-----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, MEU6HMceiuANI4AA1sh4KUpNuEZBhNu1vsOEDbf+EAmko96TkZcLlChkblW7RG/t 1tMw1jGvIMNMCwMKLf1gwA== 0000898430-98-003602.txt : 19981019 0000898430-98-003602.hdr.sgml : 19981019 ACCESSION NUMBER: 0000898430-98-003602 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980131 FILED AS OF DATE: 19981016 SROS: NASD 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/A SEC ACT: SEC FILE NUMBER: 000-19536 FILM NUMBER: 98726510 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/A 1 FORM 10-K/A - AMENDMENT #2 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A AMENDMENT NO. 2 (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 31, 1998 ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required) 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 Identification No.) incorporation or organization)
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 and 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/A or any amendment to this Form 10-K/A. [ ] As of April 15, 1998, approximately 3,134,963 shares of the Registrant's Common Stock held by non-affiliates were outstanding and the aggregate market value of such shares was approximately $6,662,000. As of April 15, 1998 there were outstanding 10,103,639 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 in October 1998 (the "Proxy Statement") are incorporated by reference into Part III hereof. The Company has amended this Form 10-K/A to reflect the following: Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, has been amended as follows: Fiscal 1997 Compared with Transition Period has been expanded in the areas of operating expenses, income taxes, and other non-recurring expenses; Transition Period Compared with Fiscal 1996 has been expanded in the areas of other non-recurring expenses; Fiscal 1996 Compared with Fiscal 1995 has been added; Liquidity and Capital Resources has been amended to add the proposed accounting for the Recapitalization transaction; Other Matters has been added to disclose the potential impact of Year 2000 issues and of a future accounting pronouncement. Item 8, Financial Statements and Supplementary Data, has been amended to add the fiscal year ended May 31, 1995 to the statement of operations, shareholders' equity and cash flows. The statement of operations for the fiscal year ended January 31, 1998, thirty-three weeks ended February 1, 1997 and fiscal year ended June 1, 1996 have been restated to reclassify other non- recurring expenses from non-operating to operating as disclosed in Note 16 to the Financial Statements. Additionally, the Notes to the Financial Statements have been amended to add certain additional disclosure. This Annual Report on Form 10-K/A 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, 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. ("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 40 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 Nursery, Baby's Health, Feeding, Travel, Developmental and Apparel. 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 merchant stores or sparsely-stocked, high-priced infant and children 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 2 that is generally less than 48 hours from receipt of catalog orders, and a 24 hour a day/365 day a year ordering capacity, The Right Start is able to differentiate itself from its competitors. RETAIL OPERATIONS - ----------------- At January 31, 1998, the Company had 43 stores in operation with 38 of these located in major regional malls throughout the United States. The remaining five stores are in Southern California: four in street locations and one in an outlet mall. 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 Company recently increased its offering to include an expanded selection of infant care products, apparel and developmental items. The number of stores open reflects the rapid growth that the Company experienced in 1996 and early 1997, wherein 24 mall stores were opened. After studying the results of both the mall and street locations, management 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 has adopted a store opening plan which calls for the opening of six or more 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 stores were identified for closure and the Company is in the process of closing those of the nine that have not already closed. 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 average annual income in excess of $60,000. ADVERTISING AND MARKETING - ------------------------- The Right Start positions its mall stores in premier locations of top malls in order to capitalize on the malls' ability to attract a high volume of customers. Accordingly, minimal promotional advertising is done for these stores. For street locations, additional marketing programs are done to establish an awareness of the stores in the local markets. These programs include direct mail pieces 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. 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 extensive 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 300 vendors. No single vendor represents more than 4% of overall sales. In total, the Company imports approximately 13% of the products offered and this source is expected to grow in the next year as the Company expands its private label and import programs. Imported items have 3 historically had higher gross profit margins and tend to provide more opportunities for the Company to offer a large selection of unique goods. RECENT DEVELOPMENTS - ------------------- 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 (the "New Notes"), together with detachable warrants to purchase an aggregate of 3,850,000 shares of common stock exercisable at $1.00 per share (the "New Warrants" and together with the New Notes, the "1998 New Securities"). The 1998 New Securities were sold for an aggregate purchase price of $3,850,000 and were purchased primarily by affiliates of the Company. In connection with the sale of the 1998 New Securities, the Company entered into an agreement with all of the holders of the Company's existing subordinated debt securities, representing an aggregate principal amount of $6,000,000. Pursuant to the agreement, each holder agreed to exchange all of its subordinated debt securities together with any warrants issued in connection therewith, for two series of preferred stock. Ten shares of preferred stock per series will be issued for each $1,000 principal amount of subordinated debt securities exchanged. The total number of shares to be issued are 30,000, 30,000 and 38,500 for Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, respectively. Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series A Preferred Stock which will have no fixed dividend rights, will not be convertible into common stock and will be 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 (the "Series A Preferred Stock"). Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series B convertible preferred stock which will have no fixed dividend rights and will be convertible into common stock at a price per share of $1.50 (the "Series B Preferred Stock"). Holders of the $3,850,000 principal amount of 1998 New Securities elected to receive Series C convertible preferred stock which will have no fixed dividend rights and will be convertible into common stock at a price per share of $1.00 (the "Series C Preferred Stock"). Pursuant to a letter agreement dated July 7, 1998, the Company has received consent from all but one of the parties that will hold the Series B Preferred Stock in order to eliminate the mandatory redemption feature of the Series B Preferred Stock upon a change of control of the Company. Additionally, pursuant to such letter agreement, the Company has received consent from all of the of the parties that will hold Series C Preferred Stock to remove the mandatory redemption feature of the Series C Preferred Stock upon the occurrence of a change of control of the Company. The issuance of the shares of preferred stock upon exchange of the subordinated debt securities is subject to approval of the Company's shareholders, which approval the Company expects to obtain at its annual meeting scheduled to be held in October 1998. EMPLOYEES - --------- As of April 26, 1998, the Company employed 321 employees, approximately 55 percent of whom were part-time. During the retail holiday season, additional temporary employees are hired. 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. 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-intense 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 4 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. TRADEMARKS - ---------- The Company has registered and continues to register, when deemed appropriate, certain U.S. trademarks and trade names, including "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 31, 1998, The Right Start operated 43 retail stores in 16 states. 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. The Right Start currently leases approximately 26,000 square feet of mixed use space in Westlake Village, California. The Company's corporate office and first retail store reside in this space. The building's lease agreement terminates in April 1998. The Company is moving its corporate office to another location in Westlake Village, California which it is leasing as a sub-tenant under an 18 month lease. The space being leased is approximately 13,000 square feet. 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 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 stock is held of record by approximately 126 registered shareholders as of April 15, 1998. 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.
Bid Price --------------------------------------- High Low ----------------- ---------------- 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 Transition Period - ----------------------------------
5
First Quarter 6.88 4.25 Second Quarter 5.63 4.56 Third Quarter (1) 6.38 5.00
(1) Covers the period from December 1, 1996 to February 1, 1997, the date to which the Company changed its fiscal year end. The Company has not paid dividends on its common stock and presently intends to continue this policy. 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. ITEM 6. SELECTED FINANCIAL DATA - (Dollars in thousands except share data) - ------- ------------------------------------------------------------------
Fiscal Year Transition Period Fiscal Year ------------ ------------------ ------------------------------------------ 1997 1996 1995 1994 EARNINGS DATA Revenues: Net Sales $ 38,521 $ 27,211 $ 40,368 $ 44,573 $ 49,204 Other revenues 877 1,168 1,311 ----------------------------------------------------------------------------- 38,521 27,211 41,245 45,741 50,515 Net income (loss) (9,241) (5,378) (3,899) (2,106) 176 Basic and diluted earnings (1.01) (0.67) (0.60) (0.33) 0.03 (loss) per share SHARE DATA Weighted average shares outstanding 9,188,172 8,006,190 6,536,813 6,300,000 6,637,142 BALANCE SHEET DATA Current assets $ 8,908 $ 11,704 $ 8,353 $ 9,660 $ 12,002 Total assets 18,462 22,982 17,475 14,632 18,221 Current liabilities 4,796 8,457 4,649 3,690 4,979 Long-term debt 8,734 5,643 Shareholders' equity 3,307 7,172 11,902 10,694 12,800
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------- ----------------------------------------------------------------------- OF OPERATION ------------ 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/A. Transition Period results 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 the comparable unaudited 52-week period of the prior year and between the Transition Period and the comparable period of Fiscal 1996. 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 6 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 some-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. 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). Included in operating expenses in Fiscal 1997 and the Transition Period are retail occupancy costs of $5.9 million or 15% of sales and $2.9 million or 11% of sales, respectively ($3.8 million or 9% of sales in the 52-week period ended February 1, 1997). The remaining $13.3 million or 35% of sales and $9.7 million or 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 ongoing efforts to reduce expenses. Pre-opening cost amortization was $.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. In the third quarter of Fiscal 1997, the Company changed its method of accounting for pre- opening costs and began expensing them in the first full month of the store's operations. Previously, the Company deferred pre-opening costs and amortized them over twelve months. 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 7 million of severance expense. 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 July 1998 and such closures generated positive cash flow 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. Interest expense, net 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. The Company has a deferred tax asset of $8.5 million, which is reserved by a valuation allowance of $7.1 million, for a net tax benefit 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 benefit of the Company's NOL carryforward if the Company's operating results alone are insufficient to realize such tax benefit, the Company could implement certain tax planning strategies including the sale of the Company's catalog operation, since such operations generally operate on a break-even 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 carryforward. 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 carryforward. 