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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 February 3, 2001
( ) 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
--------------------------
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 20, 2001, approximately 2,983,595 shares of the Registrant's Common
Stock held by non-affiliates were outstanding and the aggregate market value of
such shares was approximately $4,624,572.
As of April 20, 2001 there were outstanding 5,617,275 shares of Common Stock, no
par value, with no treasury stock.
PART I
ITEM 1. BUSINESS
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General
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The Right Start, Inc. (the "Company"), a California corporation, is a
specialty retailer of high quality developmental, educational and care products
for infants and children. Information presented as of and for the period ended
January 29, 2000 ("Fiscal 1999") reflects the consolidated results of the
Company and RightStart.com Inc. ("RightStart.com"), which previously was our
majority-owned subsidiary.
RightStart.com was formed in April 1999 for the purpose of engaging in
electronic commerce over the Internet. Effective May 1, 1999, we contributed
our catalog assets to RightStart.com. On October 10, 2000, RightStart.com
issued 2 million shares of common stock, which decreased our ownership interest
in RightStart.com to 49.4%. The sale of common stock and associated corporate
actions resulted in RightStart.com being accounted for under the equity method
of accounting and no longer consolidated with us. Accordingly, information as of
and for the period ended February 3, 2001 ("Fiscal 2000") represents the results
of operations and the financial position of The Right Start, Inc. only.
History
- -------
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, 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 offer a carefully
screened comprehensive selection of infant and toddler products that we consider
to be the "best of the best," that is, the safest, most durable, best designed
and best valued items, in a full service setting. We 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. While we
have since transferred our catalog operations to our affiliate RightStart.com,
we have grown to 63 retail stores in operation nationwide as of April 20, 2001.
Retail Store Operations and Market
- ----------------------------------
As of April 20, 2001, we have 63 retail stores in operation. Twenty-six of
these stores are located in large shopping malls and 37 are located in stand-
alone locations or in local shopping centers, some of which are known as
"lifestyle" centers because they include a mix of retailers of non-essential
products. 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 parents. For the last three fiscal years approximately 27% of
our revenues derived from sales of products in our travel category, such as car
seats, strollers and their related accessories. Products sold in our child
development category, such as musical items and toys designed to help stimulate
and develop a child's sensory and motor skills, constituted approximately 22% of
our revenues over the same three year period.
The number of retail 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,
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we adopted a store opening plan that resulted in the opening of eight street-
location stores in 1998, 13 street-location stores in 1999 and 11 street-
location stores in 2000.
As part of 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 closing plan for those stores. Nine mall stores were closed
in 1998, one mall store was closed in 1999, and two mall stores were closed in
2000. We may close additional stores if we deem such a decision to be warranted
and we can do so on what we determine is a cost effective basis. We expect to
replace all or nearly all of our mall stores with street-location stores as our
mall stores' leases expire.
Our ability to open and operate new stores profitably is dependent on the
identification and availability of suitable locations, the negotiation of
acceptable lease terms, our financial resources, the successful hiring and
training of store managers and our ability to control the operational aspects of
growth. We intend to continue to open additional street-location stores in
affluent neighborhoods that have a sufficient density of young families to fit
our criteria and primarily in high traffic street locations.
Investment in RightStart.com
- ----------------------------
RightStart.com is an affiliate that uses our brand name online and in its
catalog business. As part of its formation we contributed assets comprising our
catalog and online operations. In July 1999, RightStart.com raised $15 million
in a private equity offering to third-party investors and used that money to
build and market its catalog and online businesses.
In January 2000, RightStart.com filed with the Securities and Exchange
Commission to make its initial public offering of common stock. Due to
deteriorated market conditions, RightStart.com withdrew its filing in May 2000.
On October 10, 2000, RightStart.com issued 1.6 million shares of common
stock to a new investor (the "October Investor") and 0.4 million shares of
common stock to an existing minority investor. The new issuance represented 18%
of the shares outstanding after the issuance. Consequently, our percentage of
common stock ownership of RightStart.com was reduced from 60.2% to 49.4%. The
October Investor received a seat on the Board of Directors of RightStart.com.
The current Board of Directors of RightStart.com is comprised of the October
Investor, a representative of one of RightStart.com's original minority
investors, an affiliate of RightStart.com and the chief executive officer of
RightStart.com who is also our chief executive officer. Additionally, the
October Investor and existing investors, other than the Company, received
certain participatory rights in the management of RightStart.com. The sale of
common stock and the associated corporate actions resulted in RightStart.com
being accounted for under the equity method of accounting and no longer
consolidated with our financial results.
Accordingly, financial statements as of and for the period ended February
3, 2001, are presented on an unconsolidated basis retroactive to the beginning
of the fiscal year.
The operating losses of RightStart.com have been shown as a loss on
investment. In connection with the deconsolidation of RightStart.com, we carry
our investment in RightStart.com at zero. RightStart.com has insufficient cash
to pay its creditors and has been in discussions to resolve the situation. Due
to the uncertainty surrounding the ongoing viability of RightStart.com, we have
provided an allowance for the potential uncollectability of $400,000 in
connection with amounts owed by RightStart.com to us under a management services
agreement between us and an additional $300,000 reserve for other costs and
expenses associated with the investment. We are not obligated or committed, and
do not intend, to fund any operating losses or obligations of RightStart.com.
Under the equity method of accounting, the carrying value of an investment
is normally adjusted on a periodic basis to recognize the investor's share of
earnings and losses of the investee. The carrying value, however, generally is
not reduced below zero and in that situation the equity method is, in effect,
suspended. Accordingly, we will only make future adjustments to the carrying
value of our investment in RightStart.com if
3
and when RightStart.com reports net income in excess of its accumulated net
losses during the period the equity method of accounting has been suspended, or
if we make additional realizable advances to, or investments in, RightStart.com.
We do not expect RightStart.com to report such excess net income.
RightStart.com purchases inventory and services from us under a management
services agreement. During Fiscal 2000 we had revenues of approximately $9.4
million from sales to RightStart.com. The income for services rendered under
this agreement, which for Fiscal 2000 amounted to $405,000, is netted against
general and administrative expenses. At February 3, 2001, we were owed $400,000
by RightStart.com. Due to the uncertainty surrounding the availability of
capital for online retailers and ongoing viability of RightStart.com, the full
amount of the receivable is reserved.
Marketing and Promotion
- -----------------------
We have implemented a number of marketing programs to reinforce our brand
name and increase customer awareness of our new store locations. These programs
include advertisements in the yellow pages and on register receipts, direct mail
and e-mail campaigns, promotions with manufacturers and local efforts aimed at
community organizations and merchants.
We have also taken advantage of the cross-promotional opportunities that
exist between our retail stores and RightStart.com's online stores. We promote
RightStart.com in our retail stores through in-store signage. RightStart.com
promotes our physical stores by promoting our policy of taking returns of goods
purchased through RightStart.com, a store location listing in RightStart.com's
online stores and e-mail campaigns.
Purchasing and Warehousing
- --------------------------
We now purchase products from over 350 different vendors worldwide. In
total, we import approximately 7.3% of the products sold in our retail stores
and have one domestic vendor that accounts for 8.0% of our total purchases from
all vendors. If our ability to purchase from a particular vendor or to import
from non-domestic vendors generally were impaired, we would be required to find
replacements. We may be unable to find satisfactory replacements for certain
vendors.
We outsource our warehousing and distribution to third party service
providers and do not own or lease any warehouse facilities or trucking
capability. We do not have long-term contracts with any of these service
providers but have found our experience with them to be good.
Employees
- ---------
As of April 20, 2001, we employed 424 employees, 206 of whom were part-
time. We consider our employee relations to be good.
Competition
- -----------
The retail market for infant and toddler products served by our retail
stores is very competitive. Significant competition currently comes from "big
box" concept stores, such as Babies "R" Us, the Baby Depot department of
Burlington Coat Factory and Target, as well as a few specialty retailers such as
Zany Brainy and Imaginarium. Other competitors include small local specialty
retailers. 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 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. Competition from RightStart.com and other
internet retailers impacts us as well.
We believe that merchants in our business compete based on brand name
recognition, product selection, price, convenience and customer service. We
believe that we distinguish ourselves from our competitors by offering a
4
full assortment of children's developmental, educational and care products
carefully selected with regard to quality, safety, developmental and educational
value. As a specialty retailer, we also focus on providing the highest levels of
customer service by offering customers carefully selected products presented by
sales associates with extensive product knowledge. In addition, we currently
plan to increase our services to include car seat installation instruction and a
nationwide registry service that is integrated with the website run by
RightStart.com. We typically do not compete on price though we use price
promotions that are targeted in duration or in required response in order to
attract business. In addition, we believe the relationship between ourselves and
RightStart.com provides each of us with advantages over single channel retailers
in our respective markets, including cross-marketing opportunities, vendor
relationships, distribution capabilities and enhanced customer convenience.
Intellectual Property
- ---------------------
We have registered and continue to register, when deemed appropriate, our
trademarks, trade names and domain names, including "The Right Start" and "Right
Start". We consider these trademarks and trade names to be readily identifiable
with, and valuable to, our business. We license much of our intellectual
property to RightStart.com for use in its online business on a royalty-free
basis which we believe also provides us with value through exposure of our brand
name. If our intellectual property rights were to be challenged we could find
our time and other resources diverted from our business.
Governmental Regulation
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The products we sell are subject to provisions of the Consumer Safety Act
and the regulations issued thereunder. These laws authorize the Consumer Product
Safety Commission ("CPSC") to protect the public from products that present a
substantial risk of injury. The CPSC can require the manufacturer of defective
products to repurchase or recall such products. The CPSC may also impose fines
or penalties on the manufacturer. Similar laws exist in some states and cities
in which we market our products. A recall of any of our products may materially
adversely affect us by impairing our reputation for quality and safety and
diverting our resources from our business generally.
Seasonality
- -----------
Our business is not significantly impacted by seasonal fluctuations, when
compared to many other specialty retail operations. Our products are for the
most part need-driven and our customer is often the end user of the products we
sell as opposed to a gift giver. We do, however, experience increased sales
during the Christmas holiday season, primarily in our mall stores.
Forward-Looking Statements
- --------------------------
This Annual Report contains "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. The forward-looking statements in
this Annual Report are intended to be subject to the safe harbor protection
provided by Sections 27A and 21E. 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. Certain
important factors, including but not limited to competition from other
children's product retailers, discounted pricing in the market due to
competitors' liquidation of overstocked inventory, lower than expected rates of
maturation of cash flow in our new stores, general economic factors, energy
dislocations and limitations on access to capital to fund the expansion and the
growth in the number of our retail stores, 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 is
included elsewhere in this annual report and in our filings with the Securities
and Exchange Commission including our Registration Statement on Form S-3 (File
No. 333-84319) and periodic reports. We caution readers not to place undue
reliance on forward-looking statements, which speak only as of the date of this
5
filing. We undertake no obligation to publicly release any revisions to these
forward-looking statements to reflect events or circumstances after that date.
ITEM 2. PROPERTIES
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As of April 20, 2001, we operate 63 retail stores in the 16 states shown in
the table below. 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 the leases are triple
net with rent provisions that 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. Certain other of the leases contain escalation clauses that
provide for increases in base rental and renewal options at fair market rental
rates.
The following table sets forth the locations of our stores nationwide as of
April 20, 2001:
State Number of Stores
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California 23
Colorado 2
Connecticut 4
Illinois 6
Massachusetts 2
Maryland 1
Michigan 2
Minnesota 1
Missouri 1
New Jersey 3
New York 2
Ohio 3
Pennsylvania 2
Texas 8
Virginia 1
Washington 2
---------- --
Total 63
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. Effective July 1, 2001, we have entered into a new
five-year lease for approximately 15,000 square feet located in Calabasas,
California.
We use third-party distribution and fulfillment providers and therefore do not
directly lease or own any warehouse space.
ITEM 3. LEGAL PROCEEDINGS
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We are a party to various legal actions arising in the ordinary course of
business. In addition, we have been named in lawsuits against RightStart.com
brought by two of RightStart.com's unsecured creditors. In the opinion of
management, any claims that may arise from these actions are immaterial to us 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.
6
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ----------------------------------------------------
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS'
- ------- ---------------------------------------------------------------
MATTERS
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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 145 registered
shareholders as of April 20, 2001. The following table sets forth the range of
high and low bid prices on the Nasdaq National Market for our common stock for
Fiscal 1999 and Fiscal 2000. 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 2000 High Low
----------- ---- ---
First Quarter $18.69 $ 4.38
Second Quarter 5.94 3.75
Third Quarter 4.13 1.38
Fourth Quarter 2.88 .88
Fiscal 1999
-----------
First Quarter $ 8.50 $ 5.00
Second Quarter 10.00 6.50
Third Quarter 15.00 6.63
Fourth Quarter 23.75 13.00
(1) As of April 20, 2001, the closing price for our common stock was $1.55.
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 with
Wells Fargo Retail Finance contains financial and operational covenants that,
among other things, limit our ability to pay dividends. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
The selected financial data presented below as of and for our fiscal year
ended June 1, 1996 ("Fiscal 1996"), the 33-Week Transition Period ended February
1, 1997 ("Transition Period"), the fiscal year ended January 31, 1998 ("Fiscal
1997"), Fiscal 1998, Fiscal 1999 and Fiscal 2000 have been derived from
financial statements which, except for Fiscal 1996, the Transition Period and
Fiscal 1997, are contained elsewhere in this Annual Report on Form 10-K. The
selected 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 financial statements, the
notes thereto and other financial information included elsewhere in this Annual
Report on Form 10-K. Fiscal 1999 is presented on a consolidated basis with
RightStart.com.
7
Fiscal Year(2) 33-Week Fiscal
----------------------------------------------------- Transition Year
2000 1999 1998 1997 Period 1996
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands except share data)
Earnings Data
Revenues:
Net sales $ 44,201 $ 49,844 $ 37,593 $ 38,521 $ 27,211 $ 40,368
Sales to RightStart.com 9,408
Other revenues 877
---------- ---------- ---------- ---------- ---------- ----------
Total 53,609 49,844 37,593 38,521 27,211 41,245
Net loss (7,704) (10,842) (5,680) (9,241) (5,378) (3,899)
Basic and diluted loss $(1.46) $(2.14) $(1.13) $(2.01) $(1.34) $(1.19)
per share
Share Data (1)
Weighted average shares
outstanding 5,597,809 5,355,756 5,051,820 4,594,086 4,003,095 3,268,407
Fiscal Year 33-Week Fiscal
---------------------------------------------------- Transition Year
2000 1999 1998 1997 Period 1996
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Balance Sheet Data
Current assets $ 11,750 $ 17,424 $ 8,300 $ 8,908 $ 11,704 $ 8,353
Total assets 22,234 30,727 17,671 18,462 22,982 17,475
Current liabilities 5,637 12,943 6,572 4,796 8,457 4,649
Long-term debt 7,945 3,000 8,734 5,643
Series A Preferred stock 2,439 2,088 1,789
Shareholders' equity 4,724 7,921 7,861 3,307 7,172 11,902
(1) All share data has been restated to give effect to our one-for-two
reverse stock split, which was effective December 15, 1998.
(2) Fiscal 2000 is comprised of 53 weeks, other fiscal periods presented,
with the exception of the 33 week transition period, are comprised of 52
weeks.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- ---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Overview
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The Right Start, Inc. operates 63 retail stores in 16 states throughout the
United States as of April 20, 2001 and operated 61 retail stores as of the end
of Fiscal 2000. 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 parents.
8
The following table sets forth the statement of operations data for the
periods indicated for retail store operations, excluding operating data for
RightStart.com (which includes catalog operations), which data is unaudited for
all such periods other than Fiscal 2000:
Fiscal 2000 Fiscal 1999 Fiscal 1998
--------------------- --------------------- ---------------------
Retail Net Sales $44,201,000 100.00% $38,043,000 100.00% $31,875,000 100.00%
Cost of goods sold 21,952,000 49.66% 18,878,000 49.62% 16,396,000 51.44%
--------------------- -------------------------------------------------
Gross Profit 22,249,000 50.34% 19,165,000 50.38% 15,479,000 48.56%
Operating expense 17,121,000 38.73% 14,418,000 37.90% 12,880,000 40.41%
Marketing and advertising costs 1,000,000 2.26% 830,000 2.18% 387,000 1.21%
General and administrative expenses 4,017,000 9.09% 3,310,000 8.70% 2,899,000 9.09%
Non-cash compensation expense 93,000 0.21% 1,794,000 4.72% - 0.00%
Depreciation and amortization expense 2,184,000 4.94% 1,672,000 4.40% 1,470,000 4.61%
Store closing (income) expense 401,000 0.91% 151,000 0.40% (113,000) -0.35%
Pre-opening costs 456,000 1.03% 323,000 0.85% 209,000 0.66%
----------- ------- ----------- ------- ----------- -------
Operating loss (3,023,000) (3,333,000) (2,253,000)
----------- ----------- -----------
Non-cash beneficial conversion feature - 0.00% - 0.00% 3,850,000 12.08%
Loss on investment in RightStart.com Inc. 3,406,000 7.71% - 0.00% - 0.00%
Interest expense 1,197,000 2.71% 465,000 1.22% 640,000 2.01%
--------------------- -------------------------------------------------
Loss before income taxes and extraordinary (7,626,000) -17.25% (3,798,000) -9.98% (6,743,000) -21.15%
items
Extraordinary gain on debt restructure, net - 0.00% - 0.00% 1,211,000 3.80%
Tax provision 78,000 0.18% 68,000 0.18% 22,000 0.07%
--------------------- --------------------- ---------------------
Net loss $(7,704,000) -17.43% $(3,866,000) -10.16% $(5,554,000) -17.42%
=========== =========== ===========
Fiscal 2000 Compared With Fiscal 1999
- -------------------------------------
Net Sales. Retail net sales consist of gross product sales to customers
net of returns. Retail net sales increased by $6.2 million, or 16.2%, from
$38.0 million in Fiscal 1999 to $44.2 million in Fiscal 2000. The net sales
growth reflects the addition of 11 new store locations offset by the impact of
two store closures. Fiscal 2000 was a 53 week year while Fiscal 1999 consisted
of 52 weeks. Same store sales for Fiscal 2000 increased 0.9% after adding the
first week of Fiscal 2000 to Fiscal 1999 sales in order to adjust for the
additional week that Fiscal 2000 would otherwise have over Fiscal 1999.
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 remained relatively unchanged from 50.4% in Fiscal 1999 to 50.3% in
Fiscal 2000.
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 $17.1
million in Fiscal 2000 as compared to $14.4 million in Fiscal 1999. The $2.7
million or 18.8% increase primarily reflects the addition of 11 new store
locations offset by a reduction in average per store payroll and occupancy
costs. Retail operating expense as a percentage of retail net sales increased
from 37.9% in Fiscal 1999 to 38.7% in Fiscal 2000. The addition of 11 new
stores in Fiscal 2000 had the anticipated effect of initially increasing
operating expenses at a rate greater than net sales.
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 $0.8 million in Fiscal 1999 to $1.0 million in Fiscal
2000. This growth reflects
9
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 management, professional service fees and other administrative
support. General and administrative expense increased 21.4% to $4.0 million for
Fiscal 2000 compared to $3.3 million for Fiscal 1999. The increase is due
primarily to an increase in staffing and related costs. As a percentage of
sales, this expense line increased by 0.4% over prior year. General and
administrative expense includes net credits in the amount of $405,000 and
$407,000 for the current and prior fiscal year, respectively. These credits are
the result of net billings for services provided to RightStart.com under a
management services agreement between us.
Non-cash compensation expense. During the second quarter of 1999, we
recorded $1.8 million of non-cash compensation expense associated with the
vesting of performance options that had been granted to our executive officers.
This expense resulted 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. The
$93,000 reported for Fiscal 2000 is made up of $57,000 related to options held
by RightStart.com employees after deconsolidation and $36,000 of deferred
compensation amortization related to non-employee director grants in Fiscal
1999.
Depreciation and amortization. Depreciation and amortization expense
increased $0.5 million or 30.6% from $1.7 million in Fiscal 1999 to $2.2
million in Fiscal 2000. The increase was due to the additional assets placed in
service related to new store openings.
