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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark one) FORM 10-K
( ) 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 ___________________
(X) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 (No fee required)
For the transition period from June 2, 1996 to February 1, 1997
Commission file no. 0-19536
THE RIGHT START, INC.
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(Exact name of registrant as specified in its charter)
California 95-3971414
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5334 Sterling Center Drive, Westlake Village, California 91361
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code
(818) 707-7100
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
--------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 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 or any amendment to this
Form 10-K. [ ]
As of April 28, 1997, approximately 2,805,763 shares of the Registrant's Common
Stock held by non-affiliates were outstanding and the aggregate market value of
such shares was approximately $6,619,000.
As of April 28, 1997 there were outstanding 8,593,639 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 on July 22, 1997 (the "Transition Period Proxy
Statement") are incorporated by reference into Part III hereof.
Total number of pages in this report: ____
(Exhibit index located on page ____)
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This Annual Report on form 10-K contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Discussions
containing such forward-looking statements may be found in the material set
forth under Item 1. Business and Item 7. Management's Discussion and Analysis,
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 will 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
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GENERAL
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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 38 retail stores, primarily located in
major regional malls across the nation, 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, Learning/Play and Apparel.
HISTORY
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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 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
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shipment 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
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The Company operates 38 retail stores, 36 of which are located in major
regional malls throughout the United States. Two of the stores are in non-mall
locations in California. The Right Start store sites are selected based on mall
strength, relative strength of certain comparable specialty store operators in
the same mall, the extent of Right Start Catalog customer/brand development,
available census, demographic and psychographic data, and lease economics. The
stores are designed to provide a bright, cheerful, safe and baby-friendly
environment with many amenities for the shopping ease of new parents.
The Company has been rapidly expanding its retail operations with 19 of its
stores having opened in the last twelve months. In March 1997, the Company made
a decision to slow its retail growth in the near term and to focus management's
efforts on making certain enhancements to its merchandising strategy and
operating systems. Specifically, the Company's product mix is being expanded to
include a more complete line of products for infants and toddlers. The store
layout is being modified to better present its expanded line of infant and
toddler care products and more effectively allocate space among its product
categories. Finally, the Company will be enhancing its in-store signage in
order to better communicate its positioning and the attributes of its products
to the consumer.
The Company currently has two additional store openings planned for the
year ending January 31, 1998.
THE RIGHT START CATALOG
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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.
RECENT DEVELOPMENTS
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Effective February 1, 1997, the Company changed its fiscal year end to the
Saturday closest to the last day of January. Previously, the Company reported
on a fiscal year ending the Saturday closest to the last day of May. This
resulted in a thirty-three week reporting period for the period June 2, 1996
through February 1, 1997 ("the Transition Period").
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The Company issued and sold subordinated convertible debentures in the
aggregate principal amount of $3 million in October 1996. The debentures are
convertible into 500,000 shares of common stock at $6.00 per share at any time
prior to May 31, 2002. David Warnock is a principal of the holders of the
debentures and was elected to The Right Start Board of Directors in November
1996.
In October 1996, Stanley Fridstein, one of the co-founders of The Right
Start, resigned from his position as President and Director. Jerry Welch,
Chairman of the Board and Chief Executive Officer, assumed the title of
President.
ADVERTISING AND MARKETING
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The Right Start positions its 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 the individual stores.
The Right Start Catalog, however, provides effective marketing support for the
stores. Catalogs are distributed in existing and future retail markets to a
targetted customer base. In addition, the stores' point of sale system also
provides a strong marketing database. Customers' names and addresses are
captured and are then used for promotional mailings and other follow up.
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
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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 8% 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 historically had higher gross profit margins and tend to
provide more opportunities for the Company to offer a large selection of unique
goods.
EMPLOYEES
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As of April 22, 1997 the Company employed 423 employees, approximately 58
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 represented by union. The Company
considers its
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employee relations to be good.
COMPETITION
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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 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
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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 to be readily identifiable with, and
valuable to, its business.
ITEM 2. PROPERTIES
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The Right Start operates 38 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 August 1998, with options to extend the lease through 2001.
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ITEM 3. LEGAL PROCEEDINGS
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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
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Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS'
- ------- ---------------------------------------------------------------
MATTERS
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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
115 shareholders as of April 29, 1997. 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
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Transition Period High Low
- ----------------- ---- ---
First Quarter $6.88 $4.25
Second Quarter 5.63 4.56
Third Quarter (1) 6.38 5.00
Fiscal 1996
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First Quarter 5.00 2.13
Second Quarter 5.00 3.88
Third Quarter 6.25 4.00
Fourth Quarter 6.75 3.63
(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.
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ITEM 6. SELECTED FINANCIAL DATA - (Dollars in thousands except share data)
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<TABLE>
<CAPTION>
TRANSITION FISCAL YEAR
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PERIOD 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
EARNINGS DATA
Revenues:
Net sales $ 27,211 $ 40,368 $ 44,573 $ 49,204 $ 37,261
Other revenues 399 1,418 1,168 1,311 992
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27,610 41,786 45,741 50,515 38,253
Net income (loss) (5,378) (3,899) (2,106) 176 1,032
Earnings (loss) per share (0.67) (0.60) (0.33) 0.03 0.16
SHARE DATA
Weighted average
shares outstanding 8,006,190 6,536,813 6,300,000 6,637,142 6,494,133
BALANCE DATA SHEET
Current assets $ 11,704 $ 8,353 $ 9,660 $ 12,002 $ 13,306
Total assets 22,982 17,475 14,632 18,221 18,274
Current liabilities 8,457 4,649 3,690 4,979 5,650
Long-term debt 5,643
Shareholders' equity 7,172 11,902 10,694 12,800 12,624
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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RESULTS OF OPERATION
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Results of Operations
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This discussion should be read in conjunction with the information
contained in the Consolidated Financial Statements and accompanying Notes
thereto of the Company appearing elsewhere in this Form 10-K.
