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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)
For the fiscal year ended January 29, 2000
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period from ______________ to _____________.
Commission file number 0-19536
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., 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
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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
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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 25, 2000, approximately 3,262,124 shares of the Registrant's Common
Stock held by non-affiliates were outstanding and the aggregate market value of
such shares was approximately $14,679,558.
As of April 25, 2000 there were outstanding 5,614,175 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 August 24, 2000 (the "Proxy Statement") are
incorporated by reference into Part III hereof.
PART I
ITEM 1. BUSINESS
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Forward-Looking Statements
- --------------------------
When used in this report and elsewhere by management from time to time, the
words "believes," "anticipates," and "expects" and similar expressions are
intended to identify forward-looking statements with respect to our financial
condition, results of operations and business and that of our majority-owned
online subsidiary, RightStart.com, a Delaware corporation ("RightStart.com").
Certain important factors, including but not limited to competition from other
children's product retailers, losses expected in the online business,
limitations on access to capital to fund the expansion and the growth in the
number of our physical stores and in RightStart.com's online business, the
dependence of RightStart.com on its technology services provider, consumer
acceptance of online retailing and RightStart.com's online stores and the lack
of operating experience at RightStart.com, could cause actual results to differ
materially from those expressed in our forward-looking statements. Further
information on potential factors that could affect our financial condition and
that of RightStart.com, is included in our filings and the filings of
RightStart.com with the Securities and Exchange Commission. We caution readers
not to place undue reliance on forward-looking statements, which speak only as
of the date of this filing. We undertake no obligation to publicly release any
revisions to these forward-looking statements to reflect events or circumstances
after that date.
General
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The Right Start, Inc., a California corporation, is a leading specialty
retailer of high-quality developmental, educational and care products for
infants and children. RightStart.com is our majority-owned online subsidiary.
Together, we market our products through our 53 retail stores located throughout
the United States, RightStart.com's nationally distributed catalog, and
RightStart.com's online store located at www.rightstart.com. We are a market
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leader offering approximately 1,500 items targeting infants and children through
age three in our 53 retail stores. RightStart.com is also a market leader
online and offers approximately 4,500 items for infants and children through age
twelve. Together, we are dedicated to providing our customers with a unique
shopping experience by offering a trusted assortment of products, carefully
selected with regard to quality, safety and developmental value and by providing
a high level of customer service.
History
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We were formed as a catalog company 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 our formation, new parents' alternatives
were limited to low-service, mass merchandise stores or sparsely-stocked, high-
priced infants' and children's specialty stores. To counter this, we carefully
screen infant and toddler products in order to identify those we consider to be
the "best of the best," that is, the safest, most durable, best designed and
best valued items. We and RightStart.com currently select this kind of product
from over 350 vendors worldwide.
We then expanded our distribution channels beyond The Right Start catalog
and into specialty retail sales through The Right Start stores. Based on the
results of the retail stores, our strategy evolved to include a reduction in The
Right Start catalog circulation and plans for a major retail expansion. Since
1996 when we began this expansion, we have grown to 53 retail stores currently
in operation nationwide.
We formed RightStart.com in April 1999 and in June 1999, RightStart.com
launched its online store. RightStart.com expanded the available offerings
under the Right Start brand name by establishing online stores that
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feature products for children through age twelve and their caregivers; as well
as a Teachers' Store carrying educational items for the home and classroom.
In our physical stores, we focus on customer service by offering customers
carefully selected products presented by sales associates with extensive product
knowledge. RightStart.com's online stores provide a number of customer
services aimed at bringing the specialty retail experience of our physical
stores to RightStart.com's online customers, including free ground shipping on
orders over $30, deluxe gift wrapping, guaranteed same-day shipping, guaranteed
in-stock availability of products featured on RightStart.com's online store, 24-
hour customer service, live online help and product returns to any of our
physical stores nationwide. In addition, RightStart.com's online store provides
editorial content, including articles from leading parenting publications and
interactive content from child development and health care professionals.
Retail Store Operations
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Currently, we have 53 physical stores in operation. The stores' product mix
includes a wide variety of items to meet the needs of parents of infants and
small children up to age three, all presented within a store designed to provide
a safe, baby-friendly environment for the shopping ease of new parents.
The number of physical stores open reflects the rapid growth that we
experienced in 1996 and 1997, during which period we opened 24 mall stores.
After studying the results of both mall and street locations, we concluded that
street-location stores provide our customers more convenient access and shopping
since many are shopping with infants and small children. Further, street-
location stores are more cost efficient to build and operate. Accordingly, we
adopted a store opening plan that provided for the opening of eight street-
location stores in 1998, and thirteen street-location stores in 1999.
In addition to reevaluating store location strategy, in 1997 we determined
that some of our existing mall locations were not performing at an acceptable
level and implemented a store closing plan for those stores. Nine mall stores
were closed in 1998 and one mall store was closed in 1999.
Our growth strategy for retail operations includes continued street-
location store openings.
Investment in RightStart.com
- ----------------------------
RightStart.com is our majority-owned subsidiary. As part of its formation
we contributed assets comprising our catalog and online operations to
RightStart.com. In July 1999, RightStart.com raised $15 million in a private
equity offering to third-party investors and used that money to create and
market each of the following online stores: the Baby Store (infant through two
years old), the Kids' Development Store (three through six years old), the Big
Kids' Store (six through twelve years old) and the Teachers' Store.
Together with RightStart.com, we now offer a multi-faceted retail platform
designed to leverage the Right Start brand name and increase sales from existing
and new customers for ourselves and RightStart.com. In July 1999 we entered
into a management services agreement pursuant to which we supply corporate,
administrative and marketing services, promotional services and inventory to
RightStart.com and an intellectual property agreement pursuant to which we
assigned intellectual property intrinsically related to the online stores and
catalog operations to RightStart.com, granted a license to RightStart.com to use
our customer lists and granted to RightStart.com a license to use our trademarks
and trade names and other intellectual property in connection with the online
stores. We received rights to use information collected about users by
RightStart.com, the lists of catalog customers we assigned to RightStart.com as
well as intellectual property associated with RightStart.com's online stores
(though not to be used for any other online business).
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RightStart.com has employed a strategy of outsourcing some activities
essential to the online business. Since the launch of the online store in June
1999, RightStart.com has outsourced its technology department and its
fulfillment activities, including its warehousing and logistics operations and
its call center and customer service activities. As a result, RightStart.com
has engaged employees primarily in managerial, merchandising and marketing
roles. RightStart.com is substantially dependent on the technology services it
receives from its technology services providers who host, maintain and develop
its website and provide technical assistance to its third-party distribution
provider and its in-house logistics team. RightStart.com's principal
technology service provider is also a shareholder of RightStart.com and we
believe their relationship to be good and, if necessary, RightStart.com could
locate replacement services without material difficulty. RightStart.com
recently employed a Chief Technical Officer and expects to develop its own
technology department and assume day-to-day operations and maintenance of its
online stores in early 2001. Neither we nor RightStart.com has long-term
contracts with our respective fulfillment services providers but we believe that
replacement providers could be found without material difficulty should the need
arise. Nonetheless, a failure in any of these outsourced services could have a
material adverse effect on us or RightStart.com.
The Right Start catalog offers a mail order alternative for Right Start
customers. The Right Start catalog has been in existence over fifteen years and
continues to offer a quality selection of Right Start products through national
distribution. Several attractive glossy issues are mailed each year, targeting
our principal customers: educated, first-time parents from 23-40 years old, with
an average annual income in excess of $60,000 who also constitute a substantial
portion of RightStart.com's customers. The Right Start catalog is sent to
qualified segments of the customer list we and RightStart.com have compiled and
to selected rented lists. In order to target customers efficiently, the customer
list is segmented by frequency, recency and size of purchase. Rented lists are
evaluated based on historical performance of mailings and the availability of
names meeting the Right Start customer profile.
Marketing and Promotion
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We have implemented a number of national, regional and local marketing
programs to reinforce our brand name and increase customer awareness of our new
store locations. These programs include print ads in national and regional
publications, direct mail and local newspaper advertisements and promotions such
as our January Travel Department discount program.
RightStart.com also purchases print ads in national publications and uses
its catalogs and other direct mail pieces to promote its online stores.
RightStart.com has entered into a strategic alliance with Oxygen Media, which
provides advertising across multiple formats. In addition, RightStart.com has
entered into affiliations with companies such as E-greetings in the online
greeting card sector, MP3.com in the online music sector, Allpets.com in the
online pets supplies sector and MyEvents.com in the online event and family
organizer sector and is exploring additional relationships.
Together, we and RightStart.com use a marketing database consisting of
approximately 2.7 million names and addresses we have collected. In addition,
RightStart.com recently has purchased an additional 1.4 million names and
addresses from another specialty retailer of products for children ages four to
twelve. We and RightStart.com each also collect e-mail addresses from our
respective customers. Customers' names and addresses are used, consistent with
RightStart.com's published privacy policy and general direct marketing
standards, for promotional mailings, e-mails and other direct marketing
activities.
Finally, we have taken advantage of the cross-promotional opportunities
that exist between our physical stores and RightStart.com's online stores. We
promote RightStart.com in our physical stores through in-store signage.
RightStart.com promotes our physical stores through our returns policy and store
locator in
4
RightStart.com's online stores, as well as in our joint alliances with online
entities and Oxygen Media which we believe promote brand awareness in addition
to increasing the value in RightStart.com.
Purchasing
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We and RightStart.com now purchase products from over 350 different vendors
worldwide. In total, we import approximately 12% of the products sold in our
physical stores and RightStart.com imported approximately 9% of the products it
sold online from launch through January 1, 2000.
Employees
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As of April 18, 2000, we employed 348 employees, 169 of whom were part-
time. As of April 18, 2000, RightStart.com had 34 full-time employees and 3
part-time employees. Neither our employees nor RightStart.com's employees have
entered into any collective bargaining agreements nor are they represented by
unions. We and RightStart.com each consider our employee relations to be good.
Competition
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The retail market for infant and toddler products served by our physical
stores is very competitive. Significant competition currently comes from "big
box" concept stores, such as Babies "R" Us, Burlington Baby and Target, as well
as a few specialty retailers such as Zany Brainy and Noodle Kidoodle. The "big
box" 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 and the competition for RightStart.com impacts
us as well.
The online market for developmental, educational and care products for
children is also intensely competitive. This market is newly developing and
rapidly evolving. In addition, access to capital in this market has been
constricting. We expect competition may intensify in the future as the market
consolidates and as large competitors with physical assets enter the market.
RightStart.com's online business principally competes with online retailers,
traditional store-based retailers and catalog retailers, including specialty
stores, mass-market retailers, discount chains, department stores and mail-order
catalogs. RightStart.com's competitors include Amazon.com, KB Kids.com, eToys,
Toys "R" Us, Zany Brainy, Noodle Kidoodle, Target, Wal-Mart, FAO Schwartz, Baby
Center, iBaby, AOL, Yahoo! and others.
There are a variety of general and specialty catalogs selling infants' and
children's items in competition with The Right Start catalog. Competition for
The Right Start catalog, however, has come primarily from "One Step Ahead,"
"Kids Club" by Perfectly Safe, and "Sensational Beginnings." These catalogs
emerged several years after The Right Start catalog was launched and directly
compete by offering a very similar product line at comparable price points to
the same target market.
We believe that competition for us in traditional retail business and for
RightStart.com in the online retail and catalog businesses is based on brand
name recognition, product selection, price, convenience, customer service and,
for the online and catalog businesses, the speed and reliability of fulfillment.
We believe that we distinguish ourselves and that RightStart.com distinguishes
itself by offering a full assortment of children's developmental, educational
and care products carefully selected with regard to quality, safety,
developmental and educational value. As specialty retailers, we each also focus
on providing the highest levels of customer service. In addition, we believe
the relationship between ourselves and RightStart.com provides us and
RightStart.com with advantages relative to single channel retailers in our
respective markets, including cross-marketing opportunities, vendor
5
relationships, distribution capabilities and enhanced customer convenience. We
believe RightStart.com will be able to differentiate itself from its competitors
by drawing on the strong Right Start brand name, our long-standing vendor
relationships and our extensive knowledge and experience successfully marketing
products for infants and children.
