened infant and toddler products in order to identify those
considered to be the "best of the best," that is, the safest, most durable, best
designed and best valued items.
The Right Start then expanded its distribution channel beyond The Right
Start Catalog and into specialty retail sales through The Right Start stores.
Based on the results of the retail stores, the Company's strategy evolved to
include a reduction in The Right Start Catalog circulation and plans for a major
retail expansion.
Management has always made customer service the Company's highest
priority. By offering to its customers sales associates with extensive product
knowledge, carefully selected and tested products, fast shipment that is
generally less than 48 hours from receipt of catalog orders, and a 24 hour a
day/365 day a year ordering availability, The Right Start is able to
differentiate itself from its competitors.
Retail Operations
On January 30, 1999, the Company had 40 stores in operation. The stores'
product mix includes a wide variety of items to meet the needs of the parents of
infants and small children, all presented within a store designed to provide a
safe, baby-friendly environment for the shopping ease of new parents.
The number of stores open reflects the rapid growth that the Company
experienced in 1996 and early 1997, during which time 24 mall stores were
opened. After studying the results of both mall and street locations, management
2
concluded that street locations represented a much more appropriate format for
future retail growth. These locations are more convenient to access and shop for
the Company's customers, many of whom are shopping with infants and small
children. Further, street locations are more cost efficient to build and
operate. Accordingly, the Company adopted a store opening plan which provided
for the opening of eight street-location stores in 1998.
In addition to reevaluating store location strategy, in 1997 the Company
determined that certain existing mall locations were not performing at an
acceptable level and implemented a store closing plan. Nine mall stores were
closed in 1998.
The Right Start Catalog
The Right Start catalog offers a mail order alternative for The Right
Start customers. This division of the Company represents the business on which
the Company was founded over twelve years ago, and it continues to offer a
quality selection of Right Start products through nationally distributed mail
order catalogs. Several attractive glossy issues are mailed each year, targeting
the Company's principal customers: educated, first-time parents from 23-40 years
old, with an average annual income in excess of $60,000.
Advertising and Marketing
The Right Start has implemented a number of national, regional and local
marketing programs to reinforce its strong brand name and increase customer
awareness of customers in new store locations. These programs include print ads
in national and regional publications, direct mail and local newspaper
advertising. In addition, the stores' point of sale system provides a strong
marketing database. Customers' names and addresses are captured and are then
used for promotional mailings and other follow up activities. Further, the Right
Start catalog provides effective marketing support for the stores. Catalogs are
distributed in existing and future retail markets to a targeted customer base.
The Company reaches its catalog customers through mailings of The Right
Start catalog to qualified segments of the Company's own customer list and
selected rented lists. In order to achieve this efficiently, the customer list
is segmented by frequency, recency and size of purchase. Rented lists are
evaluated based on historical performance in The Right Start mailings and
availability of names meeting the Company's customer profile.
Purchasing
The Right Start purchases products from over 500 different vendors. No
single vendor represents more than 5% of overall sales. In total, the Company
imports approximately 5% of the products offered. Imported items have
historically had higher gross profit margins and tend to provide more
opportunities for the Company to offer a large selection of unique goods.
Employees
As of April 19, 1999, the Company employed 327 employees, approximately 57
percent of whom were part-time. The Company's employees have not entered into
any collective bargaining agreements nor are they represented by union. The
Company considers its employee relations to be good.
3
Recent Developments
The Company continues to develop its plan to engage in electronic commerce
over the Internet. The Company has been developing its e-commerce Website,
RightStart.com, Inc., as subsidiary of the Company, that will own and operate
the Internet portion of the Company's business. The Company's plans call for
RightStart.com to be operational by mid-summer 1999. The Company plans to
capitalize on its valuable brand name and knowledge and expertise in children's
specialty retailing, developed through its retail store and catalog operations,
to successfully launch RightStart.com in the Internet arena.
The Company has engaged a financial advisory firm to advise it on its
e-commerce strategy and to assist the Company in funding and financing
RightStart.com. The financing will likely consist of the sale of a minority
stake in RightStart.com to strategic investors. The Company is currently in
negotiations with prospective investors regarding the size, terms and conditions
of such investment, although the Company has not yet entered into any
contractual arrangements with any such prospective investors.
Competition
The retail market for infant and toddler products is very competitive.
Significant competition currently comes from "big box" concept children's stores
which are becoming more and more prevalent. This type of operation offers
customers an extensive variety of products for children and is typically located
in up to 50,000 square feet of retail space, generally in lower real estate cost
locations. In addition, many national and regional mass merchants offer infant
and toddler products in conjunction with a full line of hard and soft goods. The
Right Start distinguishes itself from its competition by offering only select,
high-quality products in each category in a small, service-intensive
environment.
There are a variety of general and specialty catalogs selling infants' and
children's items in competition with The Right Start catalog. The Company
considers its primary catalog competition, however, to be "One Step Ahead,"
"Kids Club" by Perfectly Safe, and "Sensational Beginnings." These catalogs
emerged several years after The Right Start catalog and directly compete by
offering a very similar product line at comparable price points to the same
target market.
New entrants to The Right Start's competitive landscape include several
e-commerce sites that sell infants' and children's products on -line. These
entities are generally newcomers in the infant and children market and the
Company believes that for the most part, such entities do not have the brand
recognition or relationships necessary to quickly gain marketshare. The Right
Start expects that its e-commerce Website, RightStart.com, will be operational
during mid-Fiscal 1999. The Company believes RightStart.com will be able to
differentiate itself from its competitors by drawing on the Company's extensive
knowledge of retail sales of products for infants and children to its target
market.
Trademarks
The Company has registered and continues to register, when deemed
appropriate, certain U.S. trademarks and trade names, including
"RightStart.com", "The Right Start", and "The Right Start Catalog." The Company
considers these trademarks and tradenames to be readily identifiable with, and
valuable to, its business.
ITEM 2. PROPERTIES
At January 30, 1999, The Right Start operated 40 retail stores in 15
states including California, Colorado, Massachusetts, Minnesota, New Jersey,
Illinois, Pennsylvania, New York, Connecticut, Michigan, Washington, Missouri,
Virginia, Maryland and Ohio. The Company leases each of its retail locations
under operating leases with lease terms ranging from six to ten years, including
provisions for early termination in most locations if certain sales levels are
not achieved. At certain locations, the Company has options to extend the term
of the lease. In most cases, rent provisions include a fixed minimum rent plus a
contingent percentage rent based on net sales of the store in excess of a
certain threshold.
4
The Right Start currently leases approximately 11,000 square feet as a
sub-tenant in a mixed-use building in Westlake Village, California. The
Company's corporate office resides in this space. The sub-lease agreement
terminates in September 1999. The Company is currently negotiating with its
landlord to extend the lease term.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various legal actions arising in the ordinary
course of business. In the opinion of management, any claims which may occur are
adequately covered by insurance or are without significant merit. The Company
believes that the ultimate outcome of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED
STOCKHOLDERS' MATTERS
The Company's common stock is traded on the Nasdaq National Market system
under the symbol RTST. The Company's common stock is held of record by
approximately 121 registered shareholders as of April 19, 1999. The following
table sets forth the range of high and low bid prices on the Nasdaq National
Market for the Common Stock for the periods indicated. The bid price quotations
listed below reflect inter-dealer prices without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
Bid Price (1)
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Fiscal 1998 High Low
- ----------- ---- ---
First Quarter $4.50 $2.75
Second Quarter 3.75 1.75
Third Quarter 2.75 1.50
Fourth Quarter 4.50 2.00
Fiscal 1997
First Quarter 5.50 2.13
Second Quarter 3.38 2.25
Third Quarter 3.50 2.38
Fourth Quarter 2.69 1.75
(1)Bid prices have been restated to give effect to the Company's one-for-two
reverse stock split which was reflected on Nasdaq at the opening of trading
on December 16, 1998.
The Company has never paid dividends on its common stock and currently
does not expect to pay dividends in the future. In addition, the Company's
credit agreement contains a number of financial covenants which may, among other
things, limit the Company's ability to pay dividends. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation."
5
ITEM 6. SELECTED FINANCIAL DATA - (Dollars in thousands except share data; all
share data has been restated to give effect to the Company's one-for-two reverse
stock split which was effective December 15, 1998)
33-Week
Transition
Fiscal Year Period Fiscal Year
----------------------- -------- ----------------------
1998 1997 1996 1995
Earnings Data
Revenues:
Net sales $ 36,611 $ 38,521 $ 27,211 $ 40,368 $ 44,573
Other revenues 877 214
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36,611 38,521 27,211 41,245 44,787
Net loss (5,680) (9,241) (5,378) (3,899) (2,106)
Basic and diluted
loss per share (1.13) (2.01) (1.34) (1.19) (0.66)
Share Data
Weighted average shares
outstanding 5,051,820 4,594,086 4,003,095 3,268,407 3,150,000
33-Week
Transition
Fiscal Year Period Fiscal Year
----------------------- --------- ----------------------
1998 1997 1996 1995
Balance Sheet Data
Current assets $ 8,300 $ 8,908 $ 11,704 $ 8,353 $ 9,660
Total assets 17,671 18,462 22,982 17,475 14,632
Current liabilities 6,572 4,796 8,457 4,649 3,690
Long-term debt -- 8,734 5,643 -- --
Shareholders' equity 7,861 3,307 7,172 11,902 10,694
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Recapitalization
In order to enhance the Company's liquidity and improve its capital
structure, effective April 13, 1998 the Company completed a private placement of
non-interest bearing senior subordinated notes in an aggregate principal amount
of $3,850,000, together with detachable warrants to purchase an aggregate of
3,850,000 shares of common stock exercisable at $2.00 per share. The new
securities were sold for an aggregate purchase price of $3,850,000 and were
purchased principally by affiliates of the Company. In connection with the sale
of the new securities, the Company entered into an agreement with all of the
holders of the Company's existing subordinated debt securities (the
"Agreement"), representing an aggregate principal amount of $6,000,000. Pursuant
to the Agreement, each holder (of new and old securities) agreed to exchange all
of its subordinated debt securities, together with any warrants issued in
connection therewith, for newly issued shares of preferred stock. Ten shares of
newly issued preferred stock were issued for each $1,000 principal amount of
subordinated debt securities exchanged. The total number of shares issued were
30,000, 30,000 and 38,500 for Preferred Stock Series A, B and C, respectively.
