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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 2
- --------------------------------------------------------------------------------
(MARK ONE)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the thirteen week period ended May 2, 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.
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(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
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(Address of principal executive offices) (Zip Code)
(818) 707-7100
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(Registrant's telephone number, including area code)
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(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 May 28, 1998 - 10,103,639 shares
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THE RIGHT START, INC.
INDEX TO FORM 10-Q/A
FOR THE THIRTEEN WEEK PERIOD
ENDED MAY 2, 1998
PART I - FINANCIAL INFORMATION
<TABLE>
<S> <C>
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 10
</TABLE>
PART II - OTHER INFORMATION
<TABLE>
<S> <C>
Item 6. Exhibits and Reports on Form 8-K 13
SIGNATURES 14
</TABLE>
2
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THE RIGHT START, INC.
BALANCE SHEET
(unaudited)
<TABLE>
<CAPTION>
(Restated - Note 4)
May 2, January 31,
1998 1998
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<S> <C> <C>
ASSETS
Current assets:
Cash $ 319,000 $ 240,000
Accounts and other receivables 413,000 405,000
Merchandise inventories 7,701,000 6,602,000
Prepaid catalog expenses 519,000 297,000
Other current assets 1,237,000 1,364,000
------------ ------------
Total current assets 10,189,000 8,908,000
Property, plant and equipment, net 8,025,000 8,115,000
Other non-current assets 71,000 39,000
Deferred income tax benefit 1,400,000 1,400,000
------------ ------------
$ 19,685,000 $ 18,462,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 2,958,000 $ 2,372,000
Accrued salaries and bonuses 370,000 380,000
Advance payments on orders 45,000 30,000
Note payable 2,014,000
------------ ------------
Total current liabilities 3,373,000 4,796,000
Note payable long term 3,000,000 3,000,000
Senior subordinated notes due May 6, 2000
Senior subordinated notes due May 6, 2000 2,758,000 2,734,000
Subordinated convertible debentures due
May 31, 2002 3,000,000 3,000,000
Deferred rent 1,604,000 1,625,000
Shareholders' equity:
Common stock (25,000,000 shares authorized 22,337,000 22,337,000
at no par value; 10,103,639 issued and
outstanding)
Paid in capital 3,850,000
Accumulated deficit (20,237,000) (19,030,000)
------------ ------------
$ 19,685,000 $ 18,462,000
============ ============
</TABLE>
3
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THE RIGHT START, INC.
STATEMENT OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Thirteen weeks ended
-------------------------------------
(Restated - Note 4)
May 2, 1998 May 3, 1997
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<S> <C> <C>
Net sales:
Retail $ 7,329,000 $ 7,414,000
Catalog 1,712,000 2,522,000
----------- -----------
9,041,000 9,936,000
Costs and expenses:
Cost of goods sold 4,585,000 4,898,000
Operating expense 4,213,000 5,048,000
General and administrative expense 922,000 1,136,000
Pre-opening cost amortization 31,000 217,000
Depreciation and amortization expense 348,000 394,000
Other (income) expense (152,000)
----------- -----------
9,947,000 11,693,000
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Operating loss (906,000) (1,757,000)
Interest expense 316,000 211,000
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Loss before income taxes and extraordinary item (1,222,000) (1,968,000)
Income tax provision 12,000 10,000
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Loss before extraordinary item (1,234,000) (1,978,000)
Extraordinary gain on debt restructuring 27,000
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Net loss $(1,207,000) $(1,978,000)
=========== ===========
Basic and diluted loss per share $ (0.12) $ (0.23)
=========== ===========
Weighted average number of shares
outstanding 10,103,639 8,499,353
=========== ===========
</TABLE>
4
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THE RIGHT START, INC.