Trademarks
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We have registered and continue to register, when deemed appropriate, our
trademarks, trade names and domain names, including "The Right Start,"
"RightStart.com," and "The Right Start Catalog." We consider these trademarks
and tradenames to be readily identifiable with, and valuable to, our business
and to the business of RightStart.com. We license much of our intellectual
property to RightStart.com for use in its online business on a royalty-free
basis.
ITEM 2. PROPERTIES
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Currently, we operate 53 retail stores in the following 15 states:
California, Colorado, Massachusetts, Minnesota, New Jersey, Illinois,
Pennsylvania, New York, Connecticut, Michigan, Washington, Missouri, Virginia,
Maryland and Ohio. We lease each of our retail locations under operating leases
with lease terms ranging from five to ten years. At some locations, we have
options to extend the term of the lease. In most cases, rent provisions include
a fixed minimum rent and, in some cases, a contingent percentage rent based on
net sales of the store in excess of a defined threshold.
We currently lease approximately 23,000 square feet as a sub-tenant in a
mixed-use building in Westlake Village, California. Our corporate offices and
those of RightStart.com both reside in this space. The sub-lease agreement
terminates in June 2001.
Both we and RightStart.com use third-party distribution and fulfillment
providers and therefore do not directly lease or own any warehouse space. The
inventory for our physical stores is located in Pennsylvania and California and
the inventory for RightStart.com is located primarily in Pennsylvania.
RightStart.com's web servers are located in third-party hosting facilities in
Los Angeles, California.
ITEM 3. LEGAL PROCEEDINGS
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We are a party to various legal actions arising in the ordinary course of
business. In the opinion of management, any claims that may arise from these
actions are adequately covered by insurance or are without significant merit.
We believe that the ultimate outcome of these matters will not have a material
adverse effect on our financial position or results of operations.
RightStart.com is not a party to any litigation.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
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Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS'
- ------- ---------------------------------------------------------------
MATTERS
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Our common stock is traded on the Nasdaq National Market system under the
symbol RTST. Our common stock is held of record by approximately 86 registered
shareholders as of April 25, 2000. The following table sets
6
forth the range of high and low bid prices on the Nasdaq National Market for our
common stock for the fiscal year ended January 30, 1999 ("Fiscal 1998") and the
fiscal year ended January 29, 2000 ("Fiscal 1999"). 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)
--------------------------------------
Fiscal 1999 High Low
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First Quarter $ 8.50 $ 5.00
Second Quarter 10.00 6.50
Third Quarter 15.00 6.63
Fourth Quarter 23.75 13.00
Fiscal 1998
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First Quarter $ 4.50 $ 2.75
Second Quarter 3.75 1.75
Third Quarter 2.75 1.50
Fourth Quarter 4.50 2.00
(1) Bid prices have been restated to give effect to our one-for-two reverse
stock split which was reflected on Nasdaq at the opening of trading on
December 16, 1998.
As of April 25, 2000 our High Bid Price was $5.00 and our Low Bid Price was
$4.25.
We have never paid dividends on our common stock and currently do not
expect to pay dividends in the future. In addition, our credit agreement
contains a number of financial covenants which may, among other things, limit
our ability to pay dividends. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation."
ITEM 6. SELECTED FINANCIAL DATA - The selected consolidated financial data
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presented below as of and for our fiscal year ended June 1, 1996 ("Fiscal
1996"), the 33-Week Transition Period ended February 1, 1997, the fiscal year
ended January 31, 1998 ("Fiscal 1997"), Fiscal 1998 and Fiscal 1999 have been
derived from consolidated financial statements which, except for 1996 and the
33-Week Transition Period, are contained elsewhere in this Annual Report on
Form 10-K. The selected consolidated financial data set forth below are
qualified in their entirety by, and should be read in conjunction with,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements, the notes thereto and
other financial and statistical information included elsewhere in this Annual
Report on Form 10-K.
Fiscal 33-Week
-------------------------------------- Transition Fiscal
1999 1998 1997 Period 1996
---- ---- ---- ---------------------------
(Dollars in thousands except share data)
Earnings Data
Revenues:
Net sales $ 49,079 $ 36,611 $ 38,521 $ 27,211 $ 40,368
Other revenues 877
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49,079 36,611 38,521 27,211 41,245
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Net loss (10,842) (5,680) (9,241) (5,378) (3,899)
Basic and diluted loss (2.14) (1.13) (2.01) (1.34) (1.19)
per share
Share Data
Weighted average shares
outstanding 5,355,756 5,051,820 4,594,086 4,003,095 3,268,407
Fiscal 33-Week
-------------------------------------- Transition Fiscal
1999 1998 1997 Period 1996
---- ---- ---- ---------------------------
(Dollars in thousands)
Balance Sheet Data
Current assets $ 17,424 $ 8,300 $ 8,908 $ 11,704 $ 8,353
Total assets 30,727 17,671 18,462 22,982 17,475
Current liabilities 12,943 6,572 4,796 8,457 4,649
Long-term debt 3,000 -- 8,734 5,643 --
Shareholders' equity 7,921 7,861 3,307 7,172 11,902
All share data has been restated to give effect to our one-for-two reverse stock
split which was effective December 15, 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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RESULTS OF OPERATIONS
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Overview
The Right Start, Inc. sells developmental, educational and care products
for infants and children through retail stores ("Retail Store Operations") and
holds a majority ownership in RightStart.com, which sells a similar type of
product to a broader age group on the Internet and through a mail order catalog.
To facilitate the analysis of our historical results, each of the two distinct
operations is discussed separately below.
Retail Store Operations
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The Right Start, Inc. operates 53 retail stores in 15 states throughout the
United States. The stores' product mix includes a wide variety of items to meet
the needs of infants, small children and their care givers, all presented within
a store designed to provide a safe, baby-friendly environment for the shopping
ease of new parents.
The following table sets forth the unaudited statement of operations data
for the periods indicated for Retail Store Operations:
Fiscal 1999 Fiscal 1998 Fiscal 1997
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Retail Net Sales 38,043,000 100.00% 31,875,000 100.00% 31,107,000 100.00%
Cost of goods sold 18,878,000 49.62% 16,396,000 51.44% 15,691,000 50.44%
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Gross Profit 19,165,000 50.38% 15,479,000 48.56% 15,416,000 49.56%
Operating expense 14,418,000 37.90% 12,880,000 40.41% 14,927,000 47.99%
Marketing and advertising costs 830,000 2.18% 387,000 1.21% 193,000 0.62%
General and administrative expenses 3,310,000 8.70% 2,899,000 9.09% 3,096,000 9.95%
Non-cash compensation expense 1,794,000 4.72% - 0.00% - 0.00%
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Depreciation and amortization expense 1,672,000 4.40% 1,470,000 4.61% 1,590,000 5.11%
Other expense - 0.00% - 0.00% 698,000 2.24%
Store closing (income) expense 151,000 0.40% (113,000) -0.35% 1,207,000 3.88%
Pre-opening costs 323,000 0.85% 209,000 0.66% 711,000 2.29%
Non-cash beneficial conversion feature - 0.00% 3,850,000 12.08% - 0.00%
Interest expense 465,000 1.22% 640,000 2.01% 1,143,000 3.67%
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Loss before income taxes and extraordinary items (3,798,000) -9.98% (6,743,000) -21.15% (8,149,000) -26.20%
Extraordinary gain on debt restructure, net - 0.00% 1,211,000 3.80% - 0.00%
Tax provision 68,000 0.18% 22,000 0.07% 27,000 0.09%
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Net loss (3,866,000) -10.16% (5,554,000) -17.42% (8,176,000) -26.28%
============ ========== ==========
Fiscal 1999 Compared With Fiscal 1998
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Net Sales. Retail net sales consist of gross product sales to customers net
of returns. Retail net sales increased by $6.2 million, or 19.4%, from $31.9
million in Fiscal 1998 to $38.0 million in Fiscal 1999. The net sales growth
reflects the impact of same store sales increases of 10.1% and the opening of
thirteen new street -location stores, offset by the impact of one store closure.
Cost of goods sold. Cost of goods sold consists primarily of the cost of
products sold, inbound freight costs and inventory shrinkage costs. Retail
gross margin increased from 48.6% in Fiscal 1998 to 50.4% in Fiscal 1999 as a
result of changes in the product mix to include significantly more developmental
toys, books, videos and other media that have higher gross margins.
Operating expense. Retail operating expense consists of store operational
expenses, retail personnel costs, and costs related to the distribution and
warehousing of our retail merchandise. Retail operating expense was $14.4
million in Fiscal 1999 as compared to $12.9 million in Fiscal 1998. The $1.5
million or 11.9% increase primarily reflects the addition of thirteen new store
locations offset by a reduction in per store payroll and occupancy costs.
Marketing and advertising expense. Retail marketing and advertising expense
generally consists of print advertising in national and regional publications,
as well as promotional mailings to our customers. Marketing and advertising
expense increased from $0.4 million in Fiscal 1998 to $0.8 million in Fiscal
1999. This growth reflects our increased utilization of promotional mailings to
our customer database, as well as expenses incurred to increase brand awareness
in our regional markets.
General and administrative expense. General and administrative expense
consists primarily of the costs related to management, financial, merchandising,
inventory, professional service fees and other administrative support
attributable to Retail Store Operations. General and administrative expense
increased 14.2 % to $3.3 million for Fiscal 1999 compared to $2.9 million for
Fiscal 1998.
Pre-opening costs. Pre-opening costs consist primarily of non-recurring
marketing, advertising, and other expenses related to the opening of new store
locations. Pre-opening costs increased $0.1 million from $0.2 million in Fiscal
1998 to $0.3 million in Fiscal 1999. The increase was due to the opening of
thirteen new stores in Fiscal 1999 versus eight stores in 1998, offset by a 10%
reduction in per store costs.
Depreciation and amortization. Depreciation and amortization expense
increased $0.2 million or 13.7% from $1.5 million in Fiscal 1998 to $1.7
million in Fiscal 1999. The increase was due to the additional assets placed in
service related to new store openings.
Non-cash compensation expense. During the second quarter of 1999, we
recorded $1.8 million of non-
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cash compensation expense associated with the vesting of performance options
that had been granted to our executive officers. This expense results from the
increase in the price of our common stock from the date of grant of the options
to the date on which vesting occurred.
Store closing expense. Store closing expense in Fiscal 1999 represents the
net book value of assets written off related to the stores closed during the
second quarter of Fiscal 1999. Store closing income in Fiscal 1998 represents
the net amount recognized from the sale of leaseholds on closed stores, offset
by store closing costs.
Interest expense. Interest expense, net decreased to $0.5 million in
Fiscal 1999 from $0.6 million in Fiscal 1998. The decrease reflects a reduction
in our outstanding borrowings. In 1998, we recorded a non-cash charge of $3.85
million related to the amortization of the discount associated with the $3.85
million of non-interest bearing senior subordinated notes issued during the
first quarter of Fiscal 1998. The senior subordinated notes were exchanged for
preferred stock in December 1998. See "Liquidity and Capital Resources -
Recapitalization."
Tax provision. Provision for income taxes is related to state income taxes.
No federal or state income tax benefit was recorded for Fiscal 1999 or Fiscal
1998 due to the uncertainty surrounding realizing any tax benefits in future
years.
Fiscal 1998 Compared With Fiscal 1997
- -------------------------------------
Net Sales. Retail net sales were $31.9 million in Fiscal 1998 and $31.1
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.
Cost of goods sold. Retail cost of goods sold represented 51.4% of sales in
Fiscal 1998 compared to 50.4% 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 our
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. Retail operating expenses declined 13.7% or $2.0 million
in Fiscal 1998 as compared to Fiscal 1997. The retail reductions include $0.5
million of occupancy costs related to store closings (offset somewhat by street
location openings), $0.8 million of distribution cost reductions and $0.7
million of payroll and other operating cost reductions.