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 $528,000 in pre-opening cost amortization compared to $418,000 in Fiscal 1996 ($265,000 in the 33-week period ended February 3, 1996). The increase resulted from the retail expansion 8 over the last two years. The Company amortized its new store opening costs over the first twelve months of each store's operations. Depreciation and amortization was $833,000 during the Transition Period as compared to $938,000 in Fiscal 1996. ($581,000 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 expense of $851,000 incurred during the Transition Period were primarily attributed to the following: The Company's former President resigned in October 1996 resulting in a $280,000 severance charge; the Company prepaid its line of credit upon funding of its new credit facility resulting in $145,000 of prepayment charges; and the Company had taken action to close two unprofitable retail store locations, which has resulted in a write-off of $425,000 in non-recoverable assets. The Company recognized $207,000 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. FISCAL 1996 COMPARED WITH FISCAL 1995 - ------------------------------------- Revenues for fiscal 1996 were $41.2 million compared to $44.8 million in 1995. Catalog net sales declined $13.5 million or 37% reflecting the December 1994 sale of Children's Wear Digest (CWD) and reduced response rates and circulation on The Right Start Catalog. CWD was a wholly owned subsidiary of the Company selling children's apparel by catalog. Retail net sales increased over 100% from $7.8 million to $17.1 million. The increase resulted from an increase in store openings and an increase in same-store-sales for existing stores. Twenty-two stores were open at the end of fiscal 1996 as compared to eleven at the end of fiscal 1995. Eight stores were opened during fiscal 1995. Cost of goods sold decreased 8.7% or $2.0 million to $21.6 million in fiscal 1996. The decrease is primarily due to the decrease in net sales. Additionally, the Company's margins were negatively impacted in fiscal 1996 by inventory write-downs and shrinkage. Operating expense decreased $.6 million or 3% from $18.9 million in fiscal 1995 to $18.3 million in fiscal 1996. The decrease represents a $3.4 million decrease in catalog production costs offset by retail and other operating expense increases. The decrease in catalog production costs resulted from the decrease in The Right Start Catalog circulation. Retail operating expenses increased due to the additional payroll and occupancy costs associated with the new store openings. General and administrative expense increased to $4.3 million in fiscal 1996 from $3.0 million in fiscal 1995. This increase includes approximately $600,000 in one-time charges related to hiring and relocation expenses for new key management personnel and consulting fees related to the restructuring of the catalog operations. The remaining increase reflected the investment in the Company's infrastructure to position it to manage the accelerated store opening plans. Pre-opening cost amortization increased $304,000 in fiscal 1996 as compared to fiscal 1995. The fiscal 1996 increase reflected the impact of both fiscal 1995 and 1996 store openings. Depreciation and amortization increased $193,000 in fiscal 1996 as more assets were employed in the retail operations due to new store openings. Other non-recurring expense of $450,000 represents the severance charge associated with the resignation of the Company's former chief executive officer. 9 The Company recognized $927,000 of income tax benefit for the year ended June 1, 1996, net of a valuation allowance provided against the deferred tax asset in the fourth quarter of the fiscal year. 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 1997, the Company's primary sources of liquidity were from borrowings under its $13 million senior credit facility (the "Credit Facility") and proceeds from the sale of $3.0 million of subordinated debentures with warrants. These sources financed the Company's operations and capital expenditures. Capital expenditures of approximately $2.0 million were incurred in new store openings and refurbishing several of the Company's older stores. Cash used in funding operating capital (defined as the net change in assets and liabilities affecting operations) was $1.3 million. The primary use of funds was in the reduction of accounts payable and accrued expenses, offset by a decrease in inventory levels and accounts receivable. Decreased inventory purchases and the settlement of certain large accrued expenses resulted in the liability reduction and corresponding use of cash. The Credit Facility consists of a $10,000,000 revolving line of credit for working capital (the "Revolving Line") and a $3,000,000 capital expenditure facility (the "Capex Line"). Availability under the Revolving Line is subject to a defined borrowing base and was $3.1 million as of January 31, 1998. As of January 31, 1998, borrowings of $2,014,000 and $3,000,000 were outstanding under the Revolving Line and the Capex Line, respectively, and $1,081,000 was available under the Revolving Line. 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 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. The Credit Facility also limits the Company's earnings before interest, taxes, depreciation and amortization (EBITDA) to the following loss amounts: $1.2 million for the three months ended May 2, 1998 and the six months ended August 1, 1998, $900,000 for the nine months ended October 31, 1998 and the twelve months ended January 31, 1999 and $500,000 for the twelve months ended April 30, 1999. Minimum EBITDA of zero is required for the twelve months ended July 31, 1999 and $400,000 for the twelve months ended October 31, 1999. In addition, capital expenditures are limited to $1,750,000 in fiscal years 1998 and 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 obtain additional financing as described below. Historically, the Company has incurred losses and expects to 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. 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 (the "New Notes"), together with detachable warrants to purchase an aggregate of 3,850,000 shares of common stock exercisable at $1.00 per share (the "New Warrants" and together with the New Notes, the "1998 New Securities"). The 1998 New Securities were sold for an aggregate purchase price of $3,850,000 and were purchased primarily by affiliates of the Company. In connection with the sale of the 1998 New Securities, the Company entered into an agreement with all of the holders of the Company's existing subordinated debt securities, representing an aggregate principal amount of $6,000,000. Pursuant to the agreement, each holder agreed to exchange all of its subordinated debt securities together with any warrants issued in connection therewith, for two series of preferred stock. Ten shares of preferred stock per series will be issued for each $1,000 principal amount of subordinated debt securities exchanged. The total number of shares to be issued are 30,000, 30,000 and 38,500 for Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, respectively. Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series A Preferred Stock 10 which will have no fixed dividend rights, will not be convertible into common stock and will be 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 (the "Series A Preferred Stock"). Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series B convertible preferred stock which will have no fixed dividend rights and will be convertible into common stock at a price per share of $1.50 (the "Series B Preferred Stock"). Holders of the $3,850,000 principal amount of 1998 New Securities elected to receive Series C convertible preferred stock which will have no fixed dividend rights and will be convertible into common stock at a price per share of $1.00 (the "Series C Preferred Stock"). Pursuant to a letter agreement dated July 7, 1998, the Company has received consent from all but one of the parties that will hold Series B Preferred Stock to remove the mandatory redemption feature of the Series B Preferred Stock upon a change of control of the Company. Additionally, pursuant to such letter agreement, the Company has received consent from all of the parties that will hold Series C Preferred Stock to remove the mandatory redemption feature of the Series C Preferred Stock upon the occurrence of a change of control of the Company. The issuance of the shares of preferred stock upon exchange of the subordinated debt securities is subject to approval of the Company's shareholders, which approval the Company expects to obtain at its annual meeting scheduled to be held in October 1998. As the $3.85 million of 1998 New Securities were issued in contemplation of the exchange into convertible preferred stock, the accounting for the 1998 New Securities is analogous to convertible debt. The 1998 New Securities will be exchanged for Series C preferred stock which is convertible into common stock at a price per share of $1.00. As of the date of issue of the 1998 New Securities, the Company's common stock was trading at $2.00 per share. Since the conversion feature was the money at the date of issue, the debt the portion of the 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 is being amortized to interest expense in the historical accounts over the period from the April issuance date to the date the debt is first convertible. The date the debt is first convertible is the exchange date when the debt is exchanged for convertible preferred stock. Since the exchange transaction is subject to a proxy vote by the shareholders, the expected date of the shareholder vote, anticipated to be in October 1998, has been used to determine the amortization period of six and a half months. For the periods ended May 2, 1998 and August 1, 1998, the interest amortization is $0 and $4,000, which has been deemed immaterial. No value has been assigned to the warrants because of the requirement to exchange the warrants, together with the debt, for preferred stock that resulted in an assessment that the warrants have no independent value apart from the exchange transaction. The exchanges of the subordinated debt securities for the preferred stock will be recorded at the date of issuance of the preferred stock. The fair value of each preferred stock series will be determined as of the issuance date of the stock. The difference between the fair value of the preferred stock series granted and the carrying amount of the related subordinated debt security's balance, plus accrued interest exchanged, will be recognized as a gain or loss on the extinguishment of debt. If the convertible Series B Preferred Stock conversion feature is "in the money" at the date of issue of the preferred stock, a portion of the fair value of the preferred stock equal to the beneficial conversion feature will be allocated to additional paid in capital. The beneficial conversion feature amount allocated to paid in capital will be recognized as a return to the preferred shareholders immediately through a charge to accumulated deficit and a credit to preferred stock. The estimated gain or loss to be recorded on the total proposed recapitalization is not determinable at this time as the transactions will be measured and recorded at the date of issuance of the preferred stock. In connection with the above restructuring, 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 elimination of approximately $0.6 million in annual interest payments. In addition, the proceeds from the Company's private placement of $3,850,000 of the 1998 New Securities were used to pay off the Company's revolving line of credit. Further, the Company's lender amended the Company's existing loan agreement to provide more favorable terms which are consistent with management's financial and operational plans. These plans include the closure of certain unprofitable mall stores and opening of other store locations. 11 SEASONALITY - ----------- The Company's business is not as significantly impacted by seasonal fluctuations, as 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. IMPACT OF INFLATION - ------------------- The impact of inflation on results of operations has not been significant. OTHER MATTERS - ------------- The Company is currently working to resolve the potential impact of the year 2000 on the processing of date-sensitive information by the Company's computerized information systems. 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. Based on preliminary information, costs of addressing potential problems are not currently expected to have a material adverse impact on the Company's financial position, results of operations or cash flows in future periods. The Company plans to devote the necessary resources to resolve all significant year 2000 issues in a timely manner. FUTURE 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 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- ------------------------------------------- The financial statements and supplementary data of the Company are as set forth in the "INDEX TO FINANCIAL STATEMENTS" on the following page. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------- --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- Not applicable. 12 PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- -------------------------------------------------- DIRECTORS - --------- The directors of the Company are as follows: Name Age Director Since Business Experience ---- --- -------------- ------------------- Andrew Feshbach 37 1995 Mr. Feshbach is a Vice President of Fortune Financial, President of Big Dog Sportswear and an Executive Vice President of Fortune Fashions. Previously, Mr. Feshbach was a partner in Maiden Lane, a merchant bank, and a Vice President in the Mergers and Acquisitions Group of Bear Stearns. Robert R. Hollman 54 1995 Mr. Hollman has been President and Chief Executive Officer of Topa Management Company since 1971 and President and Chief Executive Officer of Topa Savings Bank since 1989. He has also been a Director and Officer of Topa Equities, Ltd., the parent company of Topa Savings Bank, since 1969. Fred Kayne 60 1995 Mr. Kayne is President and Chairman of Fortune Financial, where he is responsible for directing all of its investment activities. Mr. Kayne is also President of Fortune Fashions and Chairman of Big Dog Sportswear. Mr. Kayne was a partner of Bear, Stearns & Co. Inc. until its initial public offering in 1985 after which he was a Managing Director and a member of the Board of Directors until he resigned in 1986. Fred Kayne and Richard A. Kayne are brothers. Richard A. Kayne 53 1995 Mr. Kayne currently serves as President and Chief Executive Officer of Kayne Anderson Investment Management, Inc., and its broker dealer affiliate, K.A. Associates, Inc. Mr. Kayne has been with Kayne Anderson Investment Management, Inc. since 1985 when it was founded by Mr. Kayne and John E. Anderson. He is also a Director of Foremost Corporation of America and Glacier Water Services, Inc. Richard A. Kayne and Fred Kayne are brothers. Jerry R. Welch 47 1995 See "Business Experience of Executive Officers" below. Howard M. Zelikow 64 1995 Mr. Zelikow has been a management and financial consultant doing business at ZKA Associates since 1987 and has been a Managing Director of Kayne Anderson Investment Management, Inc. since 1988. Mr. Zelikow has been a director of Financial Security Assurance Holdings Ltd. since 1996 and has served as a director of Queensway Financial Holdings Limited since 1993. Mr. Zelikow was Executive Vice President and Chief Financial Officer of The Progressive Corporation from 1976 through 1987. Mr. Zelikow was a director of Victoria Financial Corporation from 1991 to 1995, a director of Capital Guaranty Corporation from 1994 to 1995, and a director of Nobel Insurance Limited from 1989 to 1993.