Store closing expense. Store closing expense consists primarily of the
write-off of non-recoverable assets and costs incurred in closing store
locations. In Fiscal 2000, $401,000 in expense was recorded in relation to the
closing of two stores. Store closing expense in Fiscal 1999 of $151,000 is
related to one store closure in that year.
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 $0.2 million from $0.3 million in Fiscal
1999 to $0.5 million in Fiscal 2000. The increase was due to 11 new stores
opened during Fiscal 2000 and carryover costs related to five stores opened at
the end of the Fiscal 1999 versus pre-opening costs recognized for eight of the
new stores opened during Fiscal 1999.
Loss on investment. As of October 10, 2000, we deconsolidated with
RightStart.com and as a result recorded losses for Fiscal 2000 up to the level
of our investment in RightStart.com of $2.7 million and recorded an allowance
for the potential uncollectability of $0.4 million in connection with amounts
owed to us by RightStart.com under the Management Services Agreement and an
additional $0.3 million reserve for other costs and expenses associated with the
investment.
Interest expense. Interest expense, net increased to $1.2 million in
Fiscal 2000 from $0.5 million in Fiscal 1999. The $0.7 million increase
reflects an increase of $0.3 million due to increased borrowings and increased
interest rates and $0.4 million due to loan fee amortization related to our
former credit facility.
Tax provision. Provision for income taxes is related to state income
taxes. No federal or state income tax provision benefit was recorded for Fiscal
2000 or Fiscal 1999 due to the uncertainty of realizing any tax benefits in
future years. As of February 3, 2001, we had net operating loss carryforwards
for federal tax purposes of $28.7 million and for state tax purposes of $11.7
million. These carryforwards expire in 2021 for federal tax purposes and in
2006 for state tax purposes, if not previously utilized.
10
Fiscal 1999 Compared With Fiscal 1998
- -------------------------------------
Retail Store Operations Comparison of Fiscal 1999 and Fiscal 1998
-----------------------------------------------------------------
Net Sales. Net sales consist of gross product sales to customers net of
returns. 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. 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. Operating expense consists of store operational
expenses, personnel costs, and costs related to the distribution and warehousing
of our retail merchandise. 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. 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. General and administrative expense includes a net credit in the
amount of $407,000 for Fiscal 1999. This credit is the result of net billings
for services provided to RightStart.com under a management services agreement
between us. The credit does not appear in our financial statements for Fiscal
1999 because RightStart.com's financial results were consolidated with ours
during that fiscal year.
Non-cash compensation expense. During the second quarter of Fiscal 1999,
we recorded $1.8 million of non-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.
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.
Store closing (income) 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.
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.
11
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 Fiscal 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 provision benefit was recorded for Fiscal 1999 or
Fiscal 1998 due to the uncertainty surrounding realizing any tax benefits in
future years. As of January 29, 2000, we had net operating loss carryforwards
for federal tax purposes of $23.7 million and for state tax purposes of $9.4
million. These carryforwards expire in 2020 for federal tax purposes and in 2005
for state tax purposes, if not previously utilized.
RightStart.com Operations Including Catalog Operations Comparing Fiscal
-----------------------------------------------------------------------
1999 and Fiscal 1998
--------------------
RightStart.com is an affiliate that uses our brand online and in its
catalog business. As part of its formation we contributed assets comprising our
catalog and online operations. On October 10, 2000, RightStart.com sold common
stock which, together with associated corporate actions, resulted in
RightStart.com being accounted for under the equity method of accounting and no
longer consolidated with us. As a result RightStart.com's financial information
was consolidated with ours for Fiscal 1999 but not during Fiscal 2000.
RightStart.com's 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 is 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 for the periods prior to Fiscal
2000:
Fiscal 1999 Fiscal 1998
----------- -----------
Catalog sales $ 3,645,000 30.9% $4,736,000 82.8%
Online store sales, net 7,391,000 62.6% - -
Shipping and handling revenues 766,000 6.5% 982,000 17.2%
----------- ----- ---------- -----
Net revenues 11,802,000 100.0% 5,718,000 100.0%
Cost of goods sold 6,401,000 54.2% 2,180,000 38.1%
Cost of shipping and handling 2,678,000 22.7% 969,000 16.9%
----------- ----- ---------- -----
Gross profit 2,723,000 23.1% 2,569,000 44.9%
Operating expense 4,040,000 34.2% 2,239,000 39.2%
Marketing and advertising expense 6,403,000 54.3% - -
General and administrative expense 1,996,000 16.9% 438,000 7.7%
Non-cash compensation expense 220,000 1.9% - -
Depreciation expense 278,000 2.4% 18,000 0.3%
Interest income (238,000) -2.0% - -
----------- ----- ---------- -----
Loss before income taxes and minority interest (9,976,000) -84.5% (126,000) -2.2%
Tax provision - - - -
Minority interest in consolidated subsidiary loss 3,000,000 25.4% - -
----------- ----- ---------- -----
Net loss $(6,976,000) -59.1% $ (126,000) -2.2%
=========== ==========
Sales. Sales consist of product sales to customers and are net of product
returns and promotional discounts. Net revenues increased by $6.1 million,
or 106.4%, to $11.8 million in Fiscal 1999 from $5.7 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
12
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. Shipping and handling
charges decreased by $0.2 million, in line with the decrease in catalog sales.
This revenue declined as a percentage of net sales due to the substantial number
of online sales that enjoyed free shipping.
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 45.8% in Fiscal 1999
from 61.9% 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.
Cost of shipping and handling. Cost of shipping and handling represents
the fulfillment expenses related to catalog and online sales. This expense
increased by $1.7 million due to the launch of the online store operations.
This expense increased as a percentage of sales due to the substantial number of
online sales that were fulfilled under a free shipping promotion.
Operating expenses. Operating expenses consist primarily of 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 $1.8 million, or 80.4%, to $4.0 million in
Fiscal 1999 from $2.2 million in Fiscal 1998. As a percentage of net sales,
operating expenses decreased to 34.2% in Fiscal 1999 from 39.2% 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
$2.0 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 86.6% of online net 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 by RightStart.com to us 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 16.9% in Fiscal 1999 from 7.7%
in Fiscal 1998. Fiscal 1999 general and administrative included direct fees paid
to The Right Start, Inc. of $0.4 million.
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.
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 that are being depreciated over a three
year period.
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.
13
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 or Fiscal 1998.
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 while it was our
subsidiary. 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.
Liquidity and Capital Resources
- --------------------------------
General
- -------
We entered into a Loan and Security Agreement with Wells Fargo Retail
Finance (the "Bank") as of January 23, 2001 (the "New Credit Facility"). A
portion of the proceeds was used to retire amounts due under our former credit
facility, which was scheduled to terminate in February 2001, and the remaining
portion is available for general corporate purposes in accordance with our
operating budget that has been approved by the Bank (the "Budget"). The New
Credit Facility consists of a standard revolving line of up to $7,000,000 under
which borrowings bear interest at a rate of 0.75% over a base rate announced by
Wells Fargo Bank from time to time and a special line of up to $3,000,000 under
which borrowings bear interest at a rate of 1.5% over the base rate. As of April
20, 2001, the Wells Fargo Bank base rate was 7.50%. Up to $2,000,000 of
borrowings under the special line can also be converted at our option to a term
loan with a 5-year amortization. The New Credit Facility is secured by
substantially all of our assets. Availability under the standard revolving line
is limited to 87.5% of net retail liquidation value of our inventory or between
70% and 74% (varying over the course of the year) of the cost value of the our
inventory, whichever is less. Availability under the special line is limited to
12.5% of net retail liquidation value of our inventory or, together with amounts
available under the standard revolving line, between 80% and 84% (varying over
the course of the year) of the cost value of our inventory, whichever is less.
We are required to maintain average availability under the New Credit Facility
of at least 85% of amounts in the Budget (calculated on a rolling two-month
average basis). As of April 7, 2001, the date of our latest measuring period,
our average availability is approximately 94.0% of Budget amounts. As of April
7, 2001, we had approximately $4,978,000 outstanding under the New Credit
Facility and aggregate availability of approximately $2,967,000. The New Credit
Facility matures on January 23, 2006.
In September and October 2000, we sold a total of $3.0 million in aggregate
principal amount of our Senior Subordinated Convertible Pay-in-Kind Notes due
2005 (the "Convertible Notes") to affiliates. The Convertible Notes bear
interest at the rate of 8% per annum and are convertible into common stock at a
price of $2.375 per share of common stock. Interest on the Convertible Notes is
due and payable semi-annually in cash or in kind, at our election, on December 1
and June 1 of each year and compounded semi-annually. The Convertible Notes are
secured by a subordinated lien on substantially all of our assets. The
Convertible Notes rank pari passu with all our other subordinated debt and
holders have registration rights with respect to our common stock issuable upon
conversion.
In October 2000, we sold 44,900 shares of our Series D Convertible Pay-in-
Kind Preferred Stock (the "Series D Convertible Preferred Stock") for $4.5
million, a portion of which was purchased by affiliates. The Series D
Convertible Preferred Stock pays dividends at a rate of 8% per annum, has a
liquidation preference of $100 per share and is convertible into common stock at
the rate of $2.00 per share. We can cause the Series D Convertible Preferred
Stock to convert after October 6, 2001, if our common stock has traded at a
price greater than $3.00 per share for twenty consecutive trading days. In
connection with the issuance of the Series D
14
Convertible Preferred Stock, we issued 449,000 warrants to purchase one share of
common stock at an exercise price of $2.00 per share of common stock. The fair
value of the warrants was estimated at $439,000 in the aggregate using the
Black-Scholes option-pricing model and has been recorded as a reduction to the
carrying amount of the Series D Convertible Preferred Stock and a credit to
paid-in capital. Holders of the Series D Convertible Preferred Stock have
registration rights with respect to the common stock issuable upon conversion of
Series D Convertible Preferred Stock and exercise of the warrants.
Each of the Convertible Notes and the Series D Convertible Preferred Stock
has a pay-in-kind feature that permits us to pay dividends and interest, as the
case may be, in additional securities. We paid the first dividends and
interest, due on December 1, 2000, in cash and may elect to do so in the future
as well.
In Fiscal 2000, we used $4.8 million in cash in our operating activities
compared to $9.3 million in Fiscal 1999 (which included $4.9 million used in
operations at RightStart.com). In the current year, investing activity includes
the loss on investment in RightStart.com of $3.4 million and $2.8 million for
fixed asset additions compared to $3.6 million for fixed asset additions for the
prior year. The primary source of funds for the current period were borrowings
under our former credit facility, the sale of Series D Convertible Preferred
Stock and the issuance of the Convertible Notes. The net proceeds of $7.5
million from the sale of the Convertible Notes and the Series D Convertible
Preferred Stock were used to reduce amounts outstanding on our former Credit
Facility.
We have a deferred tax asset of $11.9 million, which is reserved against by
a valuation allowance of $10.5 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 operating assets, including certain mall locations, the
proceeds of which sales we would expect to use for additional street stores.
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 the tax benefit.
Since Fiscal 1997, our retail store operating strategy has focused on
opening and operating new retail stores at street locations, while closing less
profitable retail stores at mall locations. We closed nine mall stores and
opened eight street-location stores in Fiscal 1998. In Fiscal 1999, we opened
thirteen street-store locations and closed one mall store. In Fiscal 2000, we
closed two mall stores and opened 11 street-store locations. We will make
capital expenditures during the upcoming fiscal year primarily in order to
continue our plan of opening street-location stores. We plan to expend
approximately $125,000 on fixed assets, $25,000 on pre-opening expenses and
$50,000, net of payables, on inventory for each new store we open. Our ability
to fund our operations, open new stores and maintain compliance with our Credit
Facility is dependent on our ability to generate sufficient cash flow from
operations and secure other financing such as capital leases. We reported
operating losses related to retail store operations for Fiscal 2000 of $3.0
million, for Fiscal 1999 of $3.3 million and for Fiscal 1998 of $2.25 million.
During an economic downturn we expect to see reduced sales at our existing
stores with our mall stores experiencing the largest impact. As a result, the
rate at which we can execute our growth plan will depend on the extent to which
we can improve operating results in the existing retail environment and bring
our new stores up to expected sales rates. We continually look for ways to
increase inventory turnover, obtain better payment terms from suppliers and
otherwise improve our operations that are aimed at accomplishing these goals. We
also continually consider our financing alternatives and monitor the success of
our efforts to improve operating results in determining the rate at which we
execute our growth strategy.
We believe that cash flow from operations and borrowings under the Credit
Facility will provide sufficient liquidity to fund operations for at least the
next twelve months. If, however, we were to pursue our growth strategy too
aggressively, experience a significant decrease in cash flow from operations or
be unable to obtain expected capital lease financings, we may be required to
obtain additional financing.
15
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. These 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 these new securities, we entered
into a recapitalization agreement with all of the holders of our existing
subordinated debt securities, representing an aggregate principal amount of
$6,000,000. Pursuant to the recapitalization agreement, each holder (of new and
existing 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 originally 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 on May 31, 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 existing subordinated debt securities elected to
receive Series B convertible preferred stock which has no fixed dividend rights
and is convertible into common stock at a price per share of $3.00. Holders of
the $3,850,000 principal amount of the new securities exchanged such 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.
Impact of Inflation
- -------------------
The impact of inflation on results of operations has not been significant
during our last three fiscal years.
Other Matters
- -------------
New Accounting Requirements
- ---------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," effective beginning in the first quarter of
2000. FAS No. 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 No. 133 was amended by Standard FAS No.
137 which defers the effective date of the FAS No. 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 will not have a material effect on our
financial position.
In April 2001, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on issue No. 00-14, "Accounting for Certain Sales Incentives," which
requires the cost of certain sales incentives, such as coupons, to be classified
as a reduction of revenue. The Company's policy with respect to coupons
complies with EITF No. 00-14 and, therefore, does not anticipate any impact on
its financial statements.
Unaudited Quarterly Data
- ------------------------
Quarter Ended Year Ended
---------------------------------------------------------------------------- -------------------
(Dollars in thousands) April 29, 2000 July 29, 2000 October 28, 2000 February 3, 2001 February 3, 2001
----------------- ---------------- ------------------- ------------------- -------------------
Net revenues $13,193 $12,948 $11,862 $15,606 $53,609
Gross profit 5,268 5,337 4,918 6,726 22,249
Pre-tax income (loss) (4,668) (3,580) 1,026 (404) (7,626)
Earnings (loss) per $ (0.86) $ (0.66) $ 0.16 $ (0.11) $ (1.46)
share
Quarter Ended Year Ended
----------------------------------------------------------------------------- -------------------
(Dollars in thousands) May 1, 1999 July 31, 1999 October 30, 1999 January 29, 2000 January 29,2000
----------------- ---------------- -------------------- ------------------- -------------------
Net revenues $11,072 $10,720 $11,661 $16,391 $ 49,844
Gross profit 5,648 5,250 4,867 6,130 21,895
Pre-tax income (loss) 20 (2,727) (3,954) (4,113) (10,774)
Earnings (loss) per $ (0.01) $ (0.56) $ (0.87) $ (0.78) $ (2.14)
share
16
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------- ----------------------------------------------------------
In the ordinary course of operations, we face no significant market risk.
Our purchase of imported products subjects us to a minimal 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 secured debt obligation which has interest rates that are linked to the
prime rate. For every $1 million in debt outstanding under our variable rate
secured debt obligations, an increase of 0.25% in our interest would cost us an
additional $25,000 per year. We have not entered into any derivative financial
instruments to manage 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 are 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 Fiscal 1999, which
selection was approved by our stockholders at our annual meeting held September
9, 1999.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------- --------------------------------------------------
Directors
- ---------
17
Director
Name Age Since Business Experience
- ---- --- -------- -------------------
Andrew Feshbach 40 1995 Mr. Feshbach is a Vice President of Fortune Financial, Chief Executive Officer of Big
Dog Holdings, Inc. and an Executive Vice President of Fortune Fashions. Previously, Mr.
Feshbach was a partner in Maiden Lane, a merchant bank, and a Vice President in the
Mergers and Acquisitions Group of Bear Stearns & Co. Inc.
Robert R. Hollman 57 1995 Mr. Hollman is President of Hollman Property Company and was President and Chief
Executive Officer of Topa Management Company from 1971 to 1999.
Fred Kayne 63 1995 Mr. Kayne is President and Chairman of Fortune Financial, where he is responsible for
directing all of its investment activities. Mr. Kayne is also President of Fortune
Fashions and Chairman of Big Dog Sportswear. Mr. Kayne was a partner of Bear, Stearns
& Co. Inc. until its initial public offering in 1985, after which time he was a
Managing Director and a member of the Board of Directors of Bear, Stearns & Co. Inc.
until he resigned in 1986. Fred Kayne and Richard A. Kayne are brothers.
Richard A. Kayne 56 1995 Mr. Kayne currently serves as President and Chief Executive Officer and a Director of
Kayne Anderson Investment Management, Inc., and its broker dealer affiliate, K.A.
Associates, Inc. Mr. Kayne has been with Kayne Anderson Investment Management, Inc.
since 1984 when it was founded by Mr. Kayne and John E. Anderson. He is also Director
of Glacier Water Services, Inc. Richard A. Kayne and Fred Kayne are brothers.
Jerry R. Welch 50 1995 See "Business Experience of Executive Officers" below.
Jill Higgins 45 2001 Ms. Higgins was appointed to fill a vacancy on the Board of Directors in April 2001.
Ms. Higgins is President and Chief Executive Officer of O.S. II, Inc., as well as a
general partner of Lakeside Enterprises and a private investor.
Howard M. Zelikow 67 1995 Mr. Zelikow has been a Managing Director of Kayne Anderson Investment Management, Inc.
since 1988. Mr. Zelikow was a director of Financial Security Assurance Holdings Ltd.
from 1996 until 2000 and served as a director of Queensway Financial Holdings Limited
from 1993 until 2000. Mr. Zelikow was a director of Victoria Financial Corporation from
1991 to 1995, a director of Capital Guaranty Corporation from 1994 to 1995, and a
director of Nobel Insurance Limited from 1989 to 1993. Mr. Zelikow has been a director
of The Navigators Group, Inc. since 1999.
Our directors serve until their successors are elected and duly qualified
at this year's Annual Meeting of Shareholders, which is expected to be held on
or about June 29, 2001.
18
Executive Officers
- ------------------
Our executive officers for Fiscal 2000 were as follows:
Name Age Position Executive Officer Since
- ----- --- -------- -----------------------
Jerry R. Welch 50 Chairman of the Board, 1996
President and Chief
Executive Officer
Raymond P. Springer 50 Executive Vice President and 2000
Chief Financial Officer
Marilyn Platfoot 46 Executive Vice President, Retail 1996
Ronald J. Blumenthal 55 Senior Vice President, Real Estate 1994
Jon Kubo 43 Senior Vice President and 2000
Chief Technology Officer
Kendrick F. Royer 37 Senior Vice President and 2000
General Counsel (*)
Gerald E. Mitchell 46 Executive Vice President, 1999
Merchandising (*)
____________
(*) Mr. Mitchell terminated his employment with us March 20, 2001; Mr. Royer
terminated his employment with us on April 13, 2001.
All officers serve at the discretion of the Board of Directors
Business Experience of Executive Officers
- -----------------------------------------
JERRY R. WELCH became our Chief Executive Officer in March 1996, assumed
the position of President in September 1996 and has served as Chairman of the
Board since August 1995. Mr. Welch has served as President and Chief Executive
Officer of RightStart.com since April 1999. Mr. Welch also serves as an officer
and a Managing Director of Kayne Anderson Investment Management, Inc. and has
served in such capacity since January 1993. Mr. Welch held the positions of
Chairman of the Board from April 1993 to September 1999 and Chief Executive
Officer from August 1994 to September 1999 of Glacier Water Services, Inc., a
retailer of vended water. Mr. Welch continues to serve as a member of the board
of directors of Glacier Water Services, Inc. and has served in such capacity
since April 1993.
RAYMOND P. SPRINGER became our Executive Vice President and Chief Financial
Officer in August 2000 and has served as Executive Vice President and Chief
Financial Officer of RightStart.com since December 1999. From August 1999 to
December 1999, Mr. Springer served as Senior Vice President and Chief Financial
Officer of Payless Cashways Inc., a retailer of building materials and home
improvement products. From April 1996 to June 1999, Mr. Springer was employed
as Executive Vice President and Chief Financial Officer of Jumbo Sports, Inc., a
sporting goods retailer. Jumbo Sports filed a voluntary petition for relief
under Chapter 11 of the United States Bankruptcy Code in December 1998. From
1987 to 1996, Mr. Springer was the Executive Vice President and Chief Financial
Officer of Kash n' Karry Food Stores, Inc., a grocery store chain.