Transition Period compared with Fiscal 1996
- -------------------------------------------
Transition Period results have been presented and discussed to
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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, to the prior fiscal year, the comparable
period of the prior year and based on annualized Transition Period data.
Unaudited comparable period data is included in the Notes to the Company's
Consolidated Financial Statements appearing elsewhere in this Form 10-K.
Annualized data was computed by multiplying the thirty-three week results by
1.58. Where annualized results are used, these calculations have been presented
for purposes of analysis only. They are in no way indicative of management's
estimates of future results.
Revenues for the Transition Period were $27.6 million compared to $41.8
million for 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 is 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. Current plans are to
continue the current, reduced circulation of the catalog.
Retail net sales were $19.6 million for the Transition Period compared to
$17.1 million for Fiscal 1996. Annualized Transition Period retail net sales
were $30.8 million. The increase in retail net sales is a result of the
Company's retail expansion; thirty-seven stores were open at February 1, 1997
as compared to twenty-two 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.
Cost of goods sold represented 53% of net sales in the Transition
Period and 54% of net sales in Fiscal 1996. The improvement in gross margin
reflects 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 is attributed to better management of inventory
levels and the elimination of excessive mark-down promotions.
Operating expense was $13.0 million, or 48% of net sales, in the Transition
Period compared to $18.8 million, or 47% of net sales, in Fiscal 1996. The
increase is 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 (or $4.6 million annualized) compared to $4.3 million in Fiscal 1996.
The increase reflects 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, offset by decreases in certain general
corporate overhead expenses.
The Transition Period increase in pre-opening cost amortization of
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$110,000 (or $414,000 on an annualized basis) compared to $418,000 in Fiscal
1996 results from the retail expansion over the last two years. The Company
amortizes 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
($1,313,000 annualized) as compared to $938,000 in Fiscal 1996. The increase is
due to the increase in property and equipment resulting from the construction of
new stores and installation of the Company's new information system.
Other expense of $851,000 incurred during the Transition Period is
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 (see Liquidity and
Capital Resources) resulting in $145,000 of prepayment charges; and the Company
has taken action to close two unprofitable retail store locations, which has
resulted in a write-off of $425,000 in non-recoverable assets. The $450,000 of
Other expense in Fiscal 1996 resulted from the severance charge associated with
the resignation of the Company's former Chief Executive Officer.
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 $41.8 million compared to $45.7 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. All but the Company's two oldest stores are located
in major upscale regional malls across the United States.
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 $1.1 million or 5% from $19.9 million
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in fiscal 1995 to $18.8 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.
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
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During the Transition Period, the company's primary sources of
liquidity were from borrowings under its $13,000,000 senior credit facility (the
"Credit Facility") and proceeds from the sale of $3,000,000 of convertible
subordinated debentures. These sources financed the Company's operations and
capital expenditures. Capital expenditures of approximately $3,600,000 were
incurred in opening 15 new retail stores and installing the information systems
necessary to support the existing stores and planned retail growth.
The Credit Facility consist 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. As of February 1, 1997, borrowings of $1,833,000
and $2,643,000 were outstanding and $2,108,000 and $357,000 were available under
the Revolving Line and the Capex Line, respectively. 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.
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At April 3, 1997, the Company was not in compliance with certain financial
and other covenants contained in the Credit Facility. On April 30, 1997, the
lender under the Credit Facility agreed to waive all outstanding defaults with
respect to these covenants and also agreed to amend certain provisions of the
Credit Facility.
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 losses from
operations during the quarters ending July 31, 1997 and October 31, 1997.
Thereafter, the Credit Facility requires the company's interest coverage (as
defined therein) to be at least (i) 1.5 to 1.0 for the fiscal quarter ending
January 31, 1998, (ii) 1.0 to 1.0 for the two fiscal quarter period ending April
30, 1998, (iii) 1.5 to 1.0 for the three fiscal quarter period ending July 31,
1998, and (iv) 2.0 to 1.0 for the four fiscal quarter period at the end of each
subsequent quarter. Interest coverage is defined in the Credit Facility as
EBITDA divided by interest expenses (each defined therein).
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 support its ability to maintain compliance
under the Credit Facility, the Company intends to raise approximately $3,000,000
through the issuance and sale to a limited number of investors (some of whom may
be affiliates of the Company) of additional subordinated debt and warrants to
purchase common stock. The Company is confident that it will be able to
consummate such financing by May 30, 1997, as is required by the Credit
Facility.
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.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------ -------------------------------------------
The consolidated financial statements and supplementary data of the Company
are as set forth in the "INDEX TO CONSOLIDATED FINANCIAL STATEMENTS" on page 13.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------ --------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------- --------------------------------------------------
The information contained in the Company's Transition Period Proxy Statement
under the captions "Executive Officers" and "Election of Directors" is
incorporated herein by reference. The Company's Proxy Statement will be filed
with the Securities and Exchange Commission no later than 120 days after the
close of the Transition Period.
