SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
Form 10-Q
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(Mark one)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-19536
THE RIGHT START, INC.
(Exact name of registrant as specified by its charter)
California 95-3971414
(State or other jurisdiction of (I.R.S. Employer
incorporation or organiztion) Identification No.)
5388 Sterling Center Drive, Unit C, Westlake Village, CA 91361
(Address of principal executive offices) (Zip Code)
(818) 707-7100
(Registrant's telephone number, including area code)
- - --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No_______
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock Outstanding as of October 31, 1998 - 10,103,639 shares
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THE RIGHT START, INC.
INDEX TO FORM 10-Q
FOR THE THIRTEEN WEEK AND THIRTY-NINE WEEK PERIODS
ENDED OCTOBER 31, 1998
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Balance Sheet 3
Statement of Operations 4
Statement of Cash Flows 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 15
2
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<TABLE>
THE RIGHT START, INC.
BALANCE SHEET
(unaudited)
October 31, January 31,
1998 1998
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<S> <C> <C>
ASSETS
Current assets:
Cash $ 321,000 $ 240,000
Accounts and other receivables 249,000 405,000
Merchandise inventories 7,705,000 6,602,000
Prepaid catalog expenses 588,000 297,000
Other current assets 1,238,000 1,364,000
--------------- --------------
Total current assets 10,101,000 8,908,000
Property, plant and equipment, net 7,474,000 8,115,000
Other non-current assets 71,000 39,000
Deferred income tax benefit 1,400,000 1,400,000
--------------- --------------
$ 19,046,000 $ 18,462,000
=============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 4,468,000 $ 2,372,000
Accrued salaries and bonuses 348,000 380,000
Advance payments on orders 24,000 30,000
Note payable 2,014,000
--------------- --------------
Total current liabilities 4,840,000 4,796,000
Note payable long term 3,000,000 3,000,000
Senior subordinated notes due May 6, 2000 1,470,000
Senior subordinated notes due May 6, 2000 2,778,000 2,734,000
Subordinated convertible debentures due
May 31, 2002 3,000,000 3,000,000
Deferred rent 1,424,000 1,625,000
Shareholders' equity:
Common stock (25,000,000 shares authorized
at no par value; 10,103,639 issued and
outstanding) 22,337,000 22,337,000
Paid in capital 3,850,000
Accumulated deficit (23,653,000) (19,030,000)
--------------- --------------
$ 19,046,000 $ 18,462,000
=============== ==============
</TABLE>
3
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<TABLE>
THE RIGHT START, INC.
STATEMENT OF OPERATIONS
(unaudited)
Thirteen weeks ended Thirty-nine weeks ended
------------------------------- ------------------------------
October 31, November 1, October 31, November 1,
1998 1997 1998 1997
-------------- --------------- -------------- --------------
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Net sales:
Retail $ 7,176,000 $ 7,311,000 $ 22,296,000 $ 22,896,000
Catalog 897,000 1,910,000 3,573,000 6,214,000
-------------- --------------- -------------- --------------
8,073,000 9,221,000 25,869,000 29,110,000
Costs and expenses:
Cost of goods sold 4,076,000 4,486,000 13,232,000 14,717,000
Operating expense 3,423,000 4,857,000 11,472,000 14,525,000
General and administrative expense 850,000 1,059,000 2,627,000 2,997,000
Pre-opening costs 68,000 142,000 118,000 519,000
Depreciation and amortization expense 471,000 395,000 1,145,000 1,186,000
Other (income) expense 35,000 (113,000) 328,000
-------------- --------------- -------------- --------------
8,888,000 10,974,000 28,481,000 34,272,000
-------------- --------------- -------------- --------------
Operating loss (815,000) (1,753,000) (2,612,000) (5,162,000)
Interest expense 1,578,000 316,000 2,016,000 806,000
-------------- --------------- -------------- --------------
Loss before income taxes and
extraordinary item (2,393,000) (2,069,000) (4,628,000) (5,968,000)
Income tax provision 5,000 7,000 22,000 27,000
-------------- --------------- -------------- --------------
Loss before extraordinary item (2,398,000) (2,076,000) (4,650,000) (5,995,000)
Extraordinary gain on debt
restructuring 27,000
-------------- --------------- -------------- --------------
Net loss $ (2,398,000) $ (2,076,000) $ (4,623,000) $ (5,995,000)
============== =============== ============== ==============
Basic and diluted loss per share $ (0.24) $ (0.22) $ (0.46) $ (0.67)
============== =============== ============== ==============
Weighted average number of shares
outstanding 10,103,639 9,566,254 10,103,639 8,886,416
============== =============== ============== ==============
</TABLE>
4
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<TABLE>
THE RIGHT START, INC.
