-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UTuakH1IBytsQHlsqT6DlJnvAtjsSs+AxCN+DJjP9qyh3QyqXtGknDMzGYf6pj5z ZDG7xHlVHDwKTkqWM6zE6A== 0000878720-99-000003.txt : 19990503 0000878720-99-000003.hdr.sgml : 19990503 ACCESSION NUMBER: 0000878720-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990130 FILED AS OF DATE: 19990430 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RIGHT START INC /CA CENTRAL INDEX KEY: 0000878720 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-CATALOG & MAIL-ORDER HOUSES [5961] IRS NUMBER: 953971414 STATE OF INCORPORATION: CA FISCAL YEAR END: 0201 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-19536 FILM NUMBER: 99606064 BUSINESS ADDRESS: STREET 1: 5388 STERLING CENTER DR CITY: WESTLAKE VILLAGE STATE: CA ZIP: 91361 BUSINESS PHONE: 8187077100 MAIL ADDRESS: STREET 1: 5388 STERLING CENTER DRIVE CITY: WESTLAKE VILLAGE STATE: CA ZIP: 91361 10-K 1 10-K FOR THE YEAR ENDED 1/30/99 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) (X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required effective October 7, 1996) For the fiscal year ended January 30, 1999 ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period from _________________ to ___________________________. Commission file no. 0-19536 THE RIGHT START, INC. --------------------- (Exact name of registrant as specified in its charter) California 95-3971414 ---------- ---------- (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification No.) 5388 Sterling Center Dr., Unit C, Westlake Village, California 91361 - ----------------------------------------------------------------------- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (818) 707-7100 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value -------------------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of April 19, 1999, approximately 2,595,487 shares of the Registrant's Common Stock held by non-affiliates were outstanding and the aggregate market value of such shares was approximately $17,519,537. As of April 19, 1999 there were outstanding 5,051,820 shares of Common Stock, no par value, with no treasury stock. Portions of the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on June 29, 1999 (the "Proxy Statement") are incorporated by reference into Part III hereof. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section-27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Discussions containing such forward-looking statements may be found in the material set forth under Item 1. Business and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as within this Annual Report generally (including any document incorporated by reference herein). Also, documents subsequently filed by the Company with the Securities and Exchange Commission may contain forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors identified herein or in other public filings by the Company, including but not limited to, the Company's Registration Statement on Form S-3 (File No. 333-08175). PART I ITEM 1. BUSINESS General The Right Start, Inc., a California corporation ("The Right Start" or "the Company") is a leading merchant offering unique, high-quality products for infants and young children. The Company markets its products through 41 retail stores and through The Right Start catalog. The Company is a market leader offering approximately 800 items targeting infants and children from pre-birth up to age four. Products offered are carefully selected to meet parents' baby care needs in such categories as Travel, Developmental Toys, Books/Music/Video, Feeding, Nursery, Health/Safety and Bath/Potty. History The Company was formed in 1985 to capitalize upon growing trends towards the use of mail order catalogs and the demand for high quality infants' and children's goods. Until the formation of the Company, new parents' alternatives were low-service mass merchandise stores or sparsely-stocked, high-priced infants' and children's specialty stores. To counter this, The Right Start carefully screened infant and toddler products in order to identify those considered to be the "best of the best," that is, the safest, most durable, best designed and best valued items. The Right Start then expanded its distribution channel beyond The Right Start Catalog and into specialty retail sales through The Right Start stores. Based on the results of the retail stores, the Company's strategy evolved to include a reduction in The Right Start Catalog circulation and plans for a major retail expansion. Management has always made customer service the Company's highest priority. By offering to its customers sales associates with extensive product knowledge, carefully selected and tested products, fast shipment that is generally less than 48 hours from receipt of catalog orders, and a 24 hour a day/365 day a year ordering availability, The Right Start is able to differentiate itself from its competitors. Retail Operations On January 30, 1999, the Company had 40 stores in operation. The stores' product mix includes a wide variety of items to meet the needs of the parents of infants and small children, all presented within a store designed to provide a safe, baby-friendly environment for the shopping ease of new parents. The number of stores open reflects the rapid growth that the Company experienced in 1996 and early 1997, during which time 24 mall stores were opened. After studying the results of both mall and street locations, management 2 concluded that street locations represented a much more appropriate format for future retail growth. These locations are more convenient to access and shop for the Company's customers, many of whom are shopping with infants and small children. Further, street locations are more cost efficient to build and operate. Accordingly, the Company adopted a store opening plan which provided for the opening of eight street-location stores in 1998. In addition to reevaluating store location strategy, in 1997 the Company determined that certain existing mall locations were not performing at an acceptable level and implemented a store closing plan. Nine mall stores were closed in 1998. The Right Start Catalog The Right Start catalog offers a mail order alternative for The Right Start customers. This division of the Company represents the business on which the Company was founded over twelve years ago, and it continues to offer a quality selection of Right Start products through nationally distributed mail order catalogs. Several attractive glossy issues are mailed each year, targeting the Company's principal customers: educated, first-time parents from 23-40 years old, with an average annual income in excess of $60,000. Advertising and Marketing The Right Start has implemented a number of national, regional and local marketing programs to reinforce its strong brand name and increase customer awareness of customers in new store locations. These programs include print ads in national and regional publications, direct mail and local newspaper advertising. In addition, the stores' point of sale system provides a strong marketing database. Customers' names and addresses are captured and are then used for promotional mailings and other follow up activities. Further, the Right Start catalog provides effective marketing support for the stores. Catalogs are distributed in existing and future retail markets to a targeted customer base. The Company reaches its catalog customers through mailings of The Right Start catalog to qualified segments of the Company's own customer list and selected rented lists. In order to achieve this efficiently, the customer list is segmented by frequency, recency and size of purchase. Rented lists are evaluated based on historical performance in The Right Start mailings and availability of names meeting the Company's customer profile. Purchasing The Right Start purchases products from over 500 different vendors. No single vendor represents more than 5% of overall sales. In total, the Company imports approximately 5% of the products offered. Imported items have historically had higher gross profit margins and tend to provide more opportunities for the Company to offer a large selection of unique goods. Employees As of April 19, 1999, the Company employed 327 employees, approximately 57 percent of whom were part-time. The Company's employees have not entered into any collective bargaining agreements nor are they represented by union. The Company considers its employee relations to be good. 3 Recent Developments The Company continues to develop its plan to engage in electronic commerce over the Internet. The Company has been developing its e-commerce Website, RightStart.com, Inc., as subsidiary of the Company, that will own and operate the Internet portion of the Company's business. The Company's plans call for RightStart.com to be operational by mid-summer 1999. The Company plans to capitalize on its valuable brand name and knowledge and expertise in children's specialty retailing, developed through its retail store and catalog operations, to successfully launch RightStart.com in the Internet arena. The Company has engaged a financial advisory firm to advise it on its e-commerce strategy and to assist the Company in funding and financing RightStart.com. The financing will likely consist of the sale of a minority stake in RightStart.com to strategic investors. The Company is currently in negotiations with prospective investors regarding the size, terms and conditions of such investment, although the Company has not yet entered into any contractual arrangements with any such prospective investors. Competition The retail market for infant and toddler products is very competitive. Significant competition currently comes from "big box" concept children's stores which are becoming more and more prevalent. This type of operation offers customers an extensive variety of products for children and is typically located in up to 50,000 square feet of retail space, generally in lower real estate cost locations. In addition, many national and regional mass merchants offer infant and toddler products in conjunction with a full line of hard and soft goods. The Right Start distinguishes itself from its competition by offering only select, high-quality products in each category in a small, service-intensive environment. There are a variety of general and specialty catalogs selling infants' and children's items in competition with The Right Start catalog. The Company considers its primary catalog competition, however, to be "One Step Ahead," "Kids Club" by Perfectly Safe, and "Sensational Beginnings." These catalogs emerged several years after The Right Start catalog and directly compete by offering a very similar product line at comparable price points to the same target market. New entrants to The Right Start's competitive landscape include several e-commerce sites that sell infants' and children's products on -line. These entities are generally newcomers in the infant and children market and the Company believes that for the most part, such entities do not have the brand recognition or relationships necessary to quickly gain marketshare. The Right Start expects that its e-commerce Website, RightStart.com, will be operational during mid-Fiscal 1999. The Company believes RightStart.com will be able to differentiate itself from its competitors by drawing on the Company's extensive knowledge of retail sales of products for infants and children to its target market. Trademarks The Company has registered and continues to register, when deemed appropriate, certain U.S. trademarks and trade names, including "RightStart.com", "The Right Start", and "The Right Start Catalog." The Company considers these trademarks and tradenames to be readily identifiable with, and valuable to, its business. ITEM 2. PROPERTIES At January 30, 1999, The Right Start operated 40 retail stores in 15 states including California, Colorado, Massachusetts, Minnesota, New Jersey, Illinois, Pennsylvania, New York, Connecticut, Michigan, Washington, Missouri, Virginia, Maryland and Ohio. The Company leases each of its retail locations under operating leases with lease terms ranging from six to ten years, including provisions for early termination in most locations if certain sales levels are not achieved. At certain locations, the Company has options to extend the term of the lease. In most cases, rent provisions include a fixed minimum rent plus a contingent percentage rent based on net sales of the store in excess of a certain threshold. 4 The Right Start currently leases approximately 11,000 square feet as a sub-tenant in a mixed-use building in Westlake Village, California. The Company's corporate office resides in this space. The sub-lease agreement terminates in September 1999. The Company is currently negotiating with its landlord to extend the lease term. ITEM 3. LEGAL PROCEEDINGS The Company is a party to various legal actions arising in the ordinary course of business. In the opinion of management, any claims which may occur are adequately covered by insurance or are without significant merit. The Company believes that the ultimate outcome of these matters will not have a material adverse effect on the Company's financial position or results of operations. ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS' MATTERS The Company's common stock is traded on the Nasdaq National Market system under the symbol RTST. The Company's common stock is held of record by approximately 121 registered shareholders as of April 19, 1999. The following table sets forth the range of high and low bid prices on the Nasdaq National Market for the Common Stock for the periods indicated. The bid price quotations listed below reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. Bid Price (1) ------------- Fiscal 1998 High Low - ----------- ---- --- First Quarter $4.50 $2.75 Second Quarter 3.75 1.75 Third Quarter 2.75 1.50 Fourth Quarter 4.50 2.00 Fiscal 1997 First Quarter 5.50 2.13 Second Quarter 3.38 2.25 Third Quarter 3.50 2.38 Fourth Quarter 2.69 1.75 (1)Bid prices have been restated to give effect to the Company's one-for-two reverse stock split which was reflected on Nasdaq at the opening of trading on December 16, 1998.