19
MARILYN PLATFOOT became our Executive Vice President-Retail in August 1999.
Prior to that, Ms. Platfoot served as our Senior Vice President-Retail
Operations and Human Resources from May 1999 to August 1999 and Vice President-
Retail Operations from April 1996 to April 1999. Ms. Platfoot previously served
as Western Regional Manager for Brookstone Stores from 1992 to 1996.
RONALD J. BLUMENTHAL became our Senior Vice President-Real Estate in
September 1996 and served as Vice President-Retail Operations from December 1993
to September 1996. Prior to joining us, Mr. Blumenthal served as Vice President
of Store Operations for Cost Plus Imports from 1990 until 1993.
JON KUBO became our Senior Vice President and Chief Technology Officer in
December 2000 and has served as Senior Vice President and Chief Technology
Officer of RightStart.com since April of 2000. From July 1999 to April 2000,
Mr. Kubo served as Chief Technology Officer of GoodHome.com, a home furnishings
ecommerce retailer which Mr. Kubo co-founded. From July 1998 to June 1999, Mr.
Kubo was Director of Home Design Content for Broderbund which was acquired by
The Learning Company in August 1998. From February 1996 to July 1998, Mr. Kubo
was General Manager of the Creative Images Technologies Division of Autodesk,
Inc. which developed home remodeling/decorating CAD software products. From May
1993 to January 1996 Mr. Kubo was President of Creative Images Technologies,
Inc., a company he co-founded to develop CAD software and provide content
creation facilities for the residential and commercial interior design industry
and which was sold to Autodesk, Inc.
KENDRICK F. ROYER became our Senior Vice President and General Counsel in
December 2000 and has served as Senior Vice President and General Counsel of
RightStart.com since December 1999. From November 1995 to December 1999, Mr.
Royer was an associate at the law firm of Milbank, Tweed, Hadley & McCloy LLP in
Los Angeles California, practicing general corporate, securities and mergers and
acquisitions law. From November 1991 to September 1995, Mr. Royer was an
associate at the law firm of O'Melveny & Myers LLP in Los Angeles, California.
Mr. Royer terminated his employment with us on April 13, 2001.
GERALD E. MITCHELL served as our Executive Vice President - Merchandising from
December 2000 to March 2001 and as Executive Vice President - Merchandising of
RightStart.com from August 1999 to March 2001. From April 1999 to August 1999,
Mr. Mitchell served as our Senior Vice President, Merchandising and Marketing.
From July 1996 to April 1999, Mr. Mitchell served as our Vice President,
Merchandising for the Company. Mr. Mitchell terminated his employment with us
in March 2001.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
- --------------------------------------------------------------------
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires our officers and directors and persons who beneficially
own more than 10% of our common stock to file reports of ownership on Forms 3, 4
and 5 with the Securities and Exchange Commission. Officers, directors and 10%
stockholders are required by the Securities and Exchange Commission to furnish
us with copies of all Forms 3, 4 and 5 as filed.
Based solely on our review of the copies of such forms we have received, we
believe that all of our officers, directors and greater than 10% beneficial
owners complied with all the filing requirements applicable to them with respect
to transactions during Fiscal 2000 except as follows: Mr. Fred Kayne made a late
filing on Form 5 with respect to ten transactions including one that would have
been filed on Form 3, Mr. Welch made a late filing on Form 5 with respect to
four transactions, Mr. Hollman made a late filing on Form 5 with respect to nine
transactions, Mr. Zelikow made a late filing on Form 5 with respect to eleven
transactions, Mr. Feshbach made a late filing on Form 5 with respect to eleven
transactions, Mr. Springer made a late filing on Form 3 and our former chief
financial officer, Ms. Gina Engelhard made a late filing on Form 5 with respect
to four transactions including one that would have been made on Form 4. These
late filings relate primarily to director options granted in prior years for
which neither we nor the reporting person was able to locate a filing of public
record.
20
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
Executive Compensation
- ----------------------
The following table sets forth summary information concerning compensation
paid or accrued by us for services rendered during the fiscal years ended
January 29, 2000, January 30, 1999 and January 31, 1998 to our Chief Executive
Officer and the four other executive officers who received compensation of at
least $100,000 (collectively, the "Named Executive Officers").
Summary Compensation Table
--------------------------
Annual Compensation Long Term Compensation
------------------- ----------------------
Securities
Fiscal Other Annual Underlying All Other
Name and Principal Position Year Salary Bonus Compensation (1) Options (#) Compensation (2)
- ------------------------------ ---- -------- ----- ---------------- ----------- ----------------
Jerry R. Welch (3) 2000 $ 75,000 $-0- $ -0- -0- $-0-
Chairman of the Board, 1999 31,000 -0- -0- -0- -0-
President and Chief 1998 -0- -0- -0- 211,669 -0-
Executive Officer
Raymond P. Springer (4) 2000 250,000 -0- 7,800 50,000 -0-
Executive Vice President and 1999 38,000 -0- 1,300 -0- -0-
Chief Financial Officer 1998 -0- -0- -0- -0- -0-
Marilyn Platfoot 2000 176,000 -0- 7,800 -0- 325
Executive Vice President 1999 160,000 -0- 7,800 -0- 313
Retail 1998 138,000 -0- 7,800 77,500 62
Ronald J. Blumenthal 2000 158,000 -0- 7,800 -0- -0-
Senior Vice President 1999 148,000 -0- 7,800 -0- -0-
Real Estate 1998 135,000 -0- 7,800 62,500 -0-
Kendrick F. Royer (5) 2000 165,000 -0- 7,800 25,000 -0-
Senior Vice President and 1999 21,000 -0- 1,300 -0- -0-
General Counsel 1998 -0- -0- -0- -0- -0-
(1) Amounts shown represent car allowances for the named executive officers.
(2) Amounts shown include our contributions under our Employee Stock Ownership
Plan and our Employee Stock Purchase Plan, as applicable, for the listed
executive officers.
(3) The amount shown represents amounts paid to Mr. Welch by RightStart.com
during the period it was our subsidiary. RightStart.com paid Mr. Welch an
additional $25,000 during Fiscal 2000 when it was no longer our subsidiary. Mr.
Welch received no compensation for serving as our Chief Executive Officer or
President during Fiscal 2000.
(4) Mr. Springer became our Executive Vice President and Chief Financial
Officer in August 2000. Beginning in July 2000, when our prior CFO terminated
her employment with us, Mr. Springer provided executive services to us and we
reimbursed RightStart.com for the value of such services. The salary shown
includes amounts paid to Mr. Springer by RightStart.com while RightStart.com was
our subsidiary and are not broken out to reflect the charges between us and
RightStart.com for the value of Mr. Springer's services.
(5) Mr. Royer's salary prior to August 2000 was paid by RightStart.com and we
reimbursed RightStart.com for the value of the executive services he provided to
us. The salary shown includes amounts paid to Mr. Royer by RightStart.com while
RightStart.com was our subsidiary and are not broken out to reflect the charges
between us and RightStart.com for the value of Mr. Royer's services. Mr. Royer
terminated his employment with us on April 13, 2001.
21
Directors' Fees
- ---------------
All of our non-employee directors receive directors' fees of $3,000 per
quarter. All of the members of the Board of Directors have elected, in lieu of
such compensation, to receive options to purchase our common stock at the fair
market value on the date the options are granted.
Option Grants in Fiscal 2000
- ----------------------------
The following table provides certain information regarding stock options
granted to the Named Executive Officers during Fiscal 2000.
Options Granted in Fiscal 2000
------------------------------
Number of Potential Realizable
Common % of Total Value at Assumed
Shares Options Annual Rates of Stock
Underlying Granted to Exercise Price Appreciation for
Options Employees in Price (per Expiration Option Term (3)
Name Granted (1) Fiscal 2000 share) (2) Date 5% 10%
- ----------------------------------------------------------------------------------------------------------------------
Raymond P. Springer 50,000 64% $2.00 10/6/10 $162,889 $259,374
Kendrick F. Royer (4) 25,000 32% $2.00 10/6/10 $ 81,445 $129,687
(1) We granted an aggregate of 78,000 shares during Fiscal 2000 under our 1991
Employee Stock Option Plan. The options granted become exercisable and
fully vested at the rate of 34% on the first anniversary of the grant date
and 33% on each successive anniversary.
(2) All options were granted at an exercise price equal to the fair market
value of our common stock as of the grant date for such options.
(3) The potential realizable value is calculated assuming the exercise price on
the date of grant appreciates at the indicated rate for the entire term of
the option and that the option is exercised at the exercise price and sold
on the last day of its term at the appreciated price. All options listed
have a term of 10 years. Stock price appreciation of 5% and 10% is assumed
pursuant to the rules of the Securities and Exchange Commission. There can
be no assurance that the actual stock price will appreciate over the 10-
year option term at the assumed rates or at all. Unless the market price
of our common stock appreciates over the option term, no value will be
realized from the option grants made to the Named Executive Officers.
(4) Mr. Royer terminated his employment with us on April 13, 2001.
Aggregate Option Exercises in Fiscal 2000 and Option Values at Fiscal Year End
- ------------------------------------------------------------------------------
The following table provides certain information regarding the exercise of
stock options to purchase our stock held by the Named Executive Officers during
Fiscal 2000 and the number of options and the value of our options held as of
the end of such fiscal year.
Number of Securities Underlying Value of Unexercised In-The-
Shares Unexercised Options At Fiscal Money Options At Fiscal Year
Acquired Value Year End (#) End($)(1)
on Realized ------------ ---------
Name Exercise (#) ($)(1) Exercisable Unexercisable Exercisable Unexercisable
- ---- ------------ ------ ----------- ------------- ----------- -------------
Jerry R. Welch -0- -0- 223,661 -0- $52,917 $ -0-
Raymond P. Springer -0- -0- -0- 50,000 -0- 37,500
Marilyn Platfoot -0- -0- 52,500 25,000 3,750 -0-
Ronald J. Blumenthal -0- -0- 47,500 15,000 6,250 -0-
Kendrick F. Royer (2) -0- -0- -0- 25,000 -0- 18,750
22
__________
(1) On February 2, 2001 (the last day our common stock was traded in Fiscal
2000), the closing sale price of our common stock on the Nasdaq National
Market System was $2.75 per share.
(2) Mr. Royer terminated his employment with us on April 13, 2001.
Employment Agreements
- ---------------------
No employment agreements are currently in effect between us and any of our
officers or other employees.
Stock Compensation Programs
- ---------------------------
We have two stock option plans, an employee stock ownership plan and an
employee stock purchase plan.
1991 Employee Stock Option Plan.
We adopted the 1991 Employee Stock Option Plan (the "1991 Stock Option
Plan") in October 1991 in order to provide a means of encouraging certain of our
officers and employees to obtain a proprietary interest in the enterprise and
thereby create an additional incentive for such persons to further our growth
and development. The 1991 Stock Option Plan, as amended through the date of the
Annual Meeting, covers an aggregate of 1,050,000 shares of our common stock.
Options outstanding under this plan have terms ranging from three to ten years
(depending on the terms of the individual grant). The information regarding the
1991 Stock Option Plan provided herein is qualified in its entirety by the full
text of such plan, copies of which have been filed with the Securities and
Exchange Commission. Options for 833,160 shares were outstanding as of February
3, 2001 under the 1991 Stock Option Plan, 529,894 of which were exercisable. As
of February 3, 2001, 216,840 shares were available for future issuance.
The 1991 Stock Option Plan provides for the granting to our officers and
other key employees, including directors, and the officers and key employees of
any parent or subsidiary, including directors, incentive stock options within
the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, and
for the granting to officers, key employees, consultants and directors (even if
not employed by us), of nonstatutory stock options. If an optionee would have
the right in any calendar year to exercise for the first time incentive stock
options for shares having an aggregate fair market value (under all of our plans
and determined for each share as of the date the option to purchase the shares
was granted) in excess of $100,000, any such excess options will be treated as
nonstatutory stock options.
The 1991 Stock Option Plan may be administered by the Board of Directors or
a committee of the Board of Directors. The administrator determines the terms
of options granted under the 1991 Stock Option Plan, including the number of
shares subject to an option, the exercise price, and the term and exercisability
of options. The administrator may also amend the terms of options granted under
the 1991 Stock Option Plan (with the consent of the holder), including
accelerating the date on which the options become exercisable. The exercise
price of all stock options granted under the 1991 Stock Option Plan generally
must be at least equal to the fair market value of our common stock on the date
of grant. Payment of the purchase price of options may be made in cash, by
check, by the optionee's promissory note with terms approved by the
administrator, other Company common stock, cancellation of indebtedness, through
broker assisted cashless exercises, through margin loans or as determined by the
administrator.
Generally, options granted under the 1991 Stock Option Plan may not have a
term in excess of ten years and are nontransferable. The administrator
determines the vesting terms of options at the time of grant.
Upon a merger, consolidation or other reorganization (including the sale of
substantially all of our assets) in which we are not the surviving corporation,
the 1991 Stock Option Plan and all unexercised options terminate
23
unless a successor provides substantially similar consideration to the option
holders as provided to our shareholders or substitutes substantially equivalent
options covering shares of the successor corporation. If no such provision is
made, then the administrator must provide not less than 30 days written notice
of the anticipated effective date of the transaction and all options will be
accelerated and exercisable on the effective date. Some options granted under
the 1991 Stock Option Plan include a provision that independently causes such
acceleration of vesting and requires such notification allowing the grantee to
exercise the options prior to consummation of the transaction.
Unless terminated earlier, the 1991 Stock Option Plan will terminate in
October 2001. Options granted before expiration of the plan will be unaffected
by its expiration. The Board of Directors has the authority to amend, modify,
suspend or terminate the 1991 Stock Option Plan as long as such action does not
affect or impair any rights or obligations of the holders of any outstanding
options and provided that shareholder approval for any amendment or modification
to the 1991 Stock Option Plan shall be obtained to the extent and degree
required.
1995 Non-Employee Directors Option Plan.
In October 1995, we adopted the 1995 Non-Employee Directors Option Plan
(the "1995 Stock Option Plan"). The 1995 Stock Option Plan, as amended through
the date of the Annual Meeting, covers an aggregate of 275,000 shares of common
stock. The information regarding the 1995 Stock Option Plan provided herein is
qualified in its entirety by the full text of such plan, copies of which have
been filed with the Securities and Exchange Commission. The 1995 Stock Option
Plan provides for the annual issuance on the date of the annual meeting, 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. Options
outstanding under this plan have terms ranging from five to ten years (depending
on the terms of the individual grant). The amount of additional options is
determined based on an independent valuation such that the value of the options
issued is equivalent to the fees that the director would be otherwise entitled
to receive. Options issued under this plan vest on the anniversary date of
their grant and upon termination of Board membership. 200,861 options were
outstanding under the 1995 Stock Option Plan as of February 3, 2001, 155,121 of
which were exercisable. As of February 3, 2001, 74,139 shares were available
for future issuance.
The 1995 Stock Option Plan provides for the granting to our directors who
have not been our employees or any of our subsidiaries for at least one year
preceding membership on the Board of Directors, options that are not intended to
qualify as incentive stock options within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended. The Compensation Committee
administers the 1995 Stock Option Plan.
The exercise price for each option granted under the 1995 Stock Option Plan
is the fair market value of the common stock underlying that option on the first
trading day preceding its grant. Payment of the purchase price of options may
be made in cash, by certified cashier's check, bank draft or money order, by
delivery of our common stock owned by the optionee for at least six months (if
the Compensation Committee and applicable law permit) or as determined by the
Compensation Committee. Options granted under the 1995 Stock Option Plan are
generally nontransferable.
Upon a merger, reorganization or other business combination in which we are
the surviving corporation, optionees will be entitled to receive substitute
stock options on terms and conditions that substantially preserve the value,
rights and benefits of the affected option unless we elect to pay all optionees
the difference between the fair market value of the options and their exercise
price. If we are not the surviving corporation and do not elect to pay all
optionees the difference between the fair market value of the options and their
exercise price, each optionee will receive substitute options in the surviving
or resulting corporation on such terms and conditions as preserve the value,
rights and benefits of the affected options. Upon a Change of Control (as
defined in the 1995 Stock Option Plan), including certain acquisitions of more
than 50% of our common stock, approval by our shareholders of certain
reorganizations, mergers, consolidations or approval by our shareholders of our
liquidation or the sale of all or substantially all of our assets (other than to
a wholly-owned subsidiary), all options held by directors at such time become
fully vested and exercisable. Within 10 days after a Change of Control involving
24
the acquisition of our stock, optionees may require us to purchase their options
for the difference between fair market value and the exercise price.
Unless terminated earlier, the 1995 Stock Option Plan will terminate in
October 2005. Options granted before expiration of the plan will be unaffected
by its expiration. The Compensation Committee has the authority to amend or
revise the 1995 Stock Option Plan so long as such action does not alter or
impair rights or obligations of any outstanding option. Terms related to amount,
price and timing of annual grants and deferral rights under the 1995 Stock
Option Plan may not, however, be amended more than once in any six-month period
except to comply with the Internal Revenue Code of 1986, as amended, the
Employee Retirement Income Security Act of 1974, as amended, or the rules
promulgated thereunder. In addition, shareholder approval is required to
increase the maximum number of shares that may be granted under the plan, change
the minimum exercise price, increase the maximum term under the plan for any
option, materially modify the plan's eligibility requirements, change the term
of the plan or materially increase the benefits accruing to plan participants.
The weighted average exercise price of our outstanding options under the
1991 Stock Option Plan and the 1995 Stock Option Plan at February 3, 2001 was
$4.13 per share of our common stock.
Company Employee Stock Purchase Plan.
We match employees' contributions to our Employee Stock Purchase Plan at a
rate of 50%. Our contributions amounted to $13,000, $12,000, and $14,000, in
Fiscal 2000, Fiscal 1999 and Fiscal 1998, respectively.
Company Employee Stock Ownership Plan.
Our Employee Stock Ownership Plan is funded exclusively by discretionary
contributions determined by the Board of Directors. No contributions were
authorized for Fiscal 2000, Fiscal 1999 or Fiscal 1998. We are in the process
of terminating the Employee Stock Ownership Plan.
Compensation Committees Interlocks and Insider Participation
- ------------------------------------------------------------
Richard Kayne and Fred Kayne, each directors of the Company, are each
members of our Compensation Committee. Messrs. Kayne have participated in
transactions requiring disclosure under the section "Certain Relationships and
Related Transactions."
25
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
The following table sets forth certain information, as of April 20, 2001,
with respect to all those known by us to be the beneficial owners of more than
5% of our outstanding common stock, each director who owns shares of common
stock, each Named Executive Officer, and all our directors and executive
officers as a group.
______________________________________________________________________________
Name and Address Amount and Nature of Percent
Owner (1) Beneficial Ownership of
Common Stock Class
______________________________________________________________________________
Richard A. Kayne (2) 5,784,357 62.12%
Kayne Anderson Investment
Management, Inc.
1800 Avenue of the Stars
Second Floor
Los Angeles, CA 90067
Fred Kayne (3) 1,357,300 21.2%
Fortune Fashions
6501 Flotilla Street
Commerce, CA 90040
J. Carlo Cannell (4) 318,600 5.7%
Cannell Capital Management
600 California Street
San Francisco, CA 94108
Howard Kaplan 305,000 5.4%
99 Chauncy Street
Boston, MA 02111
Lloyd I. Miller, III (5) 533,900 6.8%
4550 Gordon Drive
Naples, FL 34102
Marilyn Platfoot (6) 77,803 1.4%
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
Andrew Feshbach (7) 44,613 *
Big Dog Sportswear
121 Gray Avenue, Suite 300
Santa Barbara, CA 93101
Robert R. Hollman (7) 37,230 *
Hollman Property Company
1801 Avenue of the Stars
Suite 444
Los Angeles, CA 90067
Jerry R. Welch (7) (8) 220,002 3.8%
Kayne Anderson Investment
26
Management, Inc.
1800 Avenue of the Stars
Second Floor
Los Angeles, CA 90067
Howard M. Zelikow (7) (8) 86,813 1.5%
Kayne Anderson Investment
Management, Inc.