General and administrative expense. General and administrative expense
decreased to $2.9 million in Fiscal 1998 as compared to $3.1 million in Fiscal
1997. The decrease was primarily due to payroll and occupancy cost reductions
in conjunction with management's ongoing expense management.
Pre-opening costs. Pre-opening costs decreased $0.5 million from $0.7
million in Fiscal 1997 to $0.2 million in Fiscal 1998. The reduction was due to
the reduction in pre-opening costs per store opened as well as the impact, in
Fiscal 1997, of our 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, we changed our method of accounting
for pre-opening costs and began expensing them as incurred.
Depreciation and amortization. Depreciation and amortization expense
decreased $0.1 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
10
new stores opened in the second half of the fiscal year.
Other expense. Other expense in Fiscal 1997 represents $0.2 million of
severance expense for a former senior executive and $0.4 million in fixed assets
and leasehold improvements written off in conjunction with our corporate office
and distribution center moves.
Store closing expense. Store closing income of $0.1 million in Fiscal 1998
is comprised of net revenues generated from store closings. We recovered the
value of certain of the leases through either landlords or future tenants of the
leased space. In the prior year, store closing expense includes $1.3 million of
fixed assets and leasehold improvements written off in conjunction with planned
store closures.
Non-cash beneficial conversion feature amortization. This line item
represents the one-time expense recognition associated with the issuance of our
Series C convertible Preferred Stock in connection with our recapitalization.
See "Liquidity and Capital Resources - Recapitalization."
Interest (income) expense. Interest expense decreased $0.5 million from
$1.1 million in Fiscal 1997 to $0.6 million in Fiscal 1998. The 44.0% decrease
results from the restructuring of our subordinated debt to eliminate interest on
that debt and lower overall borrowings.
RightStart.com Operations
- --------------------------
RightStart.com was formed in April 1999 to focus on sales on the Internet.
As part of its initial capitalization, RightStart.com acquired the catalog
operations from The Right Start, Inc. in order to obtain an existing fulfillment
infrastructure as well as a significant, cost-effective marketing vehicle for
promoting our online store. In addition, management of RightStart.com believes
the online store will benefit from the merchandising and marketing experience
acquired through the catalog operations as well as the catalog's database of
customer information. Management of RightStart.com intends to continue to
leverage the catalog to market and promote RightStart.com's online stores
aggressively. Each of the approximately 2.6 million catalogs distributed in
Fiscal 1999 prominently promoted RightStart.com's online stores.
Online sales are presented on a gross basis, which is after product returns
but before promotional discounts, and on a net basis after promotional
discounts. Promotional discounts have been used to attract customers to
RightStart.com's recently launched online stores. Management of RightStart.com
may continue to offer promotional discounts in order to rapidly develop a
customer base and expand product offerings to additional age groups although it
has reduced the size of its discounts and may consider further reductions as it
deems appropriate.
The online stores were launched on June 29, 1999. As a result, Fiscal 1999
is comprised of 52 weeks of catalog operations from January 31, 1999 through
January 29, 2000 and 31 weeks of online store operations from June 29, 1999
through January 29, 2000. Fiscal 1998 and Fiscal 1997 are each comprised of 52
weeks of catalog operations and no online store operations.
The following table sets forth the unaudited statement of operations data
for the periods indicated for RightStart.com:
Fiscal 1999 Fiscal 1998 Fiscal 1997
--------------------------------------------------------------------------
Catalog Sales $ 3,645,000 33.0% $4,736,000 100.0% $ 7,414,000 100.0%
Online store sales before promotional discounts 9,020,000 81.7% - -
--------------------------------------------------------------------------
Total Sales 12,665,000 114.8% 4,736,000 100.0% 7,414,000 100.0%
Promotional discounts related to online store 1,629,000 14.8% - -
--------------------------------------------------------------------------
11
Net sales 11,036,000 100.0% 4,736,000 100.0% 7,414,000 100.0%
Cost of goods sold 6,401,000 58.0% 2,180,000 46.0% 3,553,000 47.9%
--------------------------------------------------------------------------
Gross Profit 4,635,000 42.0% 2,556,000 54.0% 3,861,000 52.1%
Operating Expense 5,952,000 53.9% 2,226,000 47.0% 4,092,000 55.2%
Marketing and advertising expense 6,403,000 58.0% - 0.0% - 0.0%
General and administrative expense 1,996,000 18.1% 438,000 9.2% 816,000 11.0%
Non-cash compensation expense 220,000 2.0% - 0.0% - 0.0%
Depreciation expense 278,000 2.5% 18,000 0.4% 18,000 0.2%
Interest income (238,000) -2.2% - 0.0% - 0.0%
--------------------------------------------------------------------------
Loss before income taxes and minority interest (9,976,000) -90.4% (126,000) -2.7% (1,065,000) -14.4%
Tax provision (benefit) - 0.0% - 0.0% - 0.0%
Minority Interest in consolidated subsidiary loss 3,000,000 27.2% - 0.0% - 0.0%
--------------------------------------------------------------------------
Net loss (6,976,000) -63.2% (126,000) -2.7% (1,065,000) -14.4%
Sales. Gross sales consist of product sales to customers and are net of
product returns. Net sales are net of promotional discounts. Since
RightStart.com, during the periods presented, provided free shipping on a
substantial number of its sales, net sales does not include revenues related to
shipping charges. Net sales increased by $6.3 million, or 133.0%, to $11.0
million in Fiscal 1999 from $4.7 million in Fiscal 1998. This growth in net
sales was attributable to the launch of the online stores on June 29, 1999,
partially offset by a decline in catalog sales. Online store net sales were $7.4
million in Fiscal 1999, compared to no sales in Fiscal 1998. Fiscal 1999 online
store net sales are net of promotional discounts of $1.6 million. Catalog net
sales decreased $1.1 million, or 23.0%, to $3.6 million in Fiscal 1999 from $4.7
million in Fiscal 1998. The majority of the decline in catalog net sales was
attributable to a planned reduction in catalog circulation and a shift of a
portion of the direct-mail business from catalog to the online store operations.
Cost of goods sold. Cost of goods sold consists primarily of the cost of
products sold, inbound freight costs and inventory shrinkage costs. Gross profit
as a percentage of net sales, or gross margin, decreased to 42.0% in Fiscal 1999
from 54.0% in Fiscal 1998. Gross margin on catalog net sales increased to 56.4%
in Fiscal 1999 from 54.0% in Fiscal 1998, due to a more favorable product mix.
Gross margin on online store net sales was 34.7% in Fiscal 1999. Gross margin on
online store net sales was lower than gross margin on catalog net sales in
Fiscal 1999 due to the introductory promotional discounting offered to customers
during the initial start-up of the online store operations as well as a
different mix of products offered in the online store.
Operating expenses. Operating expenses consist primarily of net fulfillment
expenses (including shipping and handling expenses net of amounts paid by
customers), credit card processing fees and expenses related to catalog
production and distribution, product distribution and customer service, as well
as related personnel costs. Operating expenses increased by $3.7 million, or
167.4 %, to $5.9 million in Fiscal 1999 from $2.2 million in Fiscal 1998. As a
percentage of net sales, operating expenses increased to 53.9 % in Fiscal 1999
from 47.0% in Fiscal 1998. Operating expenses related to the catalog decreased
by $0.2 million, or 8.0%, to $2.0 million in Fiscal 1999 from $2.2 million in
Fiscal 1998. As a percentage of net catalog sales, operating expenses related to
the catalog increased to 56.2% in Fiscal 1999 from 47.0% in Fiscal 1998. This
increase as a percent to sales was due to lower sales. Operating expenses
related to the online store were $3.9 million in Fiscal 1999.
Marketing and advertising expense. Marketing and advertising expense
consists of radio, television, magazines, newspaper, direct mail, e-mail and on-
line solicitations, including all production and distribution, incurred in
connection with solely promoting our online store which amounted to $6.4 million
or 71.0% of online store sales in Fiscal 1999. There was no comparable activity
in the prior year.
General and administration expenses. General and administration expenses
consist primarily of the costs related to website hosting and maintenance,
management and support personnel, fees paid to The Right Start, Inc.
12
for accounting, payroll, and administrative support services under a management
services agreement, professional service fees and office lease expenses. General
and administration expenses increased $1.6 million, or 355.7 %, to $2.0 million
in Fiscal 1999 from $0.4 million in Fiscal 1998. As a percentage of net sales,
general and administrative expenses increased to 18.1% in Fiscal 1999 from 9.2%
in Fiscal 1998. Fiscal 1999 general and administrative included direct fees paid
to The Right Start, Inc. of $0.4 million.
Depreciation Expense. Depreciation expense increased $260,000 from $18,000
in Fiscal 1998 to $278,000 in Fiscal 1999. This increase was due primarily to
web site hardware and software additions which are being depreciated over a
three year period.
Non-cash compensation expenses. Non-cash compensation expenses relates to
stock options granted at exercise prices below the deemed fair value of
RightStart.com common stock. A non-cash compensation expense of $220,000 was
recorded in Fiscal 1999. There was no non-cash compensation expense in Fiscal
1998.
Interest income. Interest income related to earnings on cash generated from
the sale of preferred stock in July 1999 totaled $238,000 in Fiscal 1999. There
was no interest income in Fiscal 1998.
Tax provision. Tax provision has been computed as if RightStart.com had
operated as a separate entity for all periods presented. As a result of net
losses, no benefit for income taxes was recorded for Fiscal 1999, Fiscal 1998 or
Fiscal 1997. As of January 29, 2000, RightStart.com had net operating loss
carryforwards for federal tax purposes of $9.7 million and for state tax
purposes of $4.8 million. These carryforwards expire in 2020 for federal tax
purposes and in 2005 for state tax purposes, if not previously utilized. A tax
benefit has not been recorded for any period presented due to uncertainties
surrounding the timing of realizing any benefits in future years.
Minority interest in consolidated subsidiary. Minority interest represents
minority stockholders' share of RightStart.com losses. The allocation of the
loss to the minority interest in the amount of $3,000,000 in Fiscal 1999 was due
to the conversion of preferred stock into common stock of RightStart.com. The
allocation of the loss was on a proportional basis from the date of conversion.
Fiscal 1998 Compared to Fiscal 1997
- -----------------------------------
Net sales. Net sales for Fiscal 1998 and Fiscal 1997 were comprised of
sales from the catalog. Net sales decreased $2.7 million, or 36.1%, to $4.7
million in Fiscal 1998 from $7.4 million in Fiscal 1997. The decline in net
sales resulted from the mailing of 44.9% fewer catalogs in accordance with The
Right Start, Inc. management's operating plan to de-emphasize the catalog
business in favor of The Right Start, Inc.'s retail store operations.
Cost of goods sold. Gross margin increased to 54.0% in Fiscal 1998 from
52.1% in Fiscal 1997 due to a more favorable mix of products sold.
Operating expenses. Operating expenses decreased by $1.9 million, or 45.6%,
to $2.2 million in Fiscal 1998 from $4.1 million in Fiscal 1997. As a
percentage of net sales, operating expenses decreased to 47.0% in Fiscal 1998
from 55.2% in Fiscal 1997. This reduction is attributable to the decrease in
the number of catalogs produced and distributed as well as improved cost
controls. Distribution expenses of $45,000 in Fiscal 1998 and $473,000 in
Fiscal 1997 were allocated from The Right Start, Inc.. This decrease in the
allocations was due to a reduction in the ratio of net catalog sales to total
net sales between the periods.
13
General and administrative expenses. General and administrative expenses
decreased by $378,000, or 46.3%, to $438,000 in Fiscal 1998 from $816,000 in
Fiscal 1997. As a percentage of net sales, general and administrative expenses
decreased to 9.2% in Fiscal 1998 from 11.0% in Fiscal 1997. General and
administrative expenses of $402,000 in Fiscal 1998 and $730,000 in Fiscal 1997
were allocated from The Right Start, Inc. This decrease in the allocations was
due to a reduction in the ratio of net catalog sales to total net sales between
the periods.