STATEMENT OF CASH FLOWS
(unaudited)
Thirty-nine weeks ended
-------------------------------------------
October 31, 1998 November 1, 1997
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Cash flows from operating activities:
Net loss $ (4,623,000) $ (5,995,000)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 1,195,000 1,705,000
Loss on store closings 39,000
Amortization of discount on subordinated notes 1,514,000 57,000
Changes in assets and liabilities affecting operations 813,000 (2,428,000)
Extraordinary gain on debt restructuring (27,000)
------------------- --------------------
Net cash used in operating activities (1,089,000) (6,661,000)
------------------- --------------------
Cash flows from investing activities:
Additions to property, plant and equipment (666,000) (1,614,000)
------------------- --------------------
Cash flows from financing activities:
Net borrowings (payments) under revolving line of credit (2,014,000) (239,000)
Proceeds from note payable, long term 357,000
Proceeds from issuance of senior subordinated notes 3,850,000
Proceeds from common stock issued upon
exercise of stock options 1,320,000
Proceeds from private placement of common stock 3,705,000
Proceeds from issuance of subordinated notes 3,000,000
------------------- --------------------
Net cash provided by financing activities 1,836,000 8,143,000
------------------- --------------------
Net increase in cash 81,000 (132,000)
Cash at beginning of period 240,000 313,000
------------------- --------------------
Cash at end of period $ 321,000 $ 181,000
=================== ====================
</TABLE>
5
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THE RIGHT START, INC.
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1: Description of Business and Significant Accounting Policies
The Right Start, Inc. is a specialty merchant offering unique, high-quality
juvenile products for infants and young children. The Company markets its
products through its retail stores and through The Right Start Catalog.
There have been no changes in the Company's significant accounting
policies as set forth in the Company's financial statements for the year ended
January 31, 1998. These unaudited financial statements as of October 31, 1998
and for the thirteen and thirty-nine week periods then ended have been prepared
in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Certain reclassifications have been made to conform prior
year amounts to current year presentation.
Operating results for the thirteen and thirty-nine week periods ended
October 31, 1998 are not necessarily indicative of the results that may be
expected for the year ending January 30, 1999.
NOTE 2: Recapitalization
In order to enhance the Company's liquidity and improve its capital
structure, effective April 13, 1998 the Company completed a private placement of
non-interest bearing senior subordinated notes in an aggregate principal amount
of $3,850,000, together with detachable warrants to purchase an aggregate of
3,850,000 shares of common stock exercisable at $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 were 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, however,
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 the approval of
the Company's shareholders, which approval the Company expects to obtain at its
annual meeting.
6
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NOTE 2: (Continued)
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 $1.00. As of the date of issue of the new securities, the
stock was trading at $2.00 a share. Since the conversion feature was in the
money at the date of issue of the debt, the portion of the debt proceeds equal
to the beneficial conversion feature of $3.85 million was allocated to
additional paid in capital. The resulting debt discount of $3,850,000 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,
scheduled to be in December, 1998, was used to determine the amortization
period. 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 Series B 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 $.6 million in annual interest
payments. In addition, the proceeds from the Company's private placement of
$3,850,000 were used to pay off the Company's revolving line of credit. 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.