1800 Avenue of the Stars
Second Floor
Los Angeles, CA 90067
Ronald J. Blumenthal (9) 63,418 1.1%
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
Jill Higgins (10) 60,000 1.1%
10153 1/2 Riverside Drive #598
Toluca Lake, CA 91602
Gerald E. Mitchell (11) 102,732 1.8%
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
Raymond P. Springer -0- *
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
Kendrick F. Royer -0- *
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361 (12)
All executive officers and directors 7,834,269 72.8%
as a group (ten persons) (13)
_____________
* Less than one percent.
(1) Except as otherwise noted below, the persons named in the table have sole
voting power and investment power with respect to all shares of common stock
shown as beneficially owned by them, subject to community property laws where
applicable.
(2) The 5,784,357 shares include (i) 618,440 shares held directly by Mr. Kayne
(including 57,420 shares which may be acquired within 60 days upon exercise of
options, 250,000 which may be acquired upon conversion of the Series D Preferred
Stock and 50,000 shares which may be acquired upon exercise of Warrants issued
in connection with the Series D Preferred Stock) and (ii) 5,165,917 shares held
in accounts managed by Kayne Anderson Capital Advisors, L.P. ("KA Capital"), a
registered investment adviser (including 399,999 shares which may be acquired
upon conversion of the Series B Preferred Stock and 1,691,650 shares which may
be acquired upon conversion of the Series C Preferred Stock and 1,263,155 shares
which may be acquired upon conversion of the Senior Subordinated Notes). Mr.
Kayne has sole voting and dispositive power over the shares he holds directly.
He has shared voting and dispositive power along with Kayne Anderson Investment
Management, Inc. ("KAIM, Inc."), the general partner of KA Capital, over the
remaining shares. Mr. Kayne is the President, Chief Executive Officer and a
Director of KAIM, Inc., and the principal stockholder of its parent company. The
shares held by managed accounts of KA Capital include the following shares held
by investment funds for which KA Capital serves as general partner or manager:
1,440,574 shares held by Kayne, Anderson Non- Traditional Investments, L.P.
(including 50,000 shares which may be acquired upon conversion of the Series B
Preferred Stock, 465,200 shares which may be acquired upon conversion of the
Series C Preferred Stock and 315,750 shares which may be acquired upon
conversion of the Senior Subordinated Notes); 1,146,778 shares held by ARBCO
Associates, L.P. (including 50,000 shares which may be acquired upon conversion
of the Series B Preferred Stock, 465,200 shares which may be acquired upon
conversion of the Series C Preferred Stock and 631,500 shares which may be
acquired upon conversion of the Senior Subordinated Notes); 1,647,886 shares
held by Kayne Anderson Diversified Capital
27
Partners, L.P. (including 133,333 shares which may be acquired upon conversion
of the Series B Preferred Stock, 465,200 shares which may be acquired upon
conversion of the Series C Preferred Stock and 189,450 shares which may be
acquired upon conversion of the Senior Subordinated Notes); 551,460 shares held
by Kayne Anderson Capital Partners, L.P. (including 91,667 shares which may be
acquired upon conversion of the Series B Preferred Stock, 211,450 shares which
may be acquired upon conversion of the Series C Preferred Stock and 126,300
shares which may be acquired upon conversion of the Senior Subordinated Notes);
197,100 shares held by Kayne Anderson Offshore Limited (including 75,000 shares
which may be acquired upon conversion of the Series B Preferred Stock and 84,600
shares which may be acquired upon conversion of the Series C Preferred Stock)
and 182,119 shares managed in other accounts. KA Capital disclaims beneficial
ownership of the shares reported, except those shares attributable to it by
virtue of its general partner interests in the limited partnerships holding such
shares. Mr. Kayne disclaims beneficial ownership of the shares reported, except
those shares held by him directly or attributable to him by virtue of his
limited and general partner interests in such limited partnerships and by virtue
of his indirect interest through the interest of KAIM, Inc. in such limited
partnerships. The foregoing is based on information provided by Mr. Kayne and KA
Capital to us as of April 20, 2001 and their 13D/A filed January 8, 2001.
(3) Of the 1,357,300 shares beneficially owned, 890,107 shares are held
directly by Mr. Kayne (including 57,420 shares which may be acquired within 60
days upon exercise of options, 83,333 shares may be acquired upon conversion of
Series B Preferred Stock and 175,000 shares may be acquired upon conversion of
Series C Preferred Stock). Fortune Twenty-Fifth, Inc., a corporation of which
Mr. Kayne is the sole stockholder may acquire 400,000 shares or our common stock
upon conversion of Series D Convertible Preferred Stock and 80,000 shares upon
exercise of warrants issued in connection with the issuance of the Series D
Convertible Preferred Stock. The foregoing is based on information provided by
Mr. Kayne to us as of April 20, 2001and his 13D/A filed December 11, 2000.
(4) According to a Schedule 13G filed on February 15, 2000, other members of
the reporting group are Tonga Partners, LP, The George S. Sarlo 1995 Charitable
Remainder Trust, The Cuttyhunk Fund Limited, Goldman Sachs and Anegada Fund,
Ltd.
(5) According to a Schedule 13G filed on February 14, 2001, Mr. Miller shares
dispositive and voting power on 152,250 shares of the reported securities as an
adviser to the trustee of certain family trusts and Mr. Miller has sole voting
and dispositive power on 381,650 of the reported securities owned by him
personally and/or as the manager of a limited liability company that is the
general partner of a limited partnership.
(6) Includes currently exercisable options to purchase 77,500 shares of common
stock and 303 and 97 vested shares held by our Employee Stock Purchase Plan and
Employee Stock Ownership Plan, respectively, for the benefit of Ms. Platfoot.
Excludes 185 and 64 unvested shares held by our Employee Stock Purchase Plan and
Employee Stock Ownership Plan, respectively.
(7) All shares consist of currently exercisable options to purchase common
stock.
(8) Messrs. Welch and Zelikow are officers and Managing Directors of KAIM,
Inc.; however, they disclaim beneficial ownership with respect to shares held by
KAIM, Inc. or any of its affiliates.
(9) Includes currently exercisable stock options to purchase 62,500 shares of
common stock and 919 vested shares held by our Employee Stock Ownership Plan for
the benefit of Mr. Blumenthal.
(10) Includes 50,000 shares which may be acquired upon conversion of the Series
D Preferred Stock and 10,000 shares which may be acquired upon exercise of
warrants issued in connection with the Series D Preferred Stock.
(11) Includes 25,128 shares, options exercisable within 60 days to purchase
77,500 shares of common stock and 104 shares held by our Employee Stock
Ownership Plan for the benefit of Mr. Mitchell. Mr. Mitchell terminated his
employment with us in March 2001.
(12) Mr. Royer terminated his employment with us on April 13, 2001.
(13) Includes options and common stock beneficially owned by executive officers
and directors.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
Consulting Services
- -------------------
During Fiscal 2000, Kayne Anderson Capital Advisors, L.P. provided management,
consulting and advisory services to us for which it received a fee of $187,500.
Management Services Agreement
- -----------------------------
28
We and RightStart.com entered into a management services agreement, dated
as of July 9, 1999. Transactions between us and RightStart.com are required to
be disclosed due to options in common stock of RightStart.com granted to our
executive officers and loans made by Messrs. Kayne to RightStart.com. Pursuant
to the management services agreement, we provide basic services, inventory
supply services and promotional services to RightStart.com as detailed below:
Basic Services. We have agreed to provide RightStart.com with various
services from time to time, including, among others, services for
personnel/human resources, benefits administration, payroll processing,
insurance, tax, cash management, merchandising, advertising, inventory
management, employee relations, employee benefits, customer relations,
financial, legal, order fulfillment and collection, accounting,
telecommunications, catalog production assistance and credit card processing.
RightStart.com is free at any time, however, to perform any of these services
for itself or contract with other third parties to supply these services. In
accordance with the terms of the management services agreement, as consideration
for such services, RightStart.com pays us an amount equal to Direct Cost (as
defined below) plus five percent. "Direct Cost" is defined with respect to each
service as the direct out-of-pocket expenses paid to third parties or incurred
by us in connection with providing such service and overhead expenses directly
attributable to providing such service, including, without limitation, shipping,
handling, travel expenses, personnel costs, professional fees, printing and
postage.
Inventory Supply Services. We have agreed to supply RightStart.com with
Common Inventory (as defined below) when and as requested and Internet-Only
Inventory (as defined below) on an as needed basis to permit RightStart.com
immediately to fulfill individual customer orders. RightStart.com is no longer
ordering Internet-Only Inventory. "Common Inventory" is defined as all
inventory purchased for RightStart.com by us that is carried for sale in our
retail stores and either on RightStart.com's online store or through its catalog
operations. Common Inventory consists primarily of merchandise for infants and
children from birth to age three years old and their caregivers. "Internet-Only
Inventory" is defined as the inventory of products sold or carried for sale only
by RightStart.com in its online stores or through its catalog operations and not
sold or carried for sale in our retail stores. We supply RightStart.com at a
price equal to 105% of the aggregate of direct cost of the goods, the inbound
freight charges and all other costs charged to us by our suppliers. We have
also agreed to accept returns from RightStart.com's customers of products
purchased from RightStart.com's online store. The amount refunded to a customer
is charged to RightStart.com. In the case of saleable Common Inventory the
inventory cost or vendor credit is credited to RightStart.com.
Promotional Services. We have agreed to promote RightStart.com as our
exclusive online and catalog distribution channel for products for parents,
childcare providers, infants and children under age seventeen. We also have
agreed to provide RightStart.com with the following promotional services: (i)
prominent references to RightStart.com on customer bags, customer receipts,
labels, invoices, counter cards, in-store audio programming, emails, letterhead,
mailers, advertising and on other items to the extent such reference can be made
at a low incremental cost and (ii) in-store signs promoting RightStart.com in
all our retail stores. We give our employees incentives to implement
RightStart.com marketing and merchandising programs.
RightStart.com may terminate the management services agreement in full or
on a service-by-service basis (a) upon 30 days prior written notice to us with
respect to services provided therein, (b) upon the occurrence of a material
breach by us which is not cured within 30 days of receipt of written notice from
RightStart.com, (c) upon the occurrence of events relating to our bankruptcy,
(d) upon the liquidation, other termination, sale or transfer of our business or
substantially all of our assets or (e) if we become insolvent or unable to pay
our debts as they mature or makes an assignment for the benefit of its
creditors. The management services agreement may be terminated by us in full or
on a service-by-service basis (a) at any time after December 31, 2000, upon 120
days prior written notice to RightStart.com if (i) RightStart.com's annual sales
run rate is projected to be in excess of $40 million or (ii) We are required to
make expenditures for basic services or inventory supply services of $15,000 or
more in any month on RightStart.com's behalf if such amount cannot reimbursed or
otherwise paid by RightStart.com, (b) upon the occurrence of a material breach
by RightStart.com which is not cured within 60 days of receiving written notice
from us (except that if the material breach relates to RightStart.com's failure
29
to pay for the services received in accordance with the management services
agreement, it must be cured within 30 days), (c) upon the occurrence of certain
undismissed petitions or proceedings relating to a RightStart.com bankruptcy or
insolvency, (d) upon the liquidation, other termination, sale or transfer of
RightStart.com's business or substantially all of RightStart.com's assets or (e)
if RightStart.com makes an assignment for the benefit of its creditors. In
additions, we may terminate the inventory supply portion of the management
services agreement upon 90 days prior written notice. Invoices for inventory
purchased by RightStart.com are prepared weekly and are due in 10 days. The
income for services rendered under this agreement, which for Fiscal 2000 and
Fiscal 1999 amounted to $405,000 and $407,000, respectively, is netted against
general and administrative expenses. At February 3, 2001, we were owed $400,000
by RightStart.com. Due to the uncertainty surrounding the ongoing viability of
RightStart.com, the full amount of the receivable is reserved.
Intellectual Property Agreement
- -------------------------------
We and RightStart.com have entered into an intellectual property agreement,
dated as of July 9, 1999, pursuant to which we (i) assigned to RightStart.com
the Website IP (as defined below) and User Information (as defined below), (ii)
granted RightStart.com a worldwide, non-exclusive, (except with respect to
online usage) non-transferable, fully-paid up and royalty-free license to use
the Right Start IP (as defined below) solely in connection with its online and
catalog retail sales of products for parents, childcare providers, infants and
children and (iii) granted RightStart.com a perpetual, worldwide, exclusive,
fully-paid up and royalty-free, unrestricted sublicense and right to use the
source code and object code and certain other intellectual property owned by
Guidance Solutions, which we engaged to develop the website located at
www.rightstart.com. Pursuant to the intellectual property agreement,
RightStart.com granted to us a worldwide, non-exclusive, fully-paid up and
royalty-free license to use the Website IP and User Information solely in
connection with our retail sales of parents', childcare, infants' and children's
products (other than through online or catalog sales). "Website IP" is defined
as all files, text, graphics, graphics files in any file format, images,
artwork, audio files, audiovisual materials and e-commerce and database
applications provided by third parties or us or created by or for RightStart.com
in connection with the Website and certain copyright registrations, all domain
names, all trademarks, all service marks, all trade dress, all logos, all brands
and designs, all trade names, all Internet domain names, all metatags and
hyperlinks used in connection with the Website and the online and catalog
retailing of parents', childcare, infants' and children's products. "Right
Start IP" is defined as all lists of customers and prospective customers used in
connection with our retail sales of infants' and children's products other than
through online or catalog sales. "User Information" is defined as all
information with respect to the use and users of RightStart.com's website,
including all catalog customer lists of the Company or RightStart.com that
existed on July 9, 1999.
The intellectual property agreement is perpetual unless terminated. The
intellectual property agreement may be terminated by us (a) upon the occurrence
of mergers, reorganizations, consolidations or other business combinations
(other than with an affiliate or financial advisor) as a result of which
RightStart.com's stockholders immediately prior to such transaction hold less
than 50% of the voting power of RightStart.com and in which the acquirer is our
direct competitor and (b) upon the occurrence of a material breach by
RightStart.com that is not cured within 30 business days of receipt of written
notice from us. RightStart.com may terminate the intellectual property
agreement upon the occurrence of a material breach by us which is not cured
within 30 days of receipt of written notice from RightStart.com. After
termination, RightStart.com is automatically granted a license with respect to
(i) customer information and (ii) the Right Start IP, in each case used by
RightStart.com at the time of termination. We similarly are granted an
automatic license with respect to User Information used by us at the time of
termination. These post-termination licenses are terminable if, in the opinion
of a independent recognized arbitrator, the licensee has engaged in activity
that would substantially harm the image of the owner of the licensed
intellectual property, substantially diminish the value of such party's
intellectual property rights or the "Right Start" name.
30
Lease
- -----
Since May 1, 1999, RightStart.com has subleased office space on a month-to-
month basis from us. Rent expense under this sublease totaled $150,000 for
Fiscal 2000. The monthly rent cost is approximately $12,500 effective February
3, 2001. RightStart.com has no formal agreement with us to continue this
sublease. In April 2001, we entered into a lease agreement effective July 1,
2001, for our new corporate headquarters in Calabasas, California. We expect to
sublease space in our new corporate headquarters to RightStart.com at a rate
based on the number of square feet of space occupied by RightStart.com. We have
no obligation, however, to do so.
Bridge Loans to RightStart.com
- ------------------------------
Messrs. Kayne hold secured bridge notes of RightStart.com in the aggregate
principal amount of $2.0 million which, since they have been defaulted upon,
permit them to exercise contingent warrants to purchase approximately 29.8% of
the common stock of RightStart.com for an aggregate exercise price of $2.0
million which may be paid by surrender of the bridge notes. Affiliates of Kayne
Anderson Investment Management, Inc. and Fred Kayne hold secured convertible
bridge notes of RightStart.com in the aggregate principal amount of $800,000 and
$200,000, respectively, convertible into approximately 14.9% of the common stock
of RightStart.com. The secured convertible bridge notes are in default. In
each case the assumption is that all convertible bridge notes are converted and
all such warrants exercised. Messrs. Kayne, together with the other holders of
such notes are secured by liens on substantially all of the assets of
RightStart.com.
Baby Registry Agreement
- -----------------------
As of April 12, 2001, we entered into Baby Registry Joint Development and Use
Agreement with RightStart.com pursuant to which we and RightStart.com intend to
jointly develop a baby registry that can be accessed by our customers and
RightStart.com's customers. Upon termination of the agreement each party would
be entitled to retain all code used in the jointly developed registry, as well
as any database information collected to the date of such termination and to
operate a separate registry.
Indemnification Agreements
- --------------------------
We have entered into indemnification agreements with certain of our former
directors and executive officers which may, among other things, require us to
indemnify such persons against liabilities that may arise by reason of such
persons' status as directors or executive officers for us, other than
liabilities that may not be indemnified against including short swing profits
disgorgement liability, and to advance such persons' expenses incurred as a
result of any proceeding against them as to which they could be indemnified.
Such agreements continue even though such persons no longer serve us.
31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 10-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
Balance Sheets - February 3, 2001 and January 29, 2000 F - 2
Statements of Operations - Periods Ended February 3, 2001, January 29, F - 3
2000 and January 30, 1999
Statements of Shareholders' Equity - Periods Ended February 3, 2001, F - 4
January 29, 2000 and January 30,1999
Statements of Cash Flows - Periods Ended February 3, 2001, January 29, F - 5
2000 and January 30, 1999
Notes to Financial Statements F - 6
(2) Financial Statement Schedules:
Report of Independent Public Accountants F - 24
RightStart.com Inc. Balance Sheet - February 3, 2001 F - 25
RightStart.com Inc. Statement of Operations for the Year Ended February 3, F - 26
2001
F - 27
RightStart.com Inc. Statement of Stockholders' Deficit for the Year Ended
February 3, 2001
F - 28
RightStart.com Inc. Statement of Cash Flows For the Year Ended February 3,
2001
Notes to Financial Statements F - 29
All other financial statement schedules are omitted because they are
either not applicable or the required information is shown in the
financial statements or notes thereto.
(3) Listing of Exhibits
The following exhibits are filed as part of, or incorporated by reference
into, this annual report:
32
INDEX TO EXHIBITS
Exhibit
Number
- ------
3.1 Second Amended and Restated Articles of Incorporation of The Right Start, Inc., dated December
15, 1998
3.2 Bylaws of The Right Start, Inc. as in effect on and after October 13, 1993
3.5 Specimen Certificate of the Common Stock of The Right Start, Inc. (without par value) (1)
4.1 Certificate of Determination of Preferences of Series A Preferred Stock, Series B Preferred
Stock and Series C Preferred Stock of The Right Start, Inc., dated as of December 16, 1998.