13 The Directors of the Company serve until their successors are elected and duly qualified at next year's Annual Meeting of Shareholders, which is to be held on or about June 28, 1999. During the fiscal year ended January 31, 1998, the Company's Audit Committee consisted of Messrs. Feshbach, Hollman and Zelikow and the Company's Compensation Committee consisted of Messrs. Richard Kayne and Fred Kayne. The Board of Directors does not have a standing Nominating Committee. The Audit Committee reviews and reports to the Board of Directors with respect to various auditing and accounting matters, including the selection of the Company's independent accountants. The Compensation Committee reviews the Company's general compensation strategy and reviews and reports to the Board of Directors with respect to compensation of officers and employee benefit programs. EXECUTIVE OFFICERS - ------------------ The executive officers of the Company (the "Named Executive Officers") are as follows:
Name Age Position Officer Since ---- --- -------- ------------- Jerry R. Welch 47 Chairman of the Board, President and Chief Executive Officer 1996 Gina M. Shauer 35 Chief Financial Officer and Secretary 1994 Ronald J. Blumenthal 52 Senior Vice President 1994 Michele Iglesias 31 Vice President-Human Resources 1996 Gerald E. Mitchell 43 Vice President-Merchandising 1996 Marilyn Platfoot 44 Vice President-Retail Operations 1996 Richard Pollock 46 Vice President-Logistics 1996
All officers serve at the discretion of the Board of Directors. BUSINESS EXPERIENCE OF EXECUTIVE OFFICERS - ----------------------------------------- JERRY R. WELCH became Chief Executive Officer of the Company in March 1996, assumed the position of President in September 1996 and has served as Chairman of the Board since August 1995. Mr. Welch also serves as a Managing Director of Kayne Anderson Investment Management, Inc. and has served in such capacity since January 1993. Mr. Welch is also the Chairman of the Board and Chief Executive Officer of Glacier Water Services, Inc. and has served in such capacities since April 1993 and September 1994, respectively. GINA M. SHAUER became Chief Financial Officer of the Company in May 1994 and Secretary in August 1995. Ms Shauer served as a Senior Manager with Price Waterhouse in Woodland Hills, California from January 1986 until April 1994. RONALD J. BLUMENTHAL became Senior Vice President of the Company in September 1996 and served as Vice President-Retail Operations from December 1993 to September 1996. Prior to joining the Company, Mr. Blumenthal served as Vice President of Store Operations for Cost Plus Imports, from 1990 until 1993, and for Jos. A. Bank Clothiers from 1985 until 1990, where he also served as Vice President, Real Estate. MICHELE IGLESIAS became Vice President - Human Resources of the Company in December 1996 and served as Director of Human Resources from February 1994 to December 1996. Ms. Iglesias' previous experience includes other human resources management positions. 14 GERALD E. MITCHELL became Vice President-Merchandising of the Company in July 1996. Mr. Mitchell previously served as Vice President-Merchandising for Discovery Channel Stores in Dallas, Texas. MARILYN PLATFOOT became Vice President-Retail Operations of the Company in April 1996. Ms. Platfoot previously served as Western Regional Manager for Brookstone Stores from 1992 to 1996. Prior to that, Ms. Platfoot spent 13 years with the Foxmoor Casual chain, ultimately serving as West Coast Regional Manager. RICHARD POLLOCK became Vice President-Logistics of the Company in September 1996 and served as Director of Logistics from June to September 1996. Prior to joining the Company, Mr. Pollock served as Regional Operations Manager with USCO Distribution Services and has held several senior level distribution positions. COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934 - -------------------------------------------------------------------- Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") requires the Company's executive officers, directors and persons who own more than 10% of the Company's common stock to file reports of ownership on Forms 3, 4 and 5 with the Commission. Executive officers, directors and 10% stockholders are required by the Commission to furnish the Company with copies of all Forms 3, 4 and 5 as filed. Based solely on the Company's review of the copies of such forms it has received, the Company believes that all of its executive officers, directors and greater than 10% beneficial owners complied with all the filing requirements applicable to them with respect to transactions during the fiscal year ended January 31, 1998, except for the following: Fred Kayne did not timely file one report covering a transaction in which he purchased 224,000 shares of the Company's common stock. Mr. Ronald J. Blumenthal, Ms. Michele Iglesias, Mr. Gerald E. Mitchell, Ms. Marilyn Platfoot, Mr. Richard Pollock, Ms. Gina M. Shauer and Mr. Jerry R. Welch each did not timely file one report with respect to each of their annual stock option grants. ITEM 11. EXECUTIVE COMPENSATION - -------- ---------------------- EXECUTIVE COMPENSATION - ---------------------- The following table sets forth summary information concerning compensation paid or accrued by the Company for services rendered during the fiscal year ended January 31, 1998, the transition period from June 2, 1996 to February 1, 1997 and the fiscal year ended June 1, 1996 to the Company's Chief Executive Officer and the other executive officers who received compensation (on an annualized basis) of at least $100,000 during the periods. 15 SUMMARY COMPENSATION TABLE - --------------------------
Long Term Compensation Annual Compensation ----------------------- Fiscal ------------------- Other Annual Securities Underlying Name and Principal Position Year-End Salary Bonuses Compensation (1) Options (#) - ---------------------------------------- -------- --------- ------- ---------------- ----------------------- Jerry R. Welch (2) 1998 $ -0- $ -0- $ -0- 14,765 Chairman of the Board, President 1997 $ -0- $ -0- $ -0- 9,217 and Chief Executive Officer 1996 $ -0- $ -0- $ -0- 10,317 (3) Ronald J. Blumenthal 1998 $135,000 -0- -0- 15,000 Senior Vice President - Marketing 1997 $ 90,965 -0- -0- -0- 1996 $110,161 29,000 4,058 50,000 Gerald E. Mitchell 1998 155,000 -0- 8,048 15,000 Vice President - Merchandising 1997 80,481 -0- 3,875 75,000 Marilyn Platfoot 1998 115,000 -0- -0- 15,000 Vice President Retail Operations 1997 72,981 -0- -0- -0- 1996 6,365 -0- -0- 25,000 Gina M. Shauer 1998 105,000 -0- -0- 10,000 Chief Financial Officer and Secretary 1997 66,635 -0- 750 -0- 1996 94,138 -0- 1,300 20,000
(1) Amounts shown include Company contributions under the Company's Employee Stock Ownership Plan and the Company's Employee Stock Purchase Plan, as applicable for the listed executives. (2) Mr. Welch receives no compensation for serving as Chief Executive Officer or President. (3) Granted under the 1995 Non-Employee Director Plan prior to Mr. Welch becoming President and Chief Executive Officer. DIRECTORS' FEES - --------------- All of the Company's non-employee directors receive directors' fees of $3,000 per quarter. All of the members of the Board of Directors have elected, in lieu of such compensation, to receive options to purchase common stock of the Company at the fair market value on the date the options are granted. 16 OPTION GRANTS IN THE FISCAL YEAR ENDED JANUARY 31, 1998 - ------------------------------------------------------- The following table provides certain information regarding stock options granted to the Named Executive Officers during the fiscal year ended January 31, 1998.
NAME INDIVIDUAL GRANTS % OF TOTAL EXERCISE OR EXPIRATION POTENTIAL REALIZABLE VALUE AT - --------------- ------------------- OPTIONS BASE PRICE DATE ASSUMED ANNUAL RATES OF STOCK GRANTED TO ($/SHARE) ---------- PRICE APPRECIATION FOR EMPLOYEES IN ------------ OPTION TERM FISCAL YEAR ------------------------------- ------------- NUMBER OF 5% ($) 10% ($) SECURITIES ------- -------- UNDERLYING OPTIONS GRANTED (#) (1) ------ Jerry Welch 3,000 2.4% 2.50 7/22/07 $12,353 $ 20,303 Jerry Welch 11,765 9.6% 2.50 7/22/02 37,747 48,393 Gerald Mitchell 15,000 12.2% 2.50 7/22/07 61,763 101,514 Ron Blumenthal 15,000 12.2% 2.50 7/22/07 61,763 101,514 Marilyn Platfoot 15,000 12.2% 2.50 7/22/07 61,763 101,514 Gina Shauer 10,000 8.1% 2.50 7/22/07 41,175 67,676 Richard Pollock 10,000 8.1% 2.50 7/22/07 41,175 67,676 Michele Iglesias 10,000 8.1% 2.50 7/22/07 41,175 67,676
___________________ (1) Named Executive Officers receive options pursuant to the Company's stock compensation plans described elsewhere herein. The material terms of that program related to recipients, grant timing, number of options, option price and duration are determined by the Board of Directors, subject to certain limitations. 17 The following table provides certain information regarding the exercise of stock options held by the Named Executive Officers during the fiscal year ended January 31, 1998 and the number and value of options held as of the end of such fiscal year.