Holders of $3,000,000 principal amount of existing subordinated debt securities
6
elected to receive Series A Preferred Stock which has no fixed dividend rights,
is not convertible into common stock, is mandatorily redeemable by the Company
in May 2002 and will not accrue dividends unless the Company is unable to redeem
the Series A Preferred Stock at the required redemption date, at which point
dividends would begin to accumulate and accrue at a rate of $15 per share per
annum. Holders of $3,000,000 principal amount of subordinated debt securities
elected to receive Series B convertible preferred stock which has no fixed
dividend rights and is convertible into common stock at a price per share of
$3.00. Holders of the $3,850,000 principal amount of newly issued, non-interest
bearing senior subordinated notes exchanged such debt securities (and the
warrants issued in connection therewith) for Series C convertible preferred
stock, which has no fixed dividend rights and is convertible into common stock
at a price of $2.00 per share. The issuance of the shares of preferred stock
occurred upon exchange of the subordinated debt securities in December 1998.
Results of Operations
This discussion should be read in conjunction with the information
contained in the Financial Statements and accompanying Notes thereto of the
Company appearing elsewhere in this Form 10-K.
Results for the Transition Period (the 33-week period from June 2, 1996 to
February 1, 1997) have been presented and discussed to provide the reader with
an understanding of the Company's financial condition and results of operations.
Comparisons have been made, based on the significant operating factors in each
period, between the current fiscal year and Fiscal 1997, between Fiscal 1997 and
the comparable unaudited 52-week period of the prior year and between the
Transition Period and the comparable period of Fiscal 1996.
Fiscal 1998 Compared With Fiscal 1997
Revenues for Fiscal 1998 were $36.6 million compared to $38.5 million for
Fiscal 1997. Retail net sales were $31.9 million in Fiscal 1998 and $31.1
million in Fiscal 1997; catalog net sales were $4.7 million in Fiscal 1998 and
$7.4 million in Fiscal 1997. Retail net sales increased $.8 million or 2.5%,
reflecting the impact of same-store sales increases of 6.5% and the opening of
eight new street location stores, offset by the impact of eleven store closures.
The 36.1% decline in catalog sales resulted from the Company mailing fewer
catalogs in accordance with its operating plan.
Cost of goods sold represented 50.7% of sales in Fiscal 1998 compared to
50.0% of sales in Fiscal 1997. The slight decline in gross margin resulted from
the additional markdowns taken in conjunction with the closing of certain mall
stores and from the conversion of three of the Company's remaining mall stores
to a discount format. The discount store format was adopted in three poor
performing stores in an effort to better meet the demographics of the customers
in those markets.
Operating expense decreased $3.9 million or 20.3% in Fiscal 1998 from
$19.2 million in Fiscal 1997 to $15.3 million in Fiscal 1998. Catalog operating
expenses decreased 46% or $1.9 million in Fiscal 1998 as compared to Fiscal 1997
in conjunction with the reduction in catalog mailings and reduction of
production costs on a per-catalog basis. Retail operating expenses declined 13%
or $2.0 million in Fiscal 1998 as compared to Fiscal 1997. The retail reductions
include $.5 million of occupancy costs related to store closings (offset
somewhat by street location openings), $.8 million of distribution cost
reductions and $.7 million of payroll and other operating cost reductions. These
reductions reflect management's attention to expense management.
General and administrative expense decreased 11.6% to $3.5 million in
Fiscal 1998 as compared to $3.9 million in Fiscal 1997. The decrease was
primarily due to payroll and occupancy cost reductions in conjunction with
management's ongoing expense management.
7
Preopening costs decreased $.5 million from $.7 million in Fiscal 1997 to
$.2 million in Fiscal 1998. The reduction was due to the reduction in preopening
costs per store opened as well as the impact, in Fiscal 1997, of the Company's
previous policy of recognizing store opening costs evenly over the stores' first
twelve months of operations for the stores opened in 1996. In the third quarter
of Fiscal 1997, the Company changed its method of accounting for pre-opening
costs and began expensing them as incurred.
Depreciation and amortization expense decreased $.1 million or 7.5% in
Fiscal 1997 to $1.5 million in Fiscal 1998. The decrease resulted from the
closure of eleven stores, most of which were closed during the first half of
Fiscal 1998, offset by the depreciation expense recognized on assets for the
eight new stores opened in the second half of the fiscal year.
Other income of $.1 million in Fiscal 1998 is comprised of net revenues
generated from store closings. In December 1997, the Company's Board of
Directors approved management's plan to close seven poor performing retail
stores. Six of these stores were closed as of April 1999 and the remaining store
is in the process of being closed as of April 1999. Such closures generated
positive revenues for the Company resulting from the recovery of the value of
certain of the leases through either landlords or future tenants of the leased
space. In the prior year, other expense of $1.9 million include $1.3 million of
fixed assets and leasehold improvements written off in conjunction with planned
store closures, $.4 million in fixed assets and leasehold improvements written
off in conjunction with the Company's corporate office and distribution center
moves and $.2 million of severance expense.
Non-cash beneficial conversion feature amortization expense of $3.9
million represents the one-time expense recognition associated with the issuance
of the Company's Series C convertible Preferred Stock in connection with the
Company's recapitalization, as discussed above.
Interest expense decreased $.5 million from $1.1 million in Fiscal 1997 to
$.6 million in Fiscal 1998. The 44.0% decrease results from the restructuring of
the Company's subordinated debt to eliminate interest on that debt and lower
overall borrowings.
The Company has a deferred tax asset of $9.1 million, which is reserved
against by a valuation allowance of $7.7 million, for a net deferred tax asset
of $1.4 million. Management expects that the Company will generate $4 million of
taxable income within the next 15 years to utilize the net deferred tax asset.
The taxable income will be generated through a combination of improved operating
results and tax planning strategies. Rather than lose the tax benefit, the
Company could implement certain tax planning strategies including the sale of
the Company's catalog operations, since such operations generally operate on a
profitable basis. Alternatively, the Company could also sell its catalog
operation's mailing lists in order to generate income to enable the Company to
realize its NOL carryforwards. Based on the above operating improvements
combined with tax planning strategies in place, management believes that
adequate taxable income will be generated over the next 15 years in which to
utilize the NOL carryforwards.
Fiscal 1997 Compared With Transition Period
Revenues for Fiscal 1997 were $38.5 million compared to $27.2 million for
the Transition Period ($41.2 million for the 52-week period ended February 1,
1997). Retail net sales were $31.1 million in fiscal 1997 and $19.6 million in
the Transition Period ($26.8 million for the 52-week period ended February 1,
1997); catalog net sales were $7.4 million in Fiscal 1997 and $7.6 million in
the Transition Period ($14.4 million for the 52-week period ended February 1,
1997). Retail net sales declined 14% between Fiscal 1997 and the 52-week period
ended February 1, 1997, reflecting the partial year impact of three new stores
opened in early Fiscal 1997 and three new stores opened at the end of the year,
offset by same-store sales declines of 21%. The Company attributes its
same-store sales declines to the elimination of various marketing activities,
promotional offers and heavy couponing which enhanced sales but negatively
impacted margins and operating expenses.
8
The 49% decline in catalog net sales between Fiscal 1997 and the 52-week
period ended February 1, 1997 reflects the continued downsizing of the Company's
catalog circulation. Circulation was down 40% between Fiscal 1997 and the
52-week period ended February 1, 1997. This reflects the Company's plan to
reduce the mailings of the catalog to operate it at a more profitable level.
Cost of goods sold represented 50% of net sales in Fiscal 1997 and 53% in
the Transition Period (54% in the 52-week period ended February 1, 1997). The
Company has achieved better gross margins in Fiscal 1997, continuing the
favorable trend in gross margin that began in the Transition Period. At the same
time, average inventory turns have increased from two times in the Transition
Period to three times in Fiscal 1997. This reflects the ongoing effort to right
size inventory levels and minimize the need for markdowns.
Operating expenses increased as a percentage of net sales to 50% or $19.2
million in Fiscal 1997 compared to 46% in the Transition Period or $12.6 million
($20.0 million or 48% of net sales in the 52-week period ended February 1,
1997). The remaining $13.3 million or 35% of sales and $9.7 million 36% of
sales, respectively ($16.2 million or 40% of sales in the 52-week period ended
February 1, 1997), are payroll and other operating expenses. These costs have
decreased as a percentage of sales, reflecting management's on-going attention
to cost reductions. The burden of fixed occupancy costs in light of the decline
in same-store sales had a negative impact on the Company's results for Fiscal
1997. This fact is a major part of the Company's decision to focus its retail
expansion plans on street locations, wherein occupancy and other fixed operating
costs are substantially lower than in mall locations.
General and administrative expenses were $3.9 million in Fiscal 1997
compared to $2.9 million in the Transition Period ($4.5 million for the 52-week
period ended February 1, 1997). The Company experienced a 13% decline in general
and administrative expenses between Fiscal 1997 and the 52-week period ended
February 1, 1997. This decline reflects the impact of payroll and other overhead
cost reductions made in connection with the Company's efforts to reduce
expenses.
Pre-opening costs were $.7 million in Fiscal 1997 and $.5 million in the
Transition Period ($.7 million for the 52-week period ended February 1, 1997).
In Fiscal 1997, three stores were opened in the first half of the year (the
period through which the Company's policy of deferring pre-opening costs was in
effect) compared to twenty-one stores opened in the 52-week period ended
February 1, 1997. Due to the timing of the previous year's openings, the
majority of the amortization related to these openings was recognized in Fiscal
1997. The increased months' amortization offset by reductions in pre-opening
costs beginning in the Transition Period resulted in relatively flat
amortization expense for the comparable periods.
Depreciation and amortization expense increased to $1.6 million in Fiscal
1997 compared to $.8 million in the Transition Period ($1.2 million for the
52-week period ended February 1, 1997). The increase results from a full-year
impact of the addition of build-outs and equipment for the new stores opened
during the Transition Period and the partial-year impact of stores opened during
Fiscal 1997.
Other non-recurring expenses incurred in Fiscal 1997 include $1.3 million
of fixed assets and leasehold improvements written off in conjunction with
planned store closures, $.4 million in fixed assets and leasehold improvements
written off in conjunction with the Company's corporate office and distribution
center moves and $.2 million of severance expense.
Interest expense increased from $.2 million in the Transition Period and
for the 52-week period ended February 1, 1997 to $1.1 million in Fiscal 1997.
This reflects the interest charge on the Company's borrowings under its credit
facility and subordinated debt issuances which funded operating losses and
growth.