4.2 Certificate of Determination of Preferences of Series D Convertible Pay-in-Kind Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock of The Right Start, Inc., dated as
of October 4, 2000 (2)
4.3 Warrant dated January 18, 2000, to purchase 5,000 shares of common stock of The Right Start,
Inc. issued to Heller Financial, Inc. (3)
4.4 Warrant dated August 8, 2000, to purchase 5,000 shares of common stock of The Right Start, Inc.
issued to Heller Financial, Inc. (4)
4.5 Form of Senior Subordinated Convertible Pay-in-Kind Notes due 2005 (5)
4.6 Form of Warrant dated October 6, 2000, to purchase shares of common stock of The Right Start,
Inc. issued to purchasers of The Right Start, Inc.'s Series D Convertible Preferred Stock (2)
10.1 1991 Employee Stock Option Plan
10.3 1995 Non-employee Directors Option Plan (7)
10.4 Form of Indemnification Agreement between The Right Start, Inc. and certain of its directors
and executive officers (6)
10.5 Asset Purchase Agreement dated September 1, 1992, for acquisition of the Assets of Small
People, Inc. and Jimash Corporation by Right Start Subsidiary I, Inc. (8)
10.6 Registration Rights Agreement dated September 4, 1997, between The Right Start, Inc. and
certain funds managed by Kayne Anderson Capital Advisors, L.P., Cahill, Warnock Strategic
Partners Fund, L.P., The Travelers Indemnity Company and certain other investors named therein
(9)
10.7 Asset Purchase Agreement dated as of July 29, 1996 by and between Blasiar, Inc. (DBA Alert
Communications Company) and The Right Start, Inc. (7)
10.8 Securities Purchase Agreement dated as of September 4, 1997 between The Right Start, Inc. and
the investors named therein with respect to 1,510,000 shares of the company's common stock (10)
10.9 Management Services Agreement dated July 9, 1999, between The Right Start, Inc. and
RightStart.com Inc. (11)
10.10 First Amendment to Management Services Agreement dated as of February 1, 2000.
10.11 Second Amendment to Management Services Agreement dated as of April 1, 2001.
10.12 Intellectual Property Agreement dated July 9, 1999 between The Right Start and RightStart.com
(11)
33
10.13 Warrant dated April 18, 2000, to purchase 4,000,000 shares of the common stock of
RightStart.com Inc. issued to Fred Kayne in connection with the sale by RightStart.com of
Secured Bridge Notes (12)
10.14 Secured Bridge Note of RightStart.com Inc. dated April 18, 2000, issued to Fred Kayne (13)
10.15 Secured Bridge Note and Warrant Purchase Agreement dated April 18, 2000, among RightStart.com
Inc., Fred Kayne, Richard Kayne and Palomar Ventures I, L.P. (14)
10.16 Security Agreement dated April 18, 2000 among RightStart.com Inc., Fred Kayne, Richard Kayne
and Palomar Ventures I, L.P. (14)
10.17 First Amendment to Secured Bridge Note and Warrant Purchase Agreement and Security Agreement
dated June 1, 2000 between RightStart.com Inc. and Guidance Solutions, Inc. (14)
10.18 Secured Convertible Bridge Note Purchase Agreement dated June 22, 2000, among RightStart.com
Inc., certain funds managed by Kayne Anderson Capital Advisors, L.P., Sierra Ventures VII,
L.P., Sierra Ventures Associates VII, L.L.C. and Guidance Solutions, Inc., including form of
Note and form of Security Agreement as exhibits (15)
10.19 Securities Purchase Agreement dated September 1, 2000, between The Right Start, Inc. and fund
managed by Kayne Anderson Capital Advisors, L.P. with respect to The Right Start, Inc.'s Senior
Subordinated Pay-in-Kind Notes due 2005, including form of Note, form of Registration Rights
Agreement and form of Security Agreement as exhibits (5)
10.20 Securities Purchase Agreement dated October 6, 2000, between The Right Start, Inc. and the
purchasers thereunder with respect to The Right Start, Inc.'s Series D Convertible Pay-in-Kind
Preferred Stock, including form of Warrant and form of Registration Rights Agreement as
exhibits (2)
10.21 Common Stock Purchase Agreement dated October 10, 2000, between RightStart.com Inc. and Michael
Targoff (16)
10.22 Baby Registry Joint Development and Use Agreement dated April 12, 2001 between The Right Start,
Inc. and RightStart.com Inc.
10.23 Loan and Security Agreement between The Right Start, Inc. and Paragon Capital LLC (aka Wells
Fargo Retail Finance) as of January 23, 2001 (17)
23.1 Consent of Independent Public Accountants - Arthur Andersen LLP
23.2 Consent of Independent Accountants - PricewaterhouseCoopers LLP
__________________________
(1) Previously filed as an Exhibit to The Right Start, Inc.'s Registration
Statement of Form S-1 dated August 29, 1991.
(2) Previously filed as an Exhibit to The Right Start, Inc.'s Current Report on
Form 8-K filed October 11, 2000.
(3) Previously filed as an Exhibit to The Right Start, Inc.'s Annual Report on
Form 10-K for the fiscal year ended January 29, 2000.
(4) A substantially identical warrant was issued to Heller Financial, Inc.
exercisable for 20,000 shares of common stock of The Right Start, Inc. at
an exercise price of $5.00 per share.
(5) Previously filed as an Exhibit to The Right Start, Inc.'s Quarterly Report
on Form 10-Q for the period ended July 29, 2000.
(6) Previously filed as an Exhibit to Amendment Number 1 to The Right Start,
Inc.'s Registration Statement on Form S-1 dated September 11, 1991.
34
(7) Previously filed as an Exhibit to The Right Start, Inc.'s Annual Report on
Form 10-K for the fiscal year ended June 1, 1996.
(8) Previously filed as an Exhibit to The Right Start, Inc.'s Current Report on
Form 8-K filed September 24, 1992.
(9) Previously filed as an Exhibit to The Right Start, Inc.'s Annual Report on
Form 10-K for the fiscal year ended January 31, 1998, as amended.
(10) Previously filed as an Exhibit to The Right Start, Inc.'s Quarterly Report
on Form 10-Q for the period ended August 2, 1997.
(11) Previously filed as an Exhibit to The Right Start, Inc.'s Current Report on
Form 8-K dated July 9, 1999.
(12) Substantially identical warrants were issued to Richard Kayne (for
4,000,000 shares), Palomar Ventures I, L.P. (for 360,000 shares) and
Guidance Solutions, Inc. (for 380,220 shares).
(13) Previously filed as an Exhibit to The Right Start, Inc.'s Quarterly Report
on Form 10-Q for the period ended April 29, 2000. Substantially identical
notes were issued to Richard Kayne ($1,000,000), Palomar Ventures I, L.P.
($180,000) and Guidance Solutions ($95,055).
(14) Previously filed as an Exhibit to The Right Start, Inc.'s Quarterly Report
on Form 10-Q for the period ended April 29, 2000.
(15) Previously filed as an Exhibit to The Right Start, Inc.'s Quarterly Report
on Form 10-Q for the period ended July 29, 2000.
(16) Previously filed as an Exhibit to The Right Start, Inc.'s Quarterly Report
on Form 10-Q for the period ended October 28, 2000.
(17) Previously filed as an Exhibit to The Right Start, Inc.'s Current Report on
Form 8-K dated January 23, 2001.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on November 21, 2000, with respect
to the further sale of its convertible debt securities in a private
placement originally described in its filing October 10, 2000 on form 8-K.
The Company filed a report on Form 8-K on January 25, 2001, with respect to
the closing of a Loan and Security Agreement with Wells Fargo Retail
Finance as of January 23, 2001.
(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.
35
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: May 1, 2001 /s/ Jerry R. Welch
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, May 1, 2001
- --------------------------- Chief Executive Officer
Jerry R. Welch and President
/s/ Richard A. Kayne Director May 1, 2001
- ---------------------------
Richard A. Kayne
/s/ Andrew D. Feshbach Director May 1, 2001
- ---------------------------
Andrew D. Feshbach
/s/ Robert R. Hollman Director May 1, 2001
- ---------------------------
Robert R. Hollman
/s/ Fred Kayne Director May 1, 2001
- ---------------------------
Fred Kayne
/s/ Howard M. Zelikow Director May 1, 2001
- ---------------------------
Howard M. Zelikow
/s/ Raymond P. Springer Chief Financial Officer May 1, 2001
- --------------------------- (Principal Financial and
Raymond P. Springer Accounting Officer)
36
THE RIGHT START, INC.
REPORT AND FINANCIAL STATEMENTS
FEBRUARY 3, 2001 AND JANUARY 29, 2000
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Shareholders and the Board of Directors of The Right Start, Inc.:
We have audited the accompanying balance sheets of The Right Start, Inc. (a
California Corporation) as of February 3, 2001 and January 29, 2000 and the
related statements of operations, shareholders' equity and cash flows for the
two years 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 audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The Right Start, Inc. as of
February 3, 2001 and January 29, 2000, and the results of its operations and its
cash flows for the two years then ended in conformity with accounting principles
generally accepted in the United States.
Arthur Andersen LLP
Los Angeles, California
April 26, 2001
F-1
Report of Independent Accountants
---------------------------------
To the Board of Directors and
Shareholders of The Right Start, Inc.
In our opinion, the accompanying statements of operations, of shareholders'
equity and of cash flows for the year ended January 30, 1999 present fairly, in
all material respects, the results of operations and cash flows of The Right
Start, Inc. for the year ended January 30, 1999, in conformity with accounting
principles generally accepted in the United States of America. 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 of these statements in accordance with
auditing standards generally accepted in the United States of America, 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 audit provides a
reasonable basis for our opinion. We have not audited the 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.
BALANCE SHEETS
--------------
February 3, 2001 January 29, 2000
---------------- ----------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 254,000 $ 5,199,000
Accounts and other receivables, net of allowance for doubtful
accounts of $400,000 and $87,000, respectively 552,000 682,000
Merchandise inventories 9,784,000 9,694,000
Prepaid catalog costs - 170,000
Other current assets 1,160,000 1,679,000
------------------ -------------------
Total current assets 11,750,000 17,424,000
Noncurrent assets:
Property, plant and equipment, net 8,907,000 10,648,000
Deferred income tax asset 1,400,000 1,400,000
Other noncurrent assets 177,000 1,255,000
------------------ -------------------
$ 22,234,000 $ 30,727,000
================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 5,637,000 $ 9,566,000
Revolving line of credit - 3,377,000
------------------ -------------------
Total current liabilities 5,637,000 12,943,000
Revolving line of credit, due January 2005 4,945,000
Term note payable - 3,000,000
Senior subordinated convertible pay-in-kind notes 3,000,000
Deferred rent 1,489,000 1,378,000
Minority interest in consolidated subsidiary - 3,397,000
Commitments and contingencies
Mandatorily redeemable preferred stock Series A,
$3,000,000 redemption value 2,439,000 2,088,000
Shareholders' equity:
Convertible preferred stock, $100 liquidation preference,
$0.01 par, 25,000,000 authorized
Series B; 16,500 and 20,000 issued and outstanding,
respectively 1,547,000 1,875,000
Series C; 37,333 and 38,500 issued and outstanding,
respectively 3,733,000 3,850,000
Series D; 44,900 issued and outstanding 4,045,000
Common stock (25,000,000 shares authorized at no par value;
5,617,275 and 5,417,666 issued and
outstanding, respectively) 22,730,000 22,593,000
Paid in capital 17,000,000 15,471,000
Accumulated deficit (44,331,000) (35,868,000)
------------------ -------------------
Total shareholders' equity 4,724,000 7,921,000
------------------ -------------------
$ 22,234,000 $ 30,727,000
================== ===================
See accompanying notes to financial statements
F-2
THE RIGHT START, INC.
STATEMENTS OF OPERATIONS
------------------------
Year Ended
----------------------------------------------------------
February 3, 2001 January 29, 2000 January 30, 1999
---------------- ---------------- ----------------
Net sales:
Retail $44,201,000 $ 38,043,000 $31,875,000
Sales to RightStart.com 9,408,000 - -
Internet - 7,391,000 -
Catalog - 3,645,000 4,736,000
Shipping and handling revenues - 765,000 982,000
----------- ------------ -----------
53,609,000 49,844,000 37,593,000
----------- ------------ -----------
Costs and expenses:
Cost of goods sold 21,952,000 25,279,000 18,576,000
Cost of goods sold to RightStart.com 9,408,000 - -
Cost of shipping and handling - 2,670,000 969,000
Operating expense, includes non-cash compensation of
$93,000, $2,014,000 and none, respectively 17,214,000 20,479,000 15,119,000
Marketing and advertising expense 1,000,000 7,233,000 387,000
General and administrative expense 4,017,000 5,306,000 3,337,000
Pre-opening costs 456,000 323,000 209,000
Depreciation and amortization expense 2,184,000 1,950,000 1,488,000
Store closing (income) expense 401,000 151,000 (113,000)
----------- ------------ -----------
56,632,000 63,391,000 39,972,000
----------- ------------ -----------
Operating loss (3,023,000) (13,547,000) (2,379,000)
Non-cash beneficial conversion feature amortization - - 3,850,000
Loss on investment in RightStart.com Inc. 3,406,000 - -
Minority interest in consolidated subsidiary loss - (3,000,000) -
Interest expense, net 1,197,000 227,000 640,000
----------- ------------ -----------
Loss before income taxes and extraordinary item (7,626,000) (10,774,000) (6,869,000)
Income tax provision 78,000 68,000 22,000
----------- ------------ -----------
Loss before extraordinary item (7,704,000) (10,842,000) (6,891,000)
Extraordinary gain on debt restructuring, net - - 1,211,000
----------- ------------ -----------
Net loss $(7,704,000) $(10,842,000) $(5,680,000)
=========== ============ ===========
Basic and diluted loss per share:
Loss before extraordinary item $ (1.46) $ (2.14) $ (1.37)
Extraordinary item - - 0.24
----------- ------------ -----------
Net loss $ (1.46) $ (2.14) $ (1.13)
=========== ============ ===========
Weighted average number of shares
outstanding 5,597,809 5,355,756 5,051,820
=========== ============ ===========
See accompanying notes to financial statements.
F-3
THE RIGHT START, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
----------------------------------
Preferred Stock
-------------------------------------------------------------------------------------------------
Series B Series C Series D
--------------------------------- ----------------------------- --------------------------------
Shares Amount Shares Amount Shares Amount
--------------- --------------- ------------ --------------- ----------- ------------------
Balance January 31, 1998
Issuance of preferred stock 30,000 $2,813,000 38,500 $3,850,000
Issuance of subordinated debt
in conjunction
with recapitalization, net
Net loss
--------------- --------------- ------------ --------------- ---------- -------------------
Balance January 30, 1999 30,000 2,813,000 38,500 3,850,000
Preferred shares converted to
common (10,000) (938,000)
Issuance of shares pursuant to
the exercise of stock options
Recapitalization costs
Dividend accretion
Induced conversion of
Subsidiary's preferred stock
Issuance of shares in
connection with former credit
facility
Issuance of warrants in
connection with former credit
facility
Perfomance options
Subsidiary options
Director's options
Amortization of deferred
compensation
Issuance in common stock of
subsidiary
Net loss
--------------- --------------- ------------ --------------- ---------- -------------------
Balance January 29, 2000 20,000 1,875,000 38,500 3,850,000
Preferred shares converted to
common (3,500) (328,000) (1,167) (117,000)
Issuance of shares pursuant to
the exercise of stock options
Dividend accretion
Amortization of deferred
compensation
Issuance of warrants in
connection with former credit
facility
Issuance of preferred stock and 44,900 $4,045,000
warrants, net
Options granted to non-employees
Dividends on preferred stock
Warrants issued by subsidiary
Deferred compensation related
to subsidiary
Net loss
--------------- --------------- ------------ --------------- ---------- -------------------
Balance February 3, 2001 16,500 $1,547,000 37,333 $3,733,000 44,900 $4,045,000
=============== =============== ============ =============== ========== ===================
Common Stock Additional Retained
----------------------------- Paid in Deferred Earnings
Shares Amount Capital Compensation (Deficit) Net Equity
------------ --------------- ----------------- -------------- ---------------- ----------------
Balance January 31, 1998 5,051,820 $22,337,000 ($19,030,000) $3,307,000
Issuance of preferred stock 6,663,000
Issuance of subordinated debt $3,590,000 3,590,000
in conjunction
with recapitalization, net (19,000) (19,000)
Net loss (5,680,000) (5,680,000)
------------ --------------- ----------------- -------------- ---------------- ----------------
Balance January 30, 1999 5,051,820 22,337,000 3,571,000 (24,710,000) 7,861,000
Preferred shares converted to
common 333,333 938,000
Issuance of shares pursuant to
the exercise of stock options 27,383 155,000 155,000
Recapitalization costs (56,000) (56,000)
Dividend accretion (301,000) (301,000)
Induced conversion of
Subsidiary's preferred stock 316,000 (316,000)
Issuance of shares in
connection with former credit
facility 5,130 101,000 101,000
Issuance of warrants in
connection with former credit
facility 58,000 58,000
Perfomance 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
Issuance in common stock of
subsidiary 8,931,000 8,931,000
Net loss (10,842,000) (10,842,000)
------------ --------------- ----------------- -------------- ---------------- ----------------
Balance January 29, 2000 5,417,666 22,593,000 16,443,000 (671,000) (36,169,000) 7,921,000
Preferred shares converted to
common 175,000 445,000
Issuance of shares pursuant to
the exercise of stock options 24,609 137,000 137,000
Dividend accretion (351,000) (351,000)
Amortization of deferred
compensation 36,000 36,000
Issuance of warrants in
connection with former credit 70,000 70,000
facility
Issuance of preferred stock and
warrants, net 439,000 4,484,000
Options granted to non-employees 57,000 57,000
Dividends on preferred stock (110,000) (110,000)
Warrants issued by subsidiary 185,000 185,000
Deferred compensation related
to subsidiary (595,000) 595,000
Net loss (7,704,000) (7,704,000)
------------ --------------- ----------------- -------------- ---------------- ----------------
Balance February 3, 2001 5,617,275 $22,730,000 $17,044,000 ($40,000) ($44,334,000) $4,725,000
============ =============== ================= ============== ================ ================
See accompanying notes to financial statements
F-4
THE RIGHT START, INC.
STATEMENTS OF CASH FLOWS
------------------------
Year Ended
-----------------------------------------------
February 3, January 29, January 30,
2001 2000 1999
----------- ---------- -----------
Cash flows from operating activities:
Net loss $ (7,704,000) $(10,842,000) $ (5,680,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Depreciation and amortization 2,184,000 1,950,000 1,538,000
Amortization of debt issuance costs 128,000
Non-cash compensation 93,000 2,014,000
Non-cash beneficial conversion feature amortization 3,850,000
Non-cash advertising expense 9,000
Store closing expense 202,000 151,000 39,000
Loss on investment in RightStart.com 3,406,000
Minority interest in consolidated subsidiary loss (3,000,000)
Amortization of discount on senior subordinated notes 44,000
Extraordinary gain (1,211,000)
Change in assets and liabilities affecting operations (3,144,000) 442,000 1,760,000
-------------- -------------- --------------
Net cash (used in) provided by operating activities (4,835,000) (9,276,000) 340,000
-------------- -------------- --------------
Cash flows from investing activities:
Additions to property, plant and equipment (2,841,000) (3,603,000) (1,296,000)
Loss on investment in RightStart.com (3,406,000)
-------------- -------------- --------------
Net cash used in investing activities (6,247,000) (3,603,000) (1,296,000)
-------------- -------------- --------------
Cash flows from financing activities:
Net borrowings (payments) on revolving line of credit 1,568,000 3,377,000 (2,014,000)
Net proceeds from (payments on) term note payable (3,000,000) 250,000 (250,000)
Proceeds from sale of senior subordinated convertible pay-in-kind notes 3,000,000
Proceeds from private placement of Series D preferred stock
and warrants, net 4,484,000
Dividends paid on Series D preferred stock (52,000)
Proceeds from common stock issued upon exercise of stock options 137,000 155,000
Sale of preferred stock in consolidated subsidiary, net 13,670,000
Proceeds from sale of senior subordinated notes, net 3,606,000
-------------- -------------- --------------
Net cash provided by financing activities 6,137,000 17,452,000 1,342,000
-------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents (4,945,000) 4,573,000 386,000
Cash and cash equivalents at beginning of period 5,199,000 626,000 240,000
-------------- -------------- --------------
Cash and cash equivalents at end of period $ 254,000 $ 5,199,000 $ 626,000
============== ============== ==============
See accompanying notes to financial statements
F-5
THE RIGHT START, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES:
- ------------------------------------------------------------
The Company
- -----------
The Right Start, Inc. (the "Company"), a California corporation, is a specialty
retailer of high quality developmental, educational and care products for
infants and children. Information presented as of and for the period ended
January 29, 2000 ("Fiscal 1999") reflects the consolidated results of the
Company and RightStart.com Inc., a Delaware corporation, ("RightStart.com"),
which previously was the Company's majority-owned subsidiary.
RightStart.com was formed in April 1999 for the purpose of engaging in
electronic commerce over the internet and, effective May 1, 1999, the Company
contributed its catalog assets to RightStart.com. On October 10, 2000,
RightStart.com issued 2 million shares of common stock, which decreased the
Company's ownership interest in RightStart.com to 49.4%. The sale of common
stock and associated corporate actions resulted in RightStart.com being
accounted for under the equity method of accounting and no longer consolidated
with the Company. Accordingly, information as of and for the period ended
February 3, 2001 ("Fiscal 2000") represents the results of operations and the
financial position of The Right Start, Inc. only.
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. Fiscal 2000
consisted of fifty-three weeks; Fiscal 1999 and the fiscal year ended January
30, 1999 ("Fiscal 1998") were fifty-two week periods.