Depreciation expense. No capital additions were made to the catalog
business in fiscal 1998 and depreciation expense was unchanged from the prior
year.
Liquidity and Capital Resources
- --------------------------------
Recapitalization
- ----------------
In April 1998 we 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 were issued
for an aggregate purchase price of $3,850,000 and were purchased principally by
our affiliates. In connection with the sale of the new securities, we entered
into an agreement (the "Agreement") with all of the holders of our existing
subordinated debt 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 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 elected to receive Series A Preferred Stock which has no fixed
dividend rights, is not convertible into common stock, is mandatorily redeemable
by us in May 2002 and will not accrue dividends unless we are 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.
General
- -------
In Fiscal 1999, on a consolidated basis, we used $9.3 million in cash in
our operating activities compared to the $340,000 in cash provided by our
operating activities in Fiscal 1998. In Fiscal 1999, on a consolidated basis, we
used $3.6 million in cash in investing activities for fixed asset additions
compared to $1.3 million in Fiscal 1998 for fixed asset additions. The primary
source of funds for this use of cash in Fiscal 1999 was the sale by
RightStart.com to third-party investors of its preferred stock which netted
proceeds of $13.7 million and borrowings under our $13 million senior credit
facility (the "Credit Facility") totaling approximately $3.4 million.
Retail Store Operations
- -----------------------
During Fiscal 1999, our primary sources of liquidity for Retail Store
Operations were from borrowings under the Credit Facility. The Credit Facility
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 29, 2000 borrowings of $3.4 million were outstanding under
the Revolving Line and $3.0 million was outstanding under the Capex Line; $1.5
14
million was available at January 29, 2000 under the Revolving Line. Interest
accrues on the Revolving Line at prime plus 1.0% and at prime plus 1.5% on the
Capex Line. At January 29, 2000, the bank's prime rate of interest was 8.5%.
The Credit Facility terminates on February 19, 2001, and on such date, all
borrowings thereunder are immediately due and payable. Borrowings under the
Credit Facility are secured by substantially all of our assets (including our
stock in RightStart.com but excluding the assets of RightStart.com). We plan to
replace the Credit Facility by January 2001.
The Credit Facility, as amended, required us, excluding any contribution
from RightStart.com, at all times during Fiscal 1999, to maintain net worth
(defined to include equity, additional paid-in capital, retained earnings
(accumulated deficit) and subordinated debt and excluding the operating results
of RightStart.com) of at least $8.0 million. The Credit Facility also required
that our earnings before interest, taxes, depreciation and amortization and non
recurring charges ("EBITDA") exceed $500,000 for each of the twelve months ended
January 31, 2000, the twelve months ending April 30, 2000, the twelve months
ending July 31, 2000, the twelve months ending October 31, 2000 and the twelve
months ending January 31, 2001. In addition, our capital expenditures are
limited to $1,750,000 in Fiscal 2000. We entered into an amendment to the Credit
Facility in April 2000 that reduced our minimum required EBITDA from $500,000 to
$250,000 for the first quarter of Fiscal 2000, changed our required minimum net
worth to amounts decreasing to a low of $6,772,000 as of the end of July 2000
and returning to $8,000,000 as of the end of August 2000 and added an
amortization requirement to the Capex Line of $100,000 per month beginning May
1, 2000. We also received a waiver of compliance with the financial covenants
under the Credit Facility for periods between the fiscal year end and the date
of the amendment.
We have a deferred tax asset of $13.8 million, which is reserved against by
a valuation allowance of $12.4 million, for a net deferred tax asset of $1.4
million. Management expects that we will generate $4.0 million of taxable income
within the next 15 years to utilize a minimum of $1.4 million of 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, we could implement certain tax planning strategies including the
sale of certain of our operations or some of our investment in RightStart.com.
Based on the expected 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 a portion of the NOL
carryforwards.
Our ability to fund our operations, open new stores on our planned
timeframe and maintain compliance with our Credit Facility is dependent on our
ability to generate sufficient cash flow from operations and secure financing.
We are considering our financing alternatives. Historically, we have incurred
losses and may continue to incur losses in the near term. Depending on the
success of our business strategy, we may continue to incur losses. Losses could
negatively affect working capital and the extension of credit by our suppliers
and impact operations.
RightStart.com
- --------------
During Fiscal 1999, RightStart.com's primary sources of liquidity were from
the issuance of Series A Convertible Preferred Stock in RightStart.com to third-
party investors which provided net proceeds of $13.7 million. RightStart.com
used those proceeds to create and stock the Baby Store, Kids' Development Store,
Big Kids' Store and Teachers' Store and build an online business. The Credit
Facility does not permit us to make investments in RightStart.com without lender
consent. The offering and the purchase of website development and maintenance
services for RightStart.com from its technology services provider through the
exchange of common stock for these services has reduced our ownership of
RightStart.com to approximately 60% of its outstanding common stock. In April
2000, RightStart.com sold secured bridge notes in the aggregate principal amount
$2,180,000 (the "Bridge Notes") and warrants to purchase 109,000 shares of its
common stock at an exercise price of $6.70 to affiliates, to provide funding
until RightStart.com can obtain additional equity financing. A default on the
Bridge Notes would permit such holders to foreclose on the assets of
RightStart.com and require RightStart.com, to the extent it has not already done
so, to issue to the holders of the notes, warrants to purchase an aggregate of
8,720,000 shares, or approximately 48.9% of the outstanding common stock of
RightStart.com, at an exercise price of $0.25 per share. RightStart.com's
ability to fund its operations and grow its market share is dependant upon its
ability to raise
15
additional capital. On January 18, 2000, RightStart.com filed a registration
statement with the Securities and Exchange Commission with respect to an
offering of its common stock. It has delayed that offering because of adverse
market conditions. RightStart.com is considering its financing alternatives. In
the event additional funds are not available, RightStart.com would reduce its
spending on advertising, marketing and other operating costs.
RightStart.com entered into a term sheet in November 1999 with Oxygen Media,
LLC. The term sheet contemplates that over the three-year term of the proposed
agreement RightStart.com would provide consideration approximating $13.7 million
including in-kind consideration provided by us.
Impact of Inflation
- -------------------
The impact of inflation on results of operations has not been significant
during our last three fiscal years.
Seasonality
- -----------
Our business is not significantly impacted by seasonal fluctuations, when
compared to many other specialty retail and catalog operations. Our products are
for the most part need-driven and the customer is often the end user of the
product. We do, however, experience increased sales during the Christmas holiday
season and expect that this seasonality may increase as RightStart.com's
business for children through age twelve increases and forms a greater portion
of our financial results.
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 our
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.
We were adequately prepared for year 2000 and did not experience any
meaningful disruptions related to our information technology ("IT") and non-IT
systems. Additionally, we did not encounter any disruptions in service or
communications with our mission critical service vendors, suppliers of products,
logistics vendors or it's customers.
New Accounting Requirements
- ---------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards FAS 133, "Accounting for Derivative Instruments
and Hedging Activities," effective beginning in the first quarter of 2000. FAS
133 establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires companies to recognize all derivatives as either
assets or liabilities on the balance sheet and measure those instruments at fair
value. FAS 133 was amended by Standard FAS No. 137 which defers the effective
date of the FAS 133 to all fiscal quarters of fiscal years beginning after June
15, 2000. FAS No. 133 is effective for our first fiscal quarter in the year
2001 and is not expected to have a material effect on our financial position.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------- ----------------------------------------------------------
16
In the ordinary course of operations, we face no significant market risk.
Our purchase of imported products subjects us 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 United
States dollar, the price of imported products could increase. We have no
commitments, however, for future purchases with foreign vendors and,
additionally, we have 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 our debt obligations, the interest rates of which are linked to the prime
rate. We have not entered into any derivative financial instruments to mange
interest rate risk, currency risk or for speculative purposes and we are
currently not evaluating the future use of these instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------
Our financial statements and supplementary data is as set forth in Item
14(a) hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------- ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
We have not had any disagreements with our accountants on our accounting
and financial disclosure. As previously disclosed, we selected Arthur Andersen
LLP to be our independent public accountants beginning in our last fiscal year
which selection was approved by our stockholders at our last annual meeting held
September 9, 1999.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------- --------------------------------------------------
The information contained in our Proxy Statement under the captions
"Executive Officers" and "Election of Directors" is incorporated herein by
reference. Our Proxy Statement will be filed with the Securities and Exchange
Commission no later than 120 days after the close of Fiscal 1999.
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
The information contained in our Proxy Statement under the caption
"Executive Compensation and Other Information" is incorporated herein by
reference. Our Proxy Statement will be filed with the Securities and Exchange
Commission no later than 120 days after the close of Fiscal 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
17
The information contained in our Proxy Statement under the caption
"Principal Shareholders and Management" is incorporated herein by reference. Our
Proxy Statement will be filed with the Securities and Exchange Commission no
later than 120 days after the close of Fiscal 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
The information contained in our Proxy Statement under the caption
"Certain Relationships and Related Transactions" is incorporated herein by
reference. Our Proxy Statement will be filed with the Securities and Exchange
Commission no later than 120 days after the end of Fiscal 1999.
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 Public Accountants F - 1
Report of Independent Accountants F - 1-A
Consolidated Balance Sheets - January 29, 2000 and January 30, 1999 F - 2
Consolidated Statements of Operations - Periods Ended January 29, 2000, F - 3
January 30, 1999 and January 31, 1998
Consolidated Statements of Shareholders' Equity - Periods Ended F - 4
January 29, 2000, January 30, 1999 and January 31, 1998
Consolidated Statements of Cash Flows - Periods Ended January 29, 2000, F - 5
January 30, 1999 and January 31, 1998
Notes to Consolidated Financial Statements F - 6
(2) Financial Statement Schedules:
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
18
The following exhibits are filed as part of, or incorporated by reference
into, this annual report:
19
INDEX TO EXHIBITS
Exhibit
Number
- ------
3.1 Amended and Restated Articles of Incorporation of the company, dated August 12, 1991(1)
3.2 Amendment to Articles of Incorporation, dated August 20, 1991(1)
3.3 Form of Amendment to Articles of Incorporation, dated August 24, 1991(1)
3.4 Bylaws of the company, as amended(2)
3.5 Specimen Certificate of the Common Stock (without par value)(1)
4.1 Warrant to purchase 5,000 shares of common stock issued to Heller Financial, Inc.
4.2 Warrant to purchase 54,600 shares of common stock issued to Jonathan Davidson (3)
4.3 Warrant to purchase 119,700 shares of common stock issued to Sierra Ventures VII, L.P. (4)
4.4 Warrant to purchase 136,500 shares of common stock issued to Oxygen Media, LLC
10.1 1991 Key Employee Stock Option Plan (5)
10.2 Form of Indemnification Agreement between Registrant and its directors and executive officers
(5)
10.3 Asset Purchase Agreement for Acquisition of the Assets of Small People, Inc. and Jimash
Corporation by Right Start Subsidiary I, Inc.(6)
10.4 1995 Non-employee Directors Option Plan (7)
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(7)
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.(7)
10.7 Convertible Debenture Purchase Agreement between The Right Start, Inc. and Cahill Warnock
Strategic Partners, LP dated as of October 11, 1996(8)
10.8 First Amendment to Convertible Debenture Purchase Agreement between The Right Start, Inc. and
Cahill Warnock Strategic Partners, LP dated as of May 30, 1997 (9)
10.9 Convertible Debenture Purchase Agreement between The Right Start, Inc. and Strategic
Associates, LP dated as of October 11, 1996 (8)
10.10 First Amendment to Convertible Debenture Purchase Agreement between The Right Start, Inc. and
Strategic Associates, LP dated as of May 30, 1997 (9)
10.11 Registration Rights Agreement dated October 11, 1996 between The Right Start, Inc. and
Strategic Associates, L.P. (10)
10.12 Registration Rights Agreement dated October 11, 1996 between The Right Start, Inc. and Cahill,
Warnock Strategic Partners Fund, L.P. (10)
20
10.13 Loan and Security Agreement dated as of November 14, 1996 between The Right Start, Inc. and
Heller Financial, Inc. (8)
10.14 First Amendment to Loan and Security Agreement and Limited Waiver and Consent dated as of April
30, 1997 (11)
10.15 Second Amendment to Loan and Security Agreement and Limited Waiver and Consent dated as of June
10, 1997 (12)
10.16 Third Amendment to Loan and Security Agreement and Limited Waiver and Consent dated as of
September 3, 1997 (12)
10.17 Fourth Amendment to Loan and Security Agreement and Limited Waiver and Consent dated as of
January 30, 1998 (10)
10.18 Waiver and Fifth Amendment to Loan and Security Agreement dated as of December 9, 1998 (13)
10.19 Consent by Heller Financial, Inc. to transactions relating to RightStart.com Inc. and
modification of Loan Agreement, dated as of July 8, 1999.