9
Transition Period Compared with Fiscal 1996
Revenues for the Transition Period were $27.2 million compared to $26.5
million for the comparable period of Fiscal 1996. Catalog net sales for the
Transition Period were $7.6 million and were $16.6 million for the comparable
period of Fiscal 1996. The 54% decline in catalog net sales was a result of a
significant decrease in catalog circulation. The decrease in circulation
reflects management's efforts to discontinue the summer sale catalog which
generated very low margin sales and eliminate circulation to unprofitable
mailing lists.
Retail net sales were $19.6 million for the Transition Period compared to
$9.9 million for the comparable period of Fiscal 1996. The increase in retail
net sales was a result of the Company's retail expansion; 37 stores were open at
February 1, 1997 as compared to 22 at June 1, 1996. Further, the Transition
Period includes the benefit of a full period's results for the eleven stores
opened in Fiscal 1996. Same-store sales were flat for the Transition Period.
Cost of goods sold represented 53% of net sales in the Transition Period
and 54% of net sales in both Fiscal 1996 and the 33-week period ended February
3, 1996. The improvement in gross margin reflected the net positive impact of
steadily improved margins beginning in Fall 1996, offset by lower margins
generated at the beginning of the Transition Period due to heavy promotional
activity to improve the Company's inventory position. The margin improvement was
attributed to better management of inventory levels and the elimination of
excessive mark-down promotions.
Operating expense was $12.6 million, or 46% of net sales, in the
Transition Period compared to $18.3 million, or 45% of net sales, in Fiscal
1996. The increase was primarily attributed to the addition of senior retail
operations management and increased telemarketing costs for the catalog.
General and administrative expense in the Transition Period was $2.9
million compared to $4.3 million in Fiscal 1996 ($2.0 million in the 33-week
period ended February 3, 1996). The increase between the 33-week periods
reflected the investment made in executive and senior management in the
merchandising areas to support the Company's new retail stores and implement the
Company's merchandising strategy.
The Transition Period included $.5 million in pre-opening costs compared
to $.4 million in Fiscal 1996 ($265,000 in the 33-week period ended February 3,
1996). The increase resulted from the retail expansion over the previous two
years. The Company amortized its new store opening costs over the first twelve
months of each store's operations.
Depreciation and amortization was $.8 million during the Transition Period
as compared to $.9 million in Fiscal 1996 ($.6 million in the 33-week period
ended February 3, 1996). The increase was due to the increase in property and
equipment resulting from the construction of new stores and installation of the
Company's new information system.
Non-recurring expenses of $.9 million incurred during the Transition
Period were primarily attributed to the following: the Company's former
President resigned in October 1996 resulting in a $.3 million severance charge;
the Company prepaid its line of credit upon funding of its new credit facility
resulting in $.1 million of prepayment charges; and the Company had taken action
to close two unprofitable retail store locations, which has resulted in a
write-off of $.4 million in non-recoverable assets.
The Company recognized $.2 million of income tax expense for the
Transition Period. This charge resulted from management's revaluation of the
deferred tax asset. In evaluating the deferred tax asset, management considered
the Company's plans and projections and available tax planning strategies.
Liquidity and Capital Resources
During Fiscal 1998, the Company's primary sources of liquidity were from
proceeds from the issuance of $3.85 million of non-interest bearing senior
subordinated notes and cash from operations. These sources financed the
10
Company's debt paydown and capital expenditures. Capital expenditures of
approximately $1.3 million were incurred in opening new store locations and
refurbishing several of the Company's older stores.
The Company has a $13.0 million credit facility (the "Credit Facility")
which consists of a $10.0 million revolving line of credit for working capital
(the "Revolving Line") and a $3.0 million capital expenditure facility (the
"Capex Line"). Availability under the Revolving Line is subject to a defined
borrowing base. As of January 30, 1999, no borrowings were outstanding under the
Revolving Line and $2.75 million was outstanding under the Capex Line; $3.05
million was available at January 30, 1999 under the Revolving Line. Interest
accrues on the Revolving Line at prime plus 1% and at prime plus 1.5% on the
Capex Line. At January 30, 1999 the bank's prime rate of interest was 7.75%. The
Credit Facility terminates on November 19, 1999, and on such date, all
borrowings thereunder are immediately due and payable. Borrowings under the
Credit Facility are secured by substantially all of the Company's assets. The
Company plans to replace the Credit Facility by November 1999, and beleives that
it could extend the Credit Facility to May 2000.
The Credit Facility, as amended, requires the Company at all times to
maintain net worth (defined to include equity and subordinated debt) of at least
$8.0 million. The Credit Facility also limits the Company's earnings before
interest, taxes, depreciation and amortization (EBITDA) to the following loss
amounts: $900,000 for the twelve months ended January 31, 1999 and $500,000 for
the twelve months ending April 30, 1999. Minimum EBITDA of zero is required for
the twelve months ending July 31, 1999 and $400,000 for the twelve months ending
October 31, 1999. In addition, capital expenditures are limited to $1,750,000 in
Fiscal 1999.
The Company's ability to fund its operations, open new stores and maintain
compliance with the Credit Facility is dependent on its ability to generate
sufficient cash flow from operations and secure financing beyond November 1999
as described above. Historically, the Company has incurred losses and may
continue to incur losses in the near term. Depending on the success of its
business strategy, the Company may continue to incur losses. Losses could
negatively affect working capital and the extension of credit by the Company's
suppliers and impact the Company's operations.
In order to enhance the Company's liquidity and improve its capital
structure, the Company completed a private placement of non-interest bearing
senior subordinated notes in an aggregate principal amount of $3,850,000,
together with warrants to purchase an aggregate of 3,850,000 shares of common
stock exercisable at $2.00 per share. The new securities were sold for an
aggregate purchase price of $3,850,000 and were purchased principally by
affiliates of the Company. In connection with the sale of the new securities,
the Company entered into an agreement with all of the holders of the Company's
existing subordinated debt and warrant securities, representing an aggregate
principal amount of $6,000,000. Pursuant to the agreement, each holder agreed to
exchange all of its subordinated debt securities, together with any warrants
issued in connection therewith, for newly issued shares of preferred stock.
Holders of $3,000,000 principal amount existing subordinated debt securities
elected to receive Series A Preferred Stock which has no fixed dividend rights,
is not convertible into common stock and is mandatorily redeemable by the
Company in May 2002. Holders of $3,000,000 principal amount subordinated debt
securities elected to receive Series B convertible preferred stock which has no
fixed dividend rights, is convertible into common stock at a price per share of
$3.00 and is not mandatorily redeemable by the Company. Holders of the
$3,850,000 principal amount of new subordinated debt securities elected to
receive Series C convertible preferred stock which has no fixed dividend rights,
is convertible into common stock at a price per share of $2.00 and is not
mandatorily redeemable by the Company. The issuance of the shares of preferred
stock upon exchange of the subordinated debt securities was approved by the
Company's shareholders at its annual meeting of shareholders on December 15,
1998.
In the restructuring described above, the holders of $6.0 million
principal amount of subordinated debt permanently waived their rights to receive
interest payments and agreed to exchange such debt for preferred stock,
resulting in the Company's elimination of approximately $.6 million in annual
interest payments. In addition, the proceeds from the Company's private
placement of $3,850,000 were used to pay off the Company's revolving line of
credit.
11
Impact of Inflation
The impact of inflation on results of operations has not been significant
during the Company's last three fiscal years.
Seasonality
The Company's business is not as significantly impacted by seasonal
fluctuations, when compared to many other specialty retail and catalog
operations. The Right Start's products are for the most part need-driven and the
customer is often the end user of the product. However, the Company does
experience increased sales during the Christmas holiday season.
Other Matters
Year 2000
The year 2000 problem is the result of computer programs being written
using two digits (rather than four) to define the applicable year. Any of the
Company's programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000 which could result in
miscalculations or system failures.
The Company is currently working to identify and resolve all potential
issues relating to the year 2000 on the processing of date-sensitive information
by the Company's computerized information system. For purposes of addressing the
issues and planning the appropriate resolutions, the Company has segregated its
internal systems and individually assessed their state of readiness as follows:
Phase of Planning ("x" indicates phase is complete)
---------------------------------------------------
System Awareness Assessment Renovation Validation Implementation
- ------ --------- ---------- ---------- ---------- --------------
Credit Card Processing x x x x x
Inventory Maintenance x x x x
Accounting and Reporting x x x x
Point of Sale
Transactions x x
Non-computerized x x
systems (none are
material to the
Company's
operations)
In addition to resolving any year 2000 issues on the Company's internal
systems, the Company is working with its third party vendors in implementing the
appropriate solutions. The Company estimates that the maximum, worst-case cost
of addressing its year 2000 issues is approximately $125,000 for hardware and
software.
The Company is currently working with its software vendors for inventory
maintenance systems and accounting and reporting systems to complete the
installation of the upgraded, year 2000 compliant version of these systems. The
Company is working with its vendor for its point of sale ("POS") system to
complete the program changes required for this system to be year 2000 compliant.
If, in a worst-case scenario, the necessary upgrades could not be completed in a
timely manner, the Company's contingency plans provide for the purchase and
installation of replacement POS software. No other systems are material to the
Company's operations.
12
New Accounting Requirements
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 "Reporting on the Costs of Start-up
Activities" (SOP 98-5) which requires that the costs of start-up activities and
organization costs be expensed as incurred. The statement is effective for the
Company in Fiscal 2000 and the impact of the adoption of SOP 98-5 is not
expected to be material to the Company's financial position or results of
operations. Effective October 1, 1997 and as disclosed in Note 1, the Company
began expensing all store pre-opening costs as incurred.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of operations, the Company faces no significant
market risk. Its purchase of imported products subjects the Company to a minimum
amount of foreign currency risk. Foreign currency risk is that risk associated
with recurring transactions with foreign companies, such as purchases of goods
from foreign vendors. If the strength of foreign currencies increases compared
to the U.S. dollar, the price of imported products could increase. However, the
Company has no commitments for future purchases with foreign vendors and,
additionally, the Company has the ability to source products domestically in the
event of import price increases.
See "Management's Discussion and Analysis of Financial condition and
Results of Operations -- Liquidity and Capital Resources" above for a discussion
of debt obligations of the Company, the interest rates of which are linked to
the prime rate. The Company has not entered into any derivative financial
instruments to mange interest rate risk, currency risk or for speculative
purposes and is currently not evaluating the future use of such instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data of the Company are as set
forth in Item 14(a) hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
The Company has not had any changes in or disagreements with its
accountants on the Company's accounting and financial disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the Company's Proxy Statement under the
captions "Executive Officers" and "Election of Directors" is incorporated herein
by reference. The Company's Proxy Statement will be filed with the Securities
and Exchange Commission no later than 120 days after the close of Fiscal 1998.