Revenue Recognition
- -------------------
Retail sales are recorded at time of sale or when goods are delivered. 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
- --------------------------------------------------------
RightStart.com purchases inventory and services from the Company under a
management services agreement. The income for services rendered under this
agreement, which for Fiscal 2000 amounted to $405,000, is
F-6
netted against general and administrative expenses. At February 3, 2001, the
Company was owed $400,000 by RightStart.com. Due to the lack of available
capital for internet retailers and the uncertainty surrounding the ongoing
viability of RightStart.com, the full amount of the receivable is reserved.
Concentration of Product Fulfillment Risk
- -----------------------------------------
The Company outsources its distribution and fulfillment activities. The Company
has no long-term contracts with its fulfillment services providers but has been
operating under agreements setting forth the terms at which the Company will
purchase those services and believes that replacement providers could be found
without material difficulty should the need arise. Nonetheless, a disruption of
any of these outsourced services could have a material effect on the Company.
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. The catalog is owned by
RightStart.com, which is no longer consolidated with the Company. Therefore
there are no prepaid catalog costs recorded at February 3, 2001. Catalog
production expenses of $0, $1,334,000 and $1,363,000 were recorded in Fiscal
2000, Fiscal 1999 and Fiscal 1998, respectively.
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 for any
period presented.
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
five 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. In Fiscal 2000, of the $406,000 expended by the Company for internal
real estate and construction management costs, the Company capitalized $258,000
directly attributable to the development of new stores and expensed $148,000.
The capitalized costs are amortized over the base term of the associated lease.
In Fiscal 1999, the Company expended $312,000 for internal real estate and
construction management costs. No amounts were capitalized.
Pre-opening Costs
- -----------------
Pre-opening costs incurred for new stores are charged to expense as incurred.
Advertising
- -----------
Advertising costs are expensed as incurred or at the time of the initial print
or media broadcast. Advertising expenses of $1,000,000 were recorded in Fiscal
2000. Advertising expenses of $7,233,000, which includes $6,403,000 for
RightStart.com, were recorded in Fiscal 1999. Advertising expenses of $387,000
were recorded in Fiscal 1998.
F-7
Deferred Rent
- -------------
The Company recognizes rent expense on a straight-line basis over the life of
the underlying lease. The benefits from tenant allowances and landlord
concessions are recorded on the balance sheet as deferred rent and expensed 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 may 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.
Fiscal 2000 Fiscal 1999 Fiscal 1998
-------------- ---------------- ---------------
Loss before extraordinary item $7,704,000 $10,842,000 $6,891,000
Plus: Preferred stock accretion 351,000 301,000 19,000
Subsidiary dividend to preferred shareholders - 316,000 -
Series D preferred dividends 110,000 - -
---------- ----------- ----------
Basic and diluted loss before extraordinary item $8,165,000 $11,459,000 $6,910,000
applicable to common shareholders ========== =========== ==========
Weighted average shares 5,597,809 5,355,756 5,051,820
Loss before extraordinary item per share, basic and
diluted $ 1.46 $ 2.14 $ 1.37
========== =========== ==========
F-8
Certain securities of the Company were not included in the computation of
diluted per share loss because to do so would have been antidilutive for the
periods presented. Such securities include:
Common Stock Equivalents at:
---------------------------------------------------------------
Securities February 3, 2001 January 29, 2000 January 30, 1999
- ---------- --------------------- ------------------- -------------------
Options 1,034,021 1,001,407 890,519
Series B preferred stock 550,000 666,667 1,000,000
Series C preferred stock 1,866,650 1,925,000 1,925,000
Series D preferred stock 2,245,000 - -
Warrants 479,000 5,000 -
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 was 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 February 3, 2001 there were 77,500
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 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 credit facility approximates fair
F-9
value due to the floating rate of interest on such instrument. The senior
subordinated convertible pay-in-kind notes were sold to affiliates. There is no
current market for these notes and therefore a fair market value is not
available.
Derivatives
- -----------
The Company currently does not have or use derivative instruments.
New Accounting Pronouncements
- -----------------------------
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 will not have a material effect on the Company's financial position.
In April 2001, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on issue No. 00-14, "Accounting for Certain Sales Incentives," which
requires the cost of certain sales incentives, such as coupons, to be classified
as a reduction of revenue. The Company's policy with respect to coupons
complies with EITF No. 00-14 and, therefore, does not anticipate any impact on
its financial statements.
NOTE 2: INVESTMENT IN RIGHTSTART.COM:
- -------------------------------------
On October 10, 2000, RightStart.com issued 1.6 million shares of common stock to
a new investor (the "October Investor") and 0.4 million shares of common stock
to an existing minority investor. The new issuance represented 18% of the
shares outstanding after the issuance. Consequently, the percentage of common
stock ownership of RightStart.com by the Company was reduced from 60.2% to
49.4%. The October Investor received a seat on the Board of Directors of
RightStart.com. The current Board of Directors of RightStart.com is comprised
of the October Investor, a representative of one of RightStart.com's original
minority investors, an affiliate of the Company and the chief executive officer
of RightStart.com who is also the chief executive officer of the Company.
Additionally, the October Investor and existing investors other than the Company
received certain participatory rights in the management of RightStart.com. The
sale of common stock and the associated corporate actions result in
RightStart.com being accounted for under the equity method of accounting and no
longer consolidated with the Company.
Accordingly, financial statements as of and for the period ended February 3,
2001 are presented on an unconsolidated basis retroactive to the beginning of
the fiscal year.
The operating losses of RightStart.com have been shown as a loss on investment.
In connection with the deconsolidation of RightStart.com, the Company carries
its investment in RightStart.com at zero. Due to the lack of available capital
for internet retailers and the uncertainty surrounding the ongoing viability of
RightStart.com, the Company has provided an allowance for the potential
uncollectability of $400,000 in connection with amounts owed by RightStart.com
to the Company under the Management Services Agreement. We are not obligated or
committed, and do not intend, to fund any operating losses or obligations of
RightStart.com.
F-10
Under the equity method of accounting, the carrying value of an investment is
normally adjusted on a periodic basis to recognize the investor's share of
earnings and losses of the investee. The carrying value, however, generally is
not reduced below zero and in that situation the equity method is, in effect,
suspended. Accordingly, the Company will only make future adjustments to the
carrying value of its investment in RightStart.com if and when RightStart.com
reports net income in excess of its accumulated net losses during the period the
equity method of accounting has been suspended, or if the Company makes
additional realizable advances to, or investments in, RightStart.com.
NOTE 3 - OPERATING RESULTS AND RISKS:
- -------------------------------------
Historically, the Company has incurred losses and may incur losses in Fiscal
2001. The Company believes that its current cash on hand at February 3, 2001,
cash flow from operations and the New Credit Facility (see Note 5) will allow it
to maintain its operations, fund working capital and capital expenditures for at
least the next twelve months. The Company's needs for additional funding will
depend upon several factors, including but not limited to, generating sufficient
cash flow from operations and the opening of new stores. If additional capital
is required to grow its business or execute its business plan, the Company may
seek to raise additional equity or incur additional debt. Although there can be
no assurance given that adequate funds will be available to the Company on
acceptable terms, the Company has historically been able to raise equity and
debt financing to continue its operations and fund its growth.
NOTE 4 - PROPERTY, FIXTURES AND EQUIPMENT, NET:
- ----------------------------------------------
February 3, January 29,
2001 2000
----------- -----------
Property, fixtures and equipment, at cost:
Fixtures and equipment $ 5,310,000 $ 5,623,000
Leaseholds and leasehold improvements 9,673,000 8,770,000
Computer software 1,035,000 2,597,000
----------- -----------
16,018,000 16,990,000
Accumulated depreciation and amortization (7,111,000) (6,342,000)
----------- -----------
$ 8,907,000 $10,648,000
=========== ===========
Depreciation and amortization expense for property, fixtures and equipment
amounted to $2,170,000, $1,950,000 and $1,488,000 for Fiscal 2000, Fiscal 1999
and Fiscal 1998, respectively.
NOTE 5 - CREDIT AGREEMENTS:
- --------------------------
The Company entered into a Loan and Security Agreement with Wells Fargo Retail
Finance (the "Bank") as of January 23, 2001 (the "New Credit Facility"). A
portion of the proceeds were used to retire amounts due under the Company's
Former Credit Facility, which was scheduled to terminate in February 2001 and
the remaining portion is available for general corporate purposes in accordance
with the Company's operating budget that has been approved by the Bank (the
"Budget"). The New Credit Facility consists of a standard
F-11
revolving line of up to $7,000,000 under which borrowings bear interest at a
rate of 0.75% over a base rate announced by Wells Fargo Bank from time to time
and a special line of up to $3,000,000 under which borrowings bear interest at a
rate of 1.5% over the base rate. At February 3, 2001, the Wells Fargo Bank base
rate was 8.5%. For Fiscal 2000, the average interest rate on this facility was
8.5% and interest expense of $28,000 was recorded. Up to $2,000,000 of
borrowings under the special line can also be converted at the Company's option
to a term loan with a 5-year amortization. The New Credit Facility is secured by
substantially all of the Company's assets. Availability under the standard
revolving line is limited to 87.5% of net retail liquidation value of the
Company's inventory or between 70% and 74% (varying over the course of the year)
of the cost value of the Company's inventory, whichever is less. Availability
under the special line is limited to 12.5% of net retail liquidation value of
the Company's inventory or, together with amounts available under the standard
revolving line, between 80% and 84% (varying over the course of the year) of the
cost value of the Company's inventory, whichever is less. The Company is
required to maintain average availability under the New Credit Facility of at
least 85% of amounts in the Budget (calculated on a rolling two-month average
basis). In addition, the Company is required to maintain a ratio of cost for
inventory purchased to cost of goods sold on a trailing 3 month basis of at
least 85% of amounts in the Budget and an annualized inventory turnover rate for
inventory designated for the retail stores of at least 2.7 times through April
2001 and 3.0 times thereafter. The New Credit Facility also limits the Company's
capital expenditures to 110% of planned expenditures in the Budget in the two 6
month periods during each fiscal year. The New Credit Facility matures on
January 23, 2006.
NOTE 6 - SENIOR SUBORDINATED CONVERTIBLE PAY-IN-KIND NOTES:
- ----------------------------------------------------------
In September and October 2000, the Company sold a total of $3.0 million in
aggregate principal amount of its Senior Subordinated Convertible Pay-in-Kind
Notes due 2005 (the "Convertible Notes") to affiliated investment partnerships
managed by Kayne Anderson Capital Partners, L.P.("KA Capital") The Convertible
Notes bear interest at the rate of 8% per annum and are convertible into common
stock at a price of $2.375 per share of common stock. Interest on the
Convertible Notes is due and payable semi-annually in cash or in kind, at the
Company's election, on December 1 and June 1 of each year and compounded semi-
annually. The Convertible Notes are secured by a subordinated lien on
substantially all of the Company's assets. The Convertible Notes rank pari
passu with all other subordinated debt of the Company and holders have
registration rights with respect to the Company's common stock issuable upon
conversion.
NOTE 7 - MANDATORILY REDEEMABLE PREFERRED STOCK:
- -----------------------------------------------
In connection with the Company's recapitalization (see Note 8), the Company
issued 30,000 shares of mandatorily redeemable Series A preferred stock. 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 must 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 effective interest method, over the period from the issuance
date to the required redemption date as a charge to retained earnings.
There are no dividends payable on the Series A preferred stock unless the
Company is unable to redeem the stock at the required redemption date, at which
point dividends will cumulate and accrue on a daily basis,
F-12
without interest, at the rate of $15.00 per share per annum, payable quarterly.
NOTE 8 - SHAREHOLDERS' EQUITY:
- -----------------------------
Series D Convertible Pay-in-Kind Preferred Stock and Warrants
- -------------------------------------------------------------
In October 2000 the Company sold 44,900 shares of its Series D Convertible Pay-
in-Kind Preferred Stock (the "Series D Convertible Preferred Stock") for $4.5
million, a portion of which was purchased by affiliates. The Series D
Convertible Preferred Stock pays dividends at a rate of 8% per annum, has a
liquidation preference of $100 per share and is convertible into common stock at
the rate of $2.00 per share. The Company can cause the Series D Convertible
Preferred Stock to convert after October 6, 2001 if the Company's common stock
has traded at a price greater than $3.00 per share for twenty consecutive
trading days. In connection with the issuance of the Series D Convertible
Preferred Stock, the Company issued 449,000 warrants to purchase common shares
at an exercise price of $2.00 per share of common stock. The fair value of the
warrants was estimated using the Black-Scholes option pricing model and has been
recorded as a reduction to the carrying value of the Series D Convertible
Preferred Stock and a credit to paid in capital. Holders have registration
rights with respect to the common stock issuable upon conversion of the Series D
Convertible Preferred Stock and exercise of the warrants.
The Series D Convertible Preferred Stock has a pay-in-kind feature that permits
the Company to pay dividends in additional securities. The Company paid its
first dividends on December 1, 2000 in cash and may elect to do so in the future
as well.
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"). 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 originally 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.
F-13
The shares of Preferred Stock are non-voting. Holders of at least a majority of
the Preferred Stock acting as a class, however, 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 2000, and Fiscal 1999, 3,500 and 10,000 shares of
Series B preferred stock converted into 116,666 and 333,333 shares of common
stock respectively.
NOTE 9 - INCOME TAXES:
- ---------------------
The provision for income taxes is comprised of the following:
Year Ended
-------------------------------------
February 3, January 29, January 30,
2001 2000 1999
----------- ----------- -----------
Current provision:
Federal
State $ 78,000 $ 68,000 $ 22,000
Deferred provision:
Federal
State
----------- ----------- -----------
$ 78,000 $ 68,000 $ 22,000
=========== =========== ===========
The Company's effective income tax rate differed from the federal statutory rate
as follows:
Year Ended
----------------------------------------
February 3, January 29, January 30,
2001 2000 1999
----------- ----------- ------------
Federal statutory rate 34% 34% 34%
State income taxes, net of federal
benefit 5 3
Loss on investment in RightStart.com (7)
Valuation allowance (32) (34) (11)
Debt discount amortization (23)
Other 1 (3)
----------- ----------- ------------
Effective income tax rate 1% 0% 0%
=========== =========== ============
F-14
Deferred tax (liabilities) assets are comprised of the following:
February 3, January 29,
2001 2000
------------- ------------
Depreciation and amortization $ (452,000) $ (167,000)
Other (415,000) (27,000)
Deferred tax liabilities (867,000) (194,000)
Net operating loss carry forwards 10,676,000 12,054,000
Investment in subsidiary 209,000
Deferred rent 621,000 625,000
Deferred compensation 748,000 820,000
Other reserves 292,000 98,000
Other 286,000 280,000
Sales returns 96,000
------------- ------------
Deferred tax assets 12,832,000 13,973,000
------------- ------------
Valuation allowance (10,565,000) (12,379,000)
------------- ------------
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 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 February
3, 2001 of $28.7 million and $11.7 million, respectively. These carryforwards
will expire in fiscal years ending 2002 through 2021.
NOTE 10 - EMPLOYEE BENEFITS AND STOCK OPTIONS:
- ---------------------------------------------
In October 1991, the Company adopted the 1991 Employee Stock Option Plan, which,
as amended, covers an aggregate of 1,050,000 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. Options to purchase 833,160 shares of common stock were issued under
this plan at exercise prices ranging from $2.00 to $17.25 per share. At
February 3, 2001, 529,894 of these options were exercisable. At February
F-15
3, 2001, 216,840 shares were available for future grant under this plan.
In October 1995, the Company adopted the 1995 Non-Employee Directors Option
Plan, as amended, to cover an aggregate of 275,000 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. The amount of additional options is 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
200,861 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
price of the Company's common stock on the last trading day preceding the date
of grant. At February 3, 2001, 155,121 of the options issued under this plan
were exercisable. At February 3, 2001, 74,140 shares were available for future
grant under this plan.
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 has made no contribution since April 1996. The
Company matches employees' contributions to the ESPP at a rate of 50%. The
Company's contributions to the ESPP amounted to $13,000, $12,000 and $14,000 in
Fiscal 2000, Fiscal 1999 and Fiscal 1998, respectively.
The following table summarizes the Company's option activity through February 3,
2001:
Fair Value Options Exercisable
Number of Weighted Average of Options Exercisable Weighted Average
Options Exercise Price Granted at Year End Exercise Price
--------------- -------------------- ----------- ------------ --------------------
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
Granted 136,065 3.37 3.08
Canceled (78,851) 2.81
Exercised (24,600) 2.50
---------
Outstanding at February 3, 2001 1,034,021 4.13 685,015 3.95
=========
F-16
The following table summarizes information concerning the Company's outstanding
and exercisable stock options at February 3, 2001:
Number Weighted Average Weighted Average
Range of Outstanding at Remaining Contractual Exercise Price of Number Exercisable
Exercise Prices February 3, 2001 Life Options Outstanding at February 3, 2001
- ---------------- ----------------- ---- -------------------- --------------------
$2.00 - $3.50 749,514 7.1 years $ 2.90 536,914
$4.13 - $7.88 197,653 6.6 years 6.16 73,246
$8.50 - $17.25 86,854 5.2 years 10.19 74,855
--------- ------ -------
1,034,021 $ 3.95 685,015
========= ====== =======
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:
Fiscal 2000 Fiscal 1999 Fiscal 1998
--------------- -------------- ----------------
Risk-free interest rates 5.88% 5.27% 5.17%
Expected life (in years) 4 4 4
Dividend yield 0% 0% 0%
Expected volatility 85.06% 85.33% 76.91%
Weighted average fair value
on grant date $ 0.89 $ 5.35 $ 2.28
The Company has adopted Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). In accordance with the
provisions of SFAS 123, the Company applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
plans and does not recognize compensation expense for its stock-based
compensation plans based on the fair market value method prescribed by SFAS 123.
If the Company 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 net loss and loss per share,
including the Company's share of compensation expense related to
RightStart.com's option grants for Fiscal 2000, would be increased to the pro
forma amounts indicated below:
Year Ended
------------------------------------------------------------------
February 3, 2001 January 29, 2000 January 30, 1999
---------------------- -------------------- --------------------
Net loss:
As reported $7,704,000 $10,842,000 $5,680,000
Pro forma 8,265,000 11,922,000 6,258,000
Basic and diluted loss per share:
As reported $ 1.46 $ 2.14 $ 1.13
Pro forma 1.48 2.23 1.24
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.
F-17
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 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, which vest over three years, were granted to
non-employee directors 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 and $36,000 was
amortized in Fiscal 2000. Additionally, 100,000 stock options held by
RightStart.com employees after the deconsolidation were valued at $57,000 and
charged to non-cash compensation expense.
NOTE 11 - RELATED PARTY TRANSACTIONS:
- ------------------------------------
Kayne Anderson Investment Management, Inc. ("KAIM"), the general partner of KA
Capital, provides certain management services to the Company and charges the
Company for such services. Annual management fees of $187,500 were paid to KAIM
in Fiscal 2000 and fees of $112,500 were paid in both Fiscal 1999 and Fiscal
1998. In September and October 2000, the Company sold a total of $3.0 million in
aggregate principal amount of its Senior Subordinated Convertible Pay-in-Kind
Notes due 2005 (the "Convertible Notes") to KA Capital (See Note 6).
In July 1999, the Company entered into a management services agreement with
RightStart.com in connection with its formation. This agreement provides that
the Company will supply inventory at cost plus five percent and provide certain
Basic Services at cost plus 5%. Basic Services consists of various services
including among others, services for personnel/human resources, benefits
administration, payroll processing, insurance, tax, cash management, financial,
legal, order fulfillment and collection, accounting, telecommunications, catalog
production assistance and credit card processing. Inventory designated for
RightStart.com is stored separately from that of the Company and is billed to
RightStart.com on a weekly basis only as the merchandise is sold and shipped to
RightStart.com customers. The management services agreement may be terminated
in full or on a service-by-service basis by RightStart.com on 30 days written
notice and by the Company, in respect to inventory, upon 90 days written notice
and by either party upon the occurrence of uncured breaches and certain
bankruptcy events. The sale of inventory to RightStart.com and the related cost
of those sales are shown on the statement of operations. The income for Basic
Services rendered under this agreement, which for Fiscal 2000 amounted to
$405,000 and for Fiscal 1999 amounted to $407,000, is netted against general and
administrative expenses.