The Company has never paid dividends on its common stock and currently does not expect to pay dividends in the future. In addition, the Company's credit agreement contains a number of financial covenants which may, among other things, limit the Company's ability to pay dividends. See "Management's Discussion and Analysis of Financial Condition and Results of Operation." 5 ITEM 6. SELECTED FINANCIAL DATA - (Dollars in thousands except share data; all share data has been restated to give effect to the Company's one-for-two reverse stock split which was effective December 15, 1998) 33-Week Transition Fiscal Year Period Fiscal Year ----------------------- -------- ---------------------- 1998 1997 1996 1995 Earnings Data Revenues: Net sales $ 36,611 $ 38,521 $ 27,211 $ 40,368 $ 44,573 Other revenues 877 214 ------------------------------------------------------- 36,611 38,521 27,211 41,245 44,787 Net loss (5,680) (9,241) (5,378) (3,899) (2,106) Basic and diluted loss per share (1.13) (2.01) (1.34) (1.19) (0.66) Share Data Weighted average shares outstanding 5,051,820 4,594,086 4,003,095 3,268,407 3,150,000 33-Week Transition Fiscal Year Period Fiscal Year ----------------------- --------- ---------------------- 1998 1997 1996 1995 Balance Sheet Data Current assets $ 8,300 $ 8,908 $ 11,704 $ 8,353 $ 9,660 Total assets 17,671 18,462 22,982 17,475 14,632 Current liabilities 6,572 4,796 8,457 4,649 3,690 Long-term debt -- 8,734 5,643 -- -- Shareholders' equity 7,861 3,307 7,172 11,902 10,694 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Recapitalization In order to enhance the Company's liquidity and improve its capital structure, effective April 13, 1998 the Company completed a private placement of non-interest bearing senior subordinated notes in an aggregate principal amount of $3,850,000, together with detachable warrants to purchase an aggregate of 3,850,000 shares of common stock exercisable at $2.00 per share. The new securities were sold for an aggregate purchase price of $3,850,000 and were purchased principally by affiliates of the Company. In connection with the sale of the new securities, the Company entered into an agreement with all of the holders of the Company's existing subordinated debt securities (the "Agreement"), representing an aggregate principal amount of $6,000,000. Pursuant to the Agreement, each holder (of new and old securities) agreed to exchange all of its subordinated debt securities, together with any warrants issued in connection therewith, for newly issued shares of preferred stock. Ten shares of newly issued preferred stock were issued for each $1,000 principal amount of subordinated debt securities exchanged. The total number of shares issued were 30,000, 30,000 and 38,500 for Preferred Stock Series A, B and C, respectively. Holders of $3,000,000 principal amount of existing subordinated debt securities 6 elected to receive Series A Preferred Stock which has no fixed dividend rights, is not convertible into common stock, is mandatorily redeemable by the Company in May 2002 and will not accrue dividends unless the Company is unable to redeem the Series A Preferred Stock at the required redemption date, at which point dividends would begin to accumulate and accrue at a rate of $15 per share per annum. Holders of $3,000,000 principal amount of subordinated debt securities elected to receive Series B convertible preferred stock which has no fixed dividend rights and is convertible into common stock at a price per share of $3.00. Holders of the $3,850,000 principal amount of newly issued, non-interest bearing senior subordinated notes exchanged such debt securities (and the warrants issued in connection therewith) for Series C convertible preferred stock, which has no fixed dividend rights and is convertible into common stock at a price of $2.00 per share. The issuance of the shares of preferred stock occurred upon exchange of the subordinated debt securities in December 1998. Results of Operations This discussion should be read in conjunction with the information contained in the Financial Statements and accompanying Notes thereto of the Company appearing elsewhere in this Form 10-K. Results for the Transition Period (the 33-week period from June 2, 1996 to February 1, 1997) have been presented and discussed to provide the reader with an understanding of the Company's financial condition and results of operations. Comparisons have been made, based on the significant operating factors in each period, between the current fiscal year and Fiscal 1997, between Fiscal 1997 and the comparable unaudited 52-week period of the prior year and between the Transition Period and the comparable period of Fiscal 1996. Fiscal 1998 Compared With Fiscal 1997 Revenues for Fiscal 1998 were $36.6 million compared to $38.5 million for Fiscal 1997. Retail net sales were $31.9 million in Fiscal 1998 and $31.1 million in Fiscal 1997; catalog net sales were $4.7 million in Fiscal 1998 and $7.4 million in Fiscal 1997. Retail net sales increased $.8 million or 2.5%, reflecting the impact of same-store sales increases of 6.5% and the opening of eight new street location stores, offset by the impact of eleven store closures. The 36.1% decline in catalog sales resulted from the Company mailing fewer catalogs in accordance with its operating plan. Cost of goods sold represented 50.7% of sales in Fiscal 1998 compared to 50.0% of sales in Fiscal 1997. The slight decline in gross margin resulted from the additional markdowns taken in conjunction with the closing of certain mall stores and from the conversion of three of the Company's remaining mall stores to a discount format. The discount store format was adopted in three poor performing stores in an effort to better meet the demographics of the customers in those markets. Operating expense decreased $3.9 million or 20.3% in Fiscal 1998 from $19.2 million in Fiscal 1997 to $15.3 million in Fiscal 1998. Catalog operating expenses decreased 46% or $1.9 million in Fiscal 1998 as compared to Fiscal 1997 in conjunction with the reduction in catalog mailings and reduction of production costs on a per-catalog basis. Retail operating expenses declined 13% or $2.0 million in Fiscal 1998 as compared to Fiscal 1997. The retail reductions include $.5 million of occupancy costs related to store closings (offset somewhat by street location openings), $.8 million of distribution cost reductions and $.7 million of payroll and other operating cost reductions. These reductions reflect management's attention to expense management. General and administrative expense decreased 11.6% to $3.5 million in Fiscal 1998 as compared to $3.9 million in Fiscal 1997. The decrease was primarily due to payroll and occupancy cost reductions in conjunction with management's ongoing expense management. 7 Preopening costs decreased $.5 million from $.7 million in Fiscal 1997 to $.2 million in Fiscal 1998. The reduction was due to the reduction in preopening costs per store opened as well as the impact, in Fiscal 1997, of the Company's previous policy of recognizing store opening costs evenly over the stores' first twelve months of operations for the stores opened in 1996. In the third quarter of Fiscal 1997, the Company changed its method of accounting for pre-opening costs and began expensing them as incurred. Depreciation and amortization expense decreased $.1 million or 7.5% in Fiscal 1997 to $1.5 million in Fiscal 1998. The decrease resulted from the closure of eleven stores, most of which were closed during the first half of Fiscal 1998, offset by the depreciation expense recognized on assets for the eight new stores opened in the second half of the fiscal year. Other income of $.1 million in Fiscal 1998 is comprised of net revenues generated from store closings. In December 1997, the Company's Board of Directors approved management's plan to close seven poor performing retail stores. Six of these stores were closed as of April 1999 and the remaining store is in the process of being closed as of April 1999. Such closures generated positive revenues for the Company resulting from the recovery of the value of certain of the leases through either landlords or future tenants of the leased space. In the prior year, other expense of $1.9 million include $1.3 million of fixed assets and leasehold improvements written off in conjunction with planned store closures, $.4 million in fixed assets and leasehold improvements written off in conjunction with the Company's corporate office and distribution center moves and $.2 million of severance expense. Non-cash beneficial conversion feature amortization expense of $3.9 million represents the one-time expense recognition associated with the issuance of the Company's Series C convertible Preferred Stock in connection with the Company's recapitalization, as discussed above. Interest expense decreased $.5 million from $1.1 million in Fiscal 1997 to $.6 million in Fiscal 1998. The 44.0% decrease results from the restructuring of the Company's subordinated debt to eliminate interest on that debt and lower overall borrowings. The Company has a deferred tax asset of $9.1 million, which is reserved against by a valuation allowance of $7.7 million, for a net deferred tax asset of $1.4 million. Management expects that the Company will generate $4 million of taxable income within the next 15 years to utilize the net deferred tax asset. The taxable income will be generated through a combination of improved operating results and tax planning strategies. Rather than lose the tax benefit, the Company could implement certain tax planning strategies including the sale of the Company's catalog operations, since such operations generally operate on a profitable basis. Alternatively, the Company could also sell its catalog operation's mailing lists in order to generate income to enable the Company to realize its NOL carryforwards. Based on the above operating improvements combined with tax planning strategies in place, management believes that adequate taxable income will be generated over the next 15 years in which to utilize the NOL carryforwards. Fiscal 1997 Compared With Transition Period Revenues for Fiscal 1997 were $38.5 million compared to $27.2 million for the Transition Period ($41.2 million for the 52-week period ended February 1, 1997). Retail net sales were $31.1 million in fiscal 1997 and $19.6 million in the Transition Period ($26.8 million for the 52-week period ended February 1, 1997); catalog net sales were $7.4 million in Fiscal 1997 and $7.6 million in the Transition Period ($14.4 million for the 52-week period ended February 1, 1997). Retail net sales declined 14% between Fiscal 1997 and the 52-week period ended February 1, 1997, reflecting the partial year impact of three new stores opened in early Fiscal 1997 and three new stores opened at the end of the year, offset by same-store sales declines of 21%. The Company attributes its same-store sales declines to the elimination of various marketing activities, promotional offers and heavy couponing which enhanced sales but negatively impacted margins and operating expenses. 8 The 49% decline in catalog net sales between Fiscal 1997 and the 52-week period ended February 1, 1997 reflects the continued downsizing of the Company's catalog circulation. Circulation was down 40% between Fiscal 1997 and the 52-week period ended February 1, 1997. This reflects the Company's plan to reduce the mailings of the catalog to operate it at a more profitable level. Cost of goods sold represented 50% of net sales in Fiscal 1997 and 53% in the Transition Period (54% in the 52-week period ended February 1, 1997). The Company has achieved better gross margins in Fiscal 1997, continuing the favorable trend in gross margin that began in the Transition Period. At the same time, average inventory turns have increased from two times in the Transition Period to three times in Fiscal 1997. This reflects the ongoing effort to right size inventory levels and minimize the need for markdowns. Operating expenses increased as a percentage of net sales to 50% or $19.2 million in Fiscal 1997 compared to 46% in the Transition Period or $12.6 million ($20.0 million or 48% of net sales in the 52-week period ended February 1, 1997). The remaining $13.3 million or 35% of sales and $9.7 million 36% of sales, respectively ($16.2 million or 40% of sales in the 52-week period ended February 1, 1997), are payroll and other operating expenses. These costs have decreased as a percentage of sales, reflecting management's on-going attention to cost reductions. The burden of fixed occupancy costs in light of the decline in same-store sales had a negative impact on the Company's results for Fiscal 1997. This fact is a major part of the Company's decision to focus its retail expansion plans on street locations, wherein occupancy and other fixed operating costs are substantially lower than in mall locations. General and administrative expenses were $3.9 million in Fiscal 1997 compared to $2.9 million in the Transition Period ($4.5 million for the 52-week period ended February 1, 1997). The Company experienced a 13% decline in general and