13
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the Company's Proxy Statement under the
caption "Executive Compensation and Other Information" is incorporated herein by
reference. The Company's Proxy Statement will be filed with the Securities and
Exchange Commission no later than 120 days after the close of Fiscal 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information contained in the Company's Proxy Statement under the
caption "Principal Shareholders and Management" is incorporated herein by
reference. The Company's Proxy Statement will be filed with the Securities and
Exchange Commission no later than 120 days after the close of Fiscal 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the Company's Proxy Statement under the
caption "Certain Relationships and Related Transactions" is incorporated herein
by reference. The Company's Proxy Statement will be filed with the Securities
and Exchange Commission no later than 120 days after the end of Fiscal 1998.
14
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
(1) Financial Statements: Page
Report of Independent Accountants F - 1
Balance Sheet - January 30, 1999 and January 31, F - 2
1998
Statement of Operations - Periods Ended January
30, 1999, January 31, 1998, February 1, 1997 and
June 1, 1996 F - 3
Statement of Changes in Shareholders'Equity -
Periods Ended January 30, 1999, January 31, 1998,
February 1, 1997 and June 1, 1996 F - 4
Statement of Cash Flows - Periods
Ended January 30, 1999, January 31, 1998,
February 1, 1997 and June 1, 1996 F - 5
Notes to Financial Statements F - 6
(2) Financial Statement Schedules:
Valuation Reserves F - 21
All other financial statement schedules are omitted because they are either not
applicable or the required information is shown in the financial statements or
notes thereto.
(3) Listing of Exhibits
The following exhibits are filed as part of, or incorporated by reference into,
this annual report:
15
INDEX TO EXHIBITS
Exhibit
Number
- ------
3.1 Amended and Restated Articles of Incorporation of the
Company, dated August 12, 1991(1)
3.1.1 Amendment to Articles of Incorporation, dated August 20,
1991(1)
3.1.2 Form of Amendment to Articles of Incorporation, dated August
24, 1991(1)
3.2 Bylaws of the Company, as amended(2)
3.3 Specimen Certificate of the Common Stock (without par
value)(1)
10.1 1991 Key Employee Stock Option Plan(3)
10.2 Form of Indemnification Agreement between Registrant and its
directors and executive officers(3)
10.3 Asset Purchase Agreement for Acquisition of the Assets of
Small People, Inc. and Jimash Corporation by Right Start
Subsidiary I, Inc.(4)
10.4 1995 Non-employee Directors Option Plan(5)
10.5 Registration Rights Agreement dated August 3, 1995 between
Registrant and Kayne Anderson Non-Traditional Investments LP,
ARBCO Associates LP, Offense Group Associates LP, Opportunity
Associates LP, Fred Kayne, Albert O. Nicholas and Primerica
Life Insurance Company(5)
10.6 Asset Purchase Agreement dated as of July 29, 1996 by and
between Blasiar, Inc. (DBA Alert Communications Company) and
The Right Start, Inc.(5)
10.7 Convertible Debenture Purchase Agreement between The Right
Start, Inc. and Cahill Warnock Strategic Partners, LP dated
as of October 11, 1996(6)
10.7.1 First Amendment to Convertible Debenture Purchase Agreement
between The Right Start, Inc. and Cahill Warnock Strategic
Partners, LP dated as of May 30, 1997(11)
10.8 Convertible Debenture Purchase Agreement between The Right
Start, Inc. and Strategic Associates, LP dated as of October
11, 1996(6)
10.8.1 First Amendment to Convertible Debenture Purchase Agreement
between The Right Start, Inc. and Strategic Associates, LP
dated as of May 30, 1997(11)
10.9 Registration Rights Agreement dated October 11, 1996 between
The Right Start, Inc. and Strategic Associates, L.P.(7)
10.10 Registration Rights Agreement dated October 11, 1996 between
The Right Start, Inc. and Cahill, Warnock Strategic Partners
Fund, L.P.(7)
10.11 Loan and Security Agreement dated as of November 14, 1996
between The Right Start, Inc. and Heller Financial, Inc.(6)
10.12 First Amendment to Loan and Security Agreement and Limited
Waiver and Consent(8)
10.13 Second Amendment to Loan and Security Agreement and Limited
Waiver and Consent(9)
10.14 Third Amendment to Loan and Security Agreement and Limited
Waiver and Consent(9)
16
10.15 Fourth Amendment to Loan and Security Agreement and Limited
Waiver and Consent(7)
10.16 Registration Rights Agreement dated May 6, 1997 between The
Right Start, Inc. and certain Kayne Anderson funds, Cahill,
Warnock Strategic Partners Fund, L.P., Strategic Associates,
L.P., The Travelers Indemnity Company and certain other
investors named therein(7)
10.17 Registration Rights Agreement dated September 4, 1997 between
The Right Start, Inc. and certain Kayne Anderson funds,
Cahill, Warnock Strategic Partners Fund, L.P., The Travelers
Indemnity Company and certain other investors named therein(7)
10.18 The Right Start, Inc. Letter Agreement dated as of April 6,
1998(10)
10.19 The Right Start, Inc. Amendment to Letter Agreement dated as
of April 13, 1998(10)
10.20 The Right Start, Inc. Securities Purchase Agreement dated as of May
6, 1997 between the Company and certain investors listed therein with
respect to the Company's 11.5% Senior Subordinated Notes due May 6,
2000 and warrants to purchase the Company's common stock(10)
10.21 The Right Start, Inc. Securities Purchase Agreement dated as of April
13, 1998 between the Company and certain investors listed therein
with respect to the Company's Senior Subordinated Notes due May 6,
2000 and warrants to purchase the Company's common stock(10)
10.22 Registration Rights Agreement dated April 13, 1998 between
The Right Start, Inc. and the investors named therein(7)
10.23 The Right Start, Inc. Securities Purchase Agreement dated as
of September 4, 1997 between the Company and the investors
named therein with respect to 1,510,000 shares of the
Company's common stock(9)
23.1 Consent of Independent Accountants
27.1 Financial Data Schedule
- --------------------------
(1) Previously filed as an Exhibit to the Company's Registration Statement of
Form S-1 dated August 29, 1991.
(2) Previously filed as an Exhibit to Amendment Number 2 to the Company's
Registration Statement on Form S-1 dated October 3, 1991.
(3) Previously filed as an Exhibit to Amendment Number 1 to the Company's
Registration Statement on Form S-1 dated September 11, 1991.
(4) Previously filed as an Exhibit to the Company's 10-K for the fiscal year
ended May 26, 1993.
(5) Previously filed as an Exhibit to the Company's 10-K for the year ended
June 1, 1996.
(6) Previously filed as an Exhibit to the Company's 10-Q for the period ended
November 30, 1996.
(7) Previously filed as an Exhibit to the Company's 10-K for the fiscal year
ended January 31, 1998, as amended.
(8) Previously filed as an Exhibit to the Company's 10-K for the transition
period from June 2, 1996 to February 1, 1997.
(9) Previously filed as an Exhibit to the Company's 10-Q for the period ended
August 2, 1997.
(10) Previously filed as an Exhibit to the Company's 8-K dated April 23, 1998.
17
(11) Previously filed as an Exhibit to the Company's 10-Q for the period ended
May 3, 1997.
(12) Previously filed as an Exhibit to the Company's 8-K dated May 6, 1997.
(b) Reports on Form 8-K
A Report on Form 8-K was filed by the Company on January 25, 1999. There
were no other Reports on Form 8-K filed by the Company during the last quarter
of Fiscal 1998.
(c) A list of exhibits included as part of this report is set forth in Part IV
of this Annual Report on Form 10-K above and is hereby incorporated by reference
herein.
(d) Not applicable
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
THE RIGHT START, INC.
(Registrant)
Dated: April 29, 1999 \s\ Jerry R. Welch
----------------------
Jerry R. Welch
Chairman of the Board,
Chief Executive Officer and President
Pursuant to the requirement of 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 dates indicated.
Signature Title Date
--------- ----- ----
\s\ Jerry R. Welch Chairman of the Board, Chief April 29, 1999
- ---------------------- Executive Officer and President
Jerry R. Welch
\s\ Richard A. Kayne Director April 29, 1999
- ----------------------
sRichard A. Kayne
\s\ Andrew D. Feshbach Director April 29, 1999
- ----------------------
Andrew D. Feshbach
\s\ Robert R. Hollman Director April 29, 1999
- ----------------------
Robert R. Hollman
\s\ Fred Kayne Director April 29, 1999
- ----------------------
Fred Kayne
\s\ Howard M. Zelikow Director April 29, 1999
- ----------------------
Howard M. Zelikow
\s\ Gina M. Engelhard Chief Financial Officer April 29, 1999
- ---------------------- (Principal Financial and
Gina M. Engelhard Accounting Officer)
19
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of The Right Start, Inc.
In our opinion, the financial statements listed in the
index appearing under Item 14(a) (1) and (2) on page 15
present fairly, in all material respects, the financial
position of The Right Start, Inc. at January 30, 1999 and
January 31, 1998, and the results of its operations and
its cash flows for the years ended January 30, 1999 and
January 31, 1998, the thirty-three weeks ended February 1,
1997 and the year ended June 1, 1996, in conformity with
generally accepted accounting principles. 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 of these statements in accordance
with generally accepted auditing standards which 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, assessing the
accounting principles used and significant estimates made
by management, and evaluating the overall financial
statement presentation. We believe that our audits
provide a reasonable basis for the opinion expressed above.
/ s / PricewaterhouseCoopers LLP
Los Angeles, California
March 12, 1999, except as to
Note 3, which is as of April 29, 1999
F-1
THE RIGHT START, INC.