NAME VALUE NUMBER OF SECURITIES VALUE OF UNEXERCISED - ------------ REALIZED ($) (1) UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS OPTIONS AT FISCAL YEAR END (#) AT FISCAL YEAR END ($) (1) SHARES ACQUIRED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ON EXERCISE (#) ------------ ------------- ---------------- Jerry Welch -0- -0- 19,534 14,765 -0- -0- Ron -0- -0- 33,334 56,666 -0- -0- Blumenthal Gerald -0- -0- 37,500 52,500 -0- -0- Mitchell Marilyn -0- -0- 8,333 31,667 -0- -0- Platfoot Gina Shauer -0- -0- 23,334 31,666 -0- -0-
_________________________ (1) On January 29, 1998 (the last day the Company's common stock was traded in the fiscal year ended January 31, 1998), the closing sale price of the Company's common stock on the Nasdaq National Market System was $1.75 per share. STOCK COMPENSATION PROGRAMS - --------------------------- 1991 Employee Stock Option Plan In October 1991, the Company adopted the 1991 Employee Stock Option Plan (the "1991 Plan"), as amended to cover an aggregate of 575,000 shares of the Company's common stock, in order to provide a means of encouraging certain officers and employees of the Company to obtain a proprietary interest in the enterprise and thereby create an additional incentive for such persons to further the Company's growth and development. The information regarding the 1991 Plan provided herein is qualified in its entirety by the full text of such plan, copies of which have been filed with the Securities and Exchange Commission. Options granted vest over periods of up to five years (depending on the terms of the individual grant) commencing on the grant date and expire 10 years thereafter. Options for 389,982 shares were outstanding as of January 31, 1998, 125,717 of which were exercisable. On May 5, 1998, the Compensation Committee granted options to purchase an aggregate of 880,000 shares of the Company's common stock (the "New Option Shares") to certain executive officers and employees of the Company (each a "grantee") at an exercise price of $1.75 per share, the closing sale price per share of the Company's common stock on the date of grant. Grant of the New Option Shares is subject to shareholder approval to increase the number of shares of the Company's common stock that may be issued under the 1991 Plan. The Compensation Committee has also determined that grant of the New Option Shares to a grantee is conditioned upon such grantee's canceling all of his or her existing outstanding options to purchase the Company's common stock. The Compensation Committee may from time to time modify or amend the 1991 Plan as it deems necessary or desirable, but generally may not change an option already granted thereunder without the written consent of the holder of such option (or stock issued on exercise thereof). Of the 880,000 New Option Shares granted, 600,000 option shares were granted to executive officers of the Company in the following amounts: Gerald Mitchell (125,000 option shares), Ron Blumenthal (75,000 option shares), Marilyn Platfoot (125,000 option shares), Gina Shauer (100,000 option shares), Richard Pollock (100,000 option shares), and Michele Iglesias (75,000 option shares). The remaining 280,000 New Option Shares were granted to non-executive employees of the Company. 18 The Board of Directors of the Company has proposed an amendment to the 1991 Plan to increase the maximum number of shares of common stock issuable under such plan from 575,000 to 1,150,000 shares, subject to the approval of the shareholders of the Company as provided in the Company's 1998 annual proxy statement. 1995 Non-Employee Directors Plan In October 1995, the Company adopted the 1995 Non-Employee Director Plan (the "1995 Plan"), as amended to cover an aggregate of 250,000 shares of common stock. The information regarding the 1995 Plan provided herein is qualified in its entirety by the full text of such plan, copies of which have been filed with the Securities and Exchange Commission. The 1995 Plan provides for the annual issuance, to each non-employee director, of options to purchase 3,000 shares of common stock. In addition, each director is entitled to make an election to receive, in lieu of directors' fees, additional options to purchase common stock. The amount of additional options is determined based on an independent valuation such that the value of the options issued is equivalent to the fees that the director would be otherwise entitled to receive. Options issued under this plan vest on the anniversary date of their grant and upon termination of Board membership. 191,029 options were issued under the plan, 117,204 of which were exercisable as of January 31, 1998. The Board of Directors of the Company has proposed an amendment to the 1995 Plan to increase the maximum number of shares of common stock issuable under such plan from 250,000 to 350,000 shares, subject to the approval of the shareholders of the Company as provided in the Company's 1998 annual proxy statement. Company Employee Stock Purchase Plan The Company matches employees' contributions to the Company Employee Stock Purchase Plan at a rate of 50%. The Company's contributions amounted to $24,000, $21,000 and $28,000 in fiscal 1998, the transition period ended February 1, 1997 and fiscal 1996, respectively. Company Employee Stock Ownership Plan The Company Employee Stock Ownership Plan is funded exclusively by discretionary contributions determined by the Board of Directors. No contributions were authorized for fiscal 1998 or the transition period ended February 1, 1997. The Board of Directors authorized contributions of $70,000 in fiscal 1996. COMPENSATION COMMITTEES INTERLOCKS AND INSIDER PARTICIPATION Richard Kayne and Fred Kayne are each members of the Company's Compensation Committee and have participated in transactions requiring disclosure under the Item 13: Certain Relationships and Related Transactions. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- -------------------------------------------------------------- The following table sets forth certain information, as of May 4, 1998, with respect to all those known by the Company to be the beneficial owners of more than 5% of its outstanding common stock, each director who owns shares of common stock, each Named Executive Officer, and all directors and executive officers of the Company as a group. The following table also sets forth certain information on a pro forma basis which information gives effect to the Recapitalization (as defined in Item 13 below), as if the Recapitalization had been approved by the Company's shareholders and fully consummated on May 4, 1998. 19
Pro forma for Recapitalization -------------------------------- Name and Address of Beneficial Owner Amount and Percent of Amount and Percent of - --------------------------------------------------- Nature of Class Nature of Class Beneficial ----------- Beneficial ------------- Ownership (1) Ownership (1) -------------- ---------------- Richard A. Kayne (2) 4,365,958 42.4% 8,533,854 59.7% KAIM Non-Traditional, L.P. 1800 Avenue of the Stars Second Floor Los Angeles, CA 90067 Cahill, Warnock Strategic Partners Fund, L.P. (3) 988,333 8.9% 746,667 6.9% One South Street, Suite 2150 Baltimore, MD 21202 Travelers Group Inc. (4) 783,043 7.7% 771,376 7.6% 388 Greenwich Street New York, NY 10013 Fred Kayne (5) 914,493 9.0% 1,391,577 13.0% Fortune Fashions 6501 Flotilla Street Commerce, CA 90040 Albert O. Nicholas 625,000 6.2% 625,000 6.2% Nicholas Co., Inc. 700 North Water Street Milwaukee, WI 53202 Howard Kaplan 610,000 6.0% 610,000 6.0% 99 Chauncy Street Boston, MA 02111 Gerald E. Mitchell (6) 66,750 * 66,750 * 5388 Sterling Center Drive, Unit C Westlake Village, CA 91361 Gina M. Shauer (7) 27,392 * 27,392 * 5388 Sterling Center Drive, Unit C Westlake Village, CA 91361 Andrew Feshbach (8) 19,534 * 19,534 * Big Dog Sportswear 121 Gray Avenue, Suite 300 Santa Barbara, CA 93101 Robert R. Hollman (8) 19,534 * 19,534 * Topa Management 1800 Avenue of the Stars Suite 1400 Los Angeles, CA 90067
20
Pro forma for Recapitalization -------------------------------- Name and Address of Beneficial Owner Amount and Percent of Amount and Percent of - --------------------------------------------------- Nature of Class Nature of Class Beneficial ----------- Beneficial ------------- Ownership (1) Ownership (1) -------------- ---------------- Jerry R. Welch (8)(9) 19,534 * 19,534 * Kayne Anderson Investment Management, Inc. 1800 Avenue of the Stars Second Floor Los Angeles, CA 90067 Howard M. Zelikow (8)(9) 19,534 * 19,534 * Kayne Anderson Investment Management, Inc. 1800 Avenue of the Stars Second Floor Los Angeles, CA 90067 Ronald J. Blumenthal (10) 55,608 * 55,608 * 5388 Sterling Center Drive, Unit C Westlake Village, CA 91361 All executive officers and directors 5,532,260 52.1% 10,196,774 67.6% as a group (twelve persons) (11)
_________________________ * Less than one percent. (1) Except as otherwise noted below, the persons named in the table have sole voting power and investment power with respect to all shares of common stock shown as beneficially owned by them, subject to community property laws where applicable. (2) The 4,365,958 shares include (i) 199,034 shares held directly by Mr. Kayne (including 19,534 shares which may be acquired within 60 days upon exercise of options) and (ii) 4,166,924 shares held by managed accounts of KAIM Non- Traditional, L.P. ("KAIM, LP"), a registered investment adviser (including 190,000 shares which may be acquired within 60 days upon exercise of 1997 Warrants). Mr. Kayne has sole voting and dispositive power over the shares he holds directly. He has shared voting and dispositive power along with Kayne Anderson Investment Management, Inc. ("KAIM, Inc."), the general partner of KAIM, LP, over the remaining shares. (Mr. Kayne is the President, Chief Executive Officer and a Director of KAIM, Inc., and the principal shareholder of its parent company.) The shares held by managed accounts of KAIM, LP include the following shares held by investment funds for which KAIM, LP serves as general partner or manager: 1,481,703 shares held by Kayne Anderson Non- Traditional Investments, L.P.; 1,081,651 shares held by ARBCO Associates, L.P.; 1,023,158 shares held of Offense Group Associates, L.P.; 315,412 shares held by Opportunity Associates, L.P.; and 75,000 shares held by Kayne Anderson Offshore Limited. KAIM disclaims beneficial ownership of the shares reported, except those shares attributable to it by virtue of its general partner interests in the limited partnerships holding such shares. Mr. Kayne disclaims beneficial ownership of the shares reported, except those shares held by him directly or attributable to him by virtue of his limited and general partner interests in such limited partnerships and by virtue of his indirect interest in the interest of KAIM in such limited partnerships. The foregoing is based on information provided by Mr. Kayne and KAIM, L.P. to the Company as of May 4, 1998. 21 (3) David L. Warnock and Edward L. Cahill are each managing members of Cahill, Warnock & Company, LLC ("CW") and general partners of Cahill, Warnock Strategic Partners, L.P. ("CWSP"). CWSP and CW are the general partners, respectively, of Cahill, Warnock Strategic Partners Fund, L.P. ("SPF") and Strategic Associates, L.P. ("SA"). SPF owns 1996 Debentures currently convertible into 710,500 shares of common stock and 150,100 currently exercisable 1997 Warrants to purchase common stock. SA owns 1996 Debentures currently convertible into 39,500 shares of common stock and 8,233 currently exercisable 1997 Warrants to purchase common stock. Each of Messrs. Warnock and Cahill, CW, CWSP, SPF and SA may be deemed to beneficially own 988,333 shares of common stock. Messrs. Warnock and Cahill, CW and CWSP disclaim beneficial ownership with respect to the shares held by SPF and SA. SPF disclaims beneficial ownership with respect to the shares underlying the 1996 Debentures and the 1997 Warrants held by SA. SA disclaims beneficial ownership with respect to the shares underlying the 1996 Debentures and the 1997 Warrants held by SPF. The shares reported above and in the table exclude 9,217 currently exercisable options to purchase common stock held by Mr. Warnock. (4) The amount and nature of beneficial ownership of 783,043 shares has been taken from an Amendment No. 2 to Schedule 13G filed on January 23, 1998, which states that (i) Primerica Life Insurance Company, Travelers Insurance Holdings Inc. and The Travelers Insurance Company each report beneficial ownership of 631,376 shares and (ii) The Travelers Insurance Group Inc., PFS Services, Inc., Associated Madison Companies, Inc. and Travelers Group Inc. each report beneficial ownership of 783,043 shares. The amount reported in the table and in clause (ii) above includes currently exercisable 1997 Warrants to purchase 31,667 shares of common stock. (5) Includes 855,376 shares, 39,583 shares underlying the 1997 Warrants and 19,534 currently exercisable options to purchase common stock. (6) Includes 9,000 shares, currently exercisable options to purchase 48,750 shares of common stock and 9,000 shares held by the Company's Employee Stock Purchase Plan for the benefit of Mr. Mitchell. (7) Includes 291 shares, currently exercisable options to purchase 26,667 shares of common stock and 434 shares held by the Company's Employee Stock Ownership Plan for the benefit of Ms. Shauer. (8) All shares consist of currently exercisable options to purchase common stock. (9) Messrs. Welch and Zelikow are Managing Directors of Kayne Anderson Investment Management, Inc.; however, they disclaim beneficial ownership with respect to shares held by KAIM or any of its affiliates. (10) Includes currently exercisable stock options to purchase 55,000 shares of common stock and 608 shares held by the Company's Employee Stock Ownership Plan for the benefit of Mr. Blumenthal. (11) Includes common stock and options beneficially owned by executive officers and directors, including 21,667 with respect to Ms. Platfoot, 9,312 with respect to Ms. Iglesias and 12,478 with respect to Mr. Pollock. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ---------------------------------------------- In May 1997, certain investors, including Cahill Warnock Strategic Partners Fund, L.P. ("SPF") ($948,000), Strategic Associates, L.P. ("SA") ($52,000), Fred Kayne ($250,000) and KAIM Non-Traditional, L.P. ("KAIM") ($1,200,000) purchased an aggregate principal amount of $3,000,000 of the Company's 11.5% Senior Subordinated Notes due 2000 and warrants to purchase an aggregate of 475,000 shares of the Company's common stock at an exercise price of $3.00 per share, subject to adjustment under certain circumstances. In September 1997, certain investors, including SPF (75,800 shares), SA (4,200 shares), Fred Kayne (224,000 shares) and affiliates of KAIM (800,000 shares), purchased an aggregate of 1,510,000 shares of the Company's common stock at a price of $2.50 per share. 22 During the fiscal year ended January 31, 1998, Kayne Anderson Investment Management, Inc. provided management, consulting and advisory services to the Company for which it received a fee of $100,000. In April 1998, each of the holders, including SPF ($3,749,000), SA ($210,000), Fred Kayne ($250,000) and KAIM ($1,200,000), of (a) the Company's Convertible Debentures dated October 11, 1996, as amended on May 30, 1997, in the aggregate principal amount of $3,000,000 (the "1996 Debentures") and (b) the Company's 11.5% Senior Subordinated Notes due May 6, 2000 in the aggregate principal amount of $3,000,000 (the "'1997 Notes") and warrants to purchase 475,000 shares of the Company's common stock issued in connection with the 1997 Notes (the "1997 Warrants" and together with the 1997 Notes, the "1997 Securities") entered into a Letter Agreement dated April 6, 1998 and an Amendment to Letter Agreement dated April 13, 1998, and substantially all such holders have entered into a Letter Agreement dated July 7, 1998 (collectively, the "Amended Letter Agreement") setting forth a plan of recapitalization (the "Recapitalization"). The Recapitalization consists of the following: (a) the issuance of $3,850,000 aggregate principal amount of the Company's non-interest bearing Senior Subordinated Notes due May 6, 2000 (the "New Notes") and detachable warrants to purchase 3,850,000 shares of the Company's common stock (the "New Warrants," and together with the New Notes, the "1998 New Securities") to, among others, Fred Kayne ($350,000) and affiliates of KAIM ($3,383,333), (b) a waiver by the holders of all of their rights to interest payments accrued and owing on the 1996 Debentures and the 1997 Notes on or after February 28, 1998, (c) an agreement by the holders to exchange the 1996 Debentures and the 1997 Securities for either Series A or Series B Preferred Stock within two-hundred forty days after the issuance of the 1998 New Securities and (d) an agreement by the holders to exchange the 1998 New Securities for Series C Preferred Stock simultaneous with the exchange of the 1996 Debentures and the 1997 Securities for Series A and/or B Preferred Stock. 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. Page ---- (1) Financial Statements: Report of Independent Accountants................................................................ F-1 Consolidated Balance Sheet -- January 31, 1998 and February 1, 1997.............................. F-2 Consolidated Statement of Operations - Periods Ended January 31, 1998, February 1, 1997, June 1, 1996 and May 31, 1995................................ F-3 Consolidated Statement of Changes in Shareholders' Equity -- Periods Ended January 31, 1998, February 1, 1997, June 1, 1996 and May 31, 1995................................ F-4 Consolidated Statement of Cash Flows -- Periods Ended January 31, 1998, February 1, 1997, June 1, 1996 and May 31, 1995.................................................. F-5 Notes to Consolidated Financial Statements....................................................... F-6 (2) FINANCIAL STATEMENT SCHEDULES: Valuation Reserves............................................................................... F-18
23 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:
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 The Right Start, Inc. 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)/ 24
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)/ 10.15 Fourth Amendment to Loan and Security Agreement and Limited Waiver and Consent 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/(12)/ 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 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 dated May 26, 1993. 25 (5) Previously filed as an Exhibit to the Company's 10-K dated 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 dated January 31, 1998. (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. (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. * Previously filed as an Exhibit to this Form 10-K. (b) REPORTS ON FORM 8-K There were no Reports on Form 8-K filed during the last quarter of Fiscal 1997. (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 26 SIGNATURES Pursuant to the requirement of Sections 13 and 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. Dated: October 15, 1998 /s/ Gina M. Shauer ---------------------------------- Gina M. Shauer Chief Financial Officer (Principal Financial and Accounting Officer) 27 THE RIGHT START, INC. REPORT AND CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 1998 AND FEBRUARY 1, 1997 REPORT OF INDEPENDENT ACCOUNTANTS --------------------------------- To the Board of Directors and Shareholders of The Right Start, Inc. In our opinion, the consolidated 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 31, 1998 and February 1, 1997, and the results of its operations and its cash flows for the fiscal year ended January 31, 1998, the thirty-three weeks ended February 1, 1997 and the fiscal years ended June 1, 1996 and May 1, 1995, 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. As discussed in Note 16, the consolidated financial statements have been restated to move other expenses to a component of loss from operations. PricewaterhouseCoopers LLP Los Angeles, California March 6, 1998, except as to Notes 10 and 14 which are as of September 1, 1998 and Note 16 which is as of October 13, 1998 F-1 THE RIGHT START, INC. CONSOLIDATED BALANCE SHEET --------------------------
January 31, February 1, 1998 1997 ----------- ----------- ASSETS - ------ Current assets: Cash $ 240,000 $ 313,000 Accounts receivable 328,000 938,000 Note receivable 77,000 200,000 Merchandise inventories 6,602,000 7,664,000 Prepaid catalog expenses 297,000 782,000 Deferred pre-opening costs, net 50,000 543,000 Other current assets 1,314,000 1,264,000 ----------- ----------- 8,908,000 11,704,000 ----------- ----------- Property, plant and equipment, net 8,115,000 9,841,000 Other assets 39,000 37,000 Deferred income tax benefit 1,400,000 1,400,000 ----------- ----------- 9,554,000 11,278,000 ----------- ----------- $18,462,000 $22,982,000 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ Current liabilities: Accounts payable and accrued expenses $ 2,372,000 $ 6,076,000 Accrued salaries and bonuses 380,000 517,000 Advance payments on orders 30,000 31,000 Revolving line of credit 2,014,000 1,833,000 ----------- ----------- 4,796,000 8,457,000 ----------- ----------- Note payable 3,000,000 2,643,000 Senior subordinated notes, net of unamortized discount of $266,000 2,734,000 Subordinated convertible debentures 3,000,000 3,000,000 Deferred rent 1,625,000 1,710,000 Commitments and contingencies Shareholders' equity: Common stock (25,000,000 shares authorized, no par value; 10,103,639 and 8,153,639 shares issued and outstanding, respectively) 22,337,000 16,961,000 Accumulated deficit (19,030,000) (9,789,000) ----------- ----------- 3,307,000 7,172,000 ----------- ----------- $18,462,000 $22,982,000 =========== ===========
See accompanying notes to consolidated financial statements. F-2 THE RIGHT START, INC. CONSOLIDATED STATEMENT OF OPERATIONS ------------------------------------
Fiscal Year Thirty-three Fiscal Year Ended Ended Weeks Ended -------------------------- January 31, February 1, June 1, May 31, 1998 1997 1996 1995 ----------- ----------- ----------- ----------- (Restated- (Restated- (Restated- Note 16) Note 16) Note 16) Net Sales: Retail $31,107,000 $19,576,000 $17,075,000 $ 7,783,000 Catalog 7,414,000 7,635,000 23,293,000 36,790,000 Other revenues 877,000 214,000 ----------- ----------- ----------- ----------- 38,521,000 27,211,000 41,245,000 44,787,000 ----------- ----------- ----------- ----------- Costs and expenses: Cost of goods sold 19,244,000 14,417,000 21,605,000 23,654,000 Operating expense 19,212,000 12,608,000 18,282,000 18,925,000 General and administrative expense 3,912,000 2,941,000 4,341,000 3,008,000 Pre-opening cost amortization 711,000 528,000 418,000 114,000 Depreciation and amortization 1,608,000 833,000 938,000 745,000 Other expenses 1,905,000 851,000 450,000 ----------- ----------- ----------- ----------- 46,592,000 32,178,000 46,034,000 46,446,000 ----------- ----------- ----------- ----------- Operating loss (8,071,000) (4,967,000) (4,789,000) (1,659,000) Interest expense (income), net 1,143,000 204,000 37,000 (43,000) Loss on sale of Children's Wear Digest 1,744,000 ----------- ----------- ----------- ----------- Loss before income taxes (9,214,000) (5,171,000) (4,826,000) (3,360,000) Income tax provision (benefit) 27,000 207,000 (927,000) (1,254,000) ----------- ----------- ----------- ----------- Net loss $(9,241,000) $(5,378,000) $(3,899,000) $(2,106,000) =========== =========== =========== =========== Basic and diluted loss per share $ (1.01) $ (0.67) $ (0.60) $ (0.33) =========== =========== =========== =========== Weighted average number of shares outstanding 9,188,172 8,006,190 6,536,813 6,300,000
See accompanying notes to consolidated financial statements. F-3 THE RIGHT START, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY --------------------
Common Stock ------------------------- Retained Earnings Shares Amount (Accumulated Deficit) ---------- ----------- --------------------- Balance May 25, 1994 6,300,000 $11,206,000 $1,594,000 Net loss (2,106,000) ---------- ----------- ------------ Balance at May 31, 1995 6,300,000 11,206,000 (512,000) Issuance of shares pursuant to a rights offering 1,578,806 4,906,000 Issuance of shares pursuant to the exercise of stock options 60,500 201,000 Net loss (3,899,000) ---------- ----------- ------------ Balance at June 1, 1996 7,939,306 16,313,000 (4,411,000) Issuance of shares pursuant to the exercise of stock options 214,333 648,000 ---------- ----------- ------------ Net loss (5,378,000) ---------- ----------- ------------ Balance at February 1, 1997 8,153,639 16,961,000 (9,789,000) Issuance of shares pursuant to the exercise of stock options 440,000 1,320,000 Issuance of shares pursuant to a private placement 1,510,000 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 10,103,639 $22,337,000 ($19,030,000) ========== =========== ============