NOTE 3: Extraordinary Gain
Effective April 13, 1998, the holders of the Company's $3.0 million
subordinated notes and $3.0 million subordinated convertible debentures agreed
to waive their right to receive any and all interest payments accrued and owing
on or after February 28, 1998. This modification of terms was accounted for
prospectively, from the effective date, under Statement of Financial Accounting
Standards No. 15 "Accounting by Debtors and Creditors for Troubled Debt
Restructurings" as follows.
The carrying amount of the subordinated notes as of April 13, 1998 was
not changed as the carrying amount of the debt did not exceed the total future
cash payments of $3.0 million specified by the new terms. Interest expense was
computed using the interest method to apply a constant effective interest rate
to the payable balance between the modification date of April 13, 1998 and
maturity of the payable in May 2000.
The total future cash payments specified by the new terms of the
convertible debentures of $3.0 million is less than the carrying amount of the
liability to the debenture holders of $3,027,000, therefore, the carrying amount
was reduced to an amount equal to the total future cash payments specified by
the new terms and the Company recognized a gain on restructuring of payables
equal to the amount of the reduction as of April 13, 1998. No interest expense
shall be recognized on the payable for any period between the modification date
of April 13, 1998 and maturity of the payable in May 2002.
7
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NOTE 4: 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 652,000 and 662,000 shares of common stock at October 31, 1998 and
November 1, 1997, 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, $3,850,000 of subordinated debt was issued with
3,850,000 detachable warrants in April 1998 enabling the holder to purchase
3,850,000 shares of common stock at $1.00 per share. This could potentially
dilute basic EPS in the future.
NOTE 5: Supplemental Disclosure of Cash Flow Information
Interest paid amounted to $392,000 and $670,000 for the thirty-nine
weeks ended October 31, 1998 and November 1, 1997, respectively. Cash paid for
income taxes was $4,000 and $5,000 for the thirty-nine weeks ended October 31,
1998 and November 1, 1997, respectively.
Changes in assets and liabilities which increased (decreased) cash are
as follows:
<TABLE>
Thirty-nine weeks ended
-------------------------------------
October 31, 1998 November 1, 1997
<S> <C> <C>
Accounts and other receivables $ 156,000 $ 491,000
Merchandise inventories (1,103,000) (1,681,000)
Prepaid catalog expenses (291,000) 217,000
Other current assets 76,000 (348,000)
Other non-current assets (32,000) 2,000
Accounts payable and accrued expenses 2,113,000 (1,339,000)
Accrued salaries and bonuses (32,000) (132,000)
Advance payments on orders (6,000) 42,000
Deferred rent (68,000) 320,000
----------- -----------
$ 813,000 $(2,428,000)
=========== ===========
</TABLE>
8
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Statements in this Form 10-Q that are not purely historical are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements with respect to
the financial condition and results of operations of the Company involve risks
and uncertainties which are detailed further in the filings of the Company with
the Securities and Exchange Commission, including, but not limited to, the
Company's Registration Statement on Form S-3 (File No. 333-08157), its Annual
Report on Form 10-K/A for the year ended January 31, 1998 and its quarterly
report on Form 10-Q/A for the thirteen weeks ended August 1, 1998.
Thirteen weeks ended October 31, 1998 compared with November 1, 1997
Net sales for the thirteen weeks ended October 31, 1998 declined 12% to
$8.1 million from $9.2 million for the same period last year. For the quarter,
retail net sales declined 2% to $7.2 million as compared to $7.3 million last
year, while catalog net sales decreased 53% to $.9 million from $1.9 million
last year. Retail sales reflect sales increases due to five store openings
during and since the third quarter of the prior fiscal year offset by ten store
closings during the first three quarters of the current fiscal year; the net
impact of store openings and closures is an 8% decline in retail sales.