BALANCE SHEET
January 30, January 31,
1999 1998
---- ----
ASSETS
Current assets:
Cash $ 626,000 $ 240,000
Accounts and other receivables 585,000 405,000
Merchandise inventories 5,797,000 6,602,000
Prepaid catalog costs 363,000 297,000
Other current assets 929,000 1,364,000
----------- -----------
Total current assets 8,300,000 8,908,000
Noncurrent assets:
Property, plant and equipment, net 7,884,000 8,115,000
Deferred income taxes 1,400,000 1,400,000
Other noncurrent assets 87,000 39,000
----------- -----------
$17,671,000 $18,462,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 3,822,000 $ 2,782,000
Revolving line of credit 2,014,000
Term note payable 2,750,000
----------- -----------
Total current liabilities 6,572,000 4,796,000
Term note payable 3,000,000
Deferred rent 1,449,000 1,625,000
Senior subordinated notes, net of
unamortized discount of $266,000 2,734,000
Subordinated convertible debentures 3,000,000
Commitments and contingencies
Mandatorily redeemable preferred stock
Series A, $3,000,000 redemption value 1,789,000
Shareholders' equity:
Convertible preferred stock Series B 2,813,000
Convertible preferred stock Series C 3,850,000
Common stock (25,000,000 shares authorized
at no par value; 5,051,820 shares issued
and outstanding) 22,337,000 22,337,000
Additional paid-in capital 3,571,000
Accumulated deficit (24,710,000) (19,030,000)
----------- -----------
Total shareholders' equity 7,861,000 3,307,000
----------- -----------
$ 17,671,000 $ 18,462,000
=========== ===========
See accompanying notes to financial statements.
F-2
THE RIGHT START, INC.
STATEMENT OF OPERATIONS
Year Ended Thirty-three
------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
---- ---- ---- ----
Net sales:
Retail $31,875,000 $31,107,000 $19,576,000 $17,075,000
Catalog 4,736,000 7,414,000 7,635,000 23,293,000
Other revenues 877,000
----------- ----------- ----------- -----------
36,611,000 38,521,000 27,211,000 41,245,000
----------- ----------- ----------- -----------
Costs and expenses:
Cost of goods sold 18,576,000 19,244,000 14,417,000 21,605,000
Operating expense 15,371,000 19,212,000 12,608,000 18,282,000
General and
administrative expense 3,459,000 3,912,000 2,941,000 4,341,000
Pre-opening costs 209,000 711,000 528,000 418,000
Depreciation and
amortization expense 1,488,000 1,608,000 833,000 938,000
Other (income) expense (113,000) 1,905,000 851,000 450,000
----------- ----------- ----------- -----------
38,990,000 46,592,000 32,178,000 46,034,000
----------- ----------- ----------- -----------
Operating loss (2,379,000) 8,071,000) (4,967,000)(4,789,000)
Non-cash beneficial
conversion feature
amortization 3,850,000
Interest expense 640,000 1,143,000 204,000 37,000
----------- ----------- ----------- -----------
Loss before income taxes
and extraordinary item (6,869,000) (9,214,000) (5,171,000)(4,826,000)
Income tax provision
(benefit) 22,000 27,000 207,000 (927,000)
----------- ----------- ----------- -----------
Loss before extraordinary
item (6,891,000) (9,241,000) (5,378,000)(3,899,000)
Extraordinary gain on
debt restructuring 1,211,000
----------- ----------- ----------- -----------
Net loss $(5,680,000) $(9,241,000) $(5,378,000)$(3,899,000)
=========== =========== =========== ===========
Basic and diluted loss
per share:
Loss before extraordinary
item $ (1.37) $ (2.01) $ (1.34)$ (1.19)
Extraordinary item 0.24
----------- ----------- ----------- -----------
Net loss $ (1.13) $ (2.01) $ (1.34)$ (1.19)
=========== =========== =========== ===========
Weighted average number
of common shares outstanding 5,051,820 4,594,086 4,003,095 3,268,407
=========== =========== =========== ===========
See accompanying notes to financial statements.
F-3
THE RIGHT START, INC.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Common Stock Additional
------------------ Paid-in Accumulated
Shares Amount Capital Deficit
------ ------ ------- ----------
Balance at May 31, 1995 3,150,000 $11,206,000 ($512,000)
Issuance of shares pursuant
to a rights offering 789,403 4,906,000
Issuance of shares pursuant
to the exercise of stock options 30,250 201,000
Net loss (3,899,000)
--------- ----------- ------------
Balance at June 1, 1996 3,969,653 16,313,000 (4,411,000)
Issuance of shares pursuant
to the exercise of stock options 107,167 648,000
Net loss (5,378,000)
--------- ----------- ------------
Balance at February 1, 1997 4,076,820 16,961,000 (9,789,000)
Issuance of shares pursuant
to the exercise of stock options 220,000 1,320,000
Issuance of shares pursuant
to a private placement 755,000 3,705,000
Issuance of common stock warrants
in conjunction with sale of senior
subordinated notes 351,000
Net loss (9,241,000)
--------- ----------- ------------
Balance at January 31, 1998 5,051,820 22,337,000 (19,030,000)
Issuance of subordinated debt
in conjunction with
recapitalization, net (Note 12) $3,590,000
Accretion of mandatorily redeemable
preferred stock Series A (19,000)
Net loss (5,680,000)
--------- ----------- ---------- ------------
Balance at January 30, 1999 5,051,820 $22,337,000 $3,571,000 ($24,710,000)
========= =========== ========== ============
See accompanying notes to financial statements.
F-4
THE RIGHT START, INC.
STATEMENT OF CASH FLOWS
Year Ended Thirty-three
------------------------- Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
--------- ---------- ---------- ----------
Cash flows from operating activities:
Net loss ($5,680,000) ($9,241,000) ($5,378,000) ($3,899,000)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,538,000 2,319,000 1,361,000 1,356,000
Non-cash beneficial conversion feature
amortization 3,850,000
Amortization of discount on senior
subordinated notes 44,000 85,000
Loss on store closings 39,000 1,580,000
Extraordinary gain (1,211,000)
Change in assets and liabilities affecting
operations 1,760,000 (1,316,000) (957,000) 506,000
----------- ----------- ----------- -----------
Net cash provided by (used in)
operating activities 340,000 (6,573,000) (4,974,000) (2,037,000)
----------- ----------- ----------- -----------
Cash flows from investing activities:
Additions to property, plant and equipment (1,296,000) (2,063,000) (3,607,000) (4,165,000)
Proceeds from sale of telemarketing center 298,000
----------- ----------- ----------- -----------
Net cash used in investing activities (1,296,000) (2,063,000) (3,309,000) (4,165,000)
----------- ----------- ----------- -----------
Cash flows from financing activities:
Net proceeds from (payments on) revolving
line of credit (2,014,000) 181,000 1,833,000
Proceeds from (payments on) note payable (250,000) 357,000 2,643,000
Proceeds from sale of convertible subordinated
debentures 3,000,000
Proceeds from private placement of common
stock 3,705,000
Proceeds from common stock issued upon exercise
of stock options 1,320,000 648,000 201,000
Proceeds from common stock issued pursuant to a
rights offering 4,906,000
Proceeds from sale of senior subordinated notes,
net 3,606,000 3,000,000
----------- ----------- ----------- -----------
Net cash provided by financing activities 1,342,000 8,563,000 8,124,000 5,107,000
----------- ----------- ----------- -----------
Net increase (decrease) in cash 386,000 (73,000) (159,000) (1,095,000)
Cash at beginning of period 240,000 313,000 472,000 1,567,000
----------- ----------- ----------- -----------
Cash at end of period $ 626,000 $ 240,000 $ 313,000 $ 472,000
=========== =========== =========== ===========
See accompanying notes to financial statements.
F-5
THE RIGHT START, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES:
The Company
The Right Start, Inc. (the Company) is a specialty merchant of infants'
and children's products throughout the United States. In 1991, the
Company completed the sale of 2,300,000 shares of its common stock in
an initial public offering. Prior to that, it was a wholly owned
subsidiary of American Recreation Centers, Inc. (ARC). ARC maintained
majority ownership of the Company through July 1995. In August 1995,
an investment group led by Kayne, Anderson Investment Management, Inc.
(KAIM) acquired the 3,937,000 shares of common stock owned by ARC.
Fiscal Year
The Company has a fiscal year consisting of fifty-two or fifty-three
weeks ending on the Saturday closest to the last day in January.
Effective January 1997, the Company changed its fiscal year which had
been the fifty-two or fifty-three weeks ending on the Saturday closest
to the last day in May. The change in year end resulted in a
thirty-three week transition period from June 2, 1996 to February 1,
1997 ("the Transition Period"). The fiscal years ended January 30,
1999 ("Fiscal 1998"), January 31, 1998 ("Fiscal 1997"), and June 1,
1996 ("Fiscal 1996") were fifty-two week periods. See Note 15.
Revenue Recognition
Retail sales are recorded at time of sale or when goods are delivered.
Catalog sales are recorded at the time of shipment. The Company
provides for estimated returns at the time of the sale.
Merchandise Inventories
Merchandise inventories consist of products purchased for resale and
are stated at the lower of cost or market value. Cost is determined on
a first-in, first-out basis.
Prepaid Catalog Expenses
Prepaid catalog expenses consist of the costs to produce, print and
distribute catalogs. These costs are amortized over the expected sales
life of each catalog which does not exceed four months. Catalog
production expenses of $1,363,000, $2,753,000, $1,844,000 and
$6,061,000 were recorded in Fiscal 1998, Fiscal 1997, the Transition
Period and Fiscal 1996, respectively.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is provided using the straight-line method
based upon the estimated useful lives of the assets, generally three to
ten years. Amortization of leasehold improvements is based upon the
term of the lease or the estimated useful life of the leasehold
improvements, whichever is shorter.
F-6
NOTE1: (Continued)
Long-lived Assets
The Company periodically evaluates whether events and circumstances
have occurred that indicate the remaining estimated useful life of
long-lived assets may warrant revision or that the remaining balance
may not be recoverable. When factors indicate that the asset should be
evaluated for possible impairment, the Company uses an estimate of the
stores' undiscounted net cash flows over the remaining life of the
asset in measuring whether the asset is recoverable. Based upon the
anticipated future income and cash flow from operations, there has been
no impairment.
Store Opening Costs
Effective October 1, 1997, the Company changed the way costs incurred
in opening stores are recognized. Previously, these costs had been
deferred and amortized over 12 months commencing with the store
opening. After the effective date, any pre-opening costs incurred for
new stores were charged to expense as incurred. The impact of this
change was not significant to the Company's results of operations or
financial position.
Deferred Rent
The Company recognizes rent expense on the straight-line basis over the
life of the underlying lease. The benefit from tenant allowances and
landlord concessions are recorded as deferred rent and recognized over
the lease term.