See accompanying notes to consolidated financial statements. F-4 THE RIGHT START, INC. CONSOLIDATED STATEMENT OF CASH FLOWS ------------------------------------
Fiscal Year Thirty-three Fiscal Year Ended Ended Weeks Ended --------------------------- January 31, February 1, June 1, May 31, 1998 1997 1996 1995 ------------ ------------ ----------- ------------- Cash flows from operating activities: Net loss $(9,241,000) $(5,378,000) $(3,899,000) $(2,106,000) Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 1,608,000 833,000 938,000 745,000 Pre-opening cost amortization 711,000 528,000 418,000 114,000 Amortization of discount on senior subordinated notes 85,000 1,744,000 Loss on sale of Children's Wear Digest Loss on store closings 1,580,000 Change in assets and liabilities affecting operations (1,316,000) (957,000) 506,000 (2,256,000) ----------- ----------- ----------- ----------- Net cash used in operating activities (6,573,000) (4,974,000) (2,037,000) (1,759,000) ----------- ----------- ----------- ----------- Cash flows from investing activities: Additions to property, plant and equipment (2,063,000) (3,607,000) (4,165,000) (2,417,000) Proceeds from sale of marketable securities 1,461,000 Proceeds from sale of Children's Wear Digest 2,437,000 Payment for Children's Wear Digest acquisition (399,000) Proceeds from sale of telemarketing center 298,000 ----------- ----------- ----------- ----------- Net cash provided by (used in) investing activities (2,063,000) (3,309,000) (4,165,000) 1,082,000 ----------- ----------- ----------- ----------- Cash flows from financing activities: Net proceeds from borrowings under revolving line of credit 181,000 1,833,000 Proceeds from note payable, long term 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 a rights offering 4,906,000 Proceeds from sale of senior subordinated notes 3,000,000 ----------- ----------- ----------- Cash provided by financing activities 8,563,000 8,124,000 5,107,000 ---------- ---------- ----------- Net decrease in cash (73,000) (159,000) (1,095,000) (677,000) Cash at beginning of period 313,000 472,000 1,567,000 2,244,000 ---------- ---------- ----------- ---------- Cash at end of period $ 240,000 $ 313,000 $ 472,000 $1,567,000 ========== ========== =========== ==========
See accompanying notes to consolidated financial statements. F-5 THE RIGHT START, INC. NOTES TO CONSOLIDATED 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. The Company's financial statements also include the accounts of its wholly owned subsidiary, Children's Wear Digest (CWD) through the date the Company sold CWD (see Note 6). All material intercompany balances and transactions have been eliminated. 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 31, 1998 ("Fiscal 1997") and June 1, 1996 ("Fiscal 1996") were fifty-two week periods; the fiscal year ended May 31, 1995 ("Fiscal 1995") was a fifty-three week period. See Note 14. 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 $2,753,000, $1,844,000, $6,061,000 and $9,457,000 were recorded in Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, 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 NOTE 1 - (Continued) : - ------------------- 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 a straight-line basis over the life of the underlying lease. The benefit from tenant allowances and landlord concessions are recorded as deferred rent and recognized over the lease term. Income Taxes - ------------ The Company accounts for income taxes in accordance with Statement of Financial Accounting Standard No. 109 (FAS 109), "Accounting for Income Taxes." FAS 109 requires 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 other assets and liabilities. 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 - -------------- Basic per share data is computed by dividing income available 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. Securities that could potentially dilute basic EPS in the future that were not included in the computation of diluted EPS because to do so would have been antidilutive for the periods presented include options outstanding to purchase 652,011, 979,921, 1,047,402 and 1,042,000 shares of common stock at January 31, 1998, February 1, 1997, June 1, 1996 and May 31, 1995, respectively, debt issued with detachable warrants in May 1997 enabling the holder to purchase 475,000 shares of common stock at $3.00 per share and debentures issued in October 1996 convertible into 750,000 shares of common stock. Additionally, Note 15 describes debt issued with detachable warrants in April 1998 which could potentially dilute basic EPS in the future. 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. F-7 NOTE 2 - PROPERTY, PLANT AND EQUIPMENT, NET : - --------------------------------------------
January 31, February 1, 1998 1997 ----------- ----------- Property, plant and equipment, at cost: Machinery, furniture and equipment $3,669,000 $3,728,000 Leaseholds and leasehold improvements 6,683,000 7,676,000 Construction in progress 551,000 Computer software 821,000 693,000 ---------- ---------- 11,173,000 12,648,000 Accumulated depreciation and amortization (3,058,000) (2,807,000) ---------- ----------- $8,115,000 $ 9,841,000 ========== ===========
Depreciation and amortization expense for property, plant and equipment amounted to $1,608,000, $833,000, $935,000 and $645,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, 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 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 31, 1998, $2,014,000 and $1,081,000 were outstanding and available, respectively, under the Revolver based on a defined borrowing base of $3.1 million as of January 31, 1998. The Credit Facility is for a period of three years and is secured by substantially all the Company's assets. 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. The Credit Facility also limits the Company's earnings before interest, taxes, depreciation and amortization (EBITDA) to the following loss amounts: $1.2 million for the three months ended April 30, 1998 and the six months ended July 31, 1998, $900,000 for the nine months ended October 31, 1998 and the twelve months ended January 31, 1999 and $500,000 for the twelve months ended April 30, 1999. Minimum EBITDA of zero is required for the twelve months ended July 31, 1999 and $400,000 for the twelve months ended October 31, 1999. In addition, capital expenditures are limited to $1,750,000 in fiscal years 1998 and 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 31, 1998, the bank's prime rate of interest was 8.50%. The Company's weighted average interest rate on short-term borrowings was 9.48% and 9.42% for Fiscal 1997 and the Transition Period, respectively. Effective May 6, 1997, the Company sold subordinated notes and warrants to purchase common stock, certain of the purchasers of which are affiliates of the Company. The subordinated notes bear interest at 11.5% and are due in full on May 6, 2000. Warrants to purchase an aggregate of 475,000 shares of common stock at $3.00 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 is being amortized over the term of the notes. Subsequent to year end, the holders of the notes agreed to exchange the notes and warrants in connection with a capital restructuring. See Note 15. 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, permit the holders to convert the principal amount into 750,000 shares of the Company's common stock at $4.00 per share at any time prior to May 31, 2002, the due date of the debentures. The debentures bear interest at a rate of 8% per annum. The holders of the debentures agreed to exchange the debentures in conjunction with a capital restructuring in April 1998. See Note 15. F-8 NOTE 4 - INCOME TAXES: - --------------------- The provision (benefit) for income taxes is comprised of the following:
Fiscal Year Thirty-three Fiscal Year Ended Ended Weeks Ended --------------------------- January 31, February 1, June 1, May 31, 1998 1997 1996 1995 ----------- ----------- ---------- ----------- Current provision: Federal $ 1,000 ($424,000) State $ 27,000 Deferred provision (benefit): Federal (928,000) (725,000) State (105,000) Adjustment to valuation allowance $ 207,000 ----------- ----------- ---------- ----------- $27,000 $207,000 ($927,000) ($1,254,000) =========== =========== ========== ===========
The Company's effective income tax rate differed from the federal statutory rate as follows:
Fiscal Year Thirty-three Fiscal Year Ended Ended Weeks Ended ------------------- January 31, February 1, June 1, May 31, 1998 1997 1996 1995 ---- ---- ---- ---- Federal statutory rate 34% 34% 34% 34% State income taxes, net of federal benefit 3 1 3 2 Stock options 4 Valuation allowance (39) (45) (19) Other 2 2 1 1 ---- ---- ---- ---- Effective tax rate 0% (4)% 19% 37% ==== ==== ==== ====
F-9 NOTE 4 - (Continued) : - ------------------- Deferred tax liabilities (assets) are comprised of the following:
January 31, February 1, June 1, 1998 1997 1996 ----------- ----------- ---------- Depreciation and amortization $200,000 $236,000 $112,000 Pre-opening costs 21,000 225,000 220,000 Other 64,000 68,000 11,000 ----------- ----------- ----------- Deferred tax liabilities 285,000 529,000 343,000 ----------- ----------- ----------- Net operating loss carryforward (6,799,000) (4,157,000) (2,256,000) Deferred rent (839,000) (708,000) (380,000) Writedown of fixed assets (633,000) Other reserves (396,000) (234,000) (141,000) Other tax carryforwards (68,000) (67,000) (70,000) Sales returns (29,000) (43,000) (43,000) ----------- ----------- ----------- Deferred tax assets (8,764,000) (5,209,000) (2,890,000) ----------- ----------- ----------- Valuation allowance 7,079,000 3,280,000 940,000 ----------- ----------- ----------- Net deferred tax asset ($1,400,000) ($1,400,000) ($1,607,000) =========== =========== ===========
The Company's deferred tax asset is net of a valuation allowance of $7,079,000. In evaluating the deferred tax asset, management considered the Company's projections and available tax planning strategies. The Company's plan projects taxable income in future years which will enable the deferred tax asset to be realized. Available tax planning strategies include the sale of certain of the Company's assets which have little or no tax basis. The Company has federal and state net operating loss carryforwards at January 31, 1998 of $18,499,000 and $6,844,000, respectively. These carryforwards will expire in fiscal years ending 2002 through 2012. NOTE 5 - 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. NOTE 6 - CHILDREN'S WEAR DIGEST : - ------------------------------- Pursuant to an asset purchase agreement dated December 30, 1994 (the Agreement) and a letter of intent agreement entered in November 1994, the Company and its wholly owned subsidiary, Children's Wear Digest, Inc. (CWD), sold substantially all of the assets of CWD to Small People, Inc. (SPI). A significant owner of SPI was the president of CWD until his resignation effective December 30, 1994 and was also the owner of CWD at the time of its purchase by the Company. Under the terms of the Agreement, CWD sold certain assets, consisting primarily of inventory, fixed assets and intangible assets, in exchange for cash of approximately $2,437,000. The transaction resulted in a loss of $1,744,000. F-10 NOTE 6 - (Continued): - ------------------- In connection with the Agreement, the parties also entered into a separate Telemarketing Agreement, a Confidentiality and Noncompetition Agreement, and termination agreements related to certain employment and management contracts between CWD and its former owners which were entered when the Company purchased CWD in September 1992. The acquisition was accounted for as a purchase and the resultant goodwill was amortized over its estimated useful life. NOTE 7 - EMPLOYEE BENEFITS AND STOCK OPTIONS: - -------------------------------------------- On March 15, 1991, two now former executives were granted options to acquire up to 900,000 shares of the Company's common stock under a non-qualified stock option plan. The options were granted at fair market value of $3.33 per share. Three hundred 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 388,000 options exercisable at $3.00 per share, the fair market value at the time of reissuance. At January 31, 1998, 81,000 shares were outstanding under this plan. One of the executives covered by this plan was the Company's chief executive officer who resigned in March 1996. The other executive covered by this plan 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 450,000 shares of the Company's common stock, in October 1991. Options granted vest either 20% or 33% (depending on the terms of the individual grant) each year commencing on grant date and expire 10 years thereafter. In August 1995, those holding options under the 1991 Employee Stock Option Plan were given the right to cancel their options (the Existing Options) and have an equal number of options (the New Options) reissued to them at the fair market value of $3.00 per share. The vesting period on the Existing Options is 20% each year and the New Options vest 33% each year, both from date of grant. At January 31, 1998 there were no Existing Options outstanding. Options for 379,982 shares were outstanding as of January 31, 1998, 125,717 of which were exercisable. 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 3,000 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 five years from the date of grant. 191,029 options were issued under this plan at exercise prices which range from $2.50 to $5.13 and were equal to the closing price of the Company's 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. 117,204 of the options issued under this plan are exercisable at January 31, 1998. 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 and $50,000 in Fiscal 1996 and Fiscal 1995, respectively. The Company matches employees' contributions to the ESPP at a rate of 50%. The Company's contributions to the ESPP amounted to $24,000, $21,000, $28,000 and $58,000 in Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. F-11 NOTE 7 - (Continued) : - ------------------- The following table summarizes option activity through January 31, 1998:
Weighted Average Exercise Price -------------- Outstanding at May 25, 1994 1,084,500 $3.56 Granted 2,500 2.50 Canceled (45,000) 4.64 --------- Outstanding at May 31, 1995 1,042,000 3.49 Granted 306,902 4.27 Canceled (241,000) 3.10 Exercised (60,500) 3.19 --------- Outstanding at June 1, 1996 1,047,402 3.40 Granted 163,519 5.27 Canceled (16,667) 3.42 Exercised (214,333) 3.02 --------- Outstanding at February 1, 1997 979,921 3.70 Granted 196,590 2.50 Canceled (84,500) 4.04 Exercised (440,000) 3.00 --------- Outstanding at January 31, 1998 652,011 3.81 =========
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:
Fiscal Thirty-three Fiscal Year Ended Weeks Ended Year Ended January 31, February 1, June 1, 1998 1997 1996 ----------- ----------- ----------- Net loss: As reported ($9,241,000) ($5,378,000) ($3,899,000) Pro forma (9,640,000) (5,839,000) (4,068,000) Basic and diluted loss per share: As reported ($1.01) ($0.67) ($0.60) Pro forma (1.05) (0.73) (0.62)
These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock F-12 NOTE 7 - (Continued): - ------------------- 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 1997, the Transition Period and Fiscal 1996, respectively: dividend yields of zero percent; expected monthly volatility of 79.34, 73.25 and 70.97 percent; risk free interest rates of 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 1997, the Transition Period and Fiscal 1996 for which the exercise price equals the market price on the grant date was $2.50, $3.10 and $2.39, 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 currently outstanding and exercisable stock options: Range of exercise prices $2.50 - $6.50 Number of outstanding options 652,011 Weighted average remaining contractual life 6.7 years Weighted average exercise price $ 3.81 Number of options exercisable 323,921 Weighted average price of exercisable options $ 4.17
NOTE 8 - RELATED PARTY TRANSACTIONS: - ------------------------------------ KAIM provides certain management services to the Company and charges the Company for such services. Management fees of $100,000, $66,667 and $83,333 were incurred in Fiscal 1997, the Transition Period, and Fiscal 1996, respectively. ARC incurred certain expenses on behalf of the Company and charged the Company for such expenses. These expenses include amounts allocated on an actual basis for income taxes, insurance premiums, telephone charges and professional fees. Corporate office overhead charges of $27,000 in Fiscal 1995 were allocated on the basis of estimated corporate staff effort on behalf of the Company. The Company provided telemarketing services through July 1996, to K.A. Industries, a related party to Kayne Anderson. Revenues generated from this service amount 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-13 NOTE 9 - OPERATING LEASES: - -------------------------- The Company leases real property and equipment under non-cancelable agreements expiring from 1998 through 2007. Certain retail store lease agreements provide for contingent rental payments if the store's net sales exceed stated levels ("percentage rents"). A majority 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 Ending ------------------ 1999 $3,582,000 2000 3,377,000 2001 3,254,000 2002 3,217,000 2003 3,038,000 Thereafter 8,435,000 ----------- $24,903,000 ===========
Net rental expense under operating leases was $3,802,000, $1,929,000, $1,959,000 and $1,166,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. No percentage rents were incurred in Fiscal 1997 and Fiscal 1995; percentage rents incurred in the Transition Period and Fiscal 1996 amounted to $54,000 and $82,000, respectively. NOTE 10 - STORE CLOSINGS: - ------------------------ On December 16, 1997, the board approved management's plan to close seven poor performing retail stores. The Company has written 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 consolidated statement of operations. The revenues from the stores which will be closed were $4,663,000, $3,003,000, $2,802,000 and $550,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. Operating losses from these stores were $435,000, $215,000, $48,000 and $127,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. On January 28, 1997, the board approved management's plan to close two poor performing retail stores. The Company has written 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 consolidated statement of operations. The revenues from these stores were $802,000, $616,000, $1,170,000 and $1,112,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. Operating losses from these stores were $167,000, $225,000, $155,000 and $123,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. NOTE 11 - COMMITMENTS AND CONTINGENCIES: - ---------------------------------------- The Company is not party to any material legal actions. F-14 NOTE 12 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: - ----------------------------------------------------------- Changes in assets and liabilities which increased (decreased) cash and equivalents are as follows:
Fiscal Year Thirty-three Fiscal Year Ended Ended Weeks Ended ---------------------- January 31, February 1, June 1, May 31, 1998 1997 1996 1995 ----------- ---------- --------- --------- Accounts receivable $ 610,000 ($329,000) ($126,000) $ 300,000 Note receivable 123,000 (200,000) Merchandise inventories 1,062,000 (2,400,000) (122,000) (724,000) Prepaid catalog expenses 485,000 (69,000) 268,000 731,000 Income taxes receivable 472,000 (280,000) Other current assets (50,000) (500,000) (835,000) (699,000) Deferred pre-opening costs (218,000) (540,000) Other noncurrent assets (2,000) 113,000 142,000 (42,000) Accounts payable and accrued expenses (3,503,000) 2,100,000 753,000 (522,000) Accrued salaries and bonuses (137,000) (13,000) 292,000 (84,000) Advance payments on orders (1,000) (112,000) (15,000) (112,000) Amounts due to ARC (71,000) (58,000) Deferred income taxes 207,000 (928,000) (830,000) Other liabilities (97,000) (17,000) Deferred rent 315,000 786,000 773,000 81,000 ----------- ---------- --------- ----------- ($1,316,000) ($957,000) $506,000 ($2,256,000) =========== ========== ========= ===========
Cash paid for income taxes was $5,000 and $7,000 for Fiscal 1997 and the Transition Period, respectively. Cash paid for interest was $954,000, $193,000, $73,000 and $30,000 for Fiscal 1997, the Transition Period, Fiscal 1996 and Fiscal 1995, respectively. Non-cash investing activity consists of a $250,000 note received upon the sale of the phone center operations in the Transition Period (see Note 5). NOTE 13 - 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-15 NOTE 14 - 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 $ ( 0.12) =========== Weighted average number of shares outstanding 6,302,534
NOTE 15 - SUBSEQUENT EVENT: - --------------------------- 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 $1.00 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 preferred stock. Ten shares of newly issued preferred stock will be issued for each $1,000 principal amount of subordinated debt securities exchanged. The total number of shares to be issued are 30,000, 30,000 and 38,500 for Preferred Stock Series A, B and C, respectively. Holders of $3,000,000 principal amount of existing subordinated debt securities elected to receive Series A Preferred Stock which will have no fixed dividend rights, will not be convertible into common stock, will be 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 existing subordinated debt securities elected to receive Series B convertible preferred stock which will have no fixed dividend rights and will be convertible into common stock at a price per share of $1.50. Holders of the $3,850,000 principal amount of new subordinated debt securities elected to receive Series C convertible preferred stock which will have no fixed dividend rights and will be convertible into common stock at a price per share of $1.00. The Series B Preferred Stock and the Series C Preferred Stock was mandatorily redeemable upon the occurrence of a change of control of the Company, as defined in the Agreement. Pursuant to a letter agreement dated July 7, 1998, the Company has received consent from all but one of the parties that will hold Series B Preferred Stock to remove the mandatory redemption feature of the Series B Preferred Stock upon a change of control of the Company. Additionally, pursuant to such letter agreement, the Company has receive consent from all of the parties that will hold Series C Preferred Stock to remove the mandatory redemption feature of the Series C Preferred Stock upon the occurrence of a change of control of the Company. F-16 NOTE 15 - (Continued): - -------------------- The issuance of the shares of preferred stock upon exchange of the subordinated debt securities is subject to the approval of the Company's shareholders, which approval the Company expects to obtain at its annual meeting scheduled to be held in September 1998. 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 will be exchanged for Series C preferred stock which is convertible into common stock at a price per share of $1. As of the date of issue of the New Securities the stock was trading at $2 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 is being amortized to interest expense in the historical accounts over the period from the April issuance date to the date the debt is first convertible. The date the debt is first convertible is the exchange date when the debt is exchanged for convertible preferred stock. Since the exchange transaction is subject to a proxy vote by the shareholders, the expect date of the shareholder vote, anticipated to be in October, 1998, has been used to determine the amortization period of six months. No value has been 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 have no independent value apart from the exchange transaction. The exchanges of the subordinated debt securities for the preferred stock will be recorded at the date of issuance of the preferred stock. The fair value of each preferred stock series will be determined as of the issuance date of the stock. The difference between the fair value of the preferred stock series granted and the carrying amount of the related subordinated debt security's balance plus accrued interest exchanged will be recognized as a gain or loss on the extinguishment of debt. If the convertible preferred stock series B and C conversion feature is "in the money" at the date of issue of the preferred stock, a portion of the fair value of the preferred stock equal to the beneficial conversion feature will be allocated to additional paid in capital. The beneficial conversion feature amount allocated to paid in capital will be recognized as a return to the preferred shareholders immediately through a charge to accumulated deficit and a credit to preferred stock. The estimated gain or loss to be recorded on the total proposed recapitalization is not determinable at this time as the transactions will be measured and recorded at the date of issuance of the preferred stock. In connection with the above restructuring, 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 elimination of approximately $.6 million in annual interest expense. 