Offsetting this decline is an increase in same-store sales of 6%. The reduction
in catalog net sales is due to the Company's decision to significantly reduce
circulation and operate the catalog at a smaller and more profitable level.
Cost of goods sold decreased $.4 million or 9%, resulting in a gross
margin of 50% as compared to 51% last year. The slight decline in gross margin
reflects the net impact of increased promotional activity offset by the
introduction of higher margin products and product lines including developmental
toys, books, videos and other media.
Operating expense was $3.4 million in the third quarter of 1998 as
compared to $4.9 million in the third quarter of 1997, representing a 30%
decrease. Retail operating expense decreased 14%, primarily due to reductions in
occupancy costs, in merchandise warehousing costs and in labor costs.
Additionally, catalog operating expense decreased 69% due to the decrease in
catalog sales and decreased catalog production costs.
General and administrative expense decreased 20% to $850,000 during the
third quarter of 1998 from $1,059,000 during the same period last year. The
Company has continued its trend of significantly reduced general and
administrative expenses. These costs represent the Company's corporate overhead
expenses which are fixed in nature and do not vary directly with changes in
sales.
Depreciation and amortization expense increased to $471,000 during the
third quarter of 1998 from $395,000 during the same period last year. The 19%
increase is primarily due to the revision of the estimated useful lives for
certain existing assets, which assets will be fully depreciated during the
fourth quarter of fiscal 1998.
Interest expense of $1,578,000 includes $1,466,000 of debt discount
amortization recorded in connection with the accounting for the $3.85 million of
new securities issued in April 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 $1.00. As of the date of issue of the
new securities the common stock was trading a $2.00 a share. Since the
conversion feature was in the money at the date of issue of the debt, the
portion of the debt proceeds equal to the beneficial conversion feature of $3.85
million was allocated to additional paid in capital. The resulting debt discount
of $3.85 million 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 date when the
debt is exchanged for convertible preferred stock. Since the exchange
transaction was subject to a proxy vote by the shareholders, the expected date
of the shareholder vote, scheduled to be in December, 1998, was used to
determine the amortization period. The vote approving the transaction was
obtained December 15, 1998.
9
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The remaining $112,000 of interest expense for the three quarters ended
October 31, 1998 reflects a 65% decrease as compared to the third quarter of
1997. The decrease reflects the elimination of interest expense on the Company's
subordinated convertible debentures and the reduction of interest expense on the
Company's $2,778,000 of senior subordinated notes, both due to the restructuring
that took place in conjunction with the Company's April 1998 recapitalization
transaction. Further, the Company had lower outstanding balances on its line of
credit during the first three quarters of 1998 as compared to the comparable
period of 1997.
Thirty-nine Weeks Ended October 31, 1998 Compared With November 1, 1997
Net sales for the thirty-nine weeks ended October 31, 1998 declined 11%
to $25.9 million from $29.1 million for the same period last year. Retail net
sales declined 3% to $22.3 million as compared to $22.9 million last year, while
catalog net sales decreased 43% to $3.6 million from $6.2 million last year.
Retail sales reflect the sales declines due to ten store closings during the
first three quarters of the current fiscal year, offset by sales increases due
to five store openings during and since the third quarter of the prior fiscal
year; the net impact of store openings and closures is a 2% decline in retail
sales. The remaining 1% decline represents the Company's same-store sales
results. The reduction in catalog net sales is due to the Company's decision to
significantly reduce circulation and operate the catalog at a smaller and more
profitable level.
Cost of goods sold decreased $1.5 million or 10%, resulting in a gross
margin of 49% in the current and prior year. This reflects the introduction of
higher margin products and product lines including developmental toys, books,
videos and other media, offset by the impact of certain marketing and
promotional programs.
Operating expense was $11.5 million in the first three quarters of 1998
as compared to $14.5 million in 1997, representing a 21% decrease. Retail
operating expense decreased 10%, primarily due to reductions in merchandise
warehousing costs and reduced labor costs. Additionally, catalog operating
expense decreased 51% in line with management's plan to operate a smaller, more
profitable catalog.