Income Taxes
The Company accounts for income taxes using an asset and liability
approach under which deferred tax liabilities and assets are recognized
for the expected future tax consequences of temporary differences
between the carrying amounts and the tax bases of assets and
liabilities. A valuation allowance is established against deferred tax
assets when it is more likely than not that all, or some portion, of
such deferred tax assets will not be realized.
During the periods that the Company was majority owned by ARC, the
Company provided for income taxes as a separate taxpayer. State income
taxes were settled pursuant to an informal tax sharing agreement and
the Company filed a separate federal income tax return.
Per Share Data
On December 15, 1998, the Company's shareholders approved a one-for-two
reverse split of the Company's common stock, which had previously been
approved by the Company's Board of Directors. The reverse split was
effective December 15, 1998. All references in the financial
statements to shares and related prices, weighted average number of
shares, per share amounts and stock plan data have been adjusted to
reflect the reverse split.
Basic per share data is computed by dividing net loss applicable to
common shareholders by the weighted average number of common shares
outstanding. Diluted per share data is computed by dividing income
available to common shareholders plus income associated with dilutive
securities by the weighted average number of shares outstanding plus
any potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock in each year.
F-7
NOTE1: (Continued)
Year Ended Thirty-three
------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
--------- ---------- ---------- ----------
Loss before extraordinary item $6,891,000 $9,241,000 $5,378,000 $3,899,000
Plus: Preferred stock accretion 19,000
---------- ---------- ---------- ----------
Basic and diluted loss before
extraordinary item applicable to
common shareholders $6,910,000 $9,241,000 $5,378,000 $3,899,000
========== ========== ========== ==========
Securities that could potentially dilute basic EPS in the future were
not included in the computation of diluted EPS, because to do so would
have been antidilutive for the periods presented. Such securities
include options outstanding to purchase 890,519, 326,005, 489,960, and
523,701 shares of common stock at January 30, 1999, January 31, 1998,
February 1, 1997 and June 1, 1996, respectively, Series B preferred
stock convertible into 1,000,000 shares of common stock and Series C
preferred stock convertible into 1,925,000 shares of common stock at
January 30, 1999.
Stock-Based Compensation
Compensation cost attributable to stock option plans is recognized
based on the difference, if any, between the closing market price of
the stock on the date of grant over the exercise price of the option.
The Company has not issued any stock options with an exercise price
less than the closing market price of the stock on the date of grant.
Reclassifications
Certain reclassifications have been made to conform prior period
amounts to current year presentation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). This statement divides comprehensive income into
net income and other comprehensive income. SFAS 130 was effective for
the Company during Fiscal 1998. The Company has no items of other
comprehensive income in any period presented and, consequently, is not
required to report comprehensive income.
F-8
NOTE 2 - PROPERTY, PLANT AND EQUIPMENT, NET:
January 30, January 31,
1999 1998
------------ ------------
Property, plant and equipment, at cost:
Machinery, furniture and equipment $ 4,015,000 $ 3,669,000
Leaseholds and leasehold improvements 7,511,000 6,683,000
Computer software 840,000 821,000
------------ ------------
12,366,000 11,173,000
Accumulated depreciation and amortization (4,482,000) (3,058,000)
------------ ------------
$ 7,884,000 $ 8,115,000
============ ============
Depreciation and amortization expense for property, plant and equipment
amounted to $1,488,000; $1,608,000; $833,000 and $938,000 for Fiscal
1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively.
NOTE 3 - CREDIT AGREEMENTS:
In November 1996, the Company entered into an agreement with a
financial institution for a $13 million credit facility (the "Credit
Facility"). The $13 million facility consists of a $3 million capital
expenditure facility (the "Capex Line") and a $10 million revolving
credit line for working capital (the "Revolver"). Availability under
the Revolver is subject to a defined borrowing base. As of January 30,
1999, no borrowings were outstanding and $3,054,000 was available under
the Revolver. As of January 30, 1999, $2,750,000 was outstanding on
the Capex Line. The Credit Facility, as amended, requires the Company
at all times to maintain net worth (defined to include equity and
subordinated debt) of at least $8 million and provides that cash
dividends may be paid only if written consent of the lender is
obtained. The Credit Facility also limits the Company's earnings
before interest, taxes, depreciation and amortization (EBITDA) to the
following loss amounts: $900,000 for the twelve months ended January
31, 1999 and $500,000 for the twelve months ending April 30, 1999.
Minimum EBITDA of zero is required for the twelve months ending July
31, 1999 and $400,000 for the twelve months ending October 31, 1999. In
addition, capital expenditures are limited to $1,750,000 in fiscal year
1999. Interest accrues on the revolving line of credit at prime plus
1% and at prime plus 1 1/2% on the capital expenditure facility. At
January 30, 1999, the bank's prime rate of interest was 7.75%. The
Company's weighted average interest rate on short-term borrowings was
9.43% and 9.48% for Fiscal 1998 and Fiscal 1997, respectively.
The Credit Facility is for a period of three years and is secured by
substantially all the Company's assets. The Company plans to replace the Credit
Facility by November 1999, and believes that it could extend the Credit Facility
to May 2000.
F-9
NOTE 3: (Continued)
Effective May 6, 1997, the Company sold subordinated notes in the
aggregate principal amount of $3,000,000 and warrants to purchase
common stock, certain of the purchasers of which were affiliates of the
Company. The subordinated notes bore interest at 11.5% and were due in
full on May 6, 2000. Warrants to purchase an aggregate of 237,500
shares of common stock at $6.00 per share were issued in connection
with the subordinated notes. Proceeds from the sale of the
subordinated notes and warrants were allocated to the debt security and
the warrants based on the fair value of the securities at the date of
issuance. The value assigned to the warrants was $351,000. The
resulting debt discount was amortized over the term of the notes. In
December 1998, the holders of the notes exchanged the notes and
warrants in connection with a capital restructuring. See Note 12.
The Company issued and sold subordinated convertible debentures in the
aggregate principal amount of
$3 million effective October 11, 1996. The terms of such debentures,
as amended, permitted the holders to convert the principal amount into
375,000 shares of the Company's common stock at $8.00 per share at any
time prior to May 31, 2002, the due date of the debentures. The
debentures bore interest at a rate of 8% per annum. The holders of the
debentures exchanged the debentures in conjunction with a capital
restructuring in December 1998. See Note 12.
NOTE 4 - MANDATORILY REDEEMABLE PREFERRED STOCK:
In connection with the Company's recapitalization (see Note 12), the
Company issued 30,000 shares of mandatorily redeemable preferred stock
Series A. The stock has a par value of $.01 per share and a
liquidation preference of $100 per share; it is mandatorily redeemable
at the option of the holders on May 31, 2002 at a redemption price of
$100 per share or $3,000,000. The Series A preferred stock shall also
be redeemed by the Company upon a change of control or upon the
issuance of equity securities by the Company for proceeds in excess of
$15,000,000, both as defined in the Certificate of Determination for
the Series A preferred stock.
The difference in the fair value of the mandatorily redeemable Series A
preferred stock at the date of issuance and the redemption amount is
being accreted, using the interest method, over the period from the
issuance date to the required redemption date as a charge to additional
paid-in capital.
There shall be no dividends on the Series A preferred stock unless the
Company is unable to redeem the stock at the required redemption date,
at which point dividends shall cumulate and accrue on a daily basis,
without interest, at the rate of $15.00 per share per annum, payable
quarterly.
NOTE 5 - SHAREHOLDERS' EQUITY:
Pursuant to shareholder approval in December 1998, the Company
authorized for issuance 250,000 shares of preferred stock, of which
30,000 were designated Series A (see Note 4), 30,000 were designated
for Series B and 38,500 were designated for Series C. In connection
with the Company's recapitalization (see Note 12), the Company issued
the Series A, Series B and Series C shares (collectively, the
"Preferred Shares").
The Preferred Shares are non-voting. However, holders of at least a
majority of the Preferred Shares acting as a class, must consent to
certain corporate actions, including the sale of the Company, as
defined in the respective Certificates of Determination.
F-10
NOTE 5: (Continued)
Both Series B and Series C preferred stock have a par value of $.01 per
share and a liquidation preference of $100 per share. The shares shall
be convertible in whole or in part at any time at the option of the
holders into shares of the Company's common stock. The conversion
rates are $3.00 per common share and $2.00 per common share for the
Series B preferred stock and the Series C preferred stock,
respectively, subject to anti-dilution provisions set forth in the
Certificates of Determination for the Series B and the Series C
preferred stock.
NOTE 6 - INCOME TAXES:
The provision (benefit) for income taxes is comprised of the following:
Year Ended Thirty-three
------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
------- ------- -------- ---------
Current provision:
Federal $1,000
State $22,000 $27,000
Deferred provision (benefit):
Federal (928,000)
State
Adjustment to valuation allowance $207,000
------- ------- -------- ---------
$22,000 $27,000 $207,000 ($927,000)
======= ======= ======== =========
The Company's effective income tax rate differed from the federal
statutory rate as follows:
Year Ended Thirty-three
------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
------- ------- -------- ---------
Federal statutory rate 34% 34% 34% 34%
State income taxes, net of federal
benefit 3 1 3
Stock options 4
Valuation allowance (11) (39) (45) (19)
Debt discount amortization (23)
Other 2 2 1
------- ------- -------- ---------
Effective tax rate 0% 0% (4)% 19%
======= ======= ======== =========
F-11
NOTE 6: (Continued)
Deferred tax liabilities (assets) are comprised of the following:
January 30,January 31,
1999 1998
Depreciation and amortization $ 87,000 $ 200,000
Pre-opening costs 21,000
Other 27,000 64,000
----------- -----------
Deferred tax liabilities 114,000 285,000
----------- -----------
Net operating loss carryforwards (7,672,000) (6,799,000)
Deferred rent (604,000) (839,000)
Writedown of fixed assets (633,000)
Other reserves (868,000) (396,000)
Other tax carryforwards (69,000) (68,000)
Sales returns (29,000) (29,000)
----------- -----------
Deferred tax assets (9,242,000) (8,764,000)
----------- -----------
Valuation allowance 7,728,000 7,079,000
----------- -----------
Net deferred tax asset ($1,400,000) ($1,400,000)
=========== ===========
In evaluating the realizability of the deferred tax asset, management
considered the Company's projections and available tax planning
strategies. Management expects that the Company will generate
sufficient taxable income in future years to utilize the net deferred
tax asset. In addition, the Company could implement certain tax
planning strategies including the sale of the Company's catalog
operations or its catalog operation's mailing lists in order to
generate income to enable the Company to realize its NOL
carryforwards.