administrative expenses between Fiscal 1997 and the 52-week period ended February 1, 1997. This decline reflects the impact of payroll and other overhead cost reductions made in connection with the Company's efforts to reduce expenses. Pre-opening costs were $.7 million in Fiscal 1997 and $.5 million in the Transition Period ($.7 million for the 52-week period ended February 1, 1997). In Fiscal 1997, three stores were opened in the first half of the year (the period through which the Company's policy of deferring pre-opening costs was in effect) compared to twenty-one stores opened in the 52-week period ended February 1, 1997. Due to the timing of the previous year's openings, the majority of the amortization related to these openings was recognized in Fiscal 1997. The increased months' amortization offset by reductions in pre-opening costs beginning in the Transition Period resulted in relatively flat amortization expense for the comparable periods. Depreciation and amortization expense increased to $1.6 million in Fiscal 1997 compared to $.8 million in the Transition Period ($1.2 million for the 52-week period ended February 1, 1997). The increase results from a full-year impact of the addition of build-outs and equipment for the new stores opened during the Transition Period and the partial-year impact of stores opened during Fiscal 1997. Other non-recurring expenses incurred in Fiscal 1997 include $1.3 million of fixed assets and leasehold improvements written off in conjunction with planned store closures, $.4 million in fixed assets and leasehold improvements written off in conjunction with the Company's corporate office and distribution center moves and $.2 million of severance expense. Interest expense increased from $.2 million in the Transition Period and for the 52-week period ended February 1, 1997 to $1.1 million in Fiscal 1997. This reflects the interest charge on the Company's borrowings under its credit facility and subordinated debt issuances which funded operating losses and growth. 9 Transition Period Compared with Fiscal 1996 Revenues for the Transition Period were $27.2 million compared to $26.5 million for the comparable period of Fiscal 1996. Catalog net sales for the Transition Period were $7.6 million and were $16.6 million for the comparable period of Fiscal 1996. The 54% decline in catalog net sales was a result of a significant decrease in catalog circulation. The decrease in circulation reflects management's efforts to discontinue the summer sale catalog which generated very low margin sales and eliminate circulation to unprofitable mailing lists. Retail net sales were $19.6 million for the Transition Period compared to $9.9 million for the comparable period of Fiscal 1996. The increase in retail net sales was a result of the Company's retail expansion; 37 stores were open at February 1, 1997 as compared to 22 at June 1, 1996. Further, the Transition Period includes the benefit of a full period's results for the eleven stores opened in Fiscal 1996. Same-store sales were flat for the Transition Period. Cost of goods sold represented 53% of net sales in the Transition Period and 54% of net sales in both Fiscal 1996 and the 33-week period ended February 3, 1996. The improvement in gross margin reflected the net positive impact of steadily improved margins beginning in Fall 1996, offset by lower margins generated at the beginning of the Transition Period due to heavy promotional activity to improve the Company's inventory position. The margin improvement was attributed to better management of inventory levels and the elimination of excessive mark-down promotions. Operating expense was $12.6 million, or 46% of net sales, in the Transition Period compared to $18.3 million, or 45% of net sales, in Fiscal 1996. The increase was primarily attributed to the addition of senior retail operations management and increased telemarketing costs for the catalog. General and administrative expense in the Transition Period was $2.9 million compared to $4.3 million in Fiscal 1996 ($2.0 million in the 33-week period ended February 3, 1996). The increase between the 33-week periods reflected the investment made in executive and senior management in the merchandising areas to support the Company's new retail stores and implement the Company's merchandising strategy. The Transition Period included $.5 million in pre-opening costs compared to $.4 million in Fiscal 1996 ($265,000 in the 33-week period ended February 3, 1996). The increase resulted from the retail expansion over the previous two years. The Company amortized its new store opening costs over the first twelve months of each store's operations. Depreciation and amortization was $.8 million during the Transition Period as compared to $.9 million in Fiscal 1996 ($.6 million in the 33-week period ended February 3, 1996). The increase was due to the increase in property and equipment resulting from the construction of new stores and installation of the Company's new information system. Non-recurring expenses of $.9 million incurred during the Transition Period were primarily attributed to the following: the Company's former President resigned in October 1996 resulting in a $.3 million severance charge; the Company prepaid its line of credit upon funding of its new credit facility resulting in $.1 million of prepayment charges; and the Company had taken action to close two unprofitable retail store locations, which has resulted in a write-off of $.4 million in non-recoverable assets. The Company recognized $.2 million of income tax expense for the Transition Period. This charge resulted from management's revaluation of the deferred tax asset. In evaluating the deferred tax asset, management considered the Company's plans and projections and available tax planning strategies. Liquidity and Capital Resources During Fiscal 1998, the Company's primary sources of liquidity were from proceeds from the issuance of $3.85 million of non-interest bearing senior subordinated notes and cash from operations. These sources financed the 10 Company's debt paydown and capital expenditures. Capital expenditures of approximately $1.3 million were incurred in opening new store locations and refurbishing several of the Company's older stores. The Company has a $13.0 million credit facility (the "Credit Facility") which consists of a $10.0 million revolving line of credit for working capital (the "Revolving Line") and a $3.0 million capital expenditure facility (the "Capex Line"). Availability under the Revolving Line is subject to a defined borrowing base. As of January 30, 1999, no borrowings were outstanding under the Revolving Line and $2.75 million was outstanding under the Capex Line; $3.05 million was available at January 30, 1999 under the Revolving Line. Interest accrues on the Revolving Line at prime plus 1% and at prime plus 1.5% on the Capex Line. At January 30, 1999 the bank's prime rate of interest was 7.75%. The Credit Facility terminates on November 19, 1999, and on such date, all borrowings thereunder are immediately due and payable. Borrowings under the Credit Facility are secured by substantially all of the Company's assets. The Company plans to replace the Credit Facility by November 1999, and beleives that it could extend the Credit Facility to May 2000. The Credit Facility, as amended, requires the Company at all times to maintain net worth (defined to include equity and subordinated debt) of at least $8.0 million. The Credit Facility also limits the Company's earnings before interest, taxes, depreciation and amortization (EBITDA) to the following loss amounts: $900,000 for the twelve months ended January 31, 1999 and $500,000 for the twelve months ending April 30, 1999. Minimum EBITDA of zero is required for the twelve months ending July 31, 1999 and $400,000 for the twelve months ending October 31, 1999. In addition, capital expenditures are limited to $1,750,000 in Fiscal 1999. The Company's ability to fund its operations, open new stores and maintain compliance with the Credit Facility is dependent on its ability to generate sufficient cash flow from operations and secure financing beyond November 1999 as described above. Historically, the Company has incurred losses and may continue to incur losses in the near term. Depending on the success of its business strategy, the Company may continue to incur losses. Losses could negatively affect working capital and the extension of credit by the Company's suppliers and impact the Company's operations. In order to enhance the Company's liquidity and improve its capital structure, the Company completed a private placement of non-interest bearing senior subordinated notes in an aggregate principal amount of $3,850,000, together with warrants to purchase an aggregate of 3,850,000 shares of common stock exercisable at $2.00 per share. The new securities were sold for an aggregate purchase price of $3,850,000 and were purchased principally by affiliates of the Company. In connection with the sale of the new securities, the Company entered into an agreement with all of the holders of the Company's existing subordinated debt and warrant securities, representing an aggregate principal amount of $6,000,000. Pursuant to the agreement, each holder agreed to exchange all of its subordinated debt securities, together with any warrants issued in connection therewith, for newly issued shares of preferred stock. Holders of $3,000,000 principal amount existing subordinated debt securities elected to receive Series A Preferred Stock which has no fixed dividend rights, is not convertible into common stock and is mandatorily redeemable by the Company in May 2002. Holders of $3,000,000 principal amount subordinated debt securities elected to receive Series B convertible preferred stock which has no fixed dividend rights, is convertible into common stock at a price per share of $3.00 and is not mandatorily redeemable by the Company. Holders of the $3,850,000 principal amount of new subordinated debt securities elected to receive Series C convertible preferred stock which has no fixed dividend rights, is convertible into common stock at a price per share of $2.00 and is not mandatorily redeemable by the Company. The issuance of the shares of preferred stock upon exchange of the subordinated debt securities was approved by the Company's shareholders at its annual meeting of shareholders on December 15, 1998. In the restructuring described above, the holders of $6.0 million principal amount of subordinated debt permanently waived their rights to receive interest payments and agreed to exchange such debt for preferred stock, resulting in the Company's elimination of approximately $.6 million in annual interest payments. In addition, the proceeds from the Company's private placement of $3,850,000 were used to pay off the Company's revolving line of credit. 11 Impact of Inflation The impact of inflation on results of operations has not been significant during the Company's last three fiscal years. Seasonality The Company's business is not as significantly impacted by seasonal fluctuations, when compared to many other specialty retail and catalog operations. The Right Start's products are for the most part need-driven and the customer is often the end user of the product. However, the Company does experience increased sales during the Christmas holiday season. Other Matters Year 2000 The year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000 which could result in miscalculations or system failures. The Company is currently working to identify and resolve all potential issues relating to the year 2000 on the processing of date-sensitive information by the Company's computerized information system. For purposes of addressing the issues and planning the appropriate resolutions, the Company has segregated its internal systems and individually assessed their state of readiness as follows: Phase of Planning ("x" indicates phase is complete) --------------------------------------------------- System Awareness Assessment Renovation Validation Implementation - ------ --------- ---------- ---------- ---------- -------------- Credit Card Processing x x x x x Inventory Maintenance x x x x Accounting and Reporting x x x x Point of Sale Transactions x x Non-computerized x x systems (none are material to the Company's operations) In addition to resolving any year 2000 issues on the Company's internal systems, the Company is working with its third party vendors in implementing the appropriate solutions. The Company estimates that the maximum, worst-case cost of addressing its year 2000 issues is approximately $125,000 for hardware and software. The Company is currently working with its software vendors for inventory maintenance systems and accounting and reporting systems to complete the installation of the upgraded, year 2000 compliant version of these systems. The Company is working with its vendor for its point of sale ("POS") system to complete the program changes required for this system to be year 2000 compliant. If, in a worst-case scenario, the necessary upgrades could not be completed in a timely manner, the Company's contingency plans provide for the purchase and installation of replacement POS software. No other systems are material to the Company's operations. 