STATEMENT OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Thirteen weeks ended
------------------------------------------
(Restated - Note 4)
May 2, 1998 May 3, 1997
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,207,000) $(1,978,000)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 348,000 611,000
Amortization of discount on subordinated notes 24,000
Extraordinary gain on debt restructuring (27,000)
Changes in assets and liabilities affecting operations (639,000) 515,000
----------- -----------
Net cash used in operating activities (1,501,000) (852,000)
----------- -----------
Cash flows from investing activities:
Additions to property, plant and equipment (256,000) (873,000)
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Cash flows from financing activities:
Net borrowings (payments) under revolving line of credit (2,014,000) 488,000
Proceeds from issuance of senior subordinated notes 3,850,000 1,320,000
----------- -----------
Net cash provided by financing activities 1,836,000 1,808,000
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Net increase in cash 79,000 83,000
Cash at beginning of period 240,000 313,000
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Cash at end of period $ 319,000 $ 396,000
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</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 May 2, 1998 and for the
thirteen week period 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 week period ended May 2, 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
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
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, the Company has received consent from all
but one of the parties that will hold Series B Preferred Stock to remove the
mandatory redemption feature of the Series B Preferred Stock upon a change of
control of the Company. Additionally, pursuant to such letter agreement, the
Company has receive consent from all of the parties that will hold Series C
Preferred Stock to remove the mandatory redemption feature of the Series C
Preferred Stock upon the occurrence of a change of control of the Company. The
issuance of the shares of preferred stock upon exchange of the subordinated debt
securities is subject to the approval of the Company's shareholders, which
approval the Company expects to obtain at its annual meeting scheduled to be
held in October 1998.
As the $3.85 million of 1998 new securities were issued in contemplation of
the exchange into convertible preferred stock, the accounting for the new
securities is analogous to convertible debt. The new
6
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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 over the period from the April
issuance date to the date the debt is first convertible. The date the debt is
first convertible is the exchange date when the debt is exchanged for
convertible preferred stock. Since the exchange transaction is subject to a
proxy vote by the shareholders, the expected date of the shareholder vote,
anticipated to be in October 1998, has been used to determine the amortization
period of six and a half months. No value has been assigned to the warrants
because the requirement to exchange the warrants, together with the debt, for
preferred stock resulted in an assessment that the warrants have no independent
value apart from the exchange transaction.
The exchanges of the subordinated debt securities for the preferred stock
will be recorded at the date of issuance of the preferred stock. The fair value
of each preferred stock series will be determined as of the issuance date of the
stock. The difference between the fair value of the preferred stock series
granted and the carrying amount of the related subordinated debt security's
balance, plus accrued interest exchanged, will be recognized as a gain or loss
on the extinguishment of debt. If the Series B Preferred Stock conversion
feature is "in the money" at the date of issuance of the preferred stock, a
portion of the fair value of the preferred stock equal to the beneficial
conversion feature will be allocated to additional paid in capital. The
beneficial conversion feature amount allocated to paid in capital will be
recognized as a return to the preferred shareholders immediately through a
charge to accumulated deficit and a credit to preferred stock.
The estimated gain or loss to be recorded on the total proposed
recapitalization is not determinable at this time as the transactions will be
measured and recorded at the date of issuance of the preferred stock.
In connection with the above restructuring, the holders of $6.0 million
principal amount of subordinated debt permanently waived their rights to receive
interest payments and agreed to exchange such debt for preferred stock,
resulting in the elimination of approximately $0.6 million in annual interest
expense. In addition, the proceeds from the Company's private placement of
$3,850,000 were used to pay off the Company's revolving line of credit.
Further, the Company's lender amended the existing loan agreement to provide
more favorable terms which are consistent with management's financial and
operational plans. These plans include the closure of certain unprofitable mall
stores and opening of other store locations.
As a result of the above, management believes that it has sufficient
liquidity to execute its current plan. However, the Company's ability to fund
its operations, open new stores and maintain compliance with its loan agreement
is dependent on its ability to generate sufficient cash flow from operations and
obtain additional financing as described above. Historically, the Company has
incurred losses and expects to continue to incur losses in the near term.
Depending on the success of its business strategy, the Company may continue to
incur losses beyond such period. Losses could negatively affect working capital
and the extension of credit by the Company's suppliers and impact the Company's
operations.
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
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 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 will be 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 2002.
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
7
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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.
NOTE 4: RESTATEMENT OF FINANCIAL STATEMENTS FOR THE THIRTEEN WEEK PERIOD ENDED
MAY 2, 1998
The Company has restated the financial statements for the thirteen week
period ended May 2, 1998 to reflect the following: reverse the value assigned to
the warrants of $154,000 which were attached to the $3.85 million of senior
subordinated non-interest bearing notes issued in April 1998 and record the
notes as convertible debt (see Note 2); reverse imputed interest on the non-
interest bearing notes to the extent the transaction is with a principal
shareholders; and amortize debt discount on the senior subordinated non-interest
bearing notes over the period from the April issuance date to the date the notes
are first convertible.