The Company has federal and state net operating loss carryforwards at
January 30, 1999 of $20,492,000 and $8,033,000, respectively. These
carryforwards will expire in fiscal years ending 2002 through 2019.
NOTE 7 - SALE OF TELEMARKETING CENTER:
In July 1996, the Company sold its phone center operations to a
telemarketing services provider for approximately $500,000, $250,000 of
which was in cash and the remainder of which was in a two-year note
secured by the assets of the phone center. There was no gain or loss
on the sale.
F-12
NOTE 8 - EMPLOYEE BENEFITS AND STOCK OPTIONS:
On March 15, 1991, two now former executives were granted options to
acquire up to 450,000 shares of the Company's common stock under a
non-qualified stock option plan. The options were granted at fair
market value of $6.66 per share. One hundred fifty thousand options
were exercisable at the date of grant. These options expire June 1,
2001. In conjunction with the August 1995 renegotiation of the
employment contracts with these two executives, certain option terms
were amended. Each executive's holdings became 194,000 options
exercisable at $6.00 per share, the fair market value at the time of
reissuance. At January 30, 1999, 40,500 shares were outstanding under
this plan.
One of the executives covered by these option agreements was the
Company's chief executive officer who resigned in March 1996. The
other executive covered by these option agreements was the Company's
president who resigned in October 1996. The employment contracts for
these individuals called for severance payments in aggregate of
approximately $930,000. A significant portion of each individual's
severance represented the cash surrender value of a life insurance
policy and the remainder was paid out through December 1997.
The Company adopted the 1991 Employee Stock Option Plan, covering an
aggregate of 725,000 shares of the Company's common stock, in October
1991. Options outstanding under this plan have terms ranging from
three to ten years (depending on the terms of the individual grant).
In May 1998, certain option holders were given the right to cancel
their existing options (many of which were vested) (the "Existing
Options") and have new options issued to them at the fair market value
on the date of grant of $3.50 per share (the "New Options"). The
Existing Options vested 33% per annum. The New Options vest 20% in the
first year and 40% per annum thereafter. In December 1998, the Company
granted 275,000 options which vest immediately upon the attainment of a
closing stock price, as defined in the grant agreements, of $6.50 for
thirty consecutive trading days. Other options granted under this
plan, representing 47,320 of the 696,160 outstanding options, vest
fully one year after grant date. At January 30, 1999, there were no
Existing Options outstanding. Options for 11,991 shares were
exercisable at January 30, 1999.
In October 1995, the Company adopted the 1995 Non-Employee Directors
Option Plan. This Plan provides for the annual issuance, to each
non-employee director, of options to purchase 1,500 shares of common
stock. In addition, each director is entitled to make an election to
receive, in lieu of directors' fees of $12,000 per year, additional
options to purchase common stock. The amount of additional options is
determined based on an independent valuation such that the fair value
of the options issued is equivalent to the fees that the director would
be otherwise entitled to receive on an annual basis. Options issued
under this plan vest on the anniversary date of their grant and upon
termination of Board membership. These options expire three to five
years from the date of grant. Options to purchase 153,859 shares of
common stock were issued under this plan at exercise prices ranging
from $2.50 to $10.26 per share, such exercise price being equal to the
closing price of the Company's common stock on the date of grant. No
compensation cost was recognized in income in connection with options
granted under the Non-Employee Directors Option Plan. At January 30,
1999, 95,515 of the options issued under this plan were exercisable.
In 1993, the Company adopted an employee stock ownership plan (ESOP)
and employee stock purchase plan (ESPP) for the benefit of its
employees. The ESOP is funded exclusively by discretionary
contributions determined by the Board of Directors. The Board of
Directors authorized contributions to the ESOP of $70,000 in Fiscal
1996. The Company matches employees' contributions to the ESPP at a
rate of 50%. The Company's contributions to the ESPP amounted to
$14,000, $24,000, $21,000, $28,000 in Fiscal 1998, Fiscal 1997, the
Transition Period and Fiscal 1996, respectively.
F-13
NOTE 8: (Continued)
The following table summarizes option activity through January 30, 1999:
Weighted
Number Average
of Options Exercise Price
---------- --------------
Outstanding at May 31, 1995 521,000 $ 6.98
Granted 153,451 8.54
Canceled (120,500) 6.20
Exercised (30,250) 6.38
----------
Outstanding at June 1, 1996 523,701 6.80
Granted 81,760 10.54
Canceled (8,334) 6.84
Exercised (107,167) 6.04
----------
Outstanding at February 1, 1997 489,960 7.40
Granted 98,295 5.00
Canceled (42,250) 8.08
Exercised (220,000) 6.00
----------
Outstanding at January 31, 1998 326,005 7.62
Granted 785,014 3.03
Canceled (220,500) 7.13
----------
Outstanding at January 30, 1999 890,519 3.72
==========
The Company has adopted Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123"). In accordance
with the provisions of FAS 123, the Company applies APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations
in accounting for its plans and does not recognize compensation expense
for its stock-based compensation plans based on the fair market value
method prescribed by FAS 123. If the Company had elected to recognize
compensation expense based upon the fair value at the grant date for
awards under these plans consistent with the methodology prescribed by
FAS 123, the Company's net loss and loss per share would be increased
to the pro forma amounts indicated below:
Year Ended Thirty-three
-------------------------- Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
----------- ----------- ----------- -----------
Net loss:
As reported ($5,680,000) ($9,241,000) ($5,378,000) ($3,899,000)
Pro forma (6,258,000) (9,640,000) (5,839,000) (4,068,000)
Basic and diluted loss per share:
As reported ($1.13) ($2.01) ($1.34) ($1.19)
Pro forma (1.24) (2.10) (1.46) (1.25)
F-14
NOTE 8: (Continued)
These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense
over the vesting period, and additional options may be granted in
future years. The fair value for these options was estimated at the
date of grant using the Black-Scholes options-pricing model with the
following weighted-average assumptions for Fiscal 1998, Fiscal 1997,
the Transition Period and Fiscal 1996, respectively: dividend yields
of zero percent; expected volatility of 76.91, 79.34, 73.25 and 70.97
percent; risk-free interest rates of 5.17, 6.00, 6.36 and 6.10 percent;
and expected life of four years for all periods. The weighted average
fair value of options granted during Fiscal 1998, Fiscal 1997, the
Transition Period and Fiscal 1996 for which the exercise price equals
the market price on the grant date was $1.07, $1.55, $3.10 and $4.78,
respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion,
the existing models do not necessarily provide a reliable single
measure of the fair value of employee stock options.
The following table summarizes information concerning outstanding and
exercisable stock options at January 30, 1999:
Range of exercise prices $2.50 - $3.75 $3.76 - $5.50 $5.51 - $8.25 $8.26 - $10.26
Number of outstanding options 742,513 44,296 40,500 63,210
Weighted average remaining
contractual life 8.9 years 3.3 years 6.3 years 2.0 years
Weighted average exercise price $3.05 $5.00 $6.00 $9.41
Number of options exercisable - 44,294 40,500 63,212
Weighted average exercise price of
options exercisable - $5.00 $6.00 $9.40
NOTE 9 - RELATED PARTY TRANSACTIONS:
KAIM provides certain management services to the Company and charges
the Company for such services. Management fees of $100,000, $100,000,
$66,667 and $83,333 were paid to KAIM in Fiscal 1998, Fiscal 1997, the
Transition Period and Fiscal 1996, respectively.
The Company provided telemarketing services through July 1996, to K.A.
Industries, a related party to KAIM. Revenues generated from this
service amounted to $40,000 for the Transition Period and $365,000 for
Fiscal 1996. Management believes that the terms of this agreement were
no less favorable than those that would have been negotiated with an
unrelated third party.
F-15
NOTE 10 - COMMITMENTS AND CONTINGENCIES
The Company leases real property and equipment under non-cancelable
agreements expiring from 1999 through 2007. Certain retail store lease
agreements provide for contingent rental payments if the store's net
sales exceed stated levels ("percentage rents"). Certain other of the
leases contain escalation clauses which provide for increases in base
rental for increases in future operating cost and renewal options at
fair market rental rates. The Company's minimum rental commitments are
as follows:
Fiscal Year
1999 $3,461,000
2000 3,506,000
2001 3,460,000
2002 3,283,000
2003 2,922,000
Thereafter 5,073,000
-----------
$21,705,000
===========
Net rental expense under operating leases was $3,233,000, $3,802,000,
$1,929,000 and $1,959,000 for Fiscal 1998, Fiscal 1997, the Transition
Period and Fiscal 1996, respectively. No percentage rents were
incurred in Fiscal 1998 and Fiscal 1997; percentage rents incurred in
the Transition Period and Fiscal 1996 amounted to $54,000 and $82,000,
respectively. The Company recognizes percentage rent expense when it
is probable that it will be incurred.
The Company is not a party to any material legal actions.
NOTE 11 - STORE CLOSINGS:
On December 16, 1997, the Board of Directors of the Company approved
management's plan to close seven poor-performing retail stores. The
Company wrote off $1.3 million of the net carrying value of capitalized
leasehold improvements and fixed assets related to these stores, which
is included in other expenses in the statement of operations. The
revenues from the stores which closed were $1,904,000, $4,663,000,
$3,003,000 and $2,802,000 for Fiscal 1998, Fiscal 1997, the Transition
Period and Fiscal 1996, respectively. Operating losses from these
stores were $17,000, $435,000, $215,000 and $48,000 for Fiscal 1998,
Fiscal 1997, the Transition Period and Fiscal 1996, respectively. All
but one of these stores were closed in Fiscal 1998. The remaining
store is currently being closed.
On January 28, 1997, the Board of Directors of the Company approved
management's plan to close two poor-performing retail stores. The
Company wrote off $425,000 of the net carrying value of capitalized
leasehold improvements and fixed assets related to these stores, which
is included in other expenses in the statement of operations. The
revenues from these stores were $99,000, $802,000, $616,000 and
$1,170,000 for Fiscal 1998, Fiscal 1997, the Transition Period and
Fiscal 1996, respectively. Operating losses from these stores were
$42,000, $167,000, $225,000 and $155,000 for Fiscal 1998, Fiscal 1997,
the Transition Period and Fiscal 1996, respectively. These stores were
closed in Fiscal 1998.