12 New Accounting Requirements In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5 "Reporting on the Costs of Start-up Activities" (SOP 98-5) which requires that the costs of start-up activities and organization costs be expensed as incurred. The statement is effective for the Company in Fiscal 2000 and the impact of the adoption of SOP 98-5 is not expected to be material to the Company's financial position or results of operations. Effective October 1, 1997 and as disclosed in Note 1, the Company began expensing all store pre-opening costs as incurred. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the ordinary course of operations, the Company faces no significant market risk. Its purchase of imported products subjects the Company to a minimum amount of foreign currency risk. Foreign currency risk is that risk associated with recurring transactions with foreign companies, such as purchases of goods from foreign vendors. If the strength of foreign currencies increases compared to the U.S. dollar, the price of imported products could increase. However, the Company has no commitments for future purchases with foreign vendors and, additionally, the Company has the ability to source products domestically in the event of import price increases. See "Management's Discussion and Analysis of Financial condition and Results of Operations -- Liquidity and Capital Resources" above for a discussion of debt obligations of the Company, the interest rates of which are linked to the prime rate. The Company has not entered into any derivative financial instruments to mange interest rate risk, currency risk or for speculative purposes and is currently not evaluating the future use of such instruments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data of the Company are as set forth in Item 14(a) hereof. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The Company has not had any changes in or disagreements with its accountants on the Company's accounting and financial disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained in the Company's Proxy Statement under the captions "Executive Officers" and "Election of Directors" is incorporated herein by reference. The Company's Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the close of Fiscal 1998. 13 ITEM 11. EXECUTIVE COMPENSATION The information contained in the Company's Proxy Statement under the caption "Executive Compensation and Other Information" is incorporated herein by reference. The Company's Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the close of Fiscal 1998. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information contained in the Company's Proxy Statement under the caption "Principal Shareholders and Management" is incorporated herein by reference. The Company's Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the close of Fiscal 1998. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained in the Company's Proxy Statement under the caption "Certain Relationships and Related Transactions" is incorporated herein by reference. The Company's Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the end of Fiscal 1998. 14 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report. (1) Financial Statements: Page Report of Independent Accountants F - 1 Balance Sheet - January 30, 1999 and January 31, F - 2 1998 Statement of Operations - Periods Ended January 30, 1999, January 31, 1998, February 1, 1997 and June 1, 1996 F - 3 Statement of Changes in Shareholders'Equity - Periods Ended January 30, 1999, January 31, 1998, February 1, 1997 and June 1, 1996 F - 4 Statement of Cash Flows - Periods Ended January 30, 1999, January 31, 1998, February 1, 1997 and June 1, 1996 F - 5 Notes to Financial Statements F - 6 (2) Financial Statement Schedules: Valuation Reserves F - 21 All other financial statement schedules are omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto. (3) Listing of Exhibits The following exhibits are filed as part of, or incorporated by reference into, this annual report: 15 INDEX TO EXHIBITS Exhibit Number - ------ 3.1 Amended and Restated Articles of Incorporation of the Company, dated August 12, 1991(1) 3.1.1 Amendment to Articles of Incorporation, dated August 20, 1991(1) 3.1.2 Form of Amendment to Articles of Incorporation, dated August 24, 1991(1) 3.2 Bylaws of the Company, as amended(2) 3.3 Specimen Certificate of the Common Stock (without par value)(1) 10.1 1991 Key Employee Stock Option Plan(3) 10.2 Form of Indemnification Agreement between Registrant and its directors and executive officers(3) 10.3 Asset Purchase Agreement for Acquisition of the Assets of Small People, Inc. and Jimash Corporation by Right Start Subsidiary I, Inc.(4) 10.4 1995 Non-employee Directors Option Plan(5) 10.5 Registration Rights Agreement dated August 3, 1995 between Registrant and Kayne Anderson Non-Traditional Investments LP, ARBCO Associates LP, Offense Group Associates LP, Opportunity Associates LP, Fred Kayne, Albert O. Nicholas and Primerica Life Insurance Company(5) 10.6 Asset Purchase Agreement dated as of July 29, 1996 by and between Blasiar, Inc. (DBA Alert Communications Company) and The Right Start, Inc.(5) 10.7 Convertible Debenture Purchase Agreement between The Right Start, Inc. and Cahill Warnock Strategic Partners, LP dated as of October 11, 1996(6) 10.7.1 First Amendment to Convertible Debenture Purchase Agreement between The Right Start, Inc. and Cahill Warnock Strategic Partners, LP dated as of May 30, 1997(11) 10.8 Convertible Debenture Purchase Agreement between The Right Start, Inc. and Strategic Associates, LP dated as of October 11, 1996(6) 10.8.1 First Amendment to Convertible Debenture Purchase Agreement between The Right Start, Inc. and Strategic Associates, LP dated as of May 30, 1997(11) 10.9 Registration Rights Agreement dated October 11, 1996 between The Right Start, Inc. and Strategic Associates, L.P.(7) 10.10 Registration Rights Agreement dated October 11, 1996 between The Right Start, Inc. and Cahill, Warnock Strategic Partners Fund, L.P.(7) 10.11 Loan and Security Agreement dated as of November 14, 1996 between The Right Start, Inc. and Heller Financial, Inc.(6) 10.12 First Amendment to Loan and Security Agreement and Limited Waiver and Consent(8) 10.13 Second Amendment to Loan and Security Agreement and Limited Waiver and Consent(9) 10.14 Third Amendment to Loan and Security Agreement and Limited Waiver and Consent(9) 16 10.15 Fourth Amendment to Loan and Security Agreement and Limited Waiver and Consent(7) 10.16 Registration Rights Agreement dated May 6, 1997 between The Right Start, Inc. and certain Kayne Anderson funds, Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., The Travelers Indemnity Company and certain other investors named therein(7) 10.17 Registration Rights Agreement dated September 4, 1997 between The Right Start, Inc. and certain Kayne Anderson funds, Cahill, Warnock Strategic Partners Fund, L.P., The Travelers Indemnity Company and certain other investors named therein(7) 10.18 The Right Start, Inc. Letter Agreement dated as of April 6, 1998(10) 10.19 The Right Start, Inc. Amendment to Letter Agreement dated as of April 13, 1998(10) 10.20 The Right Start, Inc. Securities Purchase Agreement dated as of May 6, 1997 between the Company and certain investors listed therein with respect to the Company's 11.5% Senior Subordinated Notes due May 6, 2000 and warrants to purchase the Company's common stock(10) 10.21 The Right Start, Inc. Securities Purchase Agreement dated as of April 13, 1998 between the Company and certain investors listed therein with respect to the Company's Senior Subordinated Notes due May 6, 2000 and warrants to purchase the Company's common stock(10) 10.22 Registration Rights Agreement dated April 13, 1998 between The Right Start, Inc. and the investors named therein(7) 10.23 The Right Start, Inc. Securities Purchase Agreement dated as of September 4, 1997 between the Company and the investors named therein with respect to 1,510,000 shares of the Company's common stock(9) 23.1 Consent of Independent Accountants 27.1 Financial Data Schedule - -------------------------- (1) Previously filed as an Exhibit to the Company's Registration Statement of Form S-1 dated August 29, 1991. (2) Previously filed as an Exhibit to Amendment Number 2 to the Company's Registration Statement on Form S-1 dated October 3, 1991. (3) Previously filed as an Exhibit to Amendment Number 1 to the Company's Registration Statement on Form S-1 dated September 11, 1991. (4) Previously filed as an Exhibit to the Company's 10-K for the fiscal year ended May 26, 1993. (5) Previously filed as an Exhibit to the Company's 10-K for the year ended June 1, 1996. (6) Previously filed as an Exhibit to the Company's 10-Q for the period ended November 30, 1996. (7) Previously filed as an Exhibit to the Company's 10-K for the fiscal year ended January 31, 1998, as amended. (8) Previously filed as an Exhibit to the Company's 10-K for the transition period from June 2, 1996 to February 1, 1997. (9) Previously filed as an Exhibit to the Company's 10-Q for the period ended August 2, 1997. (10) Previously filed as an Exhibit to the Company's 8-K dated April 23, 1998. 17 (11) Previously filed as an Exhibit to the Company's 10-Q for the period ended May 3, 1997. (12) Previously filed as an Exhibit to the Company's 8-K dated May 6, 1997. (b) Reports on Form 8-K A Report on Form 8-K was filed by the Company on January 25, 1999. There were no other Reports on Form 8-K filed by the Company during the last quarter of Fiscal 1998. (c) A list of exhibits included as part of this report is set forth in Part IV of this Annual Report on Form 10-K above and is hereby incorporated by reference herein. (d) Not applicable 18 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. THE RIGHT START, INC. (Registrant) Dated: April 29, 1999 \s\ Jerry R. Welch ---------------------- Jerry R. Welch Chairman of the Board, Chief Executive Officer and President Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- \s\ Jerry R. Welch Chairman of the Board, Chief April 29, 1999 - ---------------------- Executive Officer and President Jerry R. Welch \s\ Richard A. Kayne Director April 29, 1999 - ---------------------- sRichard A. Kayne \s\ Andrew D. Feshbach Director April 29, 1999 - ---------------------- Andrew D. Feshbach \s\ Robert R. Hollman Director April 29, 1999 - ---------------------- Robert R. Hollman \s\ Fred Kayne Director April 29, 1999 - ---------------------- Fred Kayne \s\ Howard M. Zelikow Director April 29, 1999 - ---------------------- Howard M. Zelikow \s\ Gina M. Engelhard Chief Financial Officer April 29, 1999 - ---------------------- (Principal Financial and Gina M. Engelhard Accounting Officer) 19 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of The Right Start, Inc. In our opinion, the financial statements listed in the index appearing under Item 14(a) (1) and (2) on page 15 present fairly, in all material respects, the financial position of The Right Start, Inc. at January 30, 1999 and January 31, 1998, and the results of its operations and its cash flows for the years ended January 30, 1999 and January 31, 1998, the thirty-three weeks ended February 1, 1997 and the year ended June 1, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. / s / PricewaterhouseCoopers LLP Los Angeles, California March 12, 1999, except as to Note 3, which is as of April 29, 1999 F-1 THE RIGHT START, INC. BALANCE SHEET January 30, January 31, 1999 1998 ---- ---- ASSETS Current assets: Cash $ 626,000 $ 240,000 Accounts and other receivables 585,000 405,000 Merchandise inventories 5,797,000 6,602,000 Prepaid catalog costs 363,000 297,000 Other current assets 929,000 1,364,000 ----------- ----------- Total current assets 8,300,000 8,908,000 Noncurrent assets: Property, plant and equipment, net 7,884,000 8,115,000 Deferred income taxes 1,400,000 1,400,000 Other noncurrent assets 87,000 39,000 ----------- ----------- $17,671,000 $18,462,000 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 3,822,000 $ 2,782,000 Revolving line of credit 2,014,000 Term note payable 2,750,000 ----------- ----------- Total current liabilities 6,572,000 4,796,000 Term note payable 3,000,000 Deferred rent 1,449,000 1,625,000 Senior subordinated notes, net of unamortized discount of $266,000 2,734,000 Subordinated convertible debentures 3,000,000 Commitments and contingencies Mandatorily redeemable preferred stock Series A, $3,000,000 redemption value 1,789,000 Shareholders' equity: Convertible preferred stock Series B 2,813,000 Convertible preferred stock Series C 3,850,000 Common stock (25,000,000 shares authorized at no par value; 5,051,820 shares issued and outstanding) 22,337,000 22,337,000 Additional paid-in capital 3,571,000 Accumulated deficit (24,710,000) (19,030,000) ----------- ----------- Total shareholders' equity 7,861,000 3,307,000 ----------- ----------- $ 17,671,000 $ 18,462,000 =========== =========== See accompanying notes to financial statements.