ITEM 11. EXECUTIVE COMPENSATION
- ------- ----------------------
The information contained in the Company's Transition Period Proxy Statement
under the caption "Executive Compensation and Other Information" is incorporated
herein by reference. The Company's Proxy Statement will be filed with the
Securities and Exchange Commission no later than 120 days after the close of the
Transition Period.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------- --------------------------------------------------------------
The information contained in the Company's Transition Period Proxy Statement
under the caption "Principal Shareholders and Management" is incorporated herein
by reference. The Company's Proxy Statement will be filed with the Securities
and Exchange Commission no later than 120 days after the close of the Transition
Period.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
The information contained in the Company's Transition Period Proxy
Statement under the caption "Certain Relationships and Related Transactions" is
incorporated herein by reference. The Company's Proxy Statement will be filed
with the Securities and Exchange Commission no later than 120 days after the
close of the Transition Period.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
(1) Financial Statements:
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<CAPTION>
Page
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<S> <C>
Report of Independent Accountants F-1
Consolidated Balance Sheet --
February 1, 1997 and June 1, 1996 F-2
Consolidated Statement of Operations --
Periods Ended February 1, 1997, June 1, 1996,
and May 31, 1995 F-3
Consolidated Statement of Cash Flows --
Periods Ended February 1, 1997, June 1, 1996
and May 31, 1995 F-4
Consolidated Statement of Changes in
Shareholders' Equity -- Periods Ended
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-17
</TABLE>
All other financial statement schedules are omitted because they are either
not applicable or the required information is shown in the consolidated
financial statements or notes thereto.
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(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/*/
3.1.1 Amendment to Articles of Incorporation, dated
August 20, 1991*
3.1.2 Form of Amendment to Articles of Incorporation,
dated August 24, 1991*
3.2 Bylaws of the Company, as amended*
3.3 Specimen Certificate of the Common Stock
(without par value)*
4.1 Warrant Certificate for Representative's
Warrants*
10.1 1991 Key Employee Stock Option Plan*
10.2 Stock Option Grant to Stanley Fridstein, dated
March 15, 1991, as amended (see Exhibit 10.2)*
10.3 Stock Option Grant to Lenny Targon, dated
March 15, 1991, as amended (see Exhibit 10.3)*
10.4 Form of Indemnification Agreement between
Registrant and its directors and executive
officers*
10.5 Asset Purchase Agreement for Acquisition of
the Assets of Small People, Inc. and Jimash
Corporation by Right Start Subsidiary I, Inc.*
10.6 Software License Agreement between the Registrant
and Marriner Systems, Inc., dated April 27, 1994*
10.7 Incentive Agreement between American Recreation
Centers, Inc. and Stanley M. Fridstein, effective
July 28, 1994*
10.8 Incentive Agreement between American Recreation
Centers, Inc. and Lenny M. Targon, effective
July 28, 1994*
- ----------------
/*/ Previously filed.
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10.9 1995 Non-employee Directors Option Plan*
10.10 Registration Rights Agreement between Registrant and Kayne Anderson
Non-Traditional Investments LP, ARBCO Associates LP, Offense Group
Associates LP, Opportunity Associates LP, Fred Kayne, Albert O.
Nicholas and Primerica Life Insurance Company*
10.11 Termination and Release Agreement by and between The Right Start, Inc.
and Lenny M. Targon dated February 28, 1996*
10.12 Asset Purchase Agreement dated as of July 29, 1996 by and between
Blasiar, Inc. (DBA Alert Communications Company) and The Right Start,
Inc.*
10.13 Termination and Release Agreement between The Right Start, Inc. and
Stanley M. Fridstein dated as of September 19, 1996*
10.14 Convertible Debenture Purchase Agreement between The Right Start, Inc.
and Cahill Warnock Strategic Partners, LP dated as of October 11,
1996*
10.15 Convertible Debenture Purchase Agreement between The Right Start, Inc.
and Strategic Associates, LP dated as of October 11, 1996*
10.16 Loan and Security Agreement dated as of November 14, 1996 between The
Right Start, Inc. and Heller Financial, Inc.*
10.17 First Amendment to Loan and Security Agreement and Limited Waiver and
Consent
23.1 Consent of Independent Accountants
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
(c) Not applicable
(d) Not applicable
15
<PAGE>
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.
(Registrant)
Dated: April 30, 1997 \s\ Jerry R. Welch
------------------------------
Jerry R. Welch
Chairman of the Board, Chief
Executive Officer and
President
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
\s\ Jerry R. Welch April 30, 1997
- ----------------------------------
Jerry R. Welch, Chairman of the
Board, Chief Executive Officer
and President
\s\ Richard A. Kayne April 30, 1997
- ----------------------------------
Richard A. Kayne, Director
\s\ Andrew D. Feshbach April 30, 1997
- ----------------------------------
Andrew D. Feshbach, Director
\s\ Robert R. Hollman April 30, 1997
- ----------------------------------
Robert R. Hollman, Director
\s\ Fred Kayne April 30, 1997
- ----------------------------------
Fred Kayne, Director
\s\ David Warnock April 30, 1997
- ----------------------------------
David Warnock, Director
\s\ Howard M. Zelikow April 30, 1997
- ----------------------------------
Howard M. Zelikow, Director
\s\ Gina M. Shauer April 30, 1997
- ------------------------------------
Gina M. Shauer, Chief Financial
Officer (Principal Financial and
Accounting Officer)
16
<PAGE>
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 13 present fairly, in all
material respects, the financial position of The Right Start, Inc. and its
subsidiary at February 1, 1997 and June 1, 1996, and the results of their
operations and their cash flows for the thirty-three weeks ended February 1,
1997 and each of the two fiscal years in the period ended June 1, 1996, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
\s\ Price Waterhouse LLP
PRICE WATERHOUSE LLP
Los Angeles, California
April 30, 1997
F-1
<PAGE>
THE RIGHT START, INC.