As of April 12, 2001, the Company entered into Baby Registry Joint Development
and Use Agreement with RightStart.com pursuant to which the Company and
RightStart.com intend to jointly develop a baby registry that can be accessed by
our customers and RightStart.com's customers. Upon termination of the agreement
each party would be entitled to retain all code used in the jointly developed
registry, as well as any database information collected, and to operate a
separate registry.
NOTE 12 - OPERATING LEASES:
- --------------------------
The Company leases real property and equipment under non-cancelable agreements
expiring from 2001 through 2010. Certain retail store lease agreements provide
for contingent rental payments if the store's net
F-18
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
-----------
2001 $ 4,689,000
2002 4,476,000
2003 4,249,000
2004 3,434,000
2005 2,388,000
Thereafter 1,488,000
-----------
$20,724,000
===========
Net rental expense under operating leases was $4,139,000, $3,584,000 and
$3,233,000, for Fiscal 2000, Fiscal 1999 and Fiscal 1998, respectively.
Percentage rents of $39,000 were incurred in Fiscal 2000. No percentage rents
were incurred in Fiscal 1999 or Fiscal 1998.
NOTE 13 - STORE CLOSINGS:
- ------------------------
The Company closed two stores in Fiscal 2000 and one store in Fiscal 1999 and
wrote off approximately $302,000 and $151,000, respectively, of the net book
value of the assets related to the stores.
NOTE 14 - RECAPITALIZATION AND EXTRAORDINARY GAIN:
- -------------------------------------------------
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".
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 effective 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 $3,000,000 was 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.
F-19
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 8).
NOTE 15 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- ----------------------------------------------------------
Changes in assets and liabilities which increased (decreased) cash are as
follows:
Year Ended
---------------------------------------------------------------------
February 3, 2001 January 29, 2000 January 30, 1999
------------------------ --------------------- ---------------------
Accounts and other receivables $ (565,000) $ (97,000) $ (180,000)
Merchandise inventories (768,000) (3,897,000) 805,000
Other current assets (201,000) (61,000) 319,000
Other non-current assets (45,000) (1,168,000) (48,000)
Accounts payable and accrued expenses (1,726,000) 5,736,000 1,040,000
Deferred rent 161,000 (71,000) (176,000)
----------- ----------- ----------
$(3,144,000) $ 442,000 $1,760,000
=========== =========== ==========
The changes in assets and liabilities for the year ended February 3, 2001
exclude the assets and liabilities of RightStart.com.
Supplementary disclosure of cash flow information:
Fiscal 2000 Fiscal 1999 Fiscal 1998
---------------- ------------------ -------------------
Cash paid for income taxes $ 9,000 $ 11,000 $ 3,000
Cash paid for interest 779,000 447,000 483,000
Non-cash investing and financing activities:
Fiscal 2000 Fiscal 1999 Fiscal 1998
---------------- ------------------- ------------------
Conversion of Series B preferred stock to common stock $328,000 $ 938,000 -
Conversion of Series C preferred stock to common stock 117,000 - -
Issuance of common stock and warrants in connection
with financing agreement - 159,000 -
Preferred dividend accretion 351,000 301,000 $19,000
Preferred dividend payable 58,000 - -
Exchange of subsidiary stock for software - 1,243,000 -
F-20
NOTE 16 - SEGMENT INFORMATION:
- -----------------------------
The Company currently operates in one segment, which is the retail segment. The
results of operations for Fiscal 2000 reflect only the retail stores. Operating
results of RightStart.com are reflected as a gain (loss) on investment in
RightStart.com.
The prior year consolidated financial statements included the Company and its
former majority-owned subsidiary which together had two reportable segments;
Direct-to-customers, which included online and catalog operations (the
subsidiary), and Retail (the parent), which included activities related to
retail stores. Both segments sold products to meet the needs of the parents of
infants and small children. The Direct-to-customers segment also sold products
directed to older children through age twelve. Current year financial statements
include only operating information of the Company, which as a result of the
deconsolidation of RightStart.com, has only one reportable segment. Accordingly,
segment information for the current year is not presented below.
The accounting policies of the reportable segments were 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-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 had operations that offer the same or similar
products but had a different method of delivery to its customers.
Segment information for Fiscal 1999 is as follows:
Direct-to-
Online Catalog 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
F-21
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 17 - OTHER FINANCIAL DATA:
- ------------------------------
Allowance for Doubtful Accounts
- -------------------------------
The Activity in the allowance for doubtful accounts was as follows:
Beginning Balance Provision Write-offs Ending Balance
--------------------- ----------- --------------- ------------------
Fiscal 1998 $17,000 $ 15,000 $(5,000) $ 27,000
Fiscal 1999 27,000 60,000 - 87,000
Fiscal 2000 87,000 313,000 - 400,000
Accounts payable and accrued expenses
- -------------------------------------
The components of accounts payable and accrued expenses are as follows:
Fiscal 2000 Fiscal 1999
--------------- ---------------
Accounts payable $1,216,000 $4,413,000
Bank overdraft 1,963,000 1,570,000
Accrued payroll and related expenses 383,000 484,000
Accrued merchandise costs 1,188,000 1,876,000
Accrued professional fees 186,000 485,000
Sales returns and allowances 120,000 175,000
Sales and use tax accruals 223,000 235,000
Accrued interest 71,000 41,000
Other accrued expenses 287,000 287,000
---------- ----------
$5,637,000 $9,566,000
========== ==========
NOTE 18 - COMMITMENTS AND CONTINGENCIES:
- ---------------------------------------
Future Advertising
- ------------------
As of February 3, 2001, the Company had commitments of approximately $30,000 for
future advertising.
F-22
Leases
- ------
The Company is currently subleasing its corporate office in Westlake Village,
California for $22,500 per month through June 30, 2001. In April 2001, the
Company entered into a lease agreement effective July 1, 2001 for its new
corporate headquarters in Calabasas, California. The new lease commitment is
for five years at an average rental of $28,000 per month. The move to the new
corporate office is expected to cost the Company approximately $50,000.
Legal Matters
- -------------
We are a party to various legal actions arising in the ordinary course of
business. In addition, we have been named in lawsuits against RightStart.com
brought by two of RightStart.com's unsecured creditors. In the opinion of
management, any claims that may arise from these actions are adequately covered
by insurance, are immaterial to us or are without significant merit. We believe
that the ultimate outcome of these matters will not have a material effect on
our financial position or results of operations.
F-23
RIGHTSTART.COM INC.
FINANCIAL STATEMENTS AS OF FEBRUARY 3, 2001
TOGETHER WITH REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
RightStart.com Inc.:
We have audited the accompanying balance sheet of RightStart.com Inc., a
Delaware corporation (the "Company"), as of February 3, 2001, and the related
statements of operations, stockholders' deficit 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 generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our 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 RightStart.com Inc. as of
February 3, 2001, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note 1 to the
financial statements, for the year ended February 3, 2001, the Company incurred
a loss from operations of $12,275,000 and a net loss of $14,073,000, and at
February 3, 2001, the Company had a working capital deficit of $7,499,000 and an
accumulated deficit of $24,753,000 which raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in note 1. The financial statements do not include
any adjustments relating to the recoverability and classification of asset
carrying amounts or the amount and classification of liabilities that might
result should the Company be unable to continue as a going concern.
GILDERMAN, JOHNSON & COMPANY, LLP
Encino, California
April 13, 2001
F-24
RIGHTSTART.COM INC.
BALANCE SHEET
FEBRUARY 3, 2001
ASSETS
------
Current assets:
Cash $ 19,000
Accounts and other receivables, net of allowance
for doubtful accounts of $15,000 130,000
Prepaid catalog expenses 160,000
Other 28,000
------------
Total current assets 337,000
Property and equipment, net 1,602,000
Other 36,000
------------
$ 1,975,000
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
-------------------------------------
Current liabilities:
Accounts payable $ 2,768,000
Accrued liabilities 736,000
Due to The Right Start, Inc. 397,000
Secured bridge note 2,275,000
Secured convertible bridge note 1,660,000
------------
Total current liabilities 7,836,000
------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock (5,000,000 shares authorized at $0.01 par value;
none issued or outstanding) --
Common stock (29,120,458 shares authorized at $0.01 par value;
11,112,000 shares issued and outstanding) 111,000
Additional paid-in capital 18,918,000
Deferred compensation (137,000)
Accumulated deficit (24,753,000)
------------
(5,861,000)
------------
$ 1,975,000
============
See accompanying notes to financial statements.
F-25
RIGHTSTART.COM INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED
FEBRUARY 3, 2001
Net sales $ 16,430,000
Cost of goods sold 13,052,000
-------------
Gross profit 3,378,000
Operating expenses:
Sales and marketing 9,626,000
General and administrative 4,120,000
Product development 498,000
Non-cash compensation 536,000
Write off of initial public offering costs 873,000
-------------
Loss from operations (12,275,000)
-------------
Other expenses:
Interest expense, net of interest income of $58,000 1,517,000
Loss on disposal of property 280,000
-------------
1,797,000
-------------
Loss before provision for income taxes (14,072,000)
Provision for income taxes 1,000
-------------
Net loss $ (14,073,000)
=============
Basic and diluted net loss per common share $ (1.45)
=============
Shares used to compute basic and net diluted loss per common share
9,733,000
See accompanying notes to financial statements.
F-26
RIGHTSTART.COM INC.
STATEMENT OF STOCKHOLDERS' DEFICIT
FOR THE YEAR ENDED FEBRUARY 3, 2001
Common Stock Additional
Preferred --------------------- Paid-in Deferred Accumulated
Stock Shares Amount Capital Compensation Deficit Total
---------- ---------- -------- ----------- ------------ ------------- ------------
Balance at January 29, 2000 $ -- 9,100,000 $ 91,000 $17,101,000 $(595,000) $(10,680,000) $ 5,917,000
Net proceeds from issuance of
common stock -- 2,000,000 20,000 443,000 -- -- 463,000
Proceeds from exercise of stock
options -- 12,000 -- 5,000 -- -- 5,000
Amortization of deferred
compensation -- -- -- -- 458,000 -- 458,000
Compensation from stock options
issued to non-employees -- -- -- 78,000 -- -- 78,000
Issuance of warrants in
association with secured bridge
financing -- -- -- 1,291,000 -- -- 1,291,000
Net loss -- -- -- -- -- (14,073,000) (14,073,000)
-------- --------- -------- ----------- ------- ------------ ------------
Balance February 3, 2001 $ -- 11,112,000 $111,000 $18,918,000 $(137,000) $(24,753,000) $ (5,861,000)
======== ========== ======== =========== ========= ============ ============
See accompanying notes to financial statements.
F-27
RIGHTSTART.COM INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED
FEBRUARY 3, 2001
Cash flows from operating activities:
Net loss $(14,073,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,021,000
Loss on disposal of property and equipment 280,000
Write off of non current assets 1,086,000
Amortization of discount on secured bridge notes to interest expense 1,291,000
Amortization of non-cash compensation 458,000
Compensation from stock options issued to non-employees 78,000
Change in operating assets and liabilities:
Accounts and other receivables 63,000
Inventories 678,000
Prepaid catalog expenses 10,000
Other 619,000
Accounts payable 1,800,000
Accrued liabilities (715,000)
Due to The Right Start, Inc. (182,000)
------------
Net cash used in operating activities (7,586,000)
------------
Cash flows from investing activities--
Purchase of property and equipment (808,000)
------------
Cash flows from financing activities:
Proceeds from issuance of secured bridge notes 2,275,000
Proceeds from issuance of secured convertible bridge notes 1,660,000
Net proceeds from the issuance of common stock 463,000
Proceeds from an exercise of stock options 5,000
------------
Net cash provided by financing activities 4,403,000
------------
Net decrease in cash (3,991,000)
Cash at beginning of year 4,010,000
------------
Cash at end of year $ 19,000
============
See accompanying notes to financial statements.
F-28
RightStart.com Inc.
Notes to Financial Statements
February 3, 2001
Note 1 - Formation and Operation of the Company and Going Concern
- -----------------------------------------------------------------
Organization
RightStart.com Inc. (the "Company") is an online specialty retailer focused
on high-quality developmental and educational products for children. The Company
was formed in April 1999, for the purpose of engaging in electronic commerce
over the Internet ("Online store"). As part of the Company's initial
capitalization, The Right Start, Inc. ("The Right Start"), the Company's former
majority shareholder (see note 11), contributed certain assets related to its
catalog operation to the Company; thus, the Company also serves customers and
generates sales through its catalog operations.
Prior to October 10, 2000, the Company was a majority owned subsidiary of
The Right Start. On October 10, 2000 the Company issued 2,000,000 shares of
common stock, which decreased The Right Start ownership interest to 49.4%. The
sale of common stock and associated corporate actions resulted in the Company no
longer being consolidated with The Right Start (see notes 9 and 11).
Fiscal Year
The Company's fiscal year ends on the Saturday closest to the last day of
January. The most recent fiscal year which ended on February 3, 2001 ("Fiscal
2000") is comprised of fifty-three weeks.
Going Concern
For fiscal 2000, the Company incurred a loss from operations of $12,275,000
and a net loss of $14,073,000, and at February 3, 2001, the Company had a
working capital deficit of $7,499,000 and an accumulated deficit of $24,753,000
that raise substantial doubt about its ability to continue as a going concern.
In addition, the Company used cash in operations of $7,586,000. Due to the
Company's operating losses, approximately $2.5 million of the trade accounts
payable is past due at February 3, 2001. Further, the Company has no credit
facility to enhance cash flow. In addition, the Company is in default with the
terms of its secured bridge loans (See notes 3 and 5). The Company's financial
condition is discussed further in note 3.
Management's plans in regard to these items include the following:
- - The Company raised $2,275,000 via a secured bridge loan in April 2000 (see
note 5)
F-29
- - The Company raised $1,660,000 via a secured convertible bridge note in June
2000 (see note 5)
- - The Company reduced portions of its fixed overhead expenses
- - Web site maintenance and development was brought in-house in order to reduce
costs
- - Management revised its marketing and promotional strategy and reduced
advertising expenditures
- - Management intends to focus additional efforts toward engineering a
profitable e-commerce business model
There are no assurances that the Company will be able to successfully
negotiate a settlement of amounts owed to certain vendors, raise additional
funds and negotiate with its bridge note holders. In addition, the Company is
dependent upon The Right Start for administrative and operational assistance
(see note 9). There can be no assurance that the Company will be able to
continue to maintain its management agreement services with The Right Start.
Further, there is no assurance that management will be able to successfully
maintain its presence in the e-commerce marketplace. The failure of the Company
to successfully achieve one or all of the above items will have a material
impact on the Company's financial position and results of operations. The
accompanying financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Note 2 - Summary of Significant Accounting Policies
- ---------------------------------------------------
Revenue Recognition
The Company recognizes revenues from product sales, net of discounts,
coupon redemptions and promotional allowances when products are shipped to
customers. Shipping and handling revenues and expenses are included in sales and
cost of sales, respectively. For the fiscal year ended February 3, 2001 shipping
and handling revenues and expenses were $969,000 and $3,773,470, respectively.
The Company provides for estimated returns at the time of sale. The Company is
the principal in its transactions with customers. Specifically, the Company
takes title to all products sold to its customers prior to shipment.
Furthermore, the Company bears credit risk and inventory risk; however, these
risks are mitigated through relationships with credit card issuers and shippers.
Advertising Barter
Advertising barter is recorded as revenue and expense when the advertising
surrendered is determinable based on the Company's own historical practice of
receiving cash for similar advertising from buyers unrelated to the counterparty
in the barter transaction. During fiscal 2000 the Company did not record any
revenue or expense related to advertising barter transactions.
F-30
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, Significant Customers and Financial Instruments
At February 3, 2001, accounts receivable were due from credit card
companies and others. There was no single customer who accounted for more than
10% of the Company's revenues during any period.
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of uncollateralized accounts
receivable. Accounts receivable are unsecured and the Company is at risk to the
extent such amounts become uncollectible.
Merchandise Inventory
In connection with the Company's formation, the Company entered into a
management services agreement with The Right Start (See note 9). This agreement
provides, among other things, that The Right Start will supply inventory to the
Company. Inventory owned by The Right Start but designated for the Company is
stored separately from that of The Right Start and is billed to the Company on a
weekly basis as the merchandise is sold and shipped to customers.
Prepaid Catalog Expenses
Prepaid catalog expenses consist of the costs to produce, print and
distribute catalogs. These costs are amortized over the expected sales life of
each catalog, which typically does not exceed four months. Catalog production
expenses of $1,235,000 were recorded in Fiscal 2000.
Long-lived Assets
The Company periodically evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful lives of long-lived assets
might warrant revision or that the remaining balance may not be recoverable.
When factors indicate that the asset should be evaluated for possible
impairment, the Company uses an estimate of the assets' undiscounted net cash
flows over its remaining useful life in measuring whether the asset is
recoverable. During fiscal 2000, the Company wrote off $280,000 of assets in
connection with the abandonment of online stores that focused on products to
kids over age 6 ("Big Kids Store"), teachers ("Learning Store") and maternity
clothing ("Maternity Store").
F-31
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided using the straight-line method based upon the estimated
useful lives of the assets, generally three to ten years. Software capitalized
in connection with the Company's website is being amortized over a three-year
period.
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. Income
and deferred taxes have been calculated for the Company on a stand-alone basis
for all periods.
Advertising and Marketing
Marketing expense consists primarily of advertising and catalog production
and distribution expenses. Advertising costs are expensed as incurred or at the
time of the initial print or media broadcast. Catalog costs are typically
amortized over a four-month period. Advertising expenses of $5,951,000 were
recorded in Fiscal 2000.
Statement of Cash Flows
The Company prepares its statements of cash flows using the indirect method
in accordance with Statement of Financial Accounting Standards No. 95,
"Statement of Cash Flows".
Supplemental Disclosure of Cash Flow Information for Fiscal 2000 is:
Cash paid for interest $ -
==========
Cash paid for income taxes $ -
==========
Non-cash activities:
Issuance of warrants in connection with the sale of
Secured Bridge Notes $ 299,000
----------
Issuance of the Secured Bridge Note Contingent
Warrants $ 992,000
----------
Amortization of non-cash compensation $ 458,000
==========
Compensation from stock options issued to
non-employees $ 78,000
==========
F-32
Stock-based Compensation
Stock options issued to employees, members of the Company's board of directors
and, through October 10, 2000, employees of The Right Start who provide services
to the Company, 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 when 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 No. 123, "Accounting for Stock Based
Compensation", ("SFAS 123") (See note 7).
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 25, which was 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 SFAS 123. Due to the
Company's sale of its common stock on October 10, 2000, which resulted in the
percentage ownership of the Company's common stock by The Right Start to fall
below 50%, employees of The Right Start are no longer considered employees of
the Company. Accordingly, the Company recorded a non-cash compensation charge
of $78,000 along with a corresponding credit to additional paid-in capital. As
of February 3, 2001, there were 1,101,700 options issued by the Company to non-
employees.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Comprehensive Income
The Company has not had any items of other comprehensive income during fiscal
2000.
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
F-33
certain derivative instruments embedded in other contracts (collectively
referred to as "derivatives"), and for hedging activities. SFAS 133, as amended
by SFAS No. 137 and SFAS No 138, 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 and management does not expect adoption of this
statement to have an impact on the Company's financial position or results of
operations.
In September 2000, the FASB issued SFAS No.140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, a replacement
of FASB Statement No.125." The standard is effective in 2001 and management
does not expect the adoption of this standard to have a material impact on the
Company's financial position or results of operations.
Loss Per Share
The Company computes earnings or loss per share in accordance with SFAS No.
128, "Earnings Per Share" ("SFAS 128"). Under the provisions of SFAS 128, basic
net income or loss per common share is computed by dividing net income or loss
attributable to common stockholders by the weighted average number of common
shares outstanding. Diluted per share data is computed by dividing income
available to common stockholders by the weighted average number of shares
outstanding plus any potential dilution that could occur if securities or other
agreements to issue common stock were exercised or converted into common stock
during the fiscal year. The calculation of diluted loss per common share for
fiscal 2000 does not include 17,488,000 potential shares of common stock
equivalents as their inclusion would be anti-dilutive.