10.20 Sixth Amendment to Loan and Security Agreement and First Amendment to Secured Capex Note dated
as of November 8, 1999 (13)
10.21 Seventh Amendment to Loan and Security Agreement and Second Amendment to Secured Capex Note
dated as of January 18, 2000
10.22 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 (10)
10.23 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 (10)
10.24 The Right Start, Inc. Letter Agreement dated as of April 6, 1998(14)
10.25 The Right Start, Inc. Amendment to Letter Agreement dated as of April 13, 1998(14)
10.26 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 (14)
10.27 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 (14)
10.28 Registration Rights Agreement dated April 13, 1998 between The Right Start, Inc. and the
investors named therein (10)
10.29 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 (12)
10.30 Management Services Agreement dated July 9, 1999 between The Right Start and RightStart.com (15)
10.31 Intellectual Property Agreement dated July 9, 1999 between The Right Start and RightStart.com
(15)
10.32 Series A Preferred Stock Purchase Agreement dated July 9, 1999 (15)
21
10.33 Investors' Rights Agreement dated July 9, 1999 among RightStart.com, Sierra Ventures VII, L.P.,
Sierra Ventures Associates VII, L.L.C., Ajit Shah, Robert Simon and Palomar Ventures I, L.P.
(15)
10.34 Form of Indemnification Agreement between RightStart.com and its directors
10.35 1999 RightStart.com Stock Option Plan
10.36 Subscription Agreement dated July 9, 1999 between RightStart.com and Johnathan Davidson
10.37 Subscription Agreement dated December 30, 1999 between RightStart.com and Oxygen Media, LLC
10.38 Stock Grant Agreement dated October 30, 1999 between The Right Start, RightStart.com and
Guidance Solutions
10.39 Registration Rights Agreement dated October 30, 1999 between RightStart.com and Guidance
Solutions
23.1 Consent of Independent Public Accountants - Arthur Andersen
23.2 Consent of Independent Accountants - PricewaterhouseCoopers
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) Substantially identical warrants have been granted to each of James W.
Montgomery (for 58,240 shares of common stock), Kim Enterprises, L.L.C.
(for 49,140 shares of common stock), Michael Holton(for 5,460 shares of
common stock), David P. Michaels (for 5,460 shares of common stock) and
David A. Burns (for 9,100 shares of common stock).
(4) Substantially identical warrants have been granted to Sierra Ventures
Associates VII, L.L.C. (for 11,970 shares of common stock), Ajit Shah (for
165 shares of common stock), Robert Simon (for 165 shares of common stock)
and Palomar Ventures I, L.P. (for 33,000 shares of common stock).
(5) Previously filed as an Exhibit to Amendment Number 1 to the company's
Registration Statement on Form S-1 dated September 11, 1991.
(6) Previously filed as an Exhibit to the company's 10-K for the fiscal year
ended May 26, 1993.
(7) Previously filed as an Exhibit to the company's 10-K for the year ended
June 1, 1996.
(8) Previously filed as an Exhibit to the company's 10-Q for the period ended
November 30, 1996.
(9) Previously filed as an Exhibit to the company's 10-Q for the period ended
May 3, 1997.
(10) Previously filed as an Exhibit to the company's 10-K for the fiscal year
ended January 31, 1998, as amended.
22
(11) Previously filed as an Exhibit to the company's 10-K for the transition
period from June 2, 1996 to February 1, 1997.
(12) Previously filed as an Exhibit to the company's 10-Q for the period ended
August 2, 1997.
(13) Previously filed as an Exhibit to the company's 10-Q for the period ended
October 30, 1999.
(14) Previously filed as an Exhibit to the company's 8-K dated April 23, 1998.
(15) Previously filed as an Exhibit to the company's 8-K dated July 9, 1999.
(b) Reports on Form 8-K
There were no Reports on Form 8-K filed by the company during the last
quarter of Fiscal 1999.
(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
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
THE RIGHT START, INC.
(Registrant)
Dated: April 28, 2000 / 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, April 28, 2000
- ------------------------- Chief Executive Officer and President
Jerry R. Welch
/s/ Richard A. Kayne Director April 28, 2000
- -------------------------
Richard A. Kayne
/s/ Andrew D. Feshbach Director April 28, 2000
- -------------------------
Andrew D. Feshbach
/s/ Robert R. Hollman Director April 28, 2000
- -------------------------
Robert R. Hollman
/s/ Fred Kayne Director April 28, 2000
- -------------------------
Fred Kayne
/s/ Howard M. Zelikow Director April 28, 2000
- -------------------------
Howard M. Zeliko
/s/ Gina M. Engelhard Chief Financial Officer (Principal April 28, 2000
- ------------------------- Financial and Accounting Officer)
Gina M. Engelhard
24
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Board of Directors and
Shareholders of The Right Start, Inc.
We have audited the accompanying consolidated balance sheet of The Right Start,
Inc. (a California Corporation) and subsidiary as of January 29, 2000 and the
related consolidated statements of operations, shareholders' equity and cash
flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The Right Start, Inc. and
subsidiary as of January 29, 2000, and the results of their operations and their
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Los Angeles, California
April 28, 2000
F-1
Report of Independent Accountants
To the Board of Directors and
Shareholders of The Right Start, Inc.
In our opinion, the accompanying balance sheet as of January 30, 1999 and the
related statements of operations, of changes in shareholders' equity and of cash
flows for each of the two years in the period ended January 30, 1999 present
fairly, in all material respects, the financial position, results of operations
and cash flows of The Right Start, Inc. at January 30, 1999 and for each of the
two years in the period ended January 30, 1999, in conformity with accounting
principles generally accepted in the United States. 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 auditing standards
generally accepted in the United States, 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. We have not audited the consolidated financial statements of The Right
Start, Inc. for any period subsequent to January 30, 1999.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 12, 1999
F-1-A
THE RIGHT START, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
---------------------------
January 29, 2000 January 30, 1999
---------------- ----------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 5,199,000 $ 626,000
Accounts and other receivables 682,000 585,000
Merchandise inventories 9,694,000 5,797,000
Other current assets 1,849,000 1,292,000
-------------- --------------
Total current assets 17,424,000 8,300,000
Noncurrent assets:
Property, fixtures and equipment, net 10,648,000 7,884,000
Deferred income taxes 1,400,000 1,400,000
Other noncurrent assets 1,255,000 87,000
-------------- --------------
$ 30,727,000 $ 17,671,000
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 9,566,000 $ 3,822,000
Revolving line of credit 3,377,000
Term note payable 2,750,000
-------------- --------------
Total current liabilities 12,943,000 6,572,000
Term note payable 3,000,000
Deferred rent 1,378,000 1,449,000
Minority interest in consolidated subsidiary 3,397,000
Commitments and contingencies
Mandatorily redeemable preferred stock Series A,
$3,000,000 redemption value 2,088,000 1,789,000
Shareholders' equity:
Convertible preferred stock Series B 1,875,000 2,813,000
Convertible preferred stock Series C 3,850,000 3,850,000
Common stock (25,000,000 shares authorized
at no par value; 5,417,666 and 5,051,820
issued and outstanding, respectively) 22,593,000 22,337,000
Paid in capital 16,142,000 3,571,000
Deferred compensation (671,000)
Accumulated deficit (35,868,000) (24,710,000)
-------------- --------------
Total shareholders' equity 7,921,000 7,861,000
-------------- --------------
$ 30,727,000 $ 17,671,000
============== ==============
See accompanying notes to consolidated financial statements
F-2
THE RIGHT START, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year Ended
----------------------------------------------------------
January 29, 2000 January 30, 1999 January 31, 1998
---------------- ---------------- ----------------
Retail Store Sales $ 38,043,000 $ 31,875,000 $ 31,107,000
Online sales before promotional discounts 9,020,000
Catalog sales 3,645,000 4,736,000 7,414,000
--------------- --------------- --------------
Total sales 50,708,000 36,611,000 38,521,000
Promotional discounts related to online sales 1,629,000
--------------- ------------- ------------
Net sales 49,079,000 36,611,000 38,521,000
Costs and expenses:
Cost of goods sold 25,279,000 18,576,000 19,244,000
Operating expense 20,370,000 15,106,000 19,019,000
Non-cash compensation 2,014,000
Marketing and advertising expense 7,233,000 387,000 193,000
General and administrative expense 5,306,000 3,337,000 3,912,000
Pre-opening costs 323,000 209,000 711,000
Depreciation and amortization expense 1,950,000 1,488,000 1,608,000
Other (income) and expense:
Other expense 698,000
Store closing (income) expense 151,000 (113,000) 1,207,000
--------------- --------------- --------------
62,626,000 38,990,000 46,592,000
--------------- --------------- --------------
Operating loss (11,918,000) (2,379,000) (8,071,000)
Non-cash beneficial conversion feature amortization 3,850,000
Minority interest in consolidated subsidiary loss (3,000,000)
Interest expense, net 227,000 640,000 1,143,000
--------------- --------------- --------------
Loss before income taxes and extraordinary item (9,145,000) (6,869,000) (9,214,000)
Income tax provision 68,000 22,000 27,000
--------------- --------------- --------------
Loss before extraordinary item (9,213,000) (6,891,000) (9,241,000)
Extraordinary gain on debt restructuring, net 1,211,000
--------------- --------------- --------------
Net loss $ (9,213,000) $ (5,680,000) $ (9,241,000)
=============== =============== ==============
Basic and diluted loss per share:
Loss before extraordinary item $ (1.84) $ (1.37) $ (2.01)
Extraordinary item 0.24
--------------- --------------- --------------
Net loss $ (1.84) $ (1.13) $ (2.01)
=============== =============== ==============
Weighted average number of shares
outstanding 5,355,756 5,051,820 4,594,086
=============== =============== ==============
See accompanying notes to consolidated financial statements
F-3
THE RIGHT START, INC. AND SUBSIDIARY
STATEMENTS OF SHAREHOLDERS' EQUITY
----------------------------------
Preferred Stock
----------------------------------------------------
Series B Series C Common Stock
------------------------- ------------------------ ------------
Shares Amount Shares Amount Shares
--------- -------------- ------------ ---------- ------------
Balance February 1, 1997 4,076,820
Exercise of stock options 220,000
Issuance of shares in private placement 755,000
Proceeds related to Senior subordinated notes
Net loss
--------- ----------- ---------- ------------ ----------
Balance January 31, 1998 5,051,820
Issuance of preferred stock 30,000 $2,813,000 38,500 $3,850,000
Issuance of subordinated debt in conjunction
with recapitalization, net
Preferred dividend accretion
Net loss
--------- ----------- ---------- ------------ ----------
Balance January 30, 1999 30,000 $2,813,000 38,500 $3,850,000 5,051,820
Preferred shares converted to common (10,000) ($938,000) 333,333
Issuance of shares pursuant to the exercise of stock options 27,383
Recapitalization costs
Preferred dividend accretion
Induced conversion of Subsidiary's preferred stock
Issuance of shares to Lender 5,130
Issuance of warrants to Lender
Performance options
Subsidiary options
Director's options
Amortization of deferred compensation
Gain on issuance of common stock of subsidiary
Net loss
--------- ----------- ---------- ------------ ----------
Balance January 29, 2000 20,000 $1,875,000 38,500 $3,850,000 5,417,666
========= =========== ========== ============ ==========
Common Stock
------------ Paid in Deferred Accumulated
Amount Capital Compensation Deficit Net Equity
------------ ---------- ------------ ----------- ----------
Balance February 1, 1997 $16,961,000 ($9,789,000) $7,172,000
Exercise of stock options 1,320,000
Issuance of shares in private placement 1,320,000 3,705,000
Proceeds related to Senior subordinated notes 3,705,000 351,000
Net loss 351,000 (9,241,000) (9,241,000)
----------- ----------- -------- ---------- -------------
Balance January 31, 1998 22,337,000 ($19,030,000) 3,307,000
-
Issuance of preferred stock 6,663,000
Issuance of subordinated debt in conjunction $3,590,000 3,590,000
with recapitalization, net (19,000) (19,000)
Preferred dividend accretion
Net loss (5,680,000) (5,680,000)
------------ ----------- -------- ------------ -------------