General and administrative expense decreased 12% to $2,627,000 during
the first three quarters of 1998 from $2,997,000 during thae same period last
year. The Company has continued its trend of significantly reduced general and
administrative expenses.
Depreciation and amortization expense decreased to $1,145,000 during the
first three quarters of 1998 from $1,186,000 during the same period last year.
The 3% decrease is primarily due to the expense reduction associated with fixed
assets that were written off in conjunction with the closure of eight stores,
the relocation of the Company's distribution facility and the move of the
Company's corporate office. These decreases were offset by the expense
associated with the fixed asset additions for the new stores opened in fiscal
1997.
Other (income) expense is comprised of net revenues generated from store
closings in the Fiscal 1998. In the same period of the prior year, other expense
represents the write-off of fixed assets abandoned in conjunction with the
relocation of the Company's distribution facility and severance expense.
Interest expense of $2,016,000 includes $1,470,000 of debt discount
amortization recorded in connection with the accounting for the $3.85 million of
new securities issued in April 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 $1.00. As of the date of issue of the
new securities the common stock was trading a $2.00 a share. Since the
conversion feature was in the money at the date of issue of the debt, the
portion of the debt proceeds equal to the beneficial conversion feature of $3.85
million was allocated to additional paid in capital. The resulting debt discount
of $3,850,000 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 was subject to a proxy vote by the shareholders, the expect date of
the shareholder vote, scheduled to be in December, 1998, was used to determine
the amortization period. The vote approving the transaction was obtained
December 15, 1998.
10
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The remaining $546,000 of interest expense for the three quarters ended
October 31, 1998 reflects a 32% decrease as compared to the third quarter of
1997. The decrease reflects the elimination of interest expense on the Company's
subordinated convertible debentures and the reduction of interest expense on the
Company's $2,778,000 of senior subordinated notes, both due to the restructuring
that took place in conjunction with the Company's April 1998 recapitalization
transaction. Further, the Company had lower outstanding balances on its line of
credit during the first three quarters of 1998 as compared to the comparable
period of 1997.
The Company has a deferred tax asset of $10.3 million, which is reserved
by a valuation allowance of $8.9 million, for a net tax benefit of $1.4 million.
Management expects that the Company will generate at least $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 net operating loss ("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. 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.
Liquidity and Capital Resources
During the first three quarters of Fiscal 1998, 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 approximately
$3.9 million of non-interest bearing senior subordinated notes with warrants.
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. As of October 31, 1998, borrowings of $3,000,000 were
outstanding under the Capex Line. There were no borrowings and approximately
$3.5 million 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: $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. The Company was
not in compliance with this requirement at October 31, 1998, which event of
non-compliance the Lender waived. 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. 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, 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, representing an
aggregate principal amount of $6,000,000. Pursuant to the agreement, each holder
(of old and new 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,
11
<PAGE>
respectively. Holders of $3,000,000 principal amount 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
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 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 the approval of
the Company's shareholders, which approval the Company obtained at its annual
meeting on December 15, 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 $1.00. As of the date of issue of the new securities the
common stock was trading at $2.00 a share. Since the conversion feature was in
the money at the date of issue of the debt, the portion of the debt proceeds
equal to the beneficial conversion feature of $3.85 million was allocated to
additional paid in capital. The resulting debt discount of $3.85 million 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 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 December, 1998, was used to determine the amortization
period. 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
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, however,
management does not believe that the transactions will have a material adverse
effect on the Company's financial position or results of operations.
The discount inherent in the $3,850,000 of new securities must be
amortized to interest expense over the period from the April issuance date to
the date the security is first convertible. This treatment is required by
generally accepted accounting principles. In accordance with the agreement,
however, no interest payments will be made. Further, for the fiscal year ended
January 30, 1999, there will be no impact on total shareholders' equity as a
result of the interest amortization.