The effect of the restatements on accumulated deficit and net loss as of
and for the thirteen week period ended May 2, 1998 is as follows:
<TABLE>
<CAPTION>
Net Loss Accumulated Deficit
----------- --------------------
<S> <C> <C>
As previously reported ($1,222,000) ($20,252,000)
Adjustment for the effect of restatements 15,000 15,000
----------- ------------
As adjusted ($1,207,000) ($20,237,000)
</TABLE>
The restatements had no effect on basic and diluted loss per share as previously
reported.
NOTE 5: PER SHARE DATA
Basic per share data is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding.
Diluted per share data is computed by dividing income available to common
shareholders plus income associated with dilutive securities by the weighted
average number of shares outstanding plus any potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock in each year.
Securities that could potentially dilute basic EPS in the future that were
not included in the computation of diluted EPS because to do so would have been
antidilutive for the periods presented include options outstanding to purchase
652,011 and 979,921 shares of common stock at May 2, 1998 and May 3, 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 6: NEW ACCOUNTING PROUNOUNCEMENTS
In April 1998, the American Institute of 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 expected 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.
8
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NOTE 7: SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid amounted to $201,000 and $142,000 for the thirteen weeks
ended May 2, 1998 and May 3, 1997, respectively. Cash paid for income taxes was
$5,000 and $12,000 for the thirteen weeks ended May 2, 1998 and May 3, 1997,
respectively.
Changes in assets and liabilities which increased (decreased) cash and
equivalents are as follows:
<TABLE>
<CAPTION>
Thirteen weeks ended
-----------------------------------
(Restated - Note 4)
May 2, 1998 May 3, 1997
----------- ------------
<S> <C> <C>
Accounts and other receivables $ (8,000) $ 547,000
Merchandise inventories (1,099,000) 276,000
Prepaid catalog expenses (222,000) (37,000)
Other current assets 127,000 (380,000)
Other non-current assets (34,000)
Accounts payable and accrued expenses 613,000 154,000
Accrued salaries and bonuses (10,000) (161,000)
Advance payments on orders 15,000 32,000
Deferred rent (21,000) 84,000
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$ (639,000) $ 515,000
=========== =========
</TABLE>
9
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
THIRTEEN WEEKS ENDED MAY 2, 1998 COMPARED WITH MAY 3, 1997
Amounts in this Management's Discussion and Analysis have been restated as
disclosed in Note 4 of the Notes to Financial Statements.
Net sales for the thirteen weeks ended May 2, 1998 declined 9.0% to $9.0
million from $9.9 million for the same period last year. For the quarter,
retail net sales remained relatively flat at $7.3 million as compared to $7.4
million last year, while catalog net sales decreased 32.1% to $1.7 million from
$2.5 million last year. Retail sales reflect sales increases due to six store
openings during and since the first quarter of the prior fiscal year offset by
five store closings this quarter. 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 $.3 million or 6.4%, resulting in a gross
margin of 49.3% as compared to 50.7% last year. The decline in margin reflects
the impact of planned promotional programs introduced this quarter, both to
increase sales in stores with continued operations and to clear merchandise in
conjunction with store closures. In addition, the Company implemented several
marketing programs to build awareness in its new street front locations and to
encourage repeat business in all locations through well-targeted mailings to
existing customers.
Operating expense was $4.2 million in the first quarter of 1998 as compared
to $5.0 million in the first quarter of 1997, representing a 16.5% decrease.
Retail operating expense decreased 9.0%, primarily due to reductions in
merchandise warehousing and handling costs and reduced labor costs.
Additionally, catalog operating expense decreased 40.4%, keeping in line with
the Company's decision to operate the catalog at a smaller, more profitable
level.
General and administrative expense decreased 18.8% to $922,000 during the
first quarter of 1998 from $1,136,000 during the same period last year. The
decrease results from certain cost saving measures implemented by management
during recent months. These measures resulted in savings of approximately
$90,000 in payroll costs, $60,000 in travel costs, $30,000 in consulting fees
and $30,000 in office expenses.