Balance January 30, 1999 22,337,000 3,571,000 ($24,710,000) 7,861,000
Preferred shares converted to common 938,000
Issuance of shares pursuant to the exercise of stock options 155,000 155,000
Recapitalization costs (56,000) (56,000)
Preferred dividend accretion (301,000) (301,000)
Induced conversion of Subsidiary's preferred stock 316,000 (316,000)
Issuance of shares to financial institution 101,000 101,000
Issuance of warrants to financial institution 58,000 58,000
Performance options 1,770,000 1,770,000
Subsidiary options 815,000 (815,000)
Director's options 100,000 (100,000)
Amortization of deferred compensation 244,000 244,000
Gain on issuance of common stock of Subsidiary 8,931,000 8,931,000
Net loss (10,842,000) (10,842,000)
----------- ----------- --------- ------------ -------------
Balance January 29, 2000 $22,593,000 $16,142,000 ($671,000) ($35,868,000) $7,921,000
=========== =========== ========= ============ =============
See accompanying notes to consolidated financial statements
F-4
THE RIGHT START, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Year Ended
---------------------------------------------------------
January 29, 2000 January 30, 1999 January 31, 1998
----------------- ---------------- ----------------
Cash flows from operating activities:
Net loss $ (10,842,000) $ (5,680,000) $ (9,241,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Depreciation and amortization 1,950,000 1,538,000 2,319,000
Non-cash compensation 2,014,000
Non-cash beneficial conversion feature amortization 3,850,000
Non-cash advertising expense 9,000
Store closing expense 151,000 39,000 1,580,000
Minority interest in consolidated subsidiary loss (3,000,000)
Amortization of discount on senior subordinated notes 44,000 85,000
Extraordinary gain (1,211,000)
Change in assets and liabilities affecting operations 442,000 1,760,000 (1,316,000)
------------- ------------- ------------
Net cash provided by (used in) operating activities (9,276,000) 340,000 (6,573,000)
------------- ------------- ------------
Net cash used in investing activities:
Additions to property, fixtures and equipment (3,603,000) (1,296,000) (2,063,000)
Cash flows from financing activities:
Net proceeds from (payments on) revolving line of credit 3,377,000 (2,014,000) 181,000
Net proceeds from (payments on ) term note payable 250,000 (250,000) 357,000
Proceeds from private placement of common stock 3,705,000
Proceeds from common stock issued upon exercise of
stock options 155,000 1,320,000
Sale of preferred stock in consolidated subsidiary, net 13,670,000
Proceeds from issuance of senior subordinated notes, net 3,606,000 3,000,000
------------- ------------- ------------
Net cash provided by financing activities 17,452,000 1,342,000 8,563,000
------------- ------------- ------------
Net increase (decrease) in cash and cash equivalents 4,573,000 386,000 (73,000)
Cash at beginning of period 626,000 240,000 313,000
------------- ------------- ------------
Cash and cash equivalents at end of period $ 5,199,000 $ 626,000 $ 240,000
============= ============= ============
See accompanying notes to consolidated financial statements
F-5
THE RIGHT START, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES:
- ------------------------------------------------------------
The Company
- -----------
The Right Start, Inc. (the "Company" or "Parent") is a specialty retailer of
high quality developmental, educational and care products for infants and
children. The consolidated financial statements include the results of the
"Company and its majority-owned subsidiary, RightStart.com Inc.
("RightStart.com" or the "Subsidiary"). RightStart.com was formed in April 1999
for the purpose of engaging in electronic commerce over the Internet. Effective
May 1, 1999, the Company contributed its catalog assets to RightStart.com and in
July 1999, RightStart.com issued preferred stock to certain investors then
representing 33%, on a fully-diluted basis, of RightStart.com's outstanding
capital stock. The preferred stock converted to common stock of RightStart.com
in October 1999. The Company's ownership interest in RightStart.com was 60.2%
at January 29, 2000.
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. The fiscal years
ended January 29, 2000 ("Fiscal 1999"), January 30, 1999 ("Fiscal 1998") and
January 31, 1998 ("Fiscal 1997") were fifty-two week periods.
Revenue Recognition
- -------------------
Retail sales are recorded at time of sale or when goods are delivered. Catalog
and internet sales net of discounts, coupon redemptions and promotional
allowances are recorded at the time of shipment to customers. 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 weighted average
basis.
Cash and Cash Equivalents
- -------------------------
The Company considers all highly liquid investments purchased with an original
maturity date of three months or less to be cash equivalents. At various times
the Company maintains cash accounts with financial institutions in excess of
federally insured amounts.
Concentrations of Credit Risks and Significant Customers
- --------------------------------------------------------
At January 29, 2000 and January 30, 1999 accounts receivable were due from
credit card companies and others. There were no single customers who accounted
for more than 10% of the revenues during any period.
F-6
Concentration of Product Fulfillment and Technology Risk
- --------------------------------------------------------
Since the launch of the online store in June 1999, the Subsidiary has outsourced
its technology department and its fulfillment activities, such as its
warehousing and logistics operations and its call center and customer service
activities. The Company has outsourced its distribution and fulfillment
activities. The Subsidiary is substantially dependent on the technology
services it receives from its technology services providers who host, maintain
and develop its website and provide technical assistance to its third-party
distribution provider and its in-house logistics team. The Subsidiary's
principal technology service provider is also a shareholder of the Subsidiary
and the Company believes RightStart.com's relationship with them to be very good
and, if necessary, the Subsidiary could locate replacement services without
material difficulty. Neither the Company nor the Subsidiary has long-term
contracts with its respective fulfillment services providers but the Company and
the Subsidiary have been operating under agreements setting forth the terms at
which we will purchase those services and believes that replacement providers
could be found without material difficulty should the need arise. Nonetheless,
a failure in any of these outsourced services could have a material adverse
effect on the Company or the Subsidiary.
Prepaid Catalog Costs
- ---------------------
Prepaid catalog costs consist of the costs to produce, print and distribute
catalogs. These costs are amortized over the expected sales life of each
catalog, which typically does not exceed four months. Catalog production
expenses of $1,334,000, $1,363,000 and $2,753,000 were recorded in Fiscal 1999,
Fiscal 1998 and Fiscal 1997, respectively.
Product Development Expenses
- ----------------------------
During Fiscal 1999, the Subsidiary used a third party ("Guidance Solutions") to
develop and maintain its online store. Expenses associated with the online
store consist of costs related to software development, maintenance, online
store operations, systems and telecommunications infrastructure and acquired
content.
The Company capitalizes software costs incurred related to the application
development stage. All other software development costs are expensed as
incurred. Software and website costs are amortized over a three-year period.
Long-lived Assets
- -----------------
The Company periodically evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful lives of long-lived assets
may warrant revision or that the remaining balance may not be recoverable. When
factors indicate that an asset should be evaluated for possible impairment, the
Company uses an estimate of the asset's undiscounted net cash flows over its
remaining life in measuring whether the asset is recoverable. There are no
assets that have been determined to require an impairment provision.
Property, Fixtures and Equipment
- --------------------------------
Property, fixtures and equipment are stated at cost less accumulated
depreciation and amortization. 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-7
Pre-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.
Advertising
- -----------
Advertising costs are expensed as incurred or at the time of the initial print
or media broadcast. Advertising expenses of $7,233,000, $387,000 and $193,000
were recorded in Fiscal 1999, Fiscal 1998 and Fiscal 1997, respectively.
Deferred Rent
- -------------
The Company recognizes rent expense on a 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.
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 and diluted loss per share data is computed by dividing net loss
applicable to common shareholders by the weighted average number of common
shares outstanding. Diluted income per share data is computed by dividing
income available to common shareholders plus adjustment for costs 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-8
Fiscal 1999 Fiscal 1998 Fiscal 1997
----------- ----------- -----------
Loss before extraordinary item $10,842,000 $6,891,000 $9,241,000
Plus: Preferred stock accretion 301,000 19,000
Subsidiary dividend to preferred
shareholders 316,000
----------- ---------- ----------
Basic and diluted loss before
extraordinary item applicable to common
shareholders $11,459,000 $6,910,000 $9,241,000
=========== ========== ==========
Weighted average shares 5,355,756 5,051,820 4,594,086
Loss before extraordinary item per
share, basic and diluted $ 2.14 $ 1.37 $ 2.01
Certain securities of the Parent 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 1,001,407, 890,519 and
326,005 shares of common stock at January 29, 2000, January 30, 1999 and January
31, 1998, respectively, Series B preferred stock convertible into 666,667 and
1,000,000 shares of common stock at January 29, 2000 and January 30, 1999 and
Series C preferred stock convertible into 1,925,000 shares of common stock at
January 29, 2000 and January 30, 1999.
Stock-Based Compensation
- ------------------------
Stock options issued to employees and members of the Company's board of
directors are accounted for in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
Accordingly, compensation expense is recorded for options awarded to employees
and directors to the extent that the exercise prices are less than the fair
market value of the common stock on the date of grant where the number of
options and the exercise price are fixed. The difference between the fair value
of the common stock and the exercise price of the stock option is recorded as
deferred compensation, which is charged to expense over the vesting period of
the underlying stock option. The Company follows the disclosure requirements of
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock Based Compensation".
In April 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation", an interpretation of APB opinion No. 25 which is effective July
1, 2000. The interpretation requires that any options granted to non-employees
of the Company after December 15, 1998 be accounted for under statement of
Financial Accounting Standard No. 123. As of January 29, 2000 there were no
options issued by the Company to non-employees.
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
F-9
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Comprehensive Income
- --------------------
The Company has not had any items of other comprehensive income in any period
presented.
Fair Value of Financial Instruments
- -----------------------------------
The carrying amounts of all receivables, payables and accrued expenses
approximate fair value due to the short-term nature of such instruments. The
carrying amount of the revolving and Capex credit facilities approximates fair
value due to the floating rate on such instruments.
New Accounting Pronouncements
- -----------------------------
In June 1999, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting For Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities.
SFAS 133, as amended by SFAS 137, is effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. The Company currently does not have
or use derivative instruments.
NOTE 2 - CONSOLIDATED OPERATING RESULTS AND RISKS
- -------------------------------------------------
For Fiscal 1999, the Company had a net loss of $10,842,000 and a use of cash
from operating activities of approximately $9,276,000. The Company is currently
projecting to have operating losses through Fiscal 2000.