F-2 THE RIGHT START, INC. STATEMENT OF OPERATIONS Year Ended Thirty-three ------------------------ Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 ---- ---- ---- ---- Net sales: Retail $31,875,000 $31,107,000 $19,576,000 $17,075,000 Catalog 4,736,000 7,414,000 7,635,000 23,293,000 Other revenues 877,000 ----------- ----------- ----------- ----------- 36,611,000 38,521,000 27,211,000 41,245,000 ----------- ----------- ----------- ----------- Costs and expenses: Cost of goods sold 18,576,000 19,244,000 14,417,000 21,605,000 Operating expense 15,371,000 19,212,000 12,608,000 18,282,000 General and administrative expense 3,459,000 3,912,000 2,941,000 4,341,000 Pre-opening costs 209,000 711,000 528,000 418,000 Depreciation and amortization expense 1,488,000 1,608,000 833,000 938,000 Other (income) expense (113,000) 1,905,000 851,000 450,000 ----------- ----------- ----------- ----------- 38,990,000 46,592,000 32,178,000 46,034,000 ----------- ----------- ----------- ----------- Operating loss (2,379,000) 8,071,000) (4,967,000)(4,789,000) Non-cash beneficial conversion feature amortization 3,850,000 Interest expense 640,000 1,143,000 204,000 37,000 ----------- ----------- ----------- ----------- Loss before income taxes and extraordinary item (6,869,000) (9,214,000) (5,171,000)(4,826,000) Income tax provision (benefit) 22,000 27,000 207,000 (927,000) ----------- ----------- ----------- ----------- Loss before extraordinary item (6,891,000) (9,241,000) (5,378,000)(3,899,000) Extraordinary gain on debt restructuring 1,211,000 ----------- ----------- ----------- ----------- Net loss $(5,680,000) $(9,241,000) $(5,378,000)$(3,899,000) =========== =========== =========== =========== Basic and diluted loss per share: Loss before extraordinary item $ (1.37) $ (2.01) $ (1.34)$ (1.19) Extraordinary item 0.24 ----------- ----------- ----------- ----------- Net loss $ (1.13) $ (2.01) $ (1.34)$ (1.19) =========== =========== =========== =========== Weighted average number of common shares outstanding 5,051,820 4,594,086 4,003,095 3,268,407 =========== =========== =========== =========== See accompanying notes to financial statements.
F-3 THE RIGHT START, INC. STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY Common Stock Additional ------------------ Paid-in Accumulated Shares Amount Capital Deficit ------ ------ ------- ---------- Balance at May 31, 1995 3,150,000 $11,206,000 ($512,000) Issuance of shares pursuant to a rights offering 789,403 4,906,000 Issuance of shares pursuant to the exercise of stock options 30,250 201,000 Net loss (3,899,000) --------- ----------- ------------ Balance at June 1, 1996 3,969,653 16,313,000 (4,411,000) Issuance of shares pursuant to the exercise of stock options 107,167 648,000 Net loss (5,378,000) --------- ----------- ------------ Balance at February 1, 1997 4,076,820 16,961,000 (9,789,000) Issuance of shares pursuant to the exercise of stock options 220,000 1,320,000 Issuance of shares pursuant to a private placement 755,000 3,705,000 Issuance of common stock warrants in conjunction with sale of senior subordinated notes 351,000 Net loss (9,241,000) --------- ----------- ------------ Balance at January 31, 1998 5,051,820 22,337,000 (19,030,000) Issuance of subordinated debt in conjunction with recapitalization, net (Note 12) $3,590,000 Accretion of mandatorily redeemable preferred stock Series A (19,000) Net loss (5,680,000) --------- ----------- ---------- ------------ Balance at January 30, 1999 5,051,820 $22,337,000 $3,571,000 ($24,710,000) ========= =========== ========== ============ See accompanying notes to financial statements.
F-4 THE RIGHT START, INC. STATEMENT OF CASH FLOWS Year Ended Thirty-three ------------------------- Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 --------- ---------- ---------- ---------- Cash flows from operating activities: Net loss ($5,680,000) ($9,241,000) ($5,378,000) ($3,899,000) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 1,538,000 2,319,000 1,361,000 1,356,000 Non-cash beneficial conversion feature amortization 3,850,000 Amortization of discount on senior subordinated notes 44,000 85,000 Loss on store closings 39,000 1,580,000 Extraordinary gain (1,211,000) Change in assets and liabilities affecting operations 1,760,000 (1,316,000) (957,000) 506,000 ----------- ----------- ----------- ----------- Net cash provided by (used in) operating activities 340,000 (6,573,000) (4,974,000) (2,037,000) ----------- ----------- ----------- ----------- Cash flows from investing activities: Additions to property, plant and equipment (1,296,000) (2,063,000) (3,607,000) (4,165,000) Proceeds from sale of telemarketing center 298,000 ----------- ----------- ----------- ----------- Net cash used in investing activities (1,296,000) (2,063,000) (3,309,000) (4,165,000) ----------- ----------- ----------- ----------- Cash flows from financing activities: Net proceeds from (payments on) revolving line of credit (2,014,000) 181,000 1,833,000 Proceeds from (payments on) note payable (250,000) 357,000 2,643,000 Proceeds from sale of convertible subordinated debentures 3,000,000 Proceeds from private placement of common stock 3,705,000 Proceeds from common stock issued upon exercise of stock options 1,320,000 648,000 201,000 Proceeds from common stock issued pursuant to a rights offering 4,906,000 Proceeds from sale of senior subordinated notes, net 3,606,000 3,000,000 ----------- ----------- ----------- ----------- Net cash provided by financing activities 1,342,000 8,563,000 8,124,000 5,107,000 ----------- ----------- ----------- ----------- Net increase (decrease) in cash 386,000 (73,000) (159,000) (1,095,000) Cash at beginning of period 240,000 313,000 472,000 1,567,000 ----------- ----------- ----------- ----------- Cash at end of period $ 626,000 $ 240,000 $ 313,000 $ 472,000 =========== =========== =========== =========== See accompanying notes to financial statements.