F-16
NOTE 12 - RECAPITALIZATION AND EXTRAORDINARY GAIN:
In order to enhance the Company's liquidity and improve its capital
structure, effective April 13, 1998 the Company completed a private
placement of non-interest bearing senior subordinated notes in an
aggregate principal amount of $3,850,000, together with detachable
warrants to purchase an aggregate of 1,925,000 shares of common stock
exercisable at $2.00 per share (the "New Securities"). The New
Securities were sold for an aggregate purchase price of $3,850,000 and
were purchased principally by affiliates of the Company.
In connection with the sale of the New Securities, the Company entered
into an agreement (the "Agreement") with all of the holders of the
Company's existing subordinated debt and warrant securities
representing an aggregate principal amount of $6,000,000. Pursuant to
the Agreement, each holder (of new and old securities) agreed to
exchange all of its subordinated debt securities together with any
warrants issued in connection therewith, for newly issued preferred
stock. The issuance of the shares of preferred stock was subject to
the approval of the Company's shareholders, which approval was received
on December 15, 1998.
Ten shares of newly issued preferred stock were issued for each $1,000
principal amount of subordinated debt securities exchanged. The total
number of shares issued were 30,000, 30,000 and 38,500 for Series A, B
and C Preferred Stock, respectively.
Holders of $3,000,000 principal amount of existing subordinated debt
securities elected to receive Series A Preferred Stock which has no
fixed dividend rights, is not convertible into common stock, is
mandatorily redeemable by the Company in May 2002 and does not accrue
dividends unless the Company is unable to redeem the Series A Preferred
Stock at the required redemption date, at which point dividends would
begin to accumulate and accrue at a rate of $15 per share per annum.
Holders of $3,000,000 principal amount of existing subordinated debt
securities elected to receive Series B convertible preferred stock
which has no fixed dividend rights and is convertible into common stock
at a price per share of $3.00.
Holders of the $3,850,000 principal amount of New Securities elected to
receive Series C convertible preferred stock which has no fixed
dividend rights and is convertible into common stock at a price per
share of $2.00.
As the $3.85 million of New Securities were issued in contemplation of
the exchange into convertible preferred stock, the accounting for the
New Securities is analogous to convertible debt. The New Securities
were to be exchanged for Series C preferred stock which were
convertible into common stock at a price per share of $2.00. As of the
date of issue of the New Securities, the stock was trading at $4.00 a
share. Since the conversion feature was in the money at the date of
issue of the debt, the portion of the debt proceeds equal to the
beneficial conversion feature of $3.85 million was allocated to
additional paid-in capital. The resulting debt discount of $3,850,000
was amortized to interest expense over the period from the April
issuance date to the date the New Securities were first convertible.
The date the New Securities were first convertible was the exchange
date when the New Securities were exchanged for convertible preferred
stock. No value was assigned to the warrants because the requirement
to exchange the warrants, together with the debt, for preferred stock
resulted in an assessment that the warrants has no independent value
apart from the exchange transaction.
F-17
NOTE 12: (Continued)
The exchanges of the subordinated debt and warrant securities for the
preferred stock were recorded at the date of issuance of the preferred
stock. The fair value of each preferred stock series was determined as
of the issuance date of the stock. The difference between the fair
value of the Series A preferred stock granted of $1,769,000 and the
carrying amount of the related subordinated debt security's balance
exchanged of $3,000,000 was recognized as a gain on the extinguishment
of debt, net of transaction expenses, in the amount of $1,231,000. The
difference between the fair value of the Series B preferred stock
series granted of $2,812,000 and the carrying amount of the related
subordinated debt security's balance plus accrued interest exchanged of
$2,828,000 was recognized as a gain on the extinguishment of debt, net
of transaction expenses, in the amount of $16,000 with $8,000 of the
gain on the exchange of notes held by principal shareholders recorded
as a credit to additional paid-in capital. There was no gain or loss
recognized on the conversion of the New Securities.
In connection with the above restructuring, effective April 13, 1998,
the holders of the Company's $3.0 million subordinated notes and $3.0
million subordinated convertible debentures agreed to waive their right
to receive any and all interest payments accrued and owing on or after
February 28, 1998. This modification of terms was accounted for
prospectively, from the effective date, under Statement of Financial
Accounting Standards No. 15, "Accounting of Debtors and Creditors for
Troubled Debt Restructurings," as follows.
The carrying amount of the subordinated notes as of April 13, 1998 was
not changed as the carrying amount of the debt did not exceed the total
future cash payments of $3.0 million specified by the new terms.
Interest expense was computed using the interest method to apply a
constant effective interest rate to the payable balance between the
modification date of April 13, 1998, and the original maturity date of
the payable in May 2000.
The total future cash payments specified by the new terms of the
convertible debentures of $3.0 million is less than the carrying amount
of the liability to the debenture holders of $3,027,000, therefore, the
carrying amount was reduced to an amount equal to the total future cash
payments specified by the new terms and the Company recognized a gain
on restructuring of payables equal to the amount of the reduction as of
April 13, 1998. No interest expense was recognized on the payable for
any period between the modification date of April 13, 1998 and the date
the debentures were exchanged for preferred stock.
Proceeds from the Company's private placement of New Securities in the
amount of $3,850,000 were used to pay off the Company's revolving line
of credit. Further, the Company's lender amended the existing loan
agreement to provide more favorable terms which are consistent with
management's financial and operating plans. These plans include the
closure of certain unprofitable mall stores and opening of other store
locations.
As a result of the above, management believes that it has sufficient
liquidity to execute its current plan. However, the Company's ability
to fund its operations, open new stores and maintain compliance with
its loan agreement is dependent on its ability to generate sufficient
cash flow from operations and obtain additional financing as described
in Note 3. Historically, the Company has incurred losses and may
continue to incur losses in the near term. Depending on the success of
its business strategy, the Company may continue to incur losses beyond
such period. Losses could negatively affect working capital and the
extension of credit by the Company's suppliers and impact the Company's
operations.
F-18
NOTE 13 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Changes in assets and liabilities which increased (decreased) cash are
as follows:
Year Ended Thirty-three
------------------------------- Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
---------- ----------- ---------- --------
Accounts and other receivables ($ 180,000) $ 733,000 ($ 529,000) ($ 126,000)
Merchandise inventories 805,000 1,062,000 (2,400,000) (122,000)
Other current assets 319,000 217,000 (1,109,000) (95,000)
Other noncurrent assets (48,000) (2,000) 113,000 142,000
Accounts payable and accrued expenses 1,040,000 (3,641,000) 1,975,000 1,030,000
Amounts due to ARC (71,000)
Deferred income taxes 207,000 (928,000)
Other liabilities (97,000)
Deferred rent (176,000) 315,000 786,000 773,000
---------- ----------- ---------- --------
$1,760,000 ($1,316,000) ($ 957,000) $506,000
========== =========== ========== ========
Cash paid for income taxes was $3,000, $5,000 and $7,000 for Fiscal
1998, Fiscal 1997, and the Transition Period, respectively. Cash paid
for interest was $483,000, $954,000, $193,000 and $73,000 for Fiscal
1998, Fiscal 1997, the Transition Period and Fiscal 1996,
respectively. Non-cash investing activity consists of a $250,000 note
received upon the sale of the phone center operations in the Transition
Period.
NOTE 14 - NEW ACCOUNTING PRONOUNCEMENTS:
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 "Reporting on the Costs of Start-up
Activities" (SOP 98-5), which requires that the costs of start-up
activities and organization costs be expensed as incurred. The impact
of the adoption of SOP 98-5 is not expected to be material to the
Company's financial position or results of operations. Effective
October 1, 1997 and as disclosed in Note 1, the Company began expensing
all store pre-opening costs as incurred.
F-19
NOTE 15 - COMPARABLE PRIOR PERIOD DATA (Unaudited):
As described in Note 1, the Company changed its fiscal year end
effective January 1, 1997, resulting in a thirty-three week transition
period ending February 1, 1997. Comparable results of operations for
the thirty-three weeks ended February 3, 1996 are as follows:
Net sales:
Catalog $ 16,573,000
Retail 9,894,000
Other revenues 749,000
------------
27,216,000
Costs of goods sold 13,864,000
Other expenses, net 14,632,000
------------
Loss before income taxes (1,280,000)
Income tax benefit 523,000
------------
Net loss ($ 757,000)
============
Basic and diluted loss per share $ (0.24)
============
Weighted average number of common shares outstanding 3,151,267
============
NOTE 16 - SEGMENT INFORMATION:
In the Fiscal 1998 fourth quarter, the Company adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of
an Enterprise and Related Information". This statement supersedes
Statement of Financial Accounting Standards No. 14, "Financial
Reporting for Segments of a Business Enterprise", replacing the
"industry segment approach with the "management" approach. The
management approach designates the internal organization that is used
by management for making operating decisions and assessing performance
as the source of the company's reportable segments. This statement
requires disclosure of certain information by reportable segment,
geographic area and major customer. The Company is a specialty
merchant of infants' and children's products and operates only in one
reportable segment for purposes of this disclosure.
THE RIGHT START, INC.
SCHEDULE II - VALUATION RESERVES
Additional
Balance at charged Balance at
beginning to costs end
Classification of period and expenses Deductions of period
- -------------- --------- ------------ ---------- ---------
Fiscal year ended January 30, 1999
Allowance for deferred tax asset $7,079,000 $649,000 $7,728,000
Inventory reserve 121,000 369,000 $422,000 68,000
Allowance for sales returns 69,000 69,000
---------- ---------- -------- ----------
$7,269,000 $1,018,000 $422,000 $7,865,000
========== ========== ======== ==========
Fiscal year ended January 31, 1998
Allowance for deferred tax asset $3,280,000 $3,799,000 $7,079,000
Inventory reserve 81,000 425,000 $385,000 121,000
Allowance for sales returns 103,000 34,000 69,000
---------- ---------- -------- ----------
$3,464,000 $4,224,000 $419,000 $7,269,000
========== ========== ======== ==========
Thirty-three weeks ended February 1, 1997
Allowance for deferred tax asset $940,000 $2,340,000 $3,280,000
Inventory reserve 86,000 267,000 $272,000 81,000
Allowance for sales returns 103,000 103,000
---------- ---------- -------- ----------
$1,129,000 $2,607,000 $272,000 $3,464,000
========== ========== ======== ==========
Fiscal year ended June 1, 1996
Allowance for deferred tax asset $940,000 $940,000
Inventory reserve 490,000 $404,000 86,000
Allowance for sales returns $103,000 103,000
---------- ---------- -------- ----------
$103,000 $1,430,000 $404,000 $1,129,000
========== ========== ======== ==========