CONSOLIDATED BALANCE SHEET
---------------------------
<TABLE>
<CAPTION>
February 1, June 1,
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
------
Current assets:
Cash $ 313,000 $ 472,000
Accounts receivable 938,000 609,000
Note receivable 200,000
Merchandise inventories 7,664,000 5,264,000
Prepaid catalog expenses 782,000 713,000
Deferred pre-opening costs, net 543,000 531,000
Other current assets 1,264,000 764,000
----------- -----------
11,704,000 8,353,000
----------- -----------
Property, plant and equipment, net 9,841,000 7,363,000
Other noncurrent assets 37,000 152,000
Deferred income tax benefit 1,400,000 1,607,000
----------- -----------
11,278,000 9,122,000
----------- -----------
$22,982,000 $17,475,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 6,076,000 $ 3,976,000
Accrued salaries and bonuses 517,000 530,000
Advance payments on orders 31,000 143,000
Revolving line of credit 1,833,000
----------- -----------
8,457,000 4,649,000
----------- -----------
Note payable 2,643,000
Convertible subordinated debentures 3,000,000
Deferred rent 1,710,000 924,000
----------- -----------
7,353,000 924,000
----------- -----------
Commitments and contingencies
Shareholders' equity:
Common stock (25,000,000 shares authorized,
no par value; 8,153,639 and 7,939,306 shares
issued and outstanding, respectively) 16,961,000 16,313,000
Accumulated deficit (9,789,000) (4,411,000)
----------- -----------
7,172,000 11,902,000
----------- -----------
$22,982,000 $17,475,000
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
THE RIGHT START, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
------------------------------------
<TABLE>
<CAPTION>
Thirty-three Fiscal Year Ended
weeks ended ---------------------------
February 1, June 1, May 31,
1997 1996 1995
------------- ------------ ------------
<S> <C> <C> <C>
Net sales:
Catalog $ 7,635,000 $23,293,000 $ 36,790,000
Retail 19,576,000 17,075,000 7,783,000
Other revenues 399,000 1,418,000 1,168,000
----------- ----------- ------------
27,610,000 41,786,000 45,741,000
----------- ----------- ------------
Costs and expenses:
Cost of goods sold 14,417,000 21,605,000 23,654,000
Operating expense 13,007,000 18,823,000 19,879,000
General and administrative expense 2,941,000 4,341,000 3,008,000
Pre-opening cost amortization 528,000 418,000 114,000
Depreciation and amortization expense 833,000 938,000 745,000
----------- ----------- ------------
31,726,000 46,125,000 47,400,000
----------- ----------- ------------
Operating loss (4,116,000) (4,339,000) (1,659,000)
Interest (expense) income, net (204,000) (37,000) 43,000
Other expense (851,000) (450,000)
Loss on sale of Children's Wear Digest (1,744,000)
----------- ----------- ------------
Loss before income taxes (5,171,000) (4,826,000) (3,360,000)
Income tax (provision) benefit (207,000) 927,000 1,254,000
----------- ----------- ------------
Net loss $(5,378,000) $(3,899,000) $ (2,106,000)
=========== =========== ============
Loss per share $ (0.67) $ (0.60) $ (0.33)
=========== =========== ============
Weighted average number of shares
outstanding 8,006,190 6,536,813 6,300,000
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
THE RIGHT START, INC.
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY
--------------------
<TABLE>
<CAPTION>
Common Stock
----------------------- Retained Earnings
Shares Amount (Accumulated Deficit)
--------- ----------- ---------------------
<S> <C> <C> <C>
Balance, May 25, 1994 6,300,000 $11,206,000 $ 1,594,000
Net loss (2,106,000)
--------- ----------- ------------
Balance 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 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 February 1, 1997 8,153,639 $16,961,000 $ (9,789,000)
========= =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
THE RIGHT START, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
<TABLE>
<CAPTION>
Thirty-three Fiscal Year Ended
weeks ended ---------------------------------
February 1, June 1, May 31,
1997 1996 1995
------------- --------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (5,378,000) $ (3,899,000) $ (2,106,000)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization 833,000 938,000 745,000
Pre-opening cost amortization 528,000 418,000 114,000
Loss on sale of Children's Wear Digest 1,744,000
Change in assets and liabilities affecting
operations (957,000) 506,000 (2,256,000)
------------ ------------ ------------
Net cash used in operating activities (4,974,000) (2,037,000) (1,759,000)
------------ ------------ ------------
Cash flows from investing activities:
Additions to property, plant and equipment (3,607,000) (4,165,000) (2,417,000)
Proceeds from sale of telemarketing center 298,000
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)
------------ ------------ ------------
Net cash (used in) provided by investing
activities (3,309,000) (4,165,000) 1,082,000
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from borrowings under
revolving line of credit 1,833,000
Proceeds from borrowings under note payable 2,643,000
Proceeds from borrowings under subordinated
debt agreements 3,000,000
Proceeds from common stock issued upon
exercise of stock options 648,000 201,000
Proceeds from common stock issued pursuant
a rights offering 4,906,000
------------ ------------
Cash provided by financing activities 8,124,000 5,107,000
------------ ------------
Net decrease in cash (159,000) (1,095,000) (677,000)
Cash at beginning of period 472,000 1,567,000 2,244,000
------------ ------------ ------------
Cash at end of period $ 313,000 $ 472,000 $ 1,567,000
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
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. This reflects a
change from the Company's previous fiscal year which was the fifty-two or fifty-
three weeks ending on the Saturday (formerly Wednesday) closest to the last day
in May. The change in year end results in a thirty-three week transition period
from June 2, 1996 to February 1, 1997 ("the Transition Period"). The fiscal
year ended June 1, 1996 ("Fiscal 1996") was a fifty-two week period and the
fiscal year ended May 31, 1995 ("Fiscal 1995") was a fifty-three week period.
See Note 13.