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
payments. In addition, the proceeds from the Company's private placement of
$3,850,000 were used to pay off the Company's revolving
12
<PAGE>
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.
Other Matters
Year 2000
The year 2000 problem is the result of computer programs being written
using two digits (rather that 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 that the year 2000 which could result in
miscalculations or system failures.
The Company is currently working to identify and resolve all potential
issues relating to the year 2000 on the processing of date-sensitive information
by the Company's computerized information system. For purposes of addressing the
issues and planning the appropriate resolutions, the Company has segregated its
internal systems and individually assessed their state of readiness as follows:
<TABLE>
Phase of Planning ("x"indicates phase is complete)
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SYSTEM AWARENESS ASSESSMENT RENOVATION VALIDATION IMPLEMENTATION
Credit Card Processing x x x x x
Inventory Maintenance x x x
Accounting and Reporting x x x
Point of Sale Transactions x
Non-computerized systems x x
(none are material to the
Company's operations)
</TABLE>
In addition to resolving any year 2000 issues on the Company's internal
systems, the Company is working with its third party vendors in implementing the
appropriate solutions. The Company estimates that the maximum, worst-case cost
of addressing its year 2000 issues is approximately $125,000 for hardware and
software.
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"). This statement requires that the costs of start-up
activities and organization costs be expensed as incurred. The impact of SOP
98-5 is not expected to be material to the Company's financial position or
results of operations. Effective October 1, 1997, the Company began expensing
all store pre-opening costs as incurred.
Nasdaq Market Listing
As previously disclosed, the Company received notice from the staff of
The Nasdaq Stock Market, Inc. ("Nasdaq") that it was not in compliance with the
Nasdaq's new minimum net tangible assets requirement of $4 million and that
Nasdaq intended to delist the Company's common stock. In accordance with the
Nasdaq's procedures, the Company filed an appeal with the Nasdaq's Listings
Hearing Department which would allow the Company to maintain its listed status
pending the outcome of the appeal.
The Company received notice from Nasdaq that the Company would continue
its listing on the Nasdaq National Market. Such ruling is subject to the Company
meeting certain conditions, the most significant of which is that it complete
its recapitalization. The Company obtained a vote in favor of its
recapitalization at its annual shareholders meeting on December 15, 1998.
13
<PAGE>
PART II
Item 6. Exhibits and Reports on Form 8-K
The Company filed a Report on Form 8-K on October 14, 1998 which reported the
press release issued on that date. No other Reports on Form 8-K were filed
during the third quarter of Fiscal 1998.
The following exhibits of The Right Start, Inc. are included herein.
Exhibit
Number
27 Financial Data Schedule
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
and thereunto duly authorized.
THE RIGHT START, INC.
Date: December 15, 1998 /s/JERRY WELCH
-----------------------
Jerry Welch
Chief Executive Officer
Date: December 15, 1998 /s/GINA M.SHAUER
-----------------------
Gina M. Shauer
Chief Financial Officer
15
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-30-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 321
<SECURITIES> 0
<RECEIVABLES> 249
<ALLOWANCES> 0
<INVENTORY> 7,705
<CURRENT-ASSETS> 10,101
<PP&E> 11,615
<DEPRECIATION> 4,141
<TOTAL-ASSETS> 19,046
<CURRENT-LIABILITIES> 4,840
<BONDS> 0
0
0
<COMMON> 22,337
<OTHER-SE> 3,850
<TOTAL-LIABILITY-AND-EQUITY> 19,046
<SALES> 25,869
<TOTAL-REVENUES> 25,869
<CGS> 13,232
<TOTAL-COSTS> 28,481
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,016
<INCOME-PRETAX> (4,628)
<INCOME-TAX> 22
<INCOME-CONTINUING> (4,650)
<DISCONTINUED> 0
<EXTRAORDINARY> 27
<CHANGES> 0
<NET-INCOME> (4,623)
<EPS-PRIMARY> (0.46)
<EPS-DILUTED> (0.46)
</TABLE>