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. Further, the Company's lender amended the existing loan agreement to provide more favorable terms which are consistent with management's financial and operational 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 above. Historically, the Company has incurred losses and expects to 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-17 NOTE 16 - RESTATEMENT: - --------------------- Other expenses for the fiscal year ended January 31, 1998, thirty-three weeks ended February 1, 1997 and fiscal year ended June 1, 1996, consisting primarily of fixed assets and leasehold improvements written off in conjunction with planned store closures and severance resulting from the resignation of the Company's former President and Chief Executive Officer as described in Notes 10 and 7, have been reclassified from other non-operating expense to the operating costs and expenses category in the consolidated statements of operations. The affect of this restatement was to increase operating loss by $1,905,000, $851,000 and $450,000 for the fiscal year ended January 31, 1998, thirty-three weeks ended February 1, 1997 and fiscal year ended June 1, 1996, respectively. This restatement had no effect on loss before income taxes, net loss or basic and diluted loss per share or on the Company's financial position or cash flows. F-18 EX-10.15 2 FOURTH AMENDMENT TO LOAN & SECURITY AGREEMENT FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LIMITED CONSENT This Fourth Amendment to Loan and Security Agreement and Limited Consent ("Amendment") is effective as of January 30, 1998, and entered into by and between HELLER FINANCIAL, INC. ("Lender"), and THE RIGHT START, INC. ("Borrower"). WHEREAS, Lender and Borrower have entered into a Loan and Security Agreement dated November 14, 1996 (as amended, the "Loan Agreement"); and WHEREAS, Borrower wishes to (i) issue and sell "New Subordinated Debt" (as hereinafter defined) for a purchase price of $3,850,000 and (ii) convert the Subordinated Debt and the New Subordinated Debt to preferred stock; and WHEREAS, Lender has agreed to amend the agreement to permit the issuance and sale of said Senior Subordinated Notes and to consent to the conversion of the Subordinated Debt and the New Subordinated Debt to preferred stock; and WHEREAS, Lender and Borrower have agreed to amend the Agreement, subject to the following terms and conditions. NOW THEREFORE, in consideration of the mutual conditions and agreements set forth in the Agreements and this Amendment, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound, hereby agree as follows: 1. DEFINITIONS. Capitalized terms used in this Amendment, to the extent ----------- not otherwise defined herein, shall have the same meanings as in the Loan Agreement, as amended hereby. 2. AMENDMENTS. The Agreement is hereby amended as follows: ---------- (a) Subsection 1.1 is amended by inserting, in proper alphabetical order, the following new defined terms: "Capital Expenditures" means all expenditures (including deposits) for, or contracts for expenditures (excluding contracts for expenditures under or with respect to Capital Leases, but including cash down payments for assets acquired under Capital Leases) with respect to any fixed assets or improvements, or for replacements, substitutions or additions thereto, which have a useful life of more than one year, including the direct or indirect acquisition of such assets by way of increased product or service charges, offset items or otherwise. "New Subordinated Debt" means the Indebtedness of Borrower under its Senior Subordinated Notes due May 6, 2000, in the aggregate principal amount of $3,850,000 issued to ARBCO Associates, L.P., Kayne Anderson Non- Traditional Investments, L.P., Kayne Anderson Offshore Limited, Offense Group Associates, L.P., Opportunity Associates, L.P., Arthur E. Hall Money Purchase Plan and Fred Kayne (the "Purchasers"), which shall be converted to preferred stock within 240 days from the funding date thereof. "New Warrants" means the warrants to purchase 3,850,000 shares of Borrower's common stock issued to the Purchasers. "Minimum Availability" means the amount by which the Maximum Revolving Loan Amount exceeds the outstanding balance of the Revolving Loan. (b) Subsection 5 is amended by adding a new subsection 5.17 as follows: 5.17 Minimum Availability. Borrower shall maintain Minimum -------------------- Availability of at least $400,000 at all times. (c) Subsection 6.2 is deleted in its entirety and replaced with the following: 6.2 Intentionally Omitted. --------------------- (d) Subsection 6.3 is deleted in its entirety and replaced with the following: 6.3 Minimum EBITDA. Borrower shall have a minimum EBITDA for the -------------- periods set forth below in the amounts set forth below: Period Amount ------ ------ Three months ended April 30, 1998 ($1,200,000) Six months ended July 31, 1998 ($1,200,000) Nine months ended October 31, 1998 ($ 900,000) Twelve months ended January 31, 1999 ($ 900,000) Twelve months ended April 30, 1999 ($ 500,000) Twelve months ended July 31, 1999 $ 0 Twelve months ended October 31, 1999 $ 400,000 (e) Section 6 is amended by adding the following new subsection 6.4 immediately following subsection 6.3: 6.4 Capital Expenditure Limits. The aggregate amount of all Capital -------------------------- Expenditures of Borrower and its Subsidiaries (excluding trade-ins and excluding Capital Expenditures in respect of replacement assets to the extent funded with casualty insurance proceeds) will not exceed the amount set forth below for each 2 period set forth below. In the event that Borrower or any of its Subsidiaries enters into a Capital Lease or other contract with respect to fixed assets, for purposes of calculating Capital Expenditures under this subsection only, the amount of the Capital Lease or contract initially capitalized on Borrower's or any Subsidiary's balance sheet prepared in accordance with GAAP shall be considered expended in full on the date that Borrower or any of its Subsidiaries enters into such Capital Lease or contract. Fiscal Year Amount ----------- ------ 1998 $1,750,000 1999 $1,750,000 Permitted Capital Expenditures not made in any Fiscal Year may be carried over for one year only to the next Fiscal Year; provided, however, any carried-over Capital Expenditure will be deemed used only after all otherwise Permitted Capital Expenditures for that Fiscal Year have been used. (f) Subsection 7.1 is amended by deleting the first sentence of said subsection in its entirety and replacing it with the following: 7.1 Indebtedness and Liabilities. Directly or indirectly create, ---------------------------- incur, assume, guaranty, or otherwise become or remain directly or indirectly liable, on a fixed or contingent basis, with respect to any Indebtedness except: (a) the Obligations; (b) Indebtedness (excluding capital leases) not to exceed $250,000 in the aggregate at any time outstanding secured by purchase money Liens; (c) Indebtedness under Capital Leases not to exceed $200,000 outstanding at any time in the aggregate; (d) operating Leases; (e) the Subordinated Debt; (f) the New Subordinated Debt; and (f) Indebtedness existing on the Closing Date and identified on Schedule 7.1. ------------- (g) Subsection 8.1 is amended by adding a new clause "S" to end of said subsection: (S) Minimum Availability. Failure of Borrower to maintain Minimum -------------------- Availability of in accordance with subsection 5.17 herein. 3. LIMITED CONSENT. Lender hereby consents to the terms and provisions --------------- set forth in that certain Letter Agreement dated April 6, 1998 among Borrower and the Purchasers (the "Letter Agreement", attached hereto as Exhibit A), including the Borrower's (i) issuance and sale of the New Subordinated Debt and the New Warrants, (ii) exchanging the Subordinated Debt with shares of either Series A or Series B Preferred Stock, and (iii) exchanging the New Subordinated Debt with Series C Preferred Stock, as defined in the Letter Agreement. This is a limited consent which shall be effective only with respect to the specific facts set forth above. 3 4. CONDITIONS. The effectiveness of this Amendment is subject to the ---------- satisfaction of the following conditions precedent (unless specifically waived in writing by Lender): (a) as of the date of issuance of the New Subordinated Debt and the New Warrants, there shall have occurred no material adverse change in the business, operations, financial conditions, profits or prospects, or in the Collateral of Borrower, other than has been disclosed to the Lender; (b) Borrower shall have executed and delivered such other documents and instruments as Lender may require; (c) all corporate proceedings taken in connection with the transactions contemplated by this Amendment and all documents, instruments and other legal matters incident thereto shall be satisfactory to Lender and its legal counsel; (d) Borrower shall have received net proceeds in an amount of at least $3,850,000 from the sale of the New Subordinated Debt and wire transferred said proceeds to the Blocked Account; and (e) Lender shall have approved of the form and substance of the New Subordinated Debt documents; and (f) Borrower shall have paid Lender a documentation fee in the amount of $500.00. 4 5. RATIFICATION. The terms and provisions set forth in this Amendment ------------ shall modify and supersede all inconsistent terms and provisions set forth in the Agreement and, except as expressly modified and superseded by this Amendment, the terms and provisions of the Agreement, are ratified and confirmed and shall continue in full force and effect. 6. NO WAIVER. Nothing contained in this Amendment shall constitute or be --------- construed as (i) a waiver of, or an agreement to waive any Default or Event of Default under the Agreement or the other Loan Documents, now existing or arising hereafter, known or unknown, or (ii) an agreement to forbear from exercising any right or remedy in connection with any Default or Event of Default, now existing or arising hereafter, known or unknown, under the Agreement or the other Loan Documents. The execution, delivery and performance of this Amendment shall not (i) constitute a waiver of any provision of, or operate as a waiver of any right, power or remedy of Lender, under the Agreement or the other Loan Documents, or (ii) constitute or be construed as establishing a course of dealings obligating Lender to make any accommodations, financial or otherwise, to Borrower at any time in the future and Lender hereby reserves all rights and remedies under the Agreement or the other Loan Documents. 7. CORPORATE ACTION. The execution, delivery and performance of this ---------------- Amendment have been authorized by all requisite corporate action on the part of Borrower and will not violate the Articles of Incorporation or Bylaws of Borrower. 8. SEVERABILITY. Any provision of this Amendment held by a court of ------------ competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Amendment and the effect thereof shall be confined to the provision so held to be invalid or unenforceable. 9. SUCCESSORS AND ASSIGNS. This Amendment is binding upon and shall inure ---------------------- to the benefit of Lender and Borrower and their respective successors and assigns. 10. COUNTERPARTS. This Amendment may be executed in one or more ------------ counterparts, each of which when so executed shall be deemed to be an original, but all of which when taken together shall constitute one and the same instrument. 5 IN WITNESS WHEREOF, the parties have executed this Amendment on the date first above written. HELLER FINANCIAL, INC., as Lender By: /s/ Vicky Geist --------------------------- Title: ------------------------ THE RIGHT START, INC., as Borrower By: /s/ Gina Shauer --------------------------- Title: ------------------------ 6 EX-23.1 3 CONSENT OF PRICEWATERHOUSECOOPERS LLP Exhibit 23.1 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 Notes 10 and 14 which are as of September 1, 1998 and Note 16 which is as of October 13, 1998 appearing on page F-1 of this Form 10-K/A. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Los Angeles, California October 15, 1998 -----END PRIVACY-ENHANCED MESSAGE-----