Concentration of Vendors, Distribution and Technology Risk
The Company outsources its distribution and fulfillment function to a third
party product fulfillment provider under a short-term agreement. Although this
arrangement creates a concentration in sourcing of distribution, management
believes alternatives are available on similar terms and conditions. A failure
of or a change in the Company's product fulfillment provider, however, could
cause delays in the order fulfillment process and a possible loss of sales,
which would adversely affect operating results. In addition, the Company is
dependent on The Right Start to sell it inventory that it needs to fulfill
customer orders under a management services agreement under which the Company is
in default. The Right Start has not indicated that it intends to terminate the
agreement, however, it has no obligation to continue to provide such services or
to provide them at the rate at which it currently provides them. Management
believes that the termination of this contract will have a material adverse
effect on the Company's financial position.
Note 3 - Financial Condition
- ----------------------------
The Company launched its Online store on June 29, 1999. In July 1999, the
Company raised approximately $13,700,000 in net proceeds from the sale of equity
to venture
F-34
capitalists. This money allowed the Company to hire additional staff and
increase its marketing efforts. Accordingly, the Company experienced a sizable
increase in sales but at the same time experienced increasing losses. On January
18, 2000, the Company filed a registration statement with the Securities
Exchange Commission with respect to an offering of its common stock. On May 19,
2000, the Company withdrew this registration statement because of adverse market
conditions. The Company's losses continued and therefore the Company required
additional funding.
In April 2000, the Company issued 10% secured bridge notes to affiliates
(see notes 5 and 9) in the aggregate principal amount of $2,275,000 (the "Bridge
Notes"), warrants to purchase 113,753 shares of common stock (the "Bridge
Warrants") (see note 12) and contingent warrants to purchase approximately 9.1
million shares of the Company's common stock upon a default under the Bridge
Notes (the "Contingent Warrants") (See note 12). The Bridge Notes are secured
by substantially all of the Company's assets.
In June 2000, the Company issued 10% junior secured convertible bridge notes
to affiliates in the aggregate principal amount of approximately $1,660,000 (the
"Convertible Bridge Notes"). The Convertible Bridge Notes are secured by a
subordinate lien on substantially all of the Company's assets.
On June 27, 2000, the Company engaged Morgan Stanley Incorporated ("Morgan
Stanley") to explore potential business combinations. Concurrently, Management
began to contact certain service providers and let them know that the Company
was experiencing severe cash flow problems, that all future services, if not
already eliminated, should be eliminated and that invoices for past services
("Unsecured Frozen Amounts") could not be paid until the Company could conclude
a successful business combination or sale. The Unsecured Frozen Amounts owed to
these former service providers is approximately $2,500,000.
On October 10, 2000, the Company sold $500,000 of its common stock (see note
11) and requested an extension of the Bridge Notes and the Convertible Bridge
Notes until January 18, 2001. The extensions were granted. At the same time
the Company released several of its executive officers and began to obtain those
services from The Right Start under the management services agreement.
The Bridge Notes and the Convertible Bridge Notes are currently in default.
The default on the Bridge Notes permits the holders of the Bridge Notes to
exercise the Contingent Warrants. A majority of holders of the Bridge Notes
and the Convertible Bridge Notes have notified the Company that they will no
longer extend the maturity date of the Bridge Notes or the Convertible Bridge
Notes and have demanded that they be paid. The Company has insufficient cash to
pay any of the notes. The principal amount of the Bridge Notes and the
Convertible Bridge Notes exceeds the book value of the Company assets. As
evidenced by the results of the efforts of Morgan Stanley, it has been difficult
to raise the amount of money necessary to satisfy the outstanding principal
amount of the Bridge Notes and Convertible Bridge Notes. Further, the Company
is unable to pay the Unsecured Frozen Amounts and has been sued by three of the
creditors holding these receivables (see note 10). The Company is attempting to
resolve the
F-35
situation with the holders of the Bridge Notes and the Convertible
Bridge Notes. The Bridge Note holders, at any time, may elect to foreclose on
the assets of the Company if no solution can be reached otherwise. The
Convertible Bridge Note holders have subordinate rights to the Bridge Note
holders. The Bridge Note holders have not exercised their contingent warrants.
Note 4 - Property, Plant and Equipment, net
- -------------------------------------------
The components of property and equipment at February 3, 2001 are as follows:
Furniture and equipment $ 1,145,000
Leasehold improvements 46,000
Computer software 2,064,000
-----------
3,255,000
Less - accumulated depreciation
and amortization (1,653,000)
-----------
$ 1,602,000
===========
In Fiscal 2000, the Company capitalized amounts related to web site
development of approximately $660,000. These costs are being amortized over 36
months. In January 2001, the Company wrote off approximately $280,000 in
connection with the abandonment of its Big Kids Store, Learning Store and
Maternity Store.
Note 5 - Bridge Notes Payable
- -----------------------------
In April 2000, the Company issued 10% secured bridge notes to affiliates in
the aggregate principal amount of $2,275,000 (the "Bridge Notes") and warrants
to purchase 113,753 shares of its common stock at an exercise price of $6.70
(the "Bridge Warrants") (see note 12). The Bridge Notes are secured by
substantially all of the Company's assets. Using the Black-Scholes model, the
estimated fair value of the Bridge Warrants was calculated at $299,000 and has
been recorded as a reduction in the carrying amount of the Bridge Notes, with a
corresponding increase in additional paid in capital. The discount on the Bridge
Notes was amortized over the term of the notes as additional interest expense.
A default on the Bridge Notes permits such holders to foreclose on the assets of
the Company and require the Company, to the extent it has not already done so,
to issue to the holders of the Bridge Notes, additional warrants to purchase an
aggregate of 9,100,220 shares (the "Contingent Warrants") at an exercise price
of $0.25 per share, payable in cash or by surrender of Bridge Notes (see note
12). If the Contingent Warrants were converted to common stock, they would
represent approximately 45.0% of the then outstanding common stock of the
Company. The Bridge Notes were due and payable on January 18, 2001. As of
February 3, 2001 the secured Bridge Note holders had not converted the
contingent warrants to common stock.
F-36
In June 2000, the Company issued 10% junior secured convertible bridge
notes to affiliates in the aggregate principal amount of approximately
$1,660,000 (the "Convertible Bridge Notes"). The Convertible Bridge Notes are
subordinate to the Bridge Notes, are convertible at any time into common stock
at a price of $0.25 per share and were due and payable on January 18, 2001. If
the Convertible Bridge Notes were converted to common stock, they would
represent approximately 37.4% of the then outstanding common stock of the
Company. The Convertible Bridge Notes are secured by substantially all of the
Company's assets.
Both the Bridge Notes and the Convertible Bridge Notes are in default. The
holders of the Bridge Notes and the Convertible Bridge Notes have notified the
Company that they will not extend the maturity of the Bridge Notes and the
Convertible Bridge Notes, respectively. As such, the Contingent Warrants were
triggered for the benefit of the Bridge Note holders. Using the Black-Scholes
model, the estimated fair vale of the Contingent Warrants was calculated at
$992,000 and has been recorded as additional interest expense with a
corresponding increase in additional paid in capital.
If both the Contingent Warrants and the Convertible Bridge Notes were to
convert to common stock they would represent approximately 58.6% of the then
outstanding common stock.
Note 6 - Write off of Initial Public Offering Costs
- ---------------------------------------------------
On January 18, 2000, the Company filed a registration statement with the
Securities and Exchange Commission with respect to an offering of its common
stock. Costs of $873,000, incurred in connection with the offering, including
audit fees, legal fees, various filing fees and printer costs were deferred
pending the completion of the offering. On May 19, 2000, the Company withdrew
this registration statement because of adverse market conditions and expensed
the deferred costs in Fiscal 2000.
Note 7 - Stock Option Plans
- ---------------------------
In April 1999, the board of directors adopted the 1999 Stock Option Plan,
which was approved by the Company's stockholders in June 1999. The total number
of shares that can be issued under the plan is 2,031,500. The 1999 Stock Option
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 options granted through February 3, 2001, are options to employees of The
Right Start totaling 1,101,700 options. The Right Start employees provided
services to the Company at the time the options were granted. Generally,
options granted under the 1999 Stock Option 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-37
The following table summarizes the Company's stock option activity during
fiscal 2000:
Exercisable
Weighted
Weighted Fair Value Options Average
Number of Average of Options Exercisable Exercise
Options Exercise Price Granted at Year End Price
------------- -------------- ------------ ------------- ----------
Outstanding at January 29, 2000 1,769,500 $1.09 494,000 $.45
Granted 312,000 .73 .17
Canceled (317,800) 1.03
Exercised (12,000) .45
--------- -----
Outstanding at February 3, 2001 1,751,700 $1.02 842,238 $.61
========= =====
The following table summarizes information concerning the Company's outstanding
and exercisable stock options at February 3, 2001:
Number Weighted Average
Outstanding at Weighted Average Exercise Price of Number
Range of February 3, Remaining Options Exercisable
Exercise Prices 2001 Contractual Life Outstanding at February 3, 2001
- --------------- --------------- ------------------ ------------------ -------------------
$0.45 1,420,700 8.6 years $0.45 758,425
$1.90 60,000 9.4 years 1.90 -
$3.75 250,000 8.8 years 3.75 78,125
$4.50 21,000 8.8 years 4.50 5,688
--------- ----- -------
1,751,700 $1.02 842,238
========= ----- =======
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:
Risk-free interest rates 5.88%
Expected life (in years) 4
Dividend yield 0%
Expected volatility 85.06%
Compensation expense has been recognized for options granted under the
1999 Stock Option Plan pursuant to APB 25 in the amount of $536,000 for Fiscal
2000. 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 preferred stock
into common stock. Had compensation cost been determined based on the fair
value of the options at the date of
F-38
grant consistent with the provisions of SFAS 123, the Company's net loss would
have been increased to the pro forma amount indicated below. Because options
vest over several years, the pro forma result for Fiscal 2000, is not
representative of the pro forma result for future years.
Net loss attributable to common stockholders:
As Reported $14,073,000
Pro Forma $14,080,000
Net loss per common share:
As Reported $(1.45)
Pro Forma $(1.45)
Note 8 - Income Taxes
- ---------------------
As of February 3, 2001, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $19,457,000 expiring through 2021
and approximately $10,415,000 for state income tax purposes expiring through
2010. Utilization of the above carry-forwards may be subject to utilization
limitations, which may inhibit the Company's ability to use carry-forwards in
the future.
The income tax provision for the fiscal 2000 represents the minimum state
taxes due in California.
The deferred income tax assets as of February 3, 2001 are:
Net operating loss $ 7,241,000
Depreciation (34,000)
Accounts payable and accrued
liabilities 1,511,000
Deferred compensation 297,000
Other 39,000
-----------
9,054,000
Valuation allowance (9,054,000)
-----------
$ -
===========
In fiscal year 2000 the Company's valuation allowance increased by
$5,533,000. The Company's provision for income taxes differs from the expected
statutory tax benefit due
F-39
to the change in the valuation allowance.
Note 9 - Transactions with Affiliates
- --------------------------------------
In April 2000 10% Bridge Notes each totaling $1,000,000 were sold to both
Richard Kayne and Fred Kayne. Richard Kayne is the Chief Executive Officer of
Kayne Anderson Capital Partners, LLP ("KACP") which is an affiliate of The Right
Start. The Right Start owns 49.4% of the Company's common stock. Fred Kayne is
an affiliate of The Right Start, is a member of the Company's Board of
Directors, a brother of Richard Kayne and a member of the Board of Directors of
The Right Start. In June 2000 10% Convertible Bridge Notes of $800,000 were
sold to various investment partnerships managed by KACP, $200,000 to Fred Kayne
and $486,000 to Sierra Ventures LLP. Sierra Ventures LLP holds approximately 24%
of the Company's outstanding common stock and appointed a representative to one
seat on the Company's Board of Directors.
In July 1999, in connection with the formation of the Company, the Company
entered into a management services agreement with The Right Start. This
agreement provided that The Right Start would supply the Company with inventory
during Fiscal 2000, at cost plus two percent (amended to cost plus five percent
effective February 4, 2001) and provide certain basic services at cost plus five
percent. Basic Services consists of various services including among others,
services for personnel/human resources, benefits administration, payroll
processing, insurance, tax, cash management, financial, legal, order fulfillment
and collection, accounting, telecommunications, catalog production assistance
and credit card processing. Inventory designated for the Company is stored
separately from that of The Right Start and is billed to the Company on a weekly
basis only as the merchandise is sold and shipped to its customers. The
management services agreement may be terminated in full or on a service-by-
service basis by the Company on 30 days written notice and by The Right Start,
with respect to inventory supply services, upon 90 days written notice and by
either party upon the occurrence of uncured breaches and certain bankruptcy
events. The costs for the services rendered under this agreement, which for
Fiscal 2000 amounted to $371,000 is included in general and administrative
expenses in the accompanying statement of operations.
The Company entered into an intellectual property agreement with The Right
Start, dated as of July 9, 1999, pursuant to which The Right Start (i) assigned
the Website IP (as defined below) and User Information (as defined below), (ii)
granted a worldwide, non-exclusive, (except with respect to online usage) non-
transferable, fully-paid up and royalty-free license to use the Right Start IP
(as defined below) solely in connection with the Company's online and catalog
retail sales of products for parents, childcare providers, infants and children
and (iii) granted a perpetual, worldwide, exclusive, fully-paid up and royalty-
free, unrestricted sublicense and right to use the source code and object code
and certain other intellectual property owned by Guidance Solutions, which the
Company engaged to develop the website located at www.rightstart.com. Pursuant
to the intellectual property agreement, the Company granted to The Right Start a
worldwide, non-exclusive, fully-paid up and royalty-free license to use the
Website IP and User Information solely in connection with its retail sales of
parents', childcare, infants' and
F-40
children's products (other than through online or catalog sales). "Website IP"
is defined as all files, text, graphics, graphics files in any file format,
images, artwork, audio files, audiovisual materials and e-commerce and database
applications provided by third parties or The Right Start or created by or for
the Company in connection with its website and certain copyright registrations,
all domain names, all trademarks, all service marks, all trade dress, all logos,
all brands and designs, all trade names, all Internet domain names, all metatags
and hyperlinks used in connection with the Company's website and the online and
catalog retailing of parents', childcare, infants' and children's products.
"Right Start IP" is defined as all lists of customers and prospective customers
used in connection with The Right Start's retail sales of infants' and
children's products other than through online or catalog sales. "User
Information" is defined as all information with respect to the use and users of
the Company's website, including all catalog customer lists of The Right Start
or the Company that existed on July 9, 1999.
The intellectual property agreement is perpetual unless terminated. The
intellectual property agreement may be terminated by The Right Start (a) upon
the occurrence of mergers, reorganizations, consolidations or other business
combinations (other than with an affiliate or financial advisor) as a result of
which the Company's stockholders immediately prior to such transaction hold less
than 50% of the Company's voting power and in which the acquirer is a direct
competitor to The Right Start and (b) upon the occurrence of a material breach
by the Company that is not cured within 30 business days of receipt of written
notice from The Right Start. The Company may terminate the intellectual
property agreement upon the occurrence of a material breach by The Right Start
that is not cured within 30 days of receipt of written notice from the Company.
After termination, the Company is automatically granted a license with respect
to (i) customer information and (ii) the Right Start IP, in each case used by
the Company at the time of termination. The Right Start is similarly granted an
automatic license with respect to User Information used by The Right Start at
the time of termination. These post-termination licenses are terminable if, in
the opinion of a independent recognized arbitrator, the licensee has engaged in
activity that would substantially harm the image of the owner of the licensed
intellectual property, substantially diminish the value of such party's
intellectual property rights or the "Right Start" name.
The Company has entered into indemnification agreements with certain of its
directors and executive officers which may, among other things, require it to
indemnify such persons against liabilities that may arise by reason of such
persons' status as directors or executive officers for the Company, other than
liabilities arising from willful misconduct of a culpable nature, and to advance
such persons' expenses incurred as a result of any proceeding against them as to
which they could be indemnified.
For other transactions with affiliates see note 15 - Subsequent Event.
F-41
Note 10 - Commitments and Contingencies
- ---------------------------------------
Future Advertising
The Company has no commitments for future advertising but has traded
advertising services with Nestle.
Leases
Since May 1, 1999 the Company has sub-leased office space from The Right
Start on a month-to-month basis. Rent expense under this sub-lease totaled
$150,000 for Fiscal 2000. The Company has no long-term lease obligations.
Legal Matters
The Company is a party to various legal actions arising in the ordinary
course of business. The Company has been sued by three of its unsecured
creditors who provided advertising services - for which they have not received
payment. Total damages sought from these three unsecured creditors are
$431,000. Management has attempted to reach settlement with these unsecured
creditors without success to date and intends to pursue its available defenses
to their claims.
Note 11 - Common Stock
- ----------------------
On October 9, 2000 the Board of Directors of the Company authorized an
increase in the number of authorized shares form 20,000,000 to 29,120,458.
On October 10, 2000, the Company issued 1.6 million shares of common stock
to a new investor (the "October Investor") and 400,000 shares of common stock to
an existing minority investor. The Company used the $500,000 of net proceeds
it received to fund operations. The new issuance represented 18% of the
Company's shares outstanding and reduced the percentage ownership of its common
stock by The Right Start from 60.2% to 49.4%. The October Investor received a
seat on the Company's Board of Directors. The Company's current Board of
Directors is comprised of the October Investor, a representative of one of the
Company's original minority investors, an affiliate of the Company and the chief
executive officer of the Company who is also the chief executive officer of The
Right Start. Additionally, the October Investor and existing investors other
than The Right Start received certain participatory rights in the management of
the Company. The sale of common stock and the associated corporate actions
resulted in the Company no longer being consolidated with The Right Start.
Note 12 - Warrants
- ------------------
F-42
During fiscal 1999, in connection with the issuance and conversion of the
Company's convertible preferred stock, the Company issued warrants to purchase
347,000 shares at an exercise price of $4.50 per share exercisable for five
years and expiring in 2004. Also, during fiscal 1999 the Company granted
136,500 warrants to a third party vendor to purchase common stock at $11.25 per
share exercisable for five years and expiring in 2004. These warrants were
issued in connection with entering into a strategic alliance. During fiscal
1999 the Company valued the 136,500 warrants at $337,000, using the Black-
Scholes pricing model, and amortized the value of the warrants over a three year
period. During fiscal 2000 the strategic alliance was terminated and the
Company wrote off the remaining value of the warrants, $226,000, to the
statement of operations.
In connection with the issuance of the Bridge Notes in April 2000, the Company
issued 113,753 warrants. The warrants are valued at $299,000, using the Black-
Scholes pricing method. The full value of these warrants is included in
additional paid in capital in the accompanying statement of shareholders
deficit.
In connection with the event of default on the Company's Bridge Note warrants
to purchase 9,100,220 of common stock at $.25 per share have been issued to the
Bridge Note holders. The warrants are valued at $992,000, using the Black-
Scholes pricing method. The full value of these warrants is included in
additional paid in capital in the accompanying statement of shareholders
deficit.
Note 13 - Employee Benefit Plan
- -------------------------------
The Company currently maintains a defined contribution (401(k)) plan for its
employees. All employees that are at least 21 years of age with three months of
service may contribute to the Plan. At this time, the Company provides no
employer match.
Note 14 - Other Financial Data
- ------------------------------
Allowance for Doubtful Accounts
The activity in the allowance for doubtful accounts for fiscal year ended 2000
is as follows:
Beginning
Balance Provision Write-offs Ending Balance
----------- ----------- -------------- ------------------
$89,000 -- 74,000 $15,000
Accrued liabilities
The details of accrued liabilities as of February 3, 2001 is as follows:
Sales returns and allowances $ 37,000
Accrued interest 284,000
F-43
Accrued professional fees 54,000
Sales taxes payable 54,000
Accrued expenses 179,000
Accrued marketing 79,000
Accrued salaries 49,000
Note 15 - Segment Reporting
- ---------------------------
The Company operates in a single operating segment: retail sales of consumer
products. The Company has no organization structure dictated by product lines,
geography or customer type.
Note 16 - Subsequent Event
- --------------------------
As of April 12, 2001, the Company entered into Baby Registry Joint Development
and Use Agreement with The Right Start pursuant to which the Company and The
Right Start intend to jointly develop a baby registry that can be accessed by
the Company's customers and The Right Start's customers. Upon termination of
the agreement each party would be entitled to retain all code used in the
jointly developed registry, as well as any database information collected to the
date of such termination and to operate a separate registry.
F-44