Included in other income/expense is the net gain of $152,000 associated with
the closing of two stores. The gain results from the collection of key money
from an assignee and the write-off of deferred rent, net of closing expenses.
Interest expense increased to $331,000 from $211,000 in the first quarter
of the prior year. The 56.9% increase results from an increase in total
outstanding borrowings and the amortization of the discount associated with the
$3.85 million non-interest bearing senior subordinated notes issued during the
first quarter of fiscal 1998. See Liquidity and Capital Resources.
The Company has a deferred tax asset of $9.0 million, which is reserved by a
valuation allowance of $7.6 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, since such operations generally operate on a break-even
basis. Alternatively, the Company could also sell its catalog operation's
mailing lists in order to generate income to enable the Company to realize its
NOL carryforward. Based on the above operating improvements combined with tax
planning strategies in place, management believes that adequate taxable income
will be generated over the next 15 years in which to utilize the NOL
carryforward.
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LIQUIDITY AND CAPITAL RESOURCES
During the first quarter 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
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 May 2, 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: $1.2 million for the three months ended May 2, 1998 and the six months
ended August 1, 1998, $900,000 for the nine months ended October 31, 1998 and
the twelve months ended January 31, 1999 and $500,000 for the twelve months
ended April 30, 1999. Minimum EBITDA of zero is required for the twelve months
ended July 31, 1999 and $400,000 for the twelve months ended October 31, 1999.
In addition, capital expenditures are limited to $1,750,000 in fiscal years 1998
and 1999.
The Company's ability to fund its operations, open new stores and maintain
compliance with the Credit Facility is dependent on its ability to generate
sufficient cash flow from operations. 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, 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 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 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 expects
to obtain at its annual meeting scheduled to be held in October 1998.
11
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As the $3.85 million of 1998 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 issuance 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 issuance 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 over the period from the April issuance date to
the date the debt is first convertible. The date the debt is first convertible
is the exchange date when the debt is exchanged for convertible preferred stock.
Since the exchange transaction is subject to a proxy vote by the shareholders,
the expected date of the shareholder vote, anticipated to be in October 1998,
has been used to determine the amortization period of six and a half months. No
value has been assigned to the warrants because the requirement to exchange the
warrants, together with the debt, for preferred stock has resulted in an
assessment that the warrants have no independent value apart from the exchange
transaction.
The exchanges of the subordinated debt securities for the preferred stock
will be recorded at the date of issuance of the preferred stock. The fair value
of each preferred stock series will be determined as of the issuance date of the
stock. The difference between the fair value of the preferred stock series
granted and the carrying amount of the related subordinated debt security's
balance plus accrued interest exchanged will be recognized as a gain or loss on
the extinguishment of debt. If the 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 and the interest expense recorded serves to increase the
carrying value of the security and shareholders' equity.
In connection with the above restructuring, the holders of $6.0 million
principal amount of subordinated debt permanently waived their rights to receive
interest payments and agreed to exchange such debt for preferred stock,
resulting in the elimination of approximately $0.6 million in annual interest
payments. In addition, the proceeds from the Company's private placement of
$3,850,000 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.
OTHER MATTERS
Year 2000
- ---------
The Company is currently working to resolve the potential impact of the
year 2000 on the processing of date-sensitive information by the Company's
computerized information systems. The year 2000 problem is the result of
computer programs being written using two digits (rather 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. Based on
preliminary information, costs of addressing potential problems are not
currently expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in future periods. The Company
plans to devote the necessary resources to resolve all significant year 2000
issues in a timely manner.
12
<PAGE>
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.
PART II
ITEM 6. Exhibits and Reports on Form 8-K
The Company filed a Report of Form 8-K on May 6, 1998, reporting the press
release dated April 23, 1998.
The Company filed no other Reports of Form 8-K during the first quarter of
fiscal 1998.
The following exhibits of The Right Start, Inc. are included herein.
Exhibit
Number
- ------
27 Financial Data Schedule
13
<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: October 15, 1998 /s/ JERRY WELCH
------------------------------ ----------------------------
Jerry Welch
Chief Executive Officer
14
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<FISCAL-YEAR-END> JAN-30-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> MAY-02-1998
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0
0
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<INCOME-PRETAX> (1,222)
<INCOME-TAX> 12
<INCOME-CONTINUING> (1,234)
<DISCONTINUED> 0
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