The Subsidiary launched its online store in June 1999 and has incurred
significant development and marketing expenditures which have contributed
significantly to the consolidated loss in Fiscal 1999. The Company and
Subsidiary currently plan to continue to grow the Subsidiary's market share
through advertising, strategic partnerships and alliances. In order to continue
to fund operations and grow its market share it will be necessary for the
Subsidiary to raise additional capital. On January 18, 2000, the Subsidiary
filed a registration statement on Form S-1 with the Securities and Exchange
Commission. A portion of the proceeds from this offering were to be used by the
Subsidiary to fund operations and for working capital. Due to adverse market
conditions, this offering has been delayed. The Subsidiary is considering its
financing alternatives. ( see Note 18) The risks associated with the development
of an online business are significant and include, among others, competition
from other children's product retailers, losses expected in the online business,
limitations on access to capital to fund the online business, the dependence of
RightStart.com on its technology services provider, consumer acceptance of
online retailing and RightStart.com's online stores and the lack of operating
experience at RightStart.com.
At January 29, 2000 approximately $757,000 of professional fees and other costs
associated with the initial filing of an initial public offering related to
RightStart.com, were included in other assets. The Subsidiary expects these
costs to be offset against capital raised through the initial public offering or
other equity or debt financing in Fiscal year 2000.
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
F-10
Company's operations.
NOTE 3 - PROPERTY, FIXTURES AND EQUIPMENT, NET:
- ----------------------------------------------
January 29, January 30,
2000 1999
---- ----
Property, fixtures and equipment, at cost:
Fixtures and equipment $ 5,623,000 $ 4,015,000
Leaseholds and leasehold improvements 8,770,000 7,511,000
Computer software 2,597,000 840,000
----------- -----------
16,990,000 12,366,000
Accumulated depreciation and amortization (6,342,000) (4,482,000)
----------- -----------
$10,648,000 $ 7,884,000
=========== ===========
In October 1999, approximately 288,333 shares of RightStart.com common stock
owned by the Company were issued to Guidance Solutions for services rendered
through October 30, 1999 and as an incentive for Guidance Solutions to continue
to provide services to the Subsidiary over the next ten months. The Subsidiary
has recorded the fair market value of the shares at the date of transfer as a
capital contribution and capitalized or expensed the pro rata value related to
services performed through January 29, 2000. The total capitalized amounts
related to development of the online store approximated $1,819,000 and are being
amortized over 36 months. Amounts expensed related to the services provided by
Guidance Solutions through January 29, 2000 were approximately $707,000.
Depreciation and amortization expense for property, fixtures and equipment
amounted to $1,950,000, $1,488,000 and $1,608,000 for Fiscal 1999, Fiscal 1998
and Fiscal 1997, respectively.
NOTE 4 - 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
Credit Facility 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 29, 2000 borrowings of $3.4 million were
outstanding under the Revolving Line and $3.0 million was outstanding under the
Capex Line; $1.5 million was available at January 29, 2000 under the Revolving
Line. Interest accrues on the Revolving Line at prime plus 1.0% and at prime
plus 1.5% on the Capex Line. At January 29, 2000, the bank's prime rate of
interest was 8.5%. The Credit Facility terminates on February 19, 2001, 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 (including the Company's stock in the Subsidiary but excluding
the assets of the Subsidiary).
The Credit Facility, as amended, required us, excluding any contribution from
RightStart.com, to maintain net worth (defined to include equity, additional
paid-in capital, retained earnings (accumulated deficit), subordinated debt and
excluding the operating results of the subsidiary) during Fiscal 1999 of at
least $8.0
F-11
million. The Credit Facility also required that our earnings before interest,
taxes, depreciation and amortization and excluding non recurring items
("EBITDA") to exceed $500,000 for each of the twelve months ended January 31,
2000, the twelve months ending April 30, 2000, the twelve months ending July 31,
2000, the twelve months ending October 31, 2000 and the twelve months ending
January 31, 2001. In addition, our capital expenditures are limited to
$1,750,000 in Fiscal 2000. The Company entered into an amendment to the Credit
Facility in April 2000 that reduced minimum required EBITDA from $500,000 to
$250,000 for the first quarter of Fiscal 2000, changed the required minimum net
worth to amounts decreasing to a low of $6,772,000 as of the end of July 2000
and returning to $8,000,000 as of the end of August 2000 and added an
amortization requirement to the Capex Line of $100,000 per month beginning May
1, 2000. The Company also received a waiver of compliance with the financial
covenants under the Credit Facility for periods between the fiscal year end and
the date of the amendment.
Effective May 6, 1997, the Company issued subordinated notes in the aggregate
principal amount of $3,000,000 and warrants to purchase common stock. Certain
of the purchasers 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 6)
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 6)
NOTE 5 - MANDATORILY REDEEMABLE PREFERRED STOCK:
- -----------------------------------------------
In connection with the Company's recapitalization (see Note 6), 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 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 6 - SHAREHOLDERS' EQUITY:
- -----------------------------
F-12
Recapitalization
- ----------------
In April 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 were issued
for an aggregate purchase price of $3,850,000 and were purchased principally by
the Company's affiliates. 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 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 shares of preferred stock. Ten shares of newly issued preferred
stock ("the 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
elected to receive Series A Preferred Stock which has no fixed dividend rights,
is not convertible into common stock, is mandatorily redeemable by us 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.
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. Both Series B and Series C preferred stock have a
par value of $.01 per share and a liquidation preference of $100 per share.
During Fiscal 1999, 10,000 shares of Series B preferred stock converted into
333,333 shares of common stock.
F-13
NOTE 7 - INCOME TAXES:
- ---------------------
The provision for income taxes is comprised of the following:
Year Ended
---------------------------------------
January 29, January 30, January 31,
2000 1999 1998
----------- ----------- -----------
Current provision:
Federal
State $68,000 $22,000 $27,000
Deferred provision:
Federal
State __________ __________ __________
$68,000 $22,000 $27,000
=========== =========== ===========
The Company's effective income tax rate differed from the federal statutory rate
as follows:
Year Ended
------------------------------------------
January 29, January 30, January 31,
2000 1999 1998
---- ---- ----
Federal statutory rate 34% 34% 34%
State income taxes, net of federal
benefit 3 3
Stock options
Valuation allowance (34) (11) (39)
Debt discount amortization (23)
Other (3) 2
----- ----- -----
Effective income tax rate 0% 0% 0%
===== ===== =====
F-14
Deferred tax (liabilities) assets are comprised of the following:
January 29, January 30,
2000 1999
------------ -----------
Depreciation and amortization $ (167,000) $ (87,000)
Other (27,000) (27,000)
------------ -----------
Deferred tax liabilities (194,000) (114,000)
------------ -----------
Net operating loss carryforwards 12,054,000 7,672,000
Deferred rent 625,000 604,000
Deferred compensation 820,000
Other reserves 98,000 868,000
Other 280,000 69,000
Sales returns 96,000 29,000
------------ -----------
Deferred tax assets 13,973,000 9,242,000
------------ -----------
Valuation allowance (12,379,000) (7,728,000)
------------ -----------
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 $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 some of its operations or a
portion of the Company's stock ownership in RightStart.com in order to generate
income to enable the Company to realize its NOL carryforwards. Based on the
expected operating improvements, combined with tax planning strategies,
management believes that adequate taxable income will be generated over the next
15 years in which to utilize at least a portion of the NOL carryforwards
The Company has federal and state net operating loss carryforwards at January
29, 2000 of $23.7 million and $9.4 million, respectively. The Subsidiary had
federal and state net operating loss carryforwards at January 29, 2000 of
approximately $9.7 million and $4.8 million which expire in fiscal year 2020.
These carryforwards will expire in fiscal years ending 2002 through 2020.
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
F-15
options exercisable at $6.00 per share, the fair market value at the time of
reissuance. At January 29, 2000, 21,500 shares were outstanding under this plan
and there were no additional options available for future grants.
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.
In October 1991, the Company adopted the 1991 Employee Stock Option Plan, which,
as amended, covers an aggregate of 900,000 shares of the Company's common stock.
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 New Options vest in accordance with the terms of the individual grants. At
January 29, 2000, there were no Existing Options outstanding. Options for
375,960 shares were exercisable at January 29, 2000.
In October 1995, the Company adopted the 1995 Non-Employee Directors Option
Plan, as amended, to cover an aggregate of 200,000 shares of common stock. 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, additional options
to purchase common stock. The amount of additional options is determined using
the Black-Scholes option-pricing model such that the fair value of the options
issued is equivalent to the fees that the director would be otherwise entitled
to receive. Prior to Fiscal 1999, the amount of additional options was
determined based on an independent valuation. 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 172,130 shares of common stock were issued under this plan
at exercise prices ranging from $2.50 to $10.46 per share, such exercise price
being equal to the closing price of the Company's common stock on the date of
grant. In Fiscal 1999, the Company recorded $100,000 of deferred compensation
for options granted under this plan, of which $24,000 was charged to expense
during the period. At January 29, 2000, 146,477 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 Company matches employees' contributions to the ESPP at
a rate of 50%. The Company's contributions to the ESPP amounted to $12,000,
$14,000 and $24,000 in Fiscal 1999, Fiscal 1998 and Fiscal 1997, respectively.
F-16
The following table summarizes the Company' option activity through January 29,
2000:
Fair Value Options Exercisable
Number of Weighted Average of Options Exercisable Weighted Average
Options Exercise Price Granted at Year End Exercise Price
---------- ---------------- ---------- ----------- ----------------
Outstanding at February 1, 1997 489,960 $7.40
Granted 98,295 5.00 $1.55
Canceled (42,250) 8.08
Exercised (220,000) 6.00
Outstanding at January 31, 1998 326,005 7.62 323,921 $4.17
Granted 785,014 3.03 $1.07
Canceled (220,500) 7.13
Outstanding at January 30, 1999 890,519 3.72 148,006 $7.15
Granted 148,270 8.20 5.31
Canceled (9,999) 3.50
Exercised (27,383) 5.64
Outstanding at January 29, 2000 1,001,407 4.33 543,937 $3.75
The following table summarizes information concerning the Company's outstanding
and exercisable stock options at January 29, 2000:
Number Weighted Average Weighted Average
Range of Outstanding at Remaining Contractual Exercise Price of Number Exercisable
Exercise Prices January 29,2000 Life Options Outstanding at January 29,2000
- ---------------- ----------------- ---------------------- -------------------- --------------------
$2.50 - $3.50 731,514 7.9 years $ 3.03 422,314
$5.00 - $7.88 173,412 7.9 years 6.67 58,412
$8.50 - $17.25 96,481 3.0 years 10.02 63,211
--------- ------ -------
1,001,407 $ 4.33 543,937
========= ====== =======
The fair value of each option grant was estimated on the date of grant using the
Black-Sholes option-pricing model with the following assumptions:
Fiscal 1999 Fiscal 1998 Fiscal 1997
----------- ----------- -----------
Risk-free interest rates 5.27% 5.17% 6.00%
Expected life (in years) 4 4 4
Dividend yield 0% 0% 0%
Expected volatility 85.33% 76.91% 79.34%
The Company and the Subsidiary have adopted Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). In
accordance with the provisions of SFAS 123,
F-17
the Company and the Subsidiary apply 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 SFAS 123. If the
Company and the Subsidiary had elected to recognize compensation expense based
upon the fair value at the grant date for awards under their plans consistent
with the methodology prescribed by SFAS 123, the Company's consolidated net loss
and consolidated loss per share, including the Company's share of compensation
expense related to the Subsidiary's option grants, would be increased to the pro
forma amounts indicated below:
Year Ended
----------
January 29, 2000 January 30, 1999 January 31, 1998
---------------- ---------------- ----------------
Net loss:
As reported ($ 10,842,000) ($5,680,000) ($9,241,000)
Pro forma (11,922,000) (6,258,000) (9,640,000)
Basic and diluted loss per share :
As reported ($2.14) ($1.13) ($2.01)
Pro forma (2.34) (1.24) (2.10)
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 Black-Scholes option-pricing 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-pricing models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's and the Subsidiary'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.