F-5 THE RIGHT START, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES: The Company The Right Start, Inc. (the Company) is a specialty merchant of infants' and children's products throughout the United States. In 1991, the Company completed the sale of 2,300,000 shares of its common stock in an initial public offering. Prior to that, it was a wholly owned subsidiary of American Recreation Centers, Inc. (ARC). ARC maintained majority ownership of the Company through July 1995. In August 1995, an investment group led by Kayne, Anderson Investment Management, Inc. (KAIM) acquired the 3,937,000 shares of common stock owned by ARC. Fiscal Year The Company has a fiscal year consisting of fifty-two or fifty-three weeks ending on the Saturday closest to the last day in January. Effective January 1997, the Company changed its fiscal year which had been the fifty-two or fifty-three weeks ending on the Saturday closest to the last day in May. The change in year end resulted in a thirty-three week transition period from June 2, 1996 to February 1, 1997 ("the Transition Period"). The fiscal years ended January 30, 1999 ("Fiscal 1998"), January 31, 1998 ("Fiscal 1997"), and June 1, 1996 ("Fiscal 1996") were fifty-two week periods. See Note 15. Revenue Recognition Retail sales are recorded at time of sale or when goods are delivered. Catalog sales are recorded at the time of shipment. The Company provides for estimated returns at the time of the sale. Merchandise Inventories Merchandise inventories consist of products purchased for resale and are stated at the lower of cost or market value. Cost is determined on a first-in, first-out basis. Prepaid Catalog Expenses Prepaid catalog expenses consist of the costs to produce, print and distribute catalogs. These costs are amortized over the expected sales life of each catalog which does not exceed four months. Catalog production expenses of $1,363,000, $2,753,000, $1,844,000 and $6,061,000 were recorded in Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is provided using the straight-line method based upon the estimated useful lives of the assets, generally three to ten years. Amortization of leasehold improvements is based upon the term of the lease or the estimated useful life of the leasehold improvements, whichever is shorter. F-6 NOTE1: (Continued) Long-lived Assets The Company periodically evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance may not be recoverable. When factors indicate that the asset should be evaluated for possible impairment, the Company uses an estimate of the stores' undiscounted net cash flows over the remaining life of the asset in measuring whether the asset is recoverable. Based upon the anticipated future income and cash flow from operations, there has been no impairment. Store Opening Costs Effective October 1, 1997, the Company changed the way costs incurred in opening stores are recognized. Previously, these costs had been deferred and amortized over 12 months commencing with the store opening. After the effective date, any pre-opening costs incurred for new stores were charged to expense as incurred. The impact of this change was not significant to the Company's results of operations or financial position. Deferred Rent The Company recognizes rent expense on the straight-line basis over the life of the underlying lease. The benefit from tenant allowances and landlord concessions are recorded as deferred rent and recognized over the lease term. Income Taxes The Company accounts for income taxes using an asset and liability approach under which deferred tax liabilities and assets are recognized for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. A valuation allowance is established against deferred tax assets when it is more likely than not that all, or some portion, of such deferred tax assets will not be realized. During the periods that the Company was majority owned by ARC, the Company provided for income taxes as a separate taxpayer. State income taxes were settled pursuant to an informal tax sharing agreement and the Company filed a separate federal income tax return. Per Share Data On December 15, 1998, the Company's shareholders approved a one-for-two reverse split of the Company's common stock, which had previously been approved by the Company's Board of Directors. The reverse split was effective December 15, 1998. All references in the financial statements to shares and related prices, weighted average number of shares, per share amounts and stock plan data have been adjusted to reflect the reverse split. Basic per share data is computed by dividing net loss applicable to common shareholders by the weighted average number of common shares outstanding. Diluted per share data is computed by dividing income available to common shareholders plus income associated with dilutive securities by the weighted average number of shares outstanding plus any potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock in each year. F-7 NOTE1: (Continued) Year Ended Thirty-three ------------------------ Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 --------- ---------- ---------- ---------- Loss before extraordinary item $6,891,000 $9,241,000 $5,378,000 $3,899,000 Plus: Preferred stock accretion 19,000 ---------- ---------- ---------- ---------- Basic and diluted loss before extraordinary item applicable to common shareholders $6,910,000 $9,241,000 $5,378,000 $3,899,000 ========== ========== ========== ==========
Securities that could potentially dilute basic EPS in the future were not included in the computation of diluted EPS, because to do so would have been antidilutive for the periods presented. Such securities include options outstanding to purchase 890,519, 326,005, 489,960, and 523,701 shares of common stock at January 30, 1999, January 31, 1998, February 1, 1997 and June 1, 1996, respectively, Series B preferred stock convertible into 1,000,000 shares of common stock and Series C preferred stock convertible into 1,925,000 shares of common stock at January 30, 1999. Stock-Based Compensation Compensation cost attributable to stock option plans is recognized based on the difference, if any, between the closing market price of the stock on the date of grant over the exercise price of the option. The Company has not issued any stock options with an exercise price less than the closing market price of the stock on the date of grant. Reclassifications Certain reclassifications have been made to conform prior period amounts to current year presentation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Income In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). This statement divides comprehensive income into net income and other comprehensive income. SFAS 130 was effective for the Company during Fiscal 1998. The Company has no items of other comprehensive income in any period presented and, consequently, is not required to report comprehensive income. F-8 NOTE 2 - PROPERTY, PLANT AND EQUIPMENT, NET: January 30, January 31, 1999 1998 ------------ ------------ Property, plant and equipment, at cost: Machinery, furniture and equipment $ 4,015,000 $ 3,669,000 Leaseholds and leasehold improvements 7,511,000 6,683,000 Computer software 840,000 821,000 ------------ ------------ 12,366,000 11,173,000 Accumulated depreciation and amortization (4,482,000) (3,058,000) ------------ ------------ $ 7,884,000 $ 8,115,000 ============ ============ Depreciation and amortization expense for property, plant and equipment amounted to $1,488,000; $1,608,000; $833,000 and $938,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. NOTE 3 - CREDIT AGREEMENTS: In November 1996, the Company entered into an agreement with a financial institution for a $13 million credit facility (the "Credit Facility"). The $13 million facility consists of a $3 million capital expenditure facility (the "Capex Line") and a $10 million revolving credit line for working capital (the "Revolver"). Availability under the Revolver is subject to a defined borrowing base. As of January 30, 1999, no borrowings were outstanding and $3,054,000 was available under the Revolver. As of January 30, 1999, $2,750,000 was outstanding on the Capex Line. The Credit Facility, as amended, requires the Company at all times to maintain net worth (defined to include equity and subordinated debt) of at least $8 million and provides that cash dividends may be paid only if written consent of the lender is obtained. The Credit Facility also limits the Company's earnings before interest, taxes, depreciation and amortization (EBITDA) to the following loss amounts: $900,000 for the twelve months ended January 31, 1999 and $500,000 for the twelve months ending April 30, 1999. Minimum EBITDA of zero is required for the twelve months ending July 31, 1999 and $400,000 for the twelve months ending October 31, 1999. In addition, capital expenditures are limited to $1,750,000 in fiscal year 1999. Interest accrues on the revolving line of credit at prime plus 1% and at prime plus 1 1/2% on the capital expenditure facility. At January 30, 1999, the bank's prime rate of interest was 7.75%. The Company's weighted average interest rate on short-term borrowings was 9.43% and 9.48% for Fiscal 1998 and Fiscal 1997, respectively. The Credit Facility is for a period of three years and is secured by substantially all the Company's assets. The Company plans to replace the Credit Facility by November 1999, and believes that it could extend the Credit Facility to May 2000. F-9 NOTE 3: (Continued) Effective May 6, 1997, the Company sold subordinated notes in the aggregate principal amount of $3,000,000 and warrants to purchase common stock, certain of the purchasers of which were affiliates of the Company. The subordinated notes bore interest at 11.5% and were due in full on May 6, 2000. Warrants to purchase an aggregate of 237,500 shares of common stock at $6.00 per share were issued in connection with the subordinated notes. Proceeds from the sale of the subordinated notes and warrants were allocated to the debt security and the warrants based on the fair value of the securities at the date of issuance. The value assigned to the warrants was $351,000. The resulting debt discount was amortized over the term of the notes. In December 1998, the holders of the notes exchanged the notes and warrants in connection with a capital restructuring. See Note 12. The Company issued and sold subordinated convertible debentures in the aggregate principal amount of $3 million effective October 11, 1996. The terms of such debentures, as amended, permitted the holders to convert the principal amount into 375,000 shares of the Company's common stock at $8.00 per share at any time prior to May 31, 2002, the due date of the debentures. The debentures bore interest at a rate of 8% per annum. The holders of the debentures exchanged the debentures in conjunction with a capital restructuring in December 1998. See Note 12. NOTE 4 - MANDATORILY REDEEMABLE PREFERRED STOCK: In connection with the Company's recapitalization (see Note 12), the Company issued 30,000 shares of mandatorily redeemable preferred stock Series A. The stock has a par value of $.01 per share and a liquidation preference of $100 per share; it is mandatorily redeemable at the option of the holders on May 31, 2002 at a redemption price of $100 per share or $3,000,000. The Series A preferred stock shall also be redeemed by the Company upon a change of control or upon the issuance of equity securities by the Company for proceeds in excess of $15,000,000, both as defined in the Certificate of Determination for the Series A preferred stock. The difference in the fair value of the mandatorily redeemable Series A preferred stock at the date of issuance and the redemption amount is being accreted, using the interest method, over the period from the issuance date to the required redemption date as a charge to additional paid-in capital. There shall be no dividends on the Series A preferred stock unless the Company is unable to redeem the stock at the required redemption date, at which point dividends shall cumulate and accrue on a daily basis, without interest, at the rate of $15.00 per share per annum, payable quarterly. NOTE 5 - SHAREHOLDERS' EQUITY: Pursuant to shareholder approval in December 1998, the Company authorized for issuance 250,000 shares of preferred stock, of which 30,000 were designated Series A (see Note 4), 30,000 were designated for Series B and 38,500 were designated for Series C. In connection with the Company's recapitalization (see Note 12), the Company issued the Series A, Series B and Series C shares (collectively, the "Preferred Shares"). The Preferred Shares are non-voting. However, holders of at least a majority of the Preferred Shares acting as a class, must consent to certain corporate actions, including the sale of the Company, as defined in the respective Certificates of Determination. F-10 NOTE 5: (Continued) Both Series B and Series C preferred stock have a par value of $.01 per share and a liquidation preference of $100 per share. The shares shall be convertible in whole or in part at any time at the option of the holders into shares of the Company's common stock. The conversion rates are $3.00 per common share and $2.00 per common share for the Series B preferred stock and the Series C preferred stock, respectively, subject to anti-dilution provisions set forth in the Certificates of Determination for the Series B and the Series C preferred stock. NOTE 6 - INCOME TAXES: The provision (benefit) for income taxes is comprised of the following: Year Ended Thirty-three ------------------------ Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 ------- ------- -------- --------- Current provision: Federal $1,000 State $22,000 $27,000 Deferred provision (benefit): Federal (928,000) State Adjustment to valuation allowance $207,000 ------- ------- -------- --------- $22,000 $27,000 $207,000 ($927,000) ======= ======= ======== =========