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 is three months. The Company adopted Statement of Position
Number 93-7 (SOP 93-7), "Reporting on Advertising Costs", in the fourth quarter
of fiscal year 1995. The adoption of SOP 93-7 did not result in a
F-6
<PAGE>
NOTE 1: (Continued)
- ------
material impact on the Company's consolidated financial position or results of
operations. Catalog production expenses of $1,844,000, $6,061,000 and
$9,457,000 were recorded in 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.
Store Opening Costs
- -------------------
Costs incurred in opening stores are deferred and are amortized over 12 months
commencing with the store opening.
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.
Other Revenues
- --------------
Other revenues include rentals of customer mailing lists and revenues from order
fulfillment services.
Per Share Data
- --------------
Per share data is computed in accordance with the treasury stock method based
upon the weighted average number of common shares and dilutive common stock
equivalents outstanding. Common stock equivalents comprise options outstanding
under Key Executive, Employee and Non-Employee Director Plans (see Note 7).
F-7
<PAGE>
NOTE 1: (Continued)
- ------
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 year 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.
NOTE 2 - PROPERTY, PLANT AND EQUIPMENT, NET:
- -------------------------------------------
<TABLE>
<CAPTION>
February 1, June 1,
1997 1996
----------- ----------
<S> <C> <C>
Property, plant and equipment, at cost:
Machinery, furniture and equipment $ 3,728,000 $ 3,761,000
Leaseholds and leasehold improvements 7,676,000 5,316,000
Construction in progress 551,000 322,000
Computer software 693,000 570,000
----------- -----------
12,648,000 9,969,000
Accumulated depreciation and amortization (2,807,000) (2,606,000)
----------- -----------
$ 9,841,000 $ 7,363,000
=========== ===========
</TABLE>
Depreciation and amortization expense for property, plant and equipment amounted
to $833,000, $935,000 and $645,000, for 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. This facility replaced the
Company's $5 million line of credit. The new $13 million facility consists of a
$3 million capital expenditure facility and a $10 million revolving credit line
for working capital. Both lines of credit are for a period of three years,
F-8
<PAGE>
NOTE 3: (Continued)
- ------
are secured by substantially all the Company's assets and require that certain
financial covenants, including minimum net worth, be maintained. 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 February 1, 1997, the banks prime
rate of interest was 8.25%. As of February 1, 1997 the Company was not in
compliance with certain financial covenants. The financial institution agreed
to amend the terms of the agreement and waive the covenant violations as of
February 1, 1997.
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 permit the holders to convert the principal amount into 500,000
shares of the Company's common stock at $6.00 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. A principal of the holders of the debentures is a member
of the Company's Board of Directors.
NOTE 4 - INCOME TAXES:
- ---------------------
The provision (benefit) for income taxes is comprised of the following:
<TABLE>
<CAPTION>
Thirty-three Fiscal Year Ended
weeks ended -----------------------------
February 1, June 1, May 31,
1997 1996 1995
------------- ----------- ------------
<S> <C> <C> <C>
Current provision (benefit):
Federal $ (424,000)
State $ 1,000
--------- -----------
1,000 (424,000)
--------- -----------
Deferred provision (benefit):
Federal (928,000) (725,000)
State (105,000)
Adjustment to valuation allowance $ 207,000
--------- --------- -----------
207,000 (928,000) (830,000)
--------- --------- -----------
$ 207,000 $(927,000) $(1,254,000)
========= ========= ===========
</TABLE>
F-9
<PAGE>
NOTE 4: (Continued)
- ------
The Company's effective income tax rate differed from the federal statutory rate
as follows:
<TABLE>
<CAPTION>
Thirty-three Fiscal Year Ended
weeks ended ---------------------------------
February 1, June 1, May 31,
1997 1996 1995
------------- --------------- ---------------
<S> <C> <C> <C>
Federal statutory rate 34% 34% 34%
State income taxes, net of federal benefit 1 3 2
Stock options 4
Valuation allowance (45) (19)
Other 2 1 1
---- ---- ----
Effective tax rate (4%) 19% 37%
==== ==== ====
</TABLE>
Deferred tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
February 1, June 1, May 31,
1997 1996 1995
------------- --------------- ---------------
<S> <C> <C> <C>
Depreciation and amortization $ 236,000 $ 112,000 $ 133,000
Preopening costs 225,000 220,000 115,000
Other 68,000 11,000 8,000
------------ ------------ ----------
Deferred tax liabilities 529,000 343,000 256,000
------------ ------------ ----------
Deferred rent (708,000) (380,000) (102,000)
Sales returns and other reserves (277,000) (184,000) (43,000)
Net operating loss carryforward (4,157,000) (2,256,000) (763,000)
Other tax carryforwards (67,000) (70,000) (27,000)
------------ ------------ ----------
Deferred tax assets (5,209,000) (2,890,000) (935,000)
------------ ------------ ----------
Valuation allowance 3,280,000 940,000
------------ ------------ ----------
Net deferred tax asset $ (1,400,000) $ (1,607,000) $ (679,000)
============ ============ ==========
</TABLE>
The Company's deferred tax asset is net of a valuation allowance of $3,280,000.
In evaluating the deferred tax asset, management considered the Company's
projections and available tax planning strategies.
The Company has federal and state net operating loss carryforwards at February
1, 1997 of $11,252,000 and $4,479,000, respectively. These carryforwards will
expire in fiscal years ending 2002 through 2012.
F-10
<PAGE>
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.
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 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 February 1,
1997, 521,000 shares were outstanding under this plan. Subsequent to February
1, 1997, 440,000 options issued under this plan were exercised.