In Fiscal 1999, 100,000 options were granted at an exercise price of $7.25 and a
fair value at date of grant of $8.25. The Company recorded $100,000 of deferred
compensation related to these options, of which $24,000 was amortized in Fiscal
1999.
Subsidiary Options
- ------------------
In June 1999, RightStart.com adopted the RightStart.com Inc. 1999 Stock Option
Plan. The total number of shares that can be issued under the plan is
1,818,000. This plan provides for the granting to employees, including officers
and directors, of incentive stock options ("ISO") and for the granting to
employees, consultants and non-employee directors of non-statutory stock
options. Included in the Subsidiary's options granted through January 29, 2000
are 359,000 options granted to employees of The Right Start who are not
employees of the subsidiary. Generally, options granted under this Plan have a
term of ten years, are nontransferable, and vest 25% on the first anniversary of
grant and monthly thereafter over three years.
F-18
The following table summarizes RightStart.com's stock option activity from
inception through January 29, 2000:
Weighted Average Weighted Average
Number of Shares Price Per Share Exercise Price
---------------- --------------- --------------
Granted 1,769,500 $0.45 to $4.50 $1.18
Exercised
Canceled
1,769,500
=========
Weighted average fair value of options granted in Fiscal 1999 was $1.29. In
Fiscal 1999, 535,400 options were granted at an exercise price of $0.45 and a
fair market value at date of grant of $1.67 and 300,000 options were granted at
an exercise price of $3.75 and a fair market value at date of grant of $4.29.
The estimated fair value of the stock at the grant dates were based on third
party appraisals or based on the conversion price of the Subsidiary's preferred
stock converted into common stock of the Subsidiary. For Fiscal 1999 the
Subsidiary recorded $815,000 of deferred compensation in connection with options
granted under the RightStart.com Inc. 1999 Stock Option Plan and recognized
compensation expense in the amount of $220,000.
Additional information with respect to the outstanding options as of January 29,
2000 was as follows:
Weighted Average Life in Options
Range of Exercise Prices Number of Shares Exercise Price years Exercisable
------------------------- ---------------- -------------- ----- -----------
$0.45 1,396,000 $0.45 9.4 494,000
$3.75 300,000 $3.75 9.8
$4.50 73,500 $4.50 9.9
--------- ---
1,769,500 9.6
========= ===
The fair value of each option grant was estimated on the date of grant using the
Black-Sholes option-pricing model with the following assumptions:
Risk-free interest rates 5.80%
Expected life (in years) 7
Dividend yield 0%
Expected volatility 85%
Had compensation cost been determined and recorded based on the fair value at
the date of grant consistent with the provisions of SFAS 123, the Company's
share of the Subsidiary's compensation expense in Fiscal 1999 would have been
$296,000 which is included in the pro forma loss above.
NOTE 9 - RELATED PARTY TRANSACTIONS:
- -----------------------------------
Kayne Anderson Investment Management ("KAIM"), a shareholder, provides certain
management services to the Company and charges the Company for such services.
Annual management fees of $112,500
F-19
were paid to KAIM in Fiscal 1999, Fiscal 1998 and Fiscal 1997.
NOTE 10 - OPERATING LEASES:
- --------------------------
The Company leases real property and equipment under non-cancelable agreements
expiring from 2000 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
-----------
2000 $ 4,348,000
2001 4,255,000
2002 3,951,000
2003 3,606,000
2004 2,707,000
Thereafter 2,875,000
-----------
$21,742,000
-----------
Net rental expense under operating leases was $3,584,000, $3,233,000, and
$3,802,000 for Fiscal 1999, Fiscal 1998 and Fiscal 1997, respectively. No
percentage rents were incurred in Fiscal 1999, Fiscal 1998 or Fiscal 1997.
NOTE 11 - STORE CLOSINGS:
- ------------------------
In 1999 the Company closed one store and wrote off approximately $151,000 of the
net book value of the assets related to this store.
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. The revenues from the
stores which closed were $1,904,000 and $4,663,000 for Fiscal 1998 and Fiscal
1997, respectively. Operating losses from these stores were $17,000 and
$435,000 for Fiscal 1998 and Fiscal 1997, respectively. All but one of these
stores were closed in Fiscal 1998. The remaining store was closed in Fiscal
1999.
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 and $802,000 Fiscal
1998 and Fiscal 1997, respectively. Operating losses from these stores were
$42,000 and $167,000 for Fiscal 1998 and Fiscal 1997, respectively. These
stores were closed in Fiscal 1998.
NOTE 12 - RECAPITALIZATION AND EXTRAORDINARY GAIN:
- -------------------------------------------------
F-20
In connection with its recapitalization, 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.
Additionally, holders of subordinated debt and warrant securities exchanged such
securities for either Series A or Series B 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 $8,000 of the gain on the exchange of notes held by
principal shareholders recorded as a credit to additional paid-in capital.
There was no gain or loss recognized on the conversion of the New Securities.
(See Note 6)
F-21
NOTE 13 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- ----------------------------------------------------------
Changes in assets and liabilities which increased (decreased) cash are as
follows:
Year Ended
----------
January 29, 2000 January 30, 1999 January 31, 1998
---------------- ---------------- ----------------
Accounts and other receivables ($ 97,000) ($ 180,000) $ 733,000
Merchandise inventories (3,897,000) 805,000 1,062,000
Other current assets (61,000) 319,000 217,000
Other non-current assets (1,168,000) (48,000) (2,000)
Accounts payable and accrued expenses 5,736, 000 1,040,000 (3,641,000)
Deferred rent (71,000) (176,000) 315,000
----------- ----------- ------------
$ 442,000 $ 1,760,000 ($1,316,000)
=========== =========== ============
Supplementary disclosure of cash flow information:
Fiscal 1999 Fiscal 1998 Fiscal 1997
----------- ----------- -----------
Cash paid for income taxes $ 11,000 $ 3,000 $ 5,000
Cash paid for interest 447,000 483,000 954,000
Non-cash investing and financing activities:
Fiscal 1999 Fiscal 1998 Fiscal 1997
----------- ----------- -----------
Conversion of Series B preferred stock to
common stock $ 938,000
Issuance of common stock and warrants in
connection with financing agreement 159,000
Preferred dividend accretion 301,000 $19,000
Exchange of subsidiary stock for software 1,243,000
NOTE 14 - SEGMENT INFORMATION
- -----------------------------
The Company has two reportable segments; Direct-to-customers, which includes
online and catalog operations, and Retail, which includes activities related to
the Company's retail stores. Both segments sell products to meet the needs of
the parents of infants and small children. The Direct-to-customers segment also
sells products directed to older children through preteen.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on profit or loss from operations before income taxes.
The Company charges a management fee on inventory transferred from the Retail
segment to the Direct-to-
F-22
customers segment and a fee on services provided by the Retail segment on behalf
of the Direct-to-customers segment.
The Company's reportable segments have operations that offer the same or similar
products but have a different method of delivery to its customers.
Segment information for Fiscal 1999 is as follows:
Online Catalog Direct-to-Customers Retail Total
--------------- --------------- -------------------- ----------------- -----------------
Net sales $ 7,394,000 $3,642,000 $11,036,000 $38,043,000 $ 49,079,000
Interest income 238,000 238,000 238,000
Interest expense 465,000 465,000
Depreciation 278,000 278,000 1,672,000 1,950,000
Non-cash compensation 220,000 220,000 1,794,000 2,014,000
Pre-opening costs 323,000 323,000
Minority interest 3,000,000 3,000,000
Store closing expense 151,000 151,000
Pre-tax loss (6,673,000) (303,000) (6,976,000) (3,798,000) (10,774,000)
Total assets 4,294,000 252,000 4,546,000 26,181,000 30,727,000
Fixed asset additions 2,456,000 2,456,000 2,390,000 4,846,000
Segment information for Fiscal 1998 is as follows:
Catalog Retail Total
-------------- ------------------ -----------------
Net Sales $4,736,000 $31,875,000 $36,611,000
Interest expense 640,000 640,000
Depreciation 18,000 1,470,000 1,488,000
Pre-opening costs 209,000 209,000
Store closing (income) (113,000) (113,000)
Pre-tax loss (126,000) (6,743,000) (6,869,000)
Total assets 252,000 17,419,000 17,671,000
Fixed asset additions 1,296,000 1,296,000
NOTE 15 -WARRANTS
- -----------------
At January 29, 2000 there were 347,000 warrants outstanding to purchase
RightStart.com common stock at $4.50 per share exercisable for five years and
expiring in 2004. Also outstanding at January 29, 2000 were 136,500 warrants to
purchase RightStart.com common stock at $11.25 per share exercisable for five
years and expiring in 2004. These warrants were issued in connection with a
strategic alliance with a third party. The value of the 136,500 warrants, using
the Black-Sholes pricing model, was determined to be approximately $337,000 and
will be amortized over the three-year term of the agreement.
NOTE 16 - OTHER FINANCIAL DATA
- ------------------------------
F-23
Allowance for Doubtful Accounts
- -------------------------------
The Activity in the allowance for doubtful accounts was as follows:
Beginning Balance Provision Write-offs Ending Balance
----------------- --------- ---------- --------------
Fiscal 1997 $14,000 $12,000 ($9,000) $17,000
Fiscal 1998 17,000 15,000 (5,000) 27,000
Fiscal 1999 27,000 60,000 87,000
Accounts payable and accrued expenses
- -------------------------------------
The components of accounts payable and accrued expenses are as follows:
Fiscal 1999 Fiscal 1998
----------- -----------
Accounts Payable $5,963,000 $2,333,000
Accrued payroll and related expenses 504,000 431,000
Accrued merchandise costs 1,876,000 518,000
Accrued professional fees 485,000 62,000
Sales returns and allowances 175,000 69,000
Sales and use tax accruals 235,000 218,000
Other accrued expenses 328,000 191,000
---------- ----------
$9,566,000 $3,822,000
========== ==========
NOTE 17 - COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
Future Advertising
- ------------------
The Company typically commits to run advertising approximately three months in
advance. As of January 29, 2000, the Company had commitments of approximately
$800,000 for future advertising. In November 1999 the Subsidiary entered into a
term sheet with an integrated media company. The term sheet contemplates that
over the three-year term of the proposed agreement the Subsidiary would provide
consideration approximating $13.7 million.
F-24
Leases
- ------
Since May 1, 1999, the Company has subleased office space on a month-to-month
basis. Rent expense under this sublease totaled $151,000 for Fiscal 1999. The
monthly rent cost is approximately $22,500 effective January 29, 2000.
Legal Matters
- -------------
The Company is involved in legal matters that arise in the normal course of
business. Management is aware of no material claims or actions pending or
threatened against the Company and the Subsidiary.
NOTE 18 - SUBSEQUENT EVENT
- --------------------------
In April 2000, the Subsidiary sold secured bridge notes to affiliates in the
aggregate principal amount of $2,180,000 (the "Bridge Notes"), and warrants to
purchase 109,000 shares of its common stock at an exercise price of $6.70 to
provide funding until the Subsidiary can obtain additional equity financing. A
default on the Bridge Notes would permit such holders to foreclose on the assets
of the Subsidiary and require the Subsidiary, to the extent it has not already
done so, to issue to the holders of the notes, additional warrants to purchase
an aggregate of 8,720,000 shares, or approximately 48.9% of the outstanding
common stock of the Subsidiary, at an exercise price of $0.25 per share.
F-25
NOTE 19 - VALUATION RESERVES
----------------------------
Additional
Balance at charged Balance at
beginning to costs end
Classification of period and expenses Deductions of period
- ---------------------------------- ------------ -------------- ----------- ------------
Fiscal year ended January 29, 2000
- ----------------------------------
Allowance for deferred tax asset $7,728,000 $4,651,000 $12,379,000
Inventory reserve 68,000 439,000 $429,000 78,000
Allowance for sales returns 69,000 106,000 175,000
------------ -------------- ----------- ------------
$7,865,000 $4,962,000 $195,000 $12,632,000
============ ============== =========== ============
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
============ ============== =========== ============
F-26