The Company's effective income tax rate differed from the federal statutory rate as follows: Year Ended Thirty-three ------------------------ Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 ------- ------- -------- --------- Federal statutory rate 34% 34% 34% 34% State income taxes, net of federal benefit 3 1 3 Stock options 4 Valuation allowance (11) (39) (45) (19) Debt discount amortization (23) Other 2 2 1 ------- ------- -------- --------- Effective tax rate 0% 0% (4)% 19% ======= ======= ======== =========
F-11 NOTE 6: (Continued) Deferred tax liabilities (assets) are comprised of the following: January 30,January 31, 1999 1998 Depreciation and amortization $ 87,000 $ 200,000 Pre-opening costs 21,000 Other 27,000 64,000 ----------- ----------- Deferred tax liabilities 114,000 285,000 ----------- ----------- Net operating loss carryforwards (7,672,000) (6,799,000) Deferred rent (604,000) (839,000) Writedown of fixed assets (633,000) Other reserves (868,000) (396,000) Other tax carryforwards (69,000) (68,000) Sales returns (29,000) (29,000) ----------- ----------- Deferred tax assets (9,242,000) (8,764,000) ----------- ----------- Valuation allowance 7,728,000 7,079,000 ----------- ----------- Net deferred tax asset ($1,400,000) ($1,400,000) =========== =========== In evaluating the realizability of the deferred tax asset, management considered the Company's projections and available tax planning strategies. Management expects that the Company will generate sufficient taxable income in future years to utilize the net deferred tax asset. In addition, the Company could implement certain tax planning strategies including the sale of the Company's catalog operations or its catalog operation's mailing lists in order to generate income to enable the Company to realize its NOL carryforwards. The Company has federal and state net operating loss carryforwards at January 30, 1999 of $20,492,000 and $8,033,000, respectively. These carryforwards will expire in fiscal years ending 2002 through 2019. NOTE 7 - SALE OF TELEMARKETING CENTER: In July 1996, the Company sold its phone center operations to a telemarketing services provider for approximately $500,000, $250,000 of which was in cash and the remainder of which was in a two-year note secured by the assets of the phone center. There was no gain or loss on the sale. F-12 NOTE 8 - EMPLOYEE BENEFITS AND STOCK OPTIONS: On March 15, 1991, two now former executives were granted options to acquire up to 450,000 shares of the Company's common stock under a non-qualified stock option plan. The options were granted at fair market value of $6.66 per share. One hundred fifty thousand options were exercisable at the date of grant. These options expire June 1, 2001. In conjunction with the August 1995 renegotiation of the employment contracts with these two executives, certain option terms were amended. Each executive's holdings became 194,000 options exercisable at $6.00 per share, the fair market value at the time of reissuance. At January 30, 1999, 40,500 shares were outstanding under this plan. One of the executives covered by these option agreements was the Company's chief executive officer who resigned in March 1996. The other executive covered by these option agreements was the Company's president who resigned in October 1996. The employment contracts for these individuals called for severance payments in aggregate of approximately $930,000. A significant portion of each individual's severance represented the cash surrender value of a life insurance policy and the remainder was paid out through December 1997. The Company adopted the 1991 Employee Stock Option Plan, covering an aggregate of 725,000 shares of the Company's common stock, in October 1991. Options outstanding under this plan have terms ranging from three to ten years (depending on the terms of the individual grant). In May 1998, certain option holders were given the right to cancel their existing options (many of which were vested) (the "Existing Options") and have new options issued to them at the fair market value on the date of grant of $3.50 per share (the "New Options"). The Existing Options vested 33% per annum. The New Options vest 20% in the first year and 40% per annum thereafter. In December 1998, the Company granted 275,000 options which vest immediately upon the attainment of a closing stock price, as defined in the grant agreements, of $6.50 for thirty consecutive trading days. Other options granted under this plan, representing 47,320 of the 696,160 outstanding options, vest fully one year after grant date. At January 30, 1999, there were no Existing Options outstanding. Options for 11,991 shares were exercisable at January 30, 1999. In October 1995, the Company adopted the 1995 Non-Employee Directors Option Plan. This Plan provides for the annual issuance, to each non-employee director, of options to purchase 1,500 shares of common stock. In addition, each director is entitled to make an election to receive, in lieu of directors' fees of $12,000 per year, additional options to purchase common stock. The amount of additional options is determined based on an independent valuation such that the fair value of the options issued is equivalent to the fees that the director would be otherwise entitled to receive on an annual basis. Options issued under this plan vest on the anniversary date of their grant and upon termination of Board membership. These options expire three to five years from the date of grant. Options to purchase 153,859 shares of common stock were issued under this plan at exercise prices ranging from $2.50 to $10.26 per share, such exercise price being equal to the closing price of the Company's common stock on the date of grant. No compensation cost was recognized in income in connection with options granted under the Non-Employee Directors Option Plan. At January 30, 1999, 95,515 of the options issued under this plan were exercisable. In 1993, the Company adopted an employee stock ownership plan (ESOP) and employee stock purchase plan (ESPP) for the benefit of its employees. The ESOP is funded exclusively by discretionary contributions determined by the Board of Directors. The Board of Directors authorized contributions to the ESOP of $70,000 in Fiscal 1996. The Company matches employees' contributions to the ESPP at a rate of 50%. The Company's contributions to the ESPP amounted to $14,000, $24,000, $21,000, $28,000 in Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. F-13 NOTE 8: (Continued) The following table summarizes option activity through January 30, 1999: Weighted Number Average of Options Exercise Price ---------- -------------- Outstanding at May 31, 1995 521,000 $ 6.98 Granted 153,451 8.54 Canceled (120,500) 6.20 Exercised (30,250) 6.38 ---------- Outstanding at June 1, 1996 523,701 6.80 Granted 81,760 10.54 Canceled (8,334) 6.84 Exercised (107,167) 6.04 ---------- Outstanding at February 1, 1997 489,960 7.40 Granted 98,295 5.00 Canceled (42,250) 8.08 Exercised (220,000) 6.00 ---------- Outstanding at January 31, 1998 326,005 7.62 Granted 785,014 3.03 Canceled (220,500) 7.13 ---------- Outstanding at January 30, 1999 890,519 3.72 ==========
The Company has adopted Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). In accordance with the provisions of FAS 123, the Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plans and does not recognize compensation expense for its stock-based compensation plans based on the fair market value method prescribed by FAS 123. If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed by FAS 123, the Company's net loss and loss per share would be increased to the pro forma amounts indicated below: Year Ended Thirty-three -------------------------- Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 ----------- ----------- ----------- ----------- Net loss: As reported ($5,680,000) ($9,241,000) ($5,378,000) ($3,899,000) Pro forma (6,258,000) (9,640,000) (5,839,000) (4,068,000) Basic and diluted loss per share: As reported ($1.13) ($2.01) ($1.34) ($1.19) Pro forma (1.24) (2.10) (1.46) (1.25)
F-14 NOTE 8: (Continued) These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years. The fair value for these options was estimated at the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively: dividend yields of zero percent; expected volatility of 76.91, 79.34, 73.25 and 70.97 percent; risk-free interest rates of 5.17, 6.00, 6.36 and 6.10 percent; and expected life of four years for all periods. The weighted average fair value of options granted during Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996 for which the exercise price equals the market price on the grant date was $1.07, $1.55, $3.10 and $4.78, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of employee stock options. The following table summarizes information concerning outstanding and exercisable stock options at January 30, 1999: Range of exercise prices $2.50 - $3.75 $3.76 - $5.50 $5.51 - $8.25 $8.26 - $10.26 Number of outstanding options 742,513 44,296 40,500 63,210 Weighted average remaining contractual life 8.9 years 3.3 years 6.3 years 2.0 years Weighted average exercise price $3.05 $5.00 $6.00 $9.41 Number of options exercisable - 44,294 40,500 63,212 Weighted average exercise price of options exercisable - $5.00 $6.00 $9.40
NOTE 9 - RELATED PARTY TRANSACTIONS: KAIM provides certain management services to the Company and charges the Company for such services. Management fees of $100,000, $100,000, $66,667 and $83,333 were paid to KAIM in Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. The Company provided telemarketing services through July 1996, to K.A. Industries, a related party to KAIM. Revenues generated from this service amounted to $40,000 for the Transition Period and $365,000 for Fiscal 1996. Management believes that the terms of this agreement were no less favorable than those that would have been negotiated with an unrelated third party. F-15 NOTE 10 - COMMITMENTS AND CONTINGENCIES The Company leases real property and equipment under non-cancelable agreements expiring from 1999 through 2007. Certain retail store lease agreements provide for contingent rental payments if the store's net sales exceed stated levels ("percentage rents"). Certain other of the leases contain escalation clauses which provide for increases in base rental for increases in future operating cost and renewal options at fair market rental rates. The Company's minimum rental commitments are as follows: Fiscal Year 1999 $3,461,000 2000 3,506,000 2001 3,460,000 2002 3,283,000 2003 2,922,000 Thereafter 5,073,000 ----------- $21,705,000 =========== Net rental expense under operating leases was $3,233,000, $3,802,000, $1,929,000 and $1,959,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. No percentage rents were incurred in Fiscal 1998 and Fiscal 1997; percentage rents incurred in the Transition Period and Fiscal 1996 amounted to $54,000 and $82,000, respectively. The Company recognizes percentage rent expense when it is probable that it will be incurred. The Company is not a party to any material legal actions. NOTE 11 - STORE CLOSINGS: On December 16, 1997, the Board of Directors of the Company approved management's plan to close seven poor-performing retail stores. The Company wrote off $1.3 million of the net carrying value of capitalized leasehold improvements and fixed assets related to these stores, which is included in other expenses in the statement of operations. The revenues from the stores which closed were $1,904,000, $4,663,000, $3,003,000 and $2,802,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. Operating losses from these stores were $17,000, $435,000, $215,000 and $48,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. All but one of these stores were closed in Fiscal 1998. The remaining store is currently being closed. On January 28, 1997, the Board of Directors of the Company approved management's plan to close two poor-performing retail stores. The Company wrote off $425,000 of the net carrying value of capitalized leasehold improvements and fixed assets related to these stores, which is included in other expenses in the statement of operations. The revenues from these stores were $99,000, $802,000, $616,000 and $1,170,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. Operating losses from these stores were $42,000, $167,000, $225,000 and $155,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. These stores were closed in Fiscal 1998. F-16 NOTE 12 - RECAPITALIZATION AND EXTRAORDINARY GAIN: In order to enhance the Company's liquidity and improve its capital structure, effective April 13, 1998 the Company completed a private placement of non-interest bearing senior subordinated notes in an aggregate principal amount of $3,850,000, together with detachable warrants to purchase an aggregate of 1,925,000 shares of common stock exercisable at $2.00 per share (the "New Securities"). The New Securities were sold for an aggregate purchase price of $3,850,000 and were purchased principally by affiliates of the Company. In connection with the sale of the New Securities, the Company entered into an agreement (the "Agreement") with all of the holders of the Company's existing subordinated debt and warrant securities representing an aggregate principal amount of $6,000,000. Pursuant to the Agreement, each holder (of new and old securities) agreed to exchange all of its subordinated debt securities together with any warrants issued in connection therewith, for newly issued preferred stock. The issuance of the shares of preferred stock was subject to the approval of the Company's shareholders, which approval was received on December 15, 1998. Ten shares of newly issued preferred stock were issued for each $1,000 principal amount of subordinated debt securities exchanged. The total number of shares issued were 30,000, 30,000 and 38,500 for Series A, B and C Preferred Stock, respectively. Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series A Preferred Stock which has no fixed dividend rights, is not convertible into common stock, is mandatorily redeemable by the Company in May 2002 and does not accrue dividends unless the Company is unable to redeem the Series A Preferred Stock at the required redemption date, at which point dividends would begin to accumulate and accrue at a rate of $15 per share per annum. Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series B convertible preferred stock which has no fixed dividend rights and is convertible into common stock at a price per share of $3.00. Holders of the $3,850,000 principal amount of New Securities elected to receive Series C convertible preferred stock which has no fixed dividend rights and is convertible into common stock at a price per share of $2.00. As the $3.85 million of New Securities were issued in contemplation of the exchange into convertible preferred stock, the accounting for the New Securities is analogous to convertible debt. The New Securities were to be exchanged for Series C preferred stock which were convertible into common stock at a price per share of $2.00. As of the date of issue of the New Securities, the stock was trading at $4.00 a share. Since the conversion feature was in the money at the date of issue of the debt, the portion of the debt proceeds equal to the beneficial conversion feature of $3.85 million was allocated to additional paid-in capital. The resulting debt discount of $3,850,000 was amortized to interest expense over the period from the April issuance date to the date the New Securities were first convertible. The date the New Securities were first convertible was the exchange date when the New Securities were exchanged for convertible preferred stock. No value was assigned to the warrants because the requirement to exchange the warrants, together with the debt, for preferred stock resulted in an assessment that the warrants has no independent value apart from the exchange transaction. F-17 NOTE 12: (Continued) The exchanges of the subordinated debt and warrant securities for the preferred stock were recorded at the date of issuance of the preferred stock. The fair value of each preferred stock series was determined as of the issuance date of the stock. The difference between the fair value of the Series A preferred stock granted of $1,769,000 and the carrying amount of the related subordinated debt security's balance exchanged of $3,000,000 was recognized as a gain on the extinguishment of debt, net of transaction expenses, in the amount of $1,231,000. The difference between the fair value of the Series B preferred stock series granted of $2,812,000 and the carrying amount of the related subordinated debt security's balance plus accrued interest exchanged of $2,828,000 was recognized as a gain on the extinguishment of debt, net of transaction expenses, in the amount of $16,000 with $8,000 of the gain on the exchange of notes held by principal shareholders recorded as a credit to additional paid-in capital. There was no gain or loss recognized on the conversion of the New Securities. In connection with the above restructuring, effective April 13, 1998, the holders of the Company's $3.0 million subordinated notes and $3.0 million subordinated convertible debentures agreed to waive their right to receive any and all interest payments accrued and owing on or after February 28, 1998. This modification of terms was accounted for prospectively, from the effective date, under Statement of Financial Accounting Standards No. 15, "Accounting of Debtors and Creditors for Troubled Debt Restructurings," as follows. The carrying amount of the subordinated notes as of April 13, 1998 was not changed as the carrying amount of the debt did not exceed the total future cash payments of $3.0 million specified by the new terms. Interest expense was computed using the interest method to apply a constant effective interest rate to the payable balance between the modification date of April 13, 1998, and the original maturity date of the payable in May 2000. The total future cash payments specified by the new terms of the convertible debentures of $3.0 million is less than the carrying amount of the liability to the debenture holders of $3,027,000, therefore, the carrying amount was reduced to an amount equal to the total future cash payments specified by the new terms and the Company recognized a gain on restructuring of payables equal to the amount of the reduction as of April 13, 1998. No interest expense was recognized on the payable for any period between the modification date of April 13, 1998 and the date the debentures were exchanged for preferred stock. Proceeds from the Company's private placement of New Securities in the amount of $3,850,000 were used to pay off the Company's revolving line of credit. Further, the Company's lender amended the existing loan agreement to provide more favorable terms which are consistent with management's financial and operating plans. These plans include the closure of certain unprofitable mall stores and opening of other store locations. As a result of the above, management believes that it has sufficient liquidity to execute its current plan. However, the Company's ability to fund its operations, open new stores and maintain compliance with its loan agreement is dependent on its ability to generate sufficient cash flow from operations and obtain additional financing as described in Note 3. Historically, the Company has incurred losses and may continue to incur losses in the near term. Depending on the success of its business strategy, the Company may continue to incur losses beyond such period. Losses could negatively affect working capital and the extension of credit by the Company's suppliers and impact the Company's operations. F-18 NOTE 13 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Changes in assets and liabilities which increased (decreased) cash are as follows: Year Ended Thirty-three ------------------------------- Weeks Ended Year Ended January 30, January 31, February 1, June 1, 1999 1998 1997 1996 ---------- ----------- ---------- -------- Accounts and other receivables ($ 180,000) $ 733,000 ($ 529,000) ($ 126,000) Merchandise inventories 805,000 1,062,000 (2,400,000) (122,000) Other current assets 319,000 217,000 (1,109,000) (95,000) Other noncurrent assets (48,000) (2,000) 113,000 142,000 Accounts payable and accrued expenses 1,040,000 (3,641,000) 1,975,000 1,030,000 Amounts due to ARC (71,000) Deferred income taxes 207,000 (928,000) Other liabilities (97,000) Deferred rent (176,000) 315,000 786,000 773,000 ---------- ----------- ---------- -------- $1,760,000 ($1,316,000) ($ 957,000) $506,000 ========== =========== ========== ========
Cash paid for income taxes was $3,000, $5,000 and $7,000 for Fiscal 1998, Fiscal 1997, and the Transition Period, respectively. Cash paid for interest was $483,000, $954,000, $193,000 and $73,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively. Non-cash investing activity consists of a $250,000 note received upon the sale of the phone center operations in the Transition Period. NOTE 14 - NEW ACCOUNTING PRONOUNCEMENTS: In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5 "Reporting on the Costs of Start-up Activities" (SOP 98-5), which requires that the costs of start-up activities and organization costs be expensed as incurred. The impact of the adoption of SOP 98-5 is not expected to be material to the Company's financial position or results of operations. Effective October 1, 1997 and as disclosed in Note 1, the Company began expensing all store pre-opening costs as incurred. F-19 NOTE 15 - COMPARABLE PRIOR PERIOD DATA (Unaudited): As described in Note 1, the Company changed its fiscal year end effective January 1, 1997, resulting in a thirty-three week transition period ending February 1, 1997. Comparable results of operations for the thirty-three weeks ended February 3, 1996 are as follows: Net sales: Catalog $ 16,573,000 Retail 9,894,000 Other revenues 749,000 ------------ 27,216,000 Costs of goods sold 13,864,000 Other expenses, net 14,632,000 ------------ Loss before income taxes (1,280,000) Income tax benefit 523,000 ------------ Net loss ($ 757,000) ============ Basic and diluted loss per share $ (0.24) ============ Weighted average number of common shares outstanding 3,151,267 ============ NOTE 16 - SEGMENT INFORMATION: In the Fiscal 1998 fourth quarter, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information". This statement supersedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the company's reportable segments. This statement requires disclosure of certain information by reportable segment, geographic area and major customer. The Company is a specialty merchant of infants' and children's products and operates only in one reportable segment for purposes of this disclosure. THE RIGHT START, INC. SCHEDULE II - VALUATION RESERVES Additional Balance at charged Balance at beginning to costs end Classification of period and expenses Deductions of period - -------------- --------- ------------ ---------- --------- Fiscal year ended January 30, 1999 Allowance for deferred tax asset $7,079,000 $649,000 $7,728,000 Inventory reserve 121,000 369,000 $422,000 68,000 Allowance for sales returns 69,000 69,000 ---------- ---------- -------- ---------- $7,269,000 $1,018,000 $422,000 $7,865,000 ========== ========== ======== ========== Fiscal year ended January 31, 1998 Allowance for deferred tax asset $3,280,000 $3,799,000 $7,079,000 Inventory reserve 81,000 425,000 $385,000 121,000 Allowance for sales returns 103,000 34,000 69,000 ---------- ---------- -------- ---------- $3,464,000 $4,224,000 $419,000 $7,269,000 ========== ========== ======== ========== Thirty-three weeks ended February 1, 1997 Allowance for deferred tax asset $940,000 $2,340,000 $3,280,000 Inventory reserve 86,000 267,000 $272,000 81,000 Allowance for sales returns 103,000 103,000 ---------- ---------- -------- ---------- $1,129,000 $2,607,000 $272,000 $3,464,000 ========== ========== ======== ========== Fiscal year ended June 1, 1996 Allowance for deferred tax asset $940,000 $940,000 Inventory reserve 490,000 $404,000 86,000 Allowance for sales returns $103,000 103,000 ---------- ---------- -------- ---------- $103,000 $1,430,000 $404,000 $1,129,000 ========== ========== ======== ==========
EX-23 2 CONSENT OF INDEPENDENT ACCOUNTANTS Consent of Independent Accountants We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-08157) and in the Registration Statements on Form S-8 (No. 333-21749 and No. 333-21747) of The Right Start, Inc. of our report dated March 6, 1998, except as to Note 11 which is as of April 13, 1998 appearing on page F-1 of this Form 10-K. /s/Price Waterhouse LLP Los Angeles, California April 29, 1998 EX-27 3 FDS --
5 1,000 12-MOS JAN-30-1999 FEB-01-1998 JAN-30-1999 626 0 585 0 5,797 8,300 12,366 4,482 17,671 6,572 0 1,789 6,663 22,337 3,571 17,671 36,611 36,611 18,576 38,990 3,850 0 640 (6,869) 22 (6,891) 0 1,211 0 (5,680) (1.13) (1.13)
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