One of the executives covered by this plan was the Company's chief executive
officer who resigned in March 1996. His employment agreement called for a
severance of approximately $450,000. The other executive covered by this plan
was the Company's president who resigned in October 1996. His employment
contract called for a severance of approximately $280,000. The majority of each
individual's severance represents the cash surrender value of a life insurance
policy and the remainder will be paid out monthly through May 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
F-11
<PAGE>
NOTE 7: (Continued)
- ------
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. Options for 341,717 shares were outstanding
as of February 1, 1997, 38,308 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, 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. These
options expire five years from the date of grant. 117,204 options were issued
under this plan, 61,902 of which are exercisable at February 1, 1997.
Prior to fiscal 1993, the employees of the Company participated in the ARC
Employee Stock Ownership Plan (ARC ESOP) and the ARC Employee Stock Purchase
Plan (ESPP). In 1993, the Company adopted an employee stock ownership plan
(ESOP) and employee stock purchase plan (ESPP) for the benefit of its employees.
The Company matches employees' contributions to the ESPP at a rate of 50%. The
Company's contributions amounted to $21,000, $28,000 and $58,000 in the
Transition Period, Fiscal 1996 and Fiscal 1995, respectively.
The ESOP is funded exclusively by discretionary contributions determined by the
Board of Directors. The Board of Directors authorized contributions of $70,000
in Fiscal 1996 and $50,000 in Fiscal 1995.
The following table summarizes option activity through February 1, 1997:
<TABLE>
<CAPTION>
Weighted
Average
Exercise Price
--------------
<S> <C> <C>
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
=========
</TABLE>
F-12
<PAGE>
NOTE 7: (Continued)
- ------
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:
<TABLE>
<CAPTION>
Thirty-three Fiscal
weeks ended year ended
February 1, June 1,
1997 1996
------------ ----------
<S> <C> <C>
Net loss:
As reported $(5,378,000) $(3,899,000)
Pro forma (5,839,000) (4,068,000)
Loss per share:
As reported $ (0.67) $ (0.60)
Pro forma (0.73) (0.62)
</TABLE>
These pro forma amounts may not be representative of future disclosures since
the estimated fair value of stock options is amortized to expense over the
vesting period, and additional options may be granted in future years. The fair
value for these options was estimated at the date of grant using the Black-
Scholes options-pricing model with the following weighted-average assumptions
for the Transition Period and Fiscal 1996, respectively: dividend yields of
zero percent; expected monthly volatility of 73.25 and 70.97 percent; risk free
interest rates of 6.36 and 6.10 percent; and expected life of four years for
both periods. The weighted average fair value of options granted during the
Transition Period and Fiscal 1996 for which the exercise price equals the market
price on the grant date was 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.
F-13
<PAGE>
NOTE 7: (Continued)
- ------
The following table summarizes information concerning currently outstanding and
exercisable stock options:
<TABLE>
<S> <C>
Range of exercise prices $3.00 - $6.50
Number of outstanding options 979,921
Weighted average remaining contractual life 8.7 years
Weighted average exercise price $3.70
Number of options exercisable 621,210
Weighted average price of exercisable options $3.22
</TABLE>
NOTE 8 - RELATED PARTY TRANSACTIONS:
- -----------------------------------
KAIM provides certain management services to the Company and charges the Company
for such services. Management fees of $66,667 and $83,333 were incurred in 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 $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.
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:
<TABLE>
<CAPTION>
Fiscal Year Ending
- ---------------------
<S> <C>
1998 $ 3,513,000
1999 3,599,000
2000 3,409,000
2001 3,453,000
2002 3,383,000
Thereafter 11,619,000
-----------
$28,976,000
===========
</TABLE>
F-14
<PAGE>
NOTE 9: (Continued)
- ------
Net rental expense under operating leases was $1,929,000, $1,959,000 and
$1,166,000 for the Transition Period, Fiscal 1996 and Fiscal 1995, respectively.
Percentage rents incurred in the Transition Period and Fiscal 1996 amounted to
$54,000 and $82,000, respectively.
NOTE 10 - COMMITMENTS AND CONTINGENCIES:
- ---------------------------------------
The Company is not party to any material legal actions.
NOTE 11 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- ----------------------------------------------------------
Changes in assets and liabilities, net of effects of acquisition and subsequent
disposition of CWD, which increased (decreased) cash and equivalents are as
follows:
<TABLE>
<CAPTION>
Thirty-three Fiscal Year Ended
weeks ended ---------------------------
February 1, June 1, May 31,
1997 1996 1995
------------- ----------- -------------
<S> <C> <C> <C>
Accounts receivable $ (329,000) $ (126,000) $ 300,000
Note receivable (200,000)
Merchandise inventories (2,400,000) (122,000) (724,000)
Prepaid catalog expenses (69,000) 268,000 731,000
Income taxes receivable 472,000 (280,000)
Other current assets (500,000) (835,000) (699,000)
Deferred pre-opening costs (540,000)
Other noncurrent assets 113,000 142,000 (42,000)
Accounts payable and accrued expenses 2,100,000 753,000 (491,000)
Accrued salaries and bonuses (13,000) 292,000 (84,000)
Advance payments on orders (112,000) (15,000) (112,000)
Amounts due to ARC (71,000) (58,000)
Income tax liability (31,000)
Deferred income taxes 207,000 (928,000) (830,000)
Other liabilities (97,000) (17,000)
Deferred rent 786,000 773,000 81,000
----------- ---------- ------------
$ (957,000) $ 506,000 $ (2,256,000)
=========== ========== ============
</TABLE>
Cash paid for income taxes was $7,000 for the Transition Period. Non-cash
investing activity consists of a $250,000 note received upon the sale of the
phone center operations (see Note 5).
F-15
<PAGE>
NOTE 12 - NEW ACCOUNTING PRONOUNCEMENTS:
- ---------------------------------------
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"). FAS
128 will be effective for the Company for the year ending January 31, 1998. The
statement requires that basic earnings per share ("EPS") be presented instead of
primary EPS. It also requires both basic and diluted EPS be presented on the
face of the income statement, if applicable, as well as additional disclosures
on the components of EPS.
NOTE 13 - COMPARABLE PRIOR YEAR PERIOD (unaudited):
- --------------------------------------------------
As described in Note 1, the Company changed its fiscal year end. Comparable
results of operations for the thirty-three weeks ended February 3, 1996 are as
follows:
<TABLE>
<S> <C>
Net sales:
Catalog $16,573,000
Retail 9,894,000
Other revenues 1,185,000
-----------
27,652,000
Cost of goods sold 13,864,000
Other expenses, net 15,068,000
-----------
Loss before income taxes (1,280,000)
Income tax benefit 523,000
-----------
Net loss $ (757,000)
===========
Loss per share $ (0.12)
===========
Weighted average number
of shares outstanding 6,302,534
</TABLE>
F-16
<PAGE>
THE RIGHT START, INC.
SCHEDULE VIII - VALUATION RESERVES
<TABLE>
<CAPTION>
Additional
Balance at charged Balance at
beginning to costs end
Classification of period and expenses Deductions of period
- --------------------------------------- ----------- ------------- ----------- ----------
<S> <C> <C> <C> <C>
Thirty-three weeks ended February 1, 1997
- -----------------------------------------
Allowance for deferred tax asset $ 940,000 $2,340,000 $3,280,000
Allowance for sales returns 103,000 103,000
---------- ---------- -------- ----------
$1,043,000 $2,340,000 $3,383,000
========== ========== ======== ==========
Fiscal year ended June 1, 1996
- ------------------------------
Allowance for deferred tax asset $ 940,000 $940,000
Allowance for sales returns $ 103,000 103,000
---------- ---------- -------- ----------
$ 103,000 $ 940,000 $1,043,000
========== ========== ======== ==========
Fiscal year ended May 31, 1995
- ------------------------------
Allowance for sales returns $226,000 $123,000 $ 103,000
---------- ---------- -------- ----------
$226,000 $123,000 $ 103,000
========== ========== ======== ==========
</TABLE>
F-17
<PAGE>
EXHIBIT 10.17
FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT
AND LIMITED WAIVER AND CONSENT
This FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LIMITED WAIVER
AND CONSENT (this "Amendment") is dated as of April 30, 1997 and entered into by
and between THE RIGHT START, INC., a California corporation ("Borrower") and
HELLER FINANCIAL, INC. ("Lender").
WHEREAS, Borrower and Lender have entered into that certain Loan and
Security Agreement dated as of November 14, 1996 (the "Loan Agreement");
WHEREAS, Borrower has failed to meet the covenants set forth in
Section 6 of the Loan Agreement and therefore Events of Default exist under the
Loan Agreement;
WHEREAS, Borrower has requested that Lender waive the existing Events
of Default and agree to amend the financial covenants in Section 6 of the Loan
Agreement and consent to Borrower's change of its Fiscal Year and incurrence of
additional subordinated indebtedness;
WHEREAS, Lender is willing to grant a limited waiver of the existing
Events of Default and to amend the Loan Agreement as provided herein;
NOW, THEREFORE, in consideration of the premises and the agreements,
provisions and covenants in the Loan Documents and herein, Borrower and Lender
agree as follows:
1. Definitions. All capitalized terms used herein without definition
------------
shall have the meanings given such terms in the Loan Agreement.
2. Amendments to subsection 1.1 of the Loan Agreement. Subsection
---------------------------------------------------
1.1 of the Loan Agreement is amended as follows:
2.1 The definitions of "Fiscal Year" and "Net Worth" are
deleted and replaced by the following:
"Fiscal Year" means each fifty-two or fifty-three week period
ending on the Saturday which is nearest to the end of May in each year to
and including May 31, 1996 or, effective January 31, 1997, January in each
year thereafter.
"Net Worth" means, as of any date, the sum of (a) capital stock,
plus (b) additional paid-in capital, plus (c) retained earnings (or minus
---- ---- -----
accumulated deficit) plus (d) the outstanding principal balance of the
----
Subordinated Debt, each individually calculated in conformity with GAAP.
<PAGE>
2.2 The definition of "Subordinated Debt" is amended to add at
the end thereof "and the New Subordinated Debt".
2.3 The following definition is added in the appropriate
alphabetical order:
"New Subordinated Debt" means Indebtedness of Borrower in an
aggregate original principal amount not to exceed $3,000,0000, which is on
terms and conditions (including covenants, events of default and
subordination) satisfactory to Lender.
3. Amendment to subsection 2.1(G)(1) of the Loan Agreement.
--------------------------------------------------------
Subsection 2.1(G)(1) of the Loan Agreement is amended to delete "$1,000,000" and
replace it with "$2,000,000.
4. Amendments to Section 6 of the Loan Agreement.
----------------------------------------------
4.1 Subsection 6.2 is deleted and replaced with the following:
"6.2 Interest Coverage. Borrower shall not permit Interest
------------------
Coverage (a) for the fiscal quarter ending January 31, 1998 to be less than
1.5 to 1; (b) for the two fiscal quarter period ending April 30, 1998 to be
less than 1.0 to 1; (c) for the three fiscal quarter period ending July 31,
1998 to be less than 1.5 to 1; and (d) for the four fiscal quarter period
ending at the end of each fiscal quarter thereafter to be less than 2.0 to
1."
4.2 A new Subsection 6.3 is add to the Loan Agreement as
follows:
"6.3 Minimum EBITDA. Borrower shall have a minimum EBITDA for
---------------
the fiscal quarter ending July 31, 1997 of no more negative
than ($1,850,000) and for the fiscal quarter ending October
31, 1997 of no more negative than ($2,250,000)."
5. Amendment to subsection 8.1(F) of the Loan Agreement. Subsection
----------------------------------------------------
8.1(F) of the Loan Agreement is amended to add the following clause (2):
"or (2) a "Change of Control" occurs under (and as defined in)
any instrument or agreement governing any Subordinated Debt;"
6. Limited Waiver.
---------------
6.1 Borrower acknowledges that Borrower has failed to comply with the
minimum Net Worth required by subsection 6.1 of the Loan Agreement at January
31, 1997, March 1, 1997 and April 5, 1997 and failed to meet the Interest
Coverage required by subsection 6.2
<PAGE>
of the Loan Agreement for the fiscal quarter ending March 1, 1997 and that such
failures constitute Events of Default under Section 8 of the Loan Agreement (the
"Specified Events of Default").
6.2 On the Effective Date of this Agreement (as defined in Paragraph
7 below), the Specified Events of Default are hereby waived. The waiver
contained herein is limited to the Specified Events of Default existing on the
Effective Date and shall not extend to any future occurrence of any Event of
Default under such subsections or any other Default or Event of Default, and
Lender's granting of such waiver shall not obligate it to grant any similar or
other future waiver of any Default or Event of Default.
7. Conditions to the Effectiveness of this Amendment. Each of the
---------------------------------------------------
following shall be conditions precedent to the effectiveness of this Amendment
(the date on which such conditions are met being the "Effective Date"):
7.1 Borrower shall have executed and delivered a counterpart of
this Amendment to Lender.
7.2 After giving effect to this Amendment, (a) no Default or
Event of Default shall exist, (b) all of the representations and warranties
contained in the Loan Documents shall be true and correct in all material
respects, (c) Borrower shall have performed in all material respects all
agreements and satisfied all conditions which any Loan Documents provides shall
be performed by it on or prior to such date, and (d) Borrower shall have
delivered to Lender a certificate to such effect in the form attached hereto.
7.3 Borrower shall have obtained such consents and amendments to
the agreements governing the Subordinated Debt as necessary or appropriate to
permit the transactions contemplated by this Amendment, all in form and
substance acceptable to Lender.
7.4 Borrower shall have delivered to Lender a preliminary draft
of its audited financial statements for the Fiscal Year ended February 1, 1997,
which shall be in form and substance satisfactory to Lender.
7.5 Borrower shall have delivered to Lender a certificate of its
Secretary or an Assistant Secretary, certifying the resolutions of its Board of
Directors authorizing this Amendment and as to the incumbency of the officers
executing this Amendment.
8. Covenants of Borrower. Borrower covenants and agrees that it will
----------------------
comply with the following Paragraphs, and acknowledges that failure to comply
with such covenants shall constitute an Event of Default, without regard to any
grace or cure period that may exist under the Loan Agreement.
<PAGE>
8.1. The final financial statements for the 1996 Fiscal Year
(the eight month period ending February 1, 1997) delivered to Lender pursuant to
subsection 5.1(C) of the Loan Agreement shall not be materially different from
the draft thereof delivered to Lender on or prior to the Effective Date, and
shall be accompanied by the unqualified opinion of independent certified public
accountants.
8.2 On or before May 30, 1997 Borrower shall have obtained the
New Subordinated Debt, and Lender shall have approved the terms and conditions
thereof.
9. Effect of Amendment. From and after the Effective Date, all
--------------------
references in the Loan Documents to the Loan Agreement shall mean the Loan
Agreement as amended hereby. Except as expressly amended or waived herein, the
Loan Agreement and the other Loan Documents shall remain in full force and
effect.
10. Fees and Expenses. Borrower acknowledges that all fees and
------------------
expenses (including reasonable attorneys fees) incurred by Lender in connection
with this Amendment are for the account of Borrower pursuant to the Loan
Agreement.
11. Counterparts. This Agreement may be executed in any number of
-------------
counterparts, each of which when so executed and delivered shall be deemed an
original, but all such counterparts together shall constitute but one and the
same instrument.
12. Governing Law. This Amendment shall be governed by, and shall be
--------------
construed and enforced in accordance with, the internal laws of the State of
Illinois, without regard to conflicts of laws principles.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be duly executed by a duly authorized officer as of the date first above
written.
THE RIGHT START, INC.
By:___________________________
Its:__________________________
HELLER FINANCIAL, INC.
By:___________________________
Its:__________________________
<PAGE>
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 April 30, 1997 appearing on page F-1
of this Form 10-K.
\s\ Price Waterhouse LLP
PRICE WATERHOUSE LLP
Los Angeles, California
April 30, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 8-MOS
<FISCAL-YEAR-END> FEB-01-1997
<PERIOD-START> JUN-02-1996
<PERIOD-END> FEB-01-1997
<CASH> 313
<SECURITIES> 0
<RECEIVABLES> 938
<ALLOWANCES> 0
<INVENTORY> 7,664
<CURRENT-ASSETS> 11,704
<PP&E> 12,648
<DEPRECIATION> 2,807
<TOTAL-ASSETS> 22,982
<CURRENT-LIABILITIES> 8,457
<BONDS> 0
0
0
<COMMON> 16,961
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 22,982
<SALES> 27,211
<TOTAL-REVENUES> 27,610
<CGS> 14,417
<TOTAL-COSTS> 31,726
<OTHER-EXPENSES> 851
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 204
<INCOME-PRETAX> (5,171)
<INCOME-TAX> 207
<INCOME-CONTINUING> (5,171)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,378)
<EPS-PRIMARY> (0.67)
<EPS-DILUTED> (0.67